What would you do if a used-car salesman told you it's against the law to check the odometer before buying? You'd shake your head and walk straight out. Similarly, investors stalked out of AmeriCredit ( ACF) stock Wednesday after the auto lender failed to offer important data in its fiscal fourth-quarter earnings statement. Improbably in this disclosure-obsessed era, the company claimed it wouldn't share the information because of regulatory guidance. The most notable omission was AmeriCredit's figure for the effective size of its bad loan reserve. The reserve number is critical for investors attempting to gauge the amount of financial cushion a lender has against bad loans. It's especially important when the lender, like AmeriCredit, is experiencing a sharp rise in problem loans. The omission could imply that AmeriCredit, which targets borrowers with tainted or incomplete credit histories, has failed to sufficiently reserve against bad loans. Meanwhile, cash continued to circle the drain in the latest quarter and credit quality deteriorated, pointing toward a possible squeeze on the company's liquidity. AmeriCredit's already-battered stock lost a quarter of its value Wednesday, falling $4.05 to $12, a 52-week low.
On a conference call to discuss earnings for its fiscal fourth quarter ending in June, AmeriCredit CFO Daniel Berce said the company didn't disclose the reserve in an effort to stay in line with new Securities and Exchange Commission guidelines on pro forma earnings. Last December the SEC issued a statement that told companies to exercise caution when using pro forma measurements because under certain circumstance "they can mislead investors." AmeriCredit didn't return a call seeking comment. However, it's likely that the company would say in its defense that, because it's not a traditional bank-type lender and uses a certain type of accounting called 'gain-on-sale,' the bad loan reserve it always gave for its $10 billion portfolio was an artificial construct. The problem with that argument is that other lenders that also use gain-on-sale gave reserve figures for the June quarter. Household International ( HI) and Metris ( MXT) each gave the loan loss reserve for the total size of their loan portfolios in the June quarter. "The failure to disclose reserve levels is not trivial," wrote Bill Ryan, an analyst at Portales Partners, a New York-based brokerage, in a report Wednesday. (Ryan rates AmeriCredit a sell and his firm hasn't done investment banking for the company.)
Gain-on-sale accounting is used when lenders sell loans they have made. The treatment allows the seller to book upfront the profits it estimates it can make on the sold loans. The big danger with gain-on-sale is that the full gain may never materialize, usually because the loans don't behave according to company projections. AmeriCredit also omitted from the earnings release an income statement that shows how earnings would look if the company were viewed as a traditional bank that didn't use any gain-on-sale. This method was much followed by investors because it is considered more conservative. On the call, CFO Berce said "it was suggested" that AmeriCredit no longer publish the reserve because of the recent SEC statements on pro forma earnings. He didn't say who suggested the move to AmeriCredit. An SEC spokesman declined to comment when asked if it had asked AmeriCredit to remove the items and if the company is the subject of an investigation. AmeriCredit execs on the call couldn't answer a question from an investor about why a key cash flow number for the fourth quarter of fiscal 2001 was higher in last year's release than it was in the most recent release. Last year, AmeriCredit said its trusts, the entities through which it makes loan sales, produced $129 million of cash in the quarter ended June 2001. This year, it says it made only $112 million in the exact same period. Did AmeriCredit overstate its cash flow last year? If so, that could draw regulatory attention.
Cash on the Barrel
The disclosure issue weighed mightily on the stock Wednesday, but many of the operating results that investors were allowed to see were also weak. At the same time, AmeriCredit made comments suggesting that certain insurers are growing wary of guaranteeing cash deposits the company must make when it sells its loans. That could lead to AmeriCredit having to pony up more cash at a time when operating cash flows are sickly. AmeriCredit actually reported strong earnings-per-share growth Wednesday that exceeded Wall Street expectations. But shrewd investors generally ignore the headline earnings number because of the unreliability of gain-on-sale. Using AmeriCredit numbers, the company showed a $22 million cash drain in the fourth quarter, compared with a cash inflow of $77 million in the year-ago period. According to the Portales report, Ryan calculates the cash drain is even worse if effective borrowing that needs to be done to carry out loan sales are factored in. Ryan estimates that, with those adjustments, AmeriCredit experienced an effective cash drain of $117 million in the fourth quarter. On credit quality, the company's bad loan charge-off rate was 5.2% in the quarter, up from 3.2% in the year-earlier period. And on the call, an AmeriCredit official said it increased the amount of loans that were restructured in some way to bring the borrower current. This tactic, it is feared, only delays defaults and bad loans, rather than preventing them. The higher use of them partly explains the weak cash flows, since the company allows distressed borrowers to miss payments. In what could turn out to be a very serious development, AmeriCredit said it was going to have to put up more of its own cash into special cash pools that are set up when loans are sold. This is happening because the re-insurers who pledge to make the cash payments have less of an appetite for AmeriCredit risk. And that appetite will only shrink further after Wednesday.