Padilla's Corner
A Typical Conversation on a Controversial Name
“Vinnie, can I ask you a question?”
There were many times on our trading desk when I would turn to my partners, Vinnie and Porter, and start asking questions about a particular stock. That stock would typically be a new position for us and would likely have a “short” bias. The partner I would ask depended on the complexion of the company. If the stock was a traditional bank or insurance company, I would ask Porter. When it came to credit-related companies, I always went to Vinnie.
Given all the noise around subprime auto lending and rogue corporate bankruptcies, I thought this week’s theme might be timely, and, in homage to the 10th anniversary of the “The Big Short” (the movie), it comes to you in “screenplay” format. (For those who don’t know, I worked with Adam McKay to ensure that his perspective of the 2008 Financial Crisis and the products Wall Street created was accurately portrayed on the Big Screen. That all led to scenes we filmed on set in New Orleans – see a link at the end of this note.)
Setting: Trading Desk
Danny peaks over his monitor and glances to his right where Vinnie is sitting. He checks the phone turret to confirm that Vinnie isn’t on his phone. While Porter is situated on Danny’s left and might also be available, Danny’s question will be targeted at Vinnie.
Danny: “Hey Vinnie.”
Vinnie: “What’s up man?”
Danny: “Have a question for you.”
Porter raises his head a bit, and given his height, it looks like an ostrich is lifting its head out of the ground.
Vinnie: “Oh boy, what you got?”
Danny: “How do auto loan delinquencies look these days?”
Vinnie: “They’re actually decent and…”
Danny interrupts: “No, no, I am talking about subprime auto, not the prime stuff.”
Vinnie: “If you had let me finish, I was going to say that although things look fine overall, there is deterioration in subprime. In fact, some of the worst loan origination vintages we have seen in quite some time but arguably peaking. What are you thinking?”
Danny: “Okay, do you remember back in 2006 when we realized that Harley Davidson (ticker: HOG) wasn’t really a motorcycle company, but more a specialty finance company that happened to sell motorcycles. You remember that trade?”
Porter breaks into a Neil Young song and sings… “somewhere on a desert highway, she rides a Harley Davidson…”
Vinnie: “Of course I remember, we shorted the shit out of it, and they got crushed.”
Danny: “Well, it feels like there are a few specialty finance companies out there today posing as ‘Artificial Intelligence (AI) platform/technology companies’ that I think warrant a deeper dive.”
Vinnie: “Now I know the exact stock you are talking about, Upstart (ticker: UPST). Have you seen the short interest?”
Porter chimes in again, now interested in the exchange take place: “Well, to be fair, half of that short interest is just a hedge created by their converts (convertible debt).”
Danny: “Thanks Porter. Vin, can we just ignore the short interest for a minute?”
Vinnie: “Sure, what you got?” Vinnie takes a deep breath and exhales loudly as he knows Danny is about to unleash a verbal stream of consciousness that he hopes will lead to shorting Upstart.
Danny: “Well, I think we all agree that subprime auto, while not yet a disaster, is deteriorating at the margin. We also know that these “platforms” like Upstart have been benefiting from the insatiable appetite private credit firms have for all types of higher yielding loans. I know that Upstart provides personal loans and some other products like HELOCs but most of their borrower base scores as subprime in nature....”
Vinnie: “Danny, there is no sign that the appetite for these loans is diminishing, and to be fair, the securitizations from recent deals are looking fine. You aren’t wrong that Upstart really is an expensive specialty finance company trading over 8x Book Value but as long as they can originate and sell these loans to 3rd parties like private equity firms, investors will view it as a platform company.”
Danny: “I know they are reporting earnings soon, but I went over their last quarterly report and they do carry a decent amount of loans on their balance sheet.” Danny shares the following information from Upstart’s last quarter with both Vinnie and Porter:
