Who would have thought that financing a secondhand Geo Storm or Plymouth Prowler for consumers with dicey credit could become such a big -- let alone profitable -- business?

Believe it or not, though, subprime loans for used cars are indeed a huge business, and Fort Worth, Texas-based

AmeriCredit

(ACF)

has become one of the leaders in this space. AmeriCredit gives loans to those with poor credit -- be it from delinquent payments, unpaid medical bills or other financial problems -- in exchange for charging hefty interest rates. Approximately three-quarters of its loans are for used-car purchases, while the rest are for new vehicles.

Unlike a number of subprime lenders that went out of business in the late 1990s, though, AmeriCredit has found a way to reduce its risk on such loans through a proprietary database that looks at up to 200 different criteria to determine a potential borrower's creditworthiness.

This database has helped ACF grow its earnings 41% annually since 1996, with most analysts expecting earnings to continue to grow 30% a year over the next four years. Last year, AmeriCredit collected $723 million in revenue on approximately $9 billion worth of loans to 800,000 consumers; this represented roughly a 5% market share of the $200 billion-a-year subprime auto-loan underwriting business.

The company's stellar stock performance certainly reflects the company's growth. The stock is up 70.6% year to date after rising 47.3% in 2000 and an average of 46.2% over the past five years. And despite its recent ascent, AmeriCredit still trades at a reasonable

price-to-earnings ratio of 20 times trailing 12-month earnings.

The Power of the Database

How does AmeriCredit succeed in an area where other major subprime lenders, including giants like

GE Capital

, have failed?

Experts agree that AmeriCredit's foremost strength is not relying on standard credit-agency reports, but on its proprietary database to decide whom to give loans to and which customers to give more time to repay their loans. Since its founding in 1992, AmeriCredit has analyzed the success rate of every loan based on 200 different criteria.

AmeriCredit looks at such things as which bills loan applicants are paying and which they are not. The company favors borrowers who are good about paying such essential bills as their mortgage or auto loans, and is not as strict about credit card payments. The company also looks at such things as revolving credit, how long it has been since applicants' last delinquent payment and how long they've been at their existing job. Every month, AmeriCredit updates this database to continue to analyze the creditworthiness of each of its customers.

While this might sound like standard operating procedure for any lender -- prime or subprime -- in fact, it is not, says Michael Durante, a partner with

John McStay Investment Counsel

. John McStay subadvises the

(BJSCX)

Brazos Small Cap fund, which, with 4% of its $800 million in assets invested in ACF, is one of the biggest holders of ACF.

"AmeriCredit's ultimate differentiator is their extensive use of technology," Durante says.

Another of AmeriCredit's strengths is its low default rate. Roughly 7.2% of AmeriCredit's outstanding loans default each year, down 35% from a default rate of 11% in 1996, says Kim Pulliam, a spokesperson for the company. This default rate is very low for a subprime lender and not that much higher than an average prime lender, whose default rate typically is 3% to 6% a year, according to Daniel Cowles, executive editor of industry newsletter

Asset-Backed Alert

.

Defaults on the Decline
AmeriCredit's default rate as a percentage of outstanding loans

Source: AmeriCredit

Part of the reason for its low default rate is that AmeriCredit turns away 60% of its loan applicants, Pulliam says. The company also permits borrowers to defer payments up to two times a year with nine months in between, she adds. This has prevented some borrowers from going into default and has actually kept the default rate considerably lower than it might otherwise be because 18% of AmeriCredit borrowers defer payments each year.

It's the Little Things That Count

AmeriCredit has also made it a point to provide good customer service to the auto dealers through whom it makes its loans, say analysts and fund managers. AmeriCredit typically approves loans within 30 minutes. The company also has 217 branches throughout the U.S, which enables it, unlike other lenders, to have representatives on hand to pay an auto dealer cash on the very same day a customer finances a car. Other lenders are not as prompt in paying dealers, some not even making payments until the end of the month, analysts say.

Further, AmeriCredit has taken pains to review applications consistently, whereas automotive manufacturers that finance car purchases tend to change their lending criteria only when car sales are down in order "to push iron," says Mark Sickle, an analyst on the

(HLDEX)

One Group Mid Cap Value fund, which has about $44 million of its $1.1 billion portfolio invested in ACF.

The company has also been careful not to extend loans on cars that would be difficult to sell in the event of repossession. For that reason, the typical AmeriCredit loan is for a 2-year-old car with no more than 30,000 miles, although AmeriCredit will allow loans for cars up to 7 years old with 80,000 miles. Pulliam says that on average, AmeriCredit obtains half of a repossessed car's original value.

AmeriCredit also formed a joint-marketing agreement with banking giant

Chase

last fall, which should do a lot to improve AmeriCredit's image among car dealers, according to Durante. "It should help AmeriCredit move off of the used-car lot and into more showrooms," he says.

Finally, investors have taken considerable note of the success that AmeriCredit has had in raising money through the asset-backed securities market. In 26 transactions during the past nine years, AmeriCredit has raised a total of $15 billion in the asset-backed bond market and currently has $8 billion in debt.

While

Moody's

rates the company's debt Ba1, AmeriCredit's

loans

have been rated as high as AAA in the past year. This has not only made it easier for AmeriCredit to raise cash but has also enabled the company to bring these bonds to market without the added cost of insuring them.

"AmeriCredit's subprime collateral is desirable in the fixed-income market because they have high loan-underwriting standards," says Cowles of Asset-Backed Alert. "And to sell subprime auto loans without insurance is quite an accomplishment."

Potential Pitfalls

But there are downsides to ACF, however. One analyst, who asked that his name be withheld, says AmeriCredit's deferral policy is actually cause for some concern because without it the company's default rate would actually be much higher, nearing 30% or more.

Even while praising AmeriCredit, most analysts also voice concern about the continued softness of the economy and wonder if a large rise in unemployment could lead to a slowdown in AmeriCredit's growth or lead to more defaults. In fact, consumer-debt figures released earlier this week showed that nonrevolving credit for such things as automobiles, boats, mobile homes and education, which require fixed payments, fell 0.6% in March on an annualized basis from February.

It's also worth noting how small AmeriCredit's market share is of a fragmented business sector that's only growing 4% a year. Further, other subprime competitors, namely

MFN Financial

(MFNF)

and

Household Automotive

, are regaining visibility and respect among auto dealers.

But for now, most investors tend to agree with Paul Gulden, portfolio manager of the

(PXWGX) - Get Report

Pax World Growth fund, which has 3% of its $29 million portfolio in ACF. "AmeriCredit has an absolutely terrific track record, and within their own category, it is delivering absolutely fabulous performance," Gulden says.