Tuesday, November 25, 2008

Auto Finance 101 and Loan Market Direct

Loan Market Direct (“LMD”) is in the auto finance business. We are car guys and data freaks. We make money.

But making money in any finance business today doesn’t seem so easy. Ask Lehman, Goldman, AIG, Citi, etc. (way too long of a list of smarty pants companies lately). So you wonder, if big impressive companies are struggling with finance in general how come Loan Market Direct is not?

The answer is simple. Indirect lending.

Simple answer; difficult process.

If the operations of indirect lending were simple more capital bleeding companies would not be in the Washington bread line.

All right, so what is Indirect Lending? Indirect lending is where a lender buys debt. LMD buys car loans from auto dealers and finance companies. You know when you go to buy a car, the dealer always offers financing … it’s really from guys like us. The dealer arranges the financing according to guidelines that he knows will be acceptable to some indirect lender. The person at the dealership who arranges this is called the F&I guy (Finance and Insurance). You hardly ever get to see the F&I guy, he’s the one that the sales guy keeps leaving the room to pitch your offer(s) to, time and time again. To keep this simple the F&I guy is just trying to place your “note” with the “bank” that will give him the highest “advance”. Huh? It’s really called Hanging Paper and really means that he is trying to get as much money as possible for the sale of your note. Even “A” credit paper gets sold with fees. Lesser credits known as B and C, non-prime, sub-prime get sold with fees and a discount. Huh, again? O.K., here’s a simple example:

You buy a car for $12 k, put $2k down and finance $10k. Indirect lenders will bid on your note depending on the quality of the deal, your credit and the value of the car relative to the amount financed. If you have good credit and are buying a new Ford, Ford Motor Credit might pay pretty close to par or $10k for the note. If you have terrible credit, buying a used car, an indirect lender will bid at a discount of maybe only pay $8 or $9k for the deal.

LMD buys loans based on overall credit and collateral quality. We pay, or offer to pay, the “right” price based on Risk Based Pricing. This is our little niche. It will take me a year or two more of blogging to explain the details but I’m planning on it. Here’s the summary for now.

We know math, especially algebra. We know how much money we need or want to make, our return. We know all the terms of a note like rate, term and amount financed. We know, within reason, the other variables in the life of the loan that will affect return (we also paid attention in statistics). We make a little formula, plug in all the variables and solve for the PROPER price to pay.

That’s the simple part. I’m going to dive into the difficult part soon, the process, aka operations.

So you still want to know why the big fancy “in the process of getting bailed out” companies are in the spot they're in. They obviously didn’t pay attention in math class.

Come on back soon to read some of my next articles including:

“Too Big to Fail ... How About: Too dumb to Survive”
“What were they Thinking Buying all that Crap”
“Collapse from the Weight of Greed”

Sunday, November 16, 2008

A Matter of Time

Ever since the Internet became more popular than a library it was only a matter of time before Wall Street felt the pain of age. By Wall Street I mean Capital Market transactions like issuing, brokering, structuring and trading. What a great tool the Wall Street markets were for generations, a way to raise capital and perform countless financial transactions to make the capital make more capital.

As my first post to my blog I want to address one basic Wall Street transaction - Secondary Market Financing. One example of Secondary Market Financing is where companies take receivables like loans and sell them to investors. In a large transaction the investors are usually institutional investors like funds or large companies. Well, don't all funds and large companies have investors too? Sure, and many of those investors are institutional investors as well. Sooner to later down the ladder you're going to end up with an individual investor, a real human being, maybe rich, maybe poor ... but in any event he or she most likely has Internet access.

So here's my point. The company needing financing for some receivables is made up of stockholders (they probably have Internet access too), anyhow that company goes on a Wall Street transaction journey and after a whole bunch of brokers, market makers and institutional investors they end up with some individual Internet users money. Job well done, they got the transaction done. But how efficient was it to go a banker, broker, institution, etc. when all the company had to do was go directly to the individual investor. Yes, of course, Secondary Market Financing is a complicated thing ... was before the Internet anyhow.

I have a lot more to say about the Internet and financing especially in the areas of Peer-to-Peer lending and a particular hybrid P2P company called Loan Market Direct, and yes, I work there. Please come back and I'll try to tell you why the title of my blog makes all the sense in the world.