Having yesterday flagged up the impending 10th anniversary of the starting gun going off on the global financial crisis I subsequently tripped over a vignette in the International Financing Review reporting that junk sub-prime auto ABS spreads are at record lows.
It really was just a vignette and said:
“Junk-rated tranches of new sub-prime auto bond deals are pricing at record tights amid unabated enthusiasm for the asset class, Wells Fargo analysts said in a report on Monday.
Below are highlights from the report:
- Westlake’s Double Bs cleared last week at iSwaps+300bp
- That was record low for non-benchmark name
- Similar bonds fetched 800bp+ in Q1 2016.
- Investors still flocking to higher-yielding ABS”
At this point Monty Python would suggest “wink wink, nudge nudge, say no more” for it is a sobering read, not least of all if one recalls the kerfuffle in late spring about banks getting worried about the sub-prime auto sector with its rising delinquency rates. In fact it was not only the auto loan space that had been in the news but the student loan sector too and flares were going up all over the place indicating overlending to those least able to repay. Sound familiar?
But as we have collectively observed in the high-yield bond market, if the banks don’t want to lend directly, then there will be someone out there who will see the yield and step into the breach.
Syndicates
Many years ago when Michael Milken ruled the world from his California-based desk of Drexel Burnham Lambert – the “Lambert” bit indicated that the firm’s capital base had been expended by a direct investment by the rather aristocratic Banque Bruxelles Lambert - and when private equity firms were still called by their original name, corporate raiders, the key to a hostile takeover was not the junk bond issuance but the senior financing that was provided through the syndicated loan market.
The practice then was for the syndicating bank to provide other banks with nifty little floppy disks that displayed all the scenarios for the financial future of the loan. No one will be surprised that no matter how one juggled the figures in the programme, they always ended up proving that the loan was of next to no risk. I had a mentor who refused to touch the disks provided and who insisted on doing his own credit work. It stood him in good stead.
By the time of the height of the structured credit boom, matters had advanced and the algorithms, though far more complicated, did exactly what the floppies had done a generation before, which was to prove that nothing could go wrong. Or at least the embedded stress tests would prove that the sun would have to rise in the west before the structure could default. A likely story but one that an industry obsessed with lending by statistical probability simply lapped up. The lending process and subsequent management of the banks being usurped by mathematicians and statisticians, largely French educated, really was a case of the lunatics taking over the asylum.
The financial crisis was supposed to have spelt the end of the originate-to-distribute model. If the stories from spring are right and the banks have begun to withdraw from exposing their balance sheets to the sub-prime auto lending space but new structures are coming to markets, then it must be assumed that originate-to-distribute is alive and kicking. Either that or the banks are repackaging what they own, respraying it from green to pink and flogging it to yield-hungry investors with backing documentation that proves that it can’t really go wrong. Over my 40-year career I have traded third-world debt, debt of lesser developed countries and emerging market debt. Same borrowers, same default risks, different names. In the immortal words of Yogi Berra, it’s deja vu all over again.
Sub-prime Double B tranches trading at 300bp over? My apologies. How silly of me to forget that this time it will be different. Perhaps it is the time to update Hume’s First Law to state that no market excess is too great not be repeated in either even larger size and or at an even tighter price, or wherever possible, in both.
Shocking
Elsewhere news is filtering through that Tesla is now looking to the bond market for its next round of funding – or should that be borrowing? - to keep it solvent. It’s no more than six weeks ago that Tesla’s market cap surpassed, albeit only briefly, that of Ford and General Motors to become the most valuable auto company in the US. And it has yet to turn a profit. There is no question that the Tesla Model 3 represents a great leap forward in popularising electric vehicles but they remain expensive and the issues surrounding the unknown and so far unpredictable lifespan of batteries remains a problem for Joe SixPack who can’t afford to buy a car as an environmental statement.
Tesla is supposedly looking for US$1.5bn in the market, not in order to drive green investment or whatever, but simply in order to keep the lights on. So is Tesla the next Google or Amazon, or is it going to prove to be a repeat of the Suez Canal or the Channel Tunnel? Both were then and remain today stunningly visionary but both needed to go bust to wipe out early investors before they could move ahead into profitability.
At the moment Tesla has the capacity to build 1,500 Model 3s per week. By the end of the financial year this is supposed to be closer to 5,000 units per week and Elon Musk believes he can sell 700,000 units per year. To fill that demand, should it be realistic, Tesla will have to be able to knock out 15,000 cars a week. On that basis Tesla, already a B- credit, will need a hell of a lot more money. It is hard to imagine how the company will be able to achieve this without some very significant outside investment. But that’s not Musk’s style.
I have huge admiration for Musk as a visionary. I am very impressed, albeit not wholly and unconditionally convinced, by his cars. But would I want to have his bonds in my debt portfolio?