Canadian Homeowners Take Out HELOCs To Fund Subprime Purchases

Authored by Steve Saretsky via VanCityCondoGuide.com,

The HELOC (Home Equity Line of Credit) has been a blessing and a curse for Canadian households. While it has helped spur house prices and simultaneously provided consumers the ability to tap into their new found equity, it has also crippled many Canadian households into a debt trap that seems insurmountable.

Between 2000 and 2010, HELOC balances soared from $35 billion to $186 billion, according to the Financial Consumer Agency of Canada, an average annual growth rate of 20%.

As of 2016, HELOC balances sit at $211 billion, a 500% increase since the year 2000. While also pushing Canadian household debt to incomes to record highs of 168%.

HELOC Debt in Canada

Scott Terrio, a debt consultant, says the situation is a full blown “extend and pretend” meaning borrowers are just continuously refinancing or taking on more and more debt in order to sustain their lifestyle. Canadians can extend their debt repayment terms and pretend to live a lifestyle they can’t otherwise obtain.

What the HELOC has also been able to do is help spur the private lending space which has ultimately supported rising house prices. Seth Daniels of JKD Capital, one of the most astute Canada-Watchers says theres a growing trend where “a homeowner acts as a sub-prime lender by drawing a HELOC at 3% interest only, and lends it to a subprime borrower at 8-12% for one year (interest only).”

This is something i’ve been hearing on an ongoing basis from mortgage brokers and lawyers who help facilitate these deals. Especially since mortgage lending conditions tightened, starting with OSFI’s first mortgage stress test back in November, 2016 which required high ratio borrowers (less than 20% down payment) to qualify for a mortgage at the borrowing rate plus 2%. So basically you’re getting qualified on what you can borrow at 5% even though you’re borrowing at 3%.

This strategy has been bulletproof, because, well, prices can only go up.

The lender makes a juicy return, and the borrower gets his house. The borrower then transitions into a traditional mortgage once his home equity rises after the one year expires.

This has created a situation where, as of September 2017, personal loans secured against residential real estate hit a record high $247 Billion.

Source: Better Dwelling via OSFI

Thanks to an endless supply of new loans (credit) and rising house prices, mortgage arrears rate continue to fall to rock bottom lows.

Source: CMHC

But as Seth Daniels remarked, “Up to a point, the greater the debt growth, the lower the arrears because as they say ‘a rolling loan gathers no loss’. In other words when debt growth is exploding people can find ways of avoiding default by rolling the loan, refinancing, selling the asset, or whatever. So, paradoxically, the default rate will seem to improve when the actual risk in the economy is exploding”.

With another mortgage stress test set to roll out January 1, 2018, this will likely push another swarm of borrowers into the private lending space. We’re already witnessing a huge end of the year push as buyers scramble to secure a home prior to further mortgage clamp downs.

The new mortgage stress test which previously only targeted high ratio borrowers (less than 20% downpayment), will now include low ratio borrowers (more than 20% downpayment) as well. This could be substantial, considering  85% to 90% of all mortgages in Toronto & Vancouver are low-ratio.
(American Readers: Canadians can only secure a mortgage rate for a maximum term of 5 years, meaning a rising interest rate environment is much more impactful)

It’s anticipated to eliminate some 12% of low ratio borrowers while simultaneously reducing borrowing power by 20%.

This could signal a final boom for the private lending space in Canada.

Ethereum Surges To New Record Highs - Bigger Than Capital One, ICE, & eBay

Following its big surge Thursday, Ethereum has broken through the psychologically important threshold of $400, establishing a new all-time high - currently hovering above $450.

image courtesy of CoinTelegraph

As CoinTelegraph reports, despite some market stagnation caused by the news of the $280 mln Parity wallet hack in early November, the second-most-popular cryptocurrency looks stronger than ever, now with a market cap over $43 billion.

That is bigger than Capital One ($42.3bn), The Intercontinental Exchange ($39.6bn), and eBay ($37.5bn).

Just as Standpoint Research founder and analyst Ronnie Moas forecast in July, Ethereum has topped $400 (doubling since his projection).

ETH has surged from below $350 to over $450 in the last few days...

To a new record high... (surpassing June 2017"s previous peak at $407)

As CoinTelegraph reported, Moas claimed that the cryptocurrencies will sustain their solid performance and steal some shares of other assets like stocks, bonds, fiat currencies and other precious metals in the market.

"I think investors should take a shot on this and hold for a few years. If you lose a few bucks, at least you took a shot," he said.

 

"In life, you miss every shot that you do not take. It will probably be more upsetting to watch it (from the sidelines) go up another 1,000 percent."

Aside from the two leading virtual currencies, Moas also forecast that the price of the digital currency Litecoin will increase by twofold to $80 per coin.

What is driving the resurgence in Ethereum?

CoinDesk notes that total trading volume jumped to $1.845 billion yesterday – the highest since Sept. 15. A high volume rally indicates strong hands are at play and more records could be set over the weekend.

Again, South Korean desks are firing on all cylinders. Volumes in the ETH/KRW pair offered by Bithumb, one of the largest cryptocurrency exchanges in the country, have gone up by 13.57 percent today.

Emerging Market Debt: Dumb, Dumber, And Dumbest

Authored by Jonathan Rochford via Narrow Road Capital,

One of the classic signs that the credit cycle is nearing the end is that borrowers that shouldn’t be getting financed not only get funded, but get it at terms that seem crazy. I’ve recently written about the silly things happening in global high yield debt, Chinese debt and the global attitude to sovereign debt. Continuing this theme are recent examples of emerging market sovereign debt; Greece, Argentina and Iraq. Each of these shouldn’t have been funded, but the desperation for yield saw all three get funded on terms that seem crazy. Here’s the detail on each.

Argentina

In June, Argentina sold $2.75 billion of US dollar denominated 100 year bonds at a yield of 7.92%. At the time, this was a mere 5.18% yield pick-up over 30 year US treasuries. Argentina has a long history of defaulting on its government debt, including 4 defaults in the last 35 years. The 2001 default took 15 years of negotiation and litigation to resolve, with most bondholders losing their shirts and a few who bought late and fought hard getting extraordinary returns.

 The current outlook shows that not much has changed for Argentina. Inflation is running at over 20% and the government is aiming to cut the deficit this year to 4.2% of GDP, hoping to stimulate the economy out of recession. Investors are banking on the recent change in government to increased foreign investment and see sound economic management implemented. The need to reduce politically popular subsidies will be a major hurdle to that. S&P’s rating of “B” and Moody’s at “B3” reflect the country’s weak credit profile. Taking all of this into account, Argentina is unlikely to get through a decade without defaulting let alone 100 years.

Greece

In July, Greece sold €3 billion of 5 year bonds at 4.63%, a 4.78% yield pick-up relative to 5 year German government bonds. Investors have particularly short memories on Greece’s debt, with the 2012 default seeing bondholders take losses of around 75%. The 2014 issue of 5 year bonds traded as low 56% of face value, a horrible ride for those who bought into it. The constant negotiations for further bailouts always come with the threat that Greece won’t make further concessions and this time the Europeans and the IMF might have had enough.

Greece’s position remains precarious, debt to GDP currently stands at 179%. The economy has been stagnant for years as its government continues to resist the structural reforms proposed by the IMF and Europeans. Some are optimistic as Greece recorded a primary surplus (before interest expenses) in 2016. However, to achieve a fulsome surplus Greece needs to be funded at around 1%, well below the 4.78% yield it is paying bond investors. Unlike the buyers of the recent bond issue, S&P (B-) and Moody’s (Caa2) don’t see good prospects for Greece paying back its creditors.

Iraq

In early August, Iraq sold $1 billion of 5 year bonds at 6.75%, a 4.93% premium to US treasuries. Iraq faces three major medium term issues; the ongoing war, export revenues reliant on upon oil prices and dependence upon military and financial support from the US government. Each of these is out of its control. The 2016 deficit at 14% of GDP shows Iraq clearly cannot service its debts without a substantial financial turnaround. By buying the bonds, investors have effectively banked the equity case of the war ending and oil prices improving. The credit ratings from S&P (B-) and Moody’s (Caa1) are a better reflection of Iraq’s economic prospects.

Conclusion

In considering emerging market debt, investors have to be careful to consider each country on its own merits. In the examples of Argentina, Greece and Iraq, bond buyers have suspended sceptical analysis. They’ve banked the equity case, hoping for a substantial change from historical precedents, even though they won’t get a share of the upside if the rosy scenario occurs.

The examples aren’t unusual; as shown in the graph below from Bloomberg Belarus, Mongolia and Ukraine are all CCC+ rated but have bonds yielding less than 6%.

These examples point to the greater fool theory playing out in many credit markets. We’ve now reached the point in the credit cycle where further gains seem dependent upon more dumb money arriving and pushing spreads even tighter.

How much longer can this farce contiunue?

Calling the top of any cycle is nearly impossible, but calling out the current higher risk/lower return environment is simply common sense.

The Average American Had A Bigger Savings Account... In 1997

Authored by Simon Black via SovereignMan.com,

Quite literally as a I write these words to you, the heads of the world’s largest central banks are packing their bags and heading home after a three-day symposium in Jackson Hole, Wyoming.

Central bankers aren’t exactly mega-celebrities, so their conferences don’t make international news outside of financial circles.

But if people understood what was at stake, they’d probably pay more attention.

Central bankers wield totalitarian authority over their nations’ interest rates.

Setting interest rates means they have direct influence over the price of money. In other words, they influence the price of EVERYTHING–

How much you pay for your mortgage. The price of your home. How cheap (or expensive) it is for a business to borrow money for expansion… which directly affects how many people they hire.

Their influence over rates helps determine how much interest the government pays each year on its debts, which ultimately impacts tax rates and other spending programs.

It’s extraordinary power.

And whereas nearly every branch of government has some system of checks and balances to ensure no single body has too much authority, central banks aren’t technically part of the government…

… so their power is nearly entirely unchecked.

To be fair, I’m sure they’re all very nice people with good intentions.

Central bankers are not moustache-twirling villains plotting a takeover of the world.

But the decisions they make have serious implications over the lives of hundreds of millions of people.

Just like politics, every action they take has winners and losers.

And it’s easy to see who’s been winning over the last several years as a result of their policies.

Stock markets around the world are at all-time highs. Bond markets are at all-time highs. Real estate is at all-time highs.

If you own assets you’ve done extremely well.

But if you’re in the rapidly deteriorating middle class, especially the lower middle class, you haven’t.

Looking at the United States, for example, it seems quite strange that the stock market is near its ALL-TIME HIGH while the overall economy has been sluggish for years.

Annual GDP growth for the United States in 2016 was a measly 1.6%, a rate that barely keeps up with population.

And global GDP growth has been low for years.

This has had a significant impact on employment and wages.

Central bankers and politicians tout that the unemployment rate in the US is at a 10-year low.

And that sounds great.

But it’s easy to see a different picture when you look deeper at the numbers.

According to data from the US Labor Department, for example, the percentage of Americans in their prime work years (between the ages of 25 and 54) who actually have jobs is still WAY below the level prior to the 2008 Great Recession.

Wage growth has also been stagnant..

On top of that, debt levels are hitting record highs. Student debt. Consumer debt. Auto loans.

And people are once again unable to pay their debts.

Over the last 12 months, for example, Capital One’s net charge-offs increased 40%.

Cash levels are also incredibly low.

We’ve all seen the stories about how little savings the average American has.

Well, I pulled the data myself, using Bank of America as a proxy.

Bank of America’s annual report from 2016 shows that the bank has $592 billion in consumer deposits from 46 million households.

That works out to be an average of $12,870. Per HOUSEHOLD. Not per person.

And that amount includes EVERYTHING: savings, investments, retirement, etc.

What’s amazing is that, 20 years ago, Bank of America’s annual report showed the bank had $392 billion in deposits from 30 million households.

That worked out to be $13,067 per household… in 1997!

So 20 years later, Bank of America’s average customer has LESS MONEY. And that’s before adjusting for inflation.

This is one of the biggest stories of our time: the middle class… especially the lower middle class… is being decimated.

A strong middle class has long been the hallmark of modern western civilization.

In fact, history shows that throughout many dominant empires, from ancient Rome to the British Empire, a robust middle class is essential to maintain a durable society.

Where the middle class is strong and growing, civilization flourishes.

And where the middle class fails, civilization turns over.

Do you have a Plan B?

This Recovery Isn't All That Resilient, Here's Why

Authored by Danielle DiMartino Booth via Bloomberg.com,

When adjusted for inflation, credit card usage has grown faster than incomes for 18 months...

Are Federal Reserve stress tests leading economic indicators? That certainly seems to be the case. Just ask Capital One Financial Corp.

As of the first quarter, credit card loss provisions at Capital One were above 5 percent, a six-year high. The company recorded some improvement for the second quarter, yet Fed stress tests of the bank’s overall loan portfolio in a deep downturn show losses topping 12 percent. That explains Capital One’s “conditional” passing score, a black eye that prompted a reduced share buyback plan and no increase in its dividend.

Most economists today applaud the resilience of the current recovery, which has stretched into its eighth year, the third-longest in postwar history. Resilience and rising household defaults, though, don’t tend to go hand in hand.

Pressures have been building in the background for some time. When adjusted for inflation, credit card usage has grown faster than incomes for 18 months. According to Fed data, that time frame coincides with the upturn in revolving credit, a proxy for credit card debt.

In November 2015, outstanding revolving credit crossed above the $900-billion threshold for the first time since December 2009. By May of this year, annual growth was clocking 8.7 percent. Meanwhile, credit card balances hit $1.02 trillion, the highest level in almost eight years.

Whether by choice or force, the aftermath of the financial crisis prompted households to ratchet back their usage of credit cards. As the recovery got underway, frugality prevailed, punctuated by an increase in debit card purchases. It is thus notable that Bank of America data find debit card usage has weakened in recent years as households grew more comfortable rebuilding their credit card balances.

"Confidence" is the term most associated with the rising credit card debt. But it’s fair to ask why confident households would choose to pay so dearly for the privilege. At 15.83 percent, the average rate on credit card balances is at a record high.

It is more likely that households are increasingly tapping their credit cards to cover the cost of necessities, that they are less confident and more anxious about their future finances.

The latest University of Michigan consumer confidence data suggest anxiety is indeed setting in. At 80.2, the expectations component is at the lowest since October and running below the 2016 average of 81.8.

According to the University of Michigan:

The data indicate that hopes for a prolonged period of three percent GDP growth sparked by Trump’s victory have largely vanished, aside from a temporary snap back expected in Q2. The declines recorded are now consistent with just above two percent GDP growth in 2017.

The retail sales report for June corroborates the forecast for continued muted economic growth. In constructing gross domestic product, statisticians net out auto, gasoline and building materials purchases from retail sales to arrive at a "control group." At 2.4 percent, the annual growth rate of the control group has fallen to the lowest since January 2014.

The renewed weakness in consumption prompted the economists at Bank of America Merrill Lynch to reduce their forecast for second-quarter GDP to 1.9 percent. The Atlanta Fed’s GDPNow forecast is a bit higher, at 2.4 percent, but that’s a far cry from the robust 4.3 percent rate anticipated on May 1.

In her recent congressional testimony, Fed Chair Janet Yellen expressed continued optimism for a strong second-quarter rebound in GDP growth. If the Atlanta Fed’s forecast pans out, first half growth will stumble in at a 1.9 percent rate, hardly reflective of accelerating economic activity.

Even the ebullient homebuilders have begun to concede that there could be more than just a supply shortage at the root of the slowing housing market. Pending home sales have fallen for three straight months and are now 1.7 percent below their year-ago level.

The National Association of Realtors acknowledged that “weaker financial and economic confidence could also be playing a role in the slowdown in contract activity.” The NAR added that they had “found that fewer renters think it’s a good time to buy a home, and respondents overall are less confident about the economy and their financial situation than earlier this year.”

With rental inflation running 3.9 percent above its year ago rate and homes priced out of their budgets, renters are effectively trapped in a budgetary vise. Housing costs consume about a third of households’ average budgets and largely dictate consumers’ wherewithal to finance the discretionary purchases that make the consumption-driven U.S. economy hum.

Suffice it to say, when the costs of other necessities such as health care, the food you put on the table, your car payment and mobile-phone bills are also running high, it’s difficult to make ends meet. In a survey conducted by Survata and released in late June, 49 percent of households said they were living paycheck-to-paycheck; six in 10 reported that their rainy-day funds could not cover six months of living expenses.

What’s a household to do under such circumstances? It would appear they’ve had to rely on credit cards. The eventual price tag for the economy remains to be seen and won’t be known until the next recession has come and gone. As for how high the bill will be in the end, its likely Capital One already has that answer.

UBS Explains Who's Most At Risk In The Next Consumer Deleveraging Cycle

In their 2Q 2017 survey, UBS found that, for the first time since at least 2014, the trajectory of financial health of low-income households has started to diverge from that of more affluent households.  Per the graph below from UBS" credit strategy team led by Matthew Mish, while a firming job market has helped households making over $100,000 feel more confident about covering their monthly expenses, spiraling debt balances has left low-income families even more vulnerable to the slightest monthly surprises with 70% reporting that their income just barely covers monthly expenses.

Overall US consumers report a lower likelihood of defaulting on a loan payment in the next year (15% vs. 17% in Q1), but lower income households cited an increase in their default probability (13% vs 9% in Q1). Other responses suggest consumers are incrementally more confident in their ability to pay given labor market stability, but optimism on the outlook is moderating. However, replies from lower income households paint a pessimistic outlook, partly due to lackluster real wage growth, higher financing rates and highly regressive policy.

Of course, with the entire auto and student loan bubbles being fueled by a massive expansion in subprime credit to the most at-risk American households, it"s not terribly surprising that the lowest-income folks (i.e. those least prepared to absorb things like rate increases) are suddenly starting to feel the pain of their reckless balance sheet expansions.

There is a fairly strong relationship between income and credit scores, which implies the implications of this divergence will be primarily felt in non-prime and subprime consumer credit markets. Based on credit scores alone (VantageScores below 600), the three largest consumer loan markets in terms of subprime debt outstanding are the US mortgage ($570bn), student ($370bn) and auto loan markets ($180bn, Figure 4). We use the term "subprime" lightly as some regulators characterize subprime credit scores as those below 660 (vs. 600) and risk-layering in consumer loans (e.g., autos) has been prevalent (which increases the riskiness of loans), both of which would in theory increase the subprime debt balances shown.

We believe the auto loan market best illustrates the fulcrum of credit quality trends in the US subprime consumer sector – one key "canary" in the coalmine for US consumer credit. Rising collateral values and easy lending conditions supported by federal agency financing do not make the residential mortgage market a leading indicator this cycle, although US subprime mortgage delinquencies proxied by FHA delinquency rates will be important to watch. And US student loan delinquencies are heavily manipulated by the fact that many loans are not yet in payment status and deferral/ modification programs.

So, who is most at risk in the inevitable consumer deleveraging wave that is due any moment?  At least in the auto world, it"s all the usual suspects including auto captives and private finance companies that rely almost entirely of the subprime securitization market for their financing.

What are lenders" aggregate exposures to auto loans and how have they responded to recent stress? In terms of the auto loan stock, there is $1.08trn in auto loan debt outstanding, of which 4% and 16% are deep subprime and subprime debt, respectively (or roughly $220bn combined). Among lenders banks originate 35%, credit unions 26%, and finance companies (captive, independent) the remaining 40%.

However, some of this exposure is securitized and moved off balance sheet, particularly for finance companies. ABS auto loan securitization comprises $192bn (18% of the auto loan debt), of which $42bn (22%) is subprime auto loans (Figure 11). In total, we estimate approximate nominal exposures to auto loans for banks, credit unions, finance companies and ABS investors of $360bn, $285bn, $235bn and $195bn, respectively (Figure 12).

We estimate nominal exposures to auto loans for banks, credit unions, finance companies and ABS investors of c$360bn, $285bn, $235bn and $195bn, respectively. Aggregate auto loan originations have remained steady in Q1; the share of loans in the lower quality tiers has fallen incrementally (32% in Q1 "17 vs. 35% in Q1 "16), but risk layering continues with loan terms lengthening.

In Q1 "17 the auto loan finance market split 55% used/ 45% new, but the proportion of subprime and deep subprime loans in the used market exceeded that of the new by a factor of 3x (31% vs 9%, respectively). Used car loan originations were led by finance companies (38%), followed by banks (36%) and credit unions (36%), with finance companies originating a greater share of subprime loans. ABS auto loan securitizations only fund $42bn (or 22%) of the over $200bn in subprime/ deep subprime auto debt, with captive fincos semi-reliant and independents wholly dependent on auto ABS markets.

As such, it"s probably not a good sign that subprime auto losses are already soaring in 2016 vintage securitizations even as equity markets constantly confirm that "everything is awesome."

What are the current credit trends in autos? Based on the latest performance data for auto ABS loan securitizations, delinquency and recovery trends continue to deteriorate on balance. We have previously highlighted that portfolio seasoning alone will increase auto (and credit card) defaults going forward as each vintage since 2010 has performed worse than the year prior4 (Figures 5, 6). In our view, however, the more forward-looking indicator of credit risk is the change in NPLs for recent vintages. Here we focus on the change in NPLs for 2016 vs 2015 subprime (and prime) vintages, noting for subprime we utilize a modified subprime cohort as per S&P (which normalizes for the lack of a few deep subprime loans in the "16 vs "15 pools)5.

So, what now?  Well, UBS suggests that a good start might be dumping all your exposure to low-quality lenders ahead of that forthcoming disruption in the securitization market that, much like 2009, will render their business models pretty much useless for a couple of years.

Consumer loan delinquency rates should continue to rise, specifically in autos but with residual effects in other loan categories amid rising subprime consumer stress. Some lenders (e.g., banks) are clearly tightening the supply of auto loan credit; it will be critical to watch the magnitude of the aggregate credit squeeze and degrees of contagion. At this point we believe financial stability risks are contained, but rising. We are cautious on non-bank lenders, but with our latest update would focus on reducing credit exposure to subprime (e.g, Capital One, Ally1) vs. prime consumer lenders. On a total return basis our preferred core US credit holding is 7-10yr US investment grade debt.

Moody's Warns That Private-Label Credit Card Issuers Will Be Crushed By Retail Implosion

We"ve spent a lot of time of late talking about the retail implosion currently underway in the United States courtesy of a massive oversupply of retail square footage and a simultaneous shift in demand toward more online purchases.  In fact, we recently highlighted a report from Credit Suisse which suggested that nearly 9,000 retail locations could permanently close their doors in 2017, the most since at least 2000.

According to the Swiss bank"s calculations, on a unit basis, approximately 2,880 store closings were announced YTD, more than twice as many closings as the 1,153 announced during the same period last year. Historically, roughly 60% of store closure announcements occur in the first five months of the year. By extrapolating the year-to-date announcements, CS estimates that there could be more than 8,640 store closings this year, which will be higher than the historical 2008 peak of approximately 6,200 store closings, which suggests that for brick-and-mortar stores stores the current transition period is far worse than the depth of the credit crisis depression.

And here were those closings broken down by retailer:

Of course, the store closures are only part of the story as the broader economic impact of the coming retail apocalypse will be felt through a whole host of industries.  As Moody"s points out today, one such space that will be hit particularly hard is the "private-label" credit card issuers with just 5 companies accounting for nearly 80% of all credit balances outstanding.  

A small number of banks dominate US private-label card issuance, with the top five accounting for 79% of balances as of early last year. The largest issuers are: Synchrony Financial Inc. (unrated); Citigroup Inc. (Baa1, stable); Alliance Data Systems Corporation (unrated) via its Comenity Bank (unrated) subsidiary, which was formerly known as World Financial Network National Bank; Capital One Financial Corporation (Baa1, stable); Wells Fargo & Company (A2, stable) and TD Group US Holdings LLC (A2, stable).

"As retailers close stores in an effort to improve profitability over the coming years, the trend will put upward pressure on private label charge-offs, owing to the fact that some cardholders will lose access to geographically convenient stores, even as a portion of those cardholders shift at least a portion of their spending to online channels," Jody Shenn, a Moody"s Vice President says.

Meanwhile, the hardest hit names will likely be Synchrony and Alliance Data as they rely almost entirely on private-label credit cards.

Additionally, sales challenges could create incentives for retailers to push for looser underwriting standards by their card issuing partners, which would weaken the credit quality of these accounts, especially new accounts.

"Among the largest private-label card issuers, only Synchrony and Alliance Data rely heavily on the business," Warren Kornfeld, a Moody"s Senior Vice President, says. "Private-label and cobranded cards account for almost the entire loan books of both, each with heavy retail card concentrations."

Citi and Capital One rely on private-label and co-branded card loans for a high single-digit percentage of their earnings, also with heavy retail concentrations. Wells Fargo and TD Bank have very modest retail private-label and co-branded credit card exposures relative to their overall loan portfolios.

While showing up on the right-hand side of this chart was probably sold to investors as a "yugely" positive thing over the past couple of years, we suspect the messaging in future presentations will have to be "tweaked" (chart per Alliance Data investor presentation).

Meanwhile, it seems that both Alliance Data...

...and Synchrony are already starting to show some signs of stress.

But we"re sure it"s no big deal.

Commercial Banks Slash Auto Loans Outstanding For First Time In Six Years

After the subprime mortgage bubble burst back in 2009, new regulations prevented banks from rushing right back into mortgages to re-inflate a market that nearly took down the global financial system.  Of course, Uncle Sam didn"t restrict wall street from blowing massive bubbles in all asset classes, in fact the Fed seemingly condones it, just the mortgage market.

And so, all that loan volume shifted to autos...

...and student loans.

Alas, it seems as though commercials banks are finally starting to wonder whether they"ve inflated at least the auto loan bubble to the brink of bursting.  As the Financial Times points out today, the FDIC"s commercial lending report for 1Q 2017 showed that commercial banks slashed their auto loan exposure sequentially for the first time in the past six years.

But data released last week by the Federal Deposit Insurance Corporation showed the first sequential drop in car loans outstanding at commercial banks in at least six years. The total slipped $1.6bn to $440bn from the fourth quarter of last year to the first of this, suggesting that banks — wary of repeating the mistakes of the subprime mortgage crisis — have been spooked by rising delinquencies and the threat of litigation. 

Wells Fargo and JPMorgan Chase, the two biggest banks in the sector, saw first-quarter originations drop by double digits from the same period a year earlier. Even relatively aggressive specialists such as Capital One — which added a net $2bn to its $50bn car loan book over the first quarter — are toning down their outlook.

“We’re certainly one more notch cautious,” said Richard Scott Blackley, chief financial officer, noting bigger-than-expected falls in used car prices in the first quarter. “We think that by pulling back a little bit, we’re going to . . . maximise price over volume,” he said.

But for all you banking investors out there who are worried about replacing that juicy auto lending revenue stream, fear not because Citizens Financial"s CEO would like for you to know that while they "ran up auto for a while" they now see "better risk-adjusted returns" in things like student loans.... 

One of the banks pulling back is Citizens Financial Group, the US’s ninth largest by assets. Bruce van Saun, chief executive, told the Financial Times he would rather steer resources into areas such as student loans. “We ran up auto for a while when there was not much else going on. Now we have growth in other areas which offer better risk-adjusted returns.”

...which we guess is true if you simply ignore the fact that over $135 billion of student loans are currently in default.  

Of course, this shouldn"t be new news to our readers as we recently pointed out that after 21 consecutive quarters of loosening lending standards from 2Q 2011 through 2Q 2016, commercial banks finally started to pull back on auto loans in 3Q 2016...

Lending Standards Have Eased...: While overall household debt remains below pre-crisis peaks, auto debt has ballooned to all-time highs. While this debt grew, the median FICO score of borrowers receiving auto loans fell roughly 30 points from peak to trough. According to the Senior Loan Officer Opinion Survey (SLOOS), auto lenders eased lending standards for 21 consecutive quarters from 2Q 2011 through 2Q 2016.

...but Lenders Now Appear to Be Reversing Course and Tightening Standards: While FICO scores did drop precipitously, they have recovered in recent months, and the SLOOS reports 3 quarters of tightening standards after the 21 of easing. A look at the weighted average FICO scores of loans going into subprime ABS deals reveals similar trends, with a number of lenders reporting increases in these scores over recent years. However, the overall trend has moved lower since 2013.

...which probably had something to do the soaring delinquency rates that have resulted from years of declining underwriting standards.

But sure, 18mm new cars per year is probably a "normalized" level of demand for the U.S. market...just like 1.3mm in new home sales was "normal" in 2005.

6-Month Window & A Fiscal Fumble? Things That Don't Matter Could Matter Again...

Authored by Jason Leach via FusionPointCapital.com,

The first six to nine months of a presidential term are arguably the most important thanks in large part to staggered elections put in place by our forefathers. The Bush tax cuts, Clinton"s tax hikes, and the serious groundwork for Obamacare were accomplished during this time frame. President Trump and a balkanized Republican party have taken on ACA repeal/replace during this critical six month window, aiming to use fiscal year 2017 reconciliation (simple Senate majority but “nuclear” to cooperation) to get something passed before the Fall (the current House bill is dead on arrival in the Senate). Then, after this self-immolation, they aim to use the same reconciliation process to get something done on tax reform in fiscal year 2018 (they have a one-pager to work off as of now), and hope to tack on infrastructure and ongoing deregulation going into the 2018 midterm campaign season.

In the last four years, perhaps the least cohesive congress in history has passed the least legislation in over 200 years. After Obamacare passed (via reconciliation) and the subsequent killing of the use of earmark horse trading to corral votes (remember Nebraska?), the 2010 Tea Party insurgence became the “All Pros of No”, or the shutdown defense against anything serious getting done during Obama"s remaining years. Now, the six month window will probably close without real structural change to healthcare, tax reform will then likely be pushed into 2018/2019 (and be “tax relief” not reform), and infrastructure could well fall prey to pre-midterm stasis (Democrats not throwing a lifeline to “Reconciliation Republicans”).

Meanwhile, with a string of solid jobs numbers (despite anemic sub 3% growth in average hourly earnings instead of hoped for 3-5% to outpace inflation), the Fed is intent on making the “fiscal hand off”, with two rate hikes in the last six months (and unless rumors of Fed nervousness about the deteriorating credit situation are true) another hike in June (market is pricing in ~70%). Remember “Three Steps and a Stumble” from Pulling Awesome Forward? And, after seven years of feeding another asset pricing cycle (stocks, real estate) instead of productive “virtuous” cap ex cycle (outside the oil patch discussed in Crude Compression), the Fed plans to start reducing the size of the bloated $4.5 trillion balance sheet starting at the end of the year. Ben Bernanke expressed this past week that he is “calm about unwinding part of the balance sheet”, but he neglected to mention that no country has ever exited QE, so it may get rocky (if it happens at all as many view QE as a permanent part of central bank policy at this point).

After the election, consumer sentiment ("soft data") reached 17-year highs, and small business sentiment surged to 2004 levels, recording the biggest one month surge since 1980 in January. These “animal spirits” propelled markets to new highs just this past week, despite the Atlanta Fed"s GDPNow first quarter 2017 GDP forecast (that is, “hard data”, not sentiment) coming in at a severely revised down 0.2%. Consumer spending continues to lag sentiment with consumption at its lowest level in seven quarters. Business and consumers are sentimental but the virtuous cycle is not in gear. It"s just the annual first quarter blip right…

Let"s Talk About Credit…

It"s curious that the rise in LIBOR, affecting everyone with a credit card and an adjustable rate loan, is being overlooked by so many. The credit canary in the coal mine is wheezing a bit and with delinquencies on all loan bases rising - subprime mortgage, autos, and Capital One confirmed subprime credit cards are starting feel the pain (remember the Capital One turn in "06?).

That said, financial conditions and the overall market cycle has been a big focus at Fusion Point Capital. Chief Market Technician Arun S. Chopra CFA CMT has been keeping members in front of the cyclical process through a variety of longer term indicators. This is paramount at this stage of the cycle.

Some of the things Arun and I have been watching related to the overall macro story.

• Libor and the dollar started rising in 2014, the end of QE expansion, the start of tightening conditions that crashed commodities (i.e., oil), led to a string of Yuan devaluations and roiled markets (LIBOR is up 5X from bottom and double from one year ago, and is the effective borrowing cost for dollars worldwide).


• The dollar is now sitting on its rising 50 week moving average, an important overall trend level and signal (the Trump team has been talking down the greenback of late, we will see, but a move back up in the Indomintable Dollar is deflationary and oil could get hit again along with high yield, multi-national earnings, Emerging Market debt, etc.)


• At the same time in 2014, we saw the yield curve peak (i.e., potential peak in economic expansion as flattening yield curve presages economic downturns)


• There is still a 1% spread between the short and long end of the yield curve (before inversion), which can change quick depending on macro trends. 

Markets, Valuations, and Sentiment

Forward Street earnings are resurgent on “rebounding” oil (not so much anymore), anticipated tax cuts, infrastructure and deregulation – the reflationary “fiscal hand off” – all of which are looking like they are not occurring in 2017, and increasingly unlikely in anticipated form in the first half of 2018. Full year S&P 500 earnings for 2016 came in at $106. Current full year earnings estimates are $130 for 2017 and $147 for 2018, implying 23% earnings growth in 2017 and another 13% in 2018.

Citi estimated recently that every 1% of tax rate reduction adds roughly $1.75 of full year EPS to S&P 500. A significant amount of the 23% earnings growth anticipated above is based on the Trumponomics “reflation” and tax reform. Again, it does not look like it is coming soon, if at all in substantive form so take a hair cut to that S&P 2017 and 2018 earnings estimates of $130 and $147?

The much maligned non-timing tool of PE10 stands near its second highest level ever at ~30x and trailing P/E is ~25X. Remember, higher P/Es are justified by low rates and NPV (the TV says so). Additionally, and this is a point of emphasis, fully 96% of companies are now reporting non-GAAP earnings (removing “one-time” items), up from 70% in 2014, and less than 50% in 2009. That is, the one-time items boosted GAAP earnings for 2016 by 12%, to $106 from $95 – which is about the same level as 2013 when the S&P 500 traded 30% lower.

Right now, the market is easy peasie. It"s invincible - ostensibly due to overcoming every brief elevator down blip over the past 8 years of Fed asset price control. What happens when it becomes apparent there is a fiscal fumble? Things that don"t matter could possibly matter again…

How Uber Wiped Out Millions In Capital From "Mom And Pop" Investors In NYC's 'Green Cab Ponzi'

The first yellow-taxi medallions were sold in New York City in 1937 for $10 each.  Over the next several decades, the value of those medallions soared until they ultimately peaked at roughly $1.1 million in 2004, generating an annual return that far outpaced equity returns over the same period. 

So when Dr. Amarpreet Singh received a "tip" from a patient back in 2013 that NYC was expanding its taxi fleet by issuing thousands of permits for a new line of cabs, so-called green taxis that would pick up passengers in the outer boroughs and upper Manhattan, he jumped at the "opportunity" to get in on the ground floor.  Within a matter of months, Singh had purchased himself 5 green-cab permits for $75,000 plus 5 handicap accessible vehicles for another $325,000 and was ready to start raking in the dough. 

Unfortunately, Singh missed one vital detail in his due diligence: a small up and coming company called Uber. Per Crain"s

Singh liked the idea of helping disabled New Yorkers get around town, so he paid the broker $75,000 for five green-cab permits, plus another $325,000 for vehicles. Then he waited for drivers to rent his taxis. And waited some more. After nearly two years he got in touch with his patient to see what was up with the investment. Singh learned his cabs were lying fallow in Mill Basin, Brooklyn. He dashed over and found a parking lot filled with 600 cars, none with license plates and some not even outfitted as taxis.

"It was just a sea of green," said Singh. "I walked out telling myself, Oh my God, what have I done?"

The collapse of the taxi business has dramatically altered New York"s streetscape. Spurred by the advent of Uber and other apps, the number of drivers looking for passengers has grown by 40%, but the surge has meant less business for cabbies, who are making 30% fewer trips than only three years ago. Those who invested in yellow or green cabs are seeing their investments wiped out as drivers flock to rivals or pursue other work and cars sit idle.

Since 2013 5,000 taxi drivers have thrown in the towel, and last month Queens-based Melrose Credit Union was seized by state regulators after delinquent cab loans soared tenfold in just 18 months. The stock price of the city"s preeminent taxi lender, Medallion Financial Corp., has fallen so far that one share now costs less than a subway ride.

Moreover, as we recently noted, Capital One breaks out the details of its runoff commercial taxi medallion loan portfolio in its quarterly reports and they don"t paint a nice picture.  Just since March 2015, nonperforming Taxi Medallion loans have soared to over 50% from just over 1% less than two years prior.  

But investors in New York City"s green cab permits allege their losses are due to more than just market share losses to Uber.  In fact, a group of green cab investors, including Singh, have sued in Brooklyn state court, alleging their green-cab broker and his partners cheated them out of $8 million by selling taxi permits "in the manner of a Ponzi scheme." They also allege the defendants funneled millions of dollars" worth of taxi money into Platinum Partners, a large hedge fund that federal prosecutors likened to a Ponzi scheme after it collapsed last year.

Ginsburg"s investors further allege that, in an effort to hide money made from selling permits, he and Langer lent $7.2 million to Platinum Partners in June 2015 through their real estate company, White Rock Properties.

Manhattan-based Platinum was a $1.7 billion hedge fund that collapsed last year, and seven executives were charged with crimes, including the fund"s founder and chief investment officer, two co-chief investment officers and its president.

Of course, medallion broker Alan Ginsburg who made a killing selling green cab permits at multiples of their true market value, denies any wrong doing and says the pending litigation is nothing more than a "shakedown".

The broker, 33-year-old serial entrepreneur Alan J. "A.J." Ginsburg, denies any wrongdoing and said investors are blaming him for the taxi industry"s woes. "The accusations being made about me are absolute lies," he said. "This lawsuit against me is nothing but a shakedown."

It might seem like long ago, but as recently as 2013, taxis were a red-hot investment. The price for a medallion granting the right to drive a yellow cab and pick up street hails quadrupled after 2004, peaking at $1.1 million.

Yet cabs were often hard to find outside Manhattan, and lots of would-be drivers were priced out by the soaring value of medallions. To tackle both problems, in 2013 the city created green cabs, also known as Boro Taxis, and sold 6,000 permits, mostly for $1,500 apiece. Demand was so strong that by December of that year, a permit was resold for $7,000, according to Bloomberg News. The city sold a few thousand more permits the following year for $3,000 each, and still there was a waiting list of 6,300, according to the New York Post.

"People were looking at this as the next big taxi-medallion market," said Matthew Daus, a former chairman of the Taxi & Limousine Commission.

Today, a green-cab permit can be had on Craigslist for just $999, a small 93% discount to what Singh paid in 2013, and the city has declined to offer the last 6,000 permits it"s authorized to sell. Meanwhile, Nancy Soria, the first person to buy a green-cab permit from the city, said she started driving at 8:30 one recent morning and didn"t pick up a customer until 11.

Just another helpful reminder of how quickly bubbles pop...

Cab Industry On Verge Of Collapse? Capital One's Taxi NPL Rate Soars Above 50%

Having abandoned its venture to lend out roughly $1 billion to legacy Taxi "Medallion" drivers and businesses some two years ago, and shifting its backing over to Uber resulting in many unhappy drivers as well as a handful of lawsuits, Capital One has nonetheless provided a useful spotlight into the troubled state of the traditional "yellow cab" industry by breaking out the details of its runoff commercial taxi medallion loan portfolio in its quarterly reports.

And according to the latest, just released report (in which COF incidentally missed both the top and the bottom line, reported EPS and revenue of $1.45 and $6.60 billion, both below expectations), the US taxicab industry must be on the verge of collapse, because in COF"s Q4 report, the company reported that while the size of its runoff Medallion "held for investment" loans tumbled by $83 million from $773MM to $690MM, it was the surge in the nonperforming loan rate that was the stunner: surging from 38.8% in Q3 to a whopping 51.5% in Q4, it suggests that legacy cab drivers in the US are not only barely making money, but are in financial dire straits.

Of course, the irony is that the Medallion industry"s biggest nemesis, Uber, is likewise burning through billions in venture capital cash every year in hopes of putting its legacy competitor out of business. And, if these Capital One numbers are any indication, it may soon succeed.