Many Buyers for Subprime Auto
Loan Bundle
By MICHAEL CORKERY and JESSICA SILVER-GREENBERG
MARCH 15, 2015
Delinquencies on auto loans have been rising, more Americans are losing their cars
to repossession, and inquiries have begun into the subprime auto industry’s lending
practices.
Nevertheless, Santander Consumer USA had little trouble last week finding buyers
for its latest bond deal made up of auto loans to borrowers with deeply tarnished
credit.
Many of the loans bundled into the $712 million deal went to borrowers with
significantly lower credit scores than in many of Santander’s past bond deals.
Moody’s Investors Service expects losses as high as 27 percent on the bond, much
larger than the 17 percent loss that the ratings firm had projected on a bond that
Santander sold last year.
Risks in the market may be multiplying, and some lenders are pulling back. But
Santander’s latest deal shows that Wall Street’s appetite for subprime auto loans
remains as strong as ever.
Driven Into Debt
It’s easy to see the attraction for investors. Yields on the highest rated slice of the
Santander bond were 1.02 percent, compared with the equivalent Treasury bond
yield of 0.12 percent, according to Empirasign Strategies, a market data firm. In
short, investors could earn about eight times as much yield, while ostensibly taking
the same amount of risk.
A spokeswoman for Santander Consumer declined to comment on the deal, which
sold out in a matter of hours on Thursday.
The deal came a day after the auto lender’s parent company, Santander Holdings
USA, which is owned by the Spanish financial giant Banco Santander, flunked the
Federal Reserve’s annual stress test for the second consecutive year.
Still, Santander Consumer, which is based in Dallas, has been riding a broad
resurgence in subprime auto lending.
Over all, auto loans to subprime borrowers — typically people with credit scores at or
below 640 — have more than doubled since the financial crisis.
One reasons for the surge: Investors like mutual funds and insurance companies,
which have struggled to find high-yielding debt investments while the Fed keeps
interest rates near zero, have been buying billions of dollars of bonds like Santander’s
most recent deal.
Last year, such securitizations increased 28 percent from 2013 and were up 302
percent since 2010, according to Thomson Reuters IFR Markets.
Amid the rapid growth in the auto loan market, regulators have raised concerns
about whether growing competition among lenders is fueling lax lending standards.
Federal and state prosecutors are looking into whether car dealerships have been
falsifying borrowers’ loan applications to help them qualify to buy a car.
Santander Consumer is among the lenders that have received subpoenas from
federal and state authorities requesting information about its securitizations.
Santander Holdings USA, the parent company, has struggled with regulatory issues
of its own. As part of the banking stress test, the Fed analyzed the auto lender, as well
as Santander’s retail banking operations in the United States.
It is not clear what role, if any, Santander Consumer’s auto business played in the
Fed’s decision to reject the bank’s broader capital plan.
The Fed found that Santander Holdings had ample capital to weather severe
economic shocks.
But the Fed failed it on qualitative concerns, citing “critical deficiencies” in areas
including “risk identification and risk management” in the bank’s capital planning.
Santander Consumer USA, which was started as a regional subprime lender before
most of the company was acquired by Banco Santander in 2006, has developed a
reputation for deftly managing the risks of lending to troubled borrowers.
Investors say Santander uses a series of algorithms to predict a borrower’s chance of
default — a system that goes beyond a bank’s traditional method of risk assessment.
In its latest bond deal, according to the ratings firm Standard & Poor’s, roughly 13
percent of the loans went to borrowers without FICO credit scores, one of the most
common predictors.
“Those who are putting their faith in Santander are looking at how these algorithms
have performed in the past,” said Mark Palmer, an analyst with BTIG, a broker
dealer.
Still, the investors that scooped up last week’s bond deal — large asset management
firms — were afforded some protections.
As part of the deal, Santander agreed to take the first 25 percent of any losses that the
bond might suffer, according to Moody’s. In a deal last year, Santander agreed to
take 10 percent of the losses.
For Santander, the latest bond represented a shift.
Santander has always made loans to borrowers with very tarnished credit. But the
lender has usually financed those loans through private deals or held them on its
books, instead of tapping the public market, according to a person briefed on the
matter.
The latest bond deal was the first time that it has publicly sold securities backed by
auto loans with such low credit quality since the financial crisis. The timing of the
deal was driven by two factors: investor demand and a desire by Santander to free up
more capital.
The lender was hearing from investors, the person briefed on the matter said, who
were clamoring for more bonds to scoop up, especially those with higher yields.
The highest-yielding and lowest-rated slice of the bond was the first to sell out, the
person said.
http://www.nytimes.com/2015/03/16/business/dealbook/many-buyers-for-santanders-subprimeloan-bundle.html?emc=edit_ws_20150317&nl=automobiles&nlid=30595956&_r=0