Author Topic: LEAP Puts on Sub Prime Auto Lenders  (Read 7113 times)


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Re: LEAP Puts on Sub Prime Auto Lenders
« Reply #30 on: April 01, 2018, 09:23:41 AM »
In terms of the interest rate.. yes the 22% sounds about right.. might even be lower than actual interest rate charged as they are only booking the cash-flows they expect to receive. Keep in mind, CACC is lending to ppl who have no other choice. In general default / repossession rates are probably around 45-50% of loans (by number of loans) so the interest rate tends to be high

I partially agree with this but the dealer is really in a crucial role.  Often the dealer owns the relationship and the choice whether to make a loan with their own money or sell the loan.  So if you have done all the work getting the customer, etc. why would a dealer just sell the loan and allow someone else to make ~20% per year after provisions.  I wouldn't.  The dealer are very street smart types.  My point being that CACC doesn't deserve to make 20% just because the dealer can charge 20% on the loan, Unless the dealer is desperate for cash.  And a lot of the underwriting is meeting the person and following up on them and working with the borrower.  Someone comes in and throws a wrapper on your desk and want to borrow money - how do you put that in a loan app?  Super specialized, tough business.  I wouldn't touch it. 

The point is that the dealer is really the lender, if it a good loan the dealer would keep it.  Bad loan - stuff the lender if he is being stupid.  There are a lot of floorplan lenders and other lenders who will charge much less than 20%.  To me the 20% is fantasy land stuff for CACC.

Also - as a side point.  CACC is growing the loan book very fast while defaults are rising.  That is the opposite of what a disciplined lender would do.

Dealer loans are NOT floorplan loans. Thats a B2B business very very different from financing consumer auto lending.

The 20% rates are because there are no other lenders who will lend to the consumers CACC will lend to. There is a reason 50% of cars end up being repossesed. That's way way way above other lenders. Heck SC is a lender to pretty subprime customers and only has gross charge-offs of around 15-20%...

The dealer sells the loan because he doesnt want to deal with collections and wants to free up capital. In most / almost all cases the dealer is only making the loan in the legal sense.. the dealer is not the lender in any meaningful economic sense.  The sale to CACC (or another lender) is almost instantaneous.

I think CACC has tremendous regulatory risk and potentially has cash-flow issues that the plainsite report has highlighted.. i think the accounting is nuts too.. so its expensive but historically they have done fine lending to borrowers with questional credit by charging up for it..


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Re: LEAP Puts on Sub Prime Auto Lenders
« Reply #31 on: April 02, 2018, 09:34:07 AM »
"There probably should be a CACC thread.. (there may be one.. havent checked)."
Agreed. If there is more interest here, may switch to an existing thread.

This thread was started on the premise of a short position in lenders and that topic remains very relevant due to the evolving competitive landscape of the less than prime auto lending industry dynamics.

However, in the end, this thread may serve as a foundation for an opportunistic long position in CACC if/when certain risks materialize.

-A word on "floor financing".

Dealers usually use a revolving credit arrangement secured by inventory. The terms of such lending arangements are different from the "indirect" consumer loan deals to buy cars but there is a link in the sense that dealers may have a significant incentive in selling the consumer loan for the car sold in order to pay the associated inventory advance or to use the proceeds to replenish inventory with the additional unit bought used as collateral.

-Regulatory landscape

The subprime population is comprised of people that vary from those who settle for a lower value car to be used as a necessity and others who fall for more expensive alternatives. Whatever opinion one has about regulations along this spectrum, there is widespread noise about potential "predatory" practices that seem to characteristize this segment of the market now.

With internet pricing, the operating margin of dealers has been compressed and the bottom line has been maintained by squeezing profit from the "back end" of the transaction. Dealers have essentially captured (80% of financing is indirect) the financing component of the transaction, use a potential "loophole" by structuring a financing transaction outside of the financing regulatory framework (interest rate and other terms of the loan) only to sell it quasi automatically and spontaneously to an affiliated or other somehow related financial entity. This has given rise to potential heigthened scrutiny from regulators and probable (although difficult to time) action from regulators. Even discounting sensational reports, there is clear material for potential regulatory painful enforcements: amazingly high default rates, recurrent repossession of the same owner, recurrent sale of the same repossessed car, use of devices to remotely disable cars to increase efficiency of repossession, yoyo scams, loan packing etc.

Still, after a difficult to time adjustment period aimed at more transparency, larger players such as CACC are likely to be profitable and renewed survivors.

-Competitive landscape

Large auto finance companies that focus on the subprime segment compete with larger banking institutions, dealers such as the buy here pay here (BHPH) businesses and a multitude of smaller players. In the last few years, the BHPHs, larger independent dealers and smaller financial lease players have increased market share, signaling looser underwriting requirements (income verification, LTV value, absolute loan value and length of loan, up 96 months). In 2017, credit quality indicators of the credit pools have deteriorated, especially in the deep prime segment but, recently, lending standards have tightened. Beginning of the end or benign cyclical adjustment? CACC has reponded to competitive pressures by decreasing the share of loans per dealer and by increasing the number of dealers. It seems that this is a reasonable way to mitigate the lower returns expected on present pools of loans, alhough unlikely to be sufficient to go through the next cyclical adjustment unscathed.

IMO CACC's valuation is high if one discounts the potential range of outcomes going forward.
Perhaps money to be made on the short side of auto lenders but can't identify a suitable opportunity at this point.
Envision the possibility that both regulatory and market risks compound giving rise to a potential long opportunity for CACC.

Will follow closely.

« Last Edit: April 02, 2018, 09:41:51 AM by Cigarbutt »


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Re: LEAP Puts on Sub Prime Auto Lenders
« Reply #32 on: April 02, 2018, 01:44:51 PM »
A lot are written with the expectation on part of the lender and intent on the part of the borrow to have the loan flipped to a credit union fairly early in the loans life. If you read some of the credit forums as well as take a look at the top 50 credit unions by asset size you see the ballooning of auto credit on their books. This matches up with the loan level data from the securizations


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Re: LEAP Puts on Sub Prime Auto Lenders
« Reply #33 on: April 02, 2018, 01:48:45 PM »
Most of the financing companies are fine with rolling up old auto loans into the new loan because the likelyhood its refinanced is high. And if the car has to be repossessed they don't care as they can write a new loan for the same car they just repossesed in a matter of weeks if not days 


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Re: LEAP Puts on Sub Prime Auto Lenders
« Reply #34 on: April 02, 2018, 02:02:12 PM »
This reply is late but I enjoy this thread and I've been going  through it again.

Rough guess ~90% of Carmax buyers finance (includes Non KMX finance guess). 

Page 26 of the KMX 10-K through February 28, 2017 has the following:
Used vehicle financing penetration by channel (before the impact of 3-day payoffs):
49.5% CAF
17.8% Tier 2
  9.8% Tier 3
22.9% Other(5)
(5) Represents customers arranging their own financing and customers that do not require financing.

So within that 22.9% Other group we need to know what percent didn't finance.
« Last Edit: April 02, 2018, 02:03:49 PM by LongTermView »


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Re: LEAP Puts on Sub Prime Auto Lenders
« Reply #35 on: April 06, 2018, 04:02:49 PM »

Form 8-K: "On April 6, 2018, Steven M. Jones, President of Credit Acceptance Corporation (the 'Company'), announced his decision to retire as an officer and employee of the Company, effective June 30, 2018."


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Re: LEAP Puts on Sub Prime Auto Lenders
« Reply #36 on: April 09, 2018, 07:56:45 AM »
Not sure what the above "news" means but there is noise brewing in the auto financing sector, especially for the smaller players in subprime.

Still think that the best value here is long CACC past the peak when sufficient conditions are met to expect that it will be a profitable survivor but, at this point, trying to assess how it may become darkest before sunrise. All cycles are different but previous cycles (late 1990’s and 2007-9) are instructive.

Summit Financial is a relatively small subprime lender (Florida, Georgia and Alabama) that just entered ch.11. Management blames rising delinquencies from Irma but the story is larger and implies that the “margin” on loans may be particularly thin. An interesting tidbit here for Summit is that they used to offer (not anymore, regulator obliging) a course on credit counseling to help consumers “avoid bankruptcy and find a path to financial recovery”. In the subprime sector, the lenders always praise that the real aim is to allow people to fulfill their dreams :). If your aim is to return equity at very high levels, there are clearly conflicting incentives.

Anyways, for BoA, a secured lender, it looks like they feel Summit stretched the numbers as it is felt that loans were not written down in parallel to the rising rates of repossessions and increasing share of worthless trade-ins (car worth less than the underwritten loan). As  Cameron mentioned above, there are ways to re-package this but I guess there is a limit (that is being reached at least for some) as to how long a can can be kicked down the road. Summit had been around since 1984.

Spring Tree Lending (Atlanta-based) is another one folding and “fraud” is mentioned. This may be idiosyncratic but there is a grey zone along extending the dream, loosened underwriting standards and inappropriate slowness in reconciliation to real numbers.

Backed by private equity, Pelican Auto Finance who is an auto subprime specialist is moving away from the business citing shrinking margins and “intense” competition.

This may be just noise but data points are accumulating. In relation to the first post of this thread, interesting to try to define a potential catalyst or a set of criteria sufficient to point to an actual storm versus only gathering clouds.

Will look at this from a value chain perspective and think of incentives.

Since 2015-6, the volume of subprime and near-prime loans has been decreasing. Interestingly, during that period, there was an increasing amount of capital chasing a smaller pie, giving rise to this intensely competitive environment. From the work I’ve done so far, the different types of lenders have reacted differently to this new competitive landscape. I find that the underwriting standards have deteriorated particularly for smaller players and new entrants but, almost inevitably, this will have an effect on larger players such as CACC going forward, especially if delinquencies rise significantly.

The value chain goes from capital provider, to the auto lender, to the dealer and finally to the consumer. It seems that the incentive system is relatively broken at many links. For instance, there are more and more consumers who end up with loans that literally take more than a decade to pay long after they “lost” the car backing the loan. From an outside perspective, auto dealers are more into loan sales than in actual car sales and, perhaps more than ever, there is a large expectation that the transaction is not a good one in terms of what the consumer is getting for his or her money.

IMO, the “subprime” consumer is unusually stretched at this point. Dealers’ margins are squeezed and being compensated in a non-sustainable way through the back end of the transaction. Auto lenders have questionable loan pools on their books. Capital providers have started to pull the plug, to increase rates (aren’t we in a tightening mode?) and the price of credit enhancement for securitized pools has increased, squeezing even more the spread available to the funding investors who, in the end, are so distant from the underwriting process.

Carmax just reported results that showed Q4 weakness due to “unfavorable pricing dynamics”. In the late 90’s, dozens of firms filed, were shut down or were acquired at distressed prices, so we may be early in the game but this is worth watching.
« Last Edit: April 09, 2018, 08:04:59 AM by Cigarbutt »


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Re: LEAP Puts on Sub Prime Auto Lenders
« Reply #37 on: April 09, 2018, 08:49:11 AM »
Interesting post Cigarbutt.  Thanks for the data points.
This is a friend (not myself) who is a very capable consultant for oil and gas investing. 

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Re: LEAP Puts on Sub Prime Auto Lenders
« Reply #38 on: April 16, 2018, 10:20:00 AM »
Looked at some numbers and trends.

Since about 2011, private equity has put money in the auto subprime area and some players seem to be looking for an exit.
2015 and 2016 results were quite poor. In 2017, results +/- improved in the context of lower volumes and tighter standards.
Two typical examples are Exeter Finance Corp and Flagship Credit Acceptance.

Exeter is supported by Blackstone and that may explain the recent first AAA-rated securitization.
Haven't looked in details in Exeter yet but it seems to me that continuing consumer strength are expected in the numbers.

Flagship is interesting. In 2017, they also tightened their standards and pretty much abandoned some areas (do not really write the "thin-file" loans anymore).
But the loan balances are high and terms very long. Also, I find that ratio of refinancing loans to total loans to be unsustainably high in the present context.

The picture is still incomplete but somehow, notwithstanding the assumption that the consumer will continue to tap the subprime market, I find that deteriorating conditions arising from intensely competitive pressures have not, so far, shown up in reported numbers.

Maybe still early but it smells fishy.