By on August 7, 2014


Even though I’ve taken a crack at it in numerous articles, this infographic from GM Financial contains a much more thorough explanation of how auto loans are securitized. Click here for the full-size version.



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20 Comments on “Infographic Shows How Auto Loan Securitization Works...”

  • avatar
    schmitt trigger

    A banker once explained the derivatives market like selling the image that is reflected from a mirror from a valuable painting (i.e. Picasso, Van Gogh).

    It gets a little more complicated. Derivative-based securities, then purchase those images from AAA rated artists (said Picasso, Van Gogh, Da Vinci) and bundle them up with AA artists (Pollock, Rivera), and some B- or even C- rated artists (think your high school art teacher) and then sell you a mosaic of tiny, undistiguishable images.

    • 0 avatar

      For what it’s worth, these are not derivatives. A derivative would be if you turned around and sold an insurance policy on the performance of the ABS bonds, agreeing to pay the policyholder the amount of any shortfall or default on the bonds, whether or not the policyholder actually owned the bond in question.

      • 0 avatar

        You left out a critical piece of the equation, to wit, regardless as to whether the one “insuring” payout in the event of a potential default either currently has, or in the future will have, the funds on hand to cover losses accrued.

        • 0 avatar

          I did leave that out! This is actually where it gets fun, in the “How I Learned to Stop Worrying and Love the Bomb” sense of “fun.” To make sure that there’s adequate funding to cover the losses, you typically negotiate a “Credit Support Annex” when you enter into one of these things, where the insurer has to post collateral if the insured doesn’t feel confident that the insurer will be good for the payout.

          So when a purely hypothetical giant financial institution (which we’ll call “Brehman Lothers” for the sake of argument) starts to look wobbly, all of the people it’s sold derivative protection to simultaneously try to get Brehman to post collateral for their trades, just in case something goes wrong. Which means that, instead of a bank run where thousands of depositors have to stand in lines around the block waiting for hours to get to a teller window asking for the $1500 in their savings accounts, thousands of hedge funds and other investors send in electronic demands for tens of millions of collateral a piece, pretty much simultaneously, and then, like Keyser Soze, “Poof!” Brehman Lothers is gone.

          • 0 avatar

            Right, and since the biggest banks & financial entities control an even larger pool of financial assets & their equivalents, and also are more leveraged (in no small part due to derivatives), than pre-2008, the systemic risk to the global interwoven economy from another liquidity crisis will inevitably be born by the taxpayers yet again, happy talk of (meaningless) “reform” notwithstanding.

  • avatar
    Car Ramrod

    Wow, I want to know who was paying 16.9% on consumer loans in 2007…

    • 0 avatar

      Many, many people. During my time at Chase, I saw plenty of stuff originated through the indirect (dealer) channel in the 20%+ range.

    • 0 avatar

      If you lease a car, the real rate of interest built into the deal is typically in double digits. The leasing companies play games to show the customer a different number, but they’d go broke if they actually charged only that.

  • avatar
    sunridge place

    Let’s also add that AmeriCredit has been doing this successfully since 1994. Twenty years of experience. They don’t have trouble getting takers.

  • avatar
    schmitt trigger

    There is a fine balance in lending between risk and profits. There will always be some risk associated with lending.

    The key of the smart lender is to walk the tightrope between maximum profits and acceptable risk.

    However, the derivatives bundled these sub-prime borrowers with a few good borrowers (Thus the analogy of the artists), and lie to the investor, making them to believe they are all AAA grade investments.

    When a lender -because of pressure to provide more and more profits- takes higher and higher risks with shady borrowers. That is what a sub-prime market is, and as the lending interest (and profits) increase accordingly, it brings more and more players into the lending market willing to go subprime.

    The house of cards comes falling down when a small amount of those borrowers default.

    • 0 avatar

      Let’s not mix terms. The AAA rating is applied to the senior-most group of bonds sold by the securitization trust, not to the underlying assets. That means that, if you have $500 million of car loans sold into the trust and sell $450 million of bonds from the trust, the top $200 million or so gets rated “AAA” – not because it’s backed by the best $200 million of car loans, but because it gets the first $200 million of _any_ of the car loans. That means that, as long as the debtors collectively pay $200 million of the $500 million they owe (including the proceeds of any repos that are auctioned off to satisfy their loans), the AAA noteholders don’t lose a dime.

      Which, specifically, is what happened during the crisis, as no AAA auto securitization paper actually lost money, very few senior bonds were even downgraded.

    • 0 avatar

      The AAA lie is key to the bundling scam, but without government-securitization and politicians leaning on the credit agencies to give mortgage-backed securities AAA ratings (to increase liquidity to housing programs), meltdown is less likely.

      However, I could be guilty of the same sort of rationalization that led to the subprime-lending crisis of 2008.

  • avatar

    How long before this thread becomes a political melee?

  • avatar

    That is a superb graphic. Props to GM Financial for making that available.

  • avatar

    My broker sent me an article today about buying bank-loan funds. Aparently they are paying pretty good, but of course there are risks.

    • 0 avatar

      I thought so, too.

      They do leave out 2 things;

      1. There is typically limited (in time) recourse back to them on bad loans,

      2. In addition to the interest rate differential (which is mostly paid up front), they get paid around 2% to service the loans.

      The other feature of this type of program is that it works best for longer-term loans. For 3-4 year loans, the time required to season the package, then get it rated and marketed probably doesn’t justify doing it for the short term remaining.

      Works wonderfully for 6-8 year loans, though. Those loans carry a lot of extra interest cost.

  • avatar

    We gnomes know a lot about business.

    Step one, we collect all the world’s sub-prime auto loans.

    Step two…

    Step three, profit.

    Get it?

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