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When the Worst Loans Are the Best Deals

4 | By Shah Gilani

Last Wednesday, only 2 out of 31 big banks failed the Federal Reserve‘s “qualitative” round of stress tests.

One was Deutsche Bank USA, and the other was Santander Holdings USA Inc.

And then on Thursday, Santander’s biggest U.S. unit, Santander Consumer USA, was able to sell a bundle of subprime auto loans, worth $712 million, in a matter of hours.

Today I’m going to show you why this bond deal matters – and how it proves that the worst history always repeats itself…

Reward for Failure

Santander passed the Fed’s first round of stress tests the week before, the so-called “quantitative” round that measures how much capital banks have. But it failed the second round, which is about the quality of capital management and risk management relative to what a bank says it would like to do with excess capital.

Most banks want to “reward shareholders” by increasing their dividend payouts or announcing share buyback programs. They think that’s a good way to spend their excess capital. Which makes sense, because investors think banks are safe and sound and flush with capital if they’re rewarding shareholders.

(That’s something of a confidence trick, of course. Increasing equity by getting shareholders to buy shares and lift share prices just happens to be a neat way to get regulators off their backs.)

Anyway, in Round 2 of the stress tests, Santander was wrist-slapped for “critical deficiencies” in areas of “risk identification and risk management.”

So, how is it that the very next day investors lined up to buy the Spain-based bank’s subprime auto bonds that Moody’s Investor Service estimated could see losses of 27%?

Surely investors know that Santander has received subpoenas from federal and state agencies looking into how subprime auto loans are made at the dealer level to folks who don’t have jobs and who sometimes use an infant’s Social Security number for credit verification?

If those investors read the bond documents, they must have noticed that 13% of borrowers didn’t even have a FICO score.

These institutional buyers are smart men and women, so they must know that subprime auto loans (loans on credit scores lower than 640) have doubled since the credit crisis of 2007-’08 and that delinquencies and repossessions are rising.

Of course, they know all that stuff. They’re professionals – they know what they’re buying.

They know Santander is packaging up weak loans it used to keep on its books and is now selling them off.

These investors want the extra dollop of yield this kind of piggy-paper offers. That’s why the highest yielding, lowest rated slices of the Santander auto loan bond deal got bought first.

It’s all about yield.

That’s what the Fed’s zero interest rate policy (ZIRP) hath wrought… again.

We’ve seen this movie. We know how it ends.

And sure, we’ve heard this time is different.

It isn’t.

Central bank manipulation, across the globe, is all the same. At the same time it’s supposed to be buying time for economies to heal and grow their way out of the additional sovereign borrowing, this manipulation is creating massive distortions across capital markets.

You know the saying: Those who forget the past are doomed to repeat it.

P.S. I encourage you all to “like” and “follow” me on Facebook and Twitter. Once you’re there, we’ll work together to uncover Wall Street’s latest debaucheries – and then we’ll bank some sky-high profits.

4 Responses to When the Worst Loans Are the Best Deals

  1. Robert in Vancouver says:

    I doubt that institutional investors are so smart and ahead of the pack. In fact, I do quite well by doing the opposite of some of those investors (who I won’t name) because each one of them is consistently wrong about one certain thing such as the price of oil, interest rates, etc.

    Besides that, if they were so smart why do they have to keep working 9 to 5 in their cubicles for a living?

    • Tony says:

      OK I’m not in a cubicle all day or any part of the day for that matter.But that certainly doesn’t make me as smart as you or them institutional investors either. So can you tell me if I’m wrong in thinking those guys will make money even with a 27% loss of bank’s sub prime auto bonds? Because 73% of those sub prime bonds will receive payments and 27% is a wright off?

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