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Deep subprime auto company seeks bankruptcy protection amid Capital One dispute

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Deep subprime auto company seeks bankruptcy protection amid Capital One dispute

A chain of buy-here-pay-here automotive dealerships and finance companies sought Chapter 11 bankruptcy protection after a long-standing lender sought the appointment of a receiver.

Nashville, Tenn.-based debtor Auto Masters LLC claimed to owe $63 million on a syndicated line of credit from subsidiaries of Capital One Financial Corp. and First Horizon National Corp. that is purportedly secured by an estimated $56 million in commercial paper and $7.4 million in subordinated debt to Ovation Finance Holdings 2 LLC.

Buy-here-pay-here dealerships generally sell and finance used vehicles to borrowers with poor or no credit. Auto Masters explained in a bankruptcy court filing that it seeks to provide "quality cars and brand-dealership service" in a segment that, it claims, tends to be characterized by "poorly maintained caged lots" and high-mileage vehicles often "fraught with salvaged titles, rebuilt titles, poor Carfax reports, disrepair and overall reliability issues."

The buy-here-pay-here category held share of 12.9% of the used vehicles financed during the second quarter, according to Experian Automotive.

Auto Masters' owner obtained a $15 million secured line of credit from Capital One in 2011 as part of a shift in its business model to rely less on its own operating capital to self-finance the vehicles it sold. Whereas the previous model had "limited growth potential," the company said, the newfound access to funding allowed it to "dramatically increase the volume of cars that it could finance" while continuing to pay off its dealer floorplan loans.

After several years of scaling up its operations, Auto Masters and Capital One amended the credit line on multiple occasions, including in 2015 to provide for the First Tennessee Bank NA syndication. In November 2016, Auto Masters alleged, the lenders agreed to boost the maximum size of the line to $63 million, with up to $47 million to be advanced by Capital One and up to $16 million to be provided by First Tennessee.

"Throughout 2015, the Debtors' businesses were thriving," Auto Masters alleged. "Having borrowed from Capital One for years, the Debtors had an amicable relationship with Capital One's loan officers and other decision-makers."

After "some of Capital One's officers left the company to form Ovation" in early 2016, Auto Masters alleged, both entities "actively encouraged the Debtors to take on additional debt, through both an increase in the Syndicated Line and a separate high-interest $10 [million] note from Ovation." But shortly thereafter, Auto Masters claimed, new management at Capital One "unilaterally decided" to exit the buy-here-pay-here dealership market.

"This put the Debtors in a bind," Auto Masters said, as the company was "forced to find ways to satisfy Capital One in a short time frame." The situation deteriorated in January when Capital One allegedly "refused" to advance additional funds, the company claimed.

"Without access to this line, the Debtors had to revert to self-financing vehicles again," Auto Masters said. "This put a large strain on their cash flow and dramatically limited their short-term sales volume, exacerbating the difficulty in finding a take-out lender for the Syndicated Loan."

Making matters worse, Auto Masters alleged that it "discovered an accounting error" that dramatically overstated the value of their contract receivables in September. The "true value" of the receivables was about $65 million as opposed to $90 million, the company said, in a situation that it attributed to "inadvertent" misreporting, not intentional mishandling of the collateral.

Capital One subsequently filed a lawsuit seeking the employment of a receiver, an outcome that would "essentially force the Debtors' successful business to a screeching halt." Auto Masters initiated the bankruptcy case to "preserve its right" to find a workable solution, one that it claims will pay off the syndicated line and the Ovation note within "a reasonable period of time."

Capital One spokespeople did not return a message seeking comment on the bankruptcy filing or additional information regarding its complaint.

The Auto Masters case does not represent the first time in recent memory that a company focused on the subprime auto business sought bankruptcy protection to forestall the appointment of a receiver following an accounting-related dispute with a key lender. Kennesaw, Ga.-based subprime lender TAG Financial Services Inc. filed a Chapter 11 petition in August 2016 after Accord Financial Corp. accused the company of "massive misconduct and dishonesty" and secured a court order for a receiver's appointment. The case was later resolved in Accord Financial's favor.

Much like the TAG Financial situation, Auto Masters' situation appears to be specific to its own circumstances rather than a sign of broader woes within the auto finance industry. A period of rapid growth in subprime auto lending triggered comparisons in the press to the expansion of the mortgage market during the mid-2000s, particularly as measures of credit quality began to normalize from historically strong levels.