S&P Wants You To Know They "Stress Tested" Subprime Auto ABS Structures And They're "Very Stable"

The same firm that "assured" us all back in 2006 that RMBS, CDOs, synthetic CDOs and CDO-squared structures were all very safe products and well deserving of their AAA ratings would now like for you to know that they"ve "stress tested" subprime auto ABS facilities and found that they"re "very stable." 

According to the Auto Finance News, the assurances were given by S&P"s senior director, Amy Martin, at the recent ABS East conference in Miami.  Apparently Martin is undeterred by the fact that subprime ABS “losses are going up from 2015 and 2016 [vintages], even approaching recessionary levels” during a period in which employment levels continue to improve.

While rising losses have caused some concern in the industry, S&P Global Ratings found that subprime auto loans bundled in securitizations are still well positioned to weather an economic downturn.

“Losses are going up from 2015 and 2016 [vintages], even approaching recessionary levels,” Amy Martin, S&P’s senior director, told Auto Finance News during a meeting at ABS East, noting that unemployment is the lowest it’s been since 2001. “But you have to look at it relative to what’s happening with the ratings, and the ratings are very stable.”

The company ran a stress test to see how these securitizations would react under a Better Business Bureau stress scenario, which simulates another 2008 economic crisis event: lower used-vehicle values, 10% unemployment, and rising debt levels. The test found that subprime losses would rise 1.67 times higher than S&P’s baseline economic projections. That would be a large jump because it’s a large macro economic shift, but ultimately AAA and AA rated subprime auto deals would not fall by more than one category over their life under that scenario. That’s “well within” S&P’s criteria, which stipulates that AAA and AA ratings can’t move by more than one category in one year, and can’t move below investment grade in three years.

Furthermore, all of the subprime deals that S&P rates fared better than expected when compared to stress tests performed when the securitizations were first issued.

Well, if S&P has confirmed it then it must be true.

Of course, even though S&P is absolutely positive that their AAA ratings on subprime auto ABS structures are solid, they do admit it can be difficult to account for things like "lower recovery rates, regulatory scrutiny from state attorneys general, and higher interest rates."

However, there are some weaknesses to watch, such as lower recovery rates, regulatory scrutiny from state attorneys general, and higher interest rates.  “Some companies won’t be able to offset rising borrowing costs because the annual percentage rates on their loans may already be at or close to the maximum state usury limits,” Martin said in a September report. “Also, the newer subprime auto finance companies started during a benign economic environment with low-interest rates and rising employment, so their ability to survive a rising interest rate environment has not been tested.”

Do they mean "lower recovery rates" like the 50% drop in used car prices that Morgan Stanley recently said was possible in their downside scenario?

No, we"re sure that, just like all the confirmations we got from the mortgage "experts" in 2006 that home prices in America could simply never fall, Ms. Martin would be happy to assure us all that used car prices could simply never fall that much...until they do, of course.

NYC Commercial Real Estate Sales Plunge Over 50% As Owners Lever Up In The Absence Of Buyers

So what do you do when the bubbly market for your exorbitantly priced New York City commercial real estate collapses by over 50% in two years?  Well, you lever up, of course. 

As Bloomberg notes this morning, the "smart money" at U.S. banking institutions are tripping over themselves to throw money at commercial real estate projects all while "dumb money" buyers have completely dried up.

A growing chasm between what buyers are willing to pay and what sellers think their properties are worth has put the brakes on deals. In New York City, the largest U.S. market for offices, apartments and other commercial buildings, transactions in the first half of the year tumbled about 50 percent from the same period in 2016, to $15.4 billion, the slowest start since 2012, according to research firm Real Capital Analytics Inc.

At the same time, the market for debt on commercial properties is booming. Investors of all stripes -- from banks and insurance companies to hedge funds and private equity firms -- are plowing into real estate loans as an alternative to lower-yielding bonds. That’s giving building owners another option to cash in if their plans to sell don’t work out.

“Sellers have a number in mind, and the market is not there right now,” said Aaron Appel, a managing director at brokerage Jones Lang LaSalle Inc. who arranges commercial real estate debt. “Owners are pulling out capital” by refinancing loans instead of finding buyers, he said.

But don"t concern yourself with talk of bubbles because Scott Rechler of RXR would like for you to rest assured that the lack of buyers is not at all concerning...they"ve just "hit the pause button" while they wander out in search of the ever elusive "price discovery."  

At 237 Park Ave., Walton Street Capital hired a broker in March to sell its stake in the midtown Manhattan tower, acquired in a partnership with RXR Realty for $810 million in 2013. After several months of marketing, the Chicago-based firm opted instead for $850 million in loans that value the 21-story building at more than $1.3 billion, according to financing documents. The owners kept about $23.4 million.

“The basic trend is you have a really strong debt market and a sales market that has hit the pause button while it seeks to find price discovery,” said Scott Rechler, chief executive officer of RXR.

The debt market has become so appealing that landlords are looking at mortgage options while simultaneously putting out feelers for buyers, said Rechler, whose company owns $15 billion of real estate throughout New York, New Jersey and Connecticut. That’s a departure for Manhattan’s property owners, who in prior years would pursue one track at a time, he said.

Of course, this isn"t just a NYC phenomenon as sales of office towers, apartment buildings, hotels and shopping centers across the U.S. have been plunging since reaching $262 billion nationally in 2015, just behind the record $311 billion of real estate that changed hands in 2007, according to Real Capital. Property investors are on the sidelines amid concern that rising interest rates will hurt values that have jumped as much as 85 percent in big cities like New York, compounded by overbuilding and a pullback of the foreign capital that helped power the recent property boom.

The tough sales market has put some property owners in a bind -- most notably Kushner Cos., which has struggled to find partners for 666 Fifth Ave., the Midtown tower it bought for a record price in 2007. The mortgage on the building will need to be refinanced in 18 months.

Thankfully, at least someone interviewed by Bloomberg seemed to be grounded in reality with Jeff Nicholson of CreditFi saying that it just might be a "red flag" that buyers have completely abandoned the commercial real estate market at the same time that owners are massively levering up to take cash out of projects.

Some lenders view seeking a loan to take money off the table as a red flag, according to Jeff Nicholson, a senior analyst at CrediFi, a firm that collects and analyzes data on real estate loans. It may signal the borrower is less committed to the project, and makes it easier to walk away from the mortgage if something goes wrong, he said.

But, it"s probably nothing...

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.

DOJ Probing People Who Worked In Deutsche's Mortgage Unit To "Hold Individuals Accountable"

Deutsche Bank employees who were engaged in the actual trades that ended up costing the bank a $7.2 billion settlement at the end of 2016, and who were hoping to quietly get away without criminal or civil charges, are set for disappointment because as IFR reports the DOJ is probing for potential fraud by individuals who worked in Deutsche Bank"s mortgage unit in the run-up to the financial crisis. 

The investigation of former Deutsche staffers is a push to hold individuals accountable for their role in the housing crisis, IFR"s sources said. The probe follows Deutsche"s multi-billion settlement in December with the DOJ over the sale of toxic residential mortgage securities between 2006 and 2007. Observers were surprised when no individuals who worked at Deutsche were named in the settlement, leaving shareholders to foot the bill.

Now, the DOJ"s fresh probe leaves open the possibility of pursuing individuals who had worked at Deutsche. Confirming that there has been no individuals have been exempt from personal liability, in the January 17 press release outlining the facts, finalization and terms of the settlement, the DOJ said that the settlement with Deutsche does not release any individuals from potential criminal or civil liability.

Speaking of which, has anyone seen Greg Lippman these days?

* * *

Separately, and presaging what will soon take place in Deutsche Bank, Reuters writes that the DOJ in December named two former Barclays RMBS staffers in a civil suit it filed against Barclays and some of its US affiliates. The complaint against Barclays alleged that the bank and its staffers fraudulently sold tens of billions of dollars of RMBS, and repeatedly misled investors about the quality of the mortgages backing those deals. The individuals named in the Barclays complaint, Paul Menefee and John Carroll, have obtained their own legal counsel, a Barclays spokesperson said. Menefee was Barclays" head banker on its subprime RMBS securitizations, and Carroll was Barclays" head trader for subprime loan acquisitions.

"It is surprising and extremely disappointing that the government decided to file this highly unusual lawsuit. John Carroll intends to challenge these ill-conceived and baseless allegations, and expects to be fully vindicated," Crowell & Moring partner Glen McGorty, who is representing Carroll, said in an emailed statement to IFR. A response to the complaint against Carroll has not yet been filed, McGorty said.

Lawyers for Menefee did not immediately respond to requests for comment. No filing has been made on behalf of Menefee, according to a search of the federal court docket. Barclays previously said it rejects the claims made in the complaint.

"Barclays considers that the claims made in the complaint are disconnected from the facts. We have an obligation to our shareholders, customers, clients, and employees to defend ourselves against unreasonable allegations and demands. Barclays will vigorously defend the complaint and seek its dismissal at the earliest opportunity," the bank said in a statement.

Meet The New, "Safe" Synthetic CDO's That Could Spell Disaster For The European Banking System

So what do you do if you"re a European banking regulator faced with the task of maintaining a safe, sustainable financial system amid a concerning growth in bank leverage.  Well, if you said sell down risk assets then you"re just being silly or completely ignoring your implicit obligation to engineer higher banking profitability at all costs.

If we can get serious for a moment, like in the early 2000"s, when all else fails you turn to synthetic CDO"s which, courtesy of some magical, if completely incomprehensible, math, slashes the risk of bank balance sheets while having a negligible impact on profitability.  It"s called the Synthetic Collateralized Loan Obligation and it"s all the rage in Europe.

Here"s how it works:

In a synthetic securitisation a bank buys credit protection on a portfolio of loans from an investor. This means that when a loan in the portfolio defaults, the investor reimburses the bank for the losses incurred on loans in that portfolio up to a maximum, which is the amount invested. This amount therefore provides credit protection for a slice of the portfolio, which is often called the ‘first loss tranche’. The size of this tranche is typically chosen in a way to cover at least the expected losses on the portfolio as well as a share of unexpected losses. The bank usually retains the rest of the risk, which is called the ‘senior tranche’.

Before closing, the bank and the investor agree on the terms of the transaction, such as the amount the investor is at risk for, the duration of the contract and the loans that are eligible for inclusion in the portfolio. Choosing which loans are eligible can be on a disclosed basis, where the investor knows the exact names of the borrowers of these loans, or on a blind pool basis, where the investor does not know the identities of the borrowers. In the latter case the loans are chosen based on criteria, such as the type of loans, sector, geography, credit risk, et cetera.

The term ‘synthetic’ comes from the fact that, unlike in a true sale transaction, the loans being securitised are not sold by the bank but are referenced, which means they remain on the bank’s balance sheet. This way, the bank reduces the credit risk on the securitised loans and remains in charge of managing the loans and the lending relationship with their client itself. Synthetic securitisations are often used for hedging the credit risk on loans that cannot easily be sold.

As Bloomberg points out, from the regulator"s perspective the logic is that these deals are usually fully funded, with investors posting the full amount that they"re on the hook to cover should a lot of a bank"s loans go bust. They"re not highly leveraged wagers similar to the pre-crisis synthetic collateralized debt obligations, which were backed by who knows what and sold to whomever.

Of course, the problem with that perspective is that it views the risk profile of the synthetic CLO in a bubble and completely ignores all other possible second derivative implications. 

One such second derivative implication can by linked back to the primary demand for these structures, hedge funds. 

Per the graphic above, hedge funds are all too willing to post the collateral required to backstop losses on a bank"s loan portfolio but only if they can juice their returns somehow.  So how do they do that?  Well, they borrow money from banks, of course.  Yes, you read that correctly, banks are lending money to hedge funds which use that leverage to backstop losses on the bank"s loan portfolio...effectively the bank is issuing loans to backstop loans.

We vaguely remember similar shenanigans occurring roughly 10 years ago when most of wall street"s modern day titans were still watching Power Rangers in their PJs...as we recall, in the end, it didn"t work out well.