An important correction on GM...

 We have an important correction from Porter about his recommendation in the March issue of Stansberry's Investment Advisory to sell short General Motors (GM)...

 

Mea culpa. In our research on General Motors, we conflated the company's North American loan portfolio with its portfolio of foreign auto loans that the company recently acquired from its former subsidiary Ally Financial. GM acquired roughly $11 billion in foreign auto loans during 2013, all of which were made to borrowers with prime credit. This leaves the company with $11 billion in North American auto loans, not $22 billion as we reported. I (Porter Stansberry) take full responsibility for this mistake. And I greatly appreciate the time several GM executives took with me yesterday to clarify what's happening in regards to GM's exposure to subprime credit risk.

 

 What does this mean for our investment thesis? Well, there's a big difference between holding $11 billion in dodgy debt and holding $22 billion. GM holds a total of roughly $9 billion in loans that were made to consumers with a FICO score of less than 600 – or about half as much as we thought. This portfolio expanded by roughly $1 billion in 2013.

 

Our concern was that by providing so much financing to so many weak credits, GM could suffer much larger than anticipated credit losses. And indeed, roughly $1.5 billion of GM's book is now delinquent. But... by adding $11 billion in prime auto loans, GM has greatly reduced the percentage of its delinquent accounts and added a significant amount of stable interest income. Given these new facts, we don't believe GM's subprime loan book represents an immediate threat to its business or its shareholders.

 

 On the other hand, nothing has changed about our view that GM's future business is likely in jeopardy. After all, if these subprime consumers can't actually afford these cars, they will default. These cars will "rebound" back onto the market, driving down used-car prices and making it much harder for GM to sell new cars at good prices. We see plenty of evidence that's happening right now.

 

 The auto-lending business has boomed over the last few years: Outstanding auto loans have grown from around $700 million in 2010 to $860 million today – a 22% increase. Auto loans are the only kind of consumer credit that has been growing (besides student loans, which are backed by the government).

 

In short... for people with poor credit... buying cars has been about the only possible avenue to buy anything on credit. We believe that greatly increases the risks lenders are taking on these loans.

 

 As happened with subprime mortgage lending in the mid-2000s, auto-lending standards have become dangerously degraded. According to the information service Experian Automotive (which tracks auto loans), 34% of all loan balances are now subprime and 27% of all borrowers are subprime. Those are both record highs for this credit cycle.

 

Meanwhile, loan durations have grown – to as much as 84 months. Loan amounts have reached new highs, too. The average loan is now more than $26,000. Most worrisome... the amount of lending to "deep-subprime" borrowers has soared over the last three years. Experian estimates that 10% of all auto loans are owed by borrowers with a credit rating of 540 or less. GM Financial has more than $3.5 billion of these loans on the books, or roughly 30% of the entire North American portfolio.

 

 Our concern is that these loans will default, sending more and more GM vehicles back through the repo and auction process, creating a glut of used GM vehicles. In fact, we think this is already happening...

 

Last month, the percentage of car loans more than 30 days late that are a part of packaged securities (where the underwriter sold the loan) spiked to 7.6% – the highest rate seen so far since the beginning of the 2010 boom. Outright defaults are surging, too – now 6.9% from a cyclical low of 4.2%.

 

Defaults will continue to follow late payments. Likewise, the repo rate, which follows defaults, is moving higher. It's currently at 2.8%. That's the highest ever recorded since Experian Automotive began tracking this data in 2006.

 

 So what about our recommendation to short GM? We now fear we made our call too early in the credit-cycle downturn to see any meaningful reaction in GM's share price. When we thought GM would suffer both large losses on its own subprime loans and see a decline in demand for its new vehicles (because of the spike in used cars returning to the market), we were very confident in our short thesis.

 

But with half of our reason for shorting GM removed – we don't think the company will suffer huge losses on its existing loan book because half of the book is prime loans – we don't see enough catalyst to short the company today.

 

As a result, if you've sold GM short on our advice, we would recommend you close, or "cover," your position. We would prefer to wait until there's more confirmation in the market that a decline in credit quality is undermining GM's new car sales and margins.

 

 

 New 52-week highs (as of 3/26/14): C&J Energy Services (CJES), CVS Caremark (CVS), Energy Transfer Equity (ETE), and Corning (GLW).

 

 Someone reads our work and profits... Someone does not (read it). Send your feedback to feedback@stansberryresearch.com.

 

 "I first came across Doc's approach to selling puts about 18 months ago. As a long-term investor at heart, I have used this approach with trying to buy stocks I really want to own and it brings discipline to decide what I am willing to pay. I always use my maximum purchase price as the option price and then sell the puts. If I get the stock, I am happy. If the put expires worthless I am often disappointed enough to take the money and find another opportunity. Bottom line, I get paid to by the stocks I want!" – Paid-up subscriber Bob Cryderman

 

 "I recently read a comment by Porter that he is absolutely not a promoter of the Bitcoin currency. Does he have a previous Digest article pertaining to his stance or can he tell me why he feels the way he does? I've recently been studying the Bitcoin history and would truly like to know why he feels as he does. Thank you." – Paid-up subscriber Phil Davidson

 

Goldsmith comment: Yes, Phil. We answered this exact question when you sent it the first time.

 

Regards,

 

Sean Goldsmith and Porter Stansberry

New York, New York and Baltimore, Maryland

March 27, 2014