February 13, 2015
Subprime lender Santander Consumer USA Holdings recently announced a smaller provision for credit losses amid otherwise general concerns that deteriorating lending standards could impact credit quality. The company cut this reserve to $560 million in the fourth quarter of 2014 from $770 million during the prior period.
SCUSA made this move even after specifying in November that it would probably maintain its reserve, according to American Banker. The company made this prediction after announcing its quarterly provision for credit losses surged 29 percent year-over-year.
Santander Consumer USA also announced the reduction after its delinquency and charge-off ratios rose from the previous quarter. While the former ratio rose to 4.5 percent during the final quarter from 4.1 percent in the prior three months, the latter increased to 8.6 percent from 8.4 percent.
In spite of these warning signs, Thomas Dundon, CEO of Santander Consumer USA, asserted Feb. 3 that interest rates paid by borrowers have increased enough to justify lenders granting risky loans, according to American Banker. He also contended that in 2014, credit losses started to become less volatile.
"As risk increases, sometimes the market lags behind in terms of getting the correct risk-adjusted yield," Dundon stated during a conference call with analysts, American Banker reported. "We are happy with the price and the risks that we're taking."
The CEO is not the only one who believes Santander Consumer USA is on the right track, as investors pushed the company's shares up more than 7 percent on Feb. 3, and Mark Palmer, a BTIG analyst who has a "buy" rating on the subprime lender, wrote in a recent research note that "somewhat higher losses are acceptable within the context of the company's business model insofar as it is well compensated for the additional risk it takes."
The company's latest financial results reflect a company that is generating adequate compensation for risk, as Santander Consumer USA generated net income of $247 million, or 69 cents per diluted common share, for the fourth quarter of 2014. These figures compared to net income of $191.4 million, or 54 cents per diluted common share, during the third quarter.
Loan portfolio implications
If Santander Consumer USA is right in betting that subprime auto loans will enjoy stronger performance in the near-term, this situation could impact the quality of loan portfolios. If the credit risk of these pools of debt falls, they could present banks with strong investment opportunities.
Financial institutions that are considering buying such assets must be sure to conduct the proper due diligence to ensure they obtain the proper combination of risk and yield. To maximize the chances of obtaining loans that meet their needs, banks should work with Garnet Capital Advisors, a loan sale advisory firm with experience in many types of debt.