28,757,728 reasons to worry about subprime auto loans

Signs of risk in the subprime auto loan market are mounting. As stated earlier, the components that underpin these loans are unsustainable: very old cars, countless added extra costs, long terms, and insanely high interest rates. This math will struggle to work in any economy, let alone today. Recent developments signal that the struggle is reaching a fever pitch.

First, Credit Acceptance Corporation, a major subprime auto lender, issued an 8-K on April 20, 2020 in which it disclosed that its quarterly filing will be delayed. These situations can happen, especially in today’s environment, but it’s not something anyone would consider a good development.

Second, in that same case, the company disclosed that its business was in trouble and that it would be adding a new risk factor to their 10-K. The new risk factor is interesting for several reasons:

  • New risk factors are always intriguing: Arguably, you should spend a lot more time reading the 10-K risk factors than listening to management talk. Why? Management knows that if there is a problem and it is not listed as a risk factor, they could have legal problems in the future. In poker terms, it’s often a “say” about what’s really going on.
  • Liquidity comments: The 8-K said: “…it is likely that the pandemic will adversely affect our business, our team members, current and potential consumers, automotive dealers and suppliers, as well as our financial condition, liquidity and results of operations. This is true for many businesses, but perhaps even more so for subprime auto lenders.
  • Comments on Consumer Late Payments: Then the 8-K said that the economic situation, “…has led to increased unemployment and led many consumers to delay payments or reallocate resources, which has resulted in a significant decrease in our realized collections. We are working with our consumers to provide temporary relief in the possible, including the suspension of involuntary repossessions of vehicles. It would be interesting to know what these temporary relief programs consist of. Sometimes players in this industry delay payments, but with exorbitant penalties and fees.
  • Comments on used car prices: Then, specifies the company, “Furthermore, a recession or further correction in financial markets resulting from the spread of COVID-19 could negatively affect demand for used vehicles.” If your business relies on repossessing cars, but the value of those cars drops dramatically, it can lead to big problems. Especially if around 35% of loans historically don’t work, which begs the question of how many loans won’t work in a worse economy.

Now, many astute bean counters may be thinking, “Okay, the deposit delay and new risk factor are great, but what about the other 28,757,726 reasons referenced in the title?” Is equivalent to Insider Selling by Founder and Former Chairman of Credit Acceptance Corporation, Donald Foss. Here are its open market sales over the past few weeks, as detailed by Bloomberg:

  • March 24, 2020: 17,366 shares x 260/share = $4,519,502
  • March 25, 2020: 10,100 shares x 280/share = $2,835,171
  • March 26, 2020: 3,200 shares x 302/share = $965,728
  • April 2, 2020: 5,170 shares x 237/share = $1,233,998
  • April 6, 2020: 30,000 shares x 252/share = $7,566,300
  • April 7, 2020: 8,530 shares x 261/share = $2,227,354
  • April 8, 2020: 11,309 shares x 272/share = $3,076,274
  • April 9, 2020: 20,000 shares x 317/share = $6,343,400

Grand total: $28,757,726. Now that’s a good catch for a few weeks. The payout was aided by the Federal Reserve’s purchase of junk bonds which, in turn, fueled a rise in stock prices of debt-related companies and leveraged business models. Donald Foss is expected to send a thank you card to Federal Reserve Chairman Jerome Powell.

We will likely hear a lot more about subprime auto loans in the weeks and months to come. Discussions will take place on:

  • Bullish and bearish cases for equity and debt.
  • Analysis of cash flows and delinquency rates.
  • The need to support the automotive ABS market.

Lost in these discussions will be the fact that there are real people indebted to these loans. And the terrible irony is that many people on the front lines of this pandemic – delivery people, healthcare workers and restaurant workers – are the first to pay. Many will say that is the risk we should be trying to mitigate, not ‘fix’, the financial markets that fueled this kind of debt in the first place.