Santander’s Storm: When Will Skies Clear for the Subprime Giant?
Regulatory Oversight & Dundon’s Exit
Santander Consumer was founded as in 1998 by a group of entrepreneurs, but it wasn’t until 2000 that the company officially became Drive Financial Services LP. When Santander Holdings USA acquired a majority stake in 2009, Drive was forced to figure out how to transition from an auto finance company to a bank subjected to federal oversight, Parry said.
“It’s a different world for lenders who fall under a bank regulatory scheme,” he said. “Any type of move they make, such as how to account for losses, will get intense scrutiny. The company has moved from being an independent, privately held auto finance lender to a multi-product, bank-owned public company. That has meant a lot of changes as the management team makes the adjustments necessary to conform, but it is certainly not an indication of a problem with the business.”
Santander still appears to be grappling with that transformation. Shortly after parent company Santander Holdings USA failed the Federal Reserve’s stress test in 2015, the company entered into a Written Agreement — a form of enforcement action — with the Federal Reserve Bank of Boston, released on July 2, 2015.
“A written agreement is the second most severe form of regulatory enforcement, the next one being a Cease and Desist order,” a second unnamed source told AFN. “I think that was very thinly veiled message from the Fed, that they thought that management team at SCUSA was inadequate. So practically speaking, the message you’re sending to an institution in that case, is something has to change. We’re not going to tell you what it is, you tell us what you think is appropriate, and we’ll tell you if we think it’s enough.”
On that same July day, the Thursday before the July 4 holiday weekend, Santander Consumer announced that Dundon, the chairman and CEO, had left the company. Since Dundon’s departure, Jason Grubb, who was president and chief operating officer of originations, and Brad Martin, who was chief operating officer of servicing, have also left.
Meanwhile, the company has been involved in a number of other “investigations, examinations, and proceedings by government and self-regulatory agencies,” according to its 2015 annual report. In November 2015, the Massachusetts Attorney General alleged that SC violated the maximum permissible interest rates allowed by Massachusetts law due to the inclusion of guaranteed auto protection (GAP) charges in the calculation of finance charges.
On Feb. 25, 2015, the company entered into a consent order with the Department of Justice. The agency alleged that some of SC’s repossession and collection activities violated the Servicemembers Civil Relief Act (SCRA).
On July 31, 2015, the Consumer Financial Protection Bureau notified the company of potential violations of the Equal Credit Opportunity Act regarding statistical disparities in markups charged by automobile dealers to protected groups on loans originated by those dealers and purchased by the company and the treatment of certain types of income in the company’s underwriting process.
And earlier this summer, for the third straight year, Santander failed the Fed’s stress test again. Because the company has yet to submit an approved plan to the Fed, SC cannot pay any return of capital to investors or shareholders.
Leading the Subprime Storm
The Federal Reserve doesn’t have its eye on just Santander, but on the subprime sector as a whole, argues Parry.
“Regulators generally hate subprime,” said Parry. “And when I say that, I mean there’s no regulator that, after this last crisis — the subprime mortgage crisis — wants to be the one who misses any potential new issue in subprime.”
This scenario bodes poorly for Santander Consumer, considering its background in the subprime sector.
“They’re basically the largest, and potentially the only public company that has had such a large nonprime orientation. So if that’s the battleground topic, they’re the name most levered to it,” Guggenheim’s Wasserstrom said. “However, I think the market’s fear may be misguided, as the likely driver of a significant worsening in credit costs would be a surge in job losses, whereas our economy continues to benefit from job growth.”
SC has moved up the credit spectrum, simply by virtue of its relationship with Chrysler Group, acting as de-facto captive under the name Chrysler Capital. But Chrysler Capital originations dropped 36% last year, to $11.2 billion of loans and $5.1 billion of leases, according to its 2015 10-K.
“Our penetration rate has been constrained due to a more competitive landscape and low interest rates, causing our subvented loan offers not to be materially more attractive than other lenders’ offers,” the company wrote in the 2015 annual filing.
It’s just a cyclical business, an unnamed source said, and the cracks show first in subprime. However, while the industry may avoid a recession, it’s already in the middle of a slowdown, he said.
“If you ask what inning is it, I’d say you’re kind of already going through the cycle,” he added, and Santander Consumer, the biggest subprime player in the space, is getting caught up in the storm of negative headlines.
The company has undergone a host of changes, it’s had to retreat from several initiatives, fix its accounting, and address management issues, Wasserstrom said.
“While these changes may be positive for the company over the medium term, they’ve been a lot for investors to digest in a short period,” he said. “The latest accounting issue is a bit of a setback because, after the series of changes the company made late last year, the market’s view was that SC was making significant progress on remediating its challenges. This recent issue undermines that view.”
