A subprime auto lender collapsed. Wall Street has questions

0:00In 1898, John Nuveen had a vision to underwrite municipal bonds that would propel American infrastructure into the 20th century. More than 125 years later, that vision lives on. Today, Nuveen has grown into a leading global asset manager with expertise spanning public and private markets, still investing with a future in mind. Nuveen. Invest like the future is watching. Visit nuveen.com slash future to learn more. Investing involves risk. Principal loss is possible. It's Monday, September 15th. And it looks as if there was, like, an emergency evacuation. There's notes on the front desk and packages stacked up next to each other.

0:45That's my colleague Amelia Pollard. She's the FT's U.S. investment correspondent. And she's standing on the side of a highway just outside Dallas, Texas, peering into the reception area of a large car refurbishing center. Basically like a giant repair shop. It's a massive refurbishing center. Like, I mean, it just stretches back the equivalent of like seven city blocks. And there's like maybe 100 cars like sitting outside. The reason she's here is because this place is part of a sprawling auto business that collapsed earlier this month. It's huge. but there are orange cones blocking off the driveway clearly trying to prevent people from getting in.

1:37You've probably never heard of it before but this business that collapsed is called Tricolore Holdings. It's a subprime auto dealer and lender which means they work with customers with risky credit profiles. And its recent failure raised alarm bells from Main Street to Wall Street.

2:00I'm Michaela Tendera from the Financial Times. Today on Behind the Money, we're looking at what we know about the collapse of Tricolore Holdings and what questions it's raised for major firms on Wall Street.

2:33Our story begins on a Wednesday morning earlier this month. Welcome to day three of Barclays 23rd Annual Global Financial Services Conference. Thank you. We appreciate all your attendance here. We had a jam-packed... It's around 7.30 a.m. at this banking conference. And kicking off the festivities this morning, pleased to welcome back Fifth Third from the company once again, CEO Tim Spence, CFO... Tim Spence, the CEO of this American regional bank called Fifth Third, starts off with some news about his company. Good morning, everybody. As Jason mentioned, we published a slide presentation last night to our investor relations website.

3:14It transpired that the night before the company had filed this regulatory filing, disclosing that they were facing potential losses on a loan worth about$200 million. That's my colleague Akilah Quino, who covers U.S. banks for the FT. She's been reporting on this with Amelia. And so they also said in the filing that they had discovered alleged, quote, fraudulent activity, which obviously raised alarm bells. While we continue to investigate the matter, at the moment we currently estimate the loss to be substantially all of it. Needless to say, we're deeply disappointed with this development and the impact that it's going to have on an otherwise strong quarter.

3:53Fifth Third doesn't name who's responsible for this$200 million loss. And that sends our colleagues scrambling. Immediately, people started to wonder who that client was, who the borrower was, who might not be able to repay them. We then wanted to find out who else might be exposed. And then the next question was, you know, why? Why that had happened? Quickly, Akilah gets a name. So that client was Tricolor Holdings, which is a small U.S. subprime car lender that many people hadn't heard about before on Wall Street. So it is a car finance lender which sells used cars and loans to consumers so that they can purchase those cars.

4:33And actually, this specific company, they specialized in lending to low-income people in the Hispanic communities in the Southwest. As a subprime lender, Tricolor would offer car loans to people who didn't have good credit or often no credit at all. Many customers didn't submit driver's licenses or social security numbers in order to take out a loan. The interesting thing is that Tricolor branded itself as this kind of social purpose company, kind of wrote the wave of ESG, and presented itself as a lender that helped underserved communities and people who don't traditionally get access to credit get credit.

5:14With Tricolor identified, Akilah, Amelia, and our colleagues kept digging. It turned out Fifth Third wasn't the only bank that had lent Tricolor money. We managed to confirm that JPMorgan and Barclays, the UK bank, also had similar levels of exposure to what Fifth Third had lent, so about$200 million. Some other regional banks were also exposed to this fallout. And then more sudden news comes out within a few hours of that banking conference. Here's Amelia. Around noon or 1 p.m., Tricolore files for Chapter 7 bankruptcy in Texas, which means that in a matter of hours, the whole company has collapsed.

5:53and is liquidating entirely. And so then the question was, you know, what happened and how did this clap so fantastically in just a matter of really 12 hours? And that's when we find out from reporting and sources that the U.S. Department of Justice is investigating Tricolore over fraud allegations. But exactly what went on is still in question. So to recap, within the span of about a day, we learn the following. A regional American bank reveals it's taking a loss on a$200 million loan after it unearthed alleged, quote, fraudulent activity by one of its corporate clients. That client turns out to be this subprime auto lender, Tricolor.

6:37Within a few hours of that news, Tricolor files for bankruptcy. And we find out that the U.S. Department of Justice is investigating the business. Now that's a lot. So this story broke just a couple of weeks ago, and our reporters are still looking into a lot of this themselves, and more information is sure to come out. But I wanted to talk with Amelia and Akilah about what they've learned so far about what went wrong at Tricolor, how these big banks ended up involved, and what that could tell us about the U.S. economy. So, Akilah, let's dig in a bit more here. Tell me what you've learned about Tricolor's business and where it seems like things went wrong.

7:21Tricolor kind of prated itself in catering to the Hispanic community. So it was primarily operating in the southwest of the U.S. And a lot of its customers were immigrants from Latin America, Mexico. And I spoke to a few customers. One of them said he moved to the U.S., needed a car right away. And so before he even applied for a social security number, he just needed to get a car from Tricolor. So that was almost like his first stop when he moved to the U.S. So a lot of them were in those situations. And that's because Tricolor did not require a social security number, which is tied to your credit score, which most lenders rely on to kind of assess a borrower's credit worthiness.

8:05Like, will they repay them? So, yeah, that was the customer base. And that customer base has been facing huge challenges in the southwest of the U.S. Firstly, you know, economic pressure because of rising costs, potential slowdown in the job market. But all of that has really been compounded by the Trump administration's crackdown on immigration. How so? The first kind of dynamic that we've seen from that is that a lot of them have moved back or are moving back or, you know, being made to move back, being deported. But also, you know, the people in this community often operate in the cash economy.

8:42So they rely on physically going to the car dealership to make their repayments in cash. And so we've heard from a few people that they're now actually too scared of leaving their homes for fear of being targeted by ICE, by immigration services in the U.S. And so a lot of them have just kind of been staying home and not coming to the shop to repay their loans. In this specific case, there's another dynamic, which is that Tricolor would repossess customers' cars when they fail to repay their payments, their loans. But, you know, if a customer has driven back with their car to Mexico, for instance, and they're failing to repay their loans, then Tricolor would have more trouble seizing that car because it's now in Mexico.

9:22So that's been flagged by people in and around the company as one of the dynamics as well. So if some customers weren't making their loan payments, that sounds like a significant issue for the business. Do we know anything about exactly how bad things got? Yeah, so we don't have access to the data or the numbers in this. But what we do know is that some of the rating agencies have flagged changes in immigration policies as a kind of risk to the business that could lead to higher losses and delinquencies. And we then confirmed that through our reporting by speaking to workers, speaking to investors in the Dallas car finance community.

10:01I saw this firsthand when I went to Texas last week, too. I spoke to a handful of rival dealerships in similar areas to where TreeColor operates. And they all said the same thing, which is that the number of Hispanic immigrants coming in as customers has dropped a lot in just the last several months. And they think that there's so much fear hanging over deportations, but also ICE raids, that it's driven people to stay home generally and not make large purchases. So my colleague's reporting shows that Tricolore's customers have been under pressure this year. And in turn, that's put pressure on Tricolore.

10:41The FT did also reach out to the U.S. Immigration and Customs Enforcement, or ICE, for comment. A spokesperson for ICE said, quote, If a business is reliant upon illegal aliens who are breaking federal law, they should look into changing their customer base, end quote. Tricolor had said in the past that the business serves the U.S.'s immigrant community. Tricolor said in a 2023 disclosure that 69 percent of its customers are, quote, undocumented, but it did not provide specific details on their legal status. Coming up, we'll take a closer look at what we know about Tricolore's relationship to Wall Street.

11:27the future of fixed income investing will continue to blur the lines between public and private markets nuveen's credit platform was built to navigate this shifting landscape channeling capital toward the businesses infrastructure and energy solutions that are shaping tomorrow's economy all while aiming to deliver the resilience and returns that portfolios seek today nuveen Invest like the future is watching. Visit nuveen.com slash future to learn more. Investing involves risk. Principal loss is possible. The other big piece of this is Tricolor's relationship with the banks that lent to them. JP Morgan, Barclays, Fifth Third, and some others.

12:05Akilah, what do we know about that relationship? So Tricolor borrowed money from the banks, the big banks, used that money to lend it to customers, So fund their loans. So that was kind of the first part of the relationship. Then separately, they also repackaged those loans into securities, which they then sold off to investors all over Wall Street. All types of investors, including pension funds, institutional investors, then used those proceeds to pay back the banks that initially helped them fund their loans. Okay, so that whole process that you just described, that's pretty much how a typical subprime auto lender functions.

12:46But with Tricolore, the situation's a bit different. Why is that? Yeah, so what we understand from talking to various sources about the sort of irregularity that came up within that cycle of funding was that, So when Tricolor takes a loan from the banks, it typically would use its inventory of cars as collateral on those loans, meaning if it can't repay, the banks would kind of be entitled to that inventory. And one of the banks that was involved accused them of pledging the same collateral to various lenders, which is a big no-no. So help me out here. It's one subprime lender. What's the big deal?

13:29I mean, Akilah, why has this story been such an important event on your beat covering U.S. banks? So the reason this resonated so much is because everyone's been laser focused on the U.S. economy ever since, you know, Donald Trump took office and, you know, installed the kind of tariffs policy that we all know about. And so everyone's been wondering, you know, is there going to be a rise in inflation? Are customers going to start to fail repaying their loans? or there are going to be more delinquencies and credit card repayments and all of that. So everyone's been watching that on Wall Street, all the analysts, all the economists.

14:05And actually, in the first half of the year, banks were pretty much saying, look, consumers are spending, they're doing great, they're paying their loans. And that started to change a little bit in recent weeks. So, you know, we've seen Jamie Dimon, the CEO of JP Morgan, one of the leading voices in Wall Street, warning that the economy was starting to turn. And so when the tricolor situation happened, it kind of raised more questions about whether cracks were starting to appear in the U.S. economy. So the question was, is this a one-off, you know, is this like a very company-specific alleged fraud case, or does it signal that there is more pain to come in that sector?

14:40Well, so far, are you aware of any other examples where this has happened, or is this the first? So I would say tricolor has unique characteristics, especially the alleged fraud element that makes it sort of an outlier and an extreme example. But there are other subprime car lenders that are also exposed to the kind of macro downturn that we're potentially waiting for or the crackdown on immigration if it continues. news. Last year, there was another similar company called Vroom that filed for Chapter 11 bankruptcy. It has since emerged after a recapitalization. But, you know, if there is more pressure to come on that segment of the population, that could potentially spread out to different areas outside of car finance, like retail or other lending.

15:29And how have the banks been taking this news that one of their clients collapsed? So I think it's led the banks, and not just the banks that or exposed to kind of, you know, carefully comb through their books to understand how much exposure and risk there is in their portfolios of loans to the sector, to car finance. It's also highlighted a question that regulators have been grappling with in recent years, which is, what is the exact level of exposure that banks have to non-bank financial institutions? So that could be hedge funds and private equity, in this case, car finance. And there has been kind of growing concern from regulators in recent years that maybe we don't have a very clear picture of what that exposure is.

16:13So, Amelia, what about you? What do you feel like this event shows us? I think this whole situation with Tricolore shows that Wall Street is exposed to the financial health of even the lowest income Americans. And there's obviously the element of alleged fraud here, which adds a wrinkle. But if you're just looking at the company's financial distress, you know, it had attracted the world's biggest asset manager, BlackRock, to write a$90 million equity check in 2021. It had attracted JPMorgan Chase, which agreed to extend credit to the company. Tricolor is by no means the only business that caters to low-income Americans.

16:50It's by no means the only business that does so that has also attracted big investment from Wall Street. And so if there is more pain among lower-income Americans, banks, big banks, and big asset managers, too, could presumably feel that pain as well. Right. Now, I have to point out, I mean, when you hear about subprime loan businesses collapsing, it does make me think about the subprime mortgage crisis about 2008. I mean, is that what we're seeing here? It's not the next 2008, from what we can tell. I think that people hear the word subprime, liquidation, alleged fraud, and it obviously brings back fresh memories of 2008 for a lot of people on Wall Street.

17:36But given the fact that this was a subprime lender that targeted a very specific community, and then on top of that we have the component of potentially alleged fraud, adds some complicated factors here. But one thing that I do think is interesting is it's really rapid failure and clear financial stress earlier in the year as well is perhaps a sign of more pain financially among the lowest income Americans and the lowest rung of the economic totem pole. And so that's what I think is the big question moving forward of, is this a sign of pain among low-income Americans? And could there be other companies exposed to that lowest income bracket that could be feeling greater stress right now than maybe we're aware of?

18:26Now, what is Tricolor saying to all of this? So not much at all. And that is because once Tricolor filed for Chapter 7 liquidation, it effectively ceased to exist. And so all of their employees, or effectively all of them, are gone. And we've made several attempts to contact their founder and CEO, Daniel Chu, that has not responded to date. When I was in Dallas, Texas, I went to their corporate headquarters and no one was there. The office had been effectively evacuated along with all of the dealerships. And essentially now the company is being overseen by a bankruptcy trustee. And she too has said very little on this, but she's put out one official media statement.

19:07essentially saying that they're doing their best to come up with a process and a team to oversee this case and that customers should still be making payments on their cars and have the right to use the cars as long as they make their car payments. So I know that this is a fast-moving story, but tell me a bit about just what you're looking at right now. So there are a lot of questions still hanging out there for the many customers across the Southwest U.S. And I spoke to one woman a few days ago, for instance, who has been making her car payments for years over the phone. And now no one at Tricolor is picking up the phone, presumably because they've been laid off.

19:46And so she is very concerned about how to make her car payments and prevent a repo situation in which her car might be taken away. And then, of course, there's the much bigger question, which is that there were more than 25 ,000 creditors listed in Tricolor's bankruptcy petition. And so the big question now for the bankruptcy trustee is how to liquidate those assets and raise money by doing so and who should get paid back and how much throughout the bankruptcy process. And that could take months or even years to figure out.

20:21Behind the Money is hosted by me, Michaela Tindera. This episode was produced by me and Safia Efmed. Fact-checking by Simon Greaves. Special thanks to Adam Sampson. Sound design and mixing by Sam Giovinco. Original music is by Hannes Brown. Topher Forges is the FT's acting co-head of audio. Thanks for listening. See you next week.

21:12Thank you.