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Auto loan defaults are soaring – San Antonio Express-News

Auto loan defaults are soaring

By Gabrielle Coppola, Bloomberg News

Published 6:12 pm, Monday, July 17, two thousand seventeen

It`s classic subprime: hasty loans, rapid defaults, and, at times, outright fraud.

Only this isn`t the U.S. housing market circa 2007. It`s the U.S. auto industry circa 2017.

A decade after the mortgage debacle, the financial industry has embraced another type of subprime debt: auto loans. And, like last time, the risks are spreading as they`re bundled into securities for investors worldwide.

Subprime car loans have been around for ages, and no one is suggesting they`ll whip out the next crisis. But since the Fine Recession, business has exploded. In 2009, $Two.Five billion of fresh subprime auto bonds were sold. In 2016, $26 billion were, topping average precrisis levels, according to Wells Fargo & Co.

Few things capture this phenomenon like the partnership inbetween Fiat Chrysler Automobiles and Banco Santander. Since 2013, as U.S. car sales soared, the two have built one of the industry`s most powerful subprime machines.

Details of that relationship, pieced together from court documents, regulatory filings and interviews with industry insiders, lay nude some of the excesses of today`s subprime auto boom. Wall Street has rewarded lax lending standards that let people get loans without anyone verifying incomes or job histories.

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For example, Santander recently vetted incomes on fewer than one of every ten loans packaged into $1 billion of bonds, according to Moody`s Investors Service. The largest portion were for Chrysler vehicles.

Some of their dealers, meantime, gamed the loan application process so low-income borrowers could drive off in fresh cars, state prosecutors said in court documents.

Through it all, Wall Street`s appetite for high-yield investments has kept the loans – and the bonds – coming. Santander says it has cut ties with hundreds of dealerships that were pushing unsound loans, some of which defaulted as soon as the very first payment. At the same time, Santander plans to increase control over its U.S. subprime auto unit, Santander Consumer USA Holdings Inc., people familiar with the matter said.

Santander, subpoenaed or questioned by a group of about thirty states regarding its auto loan underwriting and securitization activities, declined to comment on «active legal matters.» In May, Santander agreed to pay $26 million to lodge allegations brought by Delaware and Massachusetts as part of ongoing investigations into the auto industry`s lending practices. Santander, whose partnership with Chrysler goes by the Chrysler Capital brand name, neither admitted nor denied wrongdoing.

Reid Bigland, Chrysler`s U.S. sales chief, said Santander has been a «good fucking partner.»

In latest years, lending practices in the subprime auto industry have come under enlargened scrutiny. Regulators and consumer advocates say it takes advantage of people with nowhere else to turn.

For investors, the allure of subprime car loans is clear: Securities composed of such debt can suggest yields as high as five percent. It might not seem like much, but in a world of ultra-low rates, that`s still more than triple the comparable yield for Treasuries. Of course, the market is still much smaller than the subprime-mortgage market, which triggered the credit crisis, making a repeat unlikely. But the question now is whether that premium, which has dwindled as request soared, is worth it.

«Investors seem to be overlooking the underlying risks,» said Peter Kaplan, a fund manager at Merganser Capital Management.

Asset-backed securities based on auto loans are engineered to keep paying even when some loans sour. Still, some cracks have emerged in the $1.Two trillion market for auto financing. Delinquencies have picked up, as have losses on subprime loans. Auto loan fraud, meantime, is approaching levels seen in mortgages during the bubble.

Auto finance «is not going to bring down the financial system like the mortgage crisis almost did, but it does signal more stress with the consumer,» said Stephen Caprio, a credit strategist at UBS Group.

Whatever the case, the Santander-Chrysler relationship has opened a uncommon window into an industrywide race to the bottom that may have lasting consequences.

In the years after its two thousand nine bankruptcy, Chrysler looked for a dedicated lender to help customers finance their cars quickly. One reason it picked Santander was the Spanish lender`s expertise in «automated decisioning.» At the time, a Chrysler executive said the process helped Santander «take a little bit more risk and approve more deals because they mine the data» in subprime.

Becoming Chrysler`s preferred lender made sense for Santander. It was aggressively expanding in the U.S. subprime loan market, and Chrysler, the perennial third wheel among the «Big Three,» relied more on buyers with lower credit scores than General Motors or Ford.

Problems surfaced almost from the embark. Many of them, detailed in the settlement inbetween Santander and authorities in Delaware and Massachusetts, recall some of the excesses of the subprime housing era.

Attorneys general in both states alleged Santander enabled a group of «fraud dealers» to put buyers into cars they couldn`t afford, with loans it knew they couldn`t repay. It offloaded most of the debt, which often had rates over fifteen percent, reselling them to yield-hungry Six pack investors.

State authorities also said an internal Santander review in two thousand thirteen found that ten of eleven loan applications from a Massachusetts dealer contained inflated or unverifiable incomes. (It`s not clear whether this particular case involved a Chrysler dealer.)

Santander kept originating the dealer`s loans anyway, even as they continued to default «at a high rate,» the authorities said.

Some dealerships even asked Santander to double-check customers` incomes because they didn`t trust their own employees, the authorities said. They also said the lender didn`t always oblige because that would put it at a «competitive disadvantage.» At the time of the settlement, Santander said it was «totally committed to treating its customers fairly.»

In some ways, the laissez-faire mindset reflects how competition squeezed Santander as request for fresh cars – and loans to finance them – soared.

Without a deposit base, Santander`s auto finance unit had a rough time challenging with banks for the most creditworthy buyers. Private-equity firms also poured in, vying for many of the same subprime borrowers that Santander targets, but often with more relaxed underwriting. And Santander doesn`t get the same preferences that automakers` wholly wielded finance units typically receive, Bigland said.

The irony is that what got Santander into hot water did little to help it reach the lofty goals set at the outset of the 10-year venture with Chrysler. As of April, Santander financed about nineteen percent of the carmaker`s sales, brief of the sixty four percent it targeted by that time.

While Santander takes agonies to avoid criticizing Chrysler, the lender launched a special loyalty and prizes program to vet the carmaker`s dealerships. Those that aren`t deemed fraudulent during the process are labeled «VIPs.» Santander also cut ties with more than eight hundred dealers across its network since two thousand fifteen as it attempts to boost business without exposing itself to more bad loans.

«Chrysler resumes to represent an chance for growth for us,» Richard Morrin, chief operating officer of Santander`s auto finance arm, said during an investor presentation in February. Still, «it can`t be growth at any cost.»

Chrysler declined to comment on instances of fraud at its dealer network.

Indeed, with U.S. auto sales falling after a record 2016, many lenders, including Santander, say they`re tightening standards. Santander`s underwriting practices, however, proceed to raise eyebrows. In May, Moody`s drew attention to the fact that Santander verified incomes on only eight percent of loans it bundled into bonds, based on data that auto-debt issuers have recently began to disclose.

Yet when it comes to due diligence, there`s no industrywide standard. Unlike the mortgage market, stated-income loans – also known as «liar loans» – are flawlessly legal in car buying. Last month, Jeff Brown, Ally Financial Inc.`s chief executive, said verifying income isn`t the norm. Ally, he said, checked incomes on sixty five percent of its subprime car loans. GM Financial`s AmeriCredit unit checked toughly the same percentage.

The industry has little reason to switch given the success of Wall Street`s securitization machine. Protections built into the bonds have largely insulated investors from losses even as delinquencies pile up. Most securities are upgraded over their lifetimes.

The losers, of course, are people who go into debt for cars they can`t afford.

Jerry Robinson, who worked in Santander`s debt collection unit, has seen the trouble firsthand. Robinson, who retired in August after six years with Santander, says one of his responsibilities was to get cars the lender repossessed back into their owners` arms.

Often times, he found dealers listed nonexistent features like sunroofs or alloy wheels to inflate a car`s value and win credit approval. Albeit Robinson`s job was to make sure dealers reimbursed Santander for any loan fraud, borrowers didn`t see their debts diminished, he said. Instead, their loans were usually extended, enhancing the compound interest consumers would ultimately pay after their repossessed cars were reinstated. More often than not, those payments wind up going to Six pack investors.

Bonuses were tied to how many borrowers could be reinstated, said Robinson, now a Dallas-based member of the Committee for Better Banks, a worker and consumer advocacy coalition backed by a union seeking to organize bank employees. The same cars were often repossessed numerous times.

Santander spokeswoman Laurie Kight disputed Robinson`s account and said it was part of a union campaign to discredit the lender. Santander is «unaware» of the type of conduct he described, and money reimbursed by dealers for nonexistent features is used to reduce borrowers` loan balances, she said.

Robinson contends it was more profitable for Santander to keep cash-strapped borrowers in their cars rather than auction off the vehicles.

«The business makes money putting people in the car,» he said.

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