Santander Consumer Stirs Credit Fears as Chargeoffs Rise

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Santander Consumer USA Holdings' gloomy outlook for credit quality in the coming year is stoking fresh concerns about risks in the fast-growing market for auto loans.

Santander told investors Wednesday to expect the quality of its portfolio to decline in the coming months, as competition for car loans — particularly for borrowers with low credit scores — intensifies.

The company warned that chargeoffs could increase, as borrowers with blemished credit histories face problems repaying their loans, executives said during a conference call. Earnings per share are also projected to decline, as the company continues its planned exit from personal lending.

The dim outlook for 2016 forced the company to defend its aggressive play for subprime borrowers – and tamp down suggestions that it is taking on too much risk.

"Deeper subprime loans have steeper losses earlier," Chief Executive Jason Kulas said, explaining the company's recent uptick in chargeoffs. He added that the company continues to post "acceptable returns in a challenging environment."

Fourth-quarter profits declined 73%, to $67.7 million, mostly on losses tied to the company's adieu to personal loans.

Signs of credit deterioration also emerged. The net chargeoff ratio increased 90 basis points year over year, to 9.5%, and the company told investors to expect "further declines" in the coming months, Kulas said. Total chargeoffs jumped 13%, to $668.7 million.

Analysts said the credit issues could be a sign of looming problems for the booming auto-lending industry. "There is a worry about competition increasing in 2016," said Vincent Caintic, an analyst with Macquarie Research, noting that it could lead to loosening credit standards and greater losses over time.

The declines marked the latest in a string of tumultuous quarters for Dallas-based Santander — a unit of the Spanish banking giant Banco Santander.

Kulas, since taking over as CEO six months ago as part of a surprise leadership shake-up, has made a series of high-profile — and highly scrutinized — changes.

The company in October announced its plans to exit the personal lending business, in an effort to focus its auto book on subprime loans. As part of the move, the company terminated an agreement with Lending Club, the nation's largest marketplace lender.

Additionally, Santander overhauled the way it calculates its set-aside for problem loans. Those changes raised questions about the transparency of its loan book.

Meanwhile, state and federal regulators have opened a series of investigations into the company's risk-taking and consumer protections. The Justice Department in August 2014 subpoenaed the company for information on the way it underwrites and securitizes subprime loans. Officials in New York and Massachusetts followed suit; the company agreed to pay $5.4 million as part of a settlement with Massachusetts regulators this past November.

Throughout the Santander's call with investors, Kulas reiterated that the company is taking steps to limit its exposure to the market, as signs of risk emerge.

The company has seen a "gradual decline in our overall market share," as a number of smaller competitors have entered the market for subprime loans, he said.

Additionally, Kulas reiterated throughout that the company has experience managing credit risk. While credit scores for the loans on its books remain low, they are still higher than they were during the financial meltdown, when the average score was "in the low 500s," he said.

During the fourth quarter, about 37% of the company's loans were issued to borrowers with scores between 599 and 540. Just under 30% of loans had scores below 540.

Santander is also taking steps to diversify its funding sources, executives said.

In the past year, the company has expanded its servicing business – particularly for high-quality loans that it originates, and then sells to the secondary market. Total servicing revenue more than doubled in the fourth quarter, to $42.4 million, compared with $19.6 million a year earlier.

But analysts questioned whether Santander can justify the rising cost of lending to subprime customers, given the increase in credit costs. The company's set-aside for problem loans grew 43%, to $800 million.

Mark Devries, an analyst with Barclays, questioned whether the company is offering the "right price and structure" to compensate for the growing risk. "I kind of struggle to see that," he said.

Still, some critics maintain that worries about credit could be overblown. The rise in chargeoffs has been "modest," said Mark Palmer, an analyst with BTIG.

"We believe Santander Consumer's mix shift, as a driver of the higher net-chargeoff ratio, has been overlooked, as investors have embraced the credit-deterioration narrative," Palmer said in a Jan. 27 note to clients.

Santander has increased its focus on subprime loans over the past year. But credit costs have been offset, in part, by higher servicing revenue, Palmer said.

As the company looks toward the coming year, it remains optimistic about its ability to manage potential risks.

"Challenging times are when we typically differentiate ourselves, and we expect that to be no different this time," Kulas said.

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