Photographer: Daniel Acker/Bloomberg

Is Income Verification on Subprime Auto Loans Overrated?

Trust, but no need to verify.

Santander Consumer USA, one of the biggest subprime auto loan finance companies, often ends up verifying income and employment status on only a minority of the subprime loans it underwrites. The verification has historically been considered a countermeasure to fraud.

Non-verified loans, which are packaged into bonds and sold on Wall Street, typically perform the same or even better than loans that were verified using traditional methods, the company claims.

“Verifying a subprime borrower’s income for an auto loan is neither the sole nor most precise predictor of future credit performance,” Santander spokeswoman Laurie Kight said last week in an email to Bloomberg. “Credit risk is indicated by a borrower’s credit score, loan terms, annual percentage rates, and loan-to-value ratios.”

Santander verified income on only 13.8 percent of borrowers in its auto loan bond sale priced September 13, according to an S&P presale report. That’s slightly more than recent deals. The data is part of new disclosure rules that became effective late last year.

How is this possible? Large lenders such as Santander and GM Financial have developed “risk-based” methods of vetting borrowers in recent years, using technology to create proprietary credit/risk-scoring models. Instead of immediately verifying income for every loan, Santander uses its own model as a first step to weed out and identify the ones needing traditional verification procedures.

“Based on our analysis, we believe these issuers’ assertions that their income verifications are risk-based,” S&P analyst Amy Martin wrote in a recent report, referring to the proprietary risk-scoring models. While S&P wouldn’t outright assert the superiority of the risk-based models, its research seems to bolster lenders’ claims that proprietary credit scoring models better predict defaults and risk than FICOs or other credit bureau scores.

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