Another US sub-prime boom looms as auto defaults soar

WALL STREET’S LAX LENDING STANDARDS ARE LETTING PEOPLE GET LOANS FOR CARS THEY CAN’T AFFORD WITHOUT ANYONE VERIFYING INCOMES OR JOB HISTORIES

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.

Worth It?

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 sub-prime 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 AG.

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

In the years after its 2009 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 decision.” 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 sub-prime.

Becoming Chrysler’s preferred lender made sense for Santander. It was aggressively expanding in the US sub-prime loan market, and Chrysler, the perennial third wheel among the “Big Three,” relied more on buyers with lower credit scores than General Motors Co or Ford Motor Co.

Problems surfaced almost from the start. Many of them, detailed in the settlement between Santander and authorities in Delaware and Massachusetts, recall some of the excesses of the sub-prime housing era.

‘Fraud Dealers’

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 15 per cent, reselling them to yield-hungry ABS investors.

State authorities also said an internal Santander review in 2013 found that 10 out of 11 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