By Joy Wiltermuth
A Chicago-area car lender sold a $100 million subprime auto bond deal five years ago that the U.S. Securities and Exchange Commission now claims was “secretly stuffed” with “bad loans,” disguised to look better than they actually were, according a complaint filed by the regulator on Thursday.
The SEC described the 2016 Honor Finance bond deal, or the “HATS” securitization, as “a house of cards which was doomed to fail, and it predictably collapsed when their scheme unraveled,” in its complaint.
Roughly a year after the sale, issues started to come to light, including when bankers who underwrote the transaction went back to ask questions about Honor’s loan modification process, according to the SEC.
A couple of months later, the bonds were the first subprime auto-loan securitization to be downgraded in the U.S. by credit-rating firms since the 2008 financial crisis.
Honor executives “continued to deceive the HATS underwriters and others about Honor’s loan modification process,” the complaint said, adding that top executives at the lender kept providing “false and misleading information” that was included in monthly bond reports in an effort to hide “reckless loan modification and servicing practices.”
The SEC charged Honor’s co-founders James Collins and Robert DiMeo with securities fraud in connection with the bond sale. It seeks civil penalties, a return of all “ill-gotten gains” and restrictions on their future business activities related to the complaint.
Collins and DiMeo could not immediately be reached for comment.
The Honor deal was notable in 2016 for packaging loans to high-risk borrowers paying average rates of almost 36% , despite a booming subprime lending market where private-equity-backed firms often charged double-digit interest rates to borrowers with shaky credit.
Investors scooped up its riskiest BB-, or “junk,” rated bonds at a coupon of 8.05%, according to Finsight data.
Despite concerns about aggressive lending and collections practices at many used-car financiers, Fitch Ratings recently said few downgrades of subprime auto bonds ever occurred in the wake of the 2008 financial crisis, and that no downgrades had been reported during the brief 2020 recession sparked by the pandemic.
A person with direct knowledge of the Honor matter said that subprime auto securitization industry may be based on a “garbage in, garbage out” system, where risky loans are often made because they can be securitized and sold as bonds to investors, but that most subprime auto deals have been set up to withstand even 50% of loans going bad without causing losses.
The Consumer Financial Protection Bureau has provided consumer relief to many subprime auto borrowers in the past decade, and extracted large fine s from many of the top subprime auto lenders.
Roughly $32 billion of new subprime auto bonds have been sold so far this year by Wall Street, up from $27.7 billion for all of last year, according to Finsight.