Tricolor, the main subprime auto lender, specializing in buyers with no social security numbers or credit history, is closing down.
The company filed for bankruptcy on Wednesday. Most of the companies filing for bankruptcy intend to continue business. But Tricolor doesn't – it plans to liquidate. Tricolor has not commented yet.
For buyers relying on such lenders, often undocumented immigrants, Tricolor’s failure is bad news, a special focus for Texas companies. It's not very good for major banks that invest in Tricolor debt with their loans.
But Tricolor’s problems are unlikely to disrupt the wider financial services industry like subprime mortgage lenders in 2008, bringing almost a new depression. These loans gave birth to loans called “toxic assets,” forcing the federal government to dump billions into every major bank in the country to prevent a complete outbreak and collapse of the U.S. economy.
Subprime car loans, even suspicious loans such as those offered by Tricolor, are also very different from subprime mortgages in the early 2000s.
“When it comes to market crashes, there’s no need to worry about it,” Pamela Foohey, a law professor at the University of Georgia and an expert in auto finance and bankruptcy, told CNN Thursday. “I think it’s unsettling that they take out their subprime loans and then they might take back their car if they can’t afford the payment.”
What is a subprime loan, not
Whether it is a mortgage or a car loan, “secondary” refers to borrowers with weak credit scores. However, there are many important differences between subprime mortgages and subprime auto loans.
First, the entire auto loan market is only a small part of the size of the housing mortgage market – one-eighth of the size.
Foohey said the leverage of auto loans is not that leveraged, meaning they are not sold to other investors as often as mortgages, but before the housing market crashed in 2008.
But more importantly, unlike house prices in 2007 and 2008, car values remained stable or rose. Cars are a depreciating asset.
This means that the auto lender or lender who purchases loan-backed bonds, does not expect the car to have an increase in value over the life of the loan. Mortgage lenders and those who purchase mortgage-backed securities are relying on Aughts’ house prices to keep rising to get them withdrawn from any non-performing loans.
“The biggest difference is the lender’s expectations of what will happen to the assets (cars) when the buyer defaults,” Foohey said. “In many ways, the subprime automatic lender actually expects the borrower to default on the borrower and at some point it will quickly take the car back and then resell it.”
For homeowners who missed payments, they can fight foreclosure and stay at home for a long time. Even if the lender possesses it, reselling a home at a high enough price to cover the cost can be difficult and time-consuming.
This is not the case with car loans.
“When a car buyer breaches the contract, the basic law… (allows) the lender to get a car back is very different from the house,” she said.
And returning the car is relatively simple.
Many subprime lenders build GPS features in cars to make it easier for teams that reclaim their vehicles to find them. The lender can even disable the ignition of the car to prevent owners from driving them after defaulting on loans.
Even if it doesn’t match the size and scope of the home mortgage market, the auto loan market is still quite large.
Buying a car is the second biggest purchase made by most families, if not the largest one. As of the end of June, the Fed set the total auto loan balance at $1.7 trillion, while the mortgage loans were $12.9 trillion.
Subprime auto loans accounted for 15% to 16% in the past three years in the entire auto loan market over the past three years, according to Experian data. Part of the market believes that Tricolor operates as “deep grade” 2% of the “deep grade”.
High interest rates and near-record car prices have brought huge car payments to many borrowers. More than 15% of all new car payments, including loans and leases, exceeds $1,000 per month, a record share, according to Experian.
Sub-borrowers and deep sub-borrowers are unlikely to buy new cars. About 23% of used car loans are used for subprime borrowers, and about 3% to “deep subprime” borrowers. But even used cars are at record levels. According to Experian, 4% of used car loans also exceed $1,000 per month, while another 26% range between $600 and $1,000.
This is not only the subprime borrower affected by Tricolor’s bankruptcy—the company has also bundled its loans and sold them to other investors, including banks. Tricolor's filing says its liabilities range from $1 billion to $10 billion, but also lists assets within the same range. The secured lenders listed in the creditors are JPMorgan Chase, Barclays and Fifth Bank.
The fifth third said in a filing last week that it found fraud in its relationship with commercial borrowers and is working with law enforcement. It also said it expects to bear up to $200 million in costs related to the losses.
A spokesperson for the fifth and third confirmed to CNN on Thursday that Tricolor was the commercial borrower mentioned in the document. Tricolor's bankruptcy trustee did not immediately respond to Thursday's request for comment.
Correction: A previous version of this story misunderstood the balance of auto loans as of the end of June. That's $1.7 trillion.