Risky auto loans attract investors as consumers pay the price

In hindsight, buying a Dodge Charger with a six-year loan carrying an interest rate rivaling some of the worst credit card offers probably wasn’t the best idea.

But the Goose Creek mother of two young children needed transportation for her family and to get to her job.

So in March 2011, she signed a contract agreeing to pay $554.62 a month — at 21.99 percent interest — for the next 72 months to lender Santander Consumer USA, court documents show. By the time the Goose Creek woman could call the four-door sedan her own, she would have paid almost as much in interest as she would the car’s $22,395 retail price.

Her situation is hardly unique. And some observers worry that similar loans will be the type of thing that drives the next national financial emergency.

“It won’t have the same impact as the housing crisis, but it will ripple throughout the economy,” said Chris Kukla, senior vice president of the Center for Responsible Lending in Durham, N.C.

He noted that most workers need a vehicle to get to their jobs and take care of their families.

“A lot of people will be losing their cars” due to high-interest, high-risk loans, Kukla said. That, in turn, will boost unemployment and put pressure on underfunded social service programs and public transportation.

Others, like Equifax economists Amy Crews Cutts and Dennis Carlson, say the concerns are overblown. Their February report, titled “Subprime Auto Loans: A Second Chance at Economic Opportunity,” calls the industry a well-managed and stable subset of automotive lending.

“An increased negative media focus on some worst-case scenario situations has drawn criticism to an industry that — rather than a pointed finger — deserves some recognition for weathering the storm of the Great Recession, and ultimately helping to pave the way for our recent economic recovery,” the Equifax economists state.

Subprime auto lending — generally, high-interest loans to people with credit scores below 620 — is one of the nation’s fastest-growing industries, nearly doubling in size since 2009. Of the record-breaking $870 billion in auto loan balances at the end of the third quarter last year, subprime loans accounted for 38.7 percent — or more than $336 billion, according to Experian Automotive.

An Equifax study shows 24.2 percent of all car loans made in January and February, the most recent statistics available, were subprime.

Santander is the biggest player in the subprime market. The Texas-based company accounted for more than one-third of all subprime originations last year, has more than $46 billion in assets and 2 million customers — thousands of them across South Carolina.

Santander also is at the forefront of a newly popular type of investment being pitched on Wall Street. The company is packaging its subprime auto loans into securities and selling off the bundles hundreds of millions of dollars at a time.

The latest issue — Santander Drive Auto Receivables Trust 2015-3, which was introduced in June — includes $1 billion worth of high-interest, subprime loans given to people with FICO credit scores as low as the 400s. It follows another issue introduced two months earlier of nearly $1.2 billion of packaged subprime auto loans. A third issue secured by $1.25 billion of auto loans was introduced in February.

Critics say the investments mirror the high-risk, mortgage-backed securities that brought down the housing market and sparked last decade’s global financial crisis. They say a similar bubble is about to burst in the car industry, and they point to Santander’s 16.7 percent overall auto loan delinquency rate — the highest among the nation’s top 15 auto-lending banks — as evidence.

Tom Dundon, Santander’s former CEO, scoffed at the notion of a subprime bubble during a conference call with analysts in April. Dundon, who resigned as CEO this month but remains on the company’s board, said he blames the media for hyping the concerns.

“You know, unfortunately, if the media writes something for some reason, it probably gets taken because it’s written down maybe more seriously than the facts would lead me to believe on the subject,” Dundon said, adding “there is no boom and there’s no bust.”

Jason Kulas, the company’s former chief financial officer, replaced Dundon in what the company called a planned succession. Kulas told investors this month that the company will continue its focus on subprime lending.

Santander did not respond to a request for an interview.

The U.S. Department of Justice is investigating the company’s auto loan underwriting and collateralization policies and several state attorneys general — but not South Carolina’s — are seeking similar documentation.

Earlier this year, federal officials said Santander agreed to pay at least $9.35 million to resolve a lawsuit alleging the company violated the Servicemembers Civil Relief Act by improperly repossessing vehicles of soldiers stationed overseas.

Investors appear unfazed. That’s because the interest paid on the highest-rated bundle of Santander’s offerings is about double the equivalent Treasury bond yield. The company’s issue introduced in February sold out in hours.

A report this year by the Center for Responsible Lending shows higher interest rates are only part of the problem for subprime borrowers.

Loan originators are loosening their standards, the report states, allowing for higher loan-to-value ratios on loans — an average of more than 125 percent on subprime loans for new cars.

To make the monthly payments more affordable, lenders are extending loan terms for as long as eight years, according to the report. That means subprime borrowers pay as much as 400 percent more in interest over the life of their loans than buyers with top credit scores.

Add-ons — such as dealer fees, gap insurance and service plans — boost both the price of the car and the amount of interest buyers pay because those items typically are financed over the life of the loan, according to the center’s report.

A North Charleston woman, for example, financed a $399 closing fee, $800 worth of gap insurance — coverage that will pay off the vehicle if it’s totaled — and a $2,200 service contract through her Santander loan when she bought a six-year-old Honda Accord in April 2013, court records show. At 22.91 percent annual interest, the car and add-ons would cost the woman nearly $495 a month over the 72-month term of the loan.

All of those things make it more difficult for people to keep up with their payments, Kukla said. A January report in the Wall Street Journal shows auto loan delinquency rates are soaring to recession-era levels, with more than 2.6 percent of borrowers who took out loans in the first quarter of last year missing at least one monthly payment by November.

“Some observers and government officials are expressing concern that loan standards are being lowered, or abandoned altogether, in order to pump up the volume so loans can be sold off to Wall Street,” a Credit.com report stated in March.

As the number of Santander’s subprime loans has increased, so have complaints about the lender’s alleged collection tactics.

Complaints about Santander — 1,290 of them, including 27 from South Carolina consumers — make up more than 17 percent of all auto loan-related complaints the federal Consumer Financial Protection Bureau has logged since March 2012, according to the agency’s online database.

The S.C. Department of Consumer Affairs said it has taken 22 complaints against Santander over the past year and a half, most of them over collection tactics, repossessions and payment disputes.

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Dozens of federal lawsuits have been filed against the company, alleging Santander unlawfully communicates with friends, relatives and co-workers of its debtors, and makes repeated phone calls to delinquent borrowers with the intent of harassing them. Santander denies it violates debt collection laws.

A Florence County woman sued Santander in 2013 claiming the lender refused to provide her with the title to a 2005 Chrysler Sebring after she had made the 72 payments — at 26.99 percent interest — that were due on the loan. The woman said Santander harassed her by phone for money she said she didn’t owe. Santander said in court documents that she still owed late and payment deferral fees that, with interest, totaled $6,766 — with further interest accruing at $4.57 per day. The case was settled in April.

Former CEO Dundon said during a meeting with analysts in May that the lender strives to help its customers.

“We are very flexible with our customers,” he said. “If they can’t pay, we’ll give them a deferment. We try to work with them because, in the situation that a lot of our customers are in, they don’t make their payments exactly on time.”

Legal issues haven’t kept investors away from securities backed by the risky loans. Securitizations of subprime car loans by all lenders have risen every year since 2009, and they topped $21.8 billion last year, or $200 million more than in 2013, according to industry newsletter Asset-Backed Alert.

Despite the fact that as many as a quarter of the loans in those securities are expected to go into default, investors are lured by higher returns that most ratings agencies say carry little risk.

Some within the ratings industry are starting to sound alarm bells.

Amy Martin, senior director of structured finance ratings at Standard & Poor’s, told Auto Finance News this spring that the firm is watching delinquencies closely, and that the percentage of loans at least 30 days past due hit an all-time high of 9.46 percent in December, which “highly correlates with losses” in the securitization pool.

“When they start to tick up, losses are going to tick up, too,” Martin told the publication. “They are not leveling off, they continue to rise, which does concern us.”

That runs counter to the Equifax report on subprime lending, which says, “There is no definitive evidence that suggests an auto subprime loan bubble similar to the housing bubble is forming.” The Equifax economists say higher default rates simply are the result of more loans being granted.

Through it all, Santander has been one of the best-performing companies in the subprime market. The company reported profits of $289 million during the first quarter, up from $81 million during the same period a year ago. The publicly traded company, which is 60 percent owned by a subsidiary of Spain-based Banco Santander, is set to release its second-quarter earnings July 30.

Analysts are bullish on the subprime auto lending industry because more Americans are going back to work and need cars to get there, a report in Investor’s Business Daily stated, adding that subprime auto lending is “a high-risk industry and always faces challenges.”

“There is collateral there because there is a car, so lenders are more comfortable making loans,” Chris Donat, an equity research analyst at Sandler O’Neill & Partners, told the publication. “The biggest risk is that the economy turns, and if people start losing their jobs and they start falling behind on their credit cards, student loans and auto payments.”

Reach David Wren at 937-5550 or on Twitter at @David_Wren_