What instrument would you guys use to bet against the auto loan market? I'm a RE undergrad, so a lot of the trading stuff is outside my realm of competence.
I heard a speech at my school today from a former PE guy who went out into the subprime auto loan market. He essentially works hand-in-glove with auto dealers to lend to low credit buyers who they wouldn't lend to and the banks that they normally finance with wouldn't lend to either. My understanding from speaking with our finance chair is that this guy is a billionaire a couple of times over from this business.
If you wanted to bet against his business how would you do it? Short the American auto manufacturers, American auto dealers, see if there are credit default swaps available similar to those in the subprime mortgage market? He did mention that these loans were being pooled and securitized, but didn't go into specificity on what scale this is being done on.
how to bet against subprime auto loans
There has been discussion about the subprime lending market for some time now. So it's only natural for investors to begin their speculate about a market downturn and profiting from said downturn.
Here is a piece of recent sub prime auto finance news from Bloomberg.
from certified user @nofundforoldtraders"
a couple things
1) interest rates on subprime auto loans are higher than on houses, so it takes fewer payments to return you principle
2) autos are much more liquid than houses...the lender can repo your car and sell it the next week to somebody else, never needing to lose a full payment cycle. There are more cars sold per capita than houses (cars have a shorter lifespan, and are also an order of magnitude cheaper...avg 25k car vs 250k house)so, even with a high default rate, the subprime lenders don't lose all their money when borrowers default because they just repo and resell the car to somebody else right away. Houses can take over 1-2 years to go thru the default, eviction, cleanup, and resale process...and in that time, value can drop a lot, plus years of missed interest payments.
So, combine all that, and even tho the subprime default rate is very high (vs subprime housing) the lenders don't need the insurance policies to protect against default. This is why no such liquid market exists.
from certified user @Joobacca"
Between these from a securitization standpoint, subprime auto car loans are built to have significant credit enhancement, even in the non-IG tranches, and have triggers that will increase the amount of overcollateralization as well. Subprime mortgage bonds didn't have the luxury of being greatly supported in their deal structure, and you quickly saw junior and mezz tranches have their value wiped quickly. THERE HAS NEVER BEEN A DEFAULT IN ANY SUBPRIME AUTO SECURITIZATION. Sub Auto is really a great long play, that was a relatively low WAL and almost always get called.
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You can short asset back securities, similar to trading corporate bonds and to some extend mortgage back securities.
Not true...... I'm not sure where you got that info but there are zero CDS traded broadly, they are long only instruments. Even Citi came out with a research piece saying there is no way to short the market nor is it smart
Of course he's well off. The core business is selling cars for 2-4x what their worth and financing it at a high interest rate. They usually repossess the cars within 7 months because the buyers can't afford the payments (they still owe money) and then do it all over again with the same car. It's a predatory practice like payday loans.
7 months? Cut that in half... most ABS structures charge-off the loans at 120 days and bring the cars to auction. You can't compare these with payday loans, yes the LTV is above 100 because the dealer has to make money, but they are heavily regulated by CFPB (for now) and I wouldnt classify it as predatory
considering most of the financing has shifted in-house nowadays, it's hard to short one (loans) without the other (the actual car companies). that being said, watch China data for a hint of car sales. after all, they're the largest market for BMW, Mercedes, and Audi. (and perhaps Maserati soon)
Credit linked notes is a way that one can get on the short side of auto loans, but you personally would realistically not be able to do this.
There are zero CDS in subprime auto... The loans are securitized regularly and are very well protected callable instruments that even during the credit crisis had zero defaults. There is no reason to short the subprime and prime auto loan securities... doing your research and due diligence you will see. I work with subprime and prime auto ABS on a daily basis.
If you want to "short" them, find equities that match, like CACC (credit acceptance), CPSS (consumer portfolio services), SC (Santander Consumer), ALLY. I'll be the first to say that shorting them is a waste of money. If you want more specifics feel free to reach out.
I'm looking into pitching a short of CACC in an interview. Why do you think it's a waste of money? And what do you think about potential regulatory risk(s)?
Waste because the short interest is high and the costs are massive (last time we looked into it at my fund it was like 9%) and options are very thinly traded or non-existent... speaking with people who cover it, the people who own the stock are extremely bullish on it and "go after" so to speak, those against it. Its a very weird market for that stock.
Don't take this the wrong way, but this is probably a stock to stay away from in an interview... hear me out first. Unless its interviewing for this industry, chances are your interviewer will have no idea how this company works or how their accounting works (100% not straight forward). unless you truly understand credit acceptance's model and have the ability to talk in full about their deterioration of credit without knowing their delinquencies and ABS remits are totally blank, or totally understanding their holdback model, I would advise to maybe stay away from this one as its hard to describe without a deck in front of you
Regulatory risks are hard to say as CFPB is up in the air at the moment. Could go either way.
investment banks can create credit-linked notes that you can buy. they can also sell you CDS (insurance policies on asset backed securities)
However, they will rake your eyes out to both buy and sell those custom securities...because there is no liquid market. When you only have one counterparty to a transaction...you rely on them to set the price. Recall from the movie TheBigShort....those bets against mortgages were very illiquid...they had to wait for investment banks to agree with their valuation. If you don't time it perfectly, even if you are ultimately correct, you will still lose money.
In general, you will need a minimum of 500mm of capital to play in this game.
I'll take my ball and go home then.
I'm not nearly experienced/knowledgeable enough to execute a short like this with impeccable timing and with my balance sheet the only thing a bank is creating for me is a checking account...maybe.
In general, do you/others see parallels between subprime auto and housing loans, or is my calculus off? Even if I can't play the game yet I'm interested in how experienced traders see this. Just to learn something.
a couple things 1) interest rates on subprime auto loans are higher than on houses, so it takes fewer payments to return you principle 2) autos are much more liquid than houses...the lender can repo your car and sell it the next week to somebody else, never needing to lose a full payment cycle. There are more cars sold per capita than houses (cars have a shorter lifespan, and are also an order of magnitude cheaper...avg 25k car vs 250k house)
so, even with a high default rate, the subprime lenders don't lose all their money when borrowers default because they just repo and resell the car to somebody else right away. Houses can take over 1-2 years to go thru the default, eviction, cleanup, and resale process...and in that time, value can drop a lot, plus years of missed interest payments.
So, combine all that, and even tho the subprime default rate is very high (vs subprime housing) the lenders don't need the insurance policies to protect against default. This is why no such liquid market exists.
There's no securitization of these loans and I doubt there will be...even though a car is a safer instrument than a house the default rates are rising and at this point I seriously doubt anyone would be interested in a product based on these cashflows.
What are you on about dude? There's plenty of auto loan-backed ABS products floating around (incl subprime auto abs products). Default rates might be rising but it's a helluva lot easier to repo a car and resell it than to repo a house and resell it (process is easier and way quicker for autos).
That’s completely the opposite of what I’ve been told by several people...perhaps things have changed in the last couple years?
You can repo a car but that doesn’t mean it will net you back the balance on the loan once sold at auction. I wouldn’t exactly trust subprime auto loan ABS cash flows to repos....that’s not a good idea. Not that they are, but...not really an ideal situation, to say the least.
After all, people walked away from their houses in huge numbers last time, it may be harder to repo a house but often times it’s not even necessary. If the repo’d asset is falling in value or is underwater...you still have a problem. And cars have built-in deprecation, until they get to a certain point. But those cars usually don’t have liens on them.
Again, just giving you my thoughts, if the industry has clearly decided that these are securities they’d like to transact, then I guess that’s what will happen...but it doesn’t mean they’re right, just like it didn’t mean they were right last time.
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