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The wheels are starting to come off at auto lender




The fast-growing company, which lends to borrowers with bad credit histories, Thursday evening reported fiscal second-quarter results that showed bad loans rising and cash flows wilting. The stock skidded $2.34 to $25.67 Friday, leaving it 60% off its 52-week high.

The quarter's results had been nervously anticipated by bulls and bears, who are waging a ferocious battle over the stock. But there was little in the numbers to boost the bulls' case, despite a 60% rise in per-share earnings to 91 cents. The skeptics argue that AmeriCredit is growing too fast, lending to increasingly less creditworthy borrowers and using accounting maneuvers to meet estimates.

"Earnings were basically in line with the consensus estimate. And that is about it for the good news," Bill Ryan, an analyst at New York brokerage Ventana Capital, wrote in a research note Friday. Ryan has been a longtime bear on the company, which he rates sell. (Ventana doesn't do underwriting.)

By contrast, supporters believe the company's fabulous growth can be sustained by managers they believe to be extraordinarily gifted. While they concede credit quality will get worse in a recession, they don't see it forcing the company off the road. Moreover, they say any negative issues are already priced into the stock, which is trading at a meager seven times the consensus analyst earnings estimate of $3.74 for fiscal 2002.

On the Barrel

Clearly, the critical issue is whether those earnings will materialize, and whether they can be translated into real cash, needed to help fund new lending. And on these questions, the bears appear to have the upper hand.

The first thing to remember is that AmeriCredit uses an accounting method called gain-on-sale, which allows fast-growing companies to book enormous profits upfront because the earnings are based on the company's internal assumptions. But there's a snag, as

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, a past user of gain-on-sale, found out: If those assumptions don't pan out, big losses have to be booked.

That's why cash accounting gives a helpful insight. For example, when borrowers don't pay back their loans, the company doesn't receive cash, though it may continue to accrue interest in its income statement on some of these loans. And past-due loans soared in the second quarter, to 13.4% of total loans from 11.8% in the previous quarter. This jump happened even though the company is growing at a fast clip and adding new loans that should not yet have become past-due.

No surprise, then, that the cash numbers were weak. The company reported net cash flow as being negative $11 million in the second quarter, compared with a positive $49 million in the previous quarter, thus representing a $60 million decline. The negative cash number was the first in seven quarters. Part of the reason was a higher cash tax expense, but delinquencies and actual defaults also were to blame.

Seasonal Greetings

On a conference call Friday, AmeriCredit executives said that, in addition to the recession, seasonal factors played a large role in the delinquency spike. A portion of loan-repayment money gets diverted to holiday spending. They added that the credit picture should improve by mid-February as borrowers catch up with loan repayments. Last year, delinquencies did jump in the Christmas quarter, by 0.7 of a percentage point, a much smaller amount than the 1.6 percentage point jump in the latest second quarter.

Actual credit losses, or defaults, came in around expectations at 4.3% of loans. AmeriCredit has long argued that its loss number, not the delinquency ratio, is the most important credit-quality indicator. That's because many delinquents go back to paying loans. But the loss number can be massaged in two ways.

First, the company can delay charging off a loan as a loss by holding it in the repossession inventory. A nonperforming loan moves from delinquency to repossession inventory after a certain period. In repo, the car is sold and any recovered value is added back to get a net loss number. In the second quarter, repo inventory did go up -- by 0.1 percentage point from the preceding period. If that extra 0.1% of loans on repo'd cars was added to losses, the total loss number would've jumped to 4.5%, above expectations.

Second, AmeriCredit makes heavy use of loan extensions that allow borrowers to skip payments. And extensions did go up in the quarter. In his report, Ryan wonders whether management is "trying to prevent the flow of delinquency into repossession." If loss-mitigation strategies are being overused to do this, it can't go on forever. As a result, losses on defaulted loans could move higher over the next couple of quarters.

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In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.