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Top 10 of 2017: Santander dives back into subprime auto

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Editor's note: This is the final in a series of 10 articles revisiting some of our most-read stories of the past year.

Subprime auto lending became an even riskier proposition in 2017, as lengthening loan terms and rising defaults and delinquencies raised concerns for lenders and asset-backed investors.

But that’s not deterring Santander Consumer USA.

The Dallas-based subprime lender announced in October, on an earnings conference call, that it expected to ramp up its lending to consumers with blemished credit despite the rising industrywide woes of subprime borrowers – looking instead to otherwise strong macroeconomic trendlines in low unemployment and strong projected growth.

“As we think about the market going forward, I think our outlook is less negative than it was earlier this year,” chief executive Scott Powell said in an interview with American Banker prior to the call.

That represented an about-face. Twice in the previous four quarters, Santander Consumer had reduced its lending activity to its base of subprime borrowers with an average subprime score of 605. It’s total third-quarter originations – which include prime loans through its captive finance relationship with Fiat Chrysler – were down 3% from the third quarter of 2016, and 9% from the second quarter, to just under $5 billion.

That mirrored the lighter lending activity seen from other subprime lenders in the past two years. DriveTime Auto reduced its origination volume in 2016 and 2017, shaving its managed portfolio by 3.07% to $25.3 billion as of June 30, 2017, from $26.1 billion a year earlier, according to S&P Global Ratings. It also has reduced the percentage of its loans to its lowest credit tiers.

Blackstone-controlled Exeter Finance Corp. – a frequent subprime securitizer – reduced originations by 4% in 2016 and brought in new management and a centralized underwriting system to stem the rising levels of defaults in its managed portfolio of loans. The managed portfolio grew by 7% to $3.3 billion by midyear 2017, amid slightly higher levels of charge-offs (8.8%) and 60/90-day delinquencies.

The $23-billion asset TCF Financial pulled out of its indirect auto lending business altogether in the fourth quarter, a year after it began having trouble marketing its loans to the securitization market due to investor concerns on defaults.

In its November Auto ABS Index report, Fitch Ratings noted that the cumulative net losses of 2013-2016 subprime auto asset-backed deals (all projecting in excess of 12%) “are exhibiting performance in line with 2006-2008 recessionary vintages,” a credit negative in Fitch’s view.

That has resulted in a “notable pullback” in originations beginning in 2016 and continuing in 2017, Fitch noted.

Santander Consumer’s own reduction in originations earlier in 2017 stemmed from both growing losses and defaults in the subprime sector. The company also cited its stricter underwriting policies enacted in 2016.

But another factor was Santander’s own internal problems: it had to restate earnings three times in 2016 due to accounting errors dealing with loan-loss reserves, dealer discounts and impairments from troubled debt restructurings.

Boston-based parent company Santander Holdings USA (which owns 59% of Santander Consumer) was sanctioned by regulators last March to impose stricter oversight on the $39.5-billion auto lending unit – which Santander remedied in part through a management shake-up that saw Powell take over the unit from his position as CEO of the parent firm in August.

The company has not stated the projected volume it expects to add in 2018, but Powell said the strong lending projections underscore what’s turning into “a positive, pivotal year” for Santander, which offered its first dividend in three years to shareholders.

“We do feel like we have an opportunity to grow there just by optimizing our credit underwriting and pricing models,” Powell said during the analyst call. “So we feel like there's opportunity there for us."

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