Underwriting Undercuts AmeriCredit Bulls
By Herb Greenberg
Senior Columnist
05/14/2002 12:53 PM EDT
When it comes to AmeriCredit (ACF:NYSE - news - commentary - research - analysis), the only analyst who really counts is Bill Ryan of Portales Partners, who rates the subprime auto lender a sell. So what if he doesn't work for a big brokerage firm anymore? (As if size really matters!)
What Ryan clearly knows is the business of AmeriCredit: His specialty before he started covering the company in 1997 was analyzing securitizations, or the packaging and sale of loans to investors, which plays a big role in AmeriCredit's business. What's more, Ryan comes from a family of car dealers in AmeriCredit's headquarters town of Fort Worth; he even sold cars himself for several years -- all of which helps him understand the nuances of a company like AmeriCredit.
It was those nuances in mid-2000 that first sparked concern by Ryan, then an analyst at Salomon Smith Barney, over his buy rating on AmeriCredit. He noticed changes in the company's underwriting business, with loan terms being extended to 72 months from 66 months. The company also started to waive such requirements as proof of salary and residency. "When you're dealing with a subprime person," he says, "you want to verify all sources of income."
Initially, Ryan cut the stock to a "weak buy" because there's a lag time between "when you sense a problem in underwriting and when it starts to surface," he says. "I knew back then if I changed my rating too much I would be early," he says. Within a year, the lax underwriting started to rear its head. As this column pointed out on Aug. 20 -- when its stock was $52 -- the quality of loans AmeriCredit had repackaged and sold started to deteriorate, with growing delinquencies and loan extensions (not to be confused with extended-term loans). When a loan is extended, payments are deferred without the loan being considered delinquent.
Ryan's big downgrade to a sell, while most other analysts maintained their buys, came several weeks later when he switched firms. (It's hard to beat the conviction of a bull-turned-bear!) AmeriCredit's stock, which had started to swoon, went as low as $14 by Nov. 2 and didn't really start to rebound until February, when delinquencies improved and loan extensions fell. It climbed to nearly $47 on April 23, after third-quarter earnings exceeded expectations.
But was that earnings growth just an illusion? Ryan and a number of short-sellers think so. "One of the old tricks in specialty finance is to report earnings well in excess of consensus estimates in order to ... draw investors' attention away from real issues," he wrote in a postearnings report.
Among those issues was the fact the improvement in delinquencies and the drop in loan extensions was seasonal, with both rising in almost every pool by March and April (depending on whether the loans were 30 or 60 days late). As delinquencies rose, gross cash flow from the securitized loans fell last month to $21.4 million from $23.9 million in March. (That's generally not considered a positive.)
Making matters worse, while the average age of the company's loan portfolios is stuck at around 13 months, loans that are charged off as losses have jumped to 4.8% last quarter from a low of 3.6% in June. "It tells you the loan volume is masking a bigger problem," Ryan says, "and it's not just an economic problem, but an underwriting problem." He adds that credit quality statistics show that newer loans are performing worse than older loans.
"In fact," he wrote in a report last month, "early delinquency performance in new deals is so bad it almost reminds us of the poor performance of manufactured housing loans securitized by Conseco (CNC:NYSE - news - commentary - research - analysis) in 2000 and 2001." (That stings!)
Some critics suggest that what is happening now with AmeriCredit is a replay of what happened in 1996 and 1997, when the company underestimated losses and was forced to boost reserves a year or two later. The higher reserves didn't hit earnings because the company was growing its loan portfolio so rapidly; fast loan growth is not necessarily a good thing. (It's like trying to walk up a down escalator that's speeding up.) One longtime AmeriCredit short-seller describes the company as being "trapped on a volume treadmill" by being forced to grow its loan portfolio at an ever-increasing rate just to stay even. Loan originations in the March quarter rose by 47%, up from 43% a year earlier. "Anytime you see a financial institution growing at 40% to 50% off a very large base, that should bring up a yellow flag, if not a red flag," Ryan says.
Meanwhile, AmeriCredit's return on managed assets, says Ryan -- who includes his estimate of the provision for loan losses in his calculation -- is less than 1%. Banks offering loans to prime lenders, Ryan notes, return around 1.5%. "You would expect something north of 2% for AmeriCredit," he says, "because they're taking so much incremental risk."
There's also that issue of AmeriCredit's aggressive use of loan extensions. The more loans are extended, the lower delinquencies appear to be, even though the extended loans may still become delinquent. This is something all lenders do, to some extent, to help manage collections. But if loans are extended to help manage collections, Ryan wonders, why would they be up one month, down another month and up the following month? "Our view is that credit extensions are being used to manage the data, not the business," he says.
In the end such games usually backfire, which is why Ryan believes it's only a matter of time before AmeriCredit has to announce write-offs and/or guide down earnings. "If loan growth decelerated," says one short-seller, "it would be a wipeout." As was the case in the early 1990s with Ucarco, which was run by the same team that manages AmeriCredit. It's something they want to forget so much they restructured the company and changed the name! And based on the company's continuously rising stock price, which is up around $2 today to $40, investors apparently want to forget, too. (Ostriches, I tell ya!)
AmeriCredit's spokeswoman didn't respond to an email late Monday.
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