“Big Short” Redux? Steve Eisman Is Worried About Subprime Auto

We’ve been pounding the table on subprime auto and the extent to which that odious debt has been embedded in the system via Wall Street’s securitization machine for as long as this site has been around.

For instance, in “As Subprime Auto Bubble Bursts, Lenders Use GPS To Hunt Deadbeat Borrowers,” we drew your attention to “DriveTime” and “Credit Acceptance,” highlighting the rather unnerving fact that both companies “have been using technology like ignition kill switches, which allow debt collectors to remotely disable a vehicle’s starter, and GPS devices, which can allow them to track down an automobile or truck,” to quote a Bloomberg piece out last month.

Perhaps more worrisome than that is the following chart from Morgan Stanley which shows that DriveTime and Credit Acceptance are among the subprime originators who are starting to comprise a larger and larger percentage of ABS deals:


Earlier this year, we also noted the following chart and accompanying color from Citi:

The securitization market continues to finance numerous subprime auto finance companies and total outstanding subprime auto ABS amounted to $41 bb, which accounted for 29% of total outstanding retail auto ABS as of 31 Dec 2016 (Figure 8), setting a new record market share.


And more recently, we’ve flagged the surge in off-lease supply as a possible catalyst for further declines in used car prices…

BofAML: CPI for used vehicles declined for the twelfth consecutive month. Further declines, driven in part by an increase in off-lease vehicles, are expected to place pressure on realization and recovery rates for auto lease and loan ABS.


… which in turn could end up triggering a deflationary spiral as depressed trade-in values weigh on new car sales and force automakers like GM to adopt aggressive discounting.

Well on Friday, Bloomberg’s is out with a great piece that brings everything we’ve been warning about together. Below, find some excerpts.

Via Bloomberg

For the past few months, clouds over the $1.2 trillion market for U.S. auto debt have grown darker.

The latest round of investor hand-wringing came last week when Ally Financial warned its profit would grow less than expected because of falling used-car values. That built on angst triggered by Ford Motor Co.’s decision in January to cut $300 million from its financial-service arm’s profit forecast.

It’s no secret that auto-loan borrowers are struggling to repay their debt and that some firms are starting to experience the consequences. Delinquency rates have been soaring to some of the highest levels since the financial crisis. Loan losses are greater than expected.


Going forward, all signs point to accelerating declines in auto-loan creditworthiness this year and into next. Investors should just expect to see millions of dollars of auto-related credit losses, steadily falling resale values and some large challenges for big auto manufacturers.

The problem stems in part from a phenomenon highlighted by my Gadfly colleague Chris Bryant in December: Consumers are leasing many more cars and trucks than they used to. After about three years, when the lease term is up, dealers often try to resell the returned vehicles. Because a lot of leased vehicles are due back in the coming months, resale values are going to decline.


But that’s not the only issue. Some financing firms were much looser with their lending standards than they had been in the past, resulting in more subprime and so-called deep subprime loans. About a third of the risky car loans that are bundled into bonds are considered “deep subprime,” up from about 5.1 percent in 2010, according to Morgan Stanley research reported by Matt Scully of Bloomberg News in an article this week.

This all leads to the question of just how widespread the pain will be.


Right. And remember the charts we showed you late last month? You know, the ones showing how vintages tied to quarters during which the share of loans made by lenders with lower standards were performing worse? Here they are again with the accompanying color from Morgan Stanley:

As we dissect the performance of recent vintages, we find divergence in cumulative loss trajectories across various origination quarters. Not surprisingly, those are the quarters with higher origination share from lenders with lower underwriting criteria.

Given the high proportion of 2016 subprime deals issued by lenders with lower underwriting standards, we should expect delinquencies and losses to climb even higher over the course of 2017.


Yeah, see when you put all the pieces together, this is bad news. As Abramowicz puts it, “the auto market is pocked with signs [and] almost all of them point to potentially treacherous road ahead.”

Well guess who agrees? Steve Eisman or, as you may know him, “Mark Baum” (the character based on Eisman and played in The Big Short by Steve Carell).

Via Bloomberg (again):

Steve Eisman, the Neuberger Berman Group fund manager who featured in Michael Lewis’s book “The Big Short,” said he’s concerned about the U.S. subprime-auto market, even though credit quality across the banking system has improved significantly.

“Banks make mistakes on credit quality and we are in an environment where credit quality has never been this good in anyone’s lifetime, with the one exception of subprime auto,” Eisman said in a Bloomberg TV interview on Friday. He added, though, that it’s not a big enough asset class to cause problems for the financial system as a whole.

Probably not, but as we’ve warned on countless occasions, the more of this debt that gets securitized, the more systemic this risk becomes.

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