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PR Newswire
06-10-2014, 09:13 AM
PUBLISHED OCTOBER 06, 2014
New crop of subprime bonds under scrutiny
Securities are backed by car loans and buyers snap them up based only on issuer's word
The securities are fuelling much of the 72 per cent surge in annual car sales since 2008 as near-zero interest rates lure both borrowers and lenders looking for higher-yielding assets. - PHOTO: BLOOMBERG
New York
THE US housing crisis laid bare an epidemic of fraud and sloppy paperwork on loans made to homebuyers with spotty credit. For those who bought bonds backed by the mortgages, it fuelled at least US$250 billion of losses.
Six years later, investors are snapping up a new crop of subprime bonds, this one backed by car loans. Ratings companies are awarding top grades to the securities, and buyers have almost no way to determine the accuracy of the information they get about them. Now, the market's drawing scrutiny as the US Justice Department probes underwriting and disclosure practices and the US Securities and Exchange Commission seeks to ensure investors get adequate information.
"Investors are basically taking the issuer's word that they follow certain procedures, and there is opportunity for fraud," said Eugene Grinberg, a former analyst who structured subprime car asset-backed bonds before co-founding Rockville Centre, New York-based market software firm Solve Advisors.
The securities are fuelling much of the 72 per cent surge in annual car sales since 2008 as near-zero interest rates lure both borrowers and lenders looking for higher-yielding assets.
IHS Automotive raised its light-vehicle sales forecast to 16.4 million this year, the most since 2006, as credit to buy cars becomes easier to obtain.
Car debt outstanding rose to a record US$919 billion at the end of June, according to Federal Reserve data.
While the US$168.3 billion market for bonds backed by car loans is a fraction of the US$3 trillion of securities Wall Street created from mortgages in the three years before the financial crisis, investors in home-loan bonds get more information on the underlying debt.
Ratings firms also now seek reviews from third parties to verify things like borrowers' income and property appraisals before they'll stamp their grades on mortgage notes.
The SEC in August approved expanding disclosure for publicly registered asset-backed securities including car debt. However, it shelved a proposal to extend that to private deals that are often issued by market newcomers. For public deals, the regulator reduced the amount of information it demands to 72 data points from 110 proposed in 2010.
A borrower's employment is required, for example, but the rules don't obligate lenders to disclose the same information for a second borrower such as a spouse.
The scaled-back rules mean that large swaths of bonds sold by subprime lenders from Blackstone Group's Exeter Finance Corp to Perella Weinberg Partners's CarFinance Capital can be sold to investors who receive only broad data such as aggregate credit scores.
Even for public securities sold by companies including the finance arm of General Motors, the information won't need to be verified by third parties.
"Due diligence hasn't changed much since the crisis," said John Griffin, a finance professor at the University of Texas at Austin. Investors are still at risk from "the lack of transparency".
Scrutiny is growing as subprime car payments more than 60 days late climbed to 3.63 per cent of the debt outstanding in July, from 3 per cent a year earlier, S&P said in a report last month, citing the latest available statistics.
The Justice Department is investigating the quality of the loans, sending subpoenas to GM's finance unit and to Santander Consumer USA in the last two months. It's seeking documents relating to the securitisation of the loans, the underwriting criteria used to make the loans and contractual promises made about their quality, according to company filings.
Lenders have a ready supply of funds, thanks to bond investors who are seeking securities with relatively high yields as the Fed keeps benchmark interest rates near zero for a sixth year. Top-ranked securities linked to subprime car loans are yielding 0.44 percentage point more than benchmark rates, according to Wells Fargo & Co.
Wall Street sold US$17.7 billion of the bonds through Sept 26, a pace that would make 2014 the busiest year since 2006, according to Barclays. GM Financial issued US$1.2 billion of securities in June backed by 63,045 car loans. Moody's and Fitch gave AAA ratings to US$767 million of the bonds, which pay a floating rate starting as high as 0.94 per cent.
In a prospectus for the bonds, investors who bought them were given no details on individual loans. The most specific data shows that 48 per cent of the money lent was to borrowers with credit scores from 540 to 599, below the 620 level often considered the start of subprime rankings, while another 29 per cent had lower grades.
The document doesn't explain how many of the weakest creditors were borrowing more than the value of the cars. A total of 73 per cent of the loans are greater than the stated values of the vehicles.
"The investors don't care; They're buying the rating," said William Harrington, a former analyst with Moody's. "They're getting a higher yield and are happy with that."
Less than a month after disclosing its federal subpoena, Santander Consumer USA was preparing to sell US$1.1 billion of bonds tied to subprime auto loans. Demand was so great that it boosted the size to US$1.3 billion and investors accepted lower yields than initially offered. Santander issued securities rated AA by S&P to pay 0.85 percentage point more than benchmark rates after marketing the debt at a spread of 0.95 percentage point.
Buyers and ratings firms have several methods for scrutinising the deals, said Darrin Clough, a senior fixed-income analyst at OppenheimerFund, which oversees about US$250 billion.
In addition to looking at their track records, raters and investors scrutinise the processes used by lenders to evaluate borrowers and car dealers, he said. Issuers also make promises to buy back any debt that has been misrepresented and retain the pieces of the bond deals that are in line to take losses first.
That type of safety net failed to prevent investor losses after the collapse of the housing market. Bloomberg
New crop of subprime bonds under scrutiny
Securities are backed by car loans and buyers snap them up based only on issuer's word
The securities are fuelling much of the 72 per cent surge in annual car sales since 2008 as near-zero interest rates lure both borrowers and lenders looking for higher-yielding assets. - PHOTO: BLOOMBERG
New York
THE US housing crisis laid bare an epidemic of fraud and sloppy paperwork on loans made to homebuyers with spotty credit. For those who bought bonds backed by the mortgages, it fuelled at least US$250 billion of losses.
Six years later, investors are snapping up a new crop of subprime bonds, this one backed by car loans. Ratings companies are awarding top grades to the securities, and buyers have almost no way to determine the accuracy of the information they get about them. Now, the market's drawing scrutiny as the US Justice Department probes underwriting and disclosure practices and the US Securities and Exchange Commission seeks to ensure investors get adequate information.
"Investors are basically taking the issuer's word that they follow certain procedures, and there is opportunity for fraud," said Eugene Grinberg, a former analyst who structured subprime car asset-backed bonds before co-founding Rockville Centre, New York-based market software firm Solve Advisors.
The securities are fuelling much of the 72 per cent surge in annual car sales since 2008 as near-zero interest rates lure both borrowers and lenders looking for higher-yielding assets.
IHS Automotive raised its light-vehicle sales forecast to 16.4 million this year, the most since 2006, as credit to buy cars becomes easier to obtain.
Car debt outstanding rose to a record US$919 billion at the end of June, according to Federal Reserve data.
While the US$168.3 billion market for bonds backed by car loans is a fraction of the US$3 trillion of securities Wall Street created from mortgages in the three years before the financial crisis, investors in home-loan bonds get more information on the underlying debt.
Ratings firms also now seek reviews from third parties to verify things like borrowers' income and property appraisals before they'll stamp their grades on mortgage notes.
The SEC in August approved expanding disclosure for publicly registered asset-backed securities including car debt. However, it shelved a proposal to extend that to private deals that are often issued by market newcomers. For public deals, the regulator reduced the amount of information it demands to 72 data points from 110 proposed in 2010.
A borrower's employment is required, for example, but the rules don't obligate lenders to disclose the same information for a second borrower such as a spouse.
The scaled-back rules mean that large swaths of bonds sold by subprime lenders from Blackstone Group's Exeter Finance Corp to Perella Weinberg Partners's CarFinance Capital can be sold to investors who receive only broad data such as aggregate credit scores.
Even for public securities sold by companies including the finance arm of General Motors, the information won't need to be verified by third parties.
"Due diligence hasn't changed much since the crisis," said John Griffin, a finance professor at the University of Texas at Austin. Investors are still at risk from "the lack of transparency".
Scrutiny is growing as subprime car payments more than 60 days late climbed to 3.63 per cent of the debt outstanding in July, from 3 per cent a year earlier, S&P said in a report last month, citing the latest available statistics.
The Justice Department is investigating the quality of the loans, sending subpoenas to GM's finance unit and to Santander Consumer USA in the last two months. It's seeking documents relating to the securitisation of the loans, the underwriting criteria used to make the loans and contractual promises made about their quality, according to company filings.
Lenders have a ready supply of funds, thanks to bond investors who are seeking securities with relatively high yields as the Fed keeps benchmark interest rates near zero for a sixth year. Top-ranked securities linked to subprime car loans are yielding 0.44 percentage point more than benchmark rates, according to Wells Fargo & Co.
Wall Street sold US$17.7 billion of the bonds through Sept 26, a pace that would make 2014 the busiest year since 2006, according to Barclays. GM Financial issued US$1.2 billion of securities in June backed by 63,045 car loans. Moody's and Fitch gave AAA ratings to US$767 million of the bonds, which pay a floating rate starting as high as 0.94 per cent.
In a prospectus for the bonds, investors who bought them were given no details on individual loans. The most specific data shows that 48 per cent of the money lent was to borrowers with credit scores from 540 to 599, below the 620 level often considered the start of subprime rankings, while another 29 per cent had lower grades.
The document doesn't explain how many of the weakest creditors were borrowing more than the value of the cars. A total of 73 per cent of the loans are greater than the stated values of the vehicles.
"The investors don't care; They're buying the rating," said William Harrington, a former analyst with Moody's. "They're getting a higher yield and are happy with that."
Less than a month after disclosing its federal subpoena, Santander Consumer USA was preparing to sell US$1.1 billion of bonds tied to subprime auto loans. Demand was so great that it boosted the size to US$1.3 billion and investors accepted lower yields than initially offered. Santander issued securities rated AA by S&P to pay 0.85 percentage point more than benchmark rates after marketing the debt at a spread of 0.95 percentage point.
Buyers and ratings firms have several methods for scrutinising the deals, said Darrin Clough, a senior fixed-income analyst at OppenheimerFund, which oversees about US$250 billion.
In addition to looking at their track records, raters and investors scrutinise the processes used by lenders to evaluate borrowers and car dealers, he said. Issuers also make promises to buy back any debt that has been misrepresented and retain the pieces of the bond deals that are in line to take losses first.
That type of safety net failed to prevent investor losses after the collapse of the housing market. Bloomberg
