Subprime-auto-loan bonds sell fast
Santander Consumer USA had little trouble last week finding buyers for a $712 million bond deal made up of auto loans to borrowers with deeply tarnished credit, despite evidence that more Americans are losing their cars to repossession, and inquiries have begun into the subprime auto industry’s lending practices.
Many of the loans bundled into the deal went to borrowers with significantly lower credit scores than in many of Santander’s past bond deals, a sign that Wall Street’s appetite for subprime auto loans remains as strong as ever.
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.
“You do deals when there is demand,” said Christopher Donat, an analyst with the investment bank Sandler O’Neill. “And this deal indicates that there is demand out there for subprime auto paper.”
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 spokesman for Santander Consumer declined to comment on the deal, which sold out in a matter of hours 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.
Overall, auto loans to subprime borrowers — typically people with credit scores at or below 640 — have more than doubled since the financial crisis.
One reason 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.
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.