What Auto Bubble? Subprime Lender Looks to Deflate Critics

Heading into the financial crisis, few would have predicted just how many Americans would give up on their mortgages but continue paying their car loans. In the years since, that surprising phenomenon helped fueled the rapid resurgence of subprime auto lending.

Today, many car buyers with marred credit histories are taking out longer loans at sky-high interest rates, spurring concerns about the formation of another bubble. Despite new scrutiny from the Justice Department and other agencies, investors keep gobbling up subprime auto-backed bonds.

One of the companies riding the wave is Exeter Finance in Irving, Texas, which has grown its portfolio from $150 million to $2.8 billion in just three years. In the first half of 2014, Exeter was the nation's third-largest issuer of subprime auto bonds, according to Standard & Poor's.

Despite the rapid balance-sheet growth, the firm, which is majority-owned by the private-equity giant Blackstone Group, has been operating in the red.

Last November, Exeter brought in a new chief executive officer, Thomas Anderson, 51, who previously worked at Capital One Financial and Sallie Mae. Most recently, Anderson served as CEO of Education Dynamics LLC, which helps colleges find prospective students.

Anderson's own biography touts his "track record in turnaround results." But during an interview last week, he balked at being characterized as a "turnaround guy."

"I'll sort of take that as a compliment, but I've never actually thought of myself that way," he said.

Anderson said that the costs associated with Exeter's rapid growth, which include reserves for loans expected to go bad, have resulted in short-term losses. But he argued that those numbers are misleading.

"I don't view this as a turnaround from an economic point of view," Anderson said. "If we wanted to drop a bottom-line profit, we could just slow down the growth, or turn down the marketing."

In a 25-minute interview, Anderson spoke about his company's interest in an initial public offering, the close scrutiny the industry is attracting from authorities, and the prevalence of falsified loan applications at U.S. auto dealers. He also argued that comparisons between the subprime mortgage bubble and subprime auto lending today are unfounded.

What follows is an edited and condensed transcript.

There's been some speculation about the possibility of an Exeter IPO. Is that something that's on the table?

THOMAS ANDERSON: Here's the way I would position it. A lending business, by definition if you're growing, is a capital-consuming business. We're very fortunate in that we have backers that believe in us and have continued to put capital in.

At some point we're going to clearly need to access additional sources of capital. The approach I'm taking on this is we are operating as if we are going to go public.

I think it's probably unlikely in '15, but I wouldn't rule it out.

There's obviously been a turn in terms of the level of regulatory scrutiny your industry is facing. Has that led to changes inside your company?

It's clearly an industry that has lots of attention and focus right now, whether it's the media or regulatory bodies. We don't see any reason that that will stop. It will continue, I think, and probably more so than less so.

I think probably the only real meaningful, tangible difference is it's led us to have kind of more people in, I'll call it the legal department, that are scrutinizing all of the different legal requirements.

In terms of our operating practice, we have a basic philosophy in this, which is: we're in the subprime auto space. These are folks that need an automobile to succeed in our society. On the more challenged side from an economic point of view and a credit point of view, but that doesn't mean that they don't deserve to be treated fairly and with respect. If we really focus on that, we'll be fine with the regulators.

Has the increased focus by regulators had any impact on the demand among investors for subprime auto-backed securities?

I asked that question myself when I got here, and frankly even before I got here as part of the interview process. And at least to date the answer is no.

In different investor meetings, there's an additional set of questions they tend to ask. "Gee, what about this story?" "What are you doing to make sure you're compliant with this?"

But it hasn't changed any of the actual number or demand from the investor side. And I'm guessing a lot of that is: either they're comfortable with the answers, or they also look at the performance of securitizations, and they're happy with them.

Have you received subpoenas from the Justice Department or any other agencies?

So typically we don't disclose that. I will say we have received some, but only ones that everyone else has received. We've not received any that are isolated to us.

I was looking at some of the details from a $500 million securitization that Exeter did back in August.

The average APR on those loans was 18.59%. The original term length was 70 months. Seventy-five percent of these loans had a loan-to-value ratio of over 105%. Eighty-one percent of the borrowers had a FICO score of below 600. And yet some of the securities that these loans are turned into are rated AAA.

From the perspective of a lot of outside observers, it looks like a replay of what happened in subprime mortgages. How do you respond to that?

If you actually look at auto loans, I don't believe there's ever been a securitization that hasn't paid, including through the financial crisis. They're structured completely different from mortgage securitizations.

We take first-dollar risk, we're required to hold more capital. It's a very different structure than what the mortgage stuff was.

I had one person ask me, shortly after I got here, "'You know, what happens if you have another 2006, 2007, 2008?' "I said: "'What are you talking about? We did. Every single one paid.'"

Now that doesn't mean we don't worry about risk, and we're not going to stay focused on it. We're in a risk business.

There have also been concerns raised about falsified information on auto loan applications. Do you think that's a significant problem, and are you doing anything to address it or try to prevent it?

Unlike the mortgage market before the financial crisis, we actually take the dollar risk on these losses up front. So we care a lot about this.

The vast, vast majority of dealers are responsible, and try to have right information. But I'd say not 100%. And most consumers I think are also providing accurate information, but probably not 100%.

So we have a process. We verify the information on the application. We contact 100% of the consumers after they've been through the dealership. We verify a bunch of the information. If it changes or is different than what we're told, then we modify the loan or reject it.

If we find dealers that have inaccurate information and a pattern, we won't do business with them.

The good news is I don't think it's widespread. But there are some instances, and so we police that thing like crazy.