The Big Short (Again) - The Auto Loan Asset Backed Securities (ALABS) Bubble Part 2: Ratings Agencies, Used Car Prices, Santander Drive Auto Receivables Trust (SDARTs), Trade-In Treadmills, Bombshell Reports/Lawsuits, and more. This is BAD.
Oh boy. Realizing now that my first DD barely scratched the surface of these ALABS. I foresee writing in my future. Thank you all for your concern for my health and wellbeing! I love writing and researching this stuff. If I need a break, I will absolutely take it. But for now, I'm too interested in all this to just walk away.
You can read my Part 1 here. Obviously I'd recommend that before jumping into this one. Also make sure to check out my SLABS DDs. So many bubbles, so little time!
I don't really have any corrections I'd like to make to my first part. If that changes, I will edit this post, or include the edits in a Part 3, if it happens. Let's go!
First of all, I'd just like to quickly mention that the way these loans are rated works the same as most other asset backed securities. Yup, the same exact conflict of interest exists here as it did in 2008. Ratings agencies like Moody's and S&P are paid by the servicers of ALABS to rate these very ALABS. Just thought I'd bring that up here, as it helps to link all different types of ABS - the same scumbag rating agencies are involved with many different types.
Next up, used car prices. I didn't really address appropriately in Part 1 why I believe the used car market is so hot, and the significance. So here goes. The used car market being hot greatly benefits ALABS. The more loans have to be taken out, the more money these dealerships make from these loans. Obviously, the main cause of the hot market the insane chip shortage. There just is not enough supply of new cars to satisfy demand. u/Vnmous, who works in the auto industry, had a great comment on my first part, saying "Dealers are enjoying the position of the industry at the moment. They have never made more money, even though there are no cars on most lots". My part 1 DD supports this conclusion: dealerships now make a majority of their profit on loans, not profits from the physical car. Here's a graph that shows why this hot used market benefits these dealerships.
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Interest rates are significantly higher for used cars. This means that dealerships are making more money off used car loans. Interesting. This has led them to dealerships buying back used cars that they previously sold and selling them again - many dealerships are offering high compensation for used cars you bought from them previously. However, this comes with a problem. Because the majority of cars available now are used, people are taking out more and more expensive loans due to the increasing interest rates AND the meteoric rise of used car prices, as shown by this graph.
This, in my opinion, has caused a significant increase in the probability of defaults and delinquencies, which will affect the bottom line of these ALABS.
Now, let's talk about Santander Drive Auto Receivables Trust, or SDARTS. These are a little complicated, so get ready for some reading. Per this source, "One of the more popular auto loan-backed securities is the Santander Drive Auto Receivables Trust (“SDART”) product. The SDARTs offered bonds categorized into different classes – a number of A class bonds, followed by B, C, D, and E class bonds. The payoff time was to be longer for each successively higher class, leading to greater risk but higher interest rates for the lower classes. An analysis of the SDART offerings shows the cumulative effect of rising defaults and slower payoffs in underlying loans.
Beginning with the first SDART issued in 2013, the payouts started growing longer. Whereas the October 2012 offering had the Class B payout to be completed in May 2017, the January 2013 offering called for the Class B payout by January 2019. Stated differently, a product offered four months later pushed the payout seven months out. While all of the SDART products offered through the end of 2012 are fully paid and retired, all of the products offered thereafter have one or more classes of debt still outstanding.
It seems that the trend of slower borrower loan payments is having the direct effect of causing these products to run for progressively longer periods of time. While that means that those who own the various bond classes enjoy the interest return for a longer period of time, it also means that they’re subjected to the risk inherent in the product for a longer period as well. As auto loan default rates climb, it is possible that the ratings agencies will downgrade the riskier debt classes, making it more difficult to sell those instruments on the open market." Ok. Allow me to do my best to summarize. SDARTs are a type of auto-loan backed ABS. There are different tiers, ranging from A to E, with the risk exposure and interest rate increasing with each tier. However, due to borrowers having less money in general due to inflation and the pandemic, loans are taking longer to repay. This is exposing what was supposed to be the low risk tiers, (like A and B) to as much risk are the lower tiers were previously exposed to. And now, the lower tiers are even riskier. Basically, these SDARTs just got a whoooole lot riskier. And they're extremely popular.
Now, I'd like to talk about Trade-In Treadmills. This quote, via this source, should explain things a little better than I could. "In a note out March 27, Moody's highlighted what it called a "trade-in treadmill." In other words, auto lenders are choosing to roll negative equity at trade-in in to the next vehicle loan.
It looks a little like this:
- Car Buyer acquires a Truck 1 for $100, taking out a $80 loan to make the purchase.Â
- Truck 1 drops in value by half by the time Car Buyer decides to trade in.
- In that time, Car Buyer has only paid $10 of the loan, leaving him/her with $20 in negative equity ($80 loan minus $10 payment minus $50 trade-in)
- Car Buyer rolls the $20 negative equity in to the next loan on the next purchase.Â
From Moody's note: The percentage of trade-ins with negative equity is at an all-time high, as is the average dollar amount of that negative equity. Lenders are increasingly faced with the choice of taking on greater risk by rolling negative equity at trade-in into the next vehicle loan. We believe they are increasingly taking this choice, resulting in mounting negative equity with successive new-car purchases. This “trade-in treadmill” generates higher loan to value ratios, slower principal amortization and higher loss severity when defaults occur." Woah. This is a pretty big issue. You have these loans that are just going to keep snowballing on each other because people are paying loans slowly, trading in their cars, and rolling over their negative equity. Yikes. And we know that the ratings agencies are just as corrupt as 08. So I would not be surprised if these are still being rated AA or AAA.
Now, I'd like to talk about an absolute bombshell of a report done by ConsumerReports into the true state of the auto loan industry. This was absolutely mindboggling. This article summarizes the report, while the actual ConsumerReports article can be found here. Here's a quote from the summary: "
The investigation found:
- A credit score doesn’t necessarily dictate the terms of the loan offered. Borrowers in every credit score category—ranging from super-prime, with scores of 720 and above, to deep subprime, with scores below 580—were given loans with APRs that ranged from 0 percent to more than 25 percent.
- Some high credit scorers get high-priced loans. While, on average, borrowers with low credit scores are offered the worst terms, about 21,000 borrowers with prime and super-prime credit scores, about 3 percent of the total borrowers in that group, received loans with APRs of 10 percent or greater—more than double the average rate for high scorers in our data.
- Many borrowers are put into loans they might not be able to afford. Experts say that consumers should spend no more than 10 percent of their income on an auto loan. But almost 25 percent of the loans in the data CR reviewed exceeded that threshold. Among subprime borrowers, that number is almost 50 percent, about 2.5 times more than prime and super-prime borrowers.
- Underwriting standards are often lax. Lenders rarely verified income and employment of borrowers to confirm they had sufficient income to repay their loan. Of the loans CR looked at, these verifications happened just 4 percent of the time.
- Delinquencies are common. More than 5 percent of the loans in the data — 1 in 20, or about 43,000 overall — were reported to be in arrears. While delinquencies declined over the past year and a half, likely thanks to pandemic-related deferment programs, industry groups and regulators are bracing for a potentially sharp uptick in the coming months." Holy SHIT. This is worse than I thought. You have even prime and superprime buyers being subjected to horribly high priced loans, borrowers being put into loans that these companies know they can't afford, companies not checking incomes to even verify the likelihood of repayment, and a ton of delinquencies. I don't even really know what to say at this point. The value of these ALABS are honestly jack shit. But the bubble hasn't burst yet.
Now, I'd like to talk about some pretty high profile lawsuits that show just how scummy these auto loan agencies are. First up, some quotes from this source. "Early last week, Attorney General Maura Healey filed a lawsuit against Credit Acceptance Corporation (“CAC”), a credit lender that specializes in auto loans. The complaint alleged that CAC had provided borrowers with high-interest subprime auto loans which the company knew the borrowers would be unable to repay. After borrowers defaulted, CAC aggressively pursued them for repayment, hailing them with collections calls and overcharging them for their deficiencies. The company then misled investors by packaging these high-risk loans along with other loans into asset-backed securities, which CAC misrepresented as only containing high-quality loans. As a consequence of CAC’s activities, thousands of consumers have been left in financial ruin. Borrowers of these loans risk lowering their credit score, losing their automobile, and facing accumulating fees if they default.
CAC is not the only company in the subprime auto market to be recently accused of deceitful and predatory behavior. Earlier this year, Santander agreed to a $550 million settlement with 33 states and the District of Columbia after engaging in similar conduct, approving high-cost auto loans for consumers with subprime credit. Last year, Exeter Finance paid $6 million as part of settlements with Massachusetts and Delaware based on their subprime auto loan practices as well. These lawsuits illustrate a growing and concerning trend in the auto finance industry– more and more credit lenders have been willing to offer loans without engaging in reasonable underwriting practices." This basically confirms all of what I previously described with that ConsumerReports article (also, Santander? Sound familiar? Hint hint: SDARTs). Companies are giving borrowers loans they can't repay, just to make more money off these loans. It's really an infinite money glitch - first they get the money from the insanely expensive loan they gave you, then they just go and repo your car anyways. In some ways, ALABS are even worse than SLABS in the aspect that because there is very valuable physical collateral in the form of a used car, companies have incentive to drive consumers into default so they can repo the car and resell it.
Just look at what happened to repossessions once repo moratoriums ended. Illinois and Maryland ended their pandemic repo moratoriums separately from other states, so you can really see how big an impact this had. (Via this article).
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Looks like repos are through the roof, likely due to all the previous factors I mentioned.
Now, it's time for a TLDR.
TLDR: The used car market is very hot right now due to supply shortages. This greatly benefits dealerships and therefore increases the creation of ALABS. However, these ALABS are really bad quality because of how expensive used cars are and how much higher interest rates are. Additionally, companies have been giving out loans so expensive there is little chance of repayment, even for prime and superprime borrowers. While these companies have been challenged by lawsuits, the system has yet to see major changes, and the fines were likely a slap on the wrist compared to how much profit these guys are making. Companies really have a sort of infinite money glitch - give out exorbitant loans, collect money on those loans, the borrower is still forced to default due to the near-impossible-to-repay fees, dealerships repo the car, and they run the same scheme on another sucker.
That's about all I've got for this part. Again, I'll make more parts in the future if I come across more new info. Thanks again for reading.
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.
Posted Dec 28, 2021, 9:12 PM UTC