Facing an economic downturn, captive auto finance companies are taking a vastly different approach in lending practices from the last time the industry faced this hurdle, likely limiting the negative impact that was seen in the sector early in the 1990's. Emerging in the most recent commercials, low-to-no interest subvention loans have emerged as a hot tool among captive finance units of the Big Three offered to super-prime borrowers.

Slowing auto sales and a bleak outlook for the economy in the wake of the events of Sept. 11 present auto manufacturers with a quandary: how to best use financing strategy to move cars off the lot and keep production up as economic fundamentals deteriorate.

One highly placed Big Three source noted that because the primary role of the finance arms is as a tool to sell cars profitability from lending practices is secondary. "In the big picture, we are more concerned with keeping cars moving off the assembly line and keeping plants open than the profitability of our loans," he said.

This loss-leading lending approach is in stark contrast to what was seen the last time recessionary fears crept into the American consciousness. In the early 1990s, loosened underwriting standards led to increased delinquencies and volatility within the sector, although there were no major crises.

"Back in 1992 and 1993, the captives moved down in credit to stimulate sales," said Jeff Salmon, head of ABS research at Barclays Capital. "This time the strategy is quite the opposite. While these loans return no interest, they are made to high-credit borrowers, so in an entire pool the probability of default is slim."

Subvention loans are made to entice what are called cash buyers' to finance their purchases, according to the Big Three source. "These are high net-worth individuals, with very low default risk," he added.

Barclay's Salmon says that while there is little short-term impact, "it will be interesting to see what percentage of these subvention loans are included in future auto-loan pools."

Another aspect of these loans on a pool is the increased prepayments seen among these borrowers past the second year of the loan. Salmon notes that these borrowers tend to trade in more frequently than most and their decisions are based less on interest rates and more on consumer taste and auto trends.

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