The ink on the new financial regulations is not yet dry and General Motors (GM), still a government majority owned firm, is buying a subprime lender. This is an aggressive move for GM and is very politically bold. The decision to exempt auto dealers from the authority of the new Consumer Financial Protection Agency helped create this deal. A significant portion of auto dealership profit comes from financing cars. In many cases financing is more profitable than selling cars. The national lobbies for foreign and domestic car dealers have spent many lobbyist hours and millions of dollars working to exempt members from the Consumer Financial Protection Agency. That time and money is paying off very quickly. We are less than 24 hours into the financial regulation overhaul and already the loopholes are being artfully played.
GM, 61% owned by the US Government, announced 22 July 2010 that it will use $3.5B to purchase AmeriCredit. AmeriCredit is a 20 year old, well established, Texas based auto finance firm. GM and AmeriCredit have been working together since September 2009. AmeriCredit works through auto dealers to make loans to car buyers. AmeriCredit has concentrated on used car loans and loans to low and moderate income subprime borrowers, FICO scores less than 620. Consumer complaint websites are packed with stories of angry consumers and allegations of unfair fees and repossessions. This is true of most subprime lenders. At $3.5B, or about $24.50 per share, GM is paying a high premium for the shares. This is an attempt to generate more business with and profit from the millions of Americans who can't qualify for prime borrowing terms. As you read this more than 1 in 3 Americans has a subprime credit score.
AmeriCredit uses a network of dealers to finance auto loans to folks with imperfect credit histories. The firm then takes and bundles these loans into securities-financial instruments and sells them to investors. AmeriCredit's July 2010 Strategic and Operational Overview references 1% average fees charged and 17% average annual percentage rate (APR) interest charges. This is a very expensive way to buy a car. The firm seeks to earn a profit off the difference between the relatively higher fees charged to car buyers and the lower fees paid to investors in its securities. Money is raised for approximately 3%-4% interest and lent out at 17%; this creates a net-interest margin of 13%-14%. Late and missed payments are a serious issue in this space. The firm very nearly failed during the long and deep decline in the securitization business that began in the end of 2007. Subprime auto lending was well over $100 billion in yearly activity in 2007 and has recently recovered to half of that level. Many of AmeriCredit competitors did fail and this has decreased competition. GM is buying exposure to an area that is volatile, very cyclical and offers significant public relations risk. Unemployment rates are highly correlated with loan delinquency and default in auto lending, especially subprime auto-lending.
The AmeriCredit Investor Factsheet makes clear who the average customers are. AmeriCredit's average loan is 68 months in term and charges an APR of 17%. Between 2005 and 2010 the average US interest rate on a 60 month used car loan was about 7%. AmeriCredit's borrowers are paying about 2.5 times the average interest rate. There is greater risk and profit potential in this kind of lending. The business model sounds similar to the kind of operation that the new financial regulation would cover? GM/AmeriCredit's customers are heavily subprime or near subprime borrowers. The high number of months on the average loan (68) and the average mileage at purchase (34,000) suggest lower income borrowers. The average loan made is over 100% of the value of the car. This increases the cost to the borrower and the risk to the lender. The firm's operations are financed in significant part by securitizing and selling the auto loan bundles to investors. Thus, GM is targeting the profit and ability to sell to near distressed or distressed credit buyers and get investor financing. That should sound like a familiar story.
The more things change the more they stay the same. This very well may make business sense for GM and AmeriCredit. It is amazing to see GM purchase a subprime lending and securitization firm the day after the new financial regulations pass. Of course, the $3.5B price tag makes Uncle Sam a co-investor in the subprime auto and securitization business.