pursuits

Auto Loan Securitization Probed by U.S., States, Yates Says

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The Justice Department and state authorities are looking into the securitization of auto loans for possible fraud as part of an effort to seek out emerging areas of abuse, Acting Deputy Attorney General Sally Quillian Yates said.

The department’s No. 2 official, in a speech to state attorneys general Tuesday in Washington, said prosecutors were taking a hard look at the auto lending industry to stem any abuses before they could harm the marketplace.

“We shouldn’t wait until there is a crisis to pay attention,” Yates 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.”

While the auto-loan securities market is much smaller than the market in subprime mortgages that was at the heart of the 2008 financial crisis, there are parallels. Ratings companies are awarding top grades to the securities, while it isn’t easy for buyers to verify the accuracy of those assessments, according to attorneys, academics and other auto-loan securities experts.

Cheap Funding

Scrutiny of the market is intensifying at the same time more borrowers are falling behind on their payments and sales of securities backed by the loans increase. Auto-finance firms that lend to people with bad credit lowered their standards amid increased competition as new entrants flooded the business to capitalize on cheap funding, according to Moody’s Investors Service.

The Justice Department is looking broadly at potential auto loan abuses. General Motors Co.’s financing unit and Santander Consumer USA reported receiving Justice Department subpoenas last year. GM was asked to turn over documents on underwriting criteria, origination, warranties and securitization of subprime loans since 2007.

Ally Financial Inc. received a subpoena from the Securities and Exchange Commission while Capital One, in November, disclosed that it received a subpoena from the New York District Attorney’s Office.

JPMorgan Chase & Co. disclosed Tuesday that it is in discussions with the department about potential disparities in markups charged to different races and ethnicities in auto loans originated by dealers and purchased by the bank. Toyota Motor Credit Corp., a financing arm of Japan’s Toyota Motor Corp., and American Honda Finance Corp., a unit of Honda Motor Co. Ltd, also disclosed federal probes.

Securitizations Rose

Securitizations of subprime car loans rose to $21.8 billion last year, the most since 2006 and up from $21.6 billion in 2013, according to industry newsletter Asset-Backed Alert. Payments at least 60 days late rose to 4.27 percent in December, up from 4.13 percent a year earlier, according to Standard & Poor’s.

Moody’s and Fitch Ratings have said that grades given to new issuers by their competitors are too high. The new entrants -- most of which are backed by private equity firms -- lack a track record in the bond market that shows they can handle collecting on debt amid a downturn.

“For subprime auto finance companies with short operating histories or where we perceive weakness in one or more facets of their operations, we have either declined assigning ratings to their ABS transactions or we have limited our highest rating to the A or AA category,” April Kabahar, a spokeswoman for S&P said in an e-mail.

Burden of Proof

The U.S. government’s look into auto lending is using the same 1989 law that it relied on to go after mortgage lenders it accused of wrongdoing. The law imposes a lower burden of proof than a criminal prosecution and threatens penalties of more than $1 million for each fraudulent statement or act.

Addressing criticism that the department has extracted multi-billion-dollar penalties from banks without charging individuals, Yates said the Justice Department is examining its approach to complex white-collar cases to overcome obstacles to prosecuting high-ranking officials.

“We owe it to the public we serve to double down on our efforts to determine how best to hold culpable people responsible,” she said. “The Attorney General has asked U.S. Attorneys with pending residential mortgage backed securities cases to go back and take a fresh look at whether there are criminal or civil cases to be made against individuals in these matters, and to report back in a few weeks.”

Yates, the U.S. attorney for the Northern District of Georgia, was nominated by President Barack Obama in December to replace James Cole, who announced his resignation in October. She has been serving as acting deputy attorney general since Jan. 10.

The Senate Judiciary Committee is expected to consider Yates’ nomination after voting on Loretta Lynch’s nomination for attorney general. Lynch’s committee vote is scheduled for Feb. 26.

(Updates with companies under scrutiny in sixth paragraph.)
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