Subprime auto loans are going bad at the fastest rate in years

From Justin Brill, Editor, Stansberry Digest:

Subprime auto loans are going bad at the fastest rate in years…

So said a new report out yesterday from Michael Taiano, a director at credit-ratings firm Fitch. From the report…

Subprime credit losses are accelerating faster than the prime segment, and this trend is likely to continue as a result of looser underwriting standards by lenders in recent years…

Fitch expects that deteriorating credit performance will be more acute in the subprime segment, driven to some extent by the expansion of less-tenured independent auto finance companies that have demonstrated higher-risk appetites and less underwriting discipline.

According to Fitch, delinquencies of 60 days or more on these loans are now well above 5%… And they’re quickly closing in on 6%. As you can see in the following chart, these loans are going bad faster than they did during the 2008-2009 financial crisis…

Meanwhile, market-research firm J.D. Power reports used-car prices are plunging

According to its National Automobile Dealers Association (“NADA”) Used Car Guide – out earlier this week – prices fell 1.6% last month. This marks just the second February decline in 20 years. And the firm’s used-vehicle price index plunged nearly 4%, the largest one-month decline since 2008. From the report (emphasis added)…

In a reversal of what typically occurs in February, wholesale prices of used vehicles up to eight years old fell substantially last month, dropping 1.6% compared to January. The drop was counter to the 1% increase expected for the month and marked just the second time in the past 20 years prices fell in February (last years’ scant 0.2% being the other instance).

NADA Used Car Guide’s seasonally adjusted used vehicle price index fell for the eighth straight month, declining 3.8% from January to 110.1. The drop was by far the worst recorded for any month since November 2008 as the result of a recession-related 5.6% tumble. February’s index figure was also 8% below February 2016’s 119.4 result and marked the index’s lowest level since September 2010.

As you can see in the chart below, the index has given up virtually all of its gains of the past six years…

February’s plunge in used-car pricing coincided with another massive 18.1% average increase in new-vehicle incentives. More from the report…

Automakers grew incentive spending once again in February, making it the 23rd month in a row where spending was increased. On average, spending reached $3,594 per unit versus $3,043 per unit in February 2016 according to Autodata.

Among the U.S. Big Three, GM raised incentives by 27.4% in February to an average of $5,125 per unit. Spending at Ford Motor Company rose by 20.9% to $4,012 per unit, while FCA increased incentives by 10.6% to $4,365.

Considered together, these two reports paint a troubling picture…

They suggest the latest auto boom is now rolling over.

Of course, regular Digest readers aren’t surprised. We’ve been warning about these problems for months. As Porter explained in the November 11 Digest (emphasis added)…

Demand for cars has been wildly inflated by both fleet sales to rental companies (which as you’ve seen are now falling apart) and by subprime auto lending… And that means, as subprime lending goes, so goes demand for cars… When auto loans go bad, the cars are repossessed and sold at auction… Big increases in repos and big sales from rental fleets are significantly reducing used-car prices.

Most investors won’t see these important declines in collateral values because they’re watching the Manheim Used Vehicle Value Index. The price index maintained by the wholesale car-auction firm Manheim remains strong… But the key index to watch is the National Automobile Dealers Association (NADA) index. It tracks the market for older cars and records.

The NADA index of used-car prices just “broke down”… Prices are falling down past levels they’ve been above since 2011. This tells us that much lower prices for used cars are coming.

We’ve already seen these problems weigh on some of the most vulnerable companies

Shares of subprime auto lenders like Santander Consumer USA (SC) plunged last year, and still remain well below their 2015 highs. And shares of car-rental firms Hertz Global (HTZ) and Avis Budget (CAR) have plunged in recent months along with used car prices.

But the big automakers have been relatively resilient. Shares of General Motors (GM), Ford Motor (F), and Fiat Chrysler (FCAU) remain at or near all-time highs. But Porter warned it was only a matter of time before they too suffered. More from that Digest

To profit from the collapse in subprime lending, I’d rather target the auto makers themselves, whose big debts and razor-thin margins put them at big risk from any decrease in sales value.

We’ve already seen sales volumes falling (down about 8%) and moves to further reduce supplies. (GM is closing two plants and laying off 2,000 employees.) I’m certain we’ll see more of both moves over the next year.

This, too, now appears to be starting in earnest…

Today, Ford warned that its 2017 results are likely to fall far short of analyst expectations. As the Wall Street Journal reported…

Ford raised a caution flag for the auto industry, saying higher interest rates and a steady decline in used-car values will hurt the most important factor in the recent U.S. sales boom: affordability.

The outlook, coming as the company forecast leaner results for the first quarter, comes amid a broader view that car sales in the world’s two largest markets have peaked after a string of record profits and sales for the U.S. auto industry. Ford estimates volumes will fall in the U.S. and China in 2017 and again in 2018…

Ford expects full-year adjusted operating profits of $9 billion this year, a 14% decline over 2016, due to higher costs and continued investment in autonomous cars and other advanced technologies. The company also guided to first-quarter earnings per share of between 30 cents and 35 cents, lower than the same-period a year earlier and far below analysts’ expectations of 47 cents.

Ford shares fell about 1% today. They’re now down more than 7% in the past five trading days.

Again, this should sound familiar to regular Digest readers…

Porter laid out the bearish case for Ford in particular months ago. As he explained in the November 19 edition of our Digest Masters Series…

Now, I like Ford automobiles. I drive a Ford truck. I don’t have any problems with its products. But Ford didn’t declare bankruptcy back in 2009… like GM and Chrysler did. That puts it at a grave competitive disadvantage. It’s still holding on to $130 billion worth of debt.

What you may not know is that, for all the auto sales over the last five or six years, the growth in the auto industry was powered completely by subprime leases and subprime loans. Those loans are now going bad at an alarming rate… Something like 20% of all of the subprime auto loans securitized over the last three years have defaulted.

The entire business model of selling cars to deadbeat borrowers is done. It won’t come back for another five years or so. As a result, we saw Ford’s sales decline by 8% – which was pretty shocking – year over year.

We think that’s going to continue. We think, eventually, that’s going to put pressure on Ford’s debts. Because within five years, Ford has to come up with half of $130 billion. We know it can’t do that. So whether or not Ford goes bankrupt, in our minds, is completely dependent upon the grace of its creditors.

If we end up in a default cycle, Ford is going to have a really hard time refinancing that debt. And that, of course, could see the share price go from around $12 (where it is now) to well below $5, or maybe even to zero.

Meanwhile, the outlook for shopping malls continues to darken…

We last reviewed the bearish case for mall operators in the March 13 Digest, when we noted Wall Street had found its next “Big Short.”

Since then, the news has only gotten worse, as a number of mall retailers have announced significant store closings or worse… leading some in the financial media to declare that the “retail apocalypse” has begun…

Last week, common “anchor” retailer JC Penney (JCP) announced it will close 138 additional stores by June, or 14% of its existing locations.

On Tuesday, Sears Holdings (SHLD) – the parent of fellow anchor store Sears – said it would close another 150 stores, and it admitted for the first time that it may not survive. Shares plunged as much as 16% on the news. As Bloomberg reported…

Sears suffered its worst stock decline in more than two years after acknowledging “substantial doubt” about its future, raising fresh concerns about the survival of a company that was once the world’s largest retailer.

Sears added so-called going-concern language to its latest annual report filing, suggesting that weak earnings have cast a pall on its ability to keep operating. The 131-year-old department-store chain, which has lost more than $10 billion in recent years, was cited last year by Fitch Ratings as a company carrying a high risk of defaulting…

“Our historical operating results indicate substantial doubt exists related to the company’s ability to continue as a going concern,” the Hoffman Estates, Illinois-based chain said.

Also this week, women’s-apparel chain Bebe Stores (BEBE) announced it is planning to shut all 170 of its remaining mall-based stores and relaunch as an online-only brand. And discount-shoe chain Payless announced it is planning to close 400-500 stores and could file for bankruptcy as soon as next week.

These closings join those previously announced in recent months by Macy’s (M), The Limited, Wet Seal, BCBG, Guess (GES), and others. In total, more than 3,500 mall-based retail stores are expected to close by mid-year, according to Bloomberg.

As you might expect, shares of GGP (GGP) continued to fall this week, too…

The Stansberry’s Investment Advisory short recommendation – previously known as General Growth Properties – is heavily dependent on many of these same struggling retailers. As Porter and his team explained in the September issue of Stansberry’s Investment Advisory

Of GGP’s 115 malls, 90% have a Macy’s, J.C. Penney, or Sears as an anchor store. Even worse, 41% of GGP’s malls have all three of these struggling department stores as anchors

So… department stores are dying, and GGP has the most exposure to these big-box relics. GGP’s underlying business is also weak: It’s not growing revenues. Furthermore, GGP has higher leverage than its closest peers and several problematic properties.

Of the mall owners still sporting expensive valuations, GGP has the wrong tenants, in the wrong types of malls, while sitting in the weakest financial position. It’s the best short candidate in the bunch.

GGP closed at a new two-and-a half year low of just $22.66 on Wednesday… Stansberry’s Investment Advisory subscribers are up 20% as of yesterday’s close.

Regards,

Justin Brill

Crux note: Yesterday, Dr. Steve Sjuggerud recommended shorting oil. Read his analysis right here.

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