Wall Street Gapes at AmeriCredit Wreck

Updated from Sept. 16

A 30% selloff Tuesday morning left investors standing agape over the wreckage of auto lender AmeriCredit (ACF Quote).

The Fort Worth, Texas, lender to people with poor credit histories has been grappling with rising loan defaults over the past year. But credit problems appear to have gotten so bad that the once fast-growing company wants to take drastic measures to shore up its liquidity.

The question now is whether investors will go along. After the close Monday, the company announced plans to issue as much as $575 million of stock. That slug of shares is equivalent to half of the company's market worth at Monday's closing price of $13.62. But with the stock plunging to $9 Tuesday morning, the market is signaling it isn't sure that the new cash will be enough to sustain what is clearly a flagging operation.

"This looks like an admission that the company's business model wasn't able to sustain itself over a full business cycle," says Bill Ryan, consumer finance analyst at Portales Partners, a New York-based brokerage.

Critics of the company had expected the liquidity issue to come to a head very soon; Detox first examined AmeriCredit's woes in a piece last year. And in its annual report, released Tuesday, AmeriCredit said it would need to raise at least $150 million and secure other financing¿sources if it were to "fund its liquidity needs in fiscal 2003."

Mother of Invention?

AmeriCredit took drastic action on numerous other fronts as well. In a bid to avoid making onerous cash deposits with the trusts it sells it loans to, AmeriCredit has agreed to issue warrants -- covering the purchase of 1.3 million shares -- to Financial Security Assurance, the insurance company that provides guarantees on its bonds.

AmeriCredit also set plans to change the way it reports earnings from an aggressive method called "gain on sale" to a more conservative one, a move that will lead to much lower reported earnings and which, absent adequate disclosure, will make meaningful comparisons with past periods almost impossible. Earnings guidance for its fiscal first quarter ending Sept. 30, still expressed using the gain-on-sale format,¿show that¿profits will come in well below analysts' expectations.

"I wouldn't characterize this as an emergency at all," says AmeriCredit spokesman John Hoffmann. "I'd characterize it as a new strategy."

AmeriCredit said money raised from the planned equity offering may be used to bolster the cash cushion the company puts in the trusts that it sells it loans to. Previously, AmeriCredit borrowed the cash deposits, but lenders probably became increasingly¿reluctant to extend credit.

Bond investors buy notes issued by these trusts. The proceeds from those purchases flow back to AmeriCredit. The company makes money if interest paid on the trusts' notes is below the yield on the loans in the trust after expenses like credit losses.

Trigger Man

On a conference call Tuesday, AmeriCredit said the act of placing more cash in a trust¿when it is formed¿will give the company the right to get cash out of¿it more quickly. However, because the cash injection will initially be much larger than the¿outflows,¿there would¿apparently still be a big cash drain for AmeriCredit. This, presumably, is why the company wants to raise as much as¿$575 million.

The company is effectively asking investors for upfront funds to¿help it through a liquidity crunch. However,¿anyone buying the stock now would have to believe that $575 million is enough and that AmeriCredit's business¿model and its managers are¿sound -- two increasingly hard-to-defend propositions.

An added twist is that these trusts have triggers in them that require AmeriCredit to set aside large amounts of cash in restricted pools if past-due loans go above certain levels. Faced with that prospect, AmeriCredit has gotten FSA to agree to amend these triggers so that they are now set at a level in excess of the company's current forecast for delinquencies from September 2002 through February 2003, AmeriCredit said Monday.

However, on a conference call Tuesday, Americredit executives said that the delinquency triggers would be raised only a percentage point. The executives said delinquencies are expected to rise in the fall and winter.¿AmeriCredit¿can¿defer troubled loans and¿book them as current. There are also triggers for these deferments, but one executive on the call said there is "plenty of room to execute our deferment strategy."

AmeriCredit's critics argue that it increases deferments to keep delinquency numbers down artificially, a charge the company has denied in the past.

FSA's motive appears to be to keep AmeriCredit alive. If the company collapsed, FSA could be on the hook for payments from AmeriCredit bonds. However, it is not clear at this point how much its warrants will be worth. FSA also gets a 0.25 of a percentage-point increase in insurance fees. FSA didn't return a call seeking comment Monday night.

AmeriCredit said it expects to report net income of $55 million to $60 million in its fiscal first quarter. That compares with analyst expectations of around $90 million, implying a large credit charge will be levied. On the call Tuesday, AmeriCredit executive said the shortfall would be because the company will be making a provision to establish a loan loss reserve.

Crunchy Crowd

There is a big risk that, with its stock sliding,¿AmeriCredit won't be able to raise $575 million. If it fails to do that, company executives said Tuesday that there was a contingency strategy that involved slowing the¿growth of the company's loan¿portfolio¿considerably. But¿if bad loans continue rising¿while growth slows,¿the cash crunch would be hard to survive. Improbably,¿AmeriCredit executives said Tuesday that¿loan losses would stay within previous guidance even though delinquencies are expected to¿move higher.

AmeriCredit's actions also constitute a victory for investors and analysts who believed the company was heading off the road. Many fund managers had believed passionately in the auto lender. As of June 30, AmeriCredit was the largest holding of the Legg Mason Opportunity Trust, a mutual fund managed by the highly regarded Bill Miller.

In addition, Tom Brown, who manages a hedge fund, has been an enthusiastic tout for AmeriCredit on his Web site bankstocks.com, where he wrote in August that "there is nothing materially wrong with AmeriCredit's fundamental outlook"¿and dismissed all liquidity concerns.

AmeriCredit also announced that it's appointing three "independent" directors to its board. AmeriCredit's top executives have become very rich from selling stock in recent years. Job No. 1 for the three new guys: Don't let anyone reprice their options after this mess. They've just committed the stock market equivalent of driving at 120 mph while under the influence.