The Big Short (Again) - Auto Loans Bubble Edition. Auto Loan Asset Backed Securities (ALABS): Another Huge Bubble About to Burst.
Check out Part 2 here after reading! (https://www.reddit.com/r/Superstonk/comments/rqpup4/the_big_short_again_the_auto_loan_asset_backed/)
Hey all! Welcome back to another DD but this time on a different type of Asset Backed Security. You probably know me now as the 'SLABS guy' (Student Loan Asset Backed Securities) due to my recent 5 Part DD Series on SLABS, but I figured at the request of many comments I'd take a deeper look at the auto market.
As many have pointed out, there are a ton of different collateral markets for different types of loans. Credit cards, medical, auto, student loans, etc. I am of the belief that these ABS markets are all inherently risky, as the regulatory measures like ratings have been corrupted in the pursuit of money. I decided previously to look into the Student Loan ABS bubble because of how big the market was - about $1.6T in student debt is held by the USA total. I didn't even realize that the auto market has about the similar amount of debt outstanding - approximately $1.3T. Wow. Time to go down this rabbit hole for a bit. SLABbit hole? ALABbit hole?
This is the first time I've ever really looked into auto loans and the securities market associated with them. So take this with a grain of salt. We're all still learning here.
With that said, let's go! This is gonna be a fat DD. I'll include a TL:DR at the bottom, but I'd still recommend reading the whole thing.
First of all, the structure of Auto Loan Asset Backed Securities (ALABS) functions very similarly to how SLABS work, or Mortgage Backed Securities worked back in 2008. This link (https://www.stockmarketloss.com/securities-law/auto-loan-backed-securities/) explains: "Subprime auto loans have been and are being bundled into auto loan asset-backed securities (“ABS”) and sold to the public as solid, income-producing debt investments similar to corporate bonds. They’re marketed as secure products offering above-average interest. But while a bond may be backed by an issuing company’s income and assets, these auto loan ABS products are backed solely by a pool of auto loans. The loans are bundled and the rights to receive the payments generated by the loans are sold to investors. Those rights are divided into tranches." Tranches? Subprime loans? Asset backed securities that are misleadingly marketed as secure products? That all sounds familiar.
But first, let's discuss how big the market is for these ALABS. I will be extensively referencing this study for information, and using graphs with data from the New York Fed. The study is entitled "Bursting The Auto Loan Bubble In the Wake of Covid-19". Well that title is straightforward isn't it.
It's important to understand just how many people take out loans to buy cars. "About 85% of Americans own a car, and 2/3 of car owners fund their ownership with loans". So obviously, even though these loans will not have larger dollar values than student loans or housing loans, they're still very widely used. And they're growing. A lot. This graph should help demonstrate this rise further. It uses data from the New York Fed.
The study continues, saying "During the past decade, auto debt has skyrocketed, increasing nearly 40 percent overall, with the average auto loan for a new car rising 11 percent. Part of the growth stemmed from a flourishing subprime auto loan market, which now accounts for nearly one-quarter of the $1.33 trillion in auto loan debt outstanding. Overall, as of the beginning of 2020, auto loans made up about nine percent of household debt, making “[t]he auto loan market . . . the third-largest consumer credit market in the United States,” behind home loans and student loans." Ummmmm...this should be a HUGE red flag. The subprime (aka ' very risky loans that probably never should've been given out') market alone makes up nearly $325B (a quarter of $1.33T) of the auto loan industry! And with this growing amount of subprime loans comes increasing levels of default. Just look at this graph here, compiled also from data from the New York Fed.
You can see a DRASTIC rise in auto loan defaults which as I believe is a result of increasing lending to subprime consumers. So why hasn't the bubble burst yet? Well, that same study says "Prior to the pandemic, the build-up of auto loan debt outstanding and the growth in delinquencies and defaults led experts to classify the auto loan market as a bubble and to predict that the bubble would burst soon. The United States’ strong pre-pandemic economy combined with a low unemployment rate likely were the leading reasons that the bubble did not burst at that time. Yet, even then, multiple reports recognized that the rise in auto debt in the United States showed an unsustainable dependence on automobiles financed by households." Ok. So the reason that shit hasn't hit the fan yet is because the economy was really strong before the pandemic. Well, here we are a few years into the pandemic now, and this thing still has not burst yet. In my eyes, it's only a matter of time.
A reason why defaults and delinquencies may be increasing is because people are strapped for cash recently, with inflation and now the pandemic. This article (https://www.stockmarketloss.com/securities-law/auto-loan-backed-securities/) states, "Borrowers with more cash than credit tend to pay their loans more quickly to avoid the high interest rate attached to the loans. The fact that they’re paying loans more slowly is thought to be a sign that borrowers are more strapped than they have been previously." Basically, people are paying loans more slowly, which causes interest to snowball, and will thus cause even more risk of default.
Another interesting thing to note is how auto loans actually work. While some large companies have in-house crediting, like Ford Motor Credit, typically banks partner with dealerships who then give loans to customers. This is a huge issue. Because instead of these banks directly servicing consumers, they are instead trying to please dealerships the most. This means that "the auto loan origination market prioritizes the interests of lenders over those of customers, which has led and will continue to lead people to agree to loans with disadvantageous (and inflated) interest rates, fees, and terms." Pretty straightforward - because the dealership is the middle man who is actually giving the banks business and money, the banks negotiate loan terms that are more favorable for the dealers than the buyers. This would obviously lead to increased rates of delinquency and default, but this strategy is still immensely profitable for dealers. Take a look. "Over the past decade, the relative proportion of profit that auto dealers have made from car sales versus car financing has narrowed. For instance, in 2011, dealers made 66 percent of their profit from car sales versus 34 percent from car financing. In 2018, this balance had flipped, with dealers making money from car loans than car sales. Dealers should be increasingly more interested in selling auto loans than actual cars." Woah. So now, when you go to buy a car, the dealers are actually more interested in putting you into debt and making money off your loan than making a profit off the physical car. That's pretty wild to think about.
How is this even allowed? Well, the study continues, saying "Similarly, as noted by Edward Balleisen and Melissa Jacoby, car dealers have succeeded in lobbying at the state level, leading to the lack of state-level regulation of auto loans, and have a lobbying force that is ready to take on proposed regulations." Try to act surprised.
But how does all of this tie into an ABS market? Well, similarly to other types of loans, "Auto asset-backed securities are essentially a bundling of car loans that are then sold to investors. They are grouped by the creditworthiness of the borrowers and categorized as prime, nonprime or subprime." (Link). As I explained in my DD about SLABS, the record-high levels of RRP show that everyone is absolutely desperate for collateral. So I would not be surprised if these ALABS were also being used extensively as collateral. But, as I've shown above, these ALABS are again overvalued. That article continues, saying "Delinquency rates are on the rise in auto ABS, especially in the subprime category. According to a May 2018 story in PYMNTS, “subprime delinquency for loans more than 60 days past due reached its highest since 1996 at 5.8 percent.” That number, according to Business Insider, was a jump of 0.6 percent from the year prior and up 2 percent from the same time period in 2014. Perhaps even more telling, according to PYMNTS, the default rate leading up to the 2008 financial crisis was around 5 percent." Well shit. We already know that subprime loans make up a pretty damn big percentage of all auto loans. And if defaults are on the rise, then obviously the ALABS market is being strained. This article also says that " Bloomberg reported in April that two smaller subprime lenders – Summit Financial and Spring Tree Lending — filed for bankruptcy while Pelican Auto Finance shut down completely. Furthermore, the publication notes that rising interest rates will likely make things more challenging for these lenders." This again is a pretty big red flag. These subprime lenders going under signals a significant risk that these subprime loans are dogshit, and their value is finally coming down to Earth.
Even Morgan Stanley is calling out this bullshit. As Walter White once said, 'you can't bullshit a bullshitter'. This link reads, "Morgan Stanley has stated: “In fact, since 2010, the share of Subprime Auto ABS [asset-backed securities] origination that has come from these deep subprime deals has increased from 5.1% to 32.5%.[2]” Subprime loans are those made to people with low credit scores. While there is no standard definition for “subprime,” it often refers to people with credit scores lower than 640, and “deep subprime” refers to credit scores lower than 500. The lower the borrower’s credit score, the more likely the borrower is to default on a loan. Accordingly, subprime loans are inherently riskier than prime loans and deep subprime loans are riskier still." Again, this highlights how the bottom line of this market is about to go down the shitter. This graph demonstrates even further.
It's similar to the graph I showed previously. But this one highlights how these prime and subprime markets have drastically diverged recently. And like I mentioned, banks are starting to notice. As far back as 2016, banks started decreasing their exposure to ALABS, while independent companies have taken up this slack. Hence why like I previously mentioned, it was these smaller players beginning to go under.
As you can see, banks decreased their exposure by 1.6%, with private finance companies increasing their exposure by 1.6%. These graphs are from this source.
But there is YET ANOTHER problem. As I'm sure you're aware, cars are essential to American life. And this has led some people to get desperate enough to get a car to commit fraud. This source states that "Given the higher risk inherent in subprime loans, one would hope that borrowers are being forthright in their loan applications and that lenders are being thorough in their due diligence. Unfortunately, it appears that neither may be happening. Bloomberg reports that “as many as one in five auto-loan borrowers admitted in a survey that their applications for debt contained inaccuracies . . . meaning fraud could be more pervasive than lenders planned for." Oh great. So not only do we have to deal with the risks of companies giving out subprime loans to people with horribly low credit scores, but we also have to deal with people lying about their financial situations to get a loan at all, which would expose this industry to even more risk.
But it's not just borrowers who aren't doing their due diligence. This same source continues, saying "Unfortunately, as borrowers’ inaccuracies or falsehoods increase, lenders are growing lax in their data verification. It was reported recently that Santander Consumer USA Holdings, Inc. – one of the largest subprime auto finance companies – verified income on a mere 8% of the borrowers whose loans it bundled into $1 billion of bonds. Santander agreed to pay nearly $26 million in settlements with Massachusetts and Delaware related to allegations that it facilitated unfair, high-rate auto loans for thousands of buyers. Naturally those loans were packaged into securities sold to investors. Santander is, however, not alone in its income verification procedures. Americredit, another large auto-loan company (and a unit of General Motors Financial Company), reportedly verifies only 64% of its prospective borrowers’ incomes." So not only do you have one in five auto loan borrowers committing fraud to get a loan. You also have lenders who are straight up not checking the credit scores and incomes of people they're giving loans to. And why would they? Again, like I mentioned earlier, the profit for dealerships now comes from making people take out as many loans as possible. Holy shit. Hello, 2008 again.
Here's the bottom line. Via this source. "If the underlying loan slow payments and defaults are significant enough, it is possible that investors won’t receive the interest they expected to receive. The bond values will then decrease on the open market. Investors trying to unload the under-performing or non-performing bonds may only be able to sell them at a loss, if they’re able to sell them at all. If the underlying loan performance is bad enough, some of the bonds themselves could go into default, meaning that the principal sums due are never repaid. Investors face the possibility of losing some or all of the money invested in these supposedly safe bond or bond-like investments. The bottom line is that auto loan ABS investments are not safe, secure, and better paying bonds or bond alternatives. They are subject to major losses and will become increasingly risky as car loan defaults continue to increase." This quote really just speaks for itself. This is a bubble, and a big one.
So who's left holding the bag if this goes to shit? Here's what this source thinks. "The most aggressive have been specialized lenders, including small shops backed by private equity firms, and larger lenders such as Santander Consumer USA. But they’re spreading the risks to investors by packaging their loans into subprime auto-loan backed securities, of which the highest-rated tranches have AA or even AAA ratings. And these securities are everywhere, from bond funds in the US to some pension fund in a Scandinavian city. For investors and lenders, these delinquent loans don’t represent total losses. If the default cannot be cured and the lender decides to repossess the collateral – which is easy to do with modern tracking technologies – the lender obtains a used vehicle for which there is a liquid auction market (unlike housing) with wholesale auctions around the country, and finding a buyer is generally not the problem. The problem is the difference between the price at auction and the outstanding loan amount. The difference plus expenses is the loss that the lender and investors take. This loss might be 50% of loan value." Yup. So it looks like a whoooole lot of people are about to be exposed to significant losses in their portfolios. Wonderful.
Now, it's time for a TL:DR.
TLDR: Auto Loan Asset Backed Securities are similar to Mortgage Backed Securities and Student Loan Asset Backed Securities. When loans are taken out to buy a car, these loans are then packaged into ALABS, which are then sold to investors who reap the interest rates. However, these ALABS are posing increasing risk of devaluation, due to increased numbers of default rates due to the pandemic, the drastic increase in the usage of subprime (shitty) or deep-subprime (most shitty) loans, fraudulent reporting by borrowers, incomplete due diligence on part of lenders, and slow loan payments. This relates to GME, as if these ALABS lose value, they also lose value as collateral. RRP has shown how desperate people are for collateral, so the thesis is that ALABS are being used extensively as collateral. Devalued collateral = banks get scared and raise margin requirements = margin calls = MOON. Not to mention that even if these aren't being used as collateral, tons of investors are exposed to these things, so a recession would ensue which I believe would also cause margin calls.
Thanks so much for reading you guys! We'll see if there will be any further parts. Originally I planned for my SLABS DD to be one part, yet I'm already on Part 5. As always, I will write more parts if more new information comes to light via comments or DMs. So please, put me onto some more leads!
One final thing. I am not a financial advisor. Please do not ask me how to make money off this situation. My personal investment strategy has been all GME, and this information does not change that. as always, I believe GME to be the best hedge against a market crash. Thanks again, and make sure to check out Part 2.
Posted Dec 28, 2021, 5:50 PM UTC · edited