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Santander’s Payment Mistake Points to ABS Market Risks

A recent error by a lender in distributing $71 million to investors in a bond deal linked to subprime auto loans points to the potential for more such lapses in the booming market, according to Citigroup Inc.

The inaccurate principal payments by the firm, which according to Moody’s Investors Service was Santander Consumer USA, continued for two months before being discovered and corrected earlier this month, Citigroup said. On June 13, Santander Consumer made a $71 million infusion to the $1.55 billion asset-backed deal, according to Moody’s.

The mistake exemplifies the types of administrative risks inherent in issuing asset-backed securities beyond simply collecting payments from borrowers, Citigroup analysts led by Mary Kane said in a report today. Small firms with inexperienced management and high employee turnover are at greater risk of making these types of blunders, they said.

“Servicer error and lapses in transaction governance are operational risks in securitizations that financially strong servicers can remedy,” Moody’s analyst Corey Henry wrote in a June 16 report. Santander’s move “shows the benefit of a transaction sponsor and servicer that have the ability and willingness,” to correct operational mistakes, he said.

Santander Consumer, majority-owned by Banco Santander SA, is one of the largest issuers of bonds linked to subprime auto loans, according to data compiled by Bloomberg.

Surging Issuance

The error occurred when the U.S. unit “erroneously allocated” all principal to fixed-rate notes instead of splitting it between fixed and floating rate, Citigroup said.

Santander made two incorrect payments -- $26 million in April and $45 million in May -- before the error was found at the end of last month and rectified in the June payment, according to Citigroup.

Peter Greiff, a spokesman for Santander, wasn’t immediately available to comment.

Issuance of bonds linked to subprime auto loans is surging as investors chase risker assets with central banks around the world suppressing interest rates to spur economic growth.

High profit margins in the subprime auto-lending business are attracting new players, sparking concern that underwriting standards are deteriorating as increased competition pushes lenders to make riskier loans.

Seeking Returns

The subprime auto segment has ballooned since contracting following the financial crisis. Private-equity firms have flocked to the business during the past three years. New York-based Blackstone Group LP acquired Irving, Texas-based subprime lender Exeter Finance Corp. in 2011, the same year that Perella Weinberg partnered with CarFinance Capital LLC.

Bond investors are increasingly willing to look at smaller, less-established firms in the subprime auto segment to boost returns, Wells Fargo & Co. analyst John McElravey said in a telephone interview earlier this month.

Tidewater Motor Credit, a Virginia Beach, Virginia-based lender, sold $145 million of bonds on June 9 that are backed by 7,438 loans carrying interest rates ranging from 9.45 percent to 26.55 percent, deal documents show. The transaction marks the first asset-backed bond offering for the company since 2012, according to data compiled by Bloomberg.

About $10 billion of asset-backed bonds linked to subprime auto loans have been sold this year, up 5 percent from the pace in 2013 through May 30, according to Wells Fargo. Total sales of $17.6 billion last year were more than double the $8 billion sold in 2010, when securitized-debt markets started to revive after all but shutting down amid the 2008 financial crisis.

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