JPMorgan Chase & Co. hasn’t done the trades and doesn’t recommend that clients do them, two people with knowledge of the bank’s activities said. Citigroup’s Mary Kane wrote that she advises clients not to do the trade, and an analyst for Wells Fargo said he recommends against such transactions. Spokespeople for the two banks declined to comment.
For investors who see more risks building in auto securities, shorting the bonds is a tempting proposition. Outstanding auto loans grew by nearly 50 percent between 2010 and December 2015, the last period for which the data are available, and now stand at more than $1 trillion. Rapid growth can signal that lenders have not been paying enough attention to risks, as was the case during the housing boom last decade. There were about $170 billion of bonds backed by auto debt outstanding as of the end of last year, up more than 45 percent from 2010, but below pre-crisis highs.
New risks are also emerging that weren’t seen in the last lending cycle. Those include longer loan repayment terms, ballooning loan amounts and more willingness to finance used cars.
More car debt is going bad, at least judging by loans that are bundled up into bonds and sold to investors. Net losses on securitized subprime loans rose to 7.5 percent in November, marking the highest level since 2010, Standard & Poor’s data show. Many of those delinquencies are coming from newer subprime lenders that are less heavily regulated than banks.
"A Real Scandal"
Too many borrowers are likely driving away with cars they can’t afford, said Janet Tavakoli, president and founder of Tavakoli Structured Finance. Tavakoli sounded alarms about the mortgage bubble before its collapse. Now she’s predicting troubles brewing in auto securities.
“The auto loan market is very similar to what we saw before,” she said, calling loan fraud one of her biggest concerns. “Borrowers aren’t well-documented, and in many cases they don’t even need credit scores,” she said. "It’s a real scandal this is happening.”
Even if banks were willing to do the trades, clients would be foolish to bet against auto bonds, wrote Citigroup’s Kane in her recent note. Bonds backed by auto loans have historically performed well during economic downturns, in part because the deals have enough assets backing them to protect investors against a high level of defaults, she wrote.
“Hit films are not the best source for trade ideas," Kane wrote. "The Big Short" movie, based on a nonfiction book by Michael Lewis, was released in December.
No Derivatives