by Howard Haykin

Did you hear? JPMorgan Chase and Wells Fargo have gotten ‘the yips’ when it comes to offering sub-prime loans to auto buyers. But that doesn’t mean these banks are getting out of that business. Fact is, they’re funding billions of dollars of loans – indirectly. According to Bloomberg News: 

• Wall Street banks packaged more subprime auto loans from finance companies into bonds in the Q1 of 2017 than the same period last year - $7.1 billion, up from $5.9 billion.
• Wells Fargo and JPMorgan remained the top two underwriters of the securities.

Seems like only yesterday when, in 2008, asset-backed securities (ABS’s) began to sour. And it's worth repeating that a Senate subcommittee report in 2011 laid the blame squarely on investment banks - saying that sales of structured finance products “provided a steady stream of funding for lenders originating high risk, poor quality loans and that magnified risk throughout the U.S. financial system.”

Nowadays, banks are still peddling ABS’s, though they’re more likely to be stuffed with subprime auto loans than with subprime mortgage loans. While that transition lessens the risk exposures for banks, investors who buy those ABS’s are seeing their risks grow.

How do we know?

• Subprime borrowers are falling behind on their car loan payments at the highest rate since the financial crisis.
• Borrowers are already defaulting on a growing amount of auto debt.
• Growth in auto debt since the financial crisis has set off alarm bells on Wall Street and among regulators who are concerned that borrowers may be overburdened.
• Declining car prices mean that the value of the loans’ collateral is dropping. (Can you say “underwater?”)
• Even Wells Fargo’s analysts who look at bonds backed by car loans cautioned in March that it may be a good time for investors to cut their exposure.
• At least one Wall Street bank – BofA - has steered clear of underwriting bonds backed by subprime auto loans.

WHEN YOU GET TO THE FORK, TAKE IT!    Research analysts at Wells Fargo, the #1 seller of bonds backed by subprime auto loans, have said that the bonds pose few risks to bondholders. They also recommended that investors cut their risk exposure because of valuations.

[WOULD SOMEONE PLEASE TELL WELLS FARGO THAT YOU CAN'T HAVE IT BOTH WAYS!]