How Much Are Banks Exposed to Subprime? More than we Think

Wells Fargo has $81 billion in exposure to loans that, on paper, it isn’t exposed to.

A couple of days ago, when I wrote about the soaring delinquency rates in subprime auto loans – the worst since 1996 – and the collapse of three specialized small subprime lenders, I stumbled over a special nugget.

One of the collapsed small lenders, Summit Financial Corp, when it filed for bankruptcy on March 23, disclosed that it owed Bank of America $77 million. This loan was secured by the auto loans Summit had extended to subprime customers, who’re now defaulting in large numbers. In the bankruptcy documents, BofA alleged that Summit had repossessed many of these cars without writing down the bad loans, thus under-reporting the losses and misrepresenting the value of the collateral (the loans). This allowed Summit to borrow more from BofA to fund more subprime loans, BofA said.

Summit is just a tiny lender and doesn’t really matter. But there are a whole slew of these nonbank lenders, specializing in auto loans, revolving consumer loans, payday loans, and mortgages. Some of these nonbank lenders specialize in “deep subprime.” And some of these lenders are fairly large.

Since the Financial Crisis, big banks have mostly avoided subprime lending. Instead, they’re lending to the companies that then provide financing to subprime customers. And BofA is finding out just how much risk it was taking with its loan to Summit that was secured by now defaulting auto loans that were secured by cars that, once repossessed, are worth only a fraction of the loan value when they’re sold at auction.

How much banks are exposed in this manner to subprime loans – not just auto loans, but also subprime mortgages, and subprime consumer loans – is somewhat of a mystery. But some clues are percolating to the surface. According to an analysis by the Wall Street Journal of regulatory filings, bank loans to nonbanks lenders have surged sixfold since the Financial Crisis to nearly $345 billion at the end of 2017. Here are the top contenders:

  1. Wells Fargo: $81 billion, up from $14 billion in 2010
  2. Citigroup: $30 billion
  3. Bank of America: $30 billion
  4. JP Morgan: $28 billion
  5. Goldman Sachs: $22 billion
  6. Morgan Stanley: $16 billion.

Banks extend these loans at relatively low interest rates because the loans are collateralized and don’t expose the banks directly to the risks of lending to subprime consumers. Nonbank lenders make money off the spread between the relatively low cost of money and the often double-digit rates they charge consumers. The spread is so sweet and enticing that it caused a boom in the sector and attracted private equity firms.

Among the PE firms that plowed into the auto loan subprime businesses is Blackstone Group, which acquired a majority stake in Exeter Finance in 2011. And it has been rough. The company cycled through three CEOs. As of September 2017, Exeter charged off about 9% of its loans, according to S&P Global, cited by the Wall Street Journal.

At the same time, Wells Fargo’s own pristine-credit auto-loan portfolio experienced charge-offs of only 1%.

But Wells Fargo – along with Barclays, Deutsche Bank, and Citigroup – is exposed to Exeter’s subprime loans via a credit line of $1.4 billion. Exeter draws on this line to fund the subprime loans, and then periodically, it creates subprime auto-loan-backed securities that it sells in slices as bonds to investors. It likely hangs on to the riskiest junk-rated slices that take the first losses. At the same time, there is intense interest in the higher-rated slices. Exeter then uses the proceeds to pay down the credit line, which creates room to fund new business.

So via these asset-backed securities, the risks get spread some more. But Exeter remains exposed to the first losses of the asset backed securities, and it remains exposed to the loans that it hasn’t sold off yet. And the banks remain exposed via the credit line to Exeter and its loans. This works really well, and the fees and spreads are really sweet, until consumers begin to default more than anticipated, which is the case now.

Still, banks won’t lend 100% of the value of the collateral – namely these subprime loans. They might lend 80% or so. And in a bankruptcy they have a right to those loans, and when those customers default, and when losses from prior defaults had been hidden, it gets messy in a hurry for the bank, with the collateral value plunging by the day.

Before the Financial Crisis, the spreading of risk in all directions away from the banks was thought to protect the banks. In the end, risk may have been spread, but it didn’t stay spread, so to speak. Some of it snapped back to where it had come from. And the banks’ exposure to nonbanks that are engaged in subprime lending is one of those snap-back risks.

We still don’t fully understand the magnitude of it, and even the banks might not, as BofA is finding out in the Summit bankruptcy. Summit is tiny, and any losses will be a rounding error for BofA. But as far as we know, BofA has $30 billion in exposure, and Wells Fargo $81 billion, to loans that they are, on paper, not exposed to. And those are more serious numbers.

Chapter 11 bankruptcy filings in March soared to the highest level since April 2011. It’s not just the Brick & Mortar Meltdown anymore. Read…  Chap. 11 Bankruptcies Spike 63% from Year Ago 
 

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  49 comments for “How Much Are Banks Exposed to Subprime? More than we Think

  1. Arnold Ziffel
    Apr 11, 2018 at 5:55 pm

    Nice catch! Also what about bank loans to auto dealers? The margins with the dealers are shrinking and there is a major consolidation occurring per a recent WSJ. With a seneca cliff occurring in auto sales probably as low as 12 to 13 million cars per year some of the auto dealers are going to go belly up.

    • Armando Rubio
      Apr 11, 2018 at 6:32 pm

      I believe Wolf wrote an article a while back stating that the recent hurricanes did not create nearly the demand dealers and automakers expected. Also, people are holding onto their cars for longer than ever. What do you folks think?

      • AV8R
        Apr 11, 2018 at 6:41 pm

        My 2012 Audi A6 has 40k miles on it. I see it getting replaced in 2022.

        • BradK
          Apr 11, 2018 at 8:10 pm

          My 1999 Acura has 54K miles, though I’m thinking of trading it in for an Audi soon. Thanks for the endorsement.

          Those of us who keep are cars for so long certainly aren’t doing our part to help grease the economy, though I’m not losing any sleep over it.

          @Armando: Yes, I remember Wolf’s excellent analysis of the post-hurricane sales boom that never quite was. Perhaps it’s time for a Spring update to those numbers?

        • Mike T
          Apr 12, 2018 at 6:32 am

          AV8R ditto here with my 2007 Audi A4 Avanti 3.2l that I love dearly has 130k on the clock. Bought used in 2010 just off lease at 22k on the clock. Family will likely bury me in it.

          Last month I had a choice of buy a new car or pay off the mortgage. I paid of the mortgage!

          Debt freedom feels great.

      • agathon crumb
        Apr 11, 2018 at 8:23 pm

        My 2000 Toyota Tundra V8 has been a beauty.
        Bought in 2003. Sadly, more reliable by far than Ford.
        Same tranny, frame, engine (only 150K mi.).

        • Mikey
          Apr 11, 2018 at 10:11 pm

          My 2007 camry has 110k miles and I expect to just use lyft when it dies.

        • Pat
          Apr 12, 2018 at 5:34 am

          2005 Acura TL with 150k…runs better than some new cars I’ve driven . Won’t get rid of it just yet and I don’t want car payments. Never had em always buy lightly used for cash

        • Brett
          Apr 12, 2018 at 7:59 am

          Toyotas have an awesome rep as being hard to kill, providing you change the oil when required….Audi have had a terrible reputation in the past for reliability, perhaps that has changed, I really hope so as an Audi has fantastic style.

      • ambrit
        Apr 12, 2018 at 8:54 am

        Cheap seats here. We have a 1998 dodge Dakota truck with 128k on it and a 2001 Dodge PT Cruiser with 138k on it. I, being not in the financial stratus that allows me to hire out my auto repair tasks, have learned to fix both, up to and including head gasket replacements. (That Chrysler 2.4 L 4 engine was designed with too small of a safety factor, as in, when the radiator calcifies up a bit, it runs hot. It was designed to run at around 250 degrees Fahrenheit as it is.)
        From my admittedly ‘downscale’ perspective, autos are a large investment. Seriously, if one were to have a choice between a new car with payments of four or five hundred dollars a month, or a beat up house at a similar payment level, and such are there if one is not too picky, the choice is obvious. Cars depreciate, as do houses, but land, it’s always going to be there. This might be naieve thinking, but the allure of ownership in land is strong.
        So, I and many like me will hold onto those clunkers until they die of old age.

        • Enquiring Mind
          Apr 12, 2018 at 10:36 am

          Your radiator calcification issue made me wonder the following: Would replacement of radiator water with distilled water, and routine flushing, avoid or reduce that issue? Riffing off your Brit portion, I’m envisioning some type of kettle fur. :)

          That ‘creative solution’ might be somewhat like using nitrogen in tires instead of air, in part to reduce any potentially harmful chemical interactions. Any mechanics or chemists care to weigh in?

  2. bkennedy
    Apr 11, 2018 at 6:01 pm

    And as for our canadian banksters and their bailout that “never happened” ?

    • Prairies
      Apr 12, 2018 at 11:00 am

      Canadians have had bail outs – multiple. For years if not decades, just not in the same fashion as the American Housing Crisis and rarely are they brought up in public.

      In Canada we have “equalization payments” where the rich provinces give to the poor. Annual provincial “bail outs”. Last year the government was called out for the first time in a long time because Quebec(a constantly “poor” province) gave Bombardier a Billion dollar bail out and the fed gave over 370 million on top.

      All because BRP failed to meet a deadline on a contract. Canada is as corrupted as everyone else in the world.

  3. Rates
    Apr 11, 2018 at 6:15 pm

    Wells Fargo theoretical exposure: 81 billion.
    Wells Fargo practical exposure: 0.

    Warren B will transfer those exposure to muppets.

    • Apr 11, 2018 at 9:44 pm

      JP Morgan and the gang will offer a sacrifice when TSHTF, that sacrifice is Wells Fargo.

      • Rates
        Apr 12, 2018 at 12:24 am

        Old Warren is part of the gang. First sacrifice will be Morgan Stanley. After that Bank of America.

        • Apr 12, 2018 at 11:11 am

          Maybe Morgan Stanley but BofA is one of the owners of the Federal Reserve, no way they go down

        • Rates
          Apr 12, 2018 at 6:16 pm

          MikeB, here’s the composition of New York Fed owners back in 1983 (that’s right 1983, because I wanted to show how different the owners are from right now):

          “Mullins reported that the top eight stockholders of the New York Fed were, in order from largest to smallest as of 1983, Citibank, Chase Manhatten, Morgan Guaranty Trust, Chemical Bank, Manufacturers Hanover Trust, Bankers Trust Company, National Bank of North America, and the Bank of New York (Mullins, p. 179).”

          How many of those are still around? This is about political pull. Warren B, JP and Goldman are tops. The rest are small potatoes.

        • Mugsy777
          Apr 17, 2018 at 6:43 am

          Sorry fellas but the “owners” of the Fed are not the downstream customers, no matter how twisted the logic….. The controlling interests of the Fed are kept secret…..why do you think the Fed board fights to the death to avoid a real audit?

      • Enquiring Mind
        Apr 12, 2018 at 10:39 am

        Wells is cutting back in various areas to pay for those unsolicited account class action suits. Their local branch used to have coffee, water and candy as inducements, and those are no more. Guess I’ll have to make due with the lousier coffee and candy at Chase while that lasts. ;)

  4. ScottS71
    Apr 11, 2018 at 7:02 pm

    Great reseach. Who rates the slices? and and whats the criteria (just credit scores?). It would seem like the subprime lenders would have crunched the numbers but if the numbers are not looking good, why not find/make a loophole and move some of the riskiest loans up a notch and unload them? With all this money in the system for the purpose of priming the economy, to sell more stuff to people that dont have any more real income to afford it, what could go wrong. How many Unicorns have been created with this money over the past 10 years? Stock price to earings have soared, which is a great example of money priming an asset class.

    • Apr 11, 2018 at 8:40 pm

      The usual suspects rate the slices: Fitch, Moody’s, S&P, along with DBRS and Kroll Bond Ratings Agency (KBRA).

      • d
        Apr 13, 2018 at 4:16 am

        1st tier lenders, lending to 2nd and 3rd tier lenders, who carry the risk, for a juicy spread, until it all goes pear shaped and custard like. When they cant pay the1st tier lender

        You have peeped at this issue in the US. What you found distressed you little. I was hoping most of that money in the US was coming from china not 1st tier US bank’s.

        Now think about what is hiding under the rug’s in china, operating that play book, that must one day go, BOOM.

        People who can get money out of china, still are.

        For very good reason.

  5. Sporkfed
    Apr 11, 2018 at 7:30 pm

    Those who are responsible for the losses won’t be those that
    pay for them. Funding loans for depreciating assets for consumers
    who are high risk. What could go wrong ?

  6. Bewildered
    Apr 11, 2018 at 7:56 pm

    Call it another way to skin a cat….with no oversight the Big Banks are just like your average american who has a credit card disease…bail out…slight go hand…find another way to skin a cat…what can happen? Should these people be denied transportation to get to and from work? Wait till driverless cars are available…and the general public is not allowed to own their own driverless car?

    • Setarcos
      Apr 12, 2018 at 8:27 am

      There has never been effective oversight and never will be if we simply want “more” of it. If hungry, more cardboard only feeds roaches. It is not possible for flawed (politicized) groups to oversee flawed groups and achieve honest outcomes. We really need to abandon this notion that the “good guys” will effectively oversee the “bad guys”. It’s not that simple. For some reason intelligent people are trying to increasingly micromanage everyone else (except themselves) and thinking it will be successful. Try micromanaging even your spouse and/or kids and tell me how that goes.

      For the many recent years since the recession, a very large number of bankers stopped being bankers and began being compliance officers and what did it cost all of us in terms of economic activity. Ask a small business. And ask a big bank how much the Patriot Act, Dodd Frank, etc. actually costs and then spread that number across their customer base (which includes us). Help me recall a good example of when regulators actually noticed a big problem and corrected it …or even warned about it. Housing??

      I share some of the frustration and will end with this…who do we trust to provide effective/honest oversight?

  7. KPL
    Apr 11, 2018 at 11:00 pm

    Obviously the banks are not worried. After all, they have the Fed at the ready with rate cuts (savers/prudent guys be damned!), money spigot, acronym money and QE and tax-payers to foot the bill! Capitalism at work indeed!!

    • Setarcos
      Apr 12, 2018 at 8:37 am

      Correct about the biggest banks not being worried. But, it is called “crony” capitalism, not capitalism. Many apparently don’t understand the difference, so they want more regulation, i.e. more crony capitalism.

  8. Steve clayton
    Apr 12, 2018 at 1:18 am

    Hi Wolf, I see Wells Fargo report Q1 2018 on Friday, I would love to ask the question on the investor call ref subprime.

    • Apr 12, 2018 at 7:19 am

      If you’re an analyst that is invited to ask a question during the call, and you ask this kind of question, you will never be invited to ask a question again. If you ever listen to these earnings calls, it goes like this:

      “John X with Goldman Sachs here. You guys did a great job obviously, and it’s really awesome how you were able to execute on your strategy. I just have a couple of questions: One, how were you able to reach a margin of YY% in this tough market, and two, how are your branch expansion plans coming.”

      With this type of question, John X will be invited again next time to ask a question. Your question, however, will get you banned from asking questions for life :-]

      • Steve clayton
        Apr 12, 2018 at 10:42 am

        Ha ha thanks Wolf but wouldn’t it be great to ask that question. Regards Steve.

  9. raxadian
    Apr 12, 2018 at 2:22 am

    Well this will make an interesting 2018

  10. raxadian
    Apr 12, 2018 at 6:37 am

    Don’t worry guys! It won’t be until 2019, if we believe JPMorgan Chase CEO James Dimon when he says US treasuries won’t sink the Stock Market until 2019, that this will be a real problem.

    Then again I may be wrong, oh well.

    • Apr 14, 2018 at 9:48 am

      Well, as a retired retail consumer and bank lender, guess I will live long enough to see arrival of the next financial crisis. Greed and ignorance never disappoint.

      No one will stop this party until the punch bowl is empty.

  11. lenert
    Apr 12, 2018 at 10:10 am

    Of course the auto-lending sector got exempted from Dodd-Frank.

    Meh – my anecdote: We just borrowed for a new car. The dealer finance dept signed us to some entity which would broker the loan and then they gave us the keys. I called a few days later to get the loan number for insurance but there still wasn’t one – they were still brokering our loan “with a number of lenders.” Two weeks later came the first statement from Wells-Fargo. Still not really sure what went on behind the scenes but we initially signed a loan at 3.65% which ended up “closing” at 3.5%. I guess I don’t mind that I ended up paying less than initially agreed and for the first time in 50 years paying single-digits to finance a car? For the record, I don’t really remember what interest rates were like over 50 years ago because I didn’t even know what an interest rate was but gas was 25 cents.

  12. Apr 12, 2018 at 10:25 am

    For accounting purposes repossessing a car doesn’t change the bottom line much. The loan drops off the books and you hold the asset. There is something to be said for holding assets. Typically in a recession used cars gain in value although the new era fed induced recessions are nothing like the previous history.

    • Apr 12, 2018 at 1:49 pm

      The lender has a $25,000 loan on a 2-year old car. Loan become delinquent. Lender tries to collect – calls, emails, etc. At 60 days delinquent, lender writes down the loan by x%, perhaps by 30%, as non-performing. That’s the first part of the loss = $7,500.

      At over 90 says delinquent, lender hires a company to repo the car. Cost = $500.

      Lender runs the car through the auction, gets $15,000, and charges off the loan. Total loss $10,500. And this assumes that the car is in decent shape and not wrecked.

      No one keeps cars around unless they absolutely cannot sell them. Cars are not assets. They’re expenses, and they lose too much value too quickly. Every month will cost you. In addition, there are the costs of storing vehicles and the risks of damage to the vehicle while in storage (hail, flood, vandalism, heat…).

      • Wisil
        Apr 13, 2018 at 10:16 am

        How about a different scenario (and why if I were less ethical, I would get into the business):

        Buy clean used car for $25K, sell it to subprime buyer. Install GPS tracker, and once first payment is missed, locate car, and bring it back to used car lot for detailing and resale to next subprime buyer. Wash, rinse, repeat. In the best case scenario that single car can be “sold” many times per year. I would postulate with an initial inventory of 10 cars, you could have “sales” of upwards of 50 cars per year without having to restock your inventory for years. GPS tracking has been a game changer, since repos are far less costly.

        • Apr 13, 2018 at 11:47 am

          Finding the car isn’t the problem. But the lender will still have to hire someone to get it, unless it’s a self-driving car, or unless the customer returns the vehicle on their own voluntarily (happens). But that still isn’t a big problem. It’s just a cost of a few hundred bucks.

          For lenders, the big problem is this:

          Lenders aren’t retailers. The loan value includes dealer profit, often title and taxes, the upside-down part of the trade-in, fluff and buff the dealer added, etc. So a $25,000 loan might be for a car that cost the dealer $18,000, and that can be sold at auction for $15,000. Hence the big loss.

          A version of what you’re talking about has been around for decades (minus the tracking technology). They used to be called “note lots.” But they sold old beaters, not $25,000 cars.

          The note lot might have $1,000 in a car, sell the car for $2,000, get $500 down, and finance the remaining $1,500 themselves. The customer pays a very high interest rate, and payments are relatively large compared to the price of the car.

          If customers defaults after three payments, the note lot folks repo the car. The down payment covers wear and tear, repo costs, and other expenses. The repoed car covers their original cost ($1,000). Any payments made are essentially profit.

          They then clean up the car and sell it to the next guy. It’s a sordid business. But it’s as old as the auto industry.

        • d
          Apr 14, 2018 at 2:47 am

          “They then clean up the car and sell it to the next guy. It’s a sordid business. But it’s as old as the auto industry.”

          In many countries it is illegal to operate them now.

          It the bottom of the market. Generally operated by extremely undesirable creatures, but amazingly, that’s where the GOOD margin is in auto’s, these days..

  13. John Barleycorn
    Apr 12, 2018 at 12:19 pm

    2008

  14. Steve clayton
    Apr 12, 2018 at 12:34 pm

    Hi Wolf, just been something on tv about none prime mortgages being offered to people with a score of less than 500. Company called carrington. Is 500 a bad score?

    • Setarcos
      Apr 12, 2018 at 1:01 pm

      500 is less than what even a typical sub-prime lender would accept. Probability of default on a 500 score is approx. 1 out of 3 will default within 2 years. FICO score (lots of different versions) is generally scaled 250 or 300 to 850. The average and median score is generally high in the high 600s.

    • Apr 12, 2018 at 1:55 pm

      500 is “deep subprime.”

      • Apr 12, 2018 at 1:56 pm

        Below 620 is usually considered subprime.

    • alex in san jose AKA digital Detroit
      Apr 12, 2018 at 5:19 pm

      To give you an idea, “Carrington” to most people who’ve heard the word will bring to mind a “Carrington event” which is when a big solar flare or some such thing zaps all electronics on Earth, bringing us back to the Middle Ages at best.

  15. Apr 12, 2018 at 2:55 pm

    Isn’t this a distinction without a difference? “Since the Financial Crisis, big banks have mostly avoided subprime lending. Instead, they’re lending to the companies that then provide financing to subprime customers.”

    Near us (Everett, WA) is a closed up used car lot that’s now fenced and packed with repossessed cars. Some are quite nice but most are what one would expect for person with little money but needing transportation to get to work.

  16. Steve clayton
    Apr 14, 2018 at 3:57 am

    Wells Fargo losing market share is another issue to add reference this story. Auto-college-commercial debts all lower in q1.

  17. I stay broke
    Apr 14, 2018 at 11:00 am

    As a former repo agent during 2008 in a large market, and currently as a auto damage adjuster for a large car insurance company, here is what I can add based on the “ground level”.
    Newer vehicles are being totaled at an alarming rate as is insurance fraud. People with negative equity on vehicles is beyond normal and almost always the case when vehicles are totaled. The one point not discussed is that with these subprime loans, most all subprime lendees must purchase GAP insurance. This kicks in when negative equity is the case. Are the lenders really feeling the squeeze from this? loan of 25k vehicle is valued at say 15k, GAP insurance is paying the difference from the value given by the vehicle’s auto insurance, while the lender rolls the customer right into another subprime loan? Defaults on the other hand is the key, but the biggest point from repo’ing during one of the financial crisis was at first a flood of repo assignments and claims and then the banks realized with this flood of vehicles into the auction they are not moving based on a reserve on the vehicle and no buyers. Lenders pulled back HEAVY on repo’ing and decided instead of taking the car selling it at auction for a large loss and trying to collect the difference for the lendee, they laid off on taking the property, filled call centers with cheap labor to beat on the lendees for any amount of money they could get on the phone on every payday. Banks said F it, if we take the car and sell for a loss we will never collect the negative equity for the lendee(take the car and then tell someone they still owe 10k, they just wont pay it, ever), let them keep it, take what we can from them by threatening to take the vehicle, destroy their credit and offer them incentives to turn it in for another loan on a new vehicle at a even heavier rate. Cute cycle, great business…everyone needs wheels like a roof over their head. Home rentals are relatively available without a bank, vehicle rentals or leases require dealing with a dealer and everything that goes with that and often will be pushed into a new car to get the new inventory off the lot, they work on fifo, no lifo. Someone should be leasing these light used autos-would be a good market…

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