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Take Advantage of Record-High Auto Sales… Before This Bubble Bursts

Companies / US Auto's Sep 01, 2015 - 12:59 PM GMT

By: ...


Peter Krauth writes: Based on car sales in the first half of 2015, we're on pace to beat the 17.4 million vehicles sold back in 2000.

But there's a troubling flip side to that retail boost to the economy…

You see, relatively low borrowing costs and a sympathetic bond market have helped push total U.S. auto debt to $1.01 trillion – the highest level ever.

At the same time, the rejection rate for car loans is hovering at just 3.3%. That's the lowest level on record at the New York Fed.

Even worse, more than a quarter of that debt is actually subprime, thanks to loose credit standards and the bundling of loans.

That hasn't stopped American auto production from screaming upwards, though.

We've been through this before, so we know it's all going to end badly. But that doesn't mean there's no money to be made on the way up.

America's Subprime "Dealer" of Choice

One major consequence of the financial crisis is tighter regulations for financial institutions. As a result, banks have shied away from subprime mortgages and severely curbed most other subprime loans.

So, most of these "easy" car loans are coming from one company – private equity and hedge fund firm Fortress Investment Group LLC (NYSE: FIG).

Fortress bought 80% of AIG's flailing consumer-loan unit in 2010, then renamed it Springleaf Holdings Inc. (NYSE: LEAF). It's now headed by Fortress chairman and co-founder Wesley Edens.

And Springleaf has sprung.

From Jan. 1 to April 30, Springleaf's business has originated 22% more personal loans. Since 2010, Fortress's share of Springleaf has swelled from $124 million to $3.5 billion, good for a 27-bagger return.

Equifax Inc. (NYSE: EFX) reports that in the first four months of this year, over a third of car, credit card, and personal loans were taken out by subprime borrowers, the largest portion since 2007.

Now Springleaf is angling for more, having struck a deal to buy Citigroup Inc.'s (NYSE: C) OneMain Financial unit for $4.25 billion in cash.

But that's attracted the attention of regulators.

According to The Wall Street Journal, Springleaf's management has indicated that the Justice Department has expressed "concerns" about the OneMain deal.

It's little wonder. If the purchase of OneMain succeeds, Springleaf will become America's largest subprime-focused lender, boasting 2.5 million borrowers across 2,000 branches.

Some of Springleaf's loans are unsecured, while others have collateral and can reach as much as $25,000. The average rate charged by Springleaf is 26%, which they defend since default rates are about 6% annually.

Meanwhile, north of the border, the situation is similar – but different all at the same time.

Here's what I mean…

Canadian Banks' Terrible Idea

More conservative Canadian lenders avoided the worst of the financial crisis.

But lending practices have since loosened considerably, casting doubt on the health of their auto and personal loans business.

In Canada, financial institutions have been offering car loans with extended amortization periods, some up to 96 months.

Making matters worse, car loans are regularly being made for amounts up to 135% – well beyond the vehicle's price. The reason is concerning.

Many borrowers are rolling old debt into these new loans, including credit card bills and student loans, as well as the balance on previous car loans.

Negative equity loans are gaining in popularity within the auto industry. A customer wanting a new car can show up with $8,000 owed on his car, get $4,000 on the trade-in, and still owe $4,000… on a car he no longer owns.

That outstanding $4,000 could be added to the loan amount on a new $20,000 car, now sporting $24,000 in debt.

Between high rates, old debt rolled into new loans, and extended amortization periods, some consumers end up paying as much as three times the purchase price of their new car by maturity.

Moody's Investors Service has highlighted its concerns for such practices at Canadian banks. Since 2007, their car loan portfolios have grown at a compound 20% annual rate, ballooning from $16.2 billion to $64 billion over the past seven years.

Right now, average interest rates and unemployment levels are "reasonably" low. But that can change quickly.

Some are warning that an economic slowdown could easily impair a good portion of these loans. Many borrowers simply live paycheck to paycheck and have little, if any, reserves.

But even taking all of this into account, investors can't ignore growing auto sales as a profit play.

And one of the most promising global automakers looks like a screaming bargain right now…

The Ultimate Contrarian Play for This Bubble

Tata Motors Ltd. (NYSE ADR: TTM) is the India-based vehicle conglomerate established in 1945.

The company develops, designs, assembles, and produces passenger and commercial vehicles worldwide.

Its offering covers the gamut from micro-cars to sport utility vehicles (SUVs), and from light to heavy commercial vehicles.

In 2008, at the peak of the financial crisis, Tata acquired venerable British brands Jaguar and Land Rover from Ford Motor Co. (NYSE: F).

The Jaguar and Land Rover (JLR) division continues to drive the overall performance of Tata Motors. Sales were up 9.5% in fiscal 2015.

The market appears to be concerned with the recent slowing of Chinese sales, which were weaker than projected. Tata has addressed weaker sales with improvements to its integrated Marketing Sales and Service organization, adjustments to keep supply and demand in balance through model transitions, and certain price realignments for the Chinese market.

Some worry too that China's devaluing its currency, making imports more expensive.

To that, I say look at the rupee. India's currency has just fallen to a 23-month low, making its exports cheaper in the process.

But even more encouraging is a joint venture between JLR and China's Chery Automobile Co. Ltd., which launched last year. The new manufacturing facility will have a production capacity of 130,000 units annually and is forecast to deliver three JLR models by 2016.

In fiscal 2015, JLR sales gained 27.7% for Europe, 20.5% in the UK, and 12.9% in North America.

Tata Motors is a $17 billion company with a trailing P/E ratio of just 9.90. Its share price has fallen by half since early this year.

Remember, auto loans have considerable growth upside left ahead of them.

Tata is likely to benefit from strong auto sales. Right now it's looking oversold and is likely to bounce back strongly – a move that may be in the offing as I write this.

As well, emerging markets and India in particular are suffering from very bearish sentiment; another supportive contrarian sign.


Money Morning/The Money Map Report

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