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May 10, 2019  

Prosecutors Take Notice of Honor Scandal

The U.S. Department of Justice is investigating defunct auto lender Honor Finance, whose lone asset-backed bond deal is on the verge of default.

The inquiry adds potential criminal charges to a case the government has been building against Honor since November, when the SEC began investigating whether the Evanston, Ill., subprime lender and executives James Collins and Robert DiMeo overstated historical asset performance prior to securitization.

While the exact nature of the Justice Department’s investigation is unknown, it is believed to cover some of the same ground — and possibly other suspected violations. That said, it’s unclear if the Justice Department became involved in response to a criminal referral from the SEC, or if it acted separately.

Sources pointed to the U.S. Attorney’s Office in Chicago as the entity handling the criminal side of the probe.

The SEC’s investigation is based on suspicions that Collins and DiMeo concealed defaults and delinquencies, and delayed the reporting of losses, in an effort to make Honor’s asset performance appear stronger as the company prepared to securitize. The $100 million deal priced on Dec. 7, 2016.

The SEC additionally has been reviewing the activities of Wells Fargo, which served as the issue’s bookrunner and trustee, along with rating agencies S&P and Kroll. Also under scrutiny is CIVC Partners, which purchased a majority stake in Honor in 2011. All of the parties involved in either investigation either declined to comment or didn’t respond to requests for comment.

Honor’s securitization ran into immediate trouble amid higher-than-expected losses, which one source attributed to a scheme in which Collins and DiMeo had used profits from the sales of GPS units and vehicle warranties to prop up delinquent or defaulted loans.

Sources additionally said the pair, during meetings with rating agencies, touted their experience in the mid-1990s as senior executives at subprime lender Mercury Financial. But Kroll’s presale report failed to note that Mercury had filed for bankruptcy in 1999 after overstating its earnings. It also didn’t mention that Mercury chief executive John Brincat received a 10-year prison sentence after pleading guilty in 2006 to charges that he concealed losses at the company.

Collins and DiMeo were never charged in the Mercury case. They launched Honor in 2001 and remained on board until 2018, when the company began unwinding.

Honor’s securitization has been downgraded twice by both S&P and Kroll. Most recently, Kroll cut the deal’s Class-B notes to “B+” (from “BB+”) and its Class-C notes to “C” (from “CC”) on May 1.

According to Honor’s latest servicing report, for the period ended April 15, the deal’s reserve fund has a deficiency of $2.3 million while losses have caused its over-collateralization to fall to minus-25.4%. Senior noteholders were repaid in December. Class-B investors might also be made whole. But sources expect Class-C investors to suffer some principal losses, possibly beginning with payments due in the coming weeks.