Goodbye & Good Riddance (Part 2)

Estimates of future accounting events can be the stuff of potential manipulation. Take the example of Creditrust, a Baltimore, Md., company that raised approximately $80 million in equity capital based upon gains on sale in connection with its securitizations of delinquent credit card receivables.   

In 1997, Creditrust reported net income for the year of approximately $456,000. In the first quarter of 1998, the company reported that earnings had increased substantially, but the improved results weren’t sufficient to drive Creditrust’s market capitalization to $124 million, a massive multiple of 272 times trailing year earnings. The catalyst for that leap was the Creditrust disclosure in its initial offering documents that the company had recently realized a $6.1 million gain as a result of the securitization of its defaulted credit card receivables. A second equity offering in 1999, following the report of a second securitization upon which a $7.4 million gain on sale was reported, valued the company at $190 million. 

The gains were illusory. Creditrust filed for bankruptcy in 2000, and after more than five years of litigation, class-action plaintiffs settled fraud charges for $7.5 million, a recovery that represented less than 10 percent of the equity Creditrust had raised in the capital markets. (See “Judge Gives Preliminary OK for Settlement in Creditrust Lawsuit,” by Rachel Sams in the May 6, 2005, Baltimore Business Journal.) While the losses were by no means remarkable, the fact that Creditrust could raise $80 million of equity was preposterous.