Different Market, Same Story: Subprime Auto Loan Defaults On The Rise

Stop me if you’ve heard this one before.

Subprime auto lending has soared since the U.S. mortgage bubble burst back in 2008, and, predictably, default rates have started to follow suit. This week, 90-day auto loan delinquency rates eclipsed 3.8 percent, their highest levels since the financial crisis, putting auto loan investors and shareholders of subprime auto lenders at risk.

With interest rates still at historical lows, auto debt investors have been lured by the promise of yields as high as 5 percent. However, if too many of these loans sour, investors can be left footing the bill.

Accusations Of Lender Abuse

Some troubling anecdotal evidence of lender abuse has begun popping up regularly as well. Earlier this year, Santander Consumer USA Holdings Inc SC paid $26 million to settle cases against the company related to abusive lending practices in Delaware and Massachusetts. As part of the settlement agreement, Santander admitted no wrongdoing.

In late May, Moody’s Investor Service reported that Santander verified the income of only about 8 percent of its auto borrowers.

“A lack of income verification … creates more uncertainty around whether borrowers will be able to afford their monthly payments,” the ratings firm said, according to CNN.

Related Link: Moody's Spotlights Troublesome Subprime Auto Lending

In an email to Benzinga, Santander defended its lending process.

“We are entirely committed to treating our customers fairly and lending responsibly," the statement said, adding that other variables such as down payments and credit history are considered in lending decisions.

Beyond Santander

Santander’s practices aren’t the only ones raising eyebrows. In May, analytics firm Point Predictive reported that as many as 1 percent of U.S. auto loan applications contain some form of fraud. That level of fraud is roughly in-line with fraud levels seen during the peak of the U.S. mortgage bubble.

The collapse of the mortgage market nearly took down the entire U.S. economy in 2008. Fortunately, the auto loan market has nowhere near the size and breadth of the mortgage market. UBS credit strategist Stephen Caprio recently assured investors that auto finance “is not going to bring down the financial system like the mortgage crisis almost did.”

Where's The Pressure Coming From?

However, with U.S. auto sales and auto prices on the decline in 2017, lenders are feeling even more pressure to hit their loan targets. According to Height Securities analyst Edwin Groshans, it's subprime lenders like Santander that are most exposed to the potential fallout.

“The combination of lower used car auction prices and weakening credit quality will manifest in the operations of auto finance companies with subprime lending concentrations,” Groshans recently wrote.

In addition to Santander, Height named Credit Acceptance Corp. CACC, Ally Financial Inc ALLY and Capital One Financial Corp. COF as the companies with the most exposure to the subprime auto market.