00:00Tremors have rippled through the $25 trillion US credit market.
00:04We had an exposure to tricolor.
00:06I'm obviously not happy about it.
00:08This story is about the sudden, unexpected, spectacular collapse of a subprime auto lender
00:13backed by some of the largest banks on Wall Street.
00:15Tricolor's collapse in the subprime auto lending space could be the tip of the iceberg.
00:21A used auto dealer and lender named Tricolor suddenly filed for bankruptcy in September
00:29after alleged fraud was flagged in their books.
00:32You're looking at hundreds of millions of losses across the industry.
00:35When Tricolor started to go down, it set off a wave of fear on Wall Street.
00:39Everybody was wondering, what's the next shoe to drop?
00:42The credit market has stopped buying some of these subprime auto loans
00:45and investors have started pulling away from more risky borrowings.
00:48Around the same time, there was another company in the auto sector
00:51that was also dealing with accusations of fraud, and that was First Brands.
00:55These bankruptcies have been giving Wall Street serious pause.
00:59Daniel Chu, the CEO and founder of Tricolor, started the business in 2007.
01:05His goal was to provide business and loans to underserved populations, including immigrants.
01:15Tricolor was a car dealer and a lender, meaning if you showed up to one of their dealerships,
01:20you can also get a loan there, and that meant that Tricolor didn't have to rely
01:23on outside parties to give people loans.
01:26Its subprime customers were paying higher rates.
01:28That's one of the reasons private equity was interested in this kind of lending.
01:32It was giving yields that were not seen in other parts of the market.
01:35Between 2018 and 2021, the company's dealership network grew by nearly 50%.
01:41If you look at interest rates during the pandemic, they were super low,
01:44and this allowed Tricolor to sell tons of bonds, which meant it was essentially borrowing
01:48lots of money from Wall Street, and it was using that money to propel its growth.
01:52Tricolor was previously getting its loans from private equity and regional banks,
01:56but because of its growth, it was able to catch the eye of J.P. Morgan.
01:59In 2020, J.P. Morgan agreed to provide a $100 million warehouse loan to Tricolor.
02:04Eventually, it swelled to $770 million from J.P. Morgan and other investors.
02:09Tricolor was growing rapidly, but eventually they ran into some red flags.
02:14In 2022, external auditors raised questions about how Tricolor was valuing its assets.
02:20A couple months ago, a junior analyst working with J.P. Morgan flagged there was trouble with
02:24the collateral backing the loans, including some of them being pledged more than once.
02:28Double pledging meant that one car was used as collateral for multiple loans
02:32because Tricolor was buying and selling at such a fast rate.
02:36J.P. Morgan called up Daniel Chu, who was in Italy, and told him urgently to get over to New York City.
02:41Then there was a frantic scramble to find out what had happened and how to save the company.
02:45J.P. Morgan hired outside advisors to try to raise temporary financing
02:49to keep the company alive through bankruptcy.
02:51As everything started to fall apart, J.P. Morgan pulled the plug and investors began to follow suit.
02:56But because of the severe fraud allegations, banks were scared about providing even temporary
03:01financing. And ultimately, they weren't willing to do it.
03:03On September 10th, Tricolor filed for Chapter 7 bankruptcy.
03:08We can blame due diligence. We can blame massive concentration.
03:11But at the end of it, this is what happens when people chase yield.
03:15Daniel Chu's empire, including the dealerships, warehouses, cars and loans,
03:19will be sold back to investors, some of the $2 billion that is owed to them.
03:27As all this was playing out, people on Wall Street were wondering,
03:29is this isolated or is this emblematic of something larger?
03:32My antenna goes up when things like it happened.
03:35I probably shouldn't say this, but when you see one cockroach, there are probably more.
03:40And so everyone should be forewarned on this one.
03:44Similar auto companies can expect higher interest rate from Wall Street lenders.
03:48A pullback in lending and increased inquisitions into their business.
03:52As we get a clearer sense of what exactly happened to Tricolor, people on Wall Street have been wondering,
03:57is this isolated or does this tell us something about the water economy?
04:00If it's something larger, then maybe it doesn't matter today to the average person,
04:03but in the future it could.
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