Subprime lenders rising after recession-era cuts
Growth is fueled in part by private equity and the low cost of funds
Independent subprime auto lenders are on the rise, propelled by several positive factors that yield them more money to lend.
Investor interest in the subprime segment is high, so lenders are better capitalized, industry watchers say. The cost of funds is low. So are consumer delinquencies and credit losses, by historical standards. Several independents report they are signing up franchised new-car dealers across the country.
That's the opposite of how things were during the credit freeze of the last recession and its aftermath -- roughly late 2008 to part of 2010. Investors closed their pockets. Many subprime lenders had trouble raising funds at almost any price. Several companies cut back or sold out. Dealers found it difficult to find a buyer for subprime loans.
"Ten years in this business is like 70 years -- it's like dog years, right?" joked Tommy Moore Jr., chairman of First Investors Financial Services in Houston. Moore co-founded the company in 1988.
Like many other lenders, First Investors is rebounding after cutting back drastically during the latest recession, which hit subprime lenders particularly hard. First Investors CFO Bennie Duck said last month the company had more than 1,100 franchised new-car dealerships signed up.
That's almost double the number of dealerships First Investors had just a year ago, but it's still short of the 1,300 or so it had before the recession, Duck said. "We are adding about 75 to 100 dealers a month," he said.
Private-equity firms are investing in subprime auto lenders. For example:
New York financial services firm Perella Weinberg Partners launched CarFinance Capital in May 2011. Perella Weinberg also purchased control of Flagship Credit Acceptance in 2010. In July, Flagship raised money for the first time since the Perella Weinberg investment by selling off car loans in the securitization market, a deal worth $109 million.
Blackstone Group, a New York-based private-equity firm, bought Exeter Finance Corp. in August 2011, with plans to take it nationwide from 13 states in early 2011.
Also last year, investment funds affiliated with Warburg Pincus, Kohlberg Kravis Roberts & Co. and Centerbridge Partners bought 25 percent of Santander Consumer USA of Dallas for $1 billion.
Santander Consumer USA isn't an independent finance company, but its predecessor company was. The original U.S. business got its start in the mid-1990s as an independent subprime specialist. In 2000, the group became Drive Financial Services. Spanish banking giant Banco Santander bought out Drive Financial Services in 2006.
While others cut back, Santander Consumer USA grew through acquisitions. For example, it bought Triad Financial Holdings in 2009. In 2010, it bought part of HSBC Finance Corp.'s auto loan portfolio, plus its auto loan servicing operations.
Another subprime giant, GM Financial of Fort Worth, Texas, was the independent lender AmeriCredit Corp. until GM bought it in 2010.
Besides private equity investment and mergers and acquisitions, another key factor in the rise of the independents is the comeback in the market for asset-backed securities, which is how many subprime auto lenders traditionally raised funds to make new loans. The securitization market almost completely dried up in 2008 and 2009.
Securitization is the financial practice in which a lender sells the income from a bundle of loans to investors. While the lender gets less interest than it would if it collected the loans, it gets money to make new loans. In effect, it's as if the lender borrowed money from the investors.
According to Standard & Poor's Ratings Services, through July of this year subprime auto lenders sold $10.7 billion worth of asset-backed securities. That was a 43 percent increase from the same period a year earlier.
"A lot of issuers report they are seeing a record low cost of funds on their ABS transactions," said Amy Martin, senior director for structured finance ratings at S&P.
"Interest rates are low to begin with. There's also a lot of demand for auto loan ABS, in part because this asset class held up well in recessionary periods. These assets pay fast. They are short-term. And there are not a lot of alternatives out there," she said.
That's because investors have soured on several other potential investments, such as subprime mortgages.
Berce: Rational competition
Meanwhile, GM Financial reported last month that the cost of funds on its most recent asset-backed transaction -- a $1.2 billion deal in June -- was only 1.9 percent, the company's lowest ever. GM Financial CEO Dan Berce said the company's credit losses were at a historical low, too.
"We continue to see growing but rational competition as other lenders seek to take advantage of favorable funding and performance metrics in the auto finance market," Berce said.
The fact that competition is still considered "rational" indicates that despite its current expansion, the segment still has plenty of room to grow, according to analysts and company executives.
"I don't think we're seeing anything close to how irrational it was in 2006 and 2007," said Moore of First Investors, talking about a boom that preceded the bust of 2008-09. "That was an incredibly irrational period," he said, when subprime lenders chased market share even if it was unprofitable.
John McElravey, senior analyst for consumer asset-backed securities research for Wells Fargo Securities, said at a conference in New York in July that the current growth in the subprime sector is a case of returning to normal, as opposed to overheating.
In addition, S&P's Martin pointed out that while the independent finance companies are growing, they're still small relatively speaking. She said the two biggest issuers in subprime auto securitization, GM Financial and Santander Consumer USA, this year have accounted for nearly 80 percent of the asset-backed securities volume for the entire segment, with 10 other issuers accounting for the rest.
Flagship CEO Michael Ritter echoed the same point in a phone interview last month: "We're still small. You hear a lot about private equity coming in -- and it is. But in the grand scheme of things, the industry is very much controlled by the big guys."
You can reach Jim Henry at email@example.com.