November 6th, 2011
Econintersect: The Los Angeles Times has run a three-part series on the problems of the poor in trying to buy cars. Part one describes the highly profitable “sign, drive, default, repossess and resell” auto business. The business plan runs on a high turnover of selling the same cars over and over again, with high interest rate loans and frequent repossessions. Part 3 describes some of the widely scattered alternatives to the type of business described in Part 1, known as the “Buy Here, Pay Here” (BHPH) used car business. It was in Part 2 that Econintersect found information that set off alarm bells. Click on used car image for LA Times slide show on how the BHPH process works. Follow up:
Follow up:Before we sound the alarm bells, the LA Times has a graphic that shows just how lucrative the BHPH business is:
According to the LA Times, 25% of BHPH cars default compared to 10% of all auto loans. The combination of very high interest and repeat resale of the same cars make the BHPH business extremely profitable. The Times says that investor money is pouring in to BHPH because the average profit on each car sold has been running at 38%.
Econintersect has made a hypothetical calculation with the assumption that the 25% default rate occurs on an average interval of one year. That means that the average care would be sold 1.33 times over four years. That kicks the 38% average profit per sale up the more than 50% profit per car. These are dot.com bubble numbers.
Here is the section in Part 2 that caught our attention:
Buy Here Pay Here is also being boosted by one of the sophisticated financial strategies that drove the nation's recent housing boom and bust: securitization. Loans on decade-old clunkers are being bundled into securities, just as subprime mortgages were a few years ago. In the last two years, investors have bought more than $15 billion in subprime auto securities.
Although they're backed mainly by installment contracts signed by people who can't even qualify for a credit card, most of these bonds have been rated investment grade. Many have received the highest rating: AAA.
That's because rating firms believe that with tens of thousands of loans lumped together, the securities are safe even if some of the loans prove worthless.
Some analysts worry that the rush to securitization could lead to careless lending by dealers eager to sell more loans, as happened with many mortgage-backed bonds.
"We think that investing in such companies is a ticking time bomb," said Joe Keefe, chief executive of Pax World Management, which steers its investments into businesses it deems socially and environmentally responsible. "It has ethical as well as systemic risk implications."
This spring, Moody's warned that the market for subprime auto-loan securities could get overheated. "New market entrants lured by profits and low-cost financing are susceptible to expanding 'too much too fast,'" the ratings firm wrote.
The BHPH dealers have formed a lobby group to represent them before Congress and regulators: Community Auto Finance Assn.
The LA Times articles name many of the larger companies involved in BHPH and a number of non-profits around the country that help the working poor obtain used cars under much more favorble terms.
Hat tip to Roger Erickson