Santander Consumer Modifies More Loans as Subprime Push Continues
The auto lender has changed the way it calculates its closely-watched provision for credit losses, a move that added to third-quarter profits and raised questions about the transparency of its loan book.
Santander Consumer USA Holdings expects to endure more credit losses in the coming quarters, as it expands its portfolio of higher yielding, subprime loans. But its CEO sought to assure investors that its profits would far exceed those costs.
Santander Consumer reported an uptick in loan modifications, a sign that the auto lender is continuing its aggressive play for subprime borrowers.
Troubled debt restructurings rose to about 14% of total loans in the third quarter, compared with about 12% a year earlier, the Dallas company said Thursday.
Chargeoffs in the $36 billion-asset lender's TDR portfolio also increased. TDRs that were originated in 2014 had a 26% chargeoff rate after 12 months, compared with 24% of those made in the prior year.
"I think the main driver for that was continuing to go down the spectrum," Jason Kulas, Santander Consumer's chief executive, said during the company's annual investor day.
The sale of higher-quality loans to the secondary market, as well origination growth, also contributed to the uptick, the company said during the presentation.
The company's focus on subprime lines up with broader industry trends. Auto lenders across the industry have increased originations to subprime borrowers in the past year, the Federal Reserve Bank of New York said Thursday.
At various points in the presentation, Kulas, who was promoted to CEO in a July shake-up, assured investors that his company has a handle on the subprime business.
Several of senior executives have been with the unit since the financial crisis, he said.
Additionally, the company, which is majority-owned by the Spanish banking giant Banco Santander, will pull back from the subprime lending if it senses that the market is overheating.
"We will go through points in the economic cycle where we are making decisions that are unpopular at the time," he said. "We don't think we're anywhere near that now," but Santander will be prepared "for someday in the future when we get there."
Santander Consumer provides several modification options for borrowers, including temporary reductions on monthly payments or changes to principal balances.
The uptick in TDRs comes amid broader shifts in the company's balance sheet.
Santander last month exited the personal loan business, which accounted for about 6% of the company's $30 billion in average loans.
The company plans to replace those assets with subprime auto loans — but it won't go further down the credit spectrum, Kulas said.
"We won't go deeper to offset the personal lending," he said. "We've been doing that for so long, we know exactly what to do and what not to do."
Still, Santander has aggressively courted borrowers with blemished credit histories. Loans to borrowers with FICO scores below 540 have increased to 46% of the portfolio so far in 2015, compared with 41% in 2014.
Santander's push into subprime will result in higher loan losses, executives said.
"Our frequency of losses will definitely go up," said Jason Grubb, the company's president, adding that the company is offsetting the risk by extending loan terms and lowering loan-to-value ratios.
Santander also provided additional details about accounting changes for its loan-loss provision, which it announced last month.
Those changes — designed to reduce "seasonality," or fluctuations, in the provision — contributed to a decrease in the company's set-aside for problem loans in the third quarter.
The new calculation reduces the coverage period for loan losses from 16 months to one year. It also includes a separate loss calculation for TDRs.
"We were shooting ourselves in the foot" under the old methodology, said Jennifer Davis, the company's CFO.
The accounting changes have contributed a sharp drop in the company's stock price over the past few weeks, said Chris Donat, an analyst with Sandler O'Neill.
"We think the impact on the quarterly provision is unclear," he wrote in a Nov. 16 note to clients.
Since the Oct. 29 announcement of the accounting change and exit from personal loans, the stock has fallen over 20%, to $18.18, after the market closed Thursday.