I’m going back to the theme of shorting subprime lenders.
music selection: “If You Don’t Start Drinking (I’m Gonna Leave) — George Thorogood
weigh-in: 208.8 (4.2) – back on pace!
Total consumer debt fell rapidly after the 2008 financial crisis. It has since crept back up to the level seen just before the last blow up. Worse, even more of the consumer debt out there is to subprime borrowers this time. I’m putting on two shorts. One to target subprime credit card lending and one to target subprime auto lending.
First up is Capital One Financial Corporation (COF). I shorted them before and was early to the party. I booked a small loss after capitulating. I’m ready to try again. Back in 2007, Capital One’s loan losses totaled around $2.6 billion. In 2008, losses nearly doubled to $5.1 billion, wiping out the company’s entire profits. The stock plunged from around $83 a share to $8 a share by March 2009. The weak link with COF is they issue a lot of subprime credit cards. There is no collateral and the borrowers already have a history of late and non-payment. Curiously, subprime credit card lending is their core business. By my estimates every 1% increase in default rates wipes out around 700 million in net income. A 2% increase wipes out their tangible equity and sends them into panic mode to raise new capital, probably by heavily diluting existing shareholders. I sold short 61 shares at 82.161 this morning.
Next up is Santander Consumer USA Holdings (SC). This is a big auto lending company that is heavily dependent on making subprime loans and unloading them as bundles in the Asset Backed Security (ABS) market. Here’s a statistic that should leave long investors alarmed. At the end of last year, SC reported 83% of its 27 billion in auto loans was subprime (FICO score less than 640). Santander has increasingly bet its future on creative lending to borrowers who cannot afford to repay. They have collateral but that collateral is likely to be worth less than what is on the books when a large default cycle starts. (Credit moves in cycles.) Millions of used cars on the market as fresh supply will suppress prices. This is the core of my thesis on shorts of GM, F, CAR, and HTZ. With Santander, when the price of used cars begins to fall; the market’s appetite for ABS backed by used cars dries up. Santander will find itself in a liquidity crisis and be forced to reach even farther with even more questionable underwriting to generate revenue. It is a death spiral. I sold short 380 shares at 13.1107.
These short positions were entered into with the intent of turning a profit. They also have a side benefit of acting as a hedge against a general downturn in the market and lower my Beta by introducing negatively correlated assets. There is also almost 10,000 dollars in cash deposited in my account serving as low cost leverage. Either way, this should boost and smooth out returns.
Devour your prey raptors!