THE WOLF STREET REPORT
Second PE-Firm-Owned Subprime Auto Dealer & Lender Suddenly Shuts Down after its Subprime Auto-Loan Bonds Make a Huge Mess
by Wolf Richter • Apr 18, 2023 • 128 Comments
“Net losses and gross charge-offs were understated” – Oopsie?
By Wolf Richter for WOLF STREET.
U.S. Auto Sales, a dealer chain owned by a private equity firm and focused on selling and financing lower-end older used vehicles to subprime-rated customers, suddenly “temporarily” shut its 39 dealerships in six southern states today, with a terse announcement on its website:
Attention U.S. Auto Customers. We have temporarily closed our dealerships and are working on a solution to re-open them as soon as possible. But don’t worry, we aren’t going anywhere! U.S. Auto’s affiliated loan servicing company (USASF Servicing LLC) is still open to accept your payments and assist in servicing your account. Please continue to make your payments as scheduled and reach out to us with any account questions.
Sincerely, -The U.S. Auto Team
The Lawrenceville, GA, headquartered company is owned by PE firm Milestone Partners. As part of its business, it securitizes the subprime auto loans via its funding unit, US Auto Funding, into Asset Backed Securities and sells those ABS to investors. US Auto Funding issued four of those ABS already, one a year.
At the end of June 2022, it securitized the last of the four batches of subprime auto loans into $233 million of ABS. Moody’s rated the various tranches of that bond issue from A3 at the high end to B3 at the low end. A3 is four notches into investment grade. B3 is six notches into junk. The lower-rated tranches take the first loss, starting with the equity tranche retained by the issuer, and they can quickly get wiped out if there are problems. The top tranches take the last loss, and are largely protected (here’s my cheat sheet for corporate credit ratings by ratings agency).
“Net losses and gross charge-offs were understated” – Oopsie?Ominously, on March 31, Moody’s slashed its credit ratings of the ABS issued in 2021 and of the ABS issued in 2022. On both ABS, it slashed the lower tranches by two notches. Of the 2022 ABS, it slashed the lowest tranche, the Class E Notes, from Caa2 to Ca, which is just one notch from default, nine months after having been issued.
The whole thing was a huge mess. Moody’s explains:
“The rating action is primarily driven by USASF’s recent restatement of gross and net loss data for the underlying loan pools,” Moody’s said.
“In the March servicer report, USASF disclosed that it had identified an error in the allocation of payments among principal, interest and recoveries contained in the servicer reports for the reporting periods from August 2022 through January 2023,” Moody’s said.
“The March servicer report indicates that the error had no impact on the total collections available to investors in any of the reporting periods, but notes that the error did impact the net losses and gross charge-offs, and that net losses and gross charge-offs were understated in some of the servicer reports,” Moody’s said (emphasis added).
Moody’s goes on to explain that the company has now “provided restated loss data for the current period,” and that for the ABS issued in 2021, “cumulative net loss-to-liquidation increased to 37.3% in March from 31.8% as reported in February,” and for that the ABS issued in 2022, it increased “to 45.8% in March from 32.9% as reported in February.”
Moody’s then increased its “lifetime expected net loss estimates for the underlying pools” to 40% for the ABS issued in 2021 and to 46% for the ABS issued in 2022. So that was quite an oopsie.
Which dooms the next ABS sale. So forget it and close the doors?Subprime is so called for a reason: The customers have a bad record in paying back their debts, and so they have low credit scores, but they can still borrow money, but must pay very high interest rates to the lenders so that lenders are willing to take those risks. Lenders make huge profits on these high interest rates, and investors greedily gobble up the ABS because they offer a higher yield, and Wall Street makes a ton off the fees, and everyone is happy…
Until the customers cannot make the payments because the interest rate is too high, and so the subprime loan becomes a self-fulfilling prophecy, further besmudging the credit history of the borrower, and the lender has to go out and repo the vehicle and sell it at auction.
But it gets a lot worse…Because specialized subprime is the slimy underbelly of the auto business, and it always gets a lot worse when you look at it more closely. According to a report by Kroll Bond Rating Agency, cited by Bloomberg, the loans in the ABS issued in 2022 had:
Average FICO score of 518 (620 and below is normally subprime)Average LTV (loan-to-value ratio) of over 150% holy-moly!Average loan amount: $20,199. With 150% LTV, it means the vehicle was worth $13,500 at the time of the sale.Average interest rate: 18%.In short, if you wanted to design auto loans to blow up and do a lot of damage, that’s how you’d do it.
PE firms, auto dealers, investors, bond funds… they all get into subprime auto lending because of its high yields. It’s a hugely profitable business until investors suddenly catch the heat.
Second time in two months that a PE-firm-owned subprime auto dealer shut down.In late February, American Car Center, which had over 40 subprime-focused dealerships around the country, and which was owned by PE firm York Capital Management, suddenly shut down a day after it was forced to scuttle a $222 million bond sale.
The bond sale was backed by the subprime loans it had originated to fund the sales of its used vehicles. The company cited “market conditions” for scuttling the bond sale, and without this $222 million in new funding from the sales proceeds, it appears the company ran out of funds to continue, and just shut down.
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