Executives at subprime auto lenders say the industry must adopt more reliable accounting practices if it is to recover from the fiascoes of recent months.
In the last four months, both Mercury Finance Co. and First Merchants Acceptance Corp. have restated earnings and fired top executives they accused of fudging the books, thus inflating earnings and misleading shareholders. Federal authorities are investigating Mercury.
These and other surprises have caused stocks to fall throughout the industry, and executives are starting to say more reliable accounting is needed to avoid future crises of investor confidence.
"If the industry had a more consistent reporting method it would be easier" both for investors and companies looking to buy competitors, said James F. Leary, vice chairman at Search Capital Group Inc., a Dallas subprime auto lender that has been buying distressed subprime auto lenders.
There has been talk at the American Financial Services Association about looking into how subprime auto financiers account for themselves, said spokeswoman Lynne Strang, "but it's only in the hallway discussion phase now."
Clearly, however, investors are clamoring for more realistic bookkeeping.
Last Thursday shares of Olympic Financial Ltd. rose 23% even though the Minneapolis company reported a $75.3 million first-quarter loss. The loss was primarily due to the company's adopting a more conservative accounting system.
Olympic is one of the largest subprime lenders and analysts hope its example will encourage others to follow. "This is courageous action on Olympic's part," said Reilly Tierney, analyst at Duff & Phelps Credit Rating Co.
Essentially, Olympic began assuming it will make less money from selling repossessed cars, dropping its expected recovery rate to 60 cents on the dollar from 81 cents.
Repossessing cars from delinquent customers and selling them is a crucial part of any subprime lender's business. Jayhawk Acceptance Corp. reported seizing and selling 18% of the cars for which it made loans.
The process is especially important for companies that raise money by securitizing loans, because if companies fail to make enough money from their bad loans, they have difficulty paying investors in their securities.
In the sometimes perverse world of subprime lending, companies sell their securities first, book the gains on sale, and then try to collect however much they can on the loans to pay off investors in the securities.
But this scheme can fall apart if the company runs into a rash of delinquencies, or is unable to sell its repossessed cars for as much as it expects.
And many lenders have assumed they could get high returns selling aging autos at a time when used car lots are filled with newer, better cars driven by people who leased them.