In the Federal Reserve's second-quarter report on household debt and credit, a rise in auto loan delinquencies was identified, resparking an old conversation regarding subprime auto financing by lenders like Credit Acceptance Corp. (NASDAQ: CACC) and Banco Santander SA (NYSE: SAN)'s Santander Consumer USA Holdings.
Earlier this year, Santander was in the news following the release of a Schedule 13D/A SEC filing. The firm’s shares rose almost 10% after the authorization of a $400-million share buyback.
Is it possible that the buyback helped stabilize earnings per share, smoothing out a rocky past and the risks associated with rising defaults and declining loan performance?
In the face of an uptick in subprime delinquencies, Santander's share buybacks may be lending a false sense of prosperity, with Bloomberg reporting that analysts expect the firm to experience higher losses on auto bonds compared to its peers.
Economic Slowdown Sparks Action
The share repurchase came amid a slowdown in automotive sales and global economic growth.
Since 2009, a 75% percent expansion in the auto loan market has taken place, with auto debt performance weakening due to an uptick in delinquencies among subprime borrowers, according to CityLab.
Along with rising interest rates and a growth in vehicle prices, car loan originations hit a record $584 billion last year, according to Bloomberg.
Weak Income Verification Practices
Santander lends and services auto loan debt under the Chrysler Capital brand.
In a 2019 Moody's Investor Services report analyzed by Bloomberg, Santander was criticized for only verifying incomes on less than 3% of auto loans it securitized in tranches of bonds rated as high as Aaa.
In contrast to Santander, GM Financial's AmeriCredit verified incomes on 68% of the loans included in a bond package in June, according to Bloomberg.
In a statement to Bloomberg, Santander representatives pointed to the company's consistency in income verification, despite the lower percent on recent transactions.
Santander Consumer did not respond to a request for comment on this story.
Parallels To The Great Recession
Following the burst of the home loan bubble in 2008, lenders were placed under stricter income verification requirements, increasing homeownership affordability.
Similar regulations do not exist for automotive lending. As a result, regulators are concerned that lenders are putting borrowers in cars they can’t afford.
These alleged practices are the product of a competitive lending industry that lowered its standards to increase business. The consequence is that high-interest loans with poor credit scores, no cosigner and income verification are comprising bonds marketed to the public.
In the face of allegations regarding its lending practices, Santander Consumer settled a $26-million lawsuit in 2017, as reported by Automotive News.
Even with judicial and legislative efforts underway to curb predatory lending and poor underwriting, UBS strategists detailed to Bloomberg that 1 in 5 borrowers admitted their applications for debt contained inaccurate statements.
This revelation provides insight into the partnership between FCA and Santander after Chrysler’s 2009 bankruptcy.
Santander, known for its "expertise in 'automated decisioning,'" helped Chrysler boost automotive sales on inflated and unverified incomes via a process that based lending decisions on analysis that looked past a customer’s credit score, according to Automotive News.
Time To Worry?
The auto sales boom, a result of lax lending standards and cheap credit, faces risks in the form of interest rate uncertainty, stagnant income, mounting living costs and a 47-basis point hike in 90-day delinquencies.
"Given the sheer size of the automotive finance market, an uptick in subprime is expected as a function of the overall market growing," Zo Rahim, manager of economic and industry insights at Cox Automotive, told Benzinga.
"It is important to stress that the current levels, though high, are not flashing major red flags or warning signs, given the desire of lenders to work with borrowers to get them out of delinquency status rather than repo the asset," he said.
A growth in auto loan defaults does signal serious financial duress for borrowers, said Mayra Rodríguez Valladares, managing principal of MRV Associates, told Benzinga.
"Auto loans tend to be the last loan that borrowers default, since they need their car to drive to work."
Santander shares were down 0.49% at $4.08 at the time of publication.
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