A possible about-face on accounting by FirstPlus Financial Corp. and a resignation at Green Tree Financial Corp. have shattered any hope that the specialty finance sector will pull out of its tailspin any time soon.
A sectorwide alarm went off Tuesday after FirstPlus, in a statement filed with the Securities and Exchange Commission, said it was considering eliminating gain-on-sale accounting.
Gain-on-sale accounting allows companies to book profits on estimated gains from the eventual sale of loans. The method has become controversial lately because several lenders have been forced to take writedowns when expected profits did not materialize.
The SEC filing sent FirstPlus' stock 20% lower Wednesday and triggered fears that equity in the entire sector could evaporate overnight if others were to follow suit.
FirstPlus' stock rebounded 43.75 cents Thursday, to $35.8125, while Green Tree shares fell $3.125, to $23.875, on news that its president, Robert Potts, had resigned. Other stocks in the already battered sector sank lower. Money Store fell 87.5 cents, to $22.8125; Aames Financial Corp., 37.5 cents to $13; and Delta Funding Corp., 56.25 cents to $15.
FirstPlus has not necessarily made the decision to eliminate the practice, stressed chairman Daniel T. Phillips. But a $150 million writedown by Green Tree in mid-November means that now may be the time to do it, he said.
"When Green Tree announced their writedown, I believe what credibility remained in gain-on-sale accounting was irreparably damaged," Mr. Phillips said. "The absence of standardization and the use of gain-on-sale accounting has made this industry a mine field," he said.
If the 15 largest home equity lenders were to eliminate gain on sale accounting, it would wipe $5.4 billion of assets from their balance sheets, explains Reilly Tierney, analyst with Fox-Pitt, Kelton. "It would virtually eliminate all their net worth," he said.
Ultimately, analysts say, changing accounting assumptions will result in higher quality earnings. "The question is, do you take the pain now, when no one is believing your earnings anyway?" said Mr. Tierney.
Eliminating the accounting practice is not the only thing the nonbank lending industry needs to survive, said Tom Facciola, Lehman Bros., but it "would be a good start."
Contributing to the selloff was the fear that more bad news could surface from Green Tree.
Mr. Potts' resignation reminded some observers of the resignation of Mercury Finance's comptroller in January, which preceded the disclosure of accounting irregularities and a meltdown in its stock.
Green Tree did not return phone calls.
Green Tree's Mr. Potts will be "pursuing other business interests," the company reported in a prepared statement. Mr. Potts had been with Green Tree since 1993. His duties will be assumed by company chief executive Lawrence M. Coss.
Analysts blasted specialty finance companies overall, saying that the universal slide in their stock prices was their own fault because of the industry's general lack of disclosure.
"Anytime there is bad news from one company, there will be an impact," said Mike McMahon, analyst with UBS Securities. Specialty finance companies have "done a poor job of communicating to the Street their business," he said.
If these companies "want their stocks to sell at half their current market value, they should continue doing what they're doing," he warned.
Things will undoubtedly get worse before they get better, Mr. Facciola said. "December, January, and February are ugly season," he said, "because this is when audits get done." Mr. Facciola said he expects several other home equity companies to take writedowns in the next few months.
