Not content with razor-thin profits from loans to top customers, bankers have pushed into the $50 billion a year market for subprime auto loans, chasing what they hope will be fat margins.
"The banks ought to be in this business in some form," said Henry Coffey, banking analyst at J.C. Bradford & Co. "You just hope that if they are, they don't screw it up."
Unfortunately, history is not on the side of banks, which in the past have bounded into this potentially greener pasture only to discover they couldn't handle the risk.
"I'm not sure a bank would understand this business, because it's not like the rest of the consumer portfolio," said David Stumpf, banking analyst at Wheat First, Butcher & Singer. "You can't just make a subprime loan and put it on the books like any other asset. You have to manage the risks differently."
Banks could well play the role of spoiler in this market, which routinely provides a return on assets of up to 9%, compared with the 1% or less earned on lending to the soundest car buyer.
Only a few banks have been successful in the market. Norwest Corp. and Bank of Boston Corp. have profitable subprime operations, but they run them through consumer finance subsidiaries with specialized expertise. And this month, Keycorp agreed to pay $325 million for AutoFinance Group Inc.
Executives at several banks that have not yet entered the market acknowledge they have been studying it and insist that any loans to the credit-impaired will be small and won't be underpriced.
"We would be stupid not to look at this market," said a Midwestern bank executive who insisted that he not be identified. "After the last economic cycle, fewer of our customers meet A or even B-plus criteria for a car loan. We know these people are good for the money."
Mr. Coffey, who follows banks as well as several of the major independent auto finance companies, says a measured strategy in the subprime market could be a good thing.
"I think banks have to do something with their rejected credits," he said. "But banks have a mentality of buying market share with cheap rates and paying for it later."
One example is Far West Bank, which aggressively moved into the subprime loan market in the mid-1980s. The bank failed in 1990, in part because of heavy losses from such auto credits.
"There are a number of savings and loans that we follow who are in the subprime market, and they have just gotten tremendous crap from the regulators, who don't understand the business and are just totally uncomfortable with it because of the high delinquencies," said Joe Jolson, thrift analyst at Montgomery Securities.
Regulators are likely to limit direct lending by banks. But some banks still face exposure through lines of credit to finance companies that focus exclusively on the subprime auto loan market. Moreover, competition has slashed the spread banks and others earn on such working capital loans.
TFC Enterprises, one of the established players in the subprime niche, reports that its cost of credit dropped as interest rates rose over the last year. In 1994 the company said it had a line priced at 400 basis points over 30-day Libor from GE Capital. Today the spread has thined to 145 basis points.
"That helps us maintain our margins, since we generally lend near the top of what state usury laws will allow," said a TFC official.
Stabilizing that spread is critical in this high-risk niche, because it enables lenders to charge high enough rates to offset the higher risk of subprime borrowers.
But maintaining those spreads is more difficult with heightened competition from banks, thrifts, and credit unions.
"Over time, it's our judgment that banks will become bigger players in this market," said Joe McQuillan, vice chairman at Ford Motor Co.'s Associates Corporation of North America, whose TranSouth Financial subsidiary has a $420 million subprime portfolio from a 23-state business. "So far they have been good competition, and they know that the economics of this business requires higher pricing."
One issue, according to analysts, is the threat that players flush with capital will feel pressured to quickly grow loans only to face accelerating problems.
"There is a lot of pressure on these managements," said Mr. Jolson. "So it is easy to make loans - but it is harder to get your money back."
