In the depressed area that is subprime auto finance, Wall Street has found two stocks worth buying.
Tuesday, Oppenheimer & Co. analyst Steven Eisman upgraded the shares of AmeriCredit Corp. and Consumer Portfolio Services Inc. from "market perform" to "buy."
The companies "are beginning to dominate their markets," Mr. Eisman said in a report to investors. Credit quality and underwriting standards are good at both companies, he said, and AmeriCredit is venturing into subprime mortgages.
Although many competitors are desperate for cash nowadays, AmeriCredit raised $125 million via a private placement before the industry collapsed.
But it's questionable whether AmeriCredit could attract such support today because investors have largely abandoned subprime auto lending.
Analysts and money managers say it will be difficult for subprime auto lenders to tap the capital markets with offerings of stock, debt, or commercial paper because the industry's credibility has been so damaged by reports of accounting fraud, bankruptcy filings, and heavy losses.
"The profitability equation this industry uses doesn't work anymore," said Reilly Tierney, analyst at Duff & Phelps Credit Rating Co.
Equity investors have gotten the message. J.P. Morgan & Co., one of Mercury Finance Co.'s top shareholders until the company revealed that its earnings had been overstated for four straight years because of phony bookkeeping, has since unloaded 4.26 million shares. It now holds only 3,100.
In the first quarter, Denver Investment Advisors unloaded its entire position of nearly 1.1 million shares in Arcadia (formerly Olympic) Financial Ltd. Similar examples can be found at virtually every subprime auto lender.
John C. Bogle, portfolio manager at Numeric Investors in Cambridge, Mass., said his firm had invested in Mercury when the stock traded at $11.50 per share but sold in January when it reached $14. It has since tumbled to less than $2, but Mr. Bogle said he wouldn't touch it now.
"The earnings power of Mercury and other companies is drastically less than it was," said Mr. Bogle, whose firm buys and sells stocks according to its computer-driven models. "These stocks are not attractive, especially compared to other finance-related companies."
In addition to losing equity investors, subprime lenders face difficulty luring bond buyers.
This week, Duff & Phelps downgraded to just-above-junk-bond status the debt of Arcadia Financial, First Merchants Acceptance Corp., and Reliance Acceptance Corp.
Even before these downgradings, companies had had to resort to gimmicks to attract investors. Arcadia sweetened a March bond offering by boosting the coupon about 200 basis points, to 11.5%, and offering warrants for 6.84 shares at $11. Traders say debt offerings by other subprime auto lenders have since been put on hold.
These businesses face a difficult future without access to the capital markets. They need the financing to originate loans, which they then securitize.
Moody's Investors Service announced Tuesday that it would start reporting on the credit performance of subprime auto securitizations.
Bankers are also losing faith in subprime auto lenders and may start to call in loans and refuse to underwrite securitizations, Mr. Tierney said.
First Merchants, whose loan arrangement with LaSalle National Bank was due to expire in June, recently ventured outside the bank lending market for $200 million of warehouse financing and securitization underwriting from Greenwich Capital.