Is A Subprime Auto Loan And/Or Contingent Convertible Bond Crisis Looming?

On Monday, Fitch Ratings issued a press release discussing the performance of subprime auto asset-backed securities (ABS), which take many subprime auto loans and package them together in a process known as securitization. Subprime mortgages packaged in a similar manner are seen as being responsible for the 2008 subprime mortgage collapse. According to the release, delinquencies with subprime auto loans have hit the “highest level since 1996.”

While perhaps not obviously related, contingent convertible securities being sold in Europe pose the risk of triggering a clause in their terms that would lead to their conversion to stock, which, while improving the issuing bank’s balance sheet, would result in a flood of supply to the market, not to mention dilution to earnings per share numbers.

Bloomberg describes contingent convertible securities, referred to on the street as “CoCos,” as a “cross between a bond and a stock” and of being a “high-yield investment with a hand grenade attached.” The irony is that these investments, which by all reporting have suffered a major draw-down in value over recent months, were created as a means of bolstering the financial positions of banks to meet with more stringent regulations, themselves a reaction to the 2008 subprime mortgage meltdown. It all seems seems eerily similar to the situation that Gary Kaltbaum with Fox News suspects might be occurring before us, ripe for “all heck” to break loose in a “bad economic scenario;” that irony has not been lost on observers.

Recent news out of the European Central Bank that the agency intends to buy corporate bonds, as reported by the NASDAQ, is seen as being almost unprecedented. Combined with negative interest rates, as reported by the Financial Post, the buyback news from the ECB marks a curious time in the economic history of the globe.

Examples of ABS securities that bundle subprime auto loans include securities issued by Ally Auto Receivables Trust (AART) 2015-2, as reported by Moody’s, and Skopos Auto Receivables Trust 2015-2, as reported by Business Wire.

“Subprime annualized net losses… have followed the rise in delinquencies, reaching 9.74% as of February, an increase of 34.10% YoY and 11.59% MoM from January,” the release from Fitch reads. The large year-over-year and month-over-month changes would seem significant.

Markets in shares for two publicly traded auto financing companies, Santander Consumer USA Holdings Inc. (NYSE: SC) and Consumer Portfolio Services, Inc. (NASDAQ: CPSS), have witnessed selling over recent sessions. Santander was down 8.9 percent on heavy volume yesterday, hovering just above its 52-week low, while Consumer Portfolio Services went along for the ride, finishing the day down 3.9 percent on above-average volume, just off its 52-week low of $3.64.

Wall Street consensus EPS estimates for Santander have been slashed from $2.75 to $2.30 for 2016 and from $2.93 to $2.44 for 2017 over the past 90 days. Further, Santander missed expectations with its most recent quarterly results by 66 percent; the company delivered $0.19; the market was looking for $0.56. Shares have reacted as one might expect.

The story is similar with fellow subprime auto lender Consumer Portfolio Services. Over the past 90 days, estimates for full-year 2016 CPSS EPS have been taken down from $1.16 to $1.03 and for 2017, from $1.17 to $1.05. Again, shares have reacted accordingly. Consumer Portfolio Services beat analyst expectations in the fourth quarter of 2015 by 7.4 percent.

Analysts are forecasting that both Santander and Consumer Portfolio Services will report year-over-year EPS reductions over coming quarters.

A Form 8K filed with the Securities and Exchange Commission details a multi-hundred million dollar deal involving Ally Financial Inc. (NYSE: ALLY) and Deutsche Bank AG (NYSE: DB) and some of the Ally subprime auto loan securities described above.

“Subprime auto loans aren’t big enough to take down our megabanks, the way subprime mortgages had done. But they’re big enough to take down specialized auto lenders and cause a lot of tears among investors,” Wolf Richter with Wolf Street writes.

According to the Conversation, Standard & Poor’s had cut its ratings on Deutsche Bank’s CoCo debt, prompting the bank to buy back close to $5.4 billion in contingent convertible bonds, as reported by Business Insider. Perhaps interesting to note is that the Deutsche Bank name appears in both the subprime auto and CoCo conversations. However, Deutsche Bank is far from being the only participant in these markets.

While DB stocks is well off of its low of $14.78, observed before the buyback was announced, it remains down on the year, by 16.6 percent; the Dow Jones Industrial Average (^DJI) is down by 1.0 percent over the same period.

A group of publicly trades securities bearing the contingent convertible cross includes Deutsche Bk Contingent Cap TR I (NYSE: DXB), Deutsch Bk Contingent Cap Tr V (NYSE: DKT), and Deutsche Bk Contingent Cap Tr I (NYSE: DTK), down 8.1 percent, 5.8 percent, and 6.2 percent respectively, year-to-date.

Another group includes securities issued by Axiom Alternative Investments, who describe contingent convertible bonds as “hybrid debt.”

Charts etched by securities issued by Axiom, including Axiom Contingent Capital Z (Paris: FR0012695674), down 2.1 percent year-to-date; Axiom Contingent Capital R (Paris: FR0012419661), down 2.3 percent year-to-date; Axiom Contingent Capital E (Paris: FR0012417327), down 2.3 percent year-to-date; and Axiom Contingent Capital C (Paris: FR0012419612), down 2.2 percent year-to-date, have recovered significantly after being down close to 10 percent in mid-February, yet remain seemingly volatile; of similar volatility, for example, to the Dow Jones, a pure equity index, but drawn by a class of securities described by participants as “hybrid debt.”

[Photo by John Moore/Getty Images]