Auto Loans: A Subprime Market Grows in the Shadows
The housing crisis laid bare an epidemic of fraud and sloppy paperwork on loans made to home buyers with spotty credit. Investors who purchased bonds backed by those loans suffered drastic losses.
Six years later, investors are snapping up a new crop of subprime bonds, this one backed by auto loans. Ratings companies are awarding the bonds top grades, and buyers have almost no way to determine the accuracy of the information they get about them. “Investors are basically taking the issuer’s word that they follow certain procedures,” says Eugene Grinberg, a former analyst who structured subprime auto asset-backed securities and now runs his own software company. “There is opportunity for fraud.”
Wall Street sold $17.7 billion of the bonds this year through Sept. 26, a pace that would make 2014 the busiest year since 2006, according to Barclays. Subprime auto payments more than 60 days late climbed to 3.6 percent of the debt outstanding in July, from 3 percent the year before, Standard & Poor’s said in a Sept. 18 report. Issuers include the finance arm of General Motors; Exeter, which is owned by private equity firm Blackstone; and CarFinance, which has backing from investment firm Perella Weinberg. Spokeswomen for GM, Exeter, and CarFinance declined to comment.
Investors in home mortgage bonds typically have access to spreadsheets with dozens of details on each loan, ranging from the appraised value of a property to a borrower’s salary and employment history. And since the financial crisis, ratings companies have encouraged issuers to have third parties review and confirm the data. Auto lenders collect less information on borrowers because dealers want buyers to be able to drive off the lot that day. “There’s a real pressure to sell more product,” says Chris Kukla, an attorney at the Center for Responsible Lending.
In August the Securities and Exchange Commission approved rules requiring issuers that sell asset-backed bonds to ordinary investors to provide more information about the loans used to create them. At the same time, the SEC shelved a proposal to impose the same rules on bonds sold only to wealthy individuals and institutions. And there’s no requirement that data for the bonds be verified by third parties. “Due diligence hasn’t changed much since the crisis,” says John Griffin, a finance professor at the University of Texas at Austin. Investors are still at risk from “the lack of transparency.”
Credit rating companies say their procedures for assessing subprime auto-loan bonds—which may be backed by pools of tens of thousands of loans, compared with several hundred to a few thousand in mortgage-backed bonds—are sound. “For the few subprime auto transactions that we rate, the lenders’ long track history and very granular nature of the pools has mitigated the need for additional detailed file reviews or third-party due diligence,” John Bella, a managing director for structured finance at Fitch Ratings, said in an e-mail. Moody’s also uses the issuers’ historical data “to ensure the accuracy of the data,” Tom Lemmon, a spokesman, wrote in an e-mail. S&P won’t give its highest grades to issuers with short track records, Ed Sweeney, a spokesman, said in an e-mail.
In the past two months, the U.S. Department of Justice sent subpoenas to GM’s finance unit and to Santander Consumer USA. It sought documents relating to the creation of bonds backed by subprime loans, the underwriting criteria used to make the loans, and contractual promises made about their quality, according to company regulatory filings. Less than a month after disclosing the federal subpoena, Santander Consumer USA prepared to sell $1.1 billion of bonds tied to subprime auto loans. Demand was so great that it boosted the size to $1.3 billion when it sold the bonds on Sept. 10. Spokeswomen from Santander and GM declined to comment. “The investors don’t care,” says William Harrington, a former analyst with Moody’s. “They’re buying the rating. They’re getting a higher yield and are happy with that.”