By Michael Corkery And Jessica Silver-Greenberg at the NYT
The loans were for used Dodges, Nissans and Chevrolets, many with tens of thousands of miles on the odometer, some more than a decade old.
They were also one of the hottest investments around.
So many asset managers clamored for a piece of a September bond deal made up of these loans that the size of the offering was increased 35 percent, to $1.35 billion. Even then, Santander Consumer USA received more than $1 billion in investor demand that it could not accommodate.
Driven Into Debt
Articles in this series are examining the boom in subprime auto loans.
Across the country, there is a booming business in lending to the working poor — those Americans with impaired credit who need cars to get to work. But this market is as much about Wall Street’s perpetual demand for high returns as it is about used cars. An influx of investor money is making more loans possible, but all that money may also be enabling excessive risk-taking that could have repercussions throughout the financial system, analysts and regulators caution.
In a kind of alchemy that Wall Street has previously performed with mortgages, thousands of subprime auto loans are bundled together and sold as securities to investors, including mutual funds, insurance companies and hedge funds. By slicing and dicing the securities, any losses if borrowers default can be contained, in theory.
Led by companies like Santander Consumer; GM Financial, General Motors’ lending unit; and Exeter Finance, an arm of the Blackstone Group, such securitizations have grown 302 percent, to $20.2 billion since 2010, according to Thomson Reuters IFR Markets. And even as rising delinquencies and other signs of stress in the market emerged last year, subprime securitizations increased 28 percent from 2013.
Taking On More Risk
Deals made up of auto loans to borrowers whom creditors deem riskier have increased since 2010.
Total subprime auto loan securitizations
The returns are substantial in a time of low interest rates. In the case of the Santander Consumer bond offering in September, which is backed by loans on more than 84,000 vehicles, some of the highest-rated notes yield more than twice as much as certain Treasury securities, but are just as safe, according to ratings firms.
Now questions are being raised about whether this hot Wall Street market is contributing to a broad loosening of credit standards across the subprime auto industry. A review by The New York Times of dozens of court records, and interviews with two dozen borrowers, credit analysts, legal aid lawyers and investors, show that some of the companies, which package and sell the loans, are increasingly enabling people at the extreme financial margins to obtain loans to buy cars.
The intense demand for subprime auto securities may also be fueling a more troubling development: a rise in loans that contain falsified income or employment information. The Justice Department in Washington is coordinating an investigation among prosecutors’ offices across the country into whether such faulty information ended up in securitization deals, according to people briefed on the inquiries.
The examinations, which began this summer after a front-page article in The Times reported on potential abuses in subprime auto lending, are modeled on the federal investigation into the sale of mortgage-backed securities — an effort that has already yielded billions of dollars of settlements.
Prosecutors have sent a spate of subpoenas. This summer, the office of Preet Bharara, the United States attorney for the Southern District of New York, sent subpoenas to Santander Consumer and GM Financial. The United States attorney in Detroit subpoenaed Ally Financial in December. And Consumer Portfolio Services, a subprime lender, said last week in a regulatory filing that the company had received a subpoena related to its “subprime automotive finance and related securitization activities.”
“There is so much money looking for a positive return that people get lazy,” said Christopher L. Gillock, a managing director at Colonnade Advisors, a financial advisory firm in Chicago that has worked with subprime auto lenders. “Investors see it is rated triple-A, turn off their brains and buy into the paper.”
Among the borrowers stoking the lending boom are people like Dana Payne.
Ms. Payne, a former administrative assistant in the New York Police City Department, has not made a single payment on a $30,770 Santander loan that was taken out to buy a 2011 BMW 328xi. Ms. Payne, who has no driver’s license, said she took out the loan so her daughter, who lives in New Jersey, could have a car. The loan has an interest rate of 11.89 percent, according to her loan document, a copy of which was reviewed by The Times.
Ms. Payne went with her daughter to a dealership that arranges loans for Santander and other auto lenders to buy the car. She said an employee at the dealership in Great Neck, N.Y., assured her that, even though she was on food stamps, she could afford the loan. At the time, Ms. Payne said she thought she was co-signing the loan with her daughter.
“I looked him in the eye and said, ‘I don’t have any income,’ ” said Ms. Payne.
The dealership did not comment.
The lenders point out they are providing loans to people who might not otherwise be able to buy cars. They say they have acted to insulate investors from losses. In many bonds, lenders take the first losses when loans sour, a safeguard few mortgage deals contain.
“Subprime lending by its nature involves evaluating the creditworthiness and ability to repay of borrowers who may have had financial difficulties in the past, such as a bankruptcy, a foreclosure or difficulty in managing revolving credit,” Stephen Jones, vice president investor relations at GM Financial, said in a statement.
The lenders say they vet their dealer partners, watching for patterns of complaints against dealerships and other warning signs like higher than average defaults.
Laurie Kight, vice president of communications at Santander Consumer, said in a statement that the lender has a “rigorous and active dealer control operation, which is part of the company’s overall compliance framework.” She added, “This operation audits, investigates and — if necessary — ceases operations with any dealers who conduct fraudulent or high-risk activities.”
Investors are betting that the companies are experienced enough to weed out problem loans.
Still, some credit analysts have questioned whether the market has grown too much, too fast.
Some rating firms that faced criticism after the mortgage crisis for blessing shaky investments with top ratings are taking a critical approach to subprime auto deals.
Fitch Ratings will issue its highest ratings only to bonds issued by lenders with long track records and that don’t rely entirely on securitizations to fund their business, like Santander Consumer and GM Financial. And Standard & Poor’s has recently sounded alarms about the declining quality of the loans backing the investments.
Even those warnings, critics say, do not fully capture the fundamental risks.
Mr. Gillock, the financial adviser in Chicago, said that no bond made up of subprime auto loans should ever receive a triple-A rating — a designation that only three blue-chip companies, Exxon, Microsoft and Johnson & Johnson, receive on their debt offerings.
“It is hard for me to place securities backed by subprime auto finance receivables in the same category,” he said.
The loans were for used Dodges, Nissans and Chevrolets, many with tens of thousands of miles on the odometer, some more than a decade old.
They were also one of the hottest investments around.
So many asset managers clamored for a piece of a September bond deal made up of these loans that the size of the offering was increased 35 percent, to $1.35 billion. Even then, Santander Consumer USA received more than $1 billion in investor demand that it could not accommodate.
Driven Into Debt
Articles in this series are examining the boom in subprime auto loans.
Across the country, there is a booming business in lending to the working poor — those Americans with impaired credit who need cars to get to work. But this market is as much about Wall Street’s perpetual demand for high returns as it is about used cars. An influx of investor money is making more loans possible, but all that money may also be enabling excessive risk-taking that could have repercussions throughout the financial system, analysts and regulators caution.
In a kind of alchemy that Wall Street has previously performed with mortgages, thousands of subprime auto loans are bundled together and sold as securities to investors, including mutual funds, insurance companies and hedge funds. By slicing and dicing the securities, any losses if borrowers default can be contained, in theory.
Led by companies like Santander Consumer; GM Financial, General Motors’ lending unit; and Exeter Finance, an arm of the Blackstone Group, such securitizations have grown 302 percent, to $20.2 billion since 2010, according to Thomson Reuters IFR Markets. And even as rising delinquencies and other signs of stress in the market emerged last year, subprime securitizations increased 28 percent from 2013.
Taking On More Risk
Deals made up of auto loans to borrowers whom creditors deem riskier have increased since 2010.
Total subprime auto loan securitizations
The returns are substantial in a time of low interest rates. In the case of the Santander Consumer bond offering in September, which is backed by loans on more than 84,000 vehicles, some of the highest-rated notes yield more than twice as much as certain Treasury securities, but are just as safe, according to ratings firms.
Now questions are being raised about whether this hot Wall Street market is contributing to a broad loosening of credit standards across the subprime auto industry. A review by The New York Times of dozens of court records, and interviews with two dozen borrowers, credit analysts, legal aid lawyers and investors, show that some of the companies, which package and sell the loans, are increasingly enabling people at the extreme financial margins to obtain loans to buy cars.
The intense demand for subprime auto securities may also be fueling a more troubling development: a rise in loans that contain falsified income or employment information. The Justice Department in Washington is coordinating an investigation among prosecutors’ offices across the country into whether such faulty information ended up in securitization deals, according to people briefed on the inquiries.
The examinations, which began this summer after a front-page article in The Times reported on potential abuses in subprime auto lending, are modeled on the federal investigation into the sale of mortgage-backed securities — an effort that has already yielded billions of dollars of settlements.
Prosecutors have sent a spate of subpoenas. This summer, the office of Preet Bharara, the United States attorney for the Southern District of New York, sent subpoenas to Santander Consumer and GM Financial. The United States attorney in Detroit subpoenaed Ally Financial in December. And Consumer Portfolio Services, a subprime lender, said last week in a regulatory filing that the company had received a subpoena related to its “subprime automotive finance and related securitization activities.”
“There is so much money looking for a positive return that people get lazy,” said Christopher L. Gillock, a managing director at Colonnade Advisors, a financial advisory firm in Chicago that has worked with subprime auto lenders. “Investors see it is rated triple-A, turn off their brains and buy into the paper.”
Among the borrowers stoking the lending boom are people like Dana Payne.
Ms. Payne, a former administrative assistant in the New York Police City Department, has not made a single payment on a $30,770 Santander loan that was taken out to buy a 2011 BMW 328xi. Ms. Payne, who has no driver’s license, said she took out the loan so her daughter, who lives in New Jersey, could have a car. The loan has an interest rate of 11.89 percent, according to her loan document, a copy of which was reviewed by The Times.
Ms. Payne went with her daughter to a dealership that arranges loans for Santander and other auto lenders to buy the car. She said an employee at the dealership in Great Neck, N.Y., assured her that, even though she was on food stamps, she could afford the loan. At the time, Ms. Payne said she thought she was co-signing the loan with her daughter.
“I looked him in the eye and said, ‘I don’t have any income,’ ” said Ms. Payne.
The dealership did not comment.
The lenders point out they are providing loans to people who might not otherwise be able to buy cars. They say they have acted to insulate investors from losses. In many bonds, lenders take the first losses when loans sour, a safeguard few mortgage deals contain.
“Subprime lending by its nature involves evaluating the creditworthiness and ability to repay of borrowers who may have had financial difficulties in the past, such as a bankruptcy, a foreclosure or difficulty in managing revolving credit,” Stephen Jones, vice president investor relations at GM Financial, said in a statement.
The lenders say they vet their dealer partners, watching for patterns of complaints against dealerships and other warning signs like higher than average defaults.
Laurie Kight, vice president of communications at Santander Consumer, said in a statement that the lender has a “rigorous and active dealer control operation, which is part of the company’s overall compliance framework.” She added, “This operation audits, investigates and — if necessary — ceases operations with any dealers who conduct fraudulent or high-risk activities.”
Investors are betting that the companies are experienced enough to weed out problem loans.
Still, some credit analysts have questioned whether the market has grown too much, too fast.
Some rating firms that faced criticism after the mortgage crisis for blessing shaky investments with top ratings are taking a critical approach to subprime auto deals.
Fitch Ratings will issue its highest ratings only to bonds issued by lenders with long track records and that don’t rely entirely on securitizations to fund their business, like Santander Consumer and GM Financial. And Standard & Poor’s has recently sounded alarms about the declining quality of the loans backing the investments.
Even those warnings, critics say, do not fully capture the fundamental risks.
Mr. Gillock, the financial adviser in Chicago, said that no bond made up of subprime auto loans should ever receive a triple-A rating — a designation that only three blue-chip companies, Exxon, Microsoft and Johnson & Johnson, receive on their debt offerings.
“It is hard for me to place securities backed by subprime auto finance receivables in the same category,” he said.
