Subprime loans are going bad again.
A “subprime” loan is a loan made to someone with bad credit. If the term sounds familiar, it’s because lenders issued millions of subprime loans during the early to mid-2000s.
Banks made these risky loans thinking housing prices would “never fall.” When they did, subprime borrowers stopped paying their mortgages. The U.S. housing market collapsed, triggering the worst economic downturn since the Great Depression.
These days, lenders aren’t making as many reckless mortgages. But subprime lending is alive and well in the auto market…
Since the financial crisis, subprime auto lending has exploded. According to Experian, subprime auto loans now make up more than 20% of all U.S. auto loans.
Millions of Americans with bad credit now own cars they should have never bought in the first place. Risky subprime loans have also made the auto loan market incredibly fragile.
Right now, people are falling behind on their car loans at an alarming rate. As you'll see, this isn't just a big problem for lenders and car companies… It could also spell trouble for the entire U.S. economy.
• Subprime auto loan delinquencies are skyrocketing…
CNBC reported on Friday:
Delinquencies of at least 60 days for subprime auto loans are up 13 percent month over month for July, according to Fitch Ratings, and 17 percent higher from the same period a year ago.
Folks with good credit are falling behind on their car loans too. CNBC continues:
Even prime delinquencies are on the rise — Fitch Ratings' survey said that last month's prime auto loans were 21 percent more delinquent than in July 2015.
Prime loans are loans made to people with good credit.
• The auto industry is preparing for more delinquencies…
Last month, Ford (F) and General Motors (GM) warned that rising delinquencies could hurt their businesses in the second half of this year.
According to USA Today, both giant carmakers have set aside millions of dollars to cover potential losses:
In a quarterly filing with the Securities and Exchange Commission, Ford reported in the first half of this year it allowed $449 million for credit losses, a 34% increase from the first half of 2015.
General Motors reported in a similar filing that it set aside $864 million for credit losses in that same period of 2016, up 14% from a year earlier.
• Investors who own subprime loans are taking heavy losses…
USA Today reported on Thursday:
[T]hese loans are packaged into bundles which are sold to investors, much like mortgages were packaged into bundles a decade ago before rising interest rates caused many of them to default, eventually triggering the deepest economic crisis since the Great Depression.
The annualized net loss rate — the percentage of those subprime loan bundles regarded as likely to default — rose 7.39% in July, up 28% from July 2015.
You may recall that Wall Street did the same thing with mortgages during the housing boom. They made securities from a bunch of bad mortgages. They marked them as safe and then sold them to investors.
When the underlying mortgages went bad, folks who owned these securities suffered huge losses. These dangerous products allowed the housing crisis to turn into a full-blown global financial crisis.
• By itself, a collapse of the auto loan market probably won’t trigger a repeat of the 2008 financial crisis…
That’s because the auto loan market is much smaller than the mortgage market.
The value of outstanding auto loans is “only” about $1 trillion. While that’s an all-time high, the auto loan market comes nowhere close to the $10 trillion residential mortgage market.
Still, we’re keeping a close eye on the auto loan market.
If Americans are struggling to pay their car loans, they’re going to have trouble paying their mortgages, student loans, and credit cards too.
This would obviously create problems for lenders and credit card companies. It will also hurt companies that depend on credit to make money.
• E.B. Tucker, editor of The Casey Report, is shorting one of America’s most vulnerable retailers…
In June, E.B. shorted (bet against) one of America’s biggest jewelry companies.
According to E.B., credit customers make up 62% of its customers. These customers are 350% more valuable to the company than cash customers.
In other words, this company depends heavily on credit. This is a huge problem…and will only get worse as more folks continue to fall behind on their credit card bills—or stop paying them altogether.
This is already happening at the company E.B shorted. He explained in the June issue of The Casey Report:
And the company is facing another problem…consumers failing to pay back their loans. From 2014 to fiscal 2016, its annual bad debt expenses rose from $138 million to $190 million. That’s a 30% increase. Over the same period, credit sales grew by only 20%. That means bad debt expenses rose 50% faster than credit sales.
He warned that “tough times are coming for the jewelry business.”
• E.B.’s call was spot on…
Last Thursday, the company reported bad second-quarter results. For the second straight quarter, the company’s earnings fell short of analysts’ estimates.
The company’s stock plummeted 13% on the news. It’s now down 10% since E.B. recommended shorting it in June. But E.B. says the stock is headed even lower:
We think there’s more pain to come as credit financing dries up…sales continue to drop…and more loans go unpaid.
You can learn more about this short by signing up for The Casey Report. If you act today, you can begin for just $49 a year. Watch this short video to learn how.
• This is easily one of the best deals you'll come across in our industry…
That’s because Casey readers are crushing the market. E.B.’s portfolio is up 19% this year. He’s beat the S&P 500 3-to-1.
What’s more, Casey Report readers are set up to make money no matter what happens to the economy—and that’s never been more important. To learn why, watch this short presentation.
Chart of the Day
Today’s chart compares the annual dividend yield of the U.S. 10-year Treasury with the annual dividend yield of the S&P 500. Right now, 10-years are paying about 1.5%. Companies in the S&P 500 are yielding 2.0%.
You can see the S&P 500 almost never yields more than 10-years. It’s only happened two other times since 1958. The first time was during the 2008 financial crisis. The other time was just after the recession.
If you’ve been reading the Dispatch, you know the Federal Reserve is partly responsible for this. For the past eight years, the Fed has held its key interest rate near zero. This caused bond yields to crash.
With Treasuries yielding next to nothing, many investors have bought stocks for income. But there’s a problem.
Companies in the S&P 500 are paying out $0.38 for every $1.00 they make in earnings. That’s close to an all-time high. About 44 companies in the S&P 500 are paying out more in dividends than they earned over the past year. Meanwhile, corporate earnings have been in decline since 2014.
Clearly, companies can’t continue to pay out near-record dividends for much longer.
As we explained yesterday, some companies may cut their dividends. This could cause certain dividend-paying stocks to crash. Some investors could see years’ worth of income disappear in a day.
If you own a stock for its dividend, make sure the company can keep paying you even if the economy runs into trouble. We like companies with healthy payout ratios, little or no debt, and proven dividend track records.
Delray Beach, Florida
August 30, 2016
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