Fairstone Financial’s debut high yield deal has risen more than three points and tightened by 100bps since the Canadian consumer subprime lender priced the bonds three weeks ago. The issuer shelled out nearly double the pricing of its primary unsecured bond comps, given the issue’s smaller size, lack of investor familiarity and a stack of secured that sits above the new bonds, said five sources following the deal.
Fairstone, formerly known as CitiFinancial Canada, has operated on a standalone basis for just over two years, after Citi sold the Canadian unit to an investor group led by J.C. Flowers & Co. and Varde Partners in March 2017. It’s one of just two providers of subprime lending in Canada, and has operated under various banners for nearly a century since its founding in 1923.
Its new B/B1 USD 300m 7.875% senior unsecured notes due 2024 priced on 26 June at 99.484 to yield 8%, and most recently changed hands at 102.75 yielding 7.07%, according to MarketAxess. That’s substantially tighter than official price talk of 8%-8.25%, and whispers that initially circulated at the beginning of the roadshow as wide as 8.5%, sources noted.
Proceeds from the USD 300m bonds were slated to repay secured debt as well as a portion of a shareholder loan, while the majority of the USD 445.1m shareholder loan will be equitized.
The alternative financial services provider operates through two streams: a direct lending segment including unsecured personal loans, secured personal loans, mortgages and other products such as creditor insurance; and indirect lending which contains retail point-of-sale (POS) through merchants and auto financing through dealerships, according to company documents. The company launched an auto lending segment in July 2018.
Pro forma the deal, debt to adjusted tangible equity comes to 6.2x through CAD 2.352bn of total debt. The unsecured asset coverage ratio totals 56%, based on CAD 220m of unencumbered assets and CAD 393m of pro forma unsecured debt.
The issuance comes on the heels of a decline in the quality of the consumers that Fairstone lends to, shown by the increase in its risk-adjusted yield, or the gross yield less net credit losses for its receivables, the sources said. Fairstone’s risk-adjusted yield in 2018 was 17.6%, compared to 16% in 2015 and 10.5% in 2009 coming out of the financial crisis. The yield ticked up further in 1Q19 to 18.2%, according to company documents.
So far, Fairstone has been able to manage the increased risk, pricing the loans wide enough to cover losses elsewhere in the portfolio, the sources said.
“Subprime in and of itself is not a bad animal. It’s just when people get a bit too competitive and give out rates that aren’t going to cover losses in the pool of loans, that’s when you get into trouble,” one of the sources said.
However, looking ahead, if the company securitizes more of its extended loans then it may wind up with little collateral left should it hit a liquidity crunch and need to raise even more, sources said. And on the unsecured side, investors would sit below a breadth of structurally senior debt, the sources said.
Fairstone’s secured debt to tangible assets ratio is 68.1%, while US larger competitor OneMain Financial’s ratio is 40.2%, as of 31 December. Meanwhile, Fairstone’s secured debt as a portion of total debt is roughly 83% compared to OneMain’s 52%.
At the time of issuance, Fairstone’s B/B1 bonds yielded nearly double OneMain’s Ba3/BB- USD 1.3bn 6.125% senior unsecured notes due 2024, which traded at 107.5 to yield 4.159% at the time. The difference between the two has tightened to 2.827% from 3.841%, as OneMain’s bonds have stayed somewhat in line over the last month, trading today at 107.375 to yield 4.17%, according to MarketAxess.
Apollo and Varde-owned OneMain is levered 6.8x adjusted debt to adjusted tangible equity. But sources see Fairstone as a riskier bet than OneMain, especially as the former has increased the portion of unsecured personal loans lent out to consumers.
For Fairstone the portion of unsecured loans offered to consumers has increased to 47% in 2018 from 42% in 2017 and 37% in 2008. Sources expect the company to continue this competitive approach in an attempt to access more consumers who don’t want to put up collateral or are unable to.
OneMain, on the other hand, has taken the opposite strategy by increasing its secured loans to 48% from 43% in the last year and the company’s target is 50% of secured loans.
“OneMain is a better credit than Fairstone, and it’s also bigger,” one of the sources said.
The other Fairstone comp is GoEasy Financial, which also operates in Canada. GoEasy is less levered than Fairstone at 2.6x and more seasoned in the market, although Fairstone has a larger reach and greater product diversification, according to two of the sources.
GoEasy’s Ba3/BB- shorter-dated USD 475m 7.875% senior unsecured notes due 2022 last traded today at 104.65 to yield 4.759%, in line with recent levels, according to MarketAxess.
Pro forma the deal, Fairstone’s liquidity is CAD 770m comprised of CAD 53m of cash, CAD 208mm of available funding based on current available eligible collateral and CAD 508m of contingent liquidity which is subject to available eligible collateral.
Fairstone and Citi declined to comment. Varde declined to comment.