DealTalk: Consumer finance a tough buy for private funds

NEW YORK (Reuters) - Private equity firms and hedge funds are eyeing U.S. consumer finance assets, but despite a recent Fortress Investment Group LLC (FIG.N) deal, they are likely to find it hard to do many more.

Banks such as HSBC Holdings Plc (HSBA.L) and Citigroup Inc (C.N) are scaling down their exposure to the business, so credit availability is shrinking for the subprime consumers that such companies cater to.

Some players outside the traditional banking industry believe that has created a demand-supply imbalance and they see an opportunity in lending to subprime borrowers now, deal advisers and investors said.

There is plenty available for sale, with companies such as Citigroup and Ally Financial, formerly GMAC, looking to dispose of such assets.

But nonbank buyers have a lot of potential hurdles if they are hoping to become lenders. Funding these businesses can be expensive, the assets could head further south and there could be a lot of regulatory red tape.

"If you don't have a deposit base, it's going to be tough to fund the businesses," said Bill Fitzpatrick, a stock analyst covering banks at Optique Capital Management in Milwaukee. "I don't see a hedge fund being able to provide enough funding to keep an organization that big running."

That is not keeping funds from looking at these deals. Ally's mortgage lending unit, Residential Capital, for instance, has seen several funds, including Blackstone Group LP(BX.N) and Centerbridge Partners, kick the tires, sources have told Reuters previously.

Some funds think the odds are good enough to take the chance. Fortress agreed last week to pay more than $100 million for 80 percent of American General Finance, the consumer lending unit of American International Group Inc (AIG.N). AIG had recorded the company's assets at roughly $2 billion on its books.

A Who's Who of U.S. private equity and hedge fund world looked at the business and 10 parties did due diligence on American General Finance, sources told Reuters previously.

A BIG HIT

And yet AIG, which owes U.S. taxpayers more than $100 billion, had to sell American General Finance at a cut-rate price, leaving the insurer to take a $1.9 billion hit in the third quarter.

"This deal had an awfully steep discount; it's huge. I bet a lot of people looked at these assets and that's the best you can do?" said Ralph Cole, a portfolio manager at Ferguson Wellman Capital Management in Portland, Oregon.

Fortress could make a killing if it is able to reduce leverage and restructure the unit and the economy does not tank again. It is getting control of $20 billion in assets for a small price, meaning even a 5 percent appreciation in value of assets would yield as much as $1 billion. But it is also a risky bet.

"It might be an advantage to be less regulated than a bank, but then again, that's what people said about nonbank subprime lenders," a hedge fund manager said, declining to be named. "And if the consumer protection bureau does a good job of regulating the nonbank lenders, the advantage could go away."

Other bidders for American General Finance explored various ways to make a deal work, including asking for seller financing for the asset portfolio, loan loss guarantees and earn-out provisions that depend on loan performance, sources familiar with the matter said.

"In the near-term, nobody wants to take on a lot of consumer loan assets without knowing where things are going for consumers," a banker said, declining to be named. "The stand-alone model is a problem for these things, because every time there's a credit crunch, you'll get wiped out."

BREATHING ROOM

Other sellers face less pressures than AIG to dispose of their consumer finance assets at a loss.

Citigroup has paid back bailout funds and the U.S. government is selling down its stake in the bank, giving Chief Executive Vikram Pandit leeway to hold on to consumer finance assets such as CitiFinancial till he gets the right price.

Ally Financial, which is majority-owned by the U.S. government, has said its mortgage risk is becoming manageable and aims to go public next year.

Earlier this month, it posted a second-quarter profit of $565 million. Its mortgage operations, which include ResCap, earned $230 million after a $1.3 billion year-ago loss.

The turnaround may give Ally room to hold its ground on ResCap and one source familiar with the auction said it was possible the lender may end up keeping at least part of the unit if the bids are not good enough.

Outstanding U.S. consumer debt has fallen steadily since July 2008 and, as of June was about 6 percent below its peak levels. Consumer finance companies have been hit more than the average lender-their outstanding loans have fallen nearly 10 percent from their peak in May 2008, according to U.S. Federal Reserve data.

(Reporting by Paritosh Bansal and Dan Wilchins; editing by Andre Grenon)