Total Finance Investment Inc.

February 13, 2019

We’ve been asking about distress in the automotive industry since our inception and most recently noted in “🚗The Auto Sector is Quietly Restructuring🚗 that activity is picking up in the space. Admittedly, this case isn’t exactly what we had in mind. Nevertheless, earlier this week, Total Finance Investment Inc. and Car Outlet Holding Inc. (and affiliated debtors) filed for bankruptcy in the Northern District of Illinois; the debtors are an integrated chain of buy-here pay-here used vehicle dealerships in Illinois and Wisconsin.

What does “buy-here pay-here” mean? The debtors sold used vehicles, provided financing, AND operated an insurance broker to assist customers with procurement of automobile insurance coverage from third-party insurance providers. They “specifically catered to the fast-growing and underserved population of “unbanked” and “underbanked” Hispanic consumers in Northern Illinois and Milwaukee, which historically made up approximately 70% of the Debtors’ customer base.” There’s just one problem with all of this? Competition is BRUTAL. Per the company:

In recent years, BHPH dealerships have been subject to increasing industry-wide pressures that have negatively impacted their operating results, driving a number of the Debtors’ BHPH competitors out of business. The used vehicle dealership market is highly fragmented and fiercely competitive—with approximately 1,800 used car dealerships in Illinois alone—and the Debtors historically competed with other large used car dealerships like CarMax and DriveTime, as well as other BHPH operations. The fragmented nature of the industry and relatively low barriers to entry have led to steep competition between dealerships, putting significant downward pressure on the margins BHPH dealerships earn on vehicle sales. Further, as a result of a protracted period of increased capital availability, indirect auto lenders such as banks, credit unions, and finance companies have in recent years moved to originate subprime auto loans and offer attractive financing terms to customers with lower than average credit scores, putting pressure on BHPH operators’ market share among their traditional customer base.

Because, like, why not? Nothing has ever gone wrong when there has been excessive competition fiercely pursuing the subprime market. 🙈Ironically, the day before this filing, The Washington Post reported that 7mm Americans have, to the surprise of economists, stopped paying their auto loans. Whooooops. Per the WP:

The data show that most of the borrowers whose auto loans have recently moved into delinquency are people younger than 30 years old and people with low credit scores. Eight percent of borrowers with credit scores below 620 — otherwise known as subprime — went from good standing to delinquent on their auto loans in the fourth quarter of 2018.

No. Bueno. Anyway, back to the debtors. Read this part and tell us you don’t suffer PTSD circa-2008:

…capital markets became increasingly accessible for indirect auto lenders, many of which began to originate subprime loans and offer attractive financing terms to borrowers that historically had been overwhelmingly BHPH customers. The Debtors’ prior management team responded to the change in market conditions by providing larger loans with longer terms, accepting smaller down payments, and accepting transactions with increasingly negative equity in order to increase sales volume. The shift to offering riskier loans to subprime customers ultimately led to the Debtors experiencing historically high delinquency rates and losses beginning in the second half of 2015.

But wait. There’s more:

In addition to increased competition in the auto lending industry, the Debtors have also incurred significant expenses to ensure compliance with new regulations enacted by the Consumer Financial Protection Bureau. Furthermore, the political climate following the 2016 presidential election has had a negative impact on the spending habits of the Debtors’ traditional customer base in a manner that negatively impacted the Debtors’ operating results.

The debtors, therefore, suffered a consolidated pre-tax loss of approximately $29.9mm. MAGA!!!

The company has been trying to improve cash flows and operating results for years. One major initiative included, as far back as 2016, tightening underwriting standards to reduce consumer finance portfolio losses. We sure hope that there are others who took similar steps given the Washington Post report. But we digress.

Back in 2017, the debtors also received an $84mm equity infusion from Marubeni Corporation. Nevertheless, the debtors continued to hemorrhage to the point of compromising compliance with certain financial covenants under their senior secured debt facility with BMO Harris Bank NA. Thereafter, the company entered into a series of forbearance agreements with BMO as it attempted to figure out either a refinancing or an asset sale. In the end, the debtors obtained a restructuring support agreement and filed for bankruptcy to liquidate the used auto business and transfer its auto loan servicing business to a third-party servicer (PETITION Note: earlier this week, The Wall Street Journal reported that the mortgage servicing business is en fuego — notwithstanding the Ditech Holding Corporation bankruptcy (see here). We wonder: what sort of demand is there for subprime auto loan servicing businesses?). BMO Harris will fund the estates with a $4mm DIP credit facility.

So we’re left with this question: is this chapter 11 filing the canary in the coal mine for subprime auto lenders?

• Jurisdiction: N.D. of Illinois (Judge Doyle)

• Capital Structure: see below.

• Professionals:

  • Legal: Sidley Austin LLP (Bojan Guzina, William Evanoff, Jackson Garvey)

  • Conflicts Legal: Togut Segal & Segal LLP

  • Financial Advisor: Portage Point Partners LLC

  • Interim Management: Development Specialists Inc.

  • Investment Banker: Keefe Bruyette & Woods and Miller Buckfire & Co. LLC

  • Claims Agent: KCC (*click on the link above for free docket access)

• Other Professionals:

  • Prepetition Lender: BMO Harris Bank NA

    • Legal: Chapman and Cutler LLP (David Audley, Mia D’Andrea)