News that both General Motors Financial Co. and Santander Consumer USA had been subpoenaed by the U.S. Department of Justice set off a wave of speculation throughout the industry that the government action was the tip of an approaching crackdown on subprime auto finance.
The subpoena for GMF was issued July 28. SCUSA made public its subpoena on Aug. 7.
The US Attorney’s Office for the Southern District of New York is relying on a 1989 law called the Financial Institutions Reform, Recovery and Enforcement Act, or FIRREA, for its investigation of GMF. DOJ confirmed to Auto Finance News that the New York office was leading the GMF investigation. Later, a DOJ spokeswoman would neither confirm nor deny that it had also issued the SCUSA subpoena.
Regardless, FIRREA is the same law that led to billions of dollars in fines for financial firms over questionable mortgages pooled into securities in the run-up to the financial crisis.
“DOJ may have its sights focused on subprime auto markets as it relates to representations on the quality of the loans in the securitization markets,” Kenneth Rojc, a managing partner in the automotive finance group at Nisen & Elliott LLC, told Auto Finance News.
The subpoenas come on the heels of high-profilenegative publicity surrounding subprime auto lenders and dealers. But the DOJ appears to be equally motivated by concerns that investors buying into subprime ABS pools may not fully understand the risk inherent in some of the packages sold to the market over the past seven years.
American Financial Services Association President and Chief Executive Chris Steinebert was especially critical of a recent New York Times article criticizing subprime lending, saying the numbers tell a different story.
In a letter to the editor published July 25 in The Times, Steinebert wrote that there is no bubble forming in the subprime space. The auto market, like other sectors, is cyclical. He pointed to data from Experian Automotive that showed that in the first quarter, the share of used subprime loans was lower than it had been in the first quarters of 2013 and 2012, but slightly higher than in the first quarters of 2011, 2010 and 2009. The Standard & Poor’s/Experian Consumer Credit Default Index showed that the auto loan default rate hit a historic low in April 2014, at 0.92%.
Steinebert told AFN that there are important characteristics to remember with auto that make it different from other asset-class financing. Importantly, most poeple need a car for transportation. And he pointed out that subprime lending is nothing new in the auto finance space.
“Historically, if you go back over the last 10 years or so, subprime always represented around a quarter of the loans,” he said.
TREADING CAREFULLY
In addition, Steinebert said the loans have always been priced as a depreciating asset, unlike mortgages, where people assumed they would refinance before the asset’s value resets. “I think the important thing is to look at the statistics, see what the ratios are on loan-to-value today, whether there’s been any dramatic increases,” he said.
Subprime auto lenders maintained a cautious stance on lending in the first quarter, according to a July 14 report from Moody’s, which says that this action “bodes well for new subprime auto loan-backed securities (ABS) in the US.”
Peter McNally, assistant vice president at Moody’s, said, “We analyzed a number of credit metrics from Experian that suggest that subprime lenders are becoming more cautious and making fewer loans to riskier borrowers. If this trend holds, losses on new subprime auto ABS are likely to stabilize.”
McNally said that data shows that the credit scores of borrowers taking out used-car loans rose for the second straight quarter and that subprime lenders raised their interest rates. These two trends suggest that lenders are exercising more caution, following deterioration in subprime loan performance in 2013.
The markets saw $17.6 billion of asset-backed securities tied to subprime auto loans issued last year. That’s more than double the $8 billion sold in 2010, according to Barclays PLC. This year, ratings agency Standard & Poor’s is projecting that ABS volume will reach $20 billion for subprime, and another $5 billion for what it calls nonprime. In its June Subprime Auto Loan ABS Tracker report, S&P said performance continues to weaken as subprime lending approaches pre-crisis levels, competition increases, and trends such as higher LTV ratios and longer loan terms remain prevalent.
“Over the last year, industry loan delinquencies and net losses have increased while the quality of car collateral has declined,” said Boston University Professor Mark T. Williams, a risk management expert. “Increasingly, subprime auto lending has become very competitive, motivating lenders to reduce credit standards in an attempt to gain customers.”
Williams told AFN that the Federal Reserve’s low interest rates, in place since the recession, have forced traditional investors to seek higher returns, which by nature, means higher risk. But he says what led to the decline in credit underwriting standards and increased competitive pressure is similar to the circumstances that led to the mortgage crisis.
“If the industry isn’t collectively going to put a stop to it, and say, we have to elevate standards to protect ourselves and our investors, that’s where industry regulators and independent ratings agencies need to come in,” said Williams.
S&P reported in August that year-to-date loan-to-value ratios grew to 116 from 114 last year. Midyear weighted average Fico scores slipped to 572 from 577 from last year. The S&P ABS tracker indicated that recoveries in the first quarter had slightly softened to 48.7% from 53.5% in 2013.
S&P also expected a decline in recovery rates, given the high used-vehicle prices over the past few years. Prices, it says, will likely trend lower over the next year as used vehicle values face downward price pressures.
John Bella, managing director of Fitch Ratings, said that predicted defaults and recoveries are built into subprime ABS deals, protecting them, to some degree, from loss. Strong used-car values play a key role in the performance of auto loan ABS, because when values are high, both net losses and the severity of those losses typically decline in ABS transactions.
Federal Reserve data shows that the overall debt-service ratio for consumers in the first quarter was 9.9%, and about half that was for mortgages. “In isolation, regardless if it’s in subprime mortgage or auto, in this case, auto, and delinquencies are increasing, losses are increasing, collateral quality is declining,” said Williams. “Those are all indications that credit underwriting standards are declining. That’s fact.”
AFSA’s Steinebert and others believe the industry is still operating smoothly for now. “There’s a lot of competition, but we’re not seeing stupid things happening,” he said.
Instead, auto finance has been one of the few industries that has performed relatively well in recent years, hence the attractiveness to hedge funds and private equity firms. “I don’t think the industry got stupid all of a sudden and forgot its discipline that it remembered during the whole heady times earlier this decade,” Steinebert said.
Their is more Special Finance than reguar Finance in the market-place, Even good customers that went bad on their mortgage and few credit cards from the 1998 market crunch wound up with credit scores in the mid 500 and low 600 witch qualifies them for Special Finance. I got into the Automotive business in 1971 in Colorado……and all I heard, was that California was the the Car Capital of the World. I think sone one has their wires crossed!!!! I came out to California in 1987 and worked for the Number 1 Jeep Store in the country in Finance.
I had to teach them what Leasing was all about to begin with. A deal comes back to me with 5000 down and payments of 300 a month for 48 or 60 months…..The first thing I told the customers was, If I give you back 2500 and shorten your term in half, and keep your payments the same? are you interested in how do to do this? That was simple and I inceased the profit in front by a 1000.00 and increased the back end profit.
Next was Special Finance. Colorado has Separate Special Finance Departments in most Dealers and usually separate locations and with their own Lenders, which their regular Finance Department are not allowed to use.
Every day or other day, we in Special Finance would go to regular Finance and pick up the deals that can’t get bought and get then I re worked them and got approved and re written by the customer and sent in for prompt funding. The original salesmen got half the commission and the full point for any bonuses.
When I opened a separate Special Finance Department at the Dealer to begin with, I utilized the existing employees, which was the salesmen. I advertised and when a customer came in, who ever was the salesmen that took them to me was the salesmen. All he or she did was take them for a test drive in the car I told to them to go in. Then the deal was finished and if any additional paperwork or stips were needed the salesmen followed and got everything we needed to finish the deal. He was paid a $200.00 flat and it their was closes involved in the dealership and I took one of their salesmen, I paid the salesmen $150.00 and paid the closer $50.00, which was more than they both made back in those days on any deal. When I reached 30 to 40 deals a month, I took my department and hired additional help with an assistant and my own salesmen and we then had our own separate Special Finance Department.
California still has basically no idea about Special Finance and thinks their finance managers can get all the deals done.
Yes they can get all their deals done, but they are not advertising for Special Finance customers like I do and then you need someone with expertise in Special Finance and additional Lenders to get these Special Finance Deals done, the ones I bring in on my advertising…..
I believe Santander is my favorite when it comes to Special Finance. They buy smart and have procedures in place to get more business and good business, a few examples; If you have a customer that has 25 percent of the selling price as down payment, they will automatically approve the deal, the customer must have a job and income and they waive proof of income. Makes sense to me, because if the customer is not going to pay, it is usually within the first couple of months and the bank will get the car back, cancel the warranty and gap insurance, have plenty of down payment to keep and resale the vehicle for additional profit. Like a Buy Here, Pay Here would do.
I also like Santander for giving you the Warranty to put on the vehicle and Gap, because they know the biggest problem people have with not paying is because, something major broke on the vehicle and with no warranty its 100% sure you are getting the vehicle back. Ask any bad credit customer that has a repo, what happened and you will get the same answer every time. In closing, my favorite bank in the indusrtry is Santander……
If you need more information or would like to discuss anything about the Automotive Indusrtry with me in over 40 years in the Industry, please contact me ar your earliest convenience…….Your favorite reader!!!!
My phone number is: (714) 697-7588
A good friend of mine wrote me from Colorado and said, Its hard to believe I am having so much problems in Special Finance in California, the Banks in Denver, are buying Dead People Again……
This just means Business is Good…….No Bank actaully does that……
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