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How Will the Subprime Auto Finance Industry Rally?

January 2009, F&I and Showroom - Feature

by Jim Bass

I'm sitting in a Starbucks just before Thanksgiving, writing this article, and I can’t remember a more difficult chore. Let’s see, what will the credit markets look like in the first quarter of 2009? I can honestly say that I try to be part of the glass-half-full crowd when it comes to judging the news, but this one is tough.

Last week, CitiFinancial’s stock fell to $3 and change, far from its perch at nearly $42 only six months ago. How can a bank with $2 trillion in assets on the balance sheet and another $1 trillion in off-balance-sheet subsidiaries be in such deep trouble that the government is actually considering a $20 billion bailout?

I’ve been through several troughs over my 20 years in the auto finance business, but this one takes the cake. It was easy in the mid-1990s, for example, to point out that too much capital came into the auto finance business (20 subprime companies went public in 1994 and 1995) and the quest for market share and top-line revenues led to poor underwriting, high losses and ultimate failure for several companies. However, this time, we seem to be victims rather than participants.

Tracking the bell cow

AmeriCredit’s welfare is extremely important to this segment of the auto finance industry. For many, the health of AmeriCredit is an indicator of the health of the industry. The company has survived other crises up to now, but there is some question as to its continued viability.

The securitizations that were issued in October and November 2008 were not very exciting for anyone. They were only executed to move some loans out of the warehouse facilities as the 365-day covenant was being nudged. Otherwise, there was no other economic reason to suffer through the pain. In late November, it was announced that Fairholme Capital was receiving a sizable increase in its equity stake in AmeriCredit in exchange for canceling some senior 8.5 percent notes due in 2015.

The kicker? The price for the notes was 84 percent of par! The deal meant a discount on the payback, but a heavy price in equity dilution for existing shareholders. That’s an expensive refinancing, but it frees AmeriCredit from having to accrue for the payoff of those notes and reduces a substantial interest expense.

In addition, our bell cow has abandoned several origination markets, cut off many dealers and reduced its staff substantially. It has done all this not because its performance warrants such punitive actions, but because the asset-backed securitizations market has collapsed. AmeriCredit isn’t to blame for the collapse. Subprime mortgages, rating agencies and financial guaranty company downgrades are all to blame. But AmeriCredit, along with every other finance company which derives its funding from securitizations, is in serious danger of going out of business.

So, what will change? What will make it better? One dealer acquaintance of mine opines that the era of the buy-here, pay-here dealer has arrived.

Independents’ day

Subprime customers are finding that their old reliable transportation source, the used-car department of a franchise dealership, now has no easy task in getting them financed. So if they really need a vehicle, they head off to the BHPH dealership.

Can the remaining buy-here, pay-here dealers handle the inflow of business? Unfortunately, maybe not, because most of the dealer-related finance companies also are supported by credit lines, usually from local or regional banks. Those banks, similar to the megabanks, face the same issues with extending credit to subprime finance companies.

Some money seems to be available, but only to the few dealers who have been in business a long time, are well-capitalized and willing to pay high interest rates for their funds. Many dealers are finding that the banks are auditing rigorously and being very rigid in their interpretations of credit line agreements. An existing credit line can be canceled with precious little notice.

Just six short months ago, Sixth Gear Solutions Corp. was a wonderful success story that, alas, already has closed its doors. The company had millions of equity backing by Warburg-Pincus, hundreds of millions of warehouse commitments from Lehman Brothers and a very well-seasoned management team, systems, scorecards, procedures and the like. What did they do to fail? Absolutely nothing. Lehman goes bankrupt and Warburg pulls the plug. Who could have foreseen it? What or who can fix that scenario?

Oh, I know what will pull it out – the depository institutions that own subprime auto finance companies are, for the most part, still well-funded. They can depend on customer deposits as a reliable source of funds, no asset-backed securitizations to worry about.

But, wait, they have to deal with the regulators who hate "subprime" anything. I guess that explains why Wells Fargo Auto closed its origination office in the Dallas area, CitiFinancial Auto reduced its staff by 60 percent and Regional Acceptance (owned by BB&T Corp.) tightened up in both subprime originations and the purchase of seasoned portfolios — ostensibly a “flight to quality.” Wachovia also has cut back, and they have many other problems as well.

The search continues

I think I’ll just go with the politicians and admit that I don’t have a clue when or how this will all straighten out. I know, personally, that raising equity or debt financing now is just about impossible. At the very least, some non-traditional sources of credit will have to be found. In the past, there’s been talk about European money, or some broker with money from the Saudi royal family. Those deals never seemed to bear fruit. The Euro is down against the dollar and oil revenues are declining for the Saudis. Let’s see, don’t I have Warren Buffett’s or Bill Gates’ number around here somewhere?

One final point: I encourage the risk management departments of the survivors to carefully construct their pricing models by taking into account the risk being purchased. However — and this is really important — you shouldn’t try to make up for past sins by increasing pricing to a ridiculous point. If your losses are tracking within acceptable tolerances on a static pool basis, there’s no justification for raising discounts dramatically, raising consumer interest rates to the limit, or otherwise penalizing the dealers and their customers.

Just remember that your special finance customers have already had enough credit problems. Burying them in new-vehicle purchases raises the potential for defaults. If their payments are pushed to the limit, you might actually be hastening their credit demise.

Jim Bass has more than 20 years’ experience in the sub/nonprime auto finance industry. He is currently treasurer of the National Automotive Finance (NAF) Association. E-mail Jim at

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