Credit Acceptance Corp (CACC) 2009 Q4 法說會逐字稿

Good day, everyone, and welcome to the Credit Acceptance Corporation fourth quarter and full-year 2009 earnings call. Today's call is being recorded. A webcast and transcript of today's earnings call will be made available on Credit Acceptance's website.

At this time, I would like to turn the call over to Credit Acceptance Senior Vice-President and Treasurer, Doug Busk. Please go ahead, sir.

Thank you, Jamie. Good afternoon and welcome to the Credit Acceptance fourth quarter and full-year 2009 earnings call. As you read our news release posted on the Investor Relations section of our website at creditacceptance.com, and as you listen to this conference call, please recognize that both contain forward-looking statements within the meaning of federal securities law.

These forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond our control and which could cause actual results to differ materially from such statements. These risks and uncertainties include those spelled out in the cautionary statement regarding forward-looking information included in the news release. Consider all forward-looking statements in light of those and other risks and uncertainties.

Additionally, I should mention that, to comply with the SEC's Regulation G, please refer to the Adjusted Financial Results section of our news release, which provides tables showing how non-GAAP measures reconcile to GAAP measures.

This afternoon Brett Roberts, our Chief Executive Officer, and myself will provide some comments relating to our operational and financial results, as well as our liquidity position. After we have concluded our prepared remarks, we have set aside some time for questions. To assist us in answering your questions, we also have Ken Booth, our Chief Financial Officer, with us today.

At this time, I'd like to turn the call over to Brett.

Thank you, Doug. And thanks to everyone who has joined us this afternoon for the call. As our long-term shareholders know, this is our first quarterly earnings call. We have not held quarterly calls historically as we believe the combination of our press releases, SEC filings and investor website was the most efficient and effective way to communicate to shareholders. However, as a result of our recent senior note offering, we agreed to hold quarterly calls. As we gain some experience with this new process, we hope to find a way to make it a productive use of everyone's time.

Our press release contains all the information on the most recent quarter and full-year results that we think is most relevant. We don't plan to review all this same information verbally. I will make a few introductory comments, Doug will spend a few minutes reviewing the information in the release, and then we'll open it up for questions.

I'd like to start by spending a minute reviewing our basic business model. We are an indirect auto lender, which means that the loans are originated by the auto dealer and then, shortly after origination, are assigned to us in exchange for a cash payment.

Approximately 90% of the loans assigned to us last quarter were on what we call our Portfolio Program. Under our Portfolio Program, the originating dealer shares in the risks and rewards of the loan. We make an initial cash payment to the dealer, called an advance, the customer makes their payments to us. We retain 20% of the cash collected as our fee. The other 80% is remitted to the dealer after we recover our initial advance from the dealer's 80% share.

The amount remitted to the dealer after the advances are covered is called Dealer Holdback. We group the loans received from each dealer into pools and apply the dealer's 80% share of the collections on all of the loans in the pool to reduce the aggregate advance balance owing on the pool. By sharing the cash collected from the loan with the dealer, we hope to incentivize the dealer to take actions which improve the performance of the loan.

The largest portion of our revenue consists of the cash collections we receive from the customer, less any amounts paid to the dealer. The amounts paid to the dealer include the initial advance plus the Dealer Holdback. The initial advance is based on our target return on capital, which primarily considers the cash collections we expect from the loan. Our return on capital varies based on the amount of the advance and the amount we collect on the loan.

The product we offer provides value to both the dealer and the end consumer. We provide an opportunity for our dealers to serve a very large market segment that they may not be able to serve without our program. The end consumer benefits by being able to purchase a more reliable vehicle than they could purchase on a cash basis, as well as an opportunity to establish or reestablish their credit standing.

Our goal is not to retain this customer for life but, instead, to have the customer return to the dealer with an improved credit record in position to finance their next vehicle purchase at a lower rate through a more traditional channel.

Our business model has produced very good results over a long period of time. We report both GAAP and adjusted results. Internally, we focus almost exclusively on adjusted results as we believe the adjusted results more closely reflect our true economic performance. The results that I will refer to in the next few minutes are all on an adjusted basis.

For the most recent period, we earned $35.5 million for the quarter and $125 million for the year. Earnings per share was $1.11 for the quarter and $3.95 for the year. EPS grew at 46% for the quarter and 48% for the year.

We think about our results in terms of the amount of capital invested in the business and the return we earn on that capital. The average capital invested in the business for the quarter was $990 million, which is down 2.4% from the prior year same period. For the year, average capital was $999 million, which was up 2.4% from the prior year.

Although we intend to grow the size of our business over time, growth in capital was obviously not the reason for our strong results for the most recent period. Instead, our results improved because we improved the return on capital. For the quarter, our after-tax return on capital was 16.7% compared to 12.1% for the same period of '08. For the year, our return on capital was 14.6% compared to 11.3% for 2008.

As we discussed in the release, our return on capital improved as a result of pricing changes we made during the first nine months of 2008, as well as strong loan performance. Although our ability to grow the business was constrained by our capital position, we were able to improve our bottom line as the competitive environment allowed us to improve per-loan profitability.

As you probably know from our written communications over the years, our primary financial performance metric is economic profit. Economic profit is a function of three variables -- the return on capital, the cost of capital and the amount of capital invested. Our incentive plans are based on growing economic profit. Growing economic profit requires us to either improve the spread between our return and cost of capital, or to grow the amount of capital invested.

Over the last nine years we've been successful at both growing the amount of invested capital and improving the spread between our return on capital and the cost of capital. As a result, economic profit improved from a negative $5 million in 2001 to a positive $79 million in 2009.

Since 2001, we have grown average capital at a compound rate of 9.9%, with much of that growth occurring during a period of increasing competition from 2003 through 2007. During the same period, we improved our return on capital from 7.4% in 2001 to 14.6% in 2009, while our cost of capital declined from 8.4% in 2001 to 6.7% in 2009.

It is worth noting that, if we are successful in growing the economic profit from where we are now, it is much more likely to come from increasing the size of the (inaudible) rather than from increasing our return on capital.

The return on capital in today's release reflects a very favorable competitive environment that is unlikely to continue. We have recently made pricing changes that will reduce the return we are earning on new business in exchange for more volume. The changes we have made thus far are modest but, as competition returns to the market, we may be required to make additional changes.

We are fortunate to operate in a very large market and we have considerable room to grow our originations by adding more dealers to our program. In addition, we are taking steps to increase the size of our field salesforce, which will serve as an additional driver of loan growth in future periods.

At this time, Doug will provide some additional comments on our operating and financial results, as well as on our liquidity position.

Starting with consumer loan performance. Consumer loan performance is one of the most important variables that determine our financial results. Assessing consumer loan performance at the time of origination with precision is difficult. Knowing this, we devote significant time and attention to this process. As importantly, we maintain realistic expectations about the precision of our estimates and set advance rates so that, even if loan performance is less than we expect, the loans are still highly likely to be profitable.

The most important time to assess consumer loan performance is at the time of origination since that is when we determine the advance to the dealer. Over the last 10 years we've been successful in forecasting the performance of the loans at loan inception. The table in the press release summarizes the precision of our estimates over this period.

2001 represents our worst year, with actual loan performance lagging our initial estimate by 2.9%. Although it's early, 2009 originations are performing very well, with a current expected collection rate which exceeds our initial estimate by 3.7%.

To put these numbers in perspective, a 1% change in the collection rate impacts after-tax returns on capital by approximately 50 basis points. Over the 10-year period, our initial estimates have proven to be very accurate, with an average positive variance over the 10-year period of 13 basis points.

Moving to loan volumes. Despite increasing pricing during the first nine months of 2008, our consumer loan unit and dollar volume increased during this period when compared to the same period in 2007. As we continued to make pricing changes to achieve origination levels consistent with our capital position, we began to see year-over-year declines in loan volume starting in the fourth quarter of 2008.

During the summer of 2009 we renewed our revolving credit facilities. As a result of eliminating the uncertainty associated with the renewal of these facilities, we increased advance rates modestly during the last four months of 2009. As a result, during the fourth quarter of 2009, consumer loan unit volume increased 7.6% while dollar volume increased 2.1%.

Our future growth rates will depend on how unit volumes respond to pricing changes, which will be influenced to a large degree by how rapidly competition returns to our market.

We adjusted advance rates on both September 1st and again in November. Although Q4 volumes grew, January unit volumes declined by 5.3% versus January of the prior year. It is too early to say if January results are an outlier or an indication of a changing competitive environment. Given the high returns we're expecting from current originations, we believe we have room to adjust prices further to improve our loan growth.

Moving to financial results. We recorded very strong financial results for the year and quarter ended December 31st, 2009. For the quarter we reported consolidated net income of $40.3 million, or $1.27 per diluted share, compared to net income of $18.6 million, or $0.60 per diluted share for the same period in 2008. For the year, we reported consolidated net income of $146.3 million, or $4.62 per diluted share, compared to net income of $67.2 million, or $2.16 per diluted share in 2008.

In our news release we also disclosed adjusted financial results. We do so to help shareholders better understand our financial performance. Our adjusted results include several adjustments to our reported GAAP results. In 2008 and 2009, only one of these adjustments, the floating yield adjustment, was material.

The floating yield adjustment relates to how we account for our loan portfolio. Under GAAP, positive and negative revisions to forecasted cash flows from our loan portfolio are recorded differently. Negative revisions to forecasted cash flows are recorded as a current period expense. Positive revisions are either recorded as a prospective yield adjustment or as a reversal of a previously recorded provision.

Our floating yield method is identical to GAAP except that, under this method, all changes in forecasted cash flows, both positive and negative, are treated as prospective yield adjustments and, therefore, impact earnings over time.

On an adjusted basis, consolidated net income for the quarter was $35.5 million, or $1.11 per diluted share, compared to $23.6 million or $0.76 per diluted share for the same period in 2008. For the year, adjusted consolidated net income was $125 million, or $3.95 per diluted share, compared to $82.8 million, or $2.66 per diluted share in 2008.

The increases in both GAAP and adjusted net income for the quarter and year were due to pricing changes made during the first nine months of 2008, offset to some degree by the pricing changes made during the last four months of 2009.

In addition, both GAAP and adjusted net income were impacted by the performance of our loan portfolio in each period. In 2008 we reduced our forecasted collection rates as a result of an unfavorable trend in payment patterns while, in 2009, our forecasted collection rates increased due to an improvement in payment patterns.

The way that these changes are reflected in our GAAP and adjusted results is different. Under GAAP, the reduction in forecasted cash flows in 2008 resulted in an increase in the provision for credit losses while, in 2009, the increase in forecasted cash flows resulted in a reversal of previously recorded provisions for credit losses and an increase in the yield on our loan portfolio.

In our adjusted financial results, both the reduction in forecasted cash flows in 2008, and the increase in forecasted cash flows in 2009, resulted in prospective adjustments to the yield on our portfolio.

Other factors that contributed to the increase in net income on both a GAAP and adjusted basis were a reduction in interest expense due primarily to a reduction in the amount of outstanding debt, and the formation of VSC Re in the fourth quarter of 2008. We formed VSC Re in order to enhance our control over, and the security in the trust assets, that will be used to pay future vehicle service contract claims.

This new structure required a change in the way that we account for the income we earn based on the performance of some of our vehicle service contracts. Under our current accounting, we account for this income on an accrual basis whereas, previously, it was accounted for on a cash basis. This change increased our net income on both a GAAP and an adjusted basis by $1.2 million and $6.2 million for the quarter and year ended December 31st, 2009, respectively.

The last topic that I want to discuss today is our liquidity. This summer we renewed all of our revolving credit facilities. In December, 2009 we completed a $110.5 million senior sub-securitization. And just this week we closed on a $250 million seven-year senior secured notes offering.

The notes offering leaves us in a very strong liquidity position, with over $450 million in available and unused debt capacity. This notes offering is part of our strategy to diversify our funding sources and increase the tenure of our debt.

The notes offering reduces our reliance on the short-term credit and bank markets which, as we saw in 2008, are subject to disruption from time to time. We would like to position our company to be a stable source of financing for our dealers in the event of another disruption in the credit markets.

We will continue to assess our debt structure, with the objective of lowering the financial risk associated with the way that we fund the business.

To the extent that we are very comfortable that our capital structure will provide us the ability to consistently grow our business, we will consider returning excess capital to shareholders, as we have in the past.

And now, I'd like to turn it back over to Brett.

Thanks, Doug. This concludes our prepared remarks for this afternoon. We would now like to welcome your questions.

(Operator Instructions.) And we'll take our first question from Brett Johnson with Rocket Capital Management.

Hey, guys. Great quarter.

Thank you.

I have a couple questions here. We've been a small shareholder for a while. In regards to the additional liquidity you have, the $450 million, how can we think of that in terms of your capacity for 2010? Does that $450 million get added on to what you did in new loans for 2009, or how should we think about that?

Well, the sources of capital that we have to fund new originations are really the cash flows from our existing portfolio, together with the capacity that we have under our existing facilities. We have over $400 million available as we speak. Based on anticipated origination levels and the cash available from our existing facilities and the cash that's generated from our existing portfolio, we feel comfortable with our capital position at present.

Okay. So, when we think about new loan originations, does that $450 million, does that stack on top of the amount of loans that you were able to originate in 2009?

I don't think that's the way we think about it. I guess--.

Okay.

$450 million is a lot of capacity.

Okay.

We don't think that our ability to grow originations will be limited at this point by our capacity. I guess with the one caveat is that we do have some renewals coming up in the summer that will need to go our way for that to continue to be true.

And those renewals in the summer, what kind of size is that?

We have two facilities that we intend to renew in the summer. One is actually a facility that doesn't mature until June of 2011. That facility is in the amount of $140 million. Our past practice has been to renew that facility every summer so that we always have between 12 and 24 months remaining on the facility.

The other facility is a $325 million facility that ceases to revolve if not renewed in August of next year.

Okay. Going kind of a different direction, what -- you mentioned that your average capital for the year was $999 million. Is that what you normally record as your average receivables for the year?

That's very close to the average receivable.

Very close? Okay. Because if you do the math based on your finance charges, then your yield on those loans were really good compared to the last several years.

One other question related to your revenues. This new VSC that you have with the vehicle contracts, does that get reported in other revenues? Or how does that flow into the P&L?

There's a separate line item for premiums earned.

Okay. So, that's premiums earned. And then lastly, then I'll jump back in the questions, you guys talked a little bit about the competitive landscape. Historically, how do you compare this current -- coming out of the credit crisis and the economy improving, how does this compare to historical patterns and vis-a-vis the competitive nature that you guys have right now? If you could just give a little color on that, I'd appreciate it.

Okay. Well, the competitive environment got increasingly difficult from sort of '03 through '07. And if you look at the reported volumes per dealer, you'd see that our volumes per dealer declined. During that period we were still able to grow originations by adding dealers to our program. And that was true through 2007, which was the most competitive year. Obviously, things changed at the end of '07. '08 was a much more favorable competitive environment. We were able to grow originations. At the same time, we increased our price pretty significantly during the year.

At this point, it's still a favorable competitive environment. We mentioned the unit volume decline in January. We don't know at this point whether that's because the competitive environment has now changed or whether there's some other factors involved. So I mean, at this point it's still -- if you look at the returns that we're making, it's still a very, very favorable environment for us.

Okay. And then you mentioned adding to the headcount. What -- can you say how many you added to the headcount?

In terms of the salesforce?

Yes.

We've only made modest changes so far, but we would plan to grow our salesforce by 20% to 25% this year.

Okay. Okay, great. I'll jump back in the queue.

And we'll take our next question from David Burtzlaff with Stephens, Inc.

Good afternoon, guys. Good quarter.

Thank you.

Doug, how should we think about the loss provision for 2010? I mean, obviously, you got the credits throughout 2009 -- or through the last three quarters. Is that going to be sustainable or should that actually become an expense at some point?

Well, as we discussed, in 2008 the provision for credit losses increased due to a reduction in forecasted collection rates. 2009 forecasted collection rates increased as a result of an improvement in payment patterns. This created a reversal of previously recorded provisions and an increase in the yield.

In terms of the future level of provisions, this will be largely driven by the accuracy of our forecasted collection rates. While we experienced larger than average variances in forecasted collection rates in 2008 and 2009, as I mentioned, historically our forecasts have been relatively accurate and stable.

The accounting for the majority of our loan portfolio is done on a dealer by dealer basis. As a result, even if our forecasts are accurate and stable over time in the aggregate, we record some level of positive provisions because our forecasted collection rate for a significant number of dealers declines and increases each period. Provisions are recorded when the forecasted collections for dealers declines.

So, as a result, if our forecasts are accurate and stable in the future, I think you should expect some level of positive provision. On the other hand, if collection rates vary more than they have historically, as was the case over the past couple of years, you're either going to see an increase in the level of provisions in the event that our forecast declines, or a reversal of previously recorded provisions in the event that our forecast increases.

Does that answer your question?

Yes. I mean -- so, I mean, more than likely if you're accurate enough we should see positive provision.

Yes, that's correct. I mean, the way we handle that internally is we just forecast -- our forecasts are based on the adjusted numbers. And that way, you don't have to deal with the complexity of the provisions. Over time, the adjusted numbers and the GAAP numbers will be the same. It's just in any given year or quarter they'll be different.

Okay. Okay. And then, on the VSC Re, I mean, there was a one-time increase last -- in the third quarter, I think. Is that right? Because the premiums earned and the provision for claims was down this quarter.

That's correct. We adjusted our revenue recognition last quarter, so you had a one-time pickup there.

Okay. Well, thank you very much.

And we'll take our next question from Stephan van der Mersch with RCG.

Hello, gentlemen.

Hello.

Just wondering, long term, next several years, how fast do you want to grow? How do you think about that?

I think the way we think about it is we have be flexible and just respond to whatever competitive environment that we're dealing with. I think historically we've been successful growing the business, but it hasn't been consistent. And we don't set a target and then try to achieve that target. We more just try to pay attention to what the competitive environment is like and then try to price (inaudible) achieve the highest level of economic profit that we can.

And how do you read the competitive environment? Is it only on unit volumes and pricing, or how is it that you can tell what's going on?

Yes. We can just tell from how much volume that we're getting.

Okay. So, you have sort of no anecdotal sense of what all the competitors are--.

--There's always an anecdotal sense, but I think it's -- we rely on that much less than we do the actual volumes that we see every day.

And can you share what sort of anecdotal sense you have right now is?

I would say the anecdotal sense is that there is some competition returning to the market.

And is it at a pretty accelerate pace or is it pretty gradual? What does it feel like?

I don't think I -- I don't really have a good sense for that. I don't think I can assess it with that amount of precision.

Okay. Fair enough. Thank you.

And we'll take our next question from Brian Dunn with Hovde Capital.

Hi. Thanks for taking my question. I just have one brief one. I was just wondering what impact, if any, the recent strength in used vehicle prices has had on your collection rates and your credit? And has that been any of a factor of adjusting your expected collections up at all? Thank you.

It's a very small factor. A very small percentage of our total collections come in from vehicle sale proceeds. So, a 10% or a 20% change in used car values, which would be a big change, has a very limited impact on our collection rates.

Anything further, Mr. Dunn?

No, I just had one question. Thank you.

Thank you, sir. (Operator Instructions.) We'll go next to Dan Mazur with Harvest Capital.

Good afternoon, guys. Thanks for having the call. Just wanted to touch base on the competitive front. I mean, I think I saw in a past note or filing of yours that you thought you would do around 635 of new originations assuming you didn't get any more funding. And it's about the rate you came in this year. And so, it sounds like the back half originations were less than you expected. So, I mean, is that just the result of the competition you've seen start to emerge?

No, I think it's just a function of it's very difficult to project what the originations are going to be. But the environment is changing and we price the product to achieve the best result we can, but then we just take what the market gives us.

Okay. And so, how quickly, with the volumes down in January can you kind of adjust pricing to drive unit volume?

The pricing can be adjusted very, very quickly. So, that's not an issue.

Okay. And then just -- I mean on the period where things have gotten better or competition increased, maybe you could just help me out, just what you historically, the range of kind of your return on adjusted capital maybe in that '03 to '07 period on looking at more -- a normalized area. What historically has that been for you guys?

In terms of new originations, '07 was -- we made a lot of changes from '03 through '07 that drove improvements in our profitability. So, that's -- it's hard to look at that period. But if we just looked at '07, which was the most competitive year, our returns on new business were somewhere around -- again, after-tax, around 11%. Now, we're up into the mid-16s. So, I think that's probably a reasonable range going forward. It's probably going to be a while before we see a competitive environment as difficult as 2007. There was obviously a lot of money flowing back then and I think it'll take some time to get back to that point.

Is mid-16s you view as a peak?

Yes, I would view that as a peak.

Okay. So, it's just a question of how -- it's almost a perverse, as the world gets better it's just going to hurt your returns, as strange as that is.

Correct. It's a function of competition, for sure.

Okay. That's everything I had. Thanks.

And that does conclude our question and answer session. At this time I'd like to turn the call back to you, Mr. Busk, for any additional or closing remarks.

Okay. Thank you. We'd like to thank everyone for their support and for joining us on our conference call today. If you have any additional follow-up questions, please direct them to our Investor Relations mailbox at ir@creditacceptance.com. We look forward to talking to you again next quarter. Thank you.

And once again, that does conclude today's conference. We thank you for your participation.