Subprime Is Growing

Special finance will grow sharply in the coming year.

That's because of a new federal bankruptcy law, causing an upsurge in Chapter 11 filings, and hurricane aftermaths in Gulf states.

Linked to the impending subprime increase, say lender experts, is a gradual rise in establishment of buy-here-pay-here operations at franchised dealerships.

“Up to 70%-80% of folks walking into a franchised dealership today have credit problems,” says Bill Kroskey of Direct Advance dealer finance service in Monaca, PA. “We help dealers sell affordable cars to shoppers who find themselves out of the prime category.”

A dealership that took the plunge — Toth Buick-Pontiac-GMC in Akron, OH — has raised used-car sales dramatically.

Used-car manager Russ Toth has established a separate buy-here nonprime lot, a spin-off strategy to avoid co-mingling new and used-car buyers. It has drawn qualified buyers for two-year loans with service warranties for cars that previously wound up being sold at auction.

Entering the subprime field on a dedicated basis is timely, says special finance trainer Greg Goebel.

He predicts the “best special-finance market in a decade” as an outgrowth of the new stiff bankruptcy law.

Nonprime loan originations as reported by 26 lenders to the National Auto Finance Assn. advanced 6% on a dollar basis in the latest 2005 study, he notes.

The Southeast's double-whammy of hurricanes in September is seen as another spur to used-car sales, nonprime financing and, accordingly, buy-here-pay-here operations.

So many new vehicles were washed out in the New Orleans and Houston-Galveston markets that pre-owned sales skyrocketed.

AutoNation Chairman and CEO Mike Jackson, reporting that used-car sales have been “surprisingly good,” added that “demand has been there and values have held up well.”

Other publicly owned dealership chains are expected to report increased used-vehicle sales in the third quarter, underlining the innate profitability in the pre-owned sector.

“Many people from Louisiana, Mississippi and Texas, who are ordinarily in the second-hand and subprime market, lost their cars — and we're already experiencing a demand we wouldn't have had otherwise,” says a sales manager for a Group 1 Automotive General Motors dealership in Hurricane Rita-struck Beaumont, TX.

Loan originations had been on the uptick in AmeriCredit's fourth fiscal quarter ended June 30, reaching $1.45 billion vs. $1.075 billion a year earlier. AmeriCredit President and CEO Daniel E. Berce has forecast that fiscal-year new loan volume would rise to between $5.8 billion and $6.2 billion in fiscal 2006, compared with $5.03 billion in fiscal 2005, reflecting subprime loan demand.

A National Auto Finance Assn. survey says losses on loan defaults and vehicle repossessions have been reduced this year. The average loss to subprime lenders on a repossession fell to $4,965 from $5,235 in 2003.

The survey indicates processing of subprime loans among respondents declined below 30 minutes on average, owing to greater use of the Internet.

Centrix Financial Rides Out a Storm

Subprime auto lending is expected to increase despite a hit taken by lender Centrix Financial, based in Centennial, CO.

Centrix in July notified dealer clients that it has curtailed financing and suspended taking any new contracts. That is because the National Credit Union Administration, a federal agency chartering and supervising federal credit unions, issued a “risk alert” to credit unions that outsource subprime loans through companies such as Centrix.

Credit unions by charter can't subprime loan directly because it is considered too high risk for those financial institutions. Centrix has seen phenomenal growth using a business model in which it obtains financing from credit unions, guarantees repayment and then uses the money for subprime auto loans through dealers.

The NCUA alert caused credit unions to cease such subprime participation until matters are sorted out. The NCUA wants specific regulations implemented and auditing that shows compliance.

In September, the skies cleared a bit, says John Scordo, Centrix's vice president-dealer business development. The company tapped other capital sources after receiving funding in August from Drivers' Select, a Dallas-based subprime dealership network.

Centrix is riding out the storm.

“We have an over-growing population of Americans with credit challenges,” says Scordo. “Serving the under-served remains our core product.”

Texas Dealer Helps Save AmeriCredit

By Mac Gordon

When subprime giant AmeriCredit Corp. ran into a deep ditch two years ago, it made an addition to its board of directors never before done by any auto maker, captive or major independent lender.

Determined to reassure its 12,000 dealership clients that a turnaround plan would meet their needs, the Fort Worth TX-based AmeriCredit signed on one of the most respected Texas dealers, B.J. (Red) McCombs, for a two-year term on its board of directors.

McCombs, whose 10 San Antonio-based dealerships perennially land on or near the Ward's 500 dealer roster, agreed to serve on publicly owned AmeriCredit's board until its financial turnaround was well underway.

Over the past two years, says Daniel E. Berce, AmeriCredit's president and newly appointed CEO, the presence of McCombs, 78, “has been of immeasurable support.”

That's because he looks at issues from the eyes of an experienced dealer. “As a result, we believe that AmeriCredit is a smarter organization and in a more promising position than ever before,” says Berce.

After years of record-breaking loan origination volume in a growing subprime market, AmeriCredit joined a number of independent subprime providers on the skids in 2001 and 2002.

As the U.S. economy declined and unemployment rates rose, the default rate on the company's loan portfolio increased dramatically.

In addition, says Berce, the lender, with an $11 billion portfolio in managed auto receivables, was in the tough spot of repossessing cars due to a decline in used-car auction prices. This was exacerbated by the post 9-11 startup of aggressive new-car incentives offered by GM, Ford and DaimlerChrysler (mainly zero percent loans with no down payments).

Running into a cash crunch for the first time in its history, 13-year-old AmeriCredit implemented a revised operating plan in 2003, targeted at preserving and strengthening its capital and liquidity position.

What was even more troubling for AmeriCredit's founding chairman, Clifton Morris Jr. was the fear that franchised dealers, burned by the failures of many subprime lenders in the 1990s. might bolt from AmeriCredit.

Nearly 95% of AmeriCredit's dealer clients are franchised, and often can turn to captive lenders for subprime loan originations if independent lenders or banks tighten their standards in a down market.

A loan downsizing plan was being launched by AmeriCredit, reducing loan originations from as much as $1.5 billion in past quarters to $750 million in 2003 and early 2004. Standards were to be tightened on applicant acceptances, and the AmeriCredit management was unsure of how dealers would greet the changes.

One unique feature of AmeriCredit's business strategy was its profusion of local offices serving dealers. Many of these were closed in line with the reorganization strategy, leaving up to 20% of dealer customers without a nearby AmeriCredit office.

As president and CEO, Michael R. Barrington had been Morris's right-hand man in the AmeriCredit top echelon from the start. But it was felt that a new leader was required to mastermind the reorganization and, with McCombs's assent, Berce was promoted from CFO to the top spot. Barrington remained a director.

The fiscal years 2005 and 2004 have been high achievers for AmeriCredit, during McComb's service on the board. Net income in 2003's loan-origination reduction year shrank to a company low of $21.2 million. It mushroomed in 2004 to $227.0 million and in 2005 to $285.9 million.

As the turnaround gained momentum, AmeriCredit took off the loan origination cap, resulting in fiscal-year loans for 2005 of $5.03 billion, compared to $3.47 billion in fiscal 2004, a spike of 45%. “AmeriCredit ended fiscal 2005 in its strongest shape ever,” says Berce. “Our loan originations were the highest since our restructuring in 2003, and annualized net charge offs were the lowest in four years.”

AmeriCredit, in reporting its upswing for calendar 2005 to date, noted in its annual report that the subprime market generates up to $100 billion in loan originations a year. Of this, CFO Chris Choate forecasts that the 1-million consumer customers of AmeriCredit will generate new loan volume of $5.8 billion to $6.2 billion in fiscal 2006, bringing net income of $265 million to $295 million.

Having seen AmeriCredit rebound in what finance experts agree is a steadily growing subprime market, Red McCombs decided not to seek renomination to AmeriCredit's board this fall.

As an esteemed Ford, Pontiac and Toyota dealer, he had helped an ailing loan company regain its health. Perhaps there's a lesson in this for auto makers and other lenders.