The coming wave of consumer debt defaults, from the subprime auto market to credit cards and student loans, has been a frequent topic for us over the past several months…here are just a couple of examples:
Of course, while it’s relatively easy to recognize the signs of debt bubbles (deteriorating underwriting standards, rising delinquencies, etc.) it’s almost impossible to know precisely when, where or how they will pop…as anyone who lived through the ‘great recession’ can tell you. Which is precisely why Daniel Zwirn (formerly of the now defunct DB Zwirn hedge fund) and currently of Arena Investors, says he’s taking steps today to position his fund to invest in the inevitable “tidal wave of consumer charge-offs” when the various consumer debt bubbles do finally burst. Per Bloomberg:
“We’re about to hit a tidal wave of consumer charge-off activity,” Zwirn says in an interview. “We’re working on positioning ourselves to buy a lot of that. That whole defaulted subprime consumer finance ecosystem is going to be very interesting.”
Zwirn, whose firm is based in New York, sees opportunities in the more than $1 trillion of U.S. student loan debt.
Subprime auto market has shown “cracks for an extended period of time and those are getting worse,” Zwirn says. “A lot of that has been masked by a blazing, white-hot securitization issuance market. We think that will offer opportunities as collateral performance deteriorates.”
“Many people who are buyers of those tradeable corporate, ABS and mortgage securities across the board will close their eyes,” Zwirn says. “As long as the rating is there, they’ll buy it.”
As we pointed out a couple of weeks ago, one potential catalyst, at least for the auto loan market, may come in the form of private equity firms throwing in the towel on roughly $3 billion worth of subprime auto bets they made in the wake of the ‘great recession’ that have made no money over the past eight years.
A Perella Weinberg Partners fund has been sitting on an IPO of Flagship Credit Acceptance for two years as bad loan write-offs push it into the red. Blackstone Group LP has struggled to make Exeter Finance profitable, despite sinking almost a half-billion dollars into the lender since 2011 and shaking up the C-suite multiple times. And Wall Street bankers in private say others would love to cash out too, but there’s currently no market for such exits.
Since the turn of the decade, buyout firms, hedge funds and other private investors have staked at least $3 billion on non-bank auto lenders, according to Colonnade. Among PE firms, everyone from Blackstone and KKR & Co. to Lee Equity Partners, Altamont Capital and CIVC Partners waded in.
Many targeted smaller finance companies that often catered to the least creditworthy borrowers with nowhere else to turn. Overall, subprime car loans — those extended to people with credit scores of 620 or lower — have increased 72 percent since 2011. Last year, about 20 percent of all new car loans went to subprime borrowers.
“The PE guys sailed into this thing with stars in their eyes. Some of the businesses have done fine and some haven’t,” said Chris Gillock, managing director at Colonnade Advisors, a boutique investment bank. But right now, “it’s about as out-of-favor a sector as I can think of.”
As it turns out, making money on consumer finance companies only works to the extent that manufacturers maintain some level of discipline and refrain from exploiting their captive finance companies to flood the market with new supply…a move which will eventually lead to crashing used car prices and massive subprime securitization losses.
Unfortunately, as we pointed out last month, a review of the latest Fed data on auto loans underwritten by “Banks and Credit Unions” compared to those loans provided by “Auto Finance” companies prove that the nightmare scenario is playing out for independent subprime lenders…
First, taking a look at auto loans provided by traditional banks and credit unions, one can see some marginal deterioration in subprime auto loans. That said, the deterioration is certainly nothing substantial with 90-day delinquencies pretty much in line with 2004/2005 levels and no where near the rates experienced in 2008/2009.
But, a drastically different picture emerges when looking at just the auto loans originated by America’s auto finance captives. To our great ‘shock’, auto OEMs in the U.S. seem to have been much more “flexible” on underwriting standards over the past couple of years resulting in delinquency rates that nearly rival those last experienced at the height of the great recession.
Of course, waiting for bubbles to burst can be about as rewarding as watching paint dry so we sincerely hope Zwirn is a patient investor.