De­faults on loans for autos on rise

Sub­prime debt sold to in­vestors

Northwest Arkansas Democrat-Gazette - - BUSINESS & FARM - In­for­ma­tion for this ar­ti­cle was contributed by Jamie But­ters and Adam Temp­kin of Bloomberg News.


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 un­leash the next cri­sis. But since the re­ces­sion, busi­ness has ex­ploded. In 2009, $2.5 bil­lion of new 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 be­tween 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 bare 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.

For in­stance, San­tander re­cently vet­ted in­comes on fewer than one out of ev­ery 10 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 low­in­come bor­row­ers could drive off in new 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 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 30 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 set­tle 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 part­ner.”

In re­cent years, lend­ing prac­tices in the sub­prime auto in­dus­try have come un­der in­creased 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 of­fer yields as high as 5 per­cent. It might not seem like much, but in a world of ul­tralow 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 de­mand soared, is worth it.

“In­vestors seem to be ig­nor­ing 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 $1.2 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.

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