Subprime Auto Loan Crisis Chronometer

Crisis /krīsis/: A turning point that results in a battle over loss allocation.

Will there be a crisis? Are we near one?

Practices and factors similar to those contributing to the subprime mortgage meltdown are now impacting subprime auto lending and related ABS. The gauges reflect our take on how they are impacting risks for lenders and investors.

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The Subprime Auto Loan Crisis Chronometer shows the risk of battles over loss allocation.
Sep 2018
Lending Practices and Factors i
Subprime originations have trended down but securitization volume continues to increase. Subprime delinquencies in the secondary market are on the rise and have surpassed peak levels. Risky practices are exposing specific lenders and their investors to losses, as evidenced by the closure of a number of smaller subprime auto lenders earlier this year.
ABS Practices and Factors i
Credit enhancements such as excess spread, overcollateralization and subordination have increased in new deals and continue to create a buffer from riskiest lending practices. Investors have not yet felt the sting of riskiest practices.
Auto Market Risks i
New and used vehicle prices are at all-time highs, but sales incentives and high supply of off-lease vehicles are accelerating depreciation and driving up negative equity on trade-ins. Advances in technology will likely accelerate depreciation further.

Wells Fargo is being put on a highly restrictive diet by the Federal Reserve and won’t get any relief until its compliance and governance shape up.  Under the terms of the Fed’s Consent Order, Wells cannot grow its consolidated assets beyond the total consolidated assets reported at the end of 2017.  Although Wells is dismissing the effect of the Order as a nothingburger, if there’s really no effect, it’s probably because Wells already lacks opportunity for growth in deposits and lending as a result of its recent scandals and the massive consumer distrust that has followed.  And yet, Wells has announced efforts to focus on those very activities, rather than redirecting its efforts elsewhere.  Call it being resilient or being tone-deaf, history may not be kind to Wells if it fails to get the message the Fed and consumers are sending.

Change at the Bank Should Happen Rapidly

The Fed’s Order to Cease and Desist requires Wells to develop written plans to “enhance the Board’s effectiveness in carrying out its oversight and governance” within 60 days of the Order.  In that same time period, the bank must submit to the Federal Reserve Bank of San Francisco written plans to “further improve its firm-wide compliance and operational risk management program.”  The growth restrictions will not be lifted until the Reserve Bank signs off on the plans and they are completed to the satisfaction of both the Reserve Bank and the Director of the Division of Supervision and Regulation.

However, the prospect of a prompt and smooth resolution of these issues in the prescribed period looks dimmer now that it’s come to light that in its attempt to make up for forcing customers to buy unnecessary insurance, Wells mistakenly sent refunds to the wrong people, including some who were not even bank customers.  Some customers who feel they’ve been wronged may find this karmical, but consumer banking shouldn’t be analogous to playing the lottery.

Despite all of its missteps on the consumer front, Wells remains committed to its consumer businesses, stating that to stay within the bounds of the Order, it plans to grow “core loans and deposits” while “trim[ming] deposits from financial institutions and some commercial clients as well as some low-yielding trading assets.”  But Wells may be so far down the well of consumer distrust that acquiring new customers will be a more expensive proposition than pursuing new opportunities.

New Opportunities, New Challenges

Wells wouldn’t be alone if it shifted its focus away from deposits and lending to some extent.  For instance, BNY Mellon successfully traded away its retail banking for corporate trust assets.  And, banks that haven’t had the benefit of large-scale customer deposits have had to pick and choose their niche alternatives, some providing fee-based offerings like asset management, trustee services and loan servicing, whereas others have relied more on business relationships and developed expertise, rather than lending.

Wells could attempt this kind of alternative fee-based path and perhaps increase its focus on corporate trustee work.  But then again, this could carry its own set of issues.  Given its roles as both an auto lender and a trustee, Wells could find itself on opposite sides of the same issue if investors in asset-backed securities (ABS) incur losses and direct trustees to pursue repurchase actions.  In the past, Wells has had to withdraw as trustee in residential mortgage-backed securities (RMBS) actions because of this very issue, weakening the trust’s standing in the action.

While there’s a Wells, there’s still a way. But, a successful Wells in the future may look different than it does today.  Given the bank’s size and presence in lending and securitizations, any significant transformation could reshape the credit markets.

 

James Serritella, a partner, and Massimo Giugliano, counsel, contributed to this post and are members of the Insolvency, Creditors’ Rights & Financial Products Practice Group of Davis & Gilbert.