“You do deals when there is demand,” said Christopher R. 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……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.”, Michael Corkery and Jessica Silver-Greenberg, “Many Buyers for Subprime Auto Loan Bundle”, New York Times

“It’s similar to what happened with pre-crisis subprime and nonconforming mortgage securities. The Fed’s distortion of rates (lower for safer bonds like U.S. Treasuries), results in investors knowingly taking on bigger and bigger risks to stretch for yield. These sophisticated investors, both pre and post crisis, weren’t fooled by anyone regarding the risks of the loans backing these securities  (the securities fraud allegations were bogus and not proven). And it’s also clear that when these investors stop buying securities backed by these riskier loans, lenders stop originating them. (P.S. I also think it’s more than a little rich that the former FDIC Chair Sheila Bair had so criticized the banking industry for its lending practices and “abusing borrowers”, yet she now sits on Banco Santander’s board….a big U.S. subprime auto lender, whose U.S. parent just flunked the Fed’s stress test!!!)”, Mike Perry, former Chairman and CEO, IndyMac Bank

Many Buyers for Subprime Auto Loan Bundle

By MICHAEL CORKERY and JESSICA SILVER-GREENBERG

Santander Consumer has been riding a broad resurgence in subprime auto lending. Credit Joe Raedle/Getty Images

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.

“You do deals when there is demand,” said Christopher R. 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 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.

A version of this article appears in print on March 16, 2015, on page B1 of the New York edition with the headline: Many Buyers for Subprime Loan Bundle

 

Posted on March 18, 2015, in Postings. Bookmark the permalink. Leave a comment.

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