The potential warning sign of an auto lender’s bankruptcy

Nearly two decades ago, the collapse of the subprime home loan market sparked the Great Recession and devastated the economy. There are echoes of that history in the recent collapse of Tricolor Holdings, a subprime auto lender.

Tricolor’s bankruptcy filing last week has “prompted questions about the health” of the auto finance sector, said Financial Times. The Texas firm was a “fast-growing lender” that quadrupled in size in recent years, making most of its loans to low-income Latino immigrants and other “borrowers with limited credit histories.” Tricolor charged that “financially precarious” customer base an average interest rate of 17% for loans. President Donald Trump’s deportations undercut that business model. Many borrowers were “deported back to Mexico, and they abandoned the vehicles,” said one former Tricolor employee. There were additional problems: Tricolor faces a federal fraud investigation, and the broader auto loan market has been marked by a growing number of borrower defaults and car repossessions. The company’s unraveling is "just an extreme example" of the sector’s challenges, said Rod Dubitsky, an independent financial analyst.

How does this affect the financial markets?

The crisis is “ensnaring giants including JPMorgan Chase and BlackRock,” companies that are among outlets that “lent hundreds of millions of dollars” to Tricolor, said Bloomberg. Perhaps that should not be a surprise: The auto loan market has shown “clear signs of strain,” with “mounting consumer stress and a surge in delinquencies” forcing other subprime lenders into bankruptcy, and car repossessions rising to their highest level since 2009. With the economy continuing to show signs of slowing, “market watchers say more pain is likely ahead.”

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Is this like the subprime mortgage crisis?

Opinions differ. Tricolor’s troubles “aren’t likely to upend the broader financial services industry” as happened in 2008, said CNN. That crisis forced the federal government to “pour billions into each of the nation’s major banks” in order to keep the American economy from collapsing entirely. But the $1.7 trillion car loan market is an eighth the size of the home mortgage sector. That makes subprime auto loans a “very different animal.”

The unraveling of Tricolor could be a “canary in a subprime debt mine,” The Wall Street Journal said in an editorial. The company’s troubles raise the possibility that creditors and investors ignored “financial and other risks hiding in plain sight.” The firm’s business “grew amid the Biden-era surge in migration and auto prices,” and more than two-thirds of Tricolor’s borrowers had no credit score. Despite the broader warning signs, investors still “snap up” subprime debt owed by low-income borrowers. That could be a “harbinger” of more problems.

What’s next?

“Tricolor’s collapse isn’t just about one company,” said Moneywise. When an auto lender fails and borrowers cannot pay their loans, “it signals trouble for the whole economy.” It also becomes a headache for borrowers in general. Lenders are “getting pickier” about who they lend to, so “buying a car will get even harder.” The one spot of hope? The Federal Reserve could soon cut interest rates, “which could provide some relief.”