DALLAS - Some analysts foresee a quick and painful consolidation of the subprime auto lending business in the wake of a bankruptcy filing by eight securitization companies owned by Search Capital Group Inc.
Their troubles stemmed from poor risk management in an increasingly competitive business that has attracted a rising number of yield-hungry banks.
Cliff Grubbs, director of trading for Primus Automotive Financial Services Inc. said the competition among lenders to buy or originate loans reminds him of the late 1980s. Then, rising delinquencies on auto loans led banks to either shut down their operations in this area or reduce lines of credit to companies that remained. The effect was a liquidity crunch and a consolidation in the industry.
"We think you will see a number of subprime securitizations imploding to the point where the investment bankers start to realize they shouldn't be peddling these deals," said Mr. Grubbs, whose company is an affiliate of Ford Motor Credit Corp. that would probably buy contracts from unraveled transactions.
Over the last year, the high margins on auto loans to poor-credit customers have lured at least 30 banks and thrifts to either lower their credit standards or enter the auto-loan business, according to a research report issued by San Francisco-based Montgomery Securities.
But as the competition swells, margins are already tightening, leading some analysts to take a closer look at the risks.
"This is a business where it is easy to make loans," said Joseph Jolson, a Montgomery Securities analyst. "The problem comes down to managing that risk. You really can't short-cut it."
He warns that the focus of many lenders on production is like a "virus" in the market that could lead some lenders to fail in coming years.
Lenders are trying to increase volume by lowering underwriting standards and advancing more loan funds per car. Crucial to the success of this strategy, though, is the ability to package these loans, resell them in the secondary market and recyle the funds with new loans.
"As Wall Street continues to make the process available to anyone, loan production at any cost has become the rule of the day," Mr. Jolson said.
But there are risks, and while investors holding securities backed by these loans are acutely aware of the underlying credit risk, they are confronting the threat posed by financial problems of the parent company.
The Search Capital units filed for bankruptcy protection in August, and falling economy could force more lenders to follow. And more bankruptcy filings could reduce even further the meager liquidity of the subprime auto market.
George Evans, Search Capital's new chairman and chief executive, remains optimistic that the company can raise up to $200 milliin in new loans once it reorganizes its current securitizations. A third lender is pondering lending $200 million, he said.
He asserted that it was unlikely anyone in the market would make the same mistakes Search Capital made. In particular, he said the company focused its credit decisions on the auto itself instead of on the ability of the borrower to repay. Since Mr. Evans took over in February, the company has cut defaults on the first payment to 3.8% of loans from over 14%.
"The concept that the customer doesn't matter was totally ludicrous and won't be used again in this industry," he said.
