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J.G. Wentworth IPO: Down the Pre-Crisis Rabbit Hole

NEW YORK (TheStreet) -- Gone are mortgage originators like New Century Financial, Countrywide Financial and HSBC's  (HBC) Household International, but stock investors dreaming of the good old days of originate-to-distribute finance can rejoice: J.G. Wentworth's parent company, JGWPT Holdings, is preparing for an initial public offering of up to $268.4 million.

J.G. Wentworth of Radnor, Pa., buys structured legal settlements, lottery winnings and annuities owed to consumers, that are to be paid out by highly rated counterparties, and sells them to debt investors through asset-backed securitizations. The company relies on $600 million in warehouse credit facilities to finance its acquisition of assets and upon securitization markets to unload them.

While the company doesn't take on big credit risks -- a contrast to mortgage departments at the epicenter of the housing bust -- its use of a leveraged balance sheet to acquire hard-to-value assets and its reliance on securitization markets for sales is similar to the originate-to-distribute lending model that permeated the U.S. housing market prior to the crisis. That type of business simply captures a spread from the process of creating and then selling an asset.

In that sense, J.G. Wentworth's IPO provides a rare glimpse into the types of financial structures that existed prior to the collapse of firms like New Century, Lehman Brothers and Bear Stearns.

One would assume that in the wake of the crisis, investors would shun such deals. But J.G. Wentworth will give those who continue believe in the cash-generating and the seemingly low-risk mechanics of originate-to-distribute businesses another opportunity to invest.

Earlier in October, Springleaf Financial (LEAF), a subprime consumer lender backed by private equity firm Fortress Investment Group (FIG), conducted a similar IPO.

It should be no surprise that both listings come at a moment when some on Wall Street are questioning whether the Federal Reserve's loose monetary policies are causing investors to chase the riskiest deals seen since the financial crisis.

How It Works

According to J.G. Wentworth's IPO documents, the company derives its earnings from the spread between the discount rates it uses to acquire assets and those implied in its securitizations. The company also takes residual interests in the subordinated tranches of the securities it sells.

"We act as an intermediary that identifies, underwrites and purchases individual payment streams from our customers, aggregates those payment streams and then finances them in the institutional market at discount rates below our cost to purchase," J.G. Wentworth says in its S-1 filing with the Securities and Exchange Commission.

The company believes those earnings streams are sustainable because it operates at an industry-leading scale and in a niche market that provides real services for those seeking cash on assets that pay out over an extended period.

During recent years, J.G. Wentworth has recovered from a 2009 bankruptcy and reported growth in its revenue and net income. On a pro-forma basis to include acquisitions and changes that will take place after its IPO, J.G. Wentworth turned from a moderate net loss to a $106.6 million profit in 2012, as revenue rose sharply. Those profits and revenue have trended higher in the first six months of 2013, albeit at a slower pace.

J.G. Wentworth's cash flow is even more impressive. The company generated $314.8 million in cash from its financing activities in 2012, up significantly from 2011 levels.

The company's J.G. Wentworth and Peachtree brands also carry high ratings with The Better Business Bureau

Leverage and Liquidity

The notion of building a business to help individuals cash out on their settlements or lottery winnings has an economic rationale. In fact, the firm's asset-backed securities are generally given Aaa ratings and have posted loss rates below 1%, a far lower level of losses than most mortage-backed securities.

While few investors appear worried about the quality of payment streams that J.G. Wentworth buys and sells, the manner in which it does so creates a host of risks for the company's prospective shareholders.

If J.G. Wentworth's warehouse credit lines or the securitization markets it relies on to unload assets were dry up, the company could find itself in a liquidity crisis, as its S-1 filing makes clear. The company went bankrupt during the 2009 credit crunch when its committed credit evaporated and securitization markets stalled.

"[Our] results in 2008 and 2009 were impacted by the financial crisis, which resulted in a lack of purchasers of our asset-backed securitizations and a resultant lack of capital availability from our warehouse facilities. We were forced to limit transaction volume without access to the securitization market and with limited warehouse capacity. We significantly scaled back new transactions, resulting in insufficient cash flow relative to our leverage," the company states in its S-1.

Sound familiar?

Since emerging from bankruptcy, J.G. Wentworth has increased and diversified its warehouse financing capacity, a positive development according to ratings agency Moody's.

Still, the firm's business model hasn't really changed.

"The pressures on the legacy companies' ability to originate assets and access liquidity during the interruption in securitization markets in 2008-2009 highlight the risks embedded in JGW's funding structure," Moody's said in August.

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