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A Match Made In Subprime Hell
Coming off of the best year for ABS issuance in the U.S. since 2008 and just in time for both total auto loans and total student debt outstanding to top the $1 trillion mark, we get a match made in FICO hell as the subprime lending unit of AIG (the poster child for misjudging credit risk via CDS) Springleaf has purchased OneMain, another subprime lender that’s been relegated to Citi’s Citi Holdings trash bin for years. Springleaf, whose shares rose 25% today as if no one had seen this deal coming, is paying $4.25 billion for OneMain and expects the deal to be accretive to 2017 earnings by nearly $500 million.
The deal creates a subprime lending powerhouse with some $14 billion in possibly-not-toxic receivables. It also brings together two companies that have spearheaded the unlikely re-emergence of ABS backed by subprime personal loans. In 2013 for instance, Springleaf did a $604 million ABS deal backed by nearly 200,000 personal loans (average FICO 602) with maturities ranging from 2-4 years and carrying fixed rates as high as 35%. Here’s what we had to say about the deal at the time:
Yet even in the last days of the bubble, Wall Street had a certain integrity - it sold securitized products collateralized by houses, which as S&P, and certainly Moody's, will attest were expected to never drop in price again. But one thing that was hardly ever sold even in the peak days of the 2007 credit bubble were securitizations based on personal-loans, the reason being even back then everyone's memory was still fresh with the recollection that it was precisely personal-loan securitization that was at the core of the previous, and in some ways worse, credit bubble - that of the late 1990s, which resulted with the bankruptcy of Conseco Finance. Well, in a few short days, those stalwarts of suicidal financial innovation Fortress and AIG, are about to unleash on the market (or at least those who invest other people's money in the absolutely worst possible trash to preserve their Wall Street careers while chasing a few basis points of yield) the second coming of the very worst of the last two credit bubbles.
Nevertheless, the deal was oversubscribed (investors reaching for yield wherever the can find it, even if it’s via a chunk of someone’s jet ski loan) and as Reuters noted at the time, there was “heavy interest in the lower tranches” meaning investors didn’t just want a piece of the deal, they wanted the worst piece (which incidentally carried a 5% coupon). For all the visual learners out there, here’s what this particular deal looked like:
Emboldened (and probably surprised) by their initial success, Springleaf was back at it not four months later, contemplating another $400 million ABS deal.
In 2014, the company set up two VIEs (Whitford Brook Funding Trust 2014-VFN1 and Springleaf Funding Trust 2014-A's) for the purpose of selling almost $900 million in ABS backed by consumer loans, and just last month, the company priced a $1.16 billion deal.
For its part, OneMain did a $760 million deal in April of last year (backed by quite a few unsecured loans) followed by a $1.2 billion dollar deal around three months later. The company went on to do 2015’s first securitization backed by consumer loans, a January deal that was upsized to $1.2 billion.
While the totals here aren’t large relative to size of the ABS market, the fact that these deals are seeing significant interest given the underlying assets is disturbing considering both recent trends in the subprime auto market and the fact that investors are likely to become even hungrier for yield as central banks continue to keep a lid on spreads for higher quality assets.
The larger concern however, is that today’s deal combines the two largest players in this market, both of which have undoubtedly been emboldened by the success they’ve seen with recent securitizations. For evidence of this, look no further than the following exchange between Springleaf CEO Jay Levine and Citigroup (imagine that) analyst Donald Fandetti on the company’s Q3 call:
Fandetti:
Jay, I was wondering if you talk about the depth of the securitization market for personal loans. Obviously, you did a big deal this quarter. Are investors very receptive to this product? And also, it looks like you retained some of the notes, was that more opportunistic this quarter?
Levine:
Great question. What I'd say is a couple things. I think there are 2 different types of transactions. First, on the personal loans, which is supporting our business and I think we've seen both ourselves and our OneMain competitor both tap those markets. I think we've both experienced overwhelming demand, large numbers of new investors coming into each transaction. And probably both times and a few times we've gone, as well as I think from what we've heard. When they went to the market, there's been real demand and we all could have of done larger size than was anticipated at the time.
So I would say while it's a reasonably new market or a back to the future market, what that had been bigger while ago but has been renewed over the last couple years. We think there's significant room to expand beyond where either of us have gotten so far. And the piece that we kept on the SpringCastle, Don, it was strictly opportunistic. We had cash, there were liquid securities, there was significant demand. But we thought it was a good place to put some of our cash to work given our comfort with the portfolio.
This makes it abundantly clear that the combined entity will almost undoubtedly look to meaningfully increase the number of personal loan securitizations brought to market, and with only $14 billion in combined receivables, it’s not hard to imagine the company looking to ramp up lending in order to feed a market that’s taking down $1 billion in notes at a time. As we saw during the real estate boom, increased demand for loans to feed the securitization machine invariably leads to a relaxation of lending standards something the market for subprime personal loans backed by everything from appliances to jewelry can ill afford if it’s to retain any modicum of stability. Indeed, the companies are already discussing how to speed things up and boost creativity.
From UBS:
OneMain recently invested $100MM into a new front end system for underwriting to increase efficiencies which will be rolled out across the combined business. Management expects a 5.6% ROA for the combined company (up from the current 3.9% ROA experienced by LEAF). LEAF, which has been growing its loans per branch, anticipates the combined company should be able to achieve beyond the $7MM/branch which OneMain currently experiences.
LEAF plans to expand its product capabilities including direct auto finance, as well as launch an online origination business in 3Q15.
...and here’s Barclays:
Given that neither OneMain nor Springleaf, as standalone entities, has access to cheap deposit funding, we think it is likely that any combined entity would continue to tap the ABS markets for financing.
Levine (who, by the way, will head the combined company), sounded disturbingly nonchalant on the quarterly call when asked a softball question about the behavior he seems among borrowers:
Fandetti:
Got it. And then on your customer behavior, what are you seeing these days? Are your customers more willing to take on debt? Obviously, gas prices have come down, that's meaningful to the sub prime market. Does that make you feel a little bit better about the portfolio as well in terms of coverage?
Levine:
Absolutely. It's funny how important just gas on the margin can be to a lot of our customers. I've used this stat probably on every call and every time. Nearly one out of 2 Americans doesn't have the liquidity they need in the bank to support an emergency. And certainly gas prices help. But in general, we're seeing better job stability, we're seeing better income numbers, I think across the board our customer tends to be in better shape.
Actually Jay, it’s not funny at all. Gas prices are that important to your customers because your customers generally don’t have much disposable income. In case the point isn’t clear enough: they are absolutely not the kind of people who can afford to get stuck underneath high interest loans, and besides, if gas prices are that important, it must mean that when oil prices rise, these same customers will once again struggle to make payments.
Finally, notice how the issue of regulation is quite literally written off as a formality by the Citi analyst:
Fandetti:
Okay. And then just lastly, to check the box on regulatory for personal loans. Any updates from last quarter, or is it pretty much the same?
Levine:
I'd say status quo. You see what we see. The CFPB has yet to write specific rules around installment loans. There was guidance put out and regs put forward in terms of auto lending. We think that's largely focused on the indirect lenders.
In other words: nothing to see here folks, move it along.
* * *
It seems to us that the Springleaf and OneMain deal is the product of a yield-starved investor base that, as we’ve mentioned in the past, is predisposed towards Einsteinian insanity thanks largely to an abject refusal to learn from the past. Here we have the two main players in an exceptionally risky market (that has mercifully lain dormant for nearly two decades), merging at a time when investors are literally being forced to take just the kinds of risks the combined entity will be peddling by the billions.
While the market for non-traditional ABS may currently represent a relatively small percentage of total issuance, note that last month, ABS backed by assets like personal loans was second only to securitizations backed by auto loans (another incredibly dicey market):
In closing, note what we said earlier this week about the inevitable collapse of the subprime auto market, as it is equally (if not more) applicable here:
This is perhaps the clearest sign yet that we have learned literally nothing from the crisis years. That is, this is precisely the same dynamic and it will end precisely the same way: defaults will rise, investors in assets backed by these loans will suffer outsized losses, and the assets themselves will become completely illiquid.
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Just arranging it all in one bailout package. The last bailout was too politically messy.
The government is encouraging this so that U.S. T-Bonds don't look so bad.
Sweet baby Jesus, please help these little companies to find a way to use derivatives to drop-kick the US banking system on their way to BK.
The Bigger Short?
And I wouldn't care about ANY of this if I didn't know that when the next "crisis" comes, we'll be bailing out these bastards with our tax dollars.
The game these days is to be as risky and big as you possibly can. Then you can tell the government "drop your guns or the ni**er gets it."
Cue the comments from people that never read a filing for LEAF or have a modicum of understanding of the ABS market. Remember, it's Goldman's fault.
I just don't understand the justification for placing this kind of security in your portfolio, especially the lower tranches. It's like playing Russian Roulette with only one bullet taken out of a revolver.
Cannibals
"Move the money! Stuff it! It doesn't matter how you do it, move that inventory! Bad credit? No problem! We need to make money on the loan, then have a write off and get a settlement from your Parents, Grandparents, or Great-Grandparents when you default! We'll re-possess the vehicle, shine it up, and do it all over again with another bad risk! Somebody buys the car, somebody pays us a fee, somebody pays the bankruptcy settlement, and if SHTF we get bailed out on the taxpayer dime! Amurika!"
depends who is sitting on the losses and HOW MUCH WAS CONtributed to whom.
Well I gotta say this (reaching for yield) is 'prolly NOT about individual stupidity. Sorry in advance for all the quotes but I have latched on to a bit of Galbraith - who was also VERY unpopular with his progostications, but here goes - cribbed from:
http://310907.blogspot.com/2011/01/short-history-of-financial-euphoria.html
“Anyone taken as an individual is tolerably sensible and reasonable – as a member of a crowd, he at once becomes a blockhead.” – Frederich Von Schiller
Soooo - the likely hopeful blockheads here loading up on toxic waste is YOUR pension fund and YOUR insurance firm - as they strive to reach that promised yield level (8% WOW!).
I was thinking of Kyle B when he remarked on financial memory being incredibly short, but after a bit of googling it appears that Galbraith wrote a whole book on the subject:
A Short History of Financial Euphoria
from the blog:
"The first is the extreme brevity of the financial memory. In consequence, financial disaster is quickly forgotten. In further consequence, when the same or closely similar circumstances occur again, sometimes in only a few years, they are hailed by a new, often youthful, and always supremely self-confident generation as a brilliant innovative discovery in the financial and larger economic world. There can be few fields of human endeavour in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present."
Finishing with a Keynes quote reference from Galbraith:
“Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.”
The sad thing is:
That it is YOUR pension fund and YOUR insurance firm, once conservative investors, MUST now be SPECULATORS, forced into this role by Financial Repression. Thanks Bernakellen...
Don't. Whatever you do,whine about this. Golden opportunies only come once in a lifetime. . Get stuck in, mine it for all your worth, get loan after loan on anything that you can sell the next day. Boat,plane even, use the proceeds to pay yourself more income lie like a banker and get moar. nThen cash all in and fuck off just as you get the whisper that the shit storm is burying people in your city
Yep, here comes that word Tranches again, Ya know those packaged up and gift wrapped with a bow, Special investments that only a few are going be lucky enough to get access to buy; Sliced and Diced Just right for the perfect bite-sized morsel.The things that Citibank are predicting that investors demand is spiking off the charts to get their hands on some.
"We have to buy it to see whats in it." MBS securities fraud 2.0
P. T. Barnham was right. There is a sucker born every minute.
New Mexican "legislators", aka, TOTAL bank stooges, have decided that pay day lenders can continue to help consumers with 400% interest rates. Thus proving that banksters own the votes, so.... fuck you serfs! Any wonder NM is last in education? See how dumbing down the poplulace allows for idiots to be elected.
Oh, by the way, look up Lt. Brachle shoots fellow officer in drug bust. Hint: they let the drug dealers go with no charges to avoid having the dealers say on the record what happened. Ah...New Mexico...shoot first and ask questions later...maybe and only IF you didn't bury the crime.
Santa Fe DA and Court system are in the pocket of the banks as well. Golly, am I surprised!
Are we more corrupt than New Jersey? I smell a challenge...
FIG? Fuck you and Nationstar Mortgage, LLC too!
As a visual learner, I'd have tried to fit that blue graphic into a garbage can shape:
https://athursdayschild.files.wordpress.com/2011/01/garbage-can_rgb.jpg
Who's writing naked CDS on the weak tranches?
http://davidstockmanscontracorner.com/the-student-loan-bubble/ The $1.2 Trillion Student Loan Bubble——The Ultimate Subprime Debacle
A good read.