Tricolor collapse sparks concern about health of US subprime auto sector
Texas lender’s rapid failure leaves trail of losses and questions in a fast-growing Wall Street market
Amelia Pollard in Dallas and Akila Quinio, Antoine Gara and Jamie John in New York
Lucia Hernandez, who works for a loan servicing company outside San Antonio, was thrilled in July to purchase a used Chevrolet Trailblazer, a sport utility vehicle that looked new, for $30,000 from the car dealer Tricolor Holdings.
The terms seemed fair.
She put down $3,500 and would make biweekly payments of $357 to repay the loan.
But a few weeks after buying the car, the transmission broke, forcing her to take it to the repair shop, which Tricolor also owned.
For days, she received regular text updates about the repair.
Then the messages stopped.
She went to the repair shop with her husband last Monday to discover that it was closed down.
There was not even a sign in the window.
“We’re expected to make payments for a vehicle we don’t even have,” she said.
“Everybody’s just trying to find answers.”
The collapse last week of the subprime auto lender in Texas has left a trail of losses and questions from Wall Street to low-income immigrant communities throughout the American south-west.
The US Department of Justice is investigating Tricolor over fraud allegations, the Financial Times has reported.
Tricolor Holdings, which sold used cars and offered financing to primarily Hispanic immigrants with little credit history, unravelled in a matter of days.
The regional bank Fifth Third last Tuesday disclosed it would write down the bulk of a $200mn loan after it unearthed “fraudulent activity” by one of its corporate clients.
The Financial Times reported that this client was Tricolor.
Less than 24 hours later, the auto lender filed to liquidate through bankruptcy court.
Its failure has prompted questions about the health of the $1.7tn auto finance sector, a niche but fast-growing part of Wall Street’s securitisation market.
Trillions of dollars in debts backed by assets such as car loans, farm equipment and aircraft are bundled annually by banks into securities and sold off to investors such as insurance companies and pension funds managing the savings of retirees.
In subprime auto loans, Tricolor had emerged as a fast-growing lender, bundling and selling $1.4bn of debt across 14 bond offerings, quadrupling in size over the past five years.
Its growth was funded by five lenders led by JPMorgan Chase, the largest bank in America, who collectively gave Tricolor about $1bn in revolving credit that it could draw on to make loans and then repay when they were packaged into securities.
“There is no doubt there are problems in subprime auto, and the problems have been growing for years,” said Rod Dubitsky, an independent consultant who formerly worked at Moody’s rating agency and Credit Suisse.
“This is just an extreme example of what’s affecting the entire subprime and prime auto market.”
Tricolor was founded in 2007 by Daniel Chu, who led the company as chief executive and was its majority owner until it shut down last week.
Chu did not respond to requests for comment.
Tricolor first hired bankruptcy advisers in August for a Chapter 11 restructuring, which would have allowed it to continue operating, said people familiar with the matter.
High interest rates over the past couple of years had put pressure on the company and its auto loan borrowers.
Tricolor’s customers were mostly immigrant workers in the “cash economy”, who worked in jobs such as construction without citizenship, and borrowers with limited credit histories, according to S&P Ratings, which rated its bonds.
Tricolor made most of its loans to customers who do not carry a credit score and about half did not have a social security number.
Most borrowers also did not provide a driver’s licence.
Tricolor was able to win over Wall Street investors despite its financially precarious customer base by asking car buyers to post unusually high down payments of 11 per cent of vehicle price and charging interest rates of around 17 per cent, on average.
Customers’ interest payments were made biweekly instead of monthly and in the event a customer defaulted, vehicles were equipped with GPS devices to help lenders quickly repossess them, S&P said in a June report.
Tricolor also employed an army of mechanics called “reconditioning” workers to refurbish cars from defaulted loans and sell them to the next buyer.
But mass deportations and US Immigration and Customs Enforcement raids under the Trump administration compounded that existing financial stress, putting even more pressure on Tricolor’s primary customer base.
S&P’s most recent ratings included extra modelling to account for “changes in immigration policies and enforcement . . . that could lead to higher delinquency and loss levels”.
“Once the Trump administration started we started having a lot of problems with these customers not being able to make a payment or too afraid to go outside home and being deported,” said a worker who was let go this month.
“We did have a lot of customers being deported back to Mexico and they abandoned the vehicles.”
Jesse Edwards, an administrative assistant at a California subsidiary of Tricolor, told the Financial Times that sales there had slowed substantially this year and its lots were filled with unsold cars.
He suggested the business model was predatory as Tricolor would sell a car to someone who might struggle to make the loan’s repayments, repossess the vehicle and resell it, pocketing lucrative downpayments and interest along the way from a single vehicle.
JPMorgan began probing suspicious activity at Tricolor at the end of August, according to people familiar with the matter.
One area of concern was whether Tricolor pledged the same collateral on multiple loans, said two other people familiar with the matter.
The bank contacted Tricolor about the potential problems.
Tricolor then notified its restructuring lawyers at Sidley Austin that something was awry.
JPMorgan quickly hired FTI Consulting to run a forensic analysis of the company, according to two people familiar with the matter.
It also alerted the Department of Justice, the Financial Times previously reported.
Sidley Austin and the company’s other advisers — including consultants at Alvarez & Marsal — rushed to launch their own inquiry.
Yet before they could determine who was culpable, and what had exactly taken place, the company ran out of cash.
At the start of September, it became clear Tricolor would need to liquidate instead of going through an orderly bankruptcy.
This month it laid off nearly all of its roughly 1,500 employees.
“It was so crazy when we realised the scale of it,” said one person who worked closely with the company in its final days.
“We had a fraction of the money we were told we had.
Creditors were beating down the doors.
It was all around a very stressful situation.”
Some of Wall Street’s most credible lenders and rating agencies had given the company an implicit seal of approval in recent months.
Tricolor’s biggest lenders — JPMorgan, Barclays and Fifth Third — lent hundreds of millions of dollars to the company in recent years.
Other secured lenders listed in Tricolor’s bankruptcy filings include an entity affiliated with MassPRIM, the Massachusetts state pension fund which manages $115bn, and Triumph Financial, a community bank with about $6.5bn in assets.
Triumph said it was “working to secure its vehicle collateral” on a $61mn loan facility, of which it holds approximately $23mn.
It declined to comment further. JPMorgan and regional bank Fifth Third have about $200mn worth of exposure each, the FT previously reported.
The subprime auto lender also soon became a darling of the rush into environmental, social and governance investments.
BlackRock put $90mn behind Tricolor in 2021, touting it as one of the asset manager’s first commitments in its “impact opportunities” strategy and for its use of artificial intelligence.
“It’s nonsense that it’s so heavily touted as an ESG” investment, said Dubitsky.
“It’s either a neutral product or a predatory product.”
This year, Tricolor also had its bonds rated by firms like Kroll Bond Rating Agency and S&P Global Ratings, which both blessed the least risky tranches with triple A and double A ratings, respectively.
Wall Street quickly ingested those bonds.
Major asset managers like Charles Schwab, Pimco and Capital Group snapped them up for their funds, according to regulatory filings.
Like Hernandez, the borrower for the Chevrolet Trailblazer sitting in a reconditioning lot, the banks and investors who had taken part in Tricolor’s lending machinery are now left to wonder how severe their losses will be.
KBRA, the rating agency, said last week it had been unable to reach the company in its efforts to quantify the wreckage.
JPMorgan, BlackRock, Sidley Austin, Pimco, Capital Group and FTI declined to comment.
Tricolor, Alvarez & Marsal and Charles Schwab were not immediately available for comment.
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