Investors Sink Tight-Lipped AmeriCredit

What would you do if a used-car salesman told you it's against the lawto check the odometer before buying? You'd shake your head and walkstraight out.

Similarly, investors stalked out of AmeriCredit ( ACF) stock Wednesday after the auto lender failed to offer important data in its fiscal fourth-quarterearnings statement. Improbably in this disclosure-obsessed era, the companyclaimed it wouldn't share the information because of regulatory guidance.

The most notable omission was AmeriCredit's figure for the effectivesize of its bad loan reserve. The reserve number is critical for investorsattempting to gauge the amount of financial cushion a lender has againstbad loans. It's especially important when the lender, like AmeriCredit, isexperiencing a sharp rise in problem loans.

The omission could imply that AmeriCredit, which targets borrowers withtainted or incomplete credit histories, has failed to sufficiently reserveagainst bad loans. Meanwhile, cash continued to circle the drain in thelatest quarter and credit quality deteriorated, pointing toward a possiblesqueeze on the company's liquidity. AmeriCredit's already-battered stocklost a quarter of its value Wednesday, falling $4.05 to $12, a 52-week low.

In Line

On a conference call to discuss earnings for its fiscal fourth quarterending in June, AmeriCredit CFO Daniel Berce said the company didn'tdisclose the reserve in an effort to stay in line with new Securitiesand Exchange Commission guidelines on pro forma earnings.

Last December the SEC issued a statement that told companies toexercise caution when using pro forma measurements because under certaincircumstance "they can mislead investors."

AmeriCredit didn't return a call seeking comment. However, it's likelythat the company would say in its defense that, because it's not atraditional bank-type lender and uses a certain type of accounting called'gain-on-sale,' the bad loan reserve it always gave for its $10 billionportfolio was an artificial construct. The problem with that argument isthat other lenders that also use gain-on-sale gave reserve figures for theJune quarter. Household International ( HI) and Metris ( MXT) each gave the loan loss reserve for the total sizeof their loan portfolios in the June quarter.

"The failure to disclose reserve levels is not trivial," wrote BillRyan, an analyst at Portales Partners, a New York-based brokerage, in areport Wednesday. (Ryan rates AmeriCredit a sell and his firm hasn't doneinvestment banking for the company.)

Some Gain

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 itcan make on the sold loans. The big danger with gain-on-sale is that thefull gain may never materialize, usually because the loans don't behaveaccording to company projections.

AmeriCredit also omitted from the earnings release an income statementthat shows how earnings would look if the company were viewed as atraditional bank that didn't use any gain-on-sale. This method was muchfollowed by investors because it is considered more conservative.

On the call, CFO Berce said "it was suggested" that AmeriCredit nolonger publish the reserve because of the recent SEC statements on proforma earnings. He didn't say who suggested the move to AmeriCredit. An SECspokesman declined to comment when asked if it had asked AmeriCredit toremove the items and if the company is the subject of an investigation.

AmeriCredit execs on the call couldn't answer a question from aninvestor about why a key cash flow number for the fourth quarter of fiscal2001 was higher in last year's release than it was in the most recentrelease. Last year, AmeriCredit said its trusts, the entities through whichit makes loan sales, produced $129 million of cash in the quarter endedJune 2001. This year, it says it made only $112 million in the exact sameperiod. Did AmeriCredit overstate its cash flow last year? If so, thatcould draw regulatory attention.

Cash on the Barrel

The disclosure issue weighed mightily on the stock Wednesday, but manyof the operating results that investors were allowed to see were also weak.At the same time, AmeriCredit made comments suggesting that certaininsurers are growing wary of guaranteeing cash deposits the company mustmake when it sells its loans. That could lead to AmeriCredit having to ponyup more cash at a time when operating cash flows are sickly.

AmeriCredit actually reported strong earnings-per-share growthWednesday that exceeded Wall Street expectations. But shrewd investorsgenerally ignore the headline earnings number because of the unreliabilityof gain-on-sale. Using AmeriCredit numbers, the company showed a $22million 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 iseven worse if effective borrowing that needs to be done to carry out loansales are factored in. Ryan estimates that, with those adjustments,AmeriCredit experienced an effective cash drain of $117 million in thefourth quarter.

On credit quality, the company's bad loan charge-off rate was 5.2% inthe quarter, up from 3.2% in the year-earlier period. And on the call, anAmeriCredit official said it increased the amount of loans that wererestructured in some way to bring the borrower current. This tactic, it isfeared, only delays defaults and bad loans, rather than preventing them.The higher use of them partly explains the weak cash flows, since thecompany allows distressed borrowers to miss payments.

In what could turn out to be a very serious development, AmeriCreditsaid it was going to have to put up more of its own cash into special cashpools that are set up when loans are sold. This is happening because there-insurers who pledge to make the cash payments have less of an appetitefor AmeriCredit risk.

And that appetite will only shrink further after Wednesday.

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