Tag Archives: subprime credit

Who’s Going To Stop The Madness?

Financial Markets, Gold, Housing Market, Market Manipulation, Precious Metals, U.S. Economy, , , , ,

Every month consumer debt in aggregate hits a new record. Auto loans and student loans have been hitting monthly record highs for quite some time. In November credit card debt hit a record high in total and increased a record monthly amount for any one month. Mathematically this can’t go on forever. In fact, there are signs – indicators not reported widely by the financial media and, predictably, completely disregarded by Wall Street – that indicate the debt party is coming to an end. Events that follow the end of the party will be less than pleasant for the majority of U.S. households.

Every week in the Short Seller’s Journal I present data which reflects the deteriorating condition of middle class America. For definitional purposes, “middle class” is defined as any household that is unable to afford their own politician, which means 99.5% of all households.

As an example, buried in Wells Fargo’s Q4 earnings presentation was data that showed charge-offs in WFC’s credit card loan portfolio in Q4 soared 21% vs. Q3. The charge-off rate as a percent of average loans outstanding increased to 3.66% in Q4 from 3.08% in Q3. This is a 19% increase in the charge-off rate. While this might seem like a low number outright, not only is it headed in the wrong direction, it’s not too far below the nationwide bank credit card charge-off rate in 2007 of 4.15%. Again, this fits my thesis that the financial condition of the average household is deteriorating.

In addition, the dollar volume of auto loan originations at WFC declined 33% and home mortgage originations fell 26%. in Q4 2017 vs 2016. WFC’s mortgage applications in Q4 dropped 16% in dollar volume from Q4 2016. And its application pipeline (applications submitted and waiting for the purchase to close) declined 23% for the quarter vs Q4 2016.

WFC is the second largest mortgage originator after Quicken Loans. It is also a major player in auto loan underwriting. If auto and mortgage loan origination statistics are declining at a double-digit rate at WFC, it’s a good bet that this is a secular trend across the industry. Simply put, middle America – the 99.5%’ers – are running out of capacity to assume even more debt. This in turn will translate into a unexpectedly precipitous drop in consumer spending, especially on large-ticket items like cars, furniture and homes.

I stumbled on a blog a couple weeks ago called  A Cold War Relic. The proprietor works at an auto dealership and presents valuable insight on the factors that will drive auto sales into the ground and send auto loan defaults soaring. His latest post, “What’s Going To Stop Me,” is well worth reading:

This dark momentum could strangle the industry, but everyone refuses to stop it. Every time a customer accepts a $500 monthly payment on another overpriced compact crossover, they are feeding that momentum. When dealers structure deals for far more than the car is worth, they are feeding that momentum. The problem is: who is going to actually tell anybody “no?” Customers want their cars and refuse [do not have the funds] to put money down to get them. A large number of dealerships are fighting to attain sales numbers the market can’t currently support.

I get cursed out every month when our store misses the targets set for us by the manufacturer, even though I’m fighting against larger stores offering deeper discounts on new cars. On top of that, it’s not just your credit criminal customer that isn’t reading what they’ve signed anymore. When you have consumers with 700+ FICO scores rolling over portions of debt they already couldn’t handle on top of new debt and financing the whole thing over increasingly long terms at interest rates they arguably no longer deserve. The problem is that prime credit customers are slowly becoming credit criminals.

You can read the rest of this here (highly recommended):   Auto Loan Crack-Up Boom Coming

In the latest issue of the Short Seller’s Journal, I present a no-brainer homebuilder short idea plus I illustrate the mechanics of shorting a stock for those who only use put options.  In addition I review the Company’s fundamentals.  This is probably the only homebuilder for which unit sales are dropping – in this case falling at a double-digit percentage rate. I believe shorting this stock is good – at the very least – for a 30% ROR by the end of the year, if not sooner. You can find out more details about the Short Seller’s Journal here: Subscription Information.

The Debt Bubble Is Beginning To Leak Air

Financial Markets, Housing Market, Market Manipulation, Precious Metals, U.S. Economy, , , , ,

“The current state of credit card delinquency flows can be an early indicator of future
trends and we will closely monitor the degree to which this uptick is predictive of
further consumer distress.” – New York Fed official in reference to rising delinquency rate of credit cards.

The recent sell-off in junk bonds likely reflects a growing uneasiness in the market with credit risk, where “credit risk” is defined as the probability that a borrower will be able to make debt payments. This past week SocGen’s macro strategist, Albert Edwards, issued a warning that the falling prices of junk bonds might be “the key area of vulnerability that could bring down the inflated pyramid scheme that the Central Banks have created.”

The New York Fed released its quarterly report on household debt and credit for Q3 last week. The report showed a troubling rise in the delinquency rates for auto debt and mortgages. The graph to the right shows 90-day auto loan delinquencies by credit score. As you can see, the rate of delinquency for subprime borrowers (620 and below) is just under 10%. This rate is nearly as high the peak delinquency rate for subprime auto debt at the peak of the great financial crisis. In fact, you can see in the chart that the rate of delinquency is rising for every credit profile. I find this fact quite troubling considering that we’re being told by the Fed and the White House that economic conditions continue to improve.

While the Fed reports that 20% of the $1.2 trillion in auto loans outstanding has been issued to subprime borrowers, there tends to be a significant time-lag between when an individual’s credit condition deteriorates and when the FICO score reflects that deteriorated financial condition. I would argue that the true percentage of subprime auto debt outstanding is likely over 30%.  Bloomberg reported last week that “delinquent subprime loans are nearing crisis levels at auto finance companies.”Before the 2008 crisis, the outstanding level of auto loans peaked in late 2005 at $825 billion. The current level based on the most recent data is over $1.2 trillion, or nearly 50% higher than the previous peak. More troubling, the average loan balance, at close to $30,000, is substantially higher now.

Revolving credit is now over $1 trillion. At $1.005 trillion, it’s slightly below the previous peak of $1.020 trillion in April 2008. Most of the revolving debt category as tracked by the Fed is credit card debt. The Fed reports that 4.6% of credit card debt is 90-days delinquent, up from 4.2% in Q3. I would note that the Fed relies on reporting from banks and consumer finance for the delinquency data. Accounting regulations give banks a fairly wide window of discretion before a loan is officially declared to be delinquent. Banks and consumer finance companies tend to drag their feet before declaring a loan to be delinquent because it directly affects quarterly earnings. I would bet money that the true delinquency rate is higher than is being reported.

Mortgage delinquencies are now following the trend higher in auto, student and revolving loans:

The data in the graph above is sourced from the Mortgage Bankers Association (MBA).  MBA data is lagged. again because of reporting methodology and because banks under-report delinquencies.  As such, the true current rate of delinquency is likely higher. I drew the red line to illustrate that, outside of the period from 2009 to 2014, the current rate of delinquency is at the high end of the historical range going back to 1979.

Let’s drill down a little deeper. The delinquency rate for FHA mortgages soared to 9.4% in Q3 2017 from 7.94% in Q2. That jump in the rate of delinquency is the highest quarterly increase in the history of the MBA’s survey. Recall that the FHA began offering 3.5% down-payment mortgages in 2008. Because of the minimal down payment requirement, the FHA’s share of single-family  home purchase mortgage underwriting went from 3.9%  2007 to it current 17%  share.  In effect, FHA replaced the underwriting void left by the bankrupt private-issuer subprime lenders like Countrywide and Wash Mutual.  It’s no surprise that FHA paper is starting to collapse.  Fannie and Freddie started issuing 3% down-payment mortgages in early 2015.  All three agencies (FHA, FNM, FRE) reduced the amount of mortgage insurance required for low down payment loans. Just in time for the FHA complex to start cratering.

The reduction in mortgage qualification standards was implemented by the Government in order to keep the homes sales activity artificially stimulated. Do not overlook the fact that the National Association of Realtors drops more magic money dust on Congress than the Too Big To Fail Wall Street banks combined.

The rising trend in consumer and mortgage debt delinquencies will, for a time, be dismissed as temporary or related to the hurricanes. The MBA applied a thick layer of “hurricane mascara” on the mortgage delinquency numbers. But the massive debt bubble inflated by the Fed and the Government is springing leaks. And the debt delinquency trend is seeded in economic fundamentals. The BLS released its real earnings report this past Wednesday, which showed that real average hourly earnings declined for the third month in a row. It’s no coincidence that debt payment delinquencies are rising given that after-tax income for the average household is getting squeezed. This will get worse when soaring health insurance premiums hit starting in January.

St Louis Fed President, James Bullard, asserted last Wednesday that there’s no need to raise interest rates with inflation low. I have to believe that these folks at the Fed are intelligent enough to understand that the “official” inflation numbers are phony. Given that assumption on my part, the reluctance of the Fed to raise rates – note: I do not consider the 1% hike in Fed funds over the last two years to be material – is from the fear of crashing the system.

Many of you have seen the recent reports of the “flattening” Treasury yield curve. This occurs when short term Treasury rates rise and longer term rates fall.  A flattening yield curve is the market’s signal that the economy is in trouble.  Currently, the yield spread between 2-yr and 10-yr Treasuries is 59 basis points.  The last time the Treasury curve was this “flat”  was  November 2007.

The front-end of the curve is rising for two reasons. First, the Fed let $10 billion in short term T-bills expire without replacing them, which took away the Fed’s bid for short term Treasuries. Second, when short rates rise relative long rates, it’s the market’s way of discounting an uptick in the potential for financial distress.

If the Fed were in a position of “normalized” monetary policy, it would likely be lowering rates in response to the obvious signs of rising financial distress.  But the Fed is backed into a corner.  Rates have been zero to near-zero for so long that the credit market is largely “immune” to taking rates back down to zero from the current 1% – 1.25% “target.”

The Fed inched its way into reducing its balance sheet by letting  SOMA assets fall $10 billion in value since early October.  At that rate it would take 35 years to “normalize” its balance sheet. Yet, the Treasury curve is telling us that the Fed should be easing monetary policy, not tightening.  The Fed has an 80-year track record of removing liquidity from the system at the wrong time.

The commentary above is an excerpt from the latest Short Seller’s Journal.  Two short ideas were presented in connection with the analysis presented.  To learn more about this newsletter, click here:   Short Seller’s Journal info.