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Less Business Wanted? It Worked for AmeriCredit

By reining in growth, CFO Daniel Berce kept the auto lender in the money.
Andrew OsterlandOctober 22, 2001

The financial turmoil in the fall of 1998 alarmed more than a few corporate finance executives. But for Daniel Berce, CFO of subprime auto lender AmeriCredit, it was a full-blown, career-defining crisis.

Like all specialty finance companies, AmeriCredit relies on the capital markets to fund its lending operations. And as with all CFOs in the industry, Berce’s top priority is to maintain access to that money. “The capital markets are our lifeline,” says the 46-year-old Berce, who joined AmeriCredit’s predecessor company Urcarco 11 years ago. In 1998, the lifeline was cut. Blame the Russian government for defaulting on its debt, or the rocket scientists at rogue hedge fund Long-Term Capital Management, but the capital markets fell into a sickening tailspin. With investors deciding the only safe place to hide was in U.S. Treasuries, both the equity and fixed-income markets closed to all but the bluest of blue chips–bad news for a BB-rated firm running cash- flow deficits. “It became a matter of survival for us,” says Berce.

Since 1994, the Fort Worth-based lender had been growing its business at a 75 percent annual clip, using the asset-backed securities market to finance its loan portfolio and periodically tapping the high-yield market to cover cash-flow deficits. Credit lines from the banks helped fund the loan originations before they were packaged into securities. With the market meltdown in 1998, however, all of the company’s key financial relationships were in jeopardy. The bankers refused to extend credit lines, and the company’s bond insurance guarantor and reinsurers–crucial to AmeriCredit’s access to the asset-backed securities market–also got cold feet. Virtually blackballed by the financial community, AmeriCredit had about nine months of cash to fund its business.

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AmeriCredit was by no means the only lender staring bankruptcy in the face. Indeed, most specialty finance companies no longer exist. Some went bankrupt (Mercury Finance, First Merchants Acceptance Corp.), while many mortgage lenders were acquired by banks (The Money Store). But thanks in large part to Berce’s ability to differentiate his firm and to find new sources of capital, AmeriCredit not only survived, it emerged far stronger. Now the third-largest auto-loan securitizer in the country behind Ford and Chrysler, the firm has been generating positive cash flow since the beginning of last year, and its stock has risen by 600 percent, to $46, since bottoming at $7 in November 1998. “We wouldn’t be here today without the innovative ways that [Berce] approached the capital markets,” says CEO Michael Barrington of the winner of the 2001 CFO Excellence Award for Capital Structure Management.

A Radical Plan

Berce’s first step was nothing less than radical: He proposed slowing business down. Given that it takes about 15 months before AmeriCredit sees any cash from the loans it securitizes and services, the faster the company grew, the more cash it needed. Berce and his finance team projected that if the company reduced its loan volume growth from 75 percent to 25 percent, it could generate positive cash flow by mid-2000. That meant tightening credit standards and slowing the company’s expansion–a strategy not exactly embraced by all of management. “There were some shouting sessions between the chairman, the president, and me,” admits Berce.

With a new, more-conservative plan in hand, Berce started making the rounds of Wall Street and commercial bankers. They were not a very receptive audience. “There was a lot of fear that the subprime credits were falling apart,” says Berce, despite the fact that AmeriCredit wasn’t experiencing higher loan-default rates. Because other subprime lenders were dropping like flies–only 4 of 30 specialty finance companies that went public in the 1990s are still listed–the bankers refused to renew AmeriCredit’s credit facilities.

Like most asset securitizers, AmeriCredit purchased a financial insurance guarantee that enabled it to issue AAA-rated bonds in the asset-backed securities market. It was required to set up a cash reserve account of 8 percent of each securitization transaction, although the guarantor, Financial Security Assurance, arranged for a reinsurance policy to cover 5 percent of that reserve. With the financial turmoil, however, FSA said it could no longer provide the reinsurance and AmeriCredit would have to fund the full 8 percent itself. In other words, the company would have to come up with another $50 million for every $1 billion in securitized transactions–money it didn’t have.

Give the Market What It Wants

With bankers and reinsurers giving him the cold shoulder, Berce’s only recourse was with investors. He set about shoring up the company’s credibility on two fronts. First issue: credit quality. Mercury Finance, one of AmeriCredit’s leading competitors, was already in bankruptcy because of larger-than-expected loan losses, and AmeriCredit was guilty by association. In the fall of 1998, Berce began disclosing the monthly credit performance of the company’s loan portfolio, which showed that despite the crisis on Wall Street, the company’s loan-default rate wasn’t rising.

Second issue: gain-on-sale accounting. According to generally accepted accounting principles, securitizers of such assets as car loans, mortgages, and credit-card receivables are deemed to have sold the assets, and are required to recognize gains or losses on the sales when the asset-backed securities are issued. With all the earnings from long-term loans loaded up front, the growth was unsustainable–particularly given the aggressive assumptions lenders were making about their portfolio performance. “A lot of subprime lenders were doing some pretty outrageous things,” says Tom Foley, a vice president at American General Investment Management who formerly covered specialty finance companies for Moody’s Investors Service.

Many of those lenders were subsequently forced to take huge charges in 1997 and 1998 to undo the gains they had previously booked from securitizations. Some suffered larger credit losses, but most had severely underestimated the prepayment speeds of their borrowers when interest rates dropped. When borrowers refinance, the future interest payments that the companies have already recognized as income disappear. Never mind that auto loans have a much lower rate of refinancing than mortgages; anything subprime and anything to do with gain-on-sale accounting couldn’t be trusted.

The solution was to give the market what it wants. Along with the GAAP financials, Berce began disclosing earnings on a “portfolio” basis, as if the firm had not sold its loans. It recognized income as received and costs as incurred, just like a traditional lender. The practice reassured the market that the firm’s earnings growth was no accounting mirage. “AmeriCredit managed to differentiate itself from the rest of the industry,” says Goldman Sachs analyst Robert Hottensen.

In April 1999, the increased transparency paid off when AmeriCredit became the first subprime lender since the meltdown to tap the high-yield market, raising $200 million. The rating agencies affirmed AmeriCredit’s BB- rating, but threatened a downgrade if equity wasn’t raised soon. The opportunity came four months later, when AmeriCredit also became the first subprime finance company to raise equity since before the previous fall. It took more than 80 presentations and a two-week road show, but Berce managed to raise $112 million. “The high-yield deal broke the logjam,” he says. “It took care of the short-term liquidity concern for all our constituents.”

With the liquidity issue resolved, Berce turned his attention to the reinsurers. Again he was forced to explain why his company was any less of a risk than other specialty lenders. “I made a lot of trips to New York to convince the reinsurers to step into the void,” says Berce. Again, it paid off. In October 1999, the company signed a unique $225 million revolving facility with a group of four reinsurers to fund the company’s cash-reserve requirements. Shortly thereafter, the banks came around. During the rest of 1999 and into 2000, Berce signed up 10 new banking partners for credit facilities that increased the company’s capacity from $500 million to $2 billion.

With far fewer competitors on the landscape, the company is growing at a 40 percent to 50 percent annual rate. The slowing economy will almost certainly test the credit quality of the company’s loan portfolio. But with Daniel Berce running the finances, AmeriCredit likely won’t lack for capital.

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