Pinned beneath a mountain of losses and debt that had been accumulating for over a year, Amresco Inc. last week became the second large specialty lender in four months to declare bankruptcy. Finova Group Inc. threw in its towel in March.
Though the two companies experiences may seem to illustrate the perils of lending when many markets from energy to health care have been volatile, observers maintain that the two failures had more specific causes. Far from being reflections of general market weakness, they say, the Chapter 11 filings by Finova and Amresco can be attributed to overly aggressive expansion and poor underwriting.
And some analysts even go so far as to say their exits will prove a boon for remaining players because they take weak competitors out of the marketplace.
Does it mean that the whole market is going to hell in a handbasket? I dont really think so, said Ned Armstrong, managing director and senior analyst with Friedman, Billings, Ramsey Group Inc. in Arlington, Va. Its pointing up weaknesses in lending strategy with individual lenders. There are weaknesses in certain sectors of the market, but nothing pervasively across the economy, he said.
The majority of analysts interviewed attributed both companies demise to poor management and strategy.
There were two problems at both of these companies: reckless growth and the impact of the currency crisis of 1998, said Ken Posner, an analyst with Morgan Stanley Dean Witter & Co. who, like others, has dropped coverage of the companies.
They did well in a couple of businesses and believed they could repeat their success in virtually any other business field they could enter, Mr. Posner said.
Amresco, which is based in Dallas, had specialized in managing distressed assets since it was formed from a merger between BEI Holdings Inc. and a unit of NationsBank Corp. (now Bank of America Corp.) in 1993. But in 1994 the company began an ambitious expansion, which included originating, buying, servicing, and securitizing home equity and franchisee finance loans.
The companys troubles did not start until October of 1998, when the bond market collapsed as a result of the Russian debt crisis. It was forced to sell its home equity and commercial loan portfolios for less than it anticipated. Meanwhile, the volatility of the capital markets drove up borrowing costs and it was hard hit by higher prepayment speeds and by equity investors flight from the specialty finance sector in general.
By yearend it had seriously cut back its home equity business and laid off 10% of its employees.
Its assets have continued to perform poorly ever since, leading it to drop business line after business line. By September 2000, after shedding the majority of its units and exiting its homebuilder, commercial banking, and home equity lending businesses (save for a 36% stake in the Lehman Brothers subprime unit Finance America), the company had scaled down to become a small- and middle-market business lender, primarily making loans to franchisees and small-business owners.
Meanwhile, documents filed with the Securities and Exchange Commission on May 15 state that the company is still trying to liquidate assets of business lines that it has sold or dropped, and that its liabilities total over $572 million.
All told, from 1998 to 2000, Amresco suffered net losses just shy of $508 million across its business segments.
Mr. Armstrong of Friedman Billings said that a three-year weakness in the franchise and small-business market led to Amrescos demise, though its home equity problems were a factor. The company suffered writedowns and reduced ratings because of losses in the home equity and commercial sectors, which certainly left it in a weakened position to battle problems in the franchise and small-business market, he said.
The company was open to merger talks in early 1999 but was not able to find a buyer. At the time it was saddled with $1.7 billion of debt. After toughing it out for two more years, Amresco filed for bankruptcy protection last week.
Finova, which is based in Phoenix, was spun off from Dial Corp. in 1992 and specialized in commercial lending to small- and middle-market companies. Analysts said it suffered from bad decisions and bad strategy. It was poor management decisions the classic asset-quality-driven situation where there was poor underwriting, rapid growth, inadequate controls, and ultimately loss of funding and liquidity, said David Sochol, an analyst with Legg Mason Wood Walker Inc. in Baltimore, who also dropped coverage of Finova this year.
Mr. Posner contended that Finovas acquisitions in a wide variety of different business sectors including factoring, commercial real estate, small business lending, and mezzanine finance caused it to lose control of basic blocking and tackling.
Finova made a number of bad loans that came back to haunt it in 2000. Capital markets volatility from the fall of 1998 only added to its problems, causing hedging losses which inevitably raised its borrowing costs. They never got their balance back, Mr. Posner said.
In March of 2000, its longtime chief executive officer quit as Finova reported an $80 million charge, mostly due to one bad loan, that would leave its first-quarter earnings shy of projections. The hit touched off a stock free fall and its debt was downgraded by rating agencies, raising its borrowing costs.
By the end of the year, with losses continuing to pile up, Finova was teetering. It posted net writeoffs of $239 million for the year. Its net income took a loss of $939.8 million $546.7 million from continuing operations, and $393.1 million from the sale and closing of its discontinued operations. It also had almost $11 billion of debt on its balance sheet, and was trying to find a way to restructure $1.6 billion of debt due in May 2001.
Mr. Posner said that other companies suffered the same economic conditions as Amresco and Finova but dealt with them much better. Contrast them with IndyMac Bank, a lender in Pasadena, Calif., he said. They lost a lot in 1998, but they focused, they had a good cost structure and underwriting, and they were able to recover, he said.
Other observers pointed out that though initially Finovas difficulties had a negative impact on others in the industry, the others eventually proved through performance that they were better companies, and investors figured this out, too.
It raised funding costs for some of the companies last year, like Heller Financial, but people then became more confident that they were at opposite ends of the spectrum, so investors understand the companies are different, Mr. Sochol said.
What is more, he observed, its probably made the industry a bit more rational, as youve taken out an aggressive and oftentimes irrational competitor.
Robert P. Napoli, an analyst with ABN Amro, echoed Mr. Sochols sentiments, adding that both companies failures reduced competition in the industry, and made it harder for new companies to get start-up financing.
In response to all of the criticism, a spokesman for Finova said, No comment. He added that Finova did not want to rehash the past.
Officials from Amresco also declined to comment.
Meanwhile, analysts said that both companies have prospects if they are able to make their way out of bankruptcy. Star investor Warren Buffett swooped in to rescue Finova in February with a $6 billion buyout plan, which he upped to $8.1 billion in June. Mr. Armstrong said he believes that Mr. Buffett and Berkadia LLC will fund Finova out of bankruptcy by Aug. 31. He then expects the company to let its loan portfolio run off rather than pursue new business.
A company comprised of Renewal Partners LLC, affiliates of Fortress Investment Fund LLC, and Goldman Sachs Mortgage Co., is planning to buy most of Amrescos assets for $309 million. However, Amresco has kept two of its units separate from the bankruptcy filing: Amresco Commercial Finance Inc. and Amresco Independence Funding Inc. These units have received commitment letters for up to $275 million of warehouse financing from NCS II LLC, an affiliate of NCS I LLC, to provide capital to refinance existing warehouse facilities and support the ongoing funding requirements of each entity. The replacement warehouse financing is subject to bankruptcy court approval, as it will be guaranteed by Amresco and secured by its assets.
Mr. Armstrong said he has maintained coverage of both companies. He contended that Amresco is worth more than what has been bid for it.
There are a lot of willing bidders who could provide an attractive alternative, he said. They might think that there are ways to realize value out of the assets, and might find platforms like their small business platform more valuable than the price attributed to them now, he added.
Another analyst, who sought anonymity, listed General Motors Acceptance Corp. and Royal Bank of Scotlands Greenwich Capital as likely suitors. When Finova comes out of bankruptcy, he said, the new notes outstanding represent a good risk-reward tradeoff.