Second of three parts
The J.D. Byrider used-car dealership in Visalia, Calif., sits amid a jumble of tow yards, hubcap vendors and vacant lots littered with empty beer cans. It may not look like much, but selling aging cars to waitresses, secretaries and farmworkers is a lucrative business. That's why private equity firm Altamont Capital Partners of Palo Alto bought the J.D. Byrider chain in May for a reported $50 million.
Altamont's offices, on the 10th floor of a luxury office tower overlooking Stanford University, are 200 miles and a world away from the Visalia lot.
On a recent morning, a dozen executives could be seen huddled in a glass-walled conference room, reviewing a slide presentation on plans to buy some franchised Byrider lots. It's part of a strategy to boost profit at the 135-lot chain, which had sales of $740 million last year.
Firms like Altamont pride themselves on being the smart money, identifying profitable opportunities ahead of the herd. Lately they and other investors are finding just such a windfall in a little-noticed niche of the used-car business known as Buy Here Pay Here.
These dealerships focus on people who need cars to get to work, but can't qualify for conventional loans. They sell aging, high-mileage vehicles at prices well above Kelley Blue Book value and provide their own financing. As lenders of last resort, they can charge interest at three times or more the going rate for regular used-car loans.
Many require customers to return to the lot to make their loan payments — that's why they're called Buy Here Pay Here dealerships.
If buyers default, as about 1 in 4 do, the dealer repossesses the cars and in many cases sells them again.
The dealerships make an average profit of 38% on each sale, according to the National Alliance of Buy Here Pay Here Dealers. That's more than double the profit margin of conventional retail car chains like AutoNation Inc.
"The amount of return from these loans you can't get on Wall Street. You can't get it anywhere," said Michael Diaz, national sales manager for Small Dealers Assistance Inc. in Atlanta, which buys loans originated by Buy Here Pay Here dealers. "It's the gift that keeps giving."
Investor money is pouring into the industry from several sources, helping Buy Here Pay Here dealers expand their reach and raise their profile.
In addition to private equity firms such as Altamont, several payday lending chains are moving into Buy Here Pay Here and have acquired dealerships.
Stock investors are snatching up shares in Buy Here Pay Here chains and other publicly traded companies in the business. Two of the biggest, America's Car-Mart Inc. and Credit Acceptance Corp., have seen big gains in their share prices this year, outpacing the market.
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.
Buy Here Pay Here compared to other non-traditional lenders.
Graphics reporting by Ken Bensinger
Lorena Elebee Los Angeles Times
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."
Others predict that investor scrutiny will shave a few of the sharper edges off a business notorious for high prices and interest rates, and for lightning-fast repossessions. "Investors are looking at the good operators, the ones that want to keep their customers in their cars," said John Nagy, a managing director at investment bank Stephens Inc. "We don't want to associate with the bad apples."
Dealers are using the flood of cash to move into new territories, add inventory and hire aggressively.
Buy Here Pay Here dealers last year founded a trade group, the Community Auto Finance Assn., to represent them before Congress and regulators. That has fueled concern among consumer advocates that the industry is building political muscle to ward off regulation.
"There hasn't been widespread public attention paid to Buy Here Pay Here because mortgages have been such a preoccupation," said Kathleen Keest, senior policy counsel for the nonprofit Center for Responsible Lending.
"It might be an attractive model to investors, but when it's designed to ruthlessly maximize profit, there's no way it can't hurt the consumer," Keest said.
Jeff Williams, chief financial officer of America's Car-Mart, one of the largest Buy Here Pay Here chains, said his company fills a pressing need for millions of Americans who can't qualify for conventional auto loans.
"Our customers live paycheck to paycheck, and we work with them," Williams said. "We consider ourselves to be the good guy of the industry."
The chain started with a single lot in 1981. And like its Bentonville, Ark., neighbor, Wal-Mart Stores Inc., it had grand ambitions. The company now has 111 locations in nine states, including three that opened in the last few weeks.
Car-Mart charges 14% interest on average — significantly less than many competitors. Most of the cars on its lots have about 100,000 miles on the odometer, Williams said.
Shares in the company have risen about 23% this year. By comparison, the better-known CarMax Inc. chain — which sells more expensive, late-model used cars and won't finance people with serious credit problems — has seen its shares fall about 6%.
Car-Mart's profit has nearly doubled over the last four years, to $28.2 million for its most recent fiscal year, while its loan portfolio has grown more than 30%.
Another major player, Credit Acceptance, was founded in the 1970s as one of the first Buy Here Pay Here chains. It eventually moved away from retail auto sales to focus on buying loans issued by other Buy Here Pay Here lots.
It was a shrewd move: Dealers proved eager to trade future revenue streams for cash upfront. Credit Acceptance tries to cherry-pick the highest-quality loans, which it buys at a discount.
In the second quarter of this year, nearly 3,000 dealers sold loans to Credit Acceptance. From 2007 to 2010, the Michigan company's revenue jumped 84% and profit more than tripled — to $170 million last year.
Credit Acceptance combines some of the loans into securities and sells them to investors. The buyers are usually insurance companies, banks, mutual funds and other institutional investors.
What they're buying, essentially, is the right to collect borrowers' loan payments, which are passed on by dealers and assorted intermediaries. If borrowers default, investors are stuck with the loss.
Some Buy Here Pay Here chains securitize their loan portfolios themselves.
DriveTime Automotive Group in Phoenix, a chain of 88 dealerships in 17 states has issued two offerings of bundled car loans this year totaling $461 million.
The securities consist of more than 52,000 loans with an average interest rate of 21%. The borrowers' average credit score was 518, according to rating firm DBRS.
That score, out of a possible 850, is known as "deep subprime." A prime score is anything above 720. More than $7 billion in subprime auto securities were sold by a dozen issuers through June 30, compared with $3 billion for the same period last year, according to Moody's Investors Service and Standard & Poor's Ratings Services.
Subprime auto loan issues now represent a larger percentage of all auto-loan securitizations than at any time since 2006, according to Moody's.
That means people who have never set foot on a Buy Here Pay Here lot, including retirement savers, own a small piece of the business.
OppenheimerFunds, which has more than $188 billion in assets and 11 million shareholders, holds DriveTime securities in at least six of its mutual funds, company reports show.
The returns on subprime auto-loan securities vary, but one offering sold late last year paid 3.5% annually on A-rated bonds maturing in three years — about six times the yield on comparable U.S. Treasury notes. On a $1-million investment, an investor would expect a return of $105,000, plus the principal, over the three years.
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.
Still, Kenneth Morrison, head of the asset finance and securitization practice at law firm Kirkland & Ellis, doesn't think another subprime meltdown is in the making.
"I don't think a blowup would happen because investors are very attuned to that risk now," Morrison said. "But you can't rule it out."
It's the fundamentals of the Buy Here Pay Here business, not securitization, that have been attracting some private equity firms.
Alpine Investors of San Francisco bought Minnesota-based CarHop in 2007 and has doubled the number of lots to 48 in 12 states.
Last year, Serent Capital, also of San Francisco, acquired Tricolor Auto Group in Dallas, a chain with $30 million in revenue in 2009. Serent has opened Tricolor locations in Dallas and Fort Worth and has expanded to Houston. Recruitment pamphlets for salespeople tout potential incomes of up to $250,000 a year.
Tricolor advertises aggressively in Spanish-language media. Its television ads feature a rooster dressed in the white, red and green of the Mexican flag, along with the slogan "orgullo en nuestros carros para nuestra gente" — pride in our cars for our people.
Like other Buy Here Pay Here dealers, the chain courts people on the financial edge.
Clara Gonzalez and her husband, Joaquin Ramirez, bought a 2004 Dodge Durango at a Tricolor lot in Dallas. They traded in their 1999 Ford Expedition and put $1,300 down. To come up with the rest of the $17,000 price, they took on a three-year loan at 18.7% interest, according to the sales contract.
Their payment was $250 every two weeks. It was more than they could handle after Ramirez lost his job in construction and Gonzalez — who made $11.75 an hour working in a school cafeteria — became the sole breadwinner.
The couple filed for bankruptcy. They could have gotten out from under the loan, if they were willing to give up the truck.
They weren't, so they cut a deal with Tricolor to keep the Dodge, court records show.
The payment schedule didn't change: $250 every two weeks.
With many Americans struggling financially but still in need of a car, private equity firms see rapid growth in Buy Here Pay Here.
Altamont Capital, the Palo Alto private equity fund, made J.D. Byrider its first acquisition in May and has since opened six lots. Today, the year-old fund owns 20 of the chain's 135 lots and the rest are franchises.
Newly franchised dealerships pay a $50,000 fee upfront, plus 2.5% of their gross monthly sales, among other fees, according to Byrider documents.
The industry's continued prosperity depends on people like Debbie Acevedo, who bought a 2005 Ford Taurus at the Byrider lot in Visalia.
A 58-year-old restaurant manager, Acevedo cashes her paycheck every two weeks and drives straight to the dealership to make her $180 payment in cash. Because the interest rate is nearly 22%, she'll end up paying almost $18,000 over the four-year life of the loan — nearly four times the Kelley Blue Book value of the car when she bought it.
For Acevedo, whose credit was damaged by bad debts on old loans, the monthly payment is a stretch. She can't even afford a phone. But she sees no alternative: Without the car, she wouldn't be able to get to work.
"Sometimes you gotta do what you gotta do," she said.