The 2008 financial crisis served as a stark reminder of how unchecked lending practices can lead to catastrophic economic consequences. Today, a similar pattern is emerging in the auto loan market, where delinquencies are on the rise, particularly among subprime borrowers. Banco Santander (NYSE:SAN) is one of the major players in this sector, and is a lender that’s uniquely positioned with significant exposure to high-risk auto loans. This situation raises the question: Could Santander be the next “big short” trade?
In recent years, the auto loan market has experienced substantial growth, fueled by a surge in subprime lending. Subprime auto loans are extended to borrowers with credit scores below 640, who are considered higher risk due to their history of financial instability. Lenders have been aggressively pursuing these customers, attracted by the higher interest rates they can charge to offset the increased risk.
This aggressive expansion into subprime lending draws unsettling parallels to the housing bubble of the mid-2000s. Back then, the proliferation of subprime mortgages led to widespread defaults, ultimately triggering a global financial crisis. The auto loan market today exhibits similar characteristics: relaxed lending standards, an overextension of credit to high-risk borrowers, and a lack of adequate safeguards against default.
Here’s why I think this is a top stock investors may want to be concerned with right now.
Key Points About This Article:
- Auto loan delinquencies are picking up, providing some big potential headwinds on the horizon for specific lenders in this space.
- Here’s why I think Banco Santander (SAN) is a stock investors should watch closely as a potential short trade moving forward.
- If you’re looking for some stocks with huge potential, make sure to grab a free copy of our brand-new “The Next NVIDIA” report. It features a software stock we’re confident has 10X potential.
Santander’s Exposure to the Auto Loan Market
Santander has become a focal point in this developing scenario due to its significant concentration in auto and commercial real estate (CRE) loans. In the most recent quarter, auto and CRE loans generated $1.05 billion out of $1.4 billion in total loan interest income, accounting for nearly 75% of the company’s overall business. Notably, these segments contributed almost all of Santander’s earnings before interest and taxes (EBIT).
A deeper dive into Santander’s auto loan portfolio reveals a high level of risk exposure:
- High Subprime Loan Ratio: Approximately 59% of the company’s retail installment contracts (RICs) and auto loan portfolio consists of nonprime loans, or borrowers with FICO scores below 640. This means that over half of their auto loans are extended to individuals who are statistically more likely to default.
- Long-Term Loan Maturities Increase Risk: Out of $44.9 billion in auto loans, only $573.6 million mature in less than one year. A substantial $26.2 billion matures in 1-5 years, and $18.1 billion matures in more than five years. Longer loan terms increase the likelihood of default, especially if economic conditions deteriorate over time. Borrowers may find themselves owing more on their loans than their vehicles are worth, a situation known as negative equity, which can lead to higher default rates.
Some Fundamental Areas of Concern
While Santander’s exposure to subprime auto loans is alarming in itself, several financial indicators further underscore the potential risks facing the company.
One of the most striking concerns is Santander’s narrow net interest margin. The company reported EBIT of $324 million on $44.9 billion in auto loans, implying a net interest margin of less than 1%. This razor-thin margin suggests that even a slight uptick in delinquencies (less than 1%) could potentially push the company’s earnings into negative territory, severely impacting profitability.
Adding to this concern is the company’s significant increase in impaired loans. Auto loans impaired due to bankruptcy rose by 127% from the second quarter of 2023 to the second quarter of 2024, climbing from $1.66 million to $3.78 million. This sharp increase signals a deterioration in the credit quality of Santander’s loan portfolio, indicating that more borrowers are unable to meet their financial obligations.
Furthermore, credit loss expenses in the auto segment have soared. The company reported a more than 68% increase in these expenses, from $513.6 million last year to $827.6 million this year. While Santander attributes this rise to higher loan volumes and the normalization of net charge-off rates, the minimal growth in total auto assets—$62.77 billion versus $62.56 billion—and a decrease in net interest income suggest that rising delinquencies and declining loan quality are significant factors.
Delinquencies and non-performing loans present another area of concern. Non-performing auto loans total $2.03 billion, representing about 4.5% of the auto loan portfolio. When factoring in loan modifications—primarily payment deferrals totaling $522.7 million—the percentage of auto loans currently delinquent increases to 5.6%. Additionally, loans 30-90 days past due amount to $5.07 billion, and those over 90 days past due are $491.5 million. Altogether, approximately 12.4% of Santander’s auto loan portfolio is impaired, highlighting substantial credit risk.
Bottom Line
In my view, the auto loan market today doesn’t differ much from the market we saw in 2008. Loans are being handed out to all consumers, and in this consumer-led economy, one could argue that’s a broad positive for overall economic growth. However, in the riskiest segments of the lending space, including sub-prime borrowing, there could be similar trouble brewing underneath the surface the market isn’t fully realizing right now. At least, that’s my take on this space overall.
Personally, I think Banco Santander is a top subprime lender investors should keep on their radar right now as a potential short bet. I’m not short this stock yet, but if things deteriorate further, this is a top lender I could see run into some major trouble.
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