Our bank is deciding whether or not to acqurie a small finance company. Where can I find some guidance on the type of due dilligence necessary to evaluate this decision?

Thanks for your help.

Perhaps it was the holiday that left your post unanswered, but it might also be a hesitation about the actual answer. I don't know of sources for guidance on due diligence. I'm not saying there aren't any. I just don't know. I'm sure a search of the web may find you some helpful information.

In the meantime, I'll offer some common sense stuff to look at:

Is the finance company legally established?
Is it profitable? If not, what expertise will the bank bring to the table to turn the ship around?
Are its financial reports based on GAAP?
How good are the internal controls and how believable are the financial reports?
Is this line of business consistent with the bank's strategic plan and the staff's expertise?
What products does the finance company offer?
What are the potential reputation risks of those products? (e.g., are any abusive or predatory products offered that could reflect poorly on the bank's reputation?)
What are the compliance risks of those products? Does the finance company follow appropriate consumer protection or other disclosure laws?
What are the safety and soundness risks? What is the quality of the loans generated by the finance company?

Those are some of the questions you will want to answer during your due diligence. Perhaps this will spur other BOLers to respond. AR.

Are they perceived as a predatory lender? Who are their primary consumer constituents -- e.g., credit-impaired borrowers? Consumers with low FICO scores? This sounds exciting, but continue to wear your vest so the shrapnel doesn't cut you in case of unseen explosives. Finance companies being affiliated with regulated banks is a great source of fun and joy.

This company deals exclusively in Floor Plan financing. It has about 80 clients with approximately 500 cars. They have approximately 3MM in inventory. They owner is going to put about 500MM in escrow to gurantee collection of payment on all the existing inventory. This is the business as I currently understand it.

As I mentioned earlier, you will want to review the finance company's internal controls. For example, you will want to know what its policy is for inspecting the inventory, if that policy is actually followed, if the finance company's inspectors are rotated, and what the car dealers' history of paying out of trust is. In other words, did they sell cars and not make the appropriate payment to the finance company?

I'm guessing that these aren't dealers of new cars, otherwise they would have floor plan arrangements through the manufacturers' captive finance companies. If they are dealing in used cars, you'll want to look at the finance company's policy regarding inventory turnover, particularly for cars that have been on the lot over X days. After that time, there should be a so-called curtailment payment policy that requires the dealers to begin paying down on the stale inventory. This gives incentive to the dealers to move the cars, either through retail sales or auctions, to keep a fresh inventory.

Those controls along with verifying the veracity of the finance company's financial records and legal standing, and ferreting out any pending litigation would seem to me to be the most important parts of your due diligence.

If these are new car dealers, you will want to know why they don't use the captive finance companies. I would view this as a red flag that may be an indicator of the dealer's financial condition, thus making the finance company a riskier proposition for your bank.

One final thing. If you are going to be a lender to dealers, I'd check their waste management practices, particularly if they have service or repair shops. There's nothing like an action from the EPA to stand in the way of getting repaid. AR.

AnonRegulator makes several good points, and, in particular, what stands out is the potential for floor-plan financing for credit-impaired borrowers. In short, borrowers who do not have stellar credit -- and who will be those who are less knowledgeable and less sophisticated in shopping terms, rate, and repayment programs -- are likely to be disproportionately represented by minority consumers. I would be concerned to test that similar borrowers with similar credit status get the same terms, rates, etc.(regardless of race/ethnicity/gender), to ensure that you don't have a potential fair lending or fair credit issue. Auto financing can be just as nasty as housing-secured financing. Be careful. Some of the BOLr's who are the thread monitors might be able to provide you with some good tips, so watch this thread. Good luck.

Thanks Anonymous and AnonRegulator! All of the information you provided me has been extremely helpful and given me some great points/ideas to review and ivestigate further. Thanks again for all of your help.

Before laying your cash on the table, I'd want to see independent audits of the floor-planned inventory to be sure there have been controls to prevent out-of-trust sales.