Tricolor is not the bellwether of subprime auto market (Off the Lot)

Since Tricolor ’s Sept. 10 bankruptcy filing, a lot has been said about how Tricolor may be an analogue for the condition of the subprime finance industry, including companies and borrowers. I am going to attempt to clarify how I believe Tricolor is different from most other lenders in the market; how banks and lenders in our industry can better protect themselves with better due diligence; and why this business model is different from the industry in general. Tricolor has been the subject of multiple articles replete with allegations of fraud and misdeeds . I will explore instead why this model seems to be more susceptible to ending in fraudulent activity . Buy here, pay here The difference between Tricolor and traditional subprime finance companies is the connection to the buy here, pay here (BHPH) source of receivables. Tricolor’s financing was only available to customers of its sales arm. This differs from other finance companies, which have less concentration from one seller. This is not the first finance entity with a BHPH arm that has failed. U.S. Auto Sales and USASF failed in 2023 and 2024, resulting in bankruptcy. American Car Center and American Financial failed in 2023. Credit Nation Auto Sales and Credit Nation Lending Services failed in 2016, resulting in bankruptcy and in several cases of regulatory action. It would be fair to ask whether the combination of a finance company dependent on a BHPH dealership relationship truly functions in the long term. At the very least, additional scrutiny must be applied to this model. Some of the reasons they are attractive also add risk for their capital sources if the model fails. A lender looking at a traditional finance company looks for compliance rules, fair lending, dealer concentration and, depending on the lender’s size, geographic concentration. Interestingly, most of the cases above were heavily concentrated in the Southeast. A benefit touted by BHPH finance companies is their resale arm. An unaffiliated finance company sells its repossessions through commercially acceptable, arms-length auctions while a BHPH company typically sells through its own dealerships. BHPHs have long claimed this option affords them the ability to sell their repossessions at higher prices, reducing cumulative net losses. They can develop a history of lower losses because of this sales model, selling repossessions closer to retail and reducing losses to the finance company. When these companies look to secure financing, they are typically able to show lower losses and better performance. They may gain better terms on their warehouse lines and securitizations from the standpoint of advance rates, spreads or other terms associated with the financing deal. Exposure points The capital provider is relying on performance to determine losses. But, what happens if the total entity fails? The servicing is transferred to a backup servicer that will begin servicing the portfolio in a non-affiliated way, more typically like a conventional finance company, selling repossessions through a normal commercial market. Losses will be significantly higher, and capital providers will experience much higher losses. Another potential exposure point is if the finance company has multiple warehouse lines. In the Tricolor situation, it is alleged that there was pledging of certain receivables on more than one warehouse line . If the lender has multiple lines of credit, a different level of audit and due diligence must be performed to ensure there is no fraud. Assuming fraudulent activity is not the intent of a lender, but an attempt to survive a failed business model, more imagination must be applied in the audit process to assure capital providers that everything is being operated as represented and as intended. The Tricolor situation, much like the others identified, unraveled quickly, but the conditions are likely to have been brewing for some time. Preventing implosions Capital providers must consider their risk management assessment of BHPH lenders and, rather than ingest their existing loss experiences, impute a loss experience based on the Manheim Market Report or other tools to determine fair market value of the vehicles being sold. Actual losses to the finance arm are absorbed in the dealership, resulting in a lower resale profit per unit on repossessed vehicles, instead of higher losses in the finance company. However, in the event of a failure of the entity and transfer of servicing , the bond holders and capital providers will experience higher losses . If modeled up front, this would result in different levels of warehouse line or securitization deal structures, more in line with unaffiliated lenders. Audits on an account-level basis are incomplete when a dealership is involved . While an account may be on more than one warehouse line or accounts could be created on multiple customers on a vehicle, what is constant is the vehicle. Doing an audit using the vehicle identification number as the identifier will determine if more than one borrower has been sold a vehicle. The VIN goes into the dealerships’ books, then the finance company’s books, and then if defaulted, where the vehicle was sold — either at auction or retail. If sold at retail, was another receivable created and did it end up on one of the warehouse lines, without being cleared from a previous warehouse line? In addition, warehouse line providers doing an audit on their own accounts may lead to an incomplete picture without running the accounts being audited by VIN and comparing to the other warehouse lines to assure no VIN is pledged more than one time. In extreme cases of fraudulent intent, more than one contract could be created on a single vehicle and pledged without triggering scrutiny unless audits were VIN-based instead of solely account or retail borrower based. Tricolor touted its Community Development Financial Institutions status as an achievement and became attractive to certain funds that focused on CDFI institutions. When the finance arm is associated with the dealership, while the finance company may appear to be eligible for CDFI status, its dealerships are still generating significant profits and sometimes outsized profitability, allowing for an offset on the finance side for lower rates or more favorable terms. The customer’s transaction in totality may not be as beneficial as being financed with a dealership and an unaffiliated finance company. In addition, the focus on one specific community would typically cause alarms in capital providers and should in the future. While problems may have been developing years earlier, the escalation of issues was likely exacerbated by the current immigration policies. Tricolor had a primarily Hispanic clientele. Of borrowers, 62% had no credit score, 69% were undocumented and more than 50% had no driver’s license. This level of concentration in one customer base is ill advised in any environment, and given the fair lending requirements, a variety of customers and acquisitions from a variety of dealers, is unlikely to occur for most lenders. Some additional risk must be built in when there is this much homogeneity, both on a regulatory and exposure basis. Payment flow becomes vital to the existence of a substitute servicer’s ability to assume and then perform with an absorbed portfolio. Capital providers should assure that nearly all payments were received in one master account to which they could take control in the event of a default. Allowing cash payments, dealership kiosks and other such approaches makes it nearly impossible for a sub-servicer to get control of the payments. Using a payment partner that can facilitate the cash customer as well as those making payments with multiple sources and all being received electronically will reduce exposure and make it easier for a customer to rely on a payment process in the event of a failure. Not indicative of wider market While nearly every financial publication has questioned whether Tricolor is indicative of the condition of the subprime consumer, I would caution any capital provider to assume this is the case. Certainly, we have seen significant inflation in the past few years, but there is also solid wage growth. The jobs market is tight, and there is still some wage inflation. Public policy decisions on government layoffs, H1B visa restrictions and immigration controls may lead to a softer job market and change this equation, but for now, the job market is still solid. Interest rates being higher for longer doesn’t typically affect the subprime borrower because in many cases their rates are fixed by state regulatory caps, in which case they haven’t changed significantly. As rates come down, existing companies may benefit from additional spread in their net interest margins as their borrowing costs come down and slightly release profitability pressure. In conclusion, I would caution capital providers not to overestimate the meaning of the Tricolor defaults on the general subprime finance industry. However, there should be lessons taken from this and other notable failures and their commonality of business models — a finance company with an affiliated sales arm. The analyses of performance should be conducted as if they were unaffiliated and would inform the likely portfolio performance which would be experienced by investors, if they weren’t controlling both sides of the deal or were to fail. Additionally, some of the audit procedures to include more VIN-based “true-ups” than simply account- or receivable-based audits should be rethought. Off the Lot is a monthly column from auto industry consultant Bruce Newmark, formally chief adviser of Vroom and United Auto Credit Corp . Newmark has more than 45 years of experience in automotive retail and finance. Before joining Vroom, Newmark’s tenure spanned leadership roles at Fimanco, Ford Motor Co., Hankey Automotive Group and Westlake Financial. The opinions he expresses are his own. Stay up to date on all the news coming out of Auto Finance Summit 2025 here .

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Tricolor is not the bellwether of subprime auto market (Off the Lot)

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