The change comes as Santander, which is a unit of Spanish bank Banco Santander (pronounced “sahn-tahn-DAIR”), seeks to maintain its strong growth rate.
The lender has grown through acquisitions for several years, but “the pace of acquisitions has definitely slowed,” Dundon said.
“Most of the large competitors that wanted to exit (subprime) have exited,” he said. “There's not a lot of growth to be had that way.”
That implies Santander is likely to stick with its new strategy -- if it yields growth.
Dundon said a subprime loan doesn't work like a prime-risk loan. In the prime segment, the lender buys a loan at an agreed upon “buy rate.” The dealership in effect marks up the interest rate to the rate that the customer pays, and the dealership takes a portion of the interest-rate profit.
In subprime, the lender lends at a discount, meaning it lends less than the price of the car, Dundon said in a phone interview.
For example, he said, a subprime customer might have a proposed deal to buy a car for $15,000 with $2,000 down. The down payment goes to the bank.
The customer still owes $13,000. Santander might make the customer a loan for $13,000, but only pay the dealership $12,000 for the car. In this made-up example, the $1,000 difference -- which is money out of the dealership's pocket -- is the discount.
The dealership makes a profit based on its markup on the used car, anticipating the lender's discount. In this hypothetical case, even though the customer paid $15,000, the dealership only gets $12,000.
The dealership breaks even in terms of gross profit if it paid $12,000 for the used car; it starts making a profit if the used car cost less than $12,000.
‘You can't charge enough APR'
Matt Fitzgerald, Santander's senior vice president of sales and marketing, said in a separate phone interview that the discount offsets the risk to Santander. He said the alternative would be for the bank to charge even higher interest rates, which would hurt competitiveness. “You can't charge enough APR. The rate to the customer would be too high,” he said. “This is standard procedure in subprime.”
With Santander lending more in the subprime category, dealerships in effect can pocket the difference; pass along some or all of the difference to customers in the form of a lower price; or pay more for used cars and still make a profit.
“In effect, we have been able to lower our price. That should result in more volume,” Dundon said. He said there are several reasons Santander can afford to do this. Those reasons:
• Through experience, Santander has gotten better at predicting and pricing for risk.
• Since the recession, customers are being more conscientious about making their payments.
• In the face of higher losses in recent years, Santander had raised its discounts and cut the amount it was willing to lend. In part, the recent reduction in the discount is only a return to earlier standards.
Customers for Santander's Drive subprime loans have an average Fair, Isaac Co. (FICO) credit score of about 540 and pay an average interest rate of about 18 percent, Dundon said. The lender's other channel, the nonprime Santander Auto brand, has an average FICO score of about 620, and an average interest rate of about 12 percent, he said. Those nonprime loans usually are made with little or no discount, he said.