Presenting....sub-prime AUTO loans.

[dixiegrrrrl]

Yep, just when we really need another bubble.

I made selected cuts from the story, which is long. Whole story at link.


“Today, somebody with a 500 credit score, can get approved and in a Malibu,” which starts at $22,110.

Capital One revamped a program for select dealers late last year that gives them perks such as faster approvals and exceptions for customers with borderline credit scores, said Kevin Borgmann, president of the McLean, Virginia-based lender’s auto-finance unit.

The company’s speed is “a big competitive advantage for us,” Borgmann said in a phone interview. Capitol One decides “the majority of applications for any dealer that does business with us within 30 seconds. Dealers find a lot of value in that because they can go out and sell the next car.”

Amid a slow housing market, auto demand is rebounding, spurring lenders from Bank of America Corp. to Capital One Financial Corp. to approve buyers faster and at better rates to compete for a piece of an expanding market.

“Banks have had to look elsewhere for growth opportunities, and auto has been one of the nice spaces over the last couple years,” Curt Beaudouin, a bank analyst for Moody’s Investors Service in New York, said in a phone interview. “The credit experience in terms of losses has been very good in recent times. It’s never gotten out of hand. Right now, it’s basically good for everybody in the industry.”

U.S. light-vehicle sales rose 10 percent to 12.8 million last year. That momentum continued as automakers sold cars and trucks in January at the fastest pace since the U.S. government’s “cash for clunkers” program in August 2009, according to Autodata Corp."

http://www.bloomberg.com/news/2012-02-07/auto-loans-in-30-seconds-drive-accelerating-vehicle-sales-cars.html

[Jackpine Radical]

1. So at least the poor will have nice cars to live in.

America-a free enterprise solution for every prob lem.

[d_r]

2. so many of us got credit dings in the financial mess

it would be good to be able to buy a car if you can afford one but have bad credit.

eta people would probably get a better rate and a better car than at a buy-here-pay-here.

[unblock]

3. i happen to be quite expert on this topic

having been involved in a number of sub-prime auto loan securitizations (i've also done various other types of securitization, and i now specialize in receivables (invoice) financing).

the mere existance of a product does not a bubble make, and as securitizations go, auto loans, even sub-prime auto loans are (generally) relatively conservative, especially compared to comparable mortgages, e.g.

first, there's collateral that's fairly easy (outside of louisiana) to repo and auction off to recover most of the loan if it goes bad.

second, securitizations are based on large enough pools of loans so that it's easy to be statistical about it. any sub-prime loan can go bad, but they won't ALL go bad. given a large enough pool, you can be fairly confident in the percentage range of defaults. the biggest risk is that something affects the entire pool. if you're heavily concentrated in one geographical region, that's a risk, so generally securitizations try to be fairly diverse; i assume capital one would be nationwide (with the possible exception of louisiana) so there should be no problem there.

the biggest systemic risk to the pool would be a nationwide economic downturn that affects much of the pool. but even this is not as big a risk as it sounds. a major increase in unemployment of say, 4 percentage points still only directly affect 4% of the workforce, and so isn't likely to devastate a pool of auto loans.

third, interest rates are set high enough to cover for the losses. borrowing costs are extremely low but state-by-state usury rates haven't been cut, so there's even more room than ever for the interest from paying borrowers to cover the losses from non-paying borrowers.

finally, auto loans typically pay for themselves within about 18 months. even if a securitization eventually fails, the investor might still walk away with a profit. this is because a "failure" defined as any time the investor loses even a single cent of principal, even if the investor had previously gained much more in interest.



due to the time frames and collateral involved along with other factors, many other investments, such as 30 year corporate junk bonds are FAR riskier than sub-prime auto loans.

[ms.smiler]

4. Unblock, thank you for your informative post.

It sounds as though auto loan securitization was/is handled much more responsibly than mortgage securitization.

I’m wondering if like securitized mortgages, there is a second set of accounting of the loan on Wall Street, although Credit Enhancements and Credit Default Swaps may not be quite as necessary with these pools of loans.

I’ve always paid cash for automobiles because it was my understanding that the real money wasn’t made on the auto, rather it was made on the financing.

[unblock]

5. the biggest problem with most securitization is actually origination fraud.

it's not the bundling and the slicing and dicing that causes the biggest problems.
it's just good, old-fashioned fraud at the source.

in the mortgage space, it was not just the "liar loans" (which were often based on so obviously false information that you can hardly call it "fraud&quot but also on the widespread underwriting of under-qualified candidates.

in the auto loan space, the problem is usually the dealers, many of whom are actually honest, but still a number of whom routinely lie to lenders in order to make a sale. one of the easiest scams is the sell a customer with no down payment a car for, say, $18,000, but in order to make the loan go through, they paper it up as a $20,000 sale with a $2,000 down payment.

the customer goes along because it's all the same to them, but the loan underwriter sees a $20,000 loan with 10% down as MUCH safer than an $18,000 loan with 0% down because borrowers who put something down are far more likely to actually pay the loan than those who lose none of their own money if they never make a loan payment.


the blame lies in investors and the companies putting in the chain of putting these deals together failing to do proper due diligence to keep the fraud under control. mortgage securities used to be very strict about fraud, and the results were good. but too many years of good results breeds laziness, and greed takes over. so we wound up with robo-signing teams that rubber stamped anything instead of actually verifying the collateral in order to weed out the fraud.

that could certainly happen in the sub-prime auto-loan space, or any other lending space, for that matter. there have, in fact, been some auto-loan deal blow-ups. but in general, it is safer than most.

[dixiegrrrrl]

6. Actually, I was thinking of this auto loan problem:

Worth the read.

"More attention needs to be paid to the LA Times’ excellent series on subprime auto loans.
The first installment concerned Buy Here Pay Here used car dealerships, and how they hook low-income borrowers into high-interest loans, then repossess the car when the loans go bad and resell the car to the next mark.
This is an endlessly repeating cycle, where the same lemon can be sold and resold multiple times.
And if you’re current on your payments or if you worked out what you thought was a modification, well, that’s just an inconvenience."

http://news.firedoglake.com/2011/11/02/buy-here-pay-here-the-subprime-auto-loan-scam/

[unblock]

7. i get tired of reading ill-informed articles like this one.

securitization is not an automatic scam, nor is a AAA rating an automatic scam, even if the collateral itself is lower, perhaps much lower, than AAA.

it's all in the numbers.

if you have a pool of loans than statistically, routinely produces 10% losses, then you can pretty darn safely invest if you reserve for 30% losses. that's the kind of reserves it takes to legitimately get a AAA rating. so an investor can quite safely invest $700, backed by $1000 of car loans, which are expected to produce only $900, easily covering the $700 invested. losses would have to be three times the historical average before the investor lost a single cent.

if the historical losses are 2%, you can safely lend more; if the historical losses are 20%, you have to invest much less to get the same level of safety.

but it's almost always possible, unless the collateral is REALLY terrible. and sub-prime auto losses are rarely that terrible, even in terrible economic times.

and by the way, even a AAA rating doesn't mean bullet-proof. it just means that losing principal is expected to be a very rare (though not impossible) event.


now, as i said earlier, ORIGINATION fraud is a problem, and the article implies that that's the case here. they didn't really give an example here (deception in order to repo a car is unfortunately typical, but note here that the borrower is in violation of their contract and legally has to return the car) but some dealerships certainly do commit fraud. if they're lying to or hiding from the customer the truth about what they can afford and what will happen if they don't make their payments and what fees will be assessed, those are practices that should be stopped for more reasons than protecting the investor.

[eridani]

8. The only problem with securitization of such loans is moral

Making money off of duping low income auto owners is in the same class as selling crack on playgrounds, IMO.

[unblock]

9. the securitizations are no more or less moral than the loans themselves.

originators who create loans by duping anyone should be prosecuted, whether those loans are securitized or not.

my own experience with sub-prime auto loans (not the bhph model) was that most of the people who eventually defaulted knew exactly what they signed up for and knew exactly what the consequences were. a number of them clearly had no intention of ever making a single payment, they were totally scamming a free car for a few months. then again, most (not all) of the dealers we worked with were pretty honest. the dishonest ones were scamming us, and i can guess that if they were doing that, they were scamming their customers, too. some of those dealerships actually did get prosecuted and shut down, but it takes quite a bit for that to happen.

[eridani]

10. Yes--so it's immoral to further the scam by securitizing scams

Glad you agree.

[unblock]

11. spoken like someone determined to find her conclusion in whatever she reads.

IF and to the extent that the underlying loans are immoral, and if reasonable due diligence on the part of those creating the securities should have discovered this, then yes, it is equally immoral to be involved in such loans, whether by securitizing or placing or investing in them.

but the reality is that scams are not nearly as common as the popular press would have us believe (and also more common than the popular press led us to believe prior to the crash when they seemed to say no investment could possibly fail).

and in particular, lending to someone with relatively weak credit, e.g., for a car loan, is not in and of itself a scam. it can be done ethically and responsibly (everyone wins), or it can be done recklessly and irresponsibly (investor loses), or it can be done diabolically (customer loses, and perhaps investor loses too). the devil's in the details. the article implies that bhph is diabolical, and it may well be, though it doesn't provide a clear basis for this conclusion.

in any event, this is one dealership program or chain. they're certainly not all evil.

[Yo_Mama]

12. The BHPH loans are not securitized.

You can sell loans such as these and that gives the dealerships/rackets additional capital to continue the scammish operation. Selling loans or loan participations (shares) is not creating a security. Totally different thing. It's a transaction as individual and straightforward as buying a TV with cash in most cases.

The reason that these aren't securitized is that frankly, this is not the type of business that the securitizers want to be in on.

Now if you want to ask the question about whether it is immoral to buy these BHPH loans, my answer would be "yes".

However, subprime auto loans are not in and of themselves immoral, even if the interest rates are pretty high. The interest rates have to be higher to cover the inherent risks, or no funding at all will be available to these people. The securitization actually adds an additional level of protection in most circumstances, because the entitities creating the security have to publish all sorts of detail about the underlying loans. Honesty regarding those disclosures is legally enforceable by the SEC. Unblock is right about securitizers not doing their due diligence, though.

If you have subprime buyers, you are going to have a subprime auto loan market. The best you can do is to ensure that FTC rules and lending laws are closely followed so that buyers can easily comparison shop and that they at least understand clearly what they are getting into. Because many people have to have a vehicle to earn a living, this is a needed market.

Btw, the federal government did a lot to fund this market with the Cash for Clunkers initiative. Destroying good used vehicles placed high pressure upon lower income persons who really needed a cheap vehicle. The high resale values for many used vehicles are now creating businesses such as the BHPH people - what is normally a non-profitable enterprise has become one.

[Yo_Mama]

13. A further clarification - request for action

The link appears to be confusing two different types of financing for autos.

The dealer-financed bit is quite different from securitization. Dealers can write their own loans and then sell those loans or a share in those loans (participations) to those who have money to lend. Obviously dealers will be writing to terms that they know the loan buyers will accept.

If the contracts are not correctly written, it is a violation of federal law. For example, if non-disclosed fees are charged, it is probably a violation of Reg Z's APR calculations Reg Z:
http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr&sid=635f26c4af3e2fe4327fd25ef4cb5638&tpl=/ecfrbrowse/Title12/12cfr226_main_02.tpl

If non-disclosed fees are charged later for failure to perform the contract, it's a violation of contract law. The problem is that people who are going to be customers in these places don't have a lot of spare money, time or contacts.

One of the main tools to squash bad consumer lending is to pass liability for certain contracts through to non-originators. This tends to lock such loans out of the entire capital market and effectively stops substantial origination of these loans.

Due to the creation of the Consumer Finance Protection Bureau, there should be a wider ability to crack down on what appear to be bad auto financing practices. Unfortunately so far the CFPB is asleep on this issue, and I would encourage those concerned to write to it and at least get those numbskulls to put up a complaint center about abuses in auto financing:
http://www.consumerfinance.gov/

If they put up a complaint center, then they would get complaints about the worst dealers and they could move in and rapidly shut down the worst abuses.

I would strongly encourage you to write to them. I have. It appears to require more than my voice, if you know what I mean.

Failing that, if you know that anyone has been stung you can contact the appropriate state agency, which of course varies by state. One of the best ways for the CFPB to curb bad practices in this context would simply be to funnel such complaints to the appropriate state agency.

[jtuck004]

14. They should have titled it "How You Too Can Make $$$

There's a book out there called Broke, U.S.A., details the rise of this whole sordid business, from payday loans to tax preparation to auto loans to...

But people making personal loans realized there was a whole untapped market among the working poor and those above that line a little, those with a smudged credit record. These are the folks that built the payday loan stores, car lots, tax prep places (remember the old Household Finance office - 22% to 400% for fridge?), the businesses you don't see in the strip malls near the higher income areas (these cars they finance don't always stay running, the business needs to be close to their customers) and they started making higher interest loans, justifying the rates because of the supposed defaults, even though the defaults are nearly next-to-nothing.

The vast majority of these people make SURE those bills are paid, even if they have steal the money from their mother's purse or take out another loan. A dream customer. They generally aren't paid a living wage, and this will take food out of their kid's mouth, or deny mom or dad tuition for a couple of years at a junior college or make it hard to pay for dental care. But they care deeply about their obligations, and in a country where we . It turns out that their default rate, while a bit higher, was certainly less than 10%,
often less than 5%. And they have jobs, so there is just enough stability that you can take their feed corn and they can still keep going. The principal really isn't at risk, but there are a lot of slow payments, trying to catch up, etc.

In a word, Fees. Fee$ and more Fee$. In two words, voluntary servitude. (Broke U.S.A. shows that people who make less than $40,000 a year pay an additional $3000 to $4000 - ANNUALLY - in fees that people with more money are never charged).

It was so damn successful, and the growth of the industry came at a time when the economy of the 50's was beginning to wane, so states like North Dakota and Massachusetts (and others) got rid of usury and other laws that had protected consumers from these bad practices.

Now it has gone on so long, and is so pervasive, that it seems to have affected our morals, to the point that rarely does anyone really question these practices, or suggest that this country, much less these people, would be better off if they didn't sign up for these loans, that we would all be better off if we would cooperate in making sure there was another way. Instead we seem to bestow wisdom and grace these greedy bastards because "Well, otherwise they wouldn't have a car".

Yeah, and they wouldn't be in debt to someone who would rather take their money than see it spent on food or medical care for their kids, either.

Or the purveyors of greed will invoke personal responsibility, tell us how these people know the choices they are making. Ron Paul make the same argument - personal responsibility replaces the government assistance, because you have a choice between taking non-existent jobs or living in abject poverty till you die, and you must be total control of all this, right?

That's all bullshit, all smoke and mirrors. This is nothing more than an industry of people who don't want to work and produce, they want to live from the work and lack of knowledge of others.

These borrowers could say no, but when there is a need for a couple hundred bucks to pay for something at school, or a car to get to that minimum wage job that will never cover the bills, and we are surrounded by a culture that says "Just sign on the line brother, t's the American Way", we just see more debt, and servitude. There is another group that could change this, the politically active and far better off folks in the better part of town, but they won't. Because they are making money from these, their neighbors.

And lest one says "But, they coud just say no" - look around. It's a good possibility that, in hindsight, you know you should never have taken out that home loan, or know two or three people who shouldn't have, even though trillions in private money came flooding into the credit markets - how's that worked out for the country? And who has the money now? It looked all rosy at the time, jobs were out there, you were being paid well. But it was an illusion, and the first time we saw a sign that said "0% home loans" we should have surrounded the place, picked it up from its foundation, and thrown it in the river.

A poster above suggested that simply securitizing these loans did not make them less moral. I agree. The whole enterprise has thrown morality out the window. What part of a dog turd is nicer than another?

Thanks for that DG.

Oh, and thank you to the person who gave me a heart. I appreciate it.

[dixiegrrrrl]

15. Well said.

I see so much of people living from month to month, check to check, all around, and have been there more than once in my life.
It sucks.
The legalized robbery sucks.
But the legalized robbery has gone mainstream, the only difference is who is doing it, and to whom.
It exists on all levels of society,
they feed on the level below them, and eve at the top occasionally they attack one another.