Kass: Harley Hogs Feed at the Subprime Trough

Delinquencies suggest credit-quality issues are broadening.
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Editor's note: This column by Doug Kass is a special bonus for TheStreet.com and RealMoney readers. It first appeared on Street Insight on March 28 at 8:35 a.m. EDT. To sign up for Street Insight, where you can read Kass' commentary in real time, please click here.

Judging by the commentary and the virtual invulnerability of worldwide equity prices, most see only a speed bump in the recent subprime scare. There is still a general belief on the part of the investment community that the mess is a containable fluke.

I have stressed the likelihood of a

subprime contagion

. After all, subprime is subprime and credit is correlated. Lower-quality, more-levered lending (with less collateral) is not confined to consumer loans, credit cards, homes, recreational vehicles and autos -- as investors might soon find out.

Even motorcycle (loans) are hitting potholes!

Indeed, it appears growing credit losses and delinquencies are beginning to render

Harley-Davidson's

(HOG) - Get Report

motorcycle loans, well, increasingly like hogs.

Thirty-day delinquencies (and loss trends) in Harley-Davidson's receivables book offer a clear picture that credit-quality issues are broadening as HOG's receivables experience has begun to trace a pattern of deterioration that we first began to see in subprime mortgage loans during the first half of 2006.

As I have mentioned previously, Harley's finance subsidiary (HDFS) funded almost half of Harley-Davidson's motorcycle loans. Like subprime mortgage loans, HDFS' hog loans are pooled and securitized to institutional buyers. Unfortunately -- in credit trends and terms -- HDFS is also beginning to look more and more like

New Century

(NCBC)

,

Fremont

(FMT)

and

Accredited Home Lenders

(LEND) - Get Report

did in early 2006.

In 2006-07, 28% of HDFS loans in its securitized pools had FICO scores below 650, which is considered subprime, which is very close to the 21% subprime market share of total mortgage loans made the previous year.

During the company's investor day on Feb. 28, Harley acknowledged that several of the securitization pools had breached their credit-quality metrics -- like subprime, the most recent pools' credit losses and delinquencies are rising faster than expected and more rapidly than earlier pools.

This is beginning to force Harley-Davidson to fund additional cushion reserves in the triggered securitization pools, much in the same way subprime mortgage originators have had to buy back bad loans. This takes a hefty bite out of HDFS' profitability by reducing its net interest margin.

Should the recent trend of rising credit losses and delinquencies in Harley-Davidson's loan-receivable book and in the securitization pools of their financial subsidiary (HDFS) continue, tighter lending practices likely will be instituted, and institutional buyers will be less receptive to buying HDFS' securitized pools. This could serve to reduce Harley-Davidson's sales growth and profitability.

Sound familiar?

It is beginning to look like the motorcycle lending markets are no longer "born to be wild." And, not surprisingly, I am still short Harley-Davidson.

More importantly, the fungus of subprime is beginning to spread into asset classes other than housing and mortgages. Don't believe for a moment that Harley-Davidson's dealers or the parent company were any less reluctant than the mortgage brokers to serve up loans for their product.

And last time I looked, a motorcycle is a discretionary item that is far less secure and stable than a home.

At time of publication, Kass and/or his funds were short HOG, although holdings can change at any time.

Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd. Until 1996, he was senior portfolio manager at Omega Advisors, a $4 billion investment partnership. Before that he was executive senior vice president and director of institutional equities of First Albany Corporation and JW Charles/CSG. He also was a General Partner of Glickenhaus & Co., and held various positions with Putnam Management and Kidder, Peabody. Kass received his bachelor's from Alfred University, and received a master's of business administration in finance from the University of Pennsylvania's Wharton School in 1972. He co-authored "Citibank: The Ralph Nader Report" with Nader and the Center for the Study of Responsive Law and currently serves as a guest host on CNBC's "Squawk Box."

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