“Net losses and gross charge-offs were understated” – Oopsie?
By Wolf Richter for WOLF STREET.
U.S. Auto Sales, a dealer chain owned by a private equity firm and focused on selling and financing lower-end older used vehicles to subprime-rated customers, suddenly “temporarily” shut its 39 dealerships in six southern states today, with a terse announcement on its website:
Attention U.S. Auto Customers. We have temporarily closed our dealerships and are working on a solution to re-open them as soon as possible. But don’t worry, we aren’t going anywhere! U.S. Auto’s affiliated loan servicing company (USASF Servicing LLC) is still open to accept your payments and assist in servicing your account. Please continue to make your payments as scheduled and reach out to us with any account questions.
Sincerely, -The U.S. Auto Team
The Lawrenceville, GA, headquartered company is owned by PE firm Milestone Partners. As part of its business, it securitizes the subprime auto loans via its funding unit, US Auto Funding, into Asset Backed Securities and sells those ABS to investors. US Auto Funding issued four of those ABS already, one a year.
At the end of June 2022, it securitized the last of the four batches of subprime auto loans into $233 million of ABS. Moody’s rated the various tranches of that bond issue from A3 at the high end to B3 at the low end. A3 is four notches into investment grade. B3 is six notches into junk. The lower-rated tranches take the first loss, starting with the equity tranche retained by the issuer, and they can quickly get wiped out if there are problems. The top tranches take the last loss, and are largely protected (here’s my cheat sheet for corporate credit ratings by ratings agency).
“Net losses and gross charge-offs were understated” – Oopsie?
Ominously, on March 31, Moody’s slashed its credit ratings of the ABS issued in 2021 and of the ABS issued in 2022. On both ABS, it slashed the lower tranches by two notches. Of the 2022 ABS, it slashed the lowest tranche, the Class E Notes, from Caa2 to Ca, which is just one notch from default, nine months after having been issued.
The whole thing was a huge mess. Moody’s explains:
“The rating action is primarily driven by USASF’s recent restatement of gross and net loss data for the underlying loan pools,” Moody’s said.
“In the March servicer report, USASF disclosed that it had identified an error in the allocation of payments among principal, interest and recoveries contained in the servicer reports for the reporting periods from August 2022 through January 2023,” Moody’s said.
“The March servicer report indicates that the error had no impact on the total collections available to investors in any of the reporting periods, but notes that the error did impact the net losses and gross charge-offs, and that net losses and gross charge-offs were understated in some of the servicer reports,” Moody’s said (emphasis added).
Moody’s goes on to explain that the company has now “provided restated loss data for the current period,” and that for the ABS issued in 2021, “cumulative net loss-to-liquidation increased to 37.3% in March from 31.8% as reported in February,” and for that the ABS issued in 2022, it increased “to 45.8% in March from 32.9% as reported in February.”
Moody’s then increased its “lifetime expected net loss estimates for the underlying pools” to 40% for the ABS issued in 2021 and to 46% for the ABS issued in 2022. So that was quite an oopsie.
Which dooms the next ABS sale. So forget it and close the doors?
Subprime is so called for a reason: The customers have a bad record in paying back their debts, and so they have low credit scores, but they can still borrow money, but must pay very high interest rates to the lenders so that lenders are willing to take those risks. Lenders make huge profits on these high interest rates, and investors greedily gobble up the ABS because they offer a higher yield, and Wall Street makes a ton off the fees, and everyone is happy…
Until the customers cannot make the payments because the interest rate is too high, and so the subprime loan becomes a self-fulfilling prophecy, further besmudging the credit history of the borrower, and the lender has to go out and repo the vehicle and sell it at auction.
But it gets a lot worse…
Because specialized subprime is the slimy underbelly of the auto business, and it always gets a lot worse when you look at it more closely. According to a report by Kroll Bond Rating Agency, cited by Bloomberg, the loans in the ABS issued in 2022 had:
- Average FICO score of 518 (620 and below is normally subprime)
- Average LTV (loan-to-value ratio) of over 150% holy-moly!
- Average loan amount: $20,199. With 150% LTV, it means the vehicle was worth $13,500 at the time of the sale.
- Average interest rate: 18%.
In short, if you wanted to design auto loans to blow up and do a lot of damage, that’s how you’d do it.
PE firms, auto dealers, investors, bond funds… they all get into subprime auto lending because of its high yields. It’s a hugely profitable business until investors suddenly catch the heat.
Second time in two months that a PE-firm-owned subprime auto dealer shut down.
In late February, American Car Center, which had over 40 subprime-focused dealerships around the country, and which was owned by PE firm York Capital Management, suddenly shut down a day after it was forced to scuttle a $222 million bond sale.
The bond sale was backed by the subprime loans it had originated to fund the sales of its used vehicles. The company cited “market conditions” for scuttling the bond sale, and without this $222 million in new funding from the sales proceeds, it appears the company ran out of funds to continue, and just shut down.
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
If it was a random mistake these oopsies would break 50% in favor of the companies of having a better financial picture than stated.
But they always break in the negative way.
“Net losses and gross charge-offs were understated”
Yes, that’s how subprime bond oopsies always seem to work.
Alot of stress showing in this industry now. Neither me or any dealer I know is getting hardly any calls with almost no sales now. Expect a cascade of dealer defaults forthcoming. These subprime predators just to scrounge a sale will now be paying dearly.
More than anything, I want to see car sales just absolutely implode / crater. I mean like your zombie companies.
Just like home builders, auto companies have to get back to the basics and start selling volumes of cars that people can afford.
+1 & cheers to what you said.
Every nescessary purchase shouldn’t require a luxury-priced commitment, much less on vehicles and homes that are structurally/mechanically questionable.
Surely at some point the big boys will break their hands squeezing blood out of the anemic missing (now lower by default), middle?
It’s hard to stay a highroller with broken fingers… hopefully they focus more on playing their cards right while it’s still possible, so that everyone can break even.
IMHO, doing the ethical thing rationally when nobody else is, could be a great way to garner brand loyalty from thise who don’t want to be caught with their pants down when others’ free money dries up, or rather- can’t afford to.
The one key difference between home builders and auto manufacturers is government mandated equipment and regulations. NHTSA, EPA to start with. IIHS sticks their nose under the tent as well as poor performance affects total cost of ownership through higher insurance costs.
Then there’s the tort lawsuits. The following example is real: A manufacturer was sued because they offered a “safety suite” on their higher trim vehicles, but not on the lower-to-mid trim levels. This “safety suite” included features such as collision mitigation braking, active cruise control, lane departure sensors (cameras), blind spot sensors, stability control, and a host of other features, all of which, obviously, added cost and complexity to the production of each vehicle. The lawsuit was filed under the guise that “poor people deserve the same protection as rich people” and, therefore, the manufacturer discriminated against those who could not afford the higher trim cars. There was an injury accident and the manufacturer “knew or should have known” that an accident was more likely if said features were not included. So, the solution the suits came up with was to equip the lower trim cars with the same features – but the price was adjusted accordingly.
Which is how you end up with complicated and expensive vehicles…..
BENW
“…auto companies have to get back to the basics and start selling volumes of cars that people can afford.”
I’m with you. I’ve been screaming about this for years. I’m loving it every time Tesla cuts prices. An automaker cutting sticker prices!!! That’s just kind of unheard of here. It’s tearing into the legacy oligopoly, and I’m just loving that. Did it again today. It’s building factories, it’s increasing production, and it’s cutting prices. It’s got the biggest profit margins in the industry, and it can afford to do it. This is forcing others to cut prices, including GM on its Bolt, which is now below 30k, compared to the average transaction price for all new vehicles of around $46k.
…what’s that old business saw, again? oh, yeah:
“…to dine with the elite, cater to the masses…”.
may we all find a better day.
ElK – still looking at how long it’s been since the auto industry and public education gave up on offering driver’s Ed in high school (realize it was never universal, but the program at mine in the ’60’s was supported by Chrysler, included simulators a basic-training driving range and dual-control Valiants for the advanced stages of the semester).
(Of course, it appears we’ve also generally given up on teaching civics, so my wonder is obviously misplaced…).
may we all find a better day.
Tesla undercutting prices has been so awesome.
It’s putting downward pressure not only on coal powered cars but also on the ICE cars.
I am hoping to replace my old ride with a shiny one this summer at a good discount.
Manufactures need to get there dealers in line have become predators with a take it or leave it attitude,won’t buy anything until,blood running in streets
I totally agree but what usually happens, as is happening with housing today, the prices go up, they get bailed out somehow someway and they all come out looking even better.
The greedier get the richer
I was thinking about how car companies are selling fewer cars at higher prices. In the long run they are only going to hurt themselves. This goes against the unwritten contract suburban homeowners had with the auto companies. Without (relatively) cheap personal transportation, suburbs will cease to be viable. People will begin migrating back to the cities, and unoccupied office tower could then be turned into condos and apartments.
Who needs cars in a big city (except Seinfeld)…
T-B …by who and then what? Perhaps Glenda the Good Witch will appear and fix everything with a wave of her wand??? Or a much-less munificent ghost of royalty/dictators/oligarchs past? (‘organized anarchy’ historically lacks staying power, check the Celts success against the RE…).
The work of governing ‘of and by the people’ has always been hard, tedious, unpaid, and a decidedly unsexy PITA. Toss in our modern comms/entertainment and it’s sooo-much easier for many of ‘the people’ to tune out and leave it to ‘someone else’ most days, then complain that someone/something else hasn’t provided a better world when it punches them in the face…
Wolf and his site are invaluable, even for non-players like me, in that he photographs the license tags on those economic semis that never seem to take a break from bearing down on many of us pedestrians…
(Sorry, ranting off-piste more than usual, today …).
may we all find a better day.
Average FICO score of 518 (620 and below is normally subprime)
Average LTV (loan-to-value ratio) of over 150% holy-moly!
Average loan amount: $20,199. With 150% LTV, it means the vehicle was worth $13,500 at the time of the sale.
Average interest rate: 18%.
Holy moly, 150% LTV. And used car prices declining, so when they get repossessed, they can’t cover the default. Who buys this junk? This is too much like 2008.
Thankfully, subprime is a small part of auto lending, and a tiny part of consumer lending, with only about $250 billion or so subprime loans outstanding. Plus the collateral is easy to repossess and sell at auction, and has value.
Sure, but you know defaults of those borrowers with higher credit scores will spread when all these subprime repo’d cars hit the market and resale values tank across the board.
Then, just like with housing, those who are still paying for their expensive loans on shitty cars will walk away, knowing they can now pick up a much better and cheaper car.
It is possible that prices of older cars will come down from their ridiculous highs if subprime sales/lending cools off. Though there are other reasons why they might not, including that new vehicles and 1-3-year-old vehicles from rental fleets have gotten so expensive that many people that used to buy them can no longer buy them, and they step down the ladder, which drives up prices at the older end (a 10-year-old car today is still a nice-looking car).
But subprime is just too small to have much impact. The vehicles are 5-12 years old, or older. This company here funded about $220 million a year in loans at its 40 stores, which is minuscule. A single big new-vehicle store can do that by itself. CarMax, the biggest used vehicle dealer chain, had $30 billion with a B in revenues last year.
In terms of the wholesale market, repos are minuscule. The rental fleets sell between 2.5 million to 3.5 million vehicles a year at auctions, and those are newer more expensive vehicles than repos. Lease-returns were huge at auction. There are other commercial and government fleets that sell lots of units at auction.
I recently listened to the Moody’s Talks Podcast Dated Friday April 14, titled CPI, Cars and Credit Conditions, they go over the current situation in the car business, which I found I interesting if a bit dry. Among other things, one of their guests was saying that delinquencies were high, and that in cases where they would have defaulted, say in pre Covid times, their delinquency was being carried longer by the debt owner.
Can you describe what a “Charge Off” is, how it differs from a loss?
A “charge off” is a phrase used to describe when a creditor / company, etc. acknowledges that a debt by another party is not likely to be repaid. It is therefore moved into a different section of the balance sheet.
It is a ‘loss’ in terms of losing an asset (money owed) but perhaps best understood as a more specific type of a loss.
“What is a charge off”
When loans (of all sorts, home, auto, etc.) start going bad, the lenders (who may be publicly traded and don’t want to recognize realized losses any sooner than they absolutely have to, slow walk those bad loans through multiple incremental stages (30 days delinquent, 60, 90+, nonaccrual, etc.).
The story given out is that delinquent loans may “cure” but, well, hmm…past a certain early point…not so much in reality.
But this set-up buys time for lenders to get their story straight/workout financing with regulators and/or shareholders – in other words, loans can go boots up long before banks/lenders really have to fully admit it financially.
A “charge-off” is more or less when the lender really has to finally and fully admit the full extent of their loss on the loan.
Such “charged off” loans may be bought for pennies on the dollar by specialized “recovery” firms…who because they paid so little for the loan repayment rights (1% of principal?) can haggle/threaten/worry/seduce loan debtors into paying a tiny fraction (10%?) of their debt…and the recovery firm can earn 1000% return on that given loan.
Of course, debtors who haven’t paid in a year…are unlikely to pay anybody, anything, ever…so recovery firms don’t make 1000% return per “charged off” loan on average…but it can still be an insanely lucrative if frequently shady business.
“only about $250 billion or so”
I remember when a quarter trillion dollars was a lot of money.
…Ev Dirksen’s ghost is rolling on the floor and pounding it in laughter (…and tears…).
may we all find a better day.
Why was the LTV so high? Did the dealership sell them a car they knew was worth $13.5k for $20k? Or did the customer know the car was worth $13.5k and the rest were fees? Did the customer get cash back?
The buyer may have rolled the remaining balance on their trade-in into the new loan.
That is most likely not the case.
The people with this kind of credit this bad the dealer instructs them to walk away from the other vehicle and its loan because they are likely far enough behind to have the vehicle repossessed. The people who get these loans aren’t a few thousand upside down on their pristine three-year-old trade.
I have read one of these contracts before (see my post below) and it says in the contract they may not run your credit report. Why bother when they know it’s trash to begin with?
Could be gross profit, BS fees (documentation and handling), rolled the sales tax into the contract, and other things such as a service contract.
“Just make 6 months of payments on time, then refinance with a credit union.”
– dealer
See also, ” I sleep quite well at night, with the fan on, thanks for asking.”
150% LTV!.
Holy moly is right. The car “buyers” were underwater the second they thought about using that dealer…
In fact, that number is so high, it makes you wonder if some laws maybe got indirectly tripped.
Dealers can try and sell for any price they want, but a lot of valuation representations have to be made to multiple parties at various points (tax authorities, floor financing providers, *dealers’* own general lenders, insurers, ABS buyers, etc) and with “true” collateral valuations being so low (with “sale” prices to buyers so high), it makes you wonder if the legal compliance wheels didn’t fall off somewhere in the process.
(“Normal” secured lenders in CRE might demand maximum 70% LTV, because that 30% required borrower equity is a cushion against collateral overvaluation. So what the hell is going on in a 150% LTV? A day one repo would generate an immediate 33% loss to (ABS) buyer-lenders?!)
Also…this is why you haggle with car dealers as though your life depends on it.
“150% LTV”
This is how you get hyperinflation used car prices. It’s fraud. There’s no other way around it.
I am not saying its a good thing, but I am not sure its fraud if both parties are aware of the contract. The real fraud is the FED and .gov backing up these horrible contracts with ZIRP and free money. Hopefully that is behind us.
It’s fraud on the part of whom? The buyer who knowingly pays more in order to not put any cash down or?
I recall, a long time ago in a far away place, when a “gentleman” in a dealership in South Philly was buying a $15K car (which was sticker). The payment announced to him was somewhere in the neighborhood of $535 per month for 48 months. His response? “If the bank don’t care, I don’t care.”.
The dealer rolled the first payment into the contract and made it for the “gentleman” in order to avoid first payment recourse. (aka if the customer doesn’t make the first payment, the dealer has to unwind the deal – and try and find the car, which at that time in South Philly, was long gone through a chop shop).
Not everyone who “gets screwed” in every transaction is innocent… Sometimes they’re willing participants or don’t know what they’re doing. In the latter case, I offer a quote from my father: “Experience is something you get right after you needed it”.
Funny, had a guy ask me to fill his tank at a station because he didn’t have the money to get home in his used beamer. Brakes were worn to powder. Felt sorry so I went ahead. Caveat Emptor children.
EL,
“Not everyone who “gets screwed” in every transaction is innocent…”
I agree, but…
That 150% LTV is apparently the average for all that company’s hundreds (thousands?) of deals that got packaged into the ABS…that ain’t a one-off, that is baked-into-the-business-model.
Again, it might be legal (although see my earlier post) but it is aggressive/abusive/dangerous to both the car “buyer”/borrower and the ABS buyer-lender.
The dealership? Well, the dealership is pretty much just Fast Eddie here.
…wait. there’s more:
If the average loan amount is $20,000, and they packaged $233 million of this ABS in June across 40 dealerships, that means they were selling ~292 vehicles per month! Bit large-ish no? 10 cars PER DAY at a dealership!
They did one issue of ABS per year. Last one in June, 2022.
So $233 million divided by $20k average loan value = 11,650 vehicles per year. Spread over 40 stores = 291 vehicles per store per year = 24 vehicles per store per month. Those are small lots.
Great read!
These shady types like to cloak their scurvy dealing in with patriotic sounding names like US Auto sales , or American Auto Sales. My guess is the next one to go will be Liberty Auto Sales or some such thing. Makes me think it might be better to deal with a better class of scammers who are at least honest about what they do with names like Sleazy Bobs crummy cars or Karls we-cheat-you.
“cloak their scurvy dealing in with patriotic sounding names like US Auto sales”
Well, with Gvt-debt-to-alleged-GDP being well in excess of 100%…
…there is plenty of scurviness to go around.
The Three Stooges had a publicity poster with Larry, Moe and Curley as ‘Dewey, Cheatem & Howe.’
“Asset” Backed Securities? “… and the lender has to go out and repo the vehicle and sell it at auction.”
Hard to believe, but the film ‘Repo Man’ came out thirty-nine years ago.
Seems like they would generate more fees and income if they just put the car back on the lot and resell i instead of auction Possibly wouldn’t lose any money
Yes, this is how it works and why they never want cash customers. If they can, they repossess the same vehicle time and time again selling it repeatedly off the lot. That is their business model.
“The bond sale was backed by the subprime loans it had originated to fund the sales of its used vehicles.”
Sounds like a hustle.
Seneca – was it Mencken who said: “…patriotism is the last refuge of a scoundrel…”?
may we all find better day.
No, it was Dr Johnson.
TSU – much obliged.
may we all find a better day.
These vultures ,get what they deserve,hope they all die and go too hell meaning pe firms
Which Vultures? Why not start with the Federal and state governments who even allow this BS? Look what subprime did to the housing market and economy during the 2000s.
The government response? Bailout the crooks and give them 0% for 15 years.
Actually, it is possible for both/all parties (Parties) to be lyin’ bastards.
Subprime credit became, during these low interest periods, the new welfare. “Let them eat debt,” as Raguran Rajan observed. And the subprime masses developed a culture around it, as they did welfare.
“The crooks,” IMO, were some combination of politicians, some bankers/shadow bankers, and borrowers. Many players had their wish list come true, and it turned into a nightmare — globally. And now that “0% for 15 years” solution has morphed into an endangered/degraded US dollar. We are living in its unresolved shadow.
It is kinda amazing the number of times the buyside can get burned without demanding/paying some disinterested party to do the underwriting of the initial loans.
Having the loan originators (er, ropers) do the underwriting (when everybody knows some huge fraction of loans is going to be sold away (er, dumped) is just a recipe for repeated ABS collapse.
I’m sure there are some sort of theoretical safeguards in the ABS contracts, but if the ropers are collecting/analyzing the loan apps, there are just too many places for skullduggery. Especially considering that the loans may not blow up for a number of years…the initial underwriting audits may not have been great…the retrospective ones that much more hopeless.
I think too many ABS buyers are ZIRP starved and mentally locked into some 1950’s model of how loans work. The concept of ruthless origination doesn’t seem to have sunk in with either borrowers or ABS buyer-lenders.
150% LTVs should be a wake up call.
(It is like ABS buyers can’t conceive that con men are capable of trying to con *them*. I thought this was why ABS originators were required to hold the first-loss “equity” tranche…so they had skin in the game. It doesn’t seem to be working…)
Easy to hate on these guys, and maybe deserved, but the customers are not forced to buy from them. One could start out with a $1k beater car, save up, buy a bit better vehicle, repeat until one has a nice ride. But they just gotta show off, add unnecessary upgrades, and get into a cycle of debt. All of their own making.
There haven’t been $1k beater cars for decades.
When we had our first child in 2009, I bought a minivan for $1200. It lasted 2 years until I could save up for a nice used Odyssey. That was a decade ago.
…don’t forget the supply-skew introduced by the ‘Cash for Clunkers’ program (…effects on air quality a different discussion).
may we all find a better day.
Hard to know that $1000 beaters even exist any more in an ABS-inflated world.
Once a high enough percentage of the mkt goes to “pretend qualify, pretend price”…lower end opportunities may vanish. (See new car mkt too).
If you look at online used car mkts, sub $6000-7000 prices are a tiny, tiny fraction of the total offerings.
These poor people do not have a dime to their name. They need a car to get to work so they can eat and have a few bucks for “shelter”. They have been stuck underwater for decades with no way out. 50% failure rate on ABS. They are designed to fail and the cars are designed to break down before they pay for them. This is how it’s been in the auto $$$ making business for eternity.
yes, this. Thank you. One can’t navigate life without a car in most of the USofA. And yes, poor folks, who will never own a nice house might want at least a decent car. Comments about how these folks should behave from people in entirely different economic circumstances are off base.
“need a car to get to work”
Very American thinking, that a car is the only way to get to work
What about public transit? Bicycles or a motor scooter?
Owning a car isn’t a birthright.
MM, what planet do you live on? Here in Texas we pride ourselves on having minimal public transit so a car is a necessity. The distances between work (usually well off areas) and home (bad neighborhoods where the poor live) are huge – too far for a bicycle or scooter.
Escierto,
I live on a planet called the Boston metro area.
I’ve always owned a car – but gotten got to work via bus/motor scooter because I could not *afford* to drive, or more specifically park.
In Boston and many metros, parking in the city is prohibitively expensive and therefore a luxury reserved for the wealthy. Everyone else takes the bus or train.
NB: my scooter gets 100+ mpg and I can lock it up just like a bicycle. And yes I ride year round, even in winter.
Frank,
I spent $5,000 to repair and fix up my 2000 Suburban (with 230,000 miles), a suburban I paid $5000 to buy back in 2013. I looked on Craigslist for a similar 20+ year old suburbans or trucks and anything under $10,000 was worse off than mine and probably needed more work. There is no such thing as a decent “beater car” under 5,000-$10,000, at least in California.
This comment is way out of touch with reality.
My daughter just sold a used Prius here in San Antonio that was completely functional for $5300 and she was lucky to get that.
Unfortunately Larry Fink et. al. have already been there and learned the Dark Arts
I hear radio ads all the time:
“Got a job? Have 99 cents? Want 125% value for your car in trade? Come to <>!!!!”
Those ads disappeared for a few years, and just came back maybe late last year.
If I understand this right, the big winner is the PE firm who received the proceeds from the sales of the ABS, while the scamming both the investors and the car buyers?
The PE firm might be the big winner, but not because of the ABS. The ABS essentially reimbursed US Auto Sales for the loans it issued to fund the cars it sold. There is a profit margin in there somewhere, but the rest goes to paying for the cars at auction, paying expenses, paying for credit losses, etc.
The big winner here is the credit rating agency.
“ The rating action is primarily driven by USASF’s recent restatement of gross and net loss data for the underlying loan pools,” Moody’s said….
Thanks, Moodys. That’s some hard-hitting insight right there. Way to really research it out and dig through the financials for that independent analysis.
These credit agencies are making bank off of simple cut-and-paste in Adobe and MS Word applications. That’s some great money and best part is, they don’t have to deal with an editor or publisher!
And, the credit agencies will say, their ratings are merely “opinions” (as statements of future contingent events, therefore not statements of “fact”), therefore with no accountability for “fraud.” Fraud is the normal way to hold makers of misleading statements accountable. But I have to blame any investor chasing yield into these swamps, even in times of repressed interest rates. It is hard to play dumb with decades now of subprime history!
Good grief. The “little” guys know better than this nonsense. They buy $800 junk and finance anyone for $800 down.
You were too kind calling this part of the auto business the “slimy underbelly.” I can wrap my head around the high interest rate, but the LTV average is unconscionable. Thank you for reporting on this, I wonder if something is stirring at the bottom end of the economy.
> at the bottom end of the economy
… I think of as the equity tranch, the layer that takes the first losses. Or as the Ponzi layer, the one that gambles with few chips and the worst stakes, hoping to be bailed out by a go-go economy. When the go-go economy “goes” (as it is with interest rate rises), they go, onto the sidewalks. But this matches their poorly constructed balance sheets (i.e., lifestyles).
150% LTV is nothing new. Done on new all the time and the credit buyers have done it for as far back as I can remember. Captive finance companies (those owned by the manufacturer) are as guilty as anyone.
I had a window into the buying practices due to the department I managed at a manufacturer. I’d see this stuff all the time. Funny thing is, about 95% of them went to maturity.
Where this really gets dicey is when the car is totaled and the finance contract is worth more than the insurance company will pay. That’s when that “gap” insurance comes in handy.
Interesting, I’m surprised 95% made it to maturity. I was thinking a 150% LTV coupled with an 18% interest rate is bound to fail.
Between this and your recent CRE (Bloomfield) implosion article, it’s uncanny how seem8ngly any industry can package anything as an “asset-backed security.”
I knew there was some sort of spidey-sense reason I’ve never considered investing in these types of securities and instead have mostly invested in what I could touch and see. Unfortunately, these stories, and personal experiences just make a person suspicious and paranoid – but – obviously, for good reason !!
“But don’t worry, we are…still open to accept your payments and assist in servicing your account. Please continue to make your payments as scheduled…”
You have an eye for the ironic, Mr. Wolf.
I wondered why that is and looked it up. I found this.
“A Wolf can distinguish many more shades of gray and see much better in the dark than [other] humans. A Wolf has relatively sharp vision across much of its visual horizon without having to shift its gaze.”
So that explains everything about you and your work and about why I’m mostly intrigued by your topics while enjoying your style.
In other words…thank you.
Wolves live in a cold but pure reality.
Like San Francisco…
Yeah, like Bay swimmers 😅
That’s awesome!
NAH bear:
Paranoia is defined as ”unreasonable fear”… What you and this article describe is a situation where fear is entirely justified and very reasonable.
Me too, up to now, with investing in RE and other stuff I can touch and improve with my labor and creativity.
Now, late in 8th decade of life, going to the bond and CD mkts; how convenient we are at least approaching decent returns these days, even if not quite there yet.
Subprime is a great product…..for someone else. If only these customers could obtain a credit card and make the purchase for 100% not the 150%. However bad financing did give us that great 1980’s movie “Repo Man” 40 years later nothings changed.
Officer: “…what’s in the trunk?…”.
J. Frank Parnell: “…ohhh, you don’t want to look in there…”.
may we all find a better day.
LOL!
If wholesale price is 10K the dealer will offer u 6K/7K cash. He isn’t a crook. For 9K/10K he can get it online on memo for few days.
The dealer will sell it for 12K, 20% above wholesale price, making
100% markup. The dealer makes his money on buying and mixing it with other bs,
He will finance the 12K car with 15%/18% loan, 1K down, 600/700 dollars transactions fees and 4K annual insurance cost, because u are a poor immigrant with no previous driving record.
A lot of toxic stuff in PE. I am curious what news we will read this year.
Panic as SOFR pegged debt continues to reprice higher and higher. A lot of PE owned companies leveraged up but with razor thin cash flows that cannot afford to double interest expenditures.
Lots of structures out there are resting on assumptions of suppressed interest rates forever. This will get quite interesting. We will see who was swimming naked. These changes also mean fewer investors feel constrained to chase yield into dodgy investments, so various instruments will come under stress.
I have a financially unsophisticated friend who made some dumb decisions and ended up with a $15K Fusion for $20K plus the ridiculous interest rate of mid-20 % from one of these outfits. I had read his finance contract and had never seen anything like it in my life. It was at least eight pages long and of course, nothing in it was good for the borrower.
20% is terrible but modern cars are so reliable and well built that there is hope to run that car into the ground and come out decently, as long as he doesn’t trade that in for another negative equity upgrade
My friend has been in the subprime used car business for 40 years single lot owner . He shuttered his doors this last month and kept his loan book. He is 80. His biggest reason for closing was lack of vehicles he could reasonably sell to his long time customers. He said used car prices were just too high and those vehicles could not be sold at any payment. He would keep his loans because that is where he made his money . Plenty of offers for his loan book each year he says. Same for my friend in the pawn shop business where folks constantly ask to buy his outstanding loans. Higher interest rates and higher used car prices looks to me to be the issue. However this may drive some of the used car prices lower similar to what happened in subprime housing in 2007-8. Hopefully we will keep the higher for longer narrative at the Fed .
The Toyota’s and Hondas from the 90’s are almost all gone now. Modern cars from the last 10 years have a long lifespan but are very expensive to fix if they break. I have a young freind who used to have a mobile auto repair business and fixed the kind of cars that people buy at subprime auto dealers because he was cheaper than the big shops. But as cars got more complicated and expensive to fix he gave it up because his customer base could no longer scrap up the cash to fix their cars when they broke.
That’s why they no longer call mechanics “mechanics” and now call them technicians. To repair many of these cars, you simply start firing the “parts canon” and hope you hit the right sensor/component.
My stepson is on of these low FICO people with an 18 % loan on a old Jetta. I haven’t seen him in a long while. Maybe he is on foot these days! Hard to look for work with no car I guess.
Maybe ‘Milestone’ should change its name to ‘Millstone’
Morgan Stanley tanking due to allowance for loan losses being 4x.
They say its due to commercial real estate and other lending.
Oh boy……the stuff is starting to hit the fan.
It is coming time to show your cards — your true balance sheet.
fred flintstone,
MS only has $8.6 billion in CRE loans outstanding. If all of them go to zero overnight, it would eat up just one year’s worth of net income, and so what. In other words, if all of its CRE loans go to zero, MS would still break even that year.
It raised its loan loss allowances on CRE by $129 million to $335 million. This loss provision was taken against income, and it still made a net income of $3.0 billion. CRE just isn’t big for these big banks. Barely a ripple.
Thanks……I read this stuff without time to do the work……but your insight is very useful.
Excellent point.
The real risk from CRE is at the regional banks some of which have a ratio of CRE/Tier 1 Capital and ALLL greater than 300%.
Bailouts.
Simple.
The “new” way.
And be prepared for something in that vein with the SBF FTX. (where did that Billion dollar story go?)
Lest we forget, Biden signed a bill to give $36 BILLION to Central States Pension fund….mostly to Teamsters…..in Dec of 2022.
And covered deposits at SVB and Signature. Precedents. And where to draw the line?
@longstreet.
Lest we forget, Bush and Paulson bailed out the banks andinsurance companies during the 2008 Great Recession.
This has been going on for a long time. It does not matter who is in the White House.
Both parties just want to keep the party going and kick the can down the road. It’s OPM after all.
And none of them will be in office when the fit hits the shan…
I once knew a guy who owned a sub-prime auto dealership. He would tell these fascinating stories about how he would sell the same cars multiple times. He sold a car and the owner would make payments with a HUGE interest rate (over 20%). The owner would upgrade the car with something like an expensive stereo and then default. My friend would then repossess the car with the upgrades. Repeat …
There was an old-time term for that, “______-rich,” but I can’t repeat that word.
Gee, thanks for sharing. That was insightful.
This reminds me of a great quote from the show Deadwood. One Saloon owner to another:
“Sometimes I wish we could just hit ’em over the head, rob ’em, and throw their bodies in the creek.”
-Al Swearengen
How is this behavior not just robbing the gullible and naive? Amazing.
Does this have anything to do with Ally and Capital One cutting financing to used car dealerships as I’ve been reading?
I think Capital One left this business because it was just a tiny end of its machinery and it didn’t make much money, and so it was better to lay off everyone in that division and cut expenses. Banks have been cutting expenses left and right.
If US Auto Sales used Capital One for its floorplan — I don’t know if it did — it might be an additional complication. But there are plenty of lenders that do floorplan lending. And if one lender walks on you, you can probably find another one, but you may have to pay a higher rate.
This is a good window in too what really underlies the whole rickety U.S. financial economy. At one point ( perhaps back in the 60’s or 70’s) if you owned financial assets you really owned a share of the value and future profit of steel mills, auto factories, and such. But now the financial assets people count on for retirement are based on financing contracts for rusty Jetta’s with 150% LTV, empty office buildings, imaginary currencies and so-called tech companies that spy on people and post cat videos.
As an auto dealer for years in Seattle, Washington my new car dealership sold a few auto contracts to these subprime finance companies, but they discounted the contract substantially to the point there was very little profit for us so we quit using them. I’m sure they booked the contract at full price. Nice assets increase in phony profit and phony bookkeeping. I wonder if their bookkeeper is hiding under their bed now.
Wild stuff! How is this even legal haha?
Old cars (high failure and maintenance costs), mixed with subprime borrowers (couldn’t handle credit -before inflation-)….Huh.
I just don’t understand what could possibly have gone wrong!
The PE managers must not have noticed their sub prime receivables going up in an inferno. Must be pretty grim, that much damage done by their tanking receivables, the few receivables left on their books before they could package them up and sell them to what Wolf accurately dubbed the “consentual hallucination” crowd.
CreditGB-
“I just don’t understand what could possibly have gone wrong!”
Coincidentally, Carvana has packaged $479 Million in subprime car loans to be sold off as a bond.
They better do it quick.
Real data, insightful commentary sprinkled with a bit of humor. Outstanding!
When the chips are down was good for business.
Thanks for your very informative article Wolf. I rarely comment but I feel compelled to give my 2 cents on this subject. My son runs a used car business in a suburban/semi-rural area about 35 miles east of a major southern city. About 40% of his business is buy here pay here (subprime) Since the beginning of the pandemic auto prices have increased exponentially. This is in large part due to Government created inflation. People say they are waiting for prices to come down. Used cars under 15K prices are not going to come down. Customers are frustrated and think dealers are trying to gouge them. This frustration will continue as prices continue to rise due to rising inflation. This is what is going to happen: Many people who have always found a way to have a personal car will be priced out of the market. They will not be happy and this is already happening. This is all part of the current administration policy to eliminate fossil fuel autos but that is a subject for another of your fine articles. Thanks again.
Ken,
I’ve been screaming about the high prices of new cars (and therefore of used cars) for years.
But it’s the EV makers, led by Tesla, that have been slashing their sticker prices. This is the first time I have seen this in my entire life. It’s the legacy automakers that have shifted everything upscale for years. This is not even inflation; it’s a decision to make more loaded upscale vehicles because automakers can make more money on them. That’s Wall Street pressure. The US brands have stopped making their lower-end cars altogether. The average transaction price for new vehicles is now $48k. Which is totally nuts. Many of the Tesla models and trims are well below that. You can buy a Model 3 for 40k after today’s price cuts. GM’s Bolt (a nice vehicle) is now below $30k. It looks like a price war is happening in the auto industry, and that to me is exciting.
There will always be subprime lenders and investment banks that securitize ABS products. With that said, the difference since the Fed lost its mind and committed to endless balance sheet expansion and interest rate suppression is the impact on pensions, insurance companies and other fixed income investors. The Fed is largely responsible for fixed income investors choking down dreck in the search for yield.
Question that is somewhat unrelated to this article:
How does LTV work for non-secured loans like student loans?
150% LTV sounds insane to me.
Since no one seems to ever be making any payments on student loans anymore, and no interest is accruing, I don’t consider them “loans” anymore. They’re something else, maybe a grant of some kind.
Wolf, what do you think would be an acceptable weighted average credit score and weighted average LTV for a subprime auto dealer business in this environment?
The issue isn’t the FICO score. The issue is that the people are getting ripped off, and they know it, and they play along for as long as they can.
If you sell a low-cost reliable car with little markup and a low interest rate (such as 7% now) to people with bad credit, they’ll make the payment. They know they got a good deal, and they need the car, and they can afford the payment, and they will make the payment.
I know this from experience. Back when I was running a big Ford store, I personally guaranteed several car loans with Ford Credit to sell low-end NEW cars (Escorts) to people I knew who had bad credit and who needed a reliable car to get their jobs done. New cars because we could get lower rates and longer terms, and therefore low payments, and they’d have a new car that they were proud of that they could afford. Obviously this is not possible today. New cars have become way too expensive. But older used cars are holding up much better today than back then.
If they had a reliable car and could get to work every day, and could afford the payments, they would make enough money to make the payments. One case I remember well. Ford Credit gave her the 2.9% promo rate it had going at the time, with nothing down, and a piece of junk as trade-in, and I guaranteed the loan. No one ever disappointed me. You give these people a fair deal, and they will treat you fairly too.
Obviously, I didn’t do that for everyone, I’m not that stupid, usually, but for people I knew and understood — and they had horrible credit histories.
Except that’s not how specialized subprime works. Specialized subprime is all about greed. And greed never works.
I cannot understand the prices these days. Middle class people bying a 60k, 80k car? Payment of 1k/month? 18%? 72 months? WTF?
I bought a (then) 2 y/o car, the most reliable ever made, high end Jap SUV, with 28k miles for 39k. 2020. 2.6%. nothing down. 1 more year and done. A keeper for 20 years.
Frugal? you bet.
In a sane financial environment, this type of lending wouldn’t exist at any scale. There would be (virtually) no buyers of this garbage paper because (virtually) no one would buy it with their own money.