Hedge Fund Managers Turn To Subprime Auto Loans For New Income Stream

Think the subprime mortgage fiasco caused major problems? A repeat may be on the way — and it comes from a surprising source. A collection of hedge funds, persuaded they have located the next source of income, are betting against bonds financed by subprime car loans.

Hedge Fund Managers Turn To Subprime Auto Loans For New Income Stream

Think the subprime mortgage fiasco caused major problems? A repeat may be on the way — and it comes from a surprising source.

A collection of hedge funds, persuaded they have located the next source of income, are betting against bonds financed by subprime car loans.

Yeah. Good luck getting a bank prepared to deal in that deal.

Conventional finance and interest managers are also looking askance at the idea of using subprime auto loans to boost profits.

Fund managers have considered gambling that subprime auto deals will crap out for the reasons that stakeholders bet on mortgage bonds. The reasons? The same ones that led to the recent financial crisis: mushrooming loan volume, looser lending terms, and higher delinquencies.

The demand is evolving from hedge funds that move everything from bonds to stocks. Many financial groups, including Bank of America, are not engaged in making the wagers for customers. Agents of the banks say they fear helping customers bet on car loans will be damaging to their prominence and that the new laws, and other post-9/11 laws, will make the deals difficult to happen if not awkward at best.

Mike Edman, a former Morgan Stanley Executive, said, “Most traders just don’t want that kind of risk.”

One trading department has worked this type of trade. Etai Friedman, manager of Crestwood Advisors LLC, a hedge fund in Beverly Hills, said he was working with a salesperson with whom he had associated for years. Friedman refused to name the bank making the trade, but he did admit to getting a 35 percent return.

“A wager like this is taboo now,” said Friedman.

The banks’ hesitation to assist investors as they wager against subprime loans flags that trading desks are giving more thought to how their actions will set with inspectors and the media. Goldman Sachs Group paid over $500 million in fines to settle SEC charges that it investors had been misled when Paulson & Company, another hedge fund, bet against mortgage bonds.

Temptation

Besides the Bank of America, Barclays, Deutsche Bank, and AG will not touch these trades. JPMorgan Chase recommends that clients don’t do them. Representatives for the other banks refused to comment.

For investors who don’t mind risks in auto securities, shorting the bonds is tempting. Auto loans grew by over 45 percent for the period ending December 31, 2015. There were rough $160 billion of bonds back by car debt, up over 40 percent from 2010 — but under pre-crisis highs.

A Real Scandal

Borrowers are driving away with cars they can’t afford and Tavakoli Structured Finance (TSF) has sounded alarms about the bubble. Trouble is also predicted in auto securities.

“The automobile loan market is similar to what we have seen before,” said Janet Tavakoli, founder of TSF. “Borrowers are coming in without documentation, and they are finding they don’t even need credit scores. It’s a real scandal.”

Despite the warnings, investors are showing interest.

“Some guys have done these trades over beer,” said Don McConnell, a portfolio manager at BMO Global Asset Management.