Did the Sub-Prime 2.0 Bubble Just Burst?

As you know, we’ve been tracking the sub-prime auto-loan industry closely.

Our view is that this industry represents the worst of the worst excesses of our current credit bubble, much as the subprime mortgage industry represented the worst of the worst in excess for the Housing Bubble.

For this reason, we refer to sub-prime auto-loans as Subprime 2.0.

As you no doubt recall, it was when housing prices rolled over in 2006 that the sub-prime mortgage industry began blowing up. After all, the only reason those loans were being made was because housing prices were going up. So once housing rolled over, it was only a matter of time before the sub-prime mortgage players blew up.

Well, the same thing that happened to housing in 2006 is now happening in automobiles: prices are rolling over. So the value of the underlying assets is now falling.

Even worse, total vehicle sales have ALSO rolled over. And this is happening despite ridiculous offers such as 0% down and interest free financing.

This is a MAJOR warning that the credit cycle is once again turning. The Sub-Prime 2.0 bubble is bursting as we write this.

We all know what comes next.

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Phoenix Capital Research

Subprime 2.0: Lending a $1 Trillion to People With No Proof of Job or Income

SubPrime 2.0 is proving far worse than even we suspected.

If you’ve not been following this story, our view is that the auto-loan industry is Subprime 2.0: the riskiest, worst area in a massive debt bubble, much as subprime mortgage lending was the riskiest worst part of the housing bubble.

In both instances, these lending industries were rife with fraud, terrible due diligence, and the like. So when the debt bomb blew up, they were the first to implode.

However, it would appear now that the Subprime 2.0 was even worse than Subprime 1.0 in terms of verifying income.

Santander Consumer USA Holdings Inc., one of the biggest subprime auto finance companies, verified income on just 8 percent of borrowers whose loans it recently bundled into $1 billion of bonds, according to Moody’s Investors Service.

The low level of due diligence on applicants compares with 64 percent for loans in a recent securitization sold by General Motors Financial Co.’s AmeriCredit unit. The lack of checks may be one factor in explaining higher loan losses experienced by Santander Consumer in bond deals that it has sold in recent years…

 Source: Bloomberg

Santander only verified income on just 8% of autoloans. Put another way, on more than 9 out of every 10 autoloans, Santander didn"t even check if the person had a job.

Pretty horrific.

However, the story also notes that even the more diligent lender AmeriCredit verified income on only 64% of loans.

So… two of the largest autoloan lenders basically were signing off on loans without proving the person even had a JOB either roughly half the time or roughly ALL the time.

And this is on a $1.0 TRILLION debt bubble.

Meanwhile, stocks are flirting with all time highs.

Sounds a bit like late 2007 doesn"t it?

We offer a FREE investment report outlining when the bubble will burst as well as what investments will pay out massive returns to investors when this happens. It"s called The Biggest Bubble of All Time (and three investment strategies to profit from it).

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Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

Commercial Property Lending Tumbles As Retail / Hotel Originations Plunge

For those of you out there clinging to your commercial REIT stocks for their "defensive" dividend yields while praying that the whole "retail implosion" thing will simply go away, you may want to avert your eyes now.  According to the Mortgage Bankers Association 4Q 2016 commercial real estate loan originations survey, mortgage originations related to discretionary segments of the economy are in complete free fall with retail and hotel volumes down 19% and 39%, respectively.    

A decrease in originations for hotel, health care, and retail properties led the overall decline in commercial/multifamily lending volumes when compared to the fourth quarter of 2015. The fourth quarter saw a 39 percent year-over-year decrease in the dollar volume of loans for hotel properties, a 24 percent decrease for health care properties, a 19 percent decrease for retail properties, a 4 percent decrease for industrial properties, a one percent decrease in multifamily property loans, and a 6 percent increase in office property loans.

Commercial banks and insurance companies pulled back on new originations while Fannie/Freddie picked up the slack.

Among investor types, the dollar volume of loans originated for commercial bank portfolios decreased by 17 percent year-over-year. There was a 6 percent year-over-year decline for life insurance company loans, a 2 percent decrease in Commercial Mortgage Backed Securities (CMBS) loans, and a 4 percent increase in the dollar volume of Government Sponsored Enterprises (GSEs – Fannie Mae and Freddie Mac) loans.

2016 marked the first YoY 4Q decline since the height of the "great recession".

Meanwhile, via the Wall Street Journal, prescient market observers remind us that markets tend to cycle rather than just rising in perpetuity...shocking news.

Still, the bank recognizes that property values are at record levels after rising for eight years. “I’d say, if I could look back one year ago, we’re probably more cautious [now],” Mr. Myers said.

Some lenders are competing by making riskier loans such as those that finance construction or occupy a “mezzanine” position between first mortgages and equity. In the first quarter of 2017, construction and land loans on bank balance sheets were up 12.8% to $306.1 billion compared with the same period a year earlier, according to loan tracker Trepp LLC.

Lenders and developers have gotten especially aggressive in building rental apartments. More units are under way today than in any period since the mid-1970s, experts said.

“There’s no current looming event that regulators are looking to say we foresee a problem,” said Matthew Anderson, managing director of Trepp. “It’s just the sheer volume and pace of activity and the length of how long it’s gone on.”

But we"re sure this is just another temporary BTFD opportunity.

50% Of Americans Live Payday-To-Payday; 33% Can't Write A $500 Emergency Check

It"s been more than seven years since the "great recession" officially ended, but while Fed policies have successfully generated massive asset bubbles which have accrued solely to the benefit of America"s wealthiest, the majority of American families remain as vulnerable to financial disaster as they were during the height of the crisis.

In fact, a recent study found that some 50% of Americans are woefully unprepared for a financial emergency with nearly 1 in 5 (19%) having absolutely no savings set aside to cover an unexpected expense.  Meanwhile, nearly 1 in 3 (31%) Americans couldn"t write a $500 check to cover an unexpected household emergency expense if they had to, according to a survey released by HomeServe USA, a home repair service.

Moreover, a separate survey released Monday by insurance company MetLife found that 49% of employees are “concerned, anxious or fearful about their current financial well-being” with less than 40% reporting that they"re "in control" of their finances.

If you"re like us, then perhaps you"re confused by how the information above jives with the Fed"s assertions that "everything is awesome" which seems to be reinforced by new daily highs in equity markets. 

Of course, the issue is that the overwhelming majority of Americans haven"t participated in the Fed"s latest asset bubbles and are instead still crippled under the same amount of debt as they had during the recession. In fact, the New York Federal Reserve on Monday predicted that total household debt will reach its previous peak of $12.7 trillion this year with lower mortgage balances being offset by much higher student and auto debt.

For evidence of "main street" America"s struggles with soaring debt balances, one has to look no further than the shocking delinquencies of 2016 vintage subprime auto ABS structures which are underperforming even 2007/2008 vintage securitizations.

And while most have attributed the rising delinquencies solely to deteriorating lending standards and an increasing mix of "deep subprime" loans, UBS Global Macro Strategist, Matthew Mish, thinks there is a better answer, namely failed Fed policies. 

As we"ve also argued over the years, while the Fed"s misguided QE and interest rate policies have done a masterful job of creating asset bubbles around the world they"ve done precious little to actually stimulate economic/wage growth, in real terms.

In our view, the root causes of the rise in delinquency rates can be traced back to US consumer income inequality and aggressive easing in lending conditions, primarily from non-bank lenders. In short, the mosaic we see is one where central bank reflation efforts, namely QE and low interest rate policies, have been more successful at fuelling higher asset prices and wealth creation for a subset of the consumer and less effective in stimulating real income growth (particularly at the median and below). Wealth creation becomes self-reinforcing in an environment of financial repression, with more cash looking for opportunities for deployment. For the financial sector that means more loan growth, and many less regulated, non-bank financial intermediaries have happily filled the void, incentivized by low interest rates that help sustain a lower cost of capital for themselves and lower funding costs for their borrowers.

However, the overall credit quality of borrowers has not kept pace with improvement in the aggregate economy. Our prior Evidence Lab work posits that about 38% of US consumers do not generate positive cash flow and roughly 25-30% of US consumers have not seen improving consumer finances (i.e. they do not own their own home or have significant wealth tied to stock markets). As of Q4"16, 18% of US consumers indicated they were likely to default on one loan payment over the next 12 months vs. 13% in Q3"16. This cohort of at-risk consumers reported being about 4x as likely to embark on a major durable goods purchase (e.g. house, car) in the next year.

This is not just a theoretical issue, but perhaps a problem already. 37% of those aged 21-34 in Q4"16 stated they were likely to default on one loan over the next 12 months, up from 27% in Q3, and outpacing other age brackets. We have only asked this specific question twice before in our Evidence Lab Survey and will be keen if these trends continue in our Q1 survey

And while the subprime auto market, on a standalone basis, may not represent the "systemic risk" that subprime housing did in 2007, when combined with outstanding subprime balances on student loans and other types of debt it"s a $1.3 trillion issue.

Is subprime auto lending too small to matter from a financial stability point of view? In isolation, yes. According to TransUnion, subprime auto lending balances outstanding total $179bn, or 16% of all auto loans outstanding. And subprime balances are about 1.2x above balances as of Q3"09. However, our earlier thesis would suggest subprime auto may be too narrow a lens to view the debate. More broadly, the good news is that subprime mortgage debt outstanding totals $567bn, or 7% of all mortgage loans. Subprime balances are about 0.4x 2009 levels. The bad news is subprime student loans balances total $370bn, or 30% of all loans outstanding. And balances are 2.3x 2009 levels. Subprime credit card debt totals $113bn ($88bn bankcard, $25bn private label) – reflecting 12% and 20% of all loan balances, respectively, and about 0.8x 2009 levels. And subprime personal loan balances total $17bn, or 16% of all debt, and 1.1x levels seen in 2009 (Figure 7).

In short, we estimate subprime consumer debt outstanding totals a still significant $1.25tn, comprised primarily of mortgage, student and auto loans.

But, as UBS concludes, the next massive subprime debt unwind won"t be that big of a deal because this time around all of the risk has been laid off on taxpayers...

Comparatively, however, debt levels outstanding are down from 2009 peak levels near $1.9tn. In addition, loan loss risk is increasingly borne by the government (e.g., student, FHAbacked mortgage loans), not the banks.

The Next Subprime Crisis Is Here: 12 Signs That The US Auto Industry's Day Of Reckoning Has Arrived

Authored by Michael Snyder via The Economic Collapse blog,

In 2008, subprime mortgages almost single-handedly took down the entire financial system, and now a new subprime crisis is here. 

In recent years, the auto industry has been able to boost sales by aggressively pushing people into auto loans that they cannot afford.  In particular, auto loans made to consumers with subprime credit have been accounting for an increasingly larger percentage of the market.  Unfortunately, when you make loans to people that should not be getting them, eventually a lot of those loans are going to start to go bad, and that is precisely what is happening now.  Meanwhile, automakers and dealers are starting to panic as sales have begun to fall and used car prices have started to crash.  If you work in the auto industry, you might remember how horrible the last recession was, and this new downturn could eventually turn out to be even worse.  The following are 12 signs that a day of reckoning has arrived for the U.S. auto industry…

#1 Seven out of the eight largest automakers in the United States fell short of their sales projections in March.

#2 Overall, U.S. auto sales so far in 2017 have been described as a “disaster” despite record spending on consumer incentives by automakers.

#3 Dealer inventories are now at the highest level that we have seen since the last financial crisis.  Why this is so troubling is because there are a whole lot of unsold vehicles just sitting there doing nothing, and this is becoming a major financial problem for many dealers.

#4 It now takes an average of 74 days before a dealer is able to sell a new vehicle.  This number is also the highest that it has been since the last financial crisis.

#5 Not only is Ford projecting that sales will fall this year, they are also projecting that sales will fall in 2018 as well.

#6 Used vehicle prices are already starting to decline dramatically…

The used-vehicle price index from the National Automobile Dealers Association posted a 3.8% decline in February compared to the prior month. NADA also said wholesale prices fell 1.6%.

#7 As I discussed yesterday, Morgan Stanley is projecting that used car prices “could crash by up to 50%” over the next four or five years.

#8 Right now, more than a million Americans are behind on their payments on their auto loans.  This is something that has not happened since the last financial crisis.

#9 In 2017, U.S. consumers are more “underwater” on their auto loans than they have ever been before.

#10 Subprime auto loan losses have soared to their highest level since the last financial crisis, and the delinquency rate on those loans has risen to the highest level that we have seen since the last financial crisis.  By now, I am sure that you are starting to notice a pattern in these data points.

#11 At this moment, approximately $200,000,000,000 has been loaned out by auto lenders to consumers with subprime credit.

#12 Just like with subprime mortgages in the run up to the last financial crisis, subprime auto loans have been bundled together and sold as “securities” to investors.  And just like last time around, this has turned out to be a recipe for disaster…

Many auto loans, including those considered subprime, are securitized and sold to investors. But Morgan Stanley recently reported that the share of auto securities tied to “deep subprime” loans – those given to borrowers with a FICO credit score below 550 — has risen from 5.1 percent in 2010 to 32.5 percent today. It said defaults on those bonds have risen significantly in the past five years.

Almost a quarter of the more than $1.1 trillion in U.S. auto loan debt is owed by subprime borrowers, and delinquency rates have hit their highest point in seven years.

In the old days, you could always count on the U.S. auto industry to bounce back eventually because of the economic strength of average U.S. consumers.

Unfortunately, the middle class in America is being systematically hollowed out by long-term economic trends that our leaders in Washington D.C. have consistently ignored.

We have become a nation of economic extremes.  There are more millionaires in this country than ever before, but meanwhile poverty is exploding in communities all over the country.

If you live in a prosperous area, things may be going great where you live for the moment.  But as Gallup has discovered, an all-time record high percentage of Americans are worrying “a great deal” about hunger and homelessness these days…

Over the past two years, an average of 67% of lower-income U.S. adults, up from 51% from 2010-2011, have worried “a great deal” about the problem of hunger and homelessness in the country. Concern has also increased among middle- and upper-income Americans, but they still worry far less than do lower-income Americans.

You may have plenty of money in your bank account, and so for you hunger and homelessness are not very big issues.  But for those that are just scraping by from month to month, having enough food and a place to sleep at night are top priorities.  Here is more from Gallup…

Americans at all income levels are expressing greater concern about hunger and homelessness, and it is the top worry among lower-income Americans, who are most likely to struggle to pay for adequate food and housing.

In addition to the woes of the auto industry, the retail industry is going through the worst wave of store closings in modern American history, pension funds are melting down all over the nation, and stocks are primed for a crash of epic proportions.  Things are lining up just right for the kind of scenario that I laid out in The Beginning Of The End, but unfortunately most people are not listening to the warnings.

The same thing happened just before the great financial crisis of 2008.  All of the warning signs were there well in advance, and many of the experts were warning about what was coming as early as 2005.  But because it did not happen immediately, a lot of people greatly mocked the warnings.

But then the fall of 2008 arrived and all of the mockers suddenly went silent.

As you can see from the numbers that I shared above, a new crisis has already arrived.

The only question now is how bad it will ultimately turn out to be.

As always, let us hope for the best, but let us also get prepared for the worst.

Signs Of An Auto Bubble: Soaring Delinquencies In These 266 Subprime ABS Deals Can't Be Good

If you"re among the growing minority of investors still under the impression that  "everything if awesome" in the auto industry simply because new car sales volumes continue to hover around all time highs, while turning a blind eye to soaring incentive spending and that pesky little debt bubble, then we may need your help with how we should be interpreting the following subprime auto loan delinquency stats from Morgan Stanley. 

In a recent report, Jeen Ng of Morgan Stanley took a look at 266 subprime auto ABS deals to assess the underlying "health" of the auto loan market and this is a recap of what he found.

First, despite low unemployment, high consumer confidence and debt-to-income ratios at 30-year lows, 60+ day delinquencies and default rates are soaring back to "great recession" levels for prime and subprime auto securitizations.

Meanwhile, loss severities are also starting to rise... 

....just as used car prices come under pressure...

...which likely has something to do with the flood of lease returns that are about to hit the market...

Of course, it can"t be that these deteriorating credit metrics are the result of 21 consecutive quarters of loosening lending standards from 2Q 2011 through 2Q 2016, right?

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.

Meanwhile, just like in the past housing crash, the mix of "deep subprime" collateral being pawned off on the ABS market is soaring...because who else would buy it?

Shift in Deal Mix the Real Culprit: The main driver of this dynamic appears to be that, while individual lenders are increasing their weighted average FICO scores, the securitization market has become more heavily weighted towards issuers that we would consider deep subprime - those with a weighted average FICO score below 550. In fact, since 2010, the share of Subprime Auto ABS origination that has come from these deep subprime deals has increased from 5.1% to 32.5%.

Deep Subprime Driving Delinquencies: Since 2012, 60+ delinquencies of non-deep subprime deals picked up from 3.03% to 3.92%. While that 89bps increase certainly demonstrates deterioration, it pales in comparison to the over 300bps increase coming from these deep subprime deals.

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.

Auto Lending Update - Someone Please Explain How This Is Not A Bubble

Experian recently released their Q4 2016 Automotive Finance Market update which includes a lot of statistics that seem to confirm our frequently documented concerns about the sustainability of the current level of annual auto sales (see here, here and here for our recent notes on the topic).

First, there is the staggering growth of auto loans outstanding.  It should be readily apparent to almost anyone that a 21% expansion in credit issuance over the course of just two years likely implies there has been at least some degradation in underwriting standards.

But you don"t have to speculate as Experian lays out the facts...and, sure enough, the outstanding loan balances of "Deep Subprime" borrowers have increased by double the amount of any other bucket, other than the plain "Subprime" folks, of course.

Of course, an impaired credit profile has, in no way, hampered America"s entitled consumers" demand for driving around in style as average subprime loan balances actually exceed "Super Prime."

But don"t worry, those subprime borrowers can "afford" those loans because they simply offset higher interest costs with stretched out terms...

...which keeps there average monthly payments low.

But, despite all the financial engineering, a look at 60-day auto delinquencies around the country may imply that the auto party is slowly coming to an end.

But sure, auto sales should be perfectly sustainable around 18mm per year...