Bad Credit? Car Loans You Can’t Afford Make Millions for Wall Street

One spring afternoon in 2019, James Siler wrapped up his shift as a church custodian and headed to a used-car lot in Valdosta, Georgia. He wanted to replace his broken-down old Pontiac Grand Prix, which he’d bought for about $500.

Siler and his wife, Janice, had filed for bankruptcy only six years before. Still, the salesman at Langdale Hyundai of South Georgia showed him a true upgrade, a one-year-old silver Ford F-150 truck. Janice, a school cafeteria cook, took out a $30,000 car loan. Her credit was weak, but stronger than his. “Mr. Siler, we’ll stay here as long as it takes,” he remembers the salesman telling him.

Packaging loans and reselling them as asset-backed bonds—a process known as securitization—has great appeal on Wall Street. Investment firms such as Capital Group and Bank of New York Mellon Corp. snapped up the securities in Drive 2019-3 because their yields beat Treasuries. Car loans made to people with spotty credit backed more than $37 billion of bonds last year, twice the value of a decade before, according to data compiled by Bloomberg.

If many of these subprime borrowers couldn’t repay, it hardly mattered to investors. Multiple layers of protections all but guaranteed that they’d get back their principal with interest. While customers would often lose their cars to repossession and have their lives upended, Santander stood to earn tens, if not hundreds, of millions of dollars.

Santander Consumer USA, one of the largest US subprime lenders, charged Janice Siler an annual interest rate of 22.05%, more than three times the level paid by used-car borrowers with strong credit. For the next six years, the couple would owe $750 a month on top of the $436 they were already paying monthly for another car. They soon struggled to make payments for the truck. It would end badly for the Silers even though they had additional income from a pension, Social Security and James’ part-time work. According to a Santander filing, Janice qualified for the loan based on an income of about $70,000 a year. The Silers say they never made that much.

As is typical for bonds backed by risky car loans, a Santander offering document suggests it built the security based on the assumption that much of the debt would go bad. The company initially projected that customers would fail to repay 42% of the money they borrowed. Thousands of borrowers would ultimately default. Even some in the industry question whether it makes sense to let so many customers take on more debt than they can afford. “It doesn’t really work for the consumer,” says Daniel Chu, chief executive officer of subprime auto lender Tricolor Holdings. “But it works for everyone else.”

In a country where most people rely on cars to get to work and transport their families, Santander and other lenders say they’re throwing a lifeline to those with poor credit and few other options. “The benefits of automobile ownership are substantial,” Santander Consumer USA says in a statement. “For example, consumers who own a car are more likely to have higher employment income, live in safer neighborhoods, and are more likely to exit income support programs.” For privacy reasons, Santander says it wouldn’t comment on an individual customer loan, while adding it “adheres to all regulatory requirements and industry best practices.”

In a separate statement, Bradley Cobb, president of Bowers Automotive Group, co-owner of Langdale Hyundai, says the 22.05% interest rate reflected the risk of the loan due to Janice Siler’s recent bankruptcy. The lender gave her “a second chance,” he says. “Based on the information provided by Mrs. Siler, we believe Santander made an ethical and sound decision in granting her a loan.”

Some state and federal regulators, as well as members of Congress, see an echo of the practices of the subprime mortgage lenders at the heart of the 2008 world financial crisis. Back then, brokers sold home loans to customers who couldn’t repay, sparking a foreclosure crisis.

In response, Congress passed the 2010 Dodd-Frank Act, which required mortgage lenders to scrutinize a borrower’s finances to make sure loans are affordable. The law also created the US Consumer Financial Protection Bureau to enforce compliance.

But car dealerships, where most loans are made, successfully fought for an exemption to CFPB supervision, arguing that regulation would damage an essential Main Street business. Manny Reyes, founder of Easy Way Autos, a dealer in White Plains, New York, says he tries to steer buyers with low incomes and poor credit to cheaper cars. But if lenders approve financing for a more expensive one, he doesn’t discourage them. “What am I going to say?” he says. “They’d probably be insulted.”

The CFPB and state regulators have been cracking down on the sales practices of subprime lenders, including Santander. In 2020, the company reached a $550 million settlement to resolve abusive lending allegations made by attorneys general from 33 states and the District of Columbia—among them that the company knew it made loans that were likely to default. Santander, neither admitting nor denying wrongdoing, agreed to waive some customers’ balances and, in the future, 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.”

Still, 30% or more of subprime auto loans typically default, according to LexisNexis and Moody’s Corp. That’s approaching the highest default rate for subprime mortgages 17 years ago, near the peak of the foreclosure disaster. “It was a mistake for Congress to carve out car dealers when they built the CFPB,” says US Senator Elizabeth Warren, a Massachusetts Democrat who came up with the idea of the agency as a Harvard law professor. “The proof is in the pudding.”

The arc of a single subprime loan helps explain why these bond offerings are so popular with investors and so painful for customers.

Harnessing sophisticated financial models, Drive 2019-3 was built to be Wall Street’s equivalent of Ford Tough. It had a face value of $1.21 billion. But the offering bundled in an additional $344 million of auto loans, which provided extra collateral to cushion against losses. Santander also cut up the offering into slices, known as tranches. The bonds that must be repaid first got top credit ratings, while even those last in line were considered investment grade, if only a notch or two above junk. The bonds paid interest rates ranging from 2.5% to 3.2%. The underlying car loans, reflecting the riskiness of the borrowers, had a weighted average interest rate of 19% but some were as high as 29.99%.

As long as borrowers defaulted on no more than about 60% of the money they owed, all bondholders would get repaid, according to a 2019 S&P Global Ratings report. “You could think of it as structured like a bomb shelter against a nuclear blast,” says Neil Hohmann, head of the structured finance team at Brown Brothers Harriman, speaking in general about subprime car bonds.

When customers default, technology makes it far easier to repossess cars than in the days of the grizzled, harried Repo Man, immortalized by the actor Harry Dean Stanton in the 1984 film. GPS tracking and license plate scanners can easily locate a vehicle, which can be resold and provide a constant stream of cash replenishing bondholders’ accounts. “This market is structured to make money even though it may be preying on borrowers,” says Boston College law professor Patricia McCoy, a former US Treasury official who was among the CFPB’s first top staffers.

But Jim Bass, chairman of the National Automotive Finance Association, says the subprime industry makes it possible to extend credit to people who need to recover after a setback, such as a divorce or a job loss. “If it wasn’t for the finance companies that were willing to finance these individuals, it would have such a negative impact on day-to-day life in most of the country,” he says.

As of June, subprime debt made up 21% of the $1.58 trillion in outstanding auto loans, the second-largest kind of consumer debt after mortgages, according to the Federal Reserve Bank of New York. Although overall car lending is booming, the share going to subprime borrowers has declined.

Major banks have shifted their focus to more credit-worthy customers buying ever more expensive cars. Those catering to the subprime market, including Santander and Southfield, Michigan-based Credit Acceptance Corp., tend to securitize their loans, which gives them access to more funding.

No bond is bulletproof. The subprime auto market is showing cracks as interest rates rise and the economy potentially heads into a downturn. Two securitizations packaged by lenders other than Santander are careening toward at least a partial default after the collapse of two large used-car dealers earlier this year.

Spurred by the financial crisis, regulations since late 2016 have required lenders to disclose loan-level details for certain bonds registered with the Securities and Exchange Commission. The reasoning: Investors would have a better idea what they’re buying, rather than committing to a giant black box.

The listings include loan balances, credit scores of customers, valuation of cars and other data, but not the customers’ names. Bloomberg News wanted to track down at least one to get a fuller picture of what was inside an asset-backed security. Reporters interviewed more than 40 struggling borrowers in Georgia, Florida, Texas and 14 other states who were customers of Santander, Credit Acceptance and many other subprime lenders. They paid annual interest rates ranging from 14% to almost 30%; all but seven had lost their cars in repossessions.

Many of their loans either didn’t match the SEC data or weren’t subject to disclosure. Then there was Siler. Loan No. 19974879 in Santander’s Drive 2019-3 fit his F-150 exactly.

In Dixie, Georgia, an unincorporated community near the Florida state line, Siler lives on a five-acre plot across the street from a cotton field. Hunks of scrap metal, which he’s collected to break down and sell, border his freshly mowed yard.

A former US Army mechanic, he worked in a ball-bearing factory in nearby Cairo, Georgia and, for the past 20 years, as a custodian at First Methodist Church of Valdosta.

James and Janice Siler have been married 48 years, since he got out of the service; the ceremony took place on the front lawn of his in-laws’ home, which he can see from his own. The couple, now the grandparents of three, raised four children in their faded yellow clapboard house, which still has a mortgage of about $1,000 a month.

For all their family stability, the Silers have long struggled financially. In 2013, they filed for bankruptcy because they fell behind on the mortgage. Siler, 68, tends to downplay his financial struggles. “I ain’t never been barefoot, and I never went hungry,” he says.

The couple had long driven cheap, old cars but, in March 2018, James decided to surprise Janice with a two-year-old Toyota Camry that would be more reliable. He borrowed $16,963.18 at a 22.58% interest rate, committing to six years of $435.87 monthly payments. It ended up as loan No. 18148909 in another Santander bond offering, called Drive 2018-2.

Then his own car kept dying, and the Silers bought the F-150 in March 2019. With about 32,000 miles on the odometer, it would be more reliable for his lawn-mowing work and for ferrying around elderly relatives. They took out the loan in Janice’s name this time because of her higher credit score, which was still a weak 565 on a standard range of 300 to 850, according to an SEC filing by Santander. Siler says he didn’t look carefully at the contract, which disclosed the 22.05% interest rate. If he had, he says now, he would’ve asked, “Look, man, you can’t go no lower than that?”

Almost from the beginning, the Silers struggled to keep up with the loan. James Siler would make a payment or two, quickly fall behind, catch up and then fall behind again. In the spring of 2020, the church cut back his hours because of the Covid-19 pandemic, which made it even harder to make ends meet.

Representatives called every other day about his loan, he says. Janice Siler says he’d have trouble sleeping. “He was trying to work it out with them,” she says. “They were just hounding him.” As he racked up late fees, he asked for more time to pay. “Santander was my biggest problem,” Siler says. “You can’t fight a big company like that when you’re just a regular person.”

In July 2020, at least two months behind on his loan, he figured he was done. He prioritized making car payments for his wife’s Camry, as well as their mortgage. “I was robbing Peter to pay Paul, and I just couldn’t handle it anymore,” Siler says. “Well, what’s most important, a home or a truck?” Siler told Santander to take the Ford back. “‘Do what y’all gotta do,’” he says he told a rep.

“We unequivocally at no time like to see our customers face hardship, but sometimes they make decisions we do not think have the best results,” says Cobb, the executive overseeing the dealership where the Silers bought the car.

A couple of days before Santander repossessed the truck, James Siler headed over to another Valdosta dealer, Maluda Auto Sales, and bought a 2014 Jeep Grand Cherokee with 146,550 miles on the odometer. He had no trouble getting another loan, this time for $16,259 from Credit Acceptance, one of Santander’s biggest rivals in the subprime business. The annual interest rate was 22.99%, but the payments were more manageable: $471 a month. Credit Acceptance didn’t respond to questions about the loan, and Maluda Auto declined to comment.

The next month, the Ford truck sold at auction and, according to a document she later received from a collection agency, Janice still owed $2,100. It’s unlikely that investors lost money because the Silers made a $1,200 down payment and Santander’s SEC filings indicate they made almost $6,800 in payments.

Drive 2019-3 wound down in October. Customers failed to pay back one quarter of the money they borrowed, compared with the 42% default rate originally expected. It was a bonanza for Santander.

Here’s why. To align its interests with investors, Santander was required to hold at least a 5% interest in the securitization—in this case, putting $71 million of its own money at risk. In the event of any shortfall, it would be the last to get repaid, the first to lose money. But it also got to keep a share of any excess money after everyone else is paid.

There was a lot left over, in part because of the difference between the 2.5% to 3.2% paid to investors and the 19% interest paid by customers. No doubt, it also helped that used cars held onto more of their value during the pandemic because of shortages and high demand and could be sold for more after repossession. According to the sum of distributions reported on SEC filings, Santander got to keep at least $155 million as a kind of bonus. And that was on top of its servicing fees, which totaled $121 million.

In January, still working only part time at the church, Siler filed for bankruptcy again, restructuring his debts and keeping up with the payments on the Jeep and the Camry, as well as his mortgage. He’s relying on his Jeep to collect more money in various odd jobs. “I’m supposed to be retired now,” Siler says. “I don’t think that’s in my future.”