The growth frenzy that made subprime auto lenders so captivating to investors a year ago is now causing big problems.
Prices of several auto lenders plunged after the companies, including such stalwarts as Credit Acceptance Corp., posted earnings that missed estimates because rising loan losses had forced them to build reserves.
"There are a lot of ugly things going on," said Scott Calahan, president of Boston Portfolio Advisers, a Fort Lauderdale, Fla.-based research and due diligence firm. "Companies are either doing reasonably well or miserably."
A series of blows have pummeled the subprime auto lending sector. Since January, industry leaders Mercury Finance Co., Jayhawk Acceptance Corp., and First Merchants Acceptance Corp. have all collapsed. Analysts took the latest round of earnings news as evidence that the shakeout in the sector is not over.
Industry observers attribute the latest bout of problems not to fraud or mismanagement, but to the frenzied pace of lending the companies undertook in 1995 and 1996 to build their loan portfolios.
But rising default rates on these loans to consumers with bad credit have forced some lenders into damage-control mode.
"The best-managed companies are acting pro-actively to strengthen reserves to address problems from the period of overheated competition," said Thomas C. Blum, managing director at Bear, Stearns & Co.
Last week Credit Acceptance Corp. "became the latest subprime auto lender to drop a credit-quality bomb," wrote Salomon Brothers analyst Michael Durante. One of the sector's most bullish analysts, Mr. Durante downgraded the company's stock to "underperform" from "hold" and said that future loan losses will reach 30%, up from the roughly 20% it has experienced before.
Moody's Investors Service also downgraded Credit Acceptance, and its share value plunged 51.4%, to $6.
The rising loss rates forced Credit Acceptance to take a $55 million charge to build reserves and report a third-quarter loss of 59 cents per share.
Additionally, the way the company has paid taxes on its advances to car dealers has also come under fire from the Internal Revenue Service. This could force the company to abandon its practice of making loans to dealers in favor of buying their installment contracts.
But market observers said Credit Acceptance could be hard-pressed to make this switch in time to satisfy its bank lenders, who have given the company until Dec. 15 to figure out a way to resolve the loan covenants it violated in boosting its reserves.
WFS Financial Inc. also disappointed analysts by reporting third-quarter earnings of 25 cents per share, 15 cents less than a year earlier. Its shares dropped 19.3% last week.
"Our earnings decline is a direct result of volume growth decline and continued asset-quality weakness. We believe these trends will continue at least through the fourth quarter," said Joy Schaefer, WFS president and chief operating officer.
Not even companies reporting good earnings had a good week.
Consumer Portfolios Services Inc., until recently one of the few subprime auto lenders that Wall Street still liked, saw its stock drop 24%, to $12.9375, last Thursday. Although the company reported record third- quarter earnings of 31 cents per share, Piper Jaffray and Smith Barney both downgraded the company's shares to "neutral" from "strong buy."
Piper Jaffray analyst Jeffrey Evanson said in a report that recent shifts into riskier loans and no increase in credit loss assumptions caused him to cut earnings estimates and no longer recommend the stock.
