Bad debt often masquerades as "money good" until it's no longer possible to keep up the deception. The phrase "extend and pretend" is associated with European bank debt and loans to Greece. It also applies to unfunded pension plan liabilities and our own government's promises regarding Social Security and Medicare.
"Extend and pretend" comes into play when borrowers cannot make timely payments on current debt, yet the lender refuses to admit and write down the value of the loan. Rather than honestly marking down the carrying value of that asset, the lender simply extends a new dollop of cash large enough for the debtor to keep repaying, albeit now with a longer term and perhaps a higher interest rate. Bad debt thus turns back into "profitable new loans."
Imagine if Visa (V) , MasterCard (MA) or American Express (AXP) imposed no credit limits on accounts. People could simply take a cash advance from one card each month to pay the minimum balance due on their other cards. That would put them deeper in debt every month, but their credit ratings would stay A-OK.
Banks would continue booking profits on those now-current payments, which really represent bad debts in disguise. That would all come crashing down if lenders refused to allow you to continue running up your balances.
Subprime auto loans have already started unraveling. Longer terms, some now running up to 84 months, along with rapidly deteriorating used-car prices mean that loan collateral is often less than the balance owed.
Ally Financial (ALLY) was formerly known as GMAC (General Motors Acceptance Corporation). It needed a taxpayer-funded bailout during the last financial crisis.
People apparently have forgiveness in their hearts as well as short memories. ALLY was able to go public again on April 10, 2014, at $25 per share.
The shares should not have fetched so much. ALLY never went far above that IPO price. It declined to under $20 just months later. Since then, Ally's ventured as low as $14.50 in the early 2016 selloff and as high as $23.63 last February.
Management continues to say they expect well over $2 a share in 2017 earnings and significant improvement next year. That's the only reason investors are still willing to pony up nearly 20 bucks for Ally stock.
The estimates fail to reflect the subprime loan problems bubbling just under the surface. ALLY could fall a long way, perhaps even into bankruptcy, once the firm starts acknowledging the true state of its auto-related portfolio.
Santander Consumer (SC) is in similar straits. Its trailing 12-month earnings make it look like a bargain. The smart money knows better. SC's share price is down about 50% since its 2015 peak.
Once the true worth, or lack of value, of Santander's subprime auto loans is recognized, there may be nothing left for shareholders. The best analogy to this situation was the housing market along with mortgage-backed securities back in 2007-08.
Don't fall for the "fake" profit claims of ALLY or SC. Things are much worse than they are officially admitting to.
Speculators might wish to short ALLY and/or SC shares. Each stock also offers the chance to buy puts. ALLY's extend as far as Jan. 18, 2019. SC only offers the chance to play as far out as Oct. 20, 2017.