Description

Summary

Based on a run-off analysis, United PanAm Finance Corp.'s ("UPFC" or the "Company") current market valuation suggests the business trades at a substantial discount to residual value. This thesis is based on a high probability of expected realizable cash flows from its short duration auto loan book (18-24 months) and the stock's neglect by large investors due to its recent voluntary delisting off of the NASDAQ.  The stock currently trades over-the-counter.  The Company has been buying back stock which gives us comfort that it is being decisive about maximizing value for shareholders.   We currently value the stock at $6.60 per share and are buyers of the stock below $3.00 per share as it gives our analysis a sufficient margin of safety.  Due to its low trading volume, we believe that meaningful ownership could be negotiated through larger block trades. 

Company Overview

UPFC provides automobile finance to subprime consumers. The Company, through its subsidiaries, engages in purchasing and servicing automobile installment sales contracts, which are originated by independent and franchised dealers of used automobiles. UPFC was founded in 1994 and is based in Irvine, California.  Traditionally, the Company used a warehouse facility to fund its automobile finance operation to purchase automobile contracts pending securitization.  The warehouse credit facility converted in 2008 to a term loan, which was eventually paid off in May 2009 via the sale of $218 million of installment loans for 80% of face value.  Since 2008, UPFC has stopped purchasing auto loans, downsized its operations and reduced its branch footprint in order to lower expenses and meet required liquidity needs.  Below is UPFC's current and projected capital structure, assuming status quo:

Positives

UPFC has a strong reputation for underwriting and purchasing subprime installment loans via its partnership with used car dealerships.  The Company has built a business around credit and control by hiring experienced managers formerly of the captive automotive finance companies (e.g., GMAC, Ford Motor Credit, Toyota Credit and Chrysler Credit) and training these professionals on rigid credit and underwriting processes.  In addition, the company deliberately limits volume to exploit certain service needs in the marketplace and does not usually compete with the larger, national subprime automobile finance companies like AmeriCredit, Capital One, HSBC, Citigroup and Wells Fargo.  Instead, the company primarily competes with smaller, independent finance companies.  Due to lack of competition and by emphasizing superior service to its automobile dealer customers, UPFC has received premium pricing on its existing loan book (often in the form of upfront payments at purchase) which we believe enhances its ability to faster cash flows. 

UPFC finances automobiles with an average life of five years with original contract term of 36 to 72 months.  In fact, we expect the Company's last securitization in November 2007 (Tranche 2007 B) to be fully amortized and paid by November 2010.  For loans purchased in 2008, we believe they should be fully paid by mid-2011.  Its strong ability to repossess and resell vehicles upon loan charge-off dampens the affects of increases in delinquencies and gives us more comfort in UPFC's ability to realize substantial cash flow from its legacy loan book.  As a result, we believe that UPFC's existing debt will not be impaired.  Furthermore, we believe that this general trend applies for the broader auto market and it is one of the key reasons that the ABS market for auto loans has restarted in 2009. 

Nevertheless, since 2008 the Company's board has been operating under the assumption that there will be no recovery in the ABS market for its asset class and, thus, has required further de-leveraging of the business via portfolio attrition and reduction in origination capacity and personnel.  A hard example of this strategy was seen in UPFC's termination of its old CEO and COO with the appointment of a new CEO, Jim Vagim, in July 2008.  Mr. Vagim has more than 20 years of experience in the subprime auto lending industry, most recently at a company of similar size to UPFC.  In July 2009, the company pushed out Arash Khazei as CFO.  

UPFC is predominately owned by Guillermo Bron, who is also chairman of the board.  Mr. Bron is a managing partner of ACON Investments, a highly successful private equity firm.  ACON / Bron are notably savvy investors who have generated exceptional returns over time and should manage this asset run-off "properly".  Finally, the company has been able to term out and refinance its warehouse facility, close and centralize facilities and repurchase stock.  It has also voluntarily delisted from the NASDAQ to reduce operating distraction and listing fees; although there will be less disclosure and reporting as a result.  Nevertheless, all of these measures have given us comfort that the management team and its board of directors are focused on operating the business to maximize existing value for shareholders.

Negatives

Since 2006, charge-offs and allowance for loans losses as a percentage of loans outstanding have nearly tripled to approximately 13%, due to the financial crisis.  The company typically reserves losses for its existing loan book based on estimated loan losses in the next 12 months at each reporting date.  Since there could be substantial incremental losses if the crisis were to worsen, we have sensitized our analysis for incremental losses above current reported levels.  We have found that cumulative ultimate losses would need to reach levels of 25%-30% ($120 million - $140 million in total) over the next 18 months to justify current stock valuation levels.  Although we believe that loans will worsen, this draconian scenario is very unlikely given a decently seasoned, short duration existing auto loan portfolio.  In addition, loans purchased in 2008 are of higher quality than older vintage portfolios that will be fully paid down by the middle of 2010. 

What worries us more than delinquencies is investment illiquidity and ability to accumulate size at current prices.  However, we believe that through our relationship with management, via Guillermo Bron, there could be a possibility to negotiate decently priced block trades with mutual funds or investors who might be internally pressured to sell their highly illiquid UPFC positions. 

Finally, increasing restructuring and servicing costs could eat away at residual cash flows as the company services a risky customer base in new more centralized (vs. localized) format within a more uncertain consumer environment. 

Earnings Outlook

Currently there is no earnings outlook for UPFC as a going concern.  In fact, due to its implied run-off strategy the company will probably not make a profit over our suggested holding period and hence should not trade at a premium to intrinsic book valuation.  Below is our analysis of cash flows for the existing legacy run-off book.  Cash expense items are based on Q3 financials.

Our incremental provision level is the crucial variable in this analysis, which is highly dependant on consumer unemployment levels over the next twelve months.  Our 2% level represents, roughly, a 2% increase in charge-offs/delinquencies across the book per year, beyond the already high reserve levels.  Furthermore, a 2% provision is justified due to near 50% recoveries on the collateral in its existing book of business. 

We have not accounted for the business to operate as a "going-concern".  As a result, if the business environment for securitizations in their asset class were to improve and/or the company were to attract long term financing we believe that UPFC could begin to trade at a premium to intrinsic book value and close the valuation gap with larger peer competitors who have had success in resuscitating their auto businesses - NICK, White River, ACF, CPSS are viable public companies and their valuations have improved significantly.  Although highly unlikely and materially small, there is "option value" for the UPFC franchise in a normalized world.  M&A could be another potential exit option for the Company, but we have not modeled for this scenario.

Valuation

We have assumed that the run-off residual tangible equity remaining in UPFC through 12/31/2012, discounted at a rate of 15%, is worth $6.60 per share.  We arrived at this valuation by calculating the remaining cash in the balance sheet when all liabilities have been fully paid off.  We believe that this should occur by the end of 2012, given the high cash flowing, short duration auto loan book and $78 million of cash on balance sheet.  Finally, we do not give full credit to the company's deferred tax asset of $23 million, which is our educated estimate based on the Company's latest documents, because we believe that it is unlikely that it will be used over the next three years since UPFC will most likely be running in a negative net income scenario as it runs down its business.

Catalysts

Unfortunately, we do not see a meaningful catalyst occurring in the near future as the stock is highly illiquid with a market capitalization of under $60 million.  We believe that only a special situation like a positive turn in the auto credit environment or access to long term financing could create a sufficient catalyst for meaningful jumps in the stock.  We do believe that there could be more distressed institutional selling before year end, which could depress the stock further. 

Recent Charge-off Trend Analysis

Since the company's recent delisting, reported quarterly loss trends data has ceased.  However, Moody's reports on vintage securitization loss trends are still available.  We have used UPFC Auto Receivables Trust 2006-A as a proxy for the Company's portfolio.  Since this vintage was written at the height of the consumer lending environment, we feel it is conservative to use as a proxy.  There is only 10% of principal remaining in this pool.  Furthermore, we believe that the pool would have to have a 100% loss/100% severity on the remaining balance to justify implied market loss trends.  With 40-50% recovery rates on losses that have historically borne out and accepted industry wide, we believe such severe losses are highly unlikely. 

Recommendations

We currently value the stock at $6.60 per share and are buyers of the stock below $3.00 per share to give our analysis a sufficient margin of safety.  Due to its low trading volume, we believe that meaningful ownership should only be attempted through pre-negotiated block trades. 

Risks

Current risk to our thesis includes investment illiquidity, higher sustained delinquencies, and an untimely inability to meet capital structure liquidity.

Questions

What is the likelihood of restarting the business with no financing in place?  What is the company's share buy-back/dividend expectation?  How much will true run-off cost be?  Which existing institutional investors are most likely sellers over the next few weeks?  What is the refinance risk on the Santander facility next May?

Catalyst

Unfortunately, we do not see a meaningful catalyst occurring in the near future as the stock is highly illiquid with a market capitalization of under $60 million.  We believe that only a special situation like a positive turn in the auto credit environment or access to long term financing could create a sufficient catalyst for meaningful jumps in the stock.  We do believe that there could be more distressed institutional selling before year end, which could depress the stock further.