Is Harley a Sub Prime Lender?

YES.

When the market is shooting first and asking questions later, all lenders are subprime.

Harley actually fits the bill as well.

Doug Kass of Seabbreeze Partners and TheStreet.com sent me his article from today and said I could use it. So, here it is:

It remains investment community’s general belief that the subprimelending mess is a fluke that will be contained.

I have stressed the likelihood of contagion.

“Neither a borrower nor a lender be;For loan oft loses both itself and friend,And borrowing dulls the edge of husbandry.This above all: to thine own self be true,And it must follow, as the night the day,Thou canst not then be false to any man.”— William Shakespeare, “Hamlet”

While those who are “close to the ground” and parcel through the sometimescomplex and arcane financial statements at the intermediaries who serve thehousing market (reading about such tawdry statistics as delinquencies andforeclosures) and fret about an impending economic disaster, it is not thecase to most observers.

Judging by the commentary and the virtual invulnerability of worldwideequity prices, most see only a speed bump. There still remains a generalbelief on the part of the investment community that the subprime lendingmess is a fluke that will be contained.

On The Edge I have stressed the likelihood of contagion. After all, subprimeis 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 now!

Indeed, it appears that growing credit losses and delinquencies arebeginning to render *Harley-Davidson’s* (HOG) motorcycle loans, well,increasingly like hogs (literally and figuratively).

Thirty-day delinquencies (and loss trends) in Harley-Davidson’s receivablesbook (courtesy of Lehman Brothers) give a clear picture that credit qualityissues are broadening out as HOG’s receivable experience has begun to tracea pattern of deterioration that we first began to see in subprime mortgageloans during the first half of 2006.

*Harley-Davidson’s 30-Day Delinquencies*

4Q2006 5.18%

3Q2006 4.46%

2Q2006 3.61%

1Q2006 3.69%

4Q2005 4.83%

3Q2005 4.07%

2Q2005 3.66%

1q2005 3.60%

Source: Lehman Bros.

As I mentioned yesterday, Harley’s finance subsidiary (HDFS) funded almosthalf 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 tolook more and more like *New Century* (NCBC), *Fremont* and *Accredited HomeLenders* (LEND) did in early 2006.

In 2006-07, 28% of HDFS loans in its securitized pools had FICO scores(below 650) were considered subprime, ironically very close to the 21%subprime market share of total mortgage loans made last year! During thecompany’s investor day (Feb. 28), Harley acknowledged that several of thesecuritization pools have breached their credit quality metrics (and likesubprime, the most recent pools’ credit losses and delinquencies are risingfaster than expected and more rapidly than earlier pools). This is beginningto force Harley-Davidson to fund additional cushion reserves in thetriggered securitization pools, much in the same way subprime mortgageoriginators have to buy back bad loans. (This takes a hefty bite out ofHDFS’ profitability by reducing its net interest margin.)

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

Sound familiar?

“Get your motor runnin’Head out on the highwayLookin’ for adventureAnd whatever comes our way…Like a true nature’s childWe were born, born to be wildWe can climb so highI never wanna die.”— Steppenwolf, “Born to Be Wild”

It is beginning to look like the (motorcycle) lending markets are no longer… born to be wild. And, not surprisingly, I am still shortHarley-Davidson.

More importantly, thefungusofsubprime is beginning to spread into asset classes other than housingandmortgages. Don’t think for a moment that Harley-Davidson’s dealers or theparent company were any less reluctant than the mortgage brokers to serve uploans for their product. And last time I looked, a motorcycle is far lesssecure and stable than a home.

Vroom! Vroom!

Position: *Short HOG*

Doug KassWeb Site: http://www.seabreezepartners.net