The bankruptcy filing by First Merchants Acceptance Corp. may be a critical test for the nascent market for securities backed by subprime auto loans.

Although subprime auto lenders have gone bankrupt before, analysts said First Merchants' filing could be especially noteworthy because of the amount of asset-backed securities it has issued. It has $502 million of asset-backed securities outstanding.

"We've never experienced this level of bankruptcy before in any asset class," said Reilly Tierney, analyst at Fox-Pitt Kelton. "In theory, the securities should not be affected because they're in a bankruptcy-remote trust. But in reality, how does a company that's out of money collect loans?"

The cash-starved subprime auto lender filed for protection under Chapter 11 of the bankruptcy law on Friday, after Ugly Duckling Corp. agreed to provide $10 million in debtor-in-possession financing. Bankruptcy law provides for such financing to give troubled companies some breathing room as they attempt to restructure their businesses.

Now First Merchants must figure out how to persuade customers to send checks to a bankrupt company that is already on the hook to investors in the asset-backed securities.

And the company, which already faces litigation from shareholders, could face additional pressure from bondholders because the prospectus for a $51.75 million bond offering sold last October contained references to financial information the company now says was manipulated by former top executives.

Analysts don't expect First Merchants' problems to upset the overall ABS market or even the securities of other subprime lenders in the short-term.

First Merchants is already paying security-holders 45 basis points over the London interbank offered rate, the highest rate of any subprime auto issuer according to Prudential Securities; and investors in the beleaguered auto market are desensitized to bad news, said Thomas Zimmerman, analyst at Prudential.

Greater impact may come from the bond insurance companies that guarantee subprime auto securities against default.

Financial Security Assurance Inc. insures $6.7 billion worth of subprime auto securities, according to Fitch Investors Service, or about 75% of the market.

FSA has stated that it will continue guaranteeing First Merchants' securitizations because the deals contain sufficient collateral.

But the company is not bound to that. David Litvak, analyst at Fitch Investors Service, said the insurer can cancel its deal within three months or, if certain "trigger events" occur, two weeks.

First Merchants had to file for bankruptcy because FSA refused to guarantee a portion of a $200 million financing offered by Greenwich Capital Markets Inc. A spokesman for FSA said the insurer would not guarantee a deal with only one lender involved.

One thing the First Merchants debacle shows is that finding multiple sources of financing is getting increasingly difficult for subprime auto lenders as banks withdraw from the business and finance companies reconsider their exposure.

First Merchants is trying to make good on its asset-backed securities by beefing up its loan collections staff with the $10 million it's getting from Ugly Duckling, said Fitch's Mr. Litvak.

First Merchants funds its operations by collecting a 2.5% servicing fee on its securitizations. Should FSA transfer servicing, "First Merchants would be finished," said Mr. Tierney, the Fox-Pitt Kelton analyst.

Already several class actions have been filed against the company, which in April reported that top executives had been manipulating financial records to make accounts appear more current than they were.

At the time this fraud was allegedly going on, the company was raising money in the bond market. The prospectus for a bond offering, said Smith Barney analyst William Ryan, contained financial information gathered under "false pretenses."

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