Another Subprime Situation?

Santander Consumer and GM Financial are enmeshed in another lending binge—this one involving car loans.

After the mortgage meltdown that sparked a crisis on Wall Street and the Great Recession, I thought “subprime” had become a dirty word. Apparently, Thomas Dundon and his fellow executives at Santander Consumer USA didn’t get the memo.

The Dallas-based finance company is at the center of a new subprime lending binge—this time in auto loans—that has generated billions in profits and a fortune for top players. Last year, Santander Consumer, which is 60 percent owned by the Spanish bank with the same name, earned $766.3 million. It originated $27.5 billion in loans, up 33 percent, including more than $11.5 billion through a deal with Chrysler. And in January 2014, it raised $1.8 billion by selling about 20 percent of the company in an initial public offering.  

On the other side of the region, Fort Worth-based GM Financial is another leader in this market. The former AmeriCredit, which was acquired by General Motors in 2010, earned $537 million in 2014. Loan originations increased more than 50 percent to $15.1 billion.

These companies are feeding off a growing niche: loaning money to cash-strapped working Americans, many of whom saw their credit scores dinged thanks to foreclosures and layoffs during the economic downturn. According to the Corporation for Enterprise Development, nearly 56 percent of Americans now have credit scores that qualify them only for subprime loans. Last August, economists with the Federal Reserve Bank of New York said that the dollar value of auto loans made to people with credit scores below 660 had doubled since the fourth quarter of 2009, while loans to groups with better credit were up by only half.

Subprime auto loans typically carry interest rates from 14 to 18 percent—two to three times what more secure Americans are paying. And because trucks and cars are essential to American life, borrowers tend to make those payments ahead of others. Santander says its delinquency ratios are stable.

Eager for some of the action, Wall Street is back into subprime in a big way. Just as shaky mortgages were bundled and securitized for sale to big investors a decade ago, auto loan securitizations have been peaking. The New York Times reported earlier this year that securitizations have grown 302 percent, to $20.2 billion, since 2010.

Worries are mounting that this could turn into a replay of the subprime mortgage debacle. In the past year, state and federal regulators have launched probes into these lenders to determine whether any of the same shenanigans, like faked income on applications or inflated ratings from credit agencies, have occurred.  

In August, GM Financial and Santander Consumer received subpoenas from the U.S. Department of Justice, seeking documents dating to 2007. In a speech to state attorneys general in February, acting Deputy Attorney General Sally Quillian Yates said the government is looking at both potential fraud and lending discrimination in the underwriting of auto loans, working from its experience from the subprime mortgage mess. 

“We shouldn’t wait until there is a crisis to pay attention,” she said. “We can and should use our experience investigating mortgage-backed securities to be on the lookout for, and head off, any potential threat, rather than waiting until after losses have been suffered.” 

During a conference call with analysts in February, Santander executives acknowledged the increased attention from regulators. Chief Financial Officer Jason Kulas said the company added to its oversight and compliance team in 2014, and would be adding more staff in 2015. Dundon reassured questioners that his company can meet the demands of both Washington and Wall Street.

“We’ll probably continue to make decisions that make us more compliant with regulatory expectations, and de-risk the business,” he said. “I think there’s a way to do it and still maintain who you are. You can still make money and follow regulatory expectations. It’s just a little harder.”

Success breeds such confidence. Dundon, 43, started what would become Santander Consumer 20 years ago, just a couple of years after graduating from Southern Methodist University. After working as a finance manager for auto dealers, Dundon and colleagues built a business called Drive Financial Services and in 2006 received an investment from Banco Santander. Three private equity firms came aboard in 2011, setting the stage for the 2014 IPO.

According to the prospectus, Dundon received a pay package worth $85 million in 2012 and another $13.6 million in 2014, mostly in stock. Following the IPO, he retained about 10 percent of the company, worth more than $1 billion. That’s hardly below prime.   

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