Heilig Meyers (fka HMYRQ)

[Abag]

Check this out. Says operates as The Room Store.
http://post.nyssa.org/nyssa-news/2010/07/the-ghost-of-credit-past-the-specter-of-the-heiligmeyers-fiasco-haunts-todays-failed-lenders.html
07/08/2010
The Ghost of Credit Past: The Specter of the Heilig-Meyers Fiasco Haunts Today's Failed Lenders
ShareThis“Heilig-Meyers: From AAA to Junk Bond”

“CDO Ratings Are Whacked by Moody’s—AAA to Junk in a Day Raises More Questions about Credit Agencies”

The first of these headlines appeared from Credit Card Management in 2001, and announced the collapse of what was then one of the largest American furniture retailers. The origins of that collapse lie in the late 1990s, when Heilig-Meyers began to service its own debt. As much as 75% of its sales were made with two-year installment loans.

The second headline appeared in the Wall Street Journal in 2007 (Saha-Bubna and Mollenkamp), in circumstances that will not be soon forgotten. The echo between the screamer announcing Heilig-Meyers’s meltdown and that trumpeting the emerging credit crisis is no coincidence. It may be comforting to call today’s travails unprecedented, but the Heilig-Meyers story is a clear case of a lesson not learned. The furniture chain’s eventual failure on August 16, 2000, and the associated effects on its asset-backed securities are strikingly similar to aspects of the current financial crisis.

THE STRATEGY: LOW-QUALITY LOANS, SECURITIZATION

Heilig-Meyers, like other furniture retailers, relied on financing customers’ furniture purchases with installment loans, usually of a two-year duration. Much like a financial services firm, Heilig-Meyers provided its own debt servicing and realized revenue from the interest and fees collected from servicing the installment loans. That revenue accounted for up to one-third of profit in some years (Gilligan 2000).

Eventually, many of those to whom Heilig-Meyers had provided credit became delinquent when local stores that had serviced their debt closed. By 2000, the credit quality of those who had been issued debt had steadily declined (Credit Card Management 2000), and an estimated one out of every nine bankrupt Americans owed money to Heilig-Meyers (Mollenkamp 2000).

In order to increase liquidity from the installment loans, Heilig-Meyers transferred most of its installment sales to a trust account that issued certificates backed by the collection of the installment loans—asset-backed securities, in other words. Eighty percent of the certificates were sold to third parties. The remaining 20%, which were subordinate to the publicly offered certificates, were held by Heilig-Meyers in a special-purpose entity. The certificates held by Heilig-Meyers were reported on its balance sheet at fair-market value despite the fact that these securities were never traded in a public market.

When CEO and chairman William DeRusha left the company in July of 2000, Richmond Times-Dispatch reporter Gregory Gilligan (2000) summarized Heilig-Meyers’s failing strategy. First, massive expansion failed to produce enough revenue. Secondly, those consumers with better credit quality began using credit cards for purchases rather than Heilig-Meyers installment loan plans. From a credit standpoint, then, the Heilig-Meyers installment loan plans were increasingly issued to consumers with low credit quality.

The similarities to mortgage-backed securities and the mortgage crisis are uncanny. Heilig-Meyers held the riskiest tranche of a structured financial product that was securitized with low-quality loans. Inasmuch as the first 20% of defaults had to be absorbed by this tranche, Heilig-Meyers was awash in toxic waste. Further, Heilig-Meyers was responsible for the loan collection that securitized the less risky (higher tranche) certificates offered by the trust.

Notably, the entity entrusted with insuring payments for the better tranches was also holding the worst tranche with a decentralized collection system. Yet the higher tranche certificates held a AAA rating despite the perilous position of the entity responsible for actually collecting the loans.

Rating agencies missed the crucial collection element of this arrangement, just as they did in the run-up to the bursting of the credit bubble. That became very clear when Heilig-Meyers began closing stores and loan delinquencies skyrocketed to 60%. Of 871 stores, 302 were slated to close initially, when the company filed Chapter 11. But by the summer of 2001, all the Heilig-Meyers namesake stores were closed. Some remaining locations still operate today as the RoomStore chain.

Credit Card Management (2000) details the credit situation: “‘Unlike most retailers, which have centralized collections, nearly 67% of Heilig-Meyers customers make payments at their local Heilig-Meyers stores,’ says William Black, a Moody’s analyst. That means it will be more difficult for the retailer to transfer debt collections and servicing to a centralized entity. ‘You’re not just changing the address on the payment slip,’ Black says. ‘You’re dealing with getting hold of these [customers] as well as basically trying to change their payment behavior.’”

The comment offered by Dow Jones Business News (2000) might as well have been aimed at the real estate and mortgage markets today: “The retailer, founded in 1913, targets customers who often borrow from the company to buy sofas, dining-room tables, air conditioners, and televisions. Its troubles developed in the past two years as an acquisition spree failed to generate expected revenue. At the same time, its credit unit got caught in the same crunch as other so-called subprime lenders: too much competition led to a lowering of credit standards, and more consumers defaulted on their loans.”

The risks associated with the collapse of Heilig-Meyers did not go unnoticed in the investment community (Gregory 2004), but did little to change how ratings on asset-backed securities were assessed. Rating agencies’ failure to adapt became particularly regrettable when, just a few years later, Freddie Mac and Fannie Mae stepped into the role of Heilig-Meyers.

A LAWSUIT WITH SOME FAMILIAR NAMES

How the credit crisis will eventually be resolved is unclear, but it doesn’t tax the imagination to envision some court cases stemming from the way in which securitized structures were sold to the public. The time that two banks spent in the dock over their relationship with Heilig-Meyers may foreshadow what’s still to come.

In 2003, First Union Bank and Bank of America were accused of misrepresenting the credit quality of Heilig-Meyers asset-backed securities (New York Law Journal 2003). First Union is part of Wachovia, now owned by Wells Fargo. NationsBank, which acquired BankAmerica in 1998 and became Bank of America, was involved with issuing Heilig-Meyers securities.

The plaintiffs included AIG, Allstate, Société Générale, Travelers, and a number of other institutional investors. Their original investments in Heilig-Meyers securities totaled $300 million in 1998 and were virtually valueless after the bankruptcy (Browning 2008).

In 2004, First Union settled out of court for $33 million, leaving Bank of America the lone defendant. The initial case was dismissed, but the complaint was amended. In late 2008, a trial commenced, in the course of which it came to light that Bank of America was aware of the fact that Heilig-Meyers kept two sets of books on its debt collection: “According to court documents, one of the surviving accusations is that Bank of America knew Heilig-Meyers kept ‘two sets of books related to its loss and delinquency experiences,’ and that the bank knew but didn’t disclose that comparisons between Heilig’s and similar retailers’ loss and delinquency rates were based on a liberal ‘recency method’ of accountings that artificially bolstered results, rather than a traditional ‘contractual method’” (Engel 2008).

On December 4, 2008, the plaintiffs were awarded $141 million in damages. Bank of America is still considering an appeal (Heintz 2009).

SECOND TIME’S THE CHARM?

The Heilig-Meyers bankruptcy should have made abundantly clear that ratings for a structured financial product cannot simply be based on historical default rates for an asset class. The actual collection arrangement of the securitized loan must be fully understood—particularly when the collector holds the riskiest portion of the underlying loan portfolio. But this blind spot still persists in current rating models.

It’s not as if Heilig-Meyers did not receive any cash for selling the certificates from the trust to the public. Unlike as with a bond, however, no covenant structure such as a sinking fund or dividend limit existed to protect the security holder. This critical element is missing from structured financial products, too. It could be the best improvement we can make going forward.

The process of creating asset-backed securities and similar structured products can benefit from an improved rating system in which contractual relationships, from collection to security-holder payment, are well defined, and from the covenant-like arrangements that exist for bonds. From a regulatory perspective, disclosure is the key element, but as Heilig-Meyers demonstrates, disclosure doesn’t really matter if the collection arrangement is not understood.

Bad luck comes in threes, three’s a crowd, and three strikes and you’re out. Two run-ins with the disastrous lending and collection arrangements common to both Heilig-Meyers and current-day mortgage providers should be more than enough to get the point across to rating agencies, regulators, and lenders themselves. Let’s not go to round three. If we want to have two pennies left to rub together.