Why did Santander Consumer USA decide yesterday to ditch its agreement to buy loans from Lending Club?
This is an important question because the conventional wisdom is that peer-to-peer credits, well, rock.
First, the details. Back in July 2013, Santander, mainly an auto finance company, made a deal with Lending Club to buy up to a quarter of its loans for three years. The deal gave Lending Club liquidity and Santander a new class of assets and something to do with its capital, which Santander is extremely good at raising.
This is not some inconsequential business for Santander. Last quarter, Santander purchased $158 million of loans, well off the $258 million it purchased the quarter before. Lending Club, meanwhile, originated $2.2 billion of loans last quarter.
On the surface, Santander’s Lending Club portfolio looks as shiny as Miley Cyrus’s teeth. The personal lending portfolio’s adjusted yield last quarter was 28.2%, down from 29.4% in the prior quarter. These are big league yields, people.
But the problem is in the credit performance. On a pool of $2.3 billion personal loans, Santander has $385 million reserved for loans, or 17% of the principle amount. In other words, when you take out the losses, that “big league yield” starts looking like it should be playing AA baseball.
Yesterday, Santander started to sever its relationship with Lending Club.
We delivered a notice of termination to a peer-to-peer personal lending platform company, but we continue to be party to various other agreements under which we purchased specified volumes, personal loans originated by third parties. We will continue to perform in accordance with the terms and operative provisions under those agreements.
At this point, we are in the process of engaging investment banks to assist in the sale of all installment and revolving personal lending assets. Going forward, all personal lending assets will be designated as held for sale.
Santander was asked why it was abandoning the Lending Club deal. Specifically, it was asked whether it was one of four reasons: 1) it’s a lower ROE business, but Santander’s CEO said that it is not; 2) that it would deliver more volatile ROE over time, which means it is a less predictable credit product; 3) that the business did not give Santander the operating leverage that it gets from adding more auto loans, its core business; or 4) that, given steeper capital requirements for Santander, the company wanted to deploy its incremental capital back into its core auto lending business.
Here’s how Jason Kulas, Santander’s new CEO, answered the question yesterday:
I think it would probably be the fourth more than any of the others and the reason I say that is because, if you think about this from just the perspective of we’ve got a finite amount of liquidity and capital … We think that those resources are better spent on the business that we know we’ve got the most upside in. We’ve been growing personal loans, but growing off of a very small base. We think that business is probably more core to others than it would be to us, and we can say the exact opposite about auto and particularly Chrysler [Editor: Santander is Chrysler’s captive finance company]. We think we’ve got a tremendous amount of upside there and really want to dedicate our time and our resources and our capital to making sure we play that out to the fullest extent. So, I think it’s probably the fourth more than any of the others.
There is certainly something to that. Santander began its private-label financing for Chrysler in 2013, the same year that it inked its deal with Lending Club. The Chrysler captive is a major undertaking. Chrysler Capital, as it is called, has originated $39 billion of loans and leases since its launch in May 2013. This has certainly caused some growing pains at Santander.
But the additional growing pains of the Lending Club deal would be manageable if the business was more appealing. Santander generated interest income from personal loans of $114 million last quarter, about the same as the previous quarter, and fee income totaling $47 million. Those are all fine and good, but Santander’s charge offs ballooned as a result of its personal loan book. How much of Santander’s total increase in charge offs of $442 million last quarter were from the personal loans? How about $378 million. Yeah, I know.
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