Why ‘Deep Subprime’ Auto Loans Are Beginning to Worry Wall Street
Business + Economy

Why ‘Deep Subprime’ Auto Loans Are Beginning to Worry Wall Street

© Mike Blake / Reuters

Auto loans to consumers who have very low credit scores and may not be able to pay them back are starting to worry Wall Street.

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Many auto loans, including those considered subprime, are securitized and sold to investors. But Morgan Stanley recently reported that the share of auto securities tied to “deep subprime” loans – those given to borrowers with a FICO credit score below 550 -- has risen from 5.1 percent in 2010 to 32.5 percent today. It said defaults on those bonds have risen significantly in the past five years.

Almost a quarter of the more than $1.1 trillion in U.S. auto loan debt is owed by subprime borrowers, and delinquency rates have hit their highest point in seven years.

As if to underscore the concern, the Massachusetts attorney general on Wednesday announced a $26 million, two-state settlement with the subprime auto-loan unit of Santander bank for giving high-interest loans to car buyers whom it knew could not afford them.

Attorney General Maura Healy said the bank would then package the unsound loans into securities and sell them to investors. The Boston Globe quoted Healy as saying that for Santander, “The global economic collapse wasn’t a cautionary tale. It was a blueprint.”

Under the terms of the agreement with Massachusetts and Delaware, Santander Consumer USA Holdings Inc. – a major player in subprime auto loans -- did not admit guilt, the Globe said, but bank officials said new controls have been put in place.

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Deterioration in the repayment of auto debt and softness in the auto-loan-securitization market because of deep subprime lending could undermine new-car sales, devalue used cars and increase interest rates for buyers. Used car values are already beginning to slide.

But the weakness in the market is expected to turn into a full-scale rout. As Piper Jaffray analyst Kevin Barker said in The Washington Post: “With unemployment at relatively low levels, we don’t see the auto market blowing up.”