Last week, we talked about US military veterans who've had to fight with mortgage lenders that move to foreclose on their houses. Today a look at a different corner of the lending market, where ordinary people are also struggling with payments, not on their homes but their cars. Many used car dealers offer high priced loans to hard up customers who have poor credit, sometimes leaving them with big monthly payments
and more debt than they can afford. Large financial institutions are then packaging together thousands of these higher risk subprime car loans and selling them as bonds to investors. Bloomberg's Page Smith and Scott Carpenter report that a lot of these car loans can go sour when customers fall behind. They can lose their vehicles and even end up in bankruptcy. But the banks build in rock solid protection for the investors who profit from this system.
If some thing were to happen and a large portion of those loans were to go sour, the investors would still be fine.
If all this sounds a little like the practices of the subprime mortgage lenders back in two thousand and eight, well.
When I go around the newsroom and I've been telling colleagues with them working on a story about subprime motel loans being packaged into bonds. Invariably, one of the first things people say to me is, g that reminds me a lot of the subprime housing crisis. And yet we're not experiencing the next great financial crisis. In fact, experts in this area don't think that there's systemic risk.
I'm Westksova today on the Big Take Wall Street takes used cars for a ride page. Your story starts in twenty nineteen with a married couple named James and Janis Siler. Can you tell us about them?
So, mister Syler lives in Dixie, Georgia. It's a very small, unincorporated town on the Florida Georgia line, and he is a church custodian and host. And the story sort of starts with him needing a new car. He was driving a really old Pontiac and he bought that in cash and kept breaking down and he wanted a new truck. He stepped onto this dealership in South Georgia and looked at a Ford F one fifty truck, which is one
of the country's best selling vehicles. Was just over a year old, so mister Syler's wife Janis, signed up for a thirty thousand dollars car loan. They went with Janis's name on the loan because her credit score was a bit higher than his was a little bit stronger. These were really high risk borrowers because James and Janis had filed for bankruptcy just six years before.
And the rate on that loan was pretty high.
Santander Consumer USA, a unit of the Spanish bank Manco Santander Finance the loan, and Santander Consumer USA is one of the largest subprime lenders in the US. They financed the loan for a rate of twenty two point five percent, and at that point in time, that was just about more than three times the rate of a used car for someone with a prime credit score or sort of a credit score on the higher end of the credit spectrum.
So yeah, twenty two point oh five percent is a pretty expensive car loan.
And page how much was his monthly payment for that loan?
The Sidlers drove away with a car loan that called for a seven hundred and fifty dollars monthly payment. I don't know about you, but for me that would be really expensive, Scott.
That is a lot of money to pay each month, and was he able to afford that loan?
This was a big payment and soon after taking out the loan, the Silers had trouble making the payments.
Paige, Why did he tell you he took out such an expensive loan that he possibly would have a hard time taking the payments on.
So he really was eyeing a truck to be able to do a number of the odd jobs that he was doing at that time. He was mowing lawns, he was working as a church custodian and host, but you know, he was also doing jobs on the side like many other you know, Americans do to kind of make ends meet every month. You know, I think it's important to point out that, you know, yes, consumers in the US could pay for a car in cash, but a lot, a lot a lot of US consumers opt to finance
their loans instead of paying for things in cash. And mister Siler made that choice just like a lot of other US consumers.
And did he know that his monthly payment was going to be that much when he signed those documents?
So mister Syler knew that the monthly payment was going to be seven hundred and fifty dollars, but he told us he really was not aware that the interest rate would be that high twenty two point zero five percent, And he did say that when reviewing the documents after he had already signed that he saw the interest rate and said that he'd wished he could have negotiated it down a bit more. He said it seemed pretty high to him.
Loans like Silers are considered to be subprime. They are loans made to borrowers with credit scores generally below about six twenty and people who have a history of not paying their debts back or who are inconsistent with some of their payments, who've defaulted in the past. In fact, the Silers had previously gone through a bankruptcy, which is a great example of something that would have reduced their credit score. I think what was happening with the Silers
loan was actually very common. When you're looking at people with low credit scores, they need to get a car to go to the dealership, and they end up walking away with a loan that is very expensive. So overall, what you have is dealers and auto lenders lending money for expensive loans that consumers aren't taking the time to properly understand because there are very few guardrails in this process.
It's a kind of conveyor belt of loans that's designed to give you financing as quickly as possible, and that's the goal.
It's interesting comparing sort of a buying a house with buying a car. Those are sort of two of the largest, you know, maybe the biggest purchases you might make as a US consumer in your life. And while it's not in apples to apples comparison, you know, you think of how much time and process and due diligence you might do if you're a consumer and you're buying a house, and then you contrast that with buying a car and going onto a dealer and maybe driving it away that
same day as mister Syler did. It's a very different process. One is very fast, very expedient, and that's sort of for a reason. So as a consumer, when you're at the dealership, you're signing that loan or what's known as a retail installment contract, you're committing to a really costly debt. By the time many consumers are done paying off their debts, if they make every single monthly payment. Some of them pay as much as twice the value of the cars that they.
Bought and Paige. In the US, where a lot of people rely on cars, Santander and other lenders say they're throwing a lifeline to those with poor credit and not a lot of other options. What did Santander say to you about this reporting?
Son Tander says that the benefits of car ownership are really substantial. When we asked the lender sort of what they thought of the gist of the story and the overall situation, the lender essentially said that consumers who own a car more likely to have higher income, live in safer neighborhoods, and more likely to exit income support programs. And Sonnder did say that it adheres to all regulatory
requirements and industry best practices. Bradley Cobb, the president of Bower's Automotive Group, is the co owner of Langdale Hondai of South Georgia, where the Sailors bought the Ford F one fifty, and he said that the high interest rate reflected the risk of the loan due to the siler's recent bankruptcy. The lender was essentially giving her a second chance he said, and Cobb said that Santander made an ethical and sound decision in granting Missus Syler alone based on the information provided.
I should also say that Jim Bass, who's the chairman of the National Automotive Finance Association, says that the Prime Ministry makes it possible to extend credit to people who need to recover after a setback such as a divorce or job loss. And he says, if it wasn't for the finance companies that were willing to finance these individuals, it would have such a negative impact on the day to day life in most of the country.
And Scott, this loan the Silers took out was really just the first step in your story. What happens next, That's right.
So James gets the car, he pays for it with the loan, he drives away. What does Santander do with that loan? Though James now owes monthly payments for the next several years, Santander takes that stream of money that is now owed to it and puts it into a
bond or called an asset backed security. In this case, it takes about seventy five thousand other loans that it's made to borrowers similar to Siler across the country, puts them into the asset backed security and sells this asset beech security to dozens, perhaps one hundred or more investors, mutual funds, insurance companies, asset managers. It's actually considered a very plain, vanilla thing. And that asset bach security had a name. It was called Drive twenty nineteen Dash three Scott.
Let's take a moment and really pull this apart. Why would a financial institution want to bundle together lots and lots of high risk subprime loans and sell them.
Think about it from Santander's point of view. So it's just given Siler this loan. It's just given seventy five thousand other people across the country lots of loans. Now it's got two options here. One it could keep the loans for itself and wait the five, six, seven years however long it will take for everybody to repay their loans. Or it could take those loans, package them together, sell
it in the form of a bond. The benefit of that second option is actually pretty big, because now Santander doesn't have to wait around for five years however long it will take. It can get cash immediately from the investors. The investors are happy to wait around. Santander would rather have the cash today so it can make more loans today. That is the business model that it's in. Santander is not the only auto finance company that does this, There's plenty of others.
So that explains really well why Santander would want to do this. But why would a pension fund or another place want to buy loans that are higher risk than other kinds of loans.
One word, and that word is returns. It's considered to be a very good return for the amount of risk that it has. That had to be repaid first, got top credit ratings, you know, triple A, and those that were at the bottom and they took the losses first and were repaid last, they were you know, rated lower triple B in this case triple B. They were still considered very safe. They're investment grade, but they're riskier altogether. The bonds paid interest rates ranging from two point five
to three point two percent. Meanwhile, on the underlying car loans, which are supplying the cash flows for the bonds, they have a much higher interest rate, on average nineteen percent in some cases, though going up to twenty nine point nine to nine percent. If you're a pension fund, you're not worried that top part of the bond is going
to default, and meanwhile you're getting a decent return. So it's actually considered to be very safe, and for the amount of safety that it offers, it's a good investment.
As long as no more than fifty nine percent of all of the money owed by these car loan borrowers defaulted, all of those investors and all of those bondholders would get repaid. According to some SMP Global ratings data. We had one investor even tell us that you could sort of think of these bonds as structured like a bomb shelter against a nuclear blast and paige.
You also write that if some of these loans go bad, there's another way that the financial institution is able to recoup the losses.
Yes, the repossession market is alive and well. The repelman is alive and gone are the days of driving around trying to find a car that's out for repossession. There are much more advanced technologies to help the repossession agents find and repossess vehicles of US consumers that are way behind on their loans. Essentially, it's much easier to find and repossess a car today than it was in the past.
GPS tracking devices which aren't in as many subprime cars as you would think, but things like license plate scanners really help the repilman these days.
And so if someone buys a car and then they default because they can't afford the payments, then the financial institution can repossess it, sell it and recoup some or even all of their losses.
Essentially, today it's gotten much easier, especially because used car prices are still quite elevated, they are able to recoup a good amount of that investment.
When we come back, how big is this market for subprime car loans? So is it accurate to say that because these package security these are very profitable for financial institutions and there's a big market of people who want to buy them, that there's a big incentive to give people these very expensive subprime loans and to get as many of them as possible.
There is a strong incentive. It's very profitable. You know, if you give somebody a loan with an interest rate that's very high, and if they don't default and they pay instead all the way to the time that they're finished paying the loan, you're going to make a lot of money. And the problem is when people default, and the default rates are very high. For all subprime auto loans, about thirty percent of them default. As far as we
can tell. That data is not perfect. We tried really hard to get that data, but that's as far as we can tell, about thirty percent of all loans to fault. And defaults are not good for anybody. They're not good for the borrower, They're not good for the lender. I mean to be sure the lender has an interest in the borrower paying. Because of the very high interest rates,
because of the ability to repo cars. When somebody does default, the penalty from the lenders point of view of the person defaulting is not an insurmountable obstacle to making profits. A lot of profits on lending to subprime borrowers.
Scott, How large is the subprime auto loan market? How many people have these subprime loans?
As of June, subprime debt made up twenty one percent of the roughly one point six trillion in outstanding auto loans, so it's essentially tied with student debt as the second largest kind of consumer debt after mortgages, and that's according to the Federal Reserve Bank of New York. And this is interesting because overall car lending is booming, but the share going to subprime borrowers has actually declined. The major banks have been shifting their focus to more credit worthy
borrowers who are taking out larger and larger loans. Meanwhile, lenders that focus on the subprime market, they tend to securitize their loans, meaning they put them into bonds, sell them, and overall they do this because it gives them access to more funding.
In page we've been talking about James Seiler in the truck that he bought. But you spoke to a lot of people who are in a similar situation. Is that right, Yeah.
We spoke with around forty borrowers, all of whom were struggling across I think more than a dozen states, and a lot of them just expressed that they had taken on this really expensive debt and some of them just couldn't keep up their payments. Others had life events that came up and they couldn't keep up their payments. But the vast majority of them at the time that we spoke with them had already had their cars repossessed, and we're sort of trying to figure out what to do next.
I suppose there are some people listening to this podcast saying, you know, that's a really bad situation to be in, but they decided to put themselves in this situation. They signed these loans. They knew what they could afford, and they knew what they signed up.
For definitely, And I think that consumers do. At the end of the day, it is their name that is signed on the dotted line before they drive that car off of the lot. But that being said, I think that often times consumers don't necessarily understand the full gravity of what they're signing. They don't understand that they'll be having to continue to make these payments for years and years, and for many of those payments, if they make every single payment and their loan, they will have paid twice
the value of their car. And that's a pretty shocking figure.
After the break, helping car buyers to avoid taking on more debt than they can afford. Scott, you right that what's happening in the subprime auto loan market has a pretty strong echo to two thousand and eight.
It certainly does. When I go around the newsroom and I've been telling colleagues with them working on a story about subprime auto loans being packaged in the bonds, invariably one of the first things people say to me is ge that reminds me a lot of the subprime housing crisis back in two thousand and eight. So let's talk about what's similar was different here. Back in two thousand and eight, subprime mortgages were this hot new product being
made to people with low credit scores. Subprime mortgages made in two thousand and six went on over their life to have a default rate of thirty five percent. That was the highest it ever got for subprime mortgages, according to an economist, is now at mit thirty five percent. That's as bad as got and that caused essentially the world financial markets to explode and helps lead to the
Great Financial Crisis. Today with subprime auto loans, the default rate, as best we can tell, is chronically nearly that high or higher. That is, thirty percent or higher, and yet we're not experiencing the next great financial crisis. In fact, experts in this area don't think that there's systemic risk the bonds are extraordinarily safe. They can survive extremely high default rates, and part of the reason why we're not facing systemic risk even with very high default rates. A
few reasons. One, subprime auto loans are much smaller than the subprime mortgage market was. That's one thing. Number two. Back in two thousand and seven two thousand and eight, those subprime mortgage bonds was just part of the story. They were actually getting synthetically secured, this whole other complicated thing, synthetically securitized and threading their way throughout the rest of the economy that way. That added just whole other levels
of risk that's not happening today. And also you could say that the interests of lenders are more closely aligned with borrowers today, and that's because of something in dot frank, which was a law that was passed after two thousand and eight to make sure that something similar wouldn't happen again. That requires lenders like Santander and others when they're issuing these bonds to hold some of the risk themselves. They can't get rid of all of it. They have to
keep at least five percent. The idea that here is you have skin in the game. So that your incentives. All right, you don't want to sell a bond that's going to go bad because you own some of it, you're going to experience the effects of that. And I think you can see that this it's called risk retens,
this skin in the game role is actually working. And this brings me to the last thing that's different is with subprime mortgages, the amount the volumes year after year from two thousands to two thousand and eight just went up every year, skyrocketing. That's not happening with subprime model lending. It's actually been relatively stable. You know. One of the reasons probably is because lenders are experiencing some of these high default rates on their own balance sheets, and that's
constraining them. It's caused them to pull back when conditions aren't great.
These are sort of controlled explosions. They're expected. The high rates of default are expected. The lenders expect this all to happen, and they've sort of planned accordingly. It's not like the subprime housing crisis where things really went off the rails and as Scott said, really just kind of wove through every part of the US economy. That is not happening here.
So paige. If the system is safer in that it protects the investors, it protects the financial institutions, and even protects the larger economy from shocks. But what about the individual consumers. What's protecting them from lenders who want to issue these loans so that they have something to package up into these profitable bonds.
The individual consumers are really the ones who are facing the brunt of this. After a car is repossessed very soon after you see a hit to your credit score, it's much harder to take on additional debts and also to bring it back to the silers. I mean, they had already filed for bankruptcy once before they took on this expensive debt, but then they ultimately filed for bankruptcy again in twenty twenty three earlier this year to be
able to reach shuffle their debts. So we spoke with more than forty barwers kind of struggling to pick up the pieces after their cars had been repossessed. And it is really really hard for people to go without a car in the US.
And are any federal or state agencies thinking about these buyers trying to put protections in place so that they have a better sense of the terms of these loans for people who just aren't as financially savvy.
So in the wake of the Great Financial Crisis, the subprime housing crisis in two thousand and eight, there was an agency created called the Consumer Financial Protection Bureau the CFPB. But they do not oversee car dealers themselves. They only
oversee the big lenders. And that's a tricky carve out because if you think of the actual car buying process, you drive onto a car lot to look for a used car, you sign all of the paperwork in the car dealership, but really you are dealing with a lender who might be hundreds of miles away approving this transaction. So to have that sort of carve out, that was a very intentional lobbying effort in Washington, DC, while Dodd Frank was being creative and it was successful.
Scott. When the CFPD was started, one of the first big things they did was to make sure that there was no more tiny type when describing the terms of say a credit card application. Is there any push to say, okay, buyer, if you take a loan at this amount, the actual amount you're going to pay for the car is twice, but the sticker is or something like that, to just make it very plain to people what they're getting into.
I think they certainly have tried. You are required on your auto finance contract to very clearly disclose what the APR or the interest rate is, the amount finance that's the amount that's being lent, and the finance charge, which is the amount that that money will cost you an interest. So it's clear in one sense, you can see it
right there at the top of the contract. On the other hand, I think, based on our reporting, having talked to many of these borrowers, it's still a confusing system to a lot of borrowers.
And Page what about On the state level, there.
Have been efforts on the state level to rein in some of these subprime lending practices, and to some effect they have been successful. The Massachusetts Attorney General now Governor Morihally, for example, sued a few of these lenders, and there
have been other efforts as well. The CFPB, which is the agency that oversees protections for US consumers, and state regulators have been cracking down the sales practices of subprime lenders, including Santa There in twenty twenty actually Santander reached a five hundred and fifty million dollalitler's settlement to resolve abusive lending allegations made by sort of a salew of state attorneys general, and one of the allegations was that the
company knew it made loans that were likely to default. As part of that settlement, Santander neither admitted nor denied wrongdoing, but it agreed to waive some customers balances and in the future to decline to extend credit to customers who had no income left after other debt and required spending. At the time, Santander called the matter a legacy underwriting issue.
Scotty, as you continue to report on this story, what are you looking for?
I'd like to know more of what the default rates are going to wind up being for a lot of people who are getting loans today. I'd like to see how some of these recently issued subprime auto securities are going to perform. There are some signs that they're not performing perfectly. Some of them are actually on track to deliver losses to their investors, the bond holders, which is very unusual for the most part. I think lending to issuance of these bonds is going to continue about roughly
what it is now. Twenty twenty two saw issuants of thirty seven billion of these per year will probably see roughly similar amounts going forward. But I think essentially everybody wants to know how many people are going to default on their auto loans, and nobody quite knows. One thing's for sure. Though, the investors who buy the top of these bonds, the triple A, the Double A, et cetera, they are not too worried and they'll still be understood in buying more of them.
The CFPB also does not currently collect information on how many US consumers have their cars repossessed every year, and it was really hard for us in the reporting of the story to nail down an approximation of that figure based on default data. We had to go to an number of different sources just to find out that around thirty percent of American's default on their car loans, which
effectively translates to them having their cars repossessed. And that makes it tough to figure out how consumers fare in this country.
Drive twenty nineteen to three wound down in October. The customers who had taken out all those auto loans that were packaged together paid back three quarters of the money they'd borrowed. That was way more than necessary to repay the bond holders, and it worked out very well for Santander too. Remember Scott said earlier that Santander had to have some skin in the game. It was required to hold at least a five percent interest in its securitizations.
In this case, it put seventy one million dollars of its own money at risk. In the event of any shortfall, it would be the last to get repaid and the first to lose money. But it also gets to keep a share of any excess money after everyone else is paid, and there was a lot left over. According to sec filings, Santander got to keep at least one hundred and fifty five million dollars as a kind of bonus, and that was on top of its servicing fees, which totaled one
hundred and twenty one million dollars. And Paige, what happened with the Silers. You write that ultimately they couldn't afford to keep that f one to fifty pickup truck, and in twenty twenty it was taken back and sold it auction.
For mister Syler, it got to a point where he just could no longer keep up with payments. COVID was also a really challenging time for him. The COVID pandemic was tough because the church where he was working cut his hours. He finally just sort of threw in the towel and said, if you want to come and get the truck, come and get it.
Page Scott, thanks so much for sharing your reporting on this story.
Thanks for having us.
Thanks for listening to us here at The Big Take. It's a daily podcast from Bloomberg and iHeartRadio. For more shows from iHeartRadio, visit the iHeartRadio app, Apple Podcasts, or wherever you listen, and we'd love to hear from you. Email us questions or comments to Big Take at Bloomberg dot net. The supervising producer of The Big Take is Vicky Burgolina. Our senior producer is Catherine Fink. Sam Gabauer produced this episode. Field Garcia is our engineer. Our original
music was composed by Leo Sidrin. I'm West Kasova. We'll be back tomorrow with another Big Take