Santander’s Storm: When Will Skies Clear for the Subprime Giant?
When Santander Consumer USA Inc. (SC) went public on Jan. 24, 2014, the offer was 10 times oversubscribed and shares priced at $24 each. Valued at $8.3 billion, the company was the go-to provider for Chrysler loans and leases, and it had flow agreements with Bank of America, Sovereign Bank, and peer-to-peer provider LendingClub.
Fast-forward two years, and Santander’s stock price is hovering around $11 per share, as the lender grapples with a second delay in the filing of second-quarter earnings amid confusion around accounting for credit losses. Santander was the nation’s 10th-largest lender in 2015, with $34.6 billion of loans and leases outstanding, according to Big Wheels Auto Finance 2016.
SC’s earnings delay is the latest in a series of perceived setbacks that have kept the lender in the public eye. Back in April, regulatory issues prompted the company to refine and narrow its business model. In July 2015, the company announced the abrupt departure of its chief executive, Thomas Dundon.
“All of those issues have likely reduced investor interest over time, and I think that’s why you’ve seen this very significant level of multiple contraction,” said Eric Wasserstrom, managing director at equity research firm Guggenheim Securities LLC.
Santander Consumer declined to comment for this story because it was in a quiet period before the release of second-quarter earnings.
As of Aug. 25, SC’s market capitalization was $4.2 billion. According to Daniel Parry, chief executive of Praxis Finance Corp. and former chief credit officer at Santander competitor Exeter Finance Corp., SC’s stock is at an “absurdly low level.”
“Ever since October 2015, their stock price has dropped based on the optics of a number of factors, such as slowed growth and regulatory scrutiny,” he said. “But if you sold the company and liquidated everything, you’d probably get $18 to $20 a share on the value of the assets, so in my opinion it is way undervalued.”
Santander is actually shaping up to be one of the few companies, perhaps in the country, that may show credit improvement next year, according to someone familiar with the company who preferred to remain anonymous.
“They’ve actually slowed growth, and they’ve been a little more selective in their originations,” he said. “Because in 2015, they were definitely going down a little and doing loans further down the credit spectrum, and that’s what’s been impacting credit.”
Paused Earnings
While the most recent delay in earnings — SC said on Aug. 23 that it would further delay earnings — is “certainly not a positive thing,” he added, it’s also a “non-cash issue.”
“Essentially, it’s related to discount accretion,” he said, referring to the accounting treatment for consideration of discount in estimating the allowance for credit losses.
“If they’re paying 97 cents on the dollar, and if the debt pays off at par, they’re essentially going to accrete that 3 cents over time,” the unnamed source said. “And they’re having an issue discussing the schedule of that accretion.”
There’s also a debate about whether the company should reserve on the 97 cents or on the 100 cents. “Their reserve is over 12.5%, plus they have another 1.5% of discount, so it’s almost like their reserve is at 14%.”
Although Praxis’s Parry lacked inside knowledge on the delay of SC’s earnings, he suggested that sometimes external auditors change their opinion on how to handle grey areas in accounting, or regulators express a preference for how things should be reported on a going-forward basis. “In either case, it would be better for them to delay earnings in order to satisfy those concerns than to have to change earnings after the fact,” he said.
Santander already restated earnings back in April, when it filed its 10-K with “revised methodology for estimating credit loss allowance on individually acquired retail installment contracts,” according to a company press release at the time.
“The way that they provisioned was pretty confusing,” the unnamed source said. “Basically, they were reserving for 15 months out, so it would double-count some quarters, and I think it confused a lot of analysts and people’s provisions were way off.”
The company then tried to simplify its loss accounting with a more traditional 12-month policy, ultimately removing some of the “weird seasonality,” he added.
Part of the difficulty is the lack of a universal method for modeling loss reserves. “If you ask 10 different people what a loss-reserve model should look like, you’ll get 10 different answers,” said Parry.
SC has modified its loss-reserve methodology twice since going public, something regulators often look at with suspicion, Parry said. “What people fear is that you’ve changed your loss reserve to make your numbers look better,” he said. “But that’s not really the case with Santander.”
The company was a monoline auto lender for many years, and like many older finance companies of that type, had legacy reserve periods, Parry explained. “They modified that by a few months to more closely match actual performance,” he said. “When I look at their numbers, it’s hard for me to make the case that they are in any way under-reserved.”
But changing a loss-reserve model typically garners attention from bank regulators, like the Federal Reserve, whose oversight has included SC since it became part of a broader bank entity.
