Credit Acceptance Corp (CACC) 2010 Q3 法說會逐字稿

Good day everyone and welcome to the Credit Acceptance Corporation third quarter 2010 earnings call. 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.

Thank you, Matthew. Good afternoon and welcome to the Credit Acceptance Corporation third quarter 2010 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 I 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. In our earnings releases 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 quarter, we earned $39.6 million compared to $34.7 million for the same quarter in 2009. Earnings per diluted share were $1.39, a 26.4% increase over the $1.10 reported last year. We think about our results in terms of the amount of capital invested in the business, and return we earn on that capital. Our results for the quarter improved due to an increase in our return on capital and, to a lesser extent, an increase in the amount of capital invested in our business.

Our after-tax return on capital was 17.4% compared to 16% for the same period of 2009. As we discussed in the release, our return on capital improved as a result of higher yields on our loan portfolio and lower operating expenses offset by a decline in premiums earned. Average capital invested for the quarter was almost $1.1 billion which is up 8.7% from the third quarter of 2009.

The increase in average capital is the result of the growth in loan originations in recent quarters. 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 on capital and costs of capital, or grow the amount of capital invested.

Over the last nine years, we have been successful at both growing the amount of invested capital and improving the spread between our return and cost of capital. As a result, economic profit improved from a negative $5 million in 2001 to a positive $79 million in 2009. During the most recent quarter, economic profit was $29.1 million, a 29.2% increase over the $22.5 million reported in the same quarter of last year.

As I mentioned in our last conference call, if we are successful in growing economic profit in future periods, it is much more likely to come from increasing the size of our business rather than from increasing our return on capital. The return on capital produced in the most recent period is at the high end of the historical range and reflects a very favorable competitive environment that is not expected to continue.

In fact, in late 2009, and so far this year, we are seeing competition return to the market as capital is now less constrained than it was during 2008 and much of 2009. The last four months of 2009 and the first quarter of 2010 we made pricing changes that have reduced the return we are earning on new business in exchange for more volume. The objective of these pricing changes is not to achieve a fixed growth target but, instead, they are intended to maximize the amount of economic profit we generate on new originations. This requires us to appropriately balance unit volume and profitability per loan.

We are confident that the pricing changes we have made thus far have been consistent with this objective. Our ability to grow economic profit in the future will depend in large part on to what degree competition returns to the market.

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

Thanks, Brett.

The first thing I'd like to discuss is consumer loan performance. Consumer loan performance is one of the most important variables that determine our financial results. The most important time to assess consumer loan performance is at the time of origination, since that is when we determine the amount of the advance to the dealer. If we're able to accurately assess consumer loan performance at the time the loan is originated, we'll likely attain our target return on capital and produce acceptable financial results.

Since assessing consumer loan performance at the time of origination with precision is difficult, we set advance rates so that even if loan performance is worse than we expect, the loans that we originate are still highly likely to be profitable.

Overall, consumer loan performance during the quarter ended September 30, 2010, exceeded our expectations at the beginning of the quarter. Forecasted collection rates for loans originated in 2009 and 2010 increased, while the forecasted collection rates for loans originated in other years were consistent with our expectations at the start of the period.

Moving to loan volume, the dollar and unit volume of consumer loan originations increased 51.5% and 26.9%, respectively, during the third quarter of 2010 as compared to the same period in 2009.

Turning to financial results, we recorded strong financial results for the quarter, with GAAP net income of $42 million or $1.48 per diluted share compared to net income of $40.7 million or $1.29 per diluted share for the same period in 2009.

As Brett mentioned, we also disclose adjusted financial results. We do so to better help shareholders understand our financial performance. Our adjusted results include several adjustments to our reported GAAP results. An explanation of each of these adjustments is contained in our earnings release. On an adjusted basis, consolidated net income for the quarter was $39.6 million or $1.39 per diluted share compared to $34.7 million or $1.10 per diluted share for the same period in 2009. The increases in both GAAP and adjusted net income for the quarter were due to an increase in finance charges due to an increase in the size of our loan portfolio as a result of an increase in loan originations in 2010, and an increase in the yield on our loan portfolio as a result of an increase in the yield on more recent loan originations.

Partially offsetting the increase in finance charges were a reduction in premiums earned and an increase in interest expense. Premiums earned declined due to a revision in the timing of revenue recognition that occurred during the third quarter of 2009. Interest expense increased primarily due to an increase in our pre-tax cost of debt, as a result of the $250 million senior note offering completed on February 1, 2010. To a lesser extent, interest expense increased due to an increase in the average amount of debt outstanding during the quarter, as a result of the $200 million stock buyback completed on July 26, 2010.

In addition, our GAAP results were negatively impacted by an increase in the provision for credit losses. The provision for credit losses increased to a nominal amount for the quarter from a negative provision of $3.6 million for the same period a year ago.

Under GAAP, when forecasted future cash flows declined relative to the cash flows expected at the time of loan origination, a provision for credit losses is recorded immediately as a current period expense and a corresponding allowance for credit losses is established. For purposes of calculating the allowance, dealer loans are grouped by dealer partner and purchase loans are grouped by month of purchase. As a result, regardless of the overall performance of the portfolio of consumer loans, a provision can be required if any individual loan pool performs worse than expected.

The last topic that I want to mention today is our liquidity. We continue to be in a very strong liquidity position, with approximately $250 million of unutilized borrowing capacity under our revolving credit facilities as of September 30, 2010. 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) Our first phone question comes from John Rowan of Sidoti & Company.

Good evening, everyone.

Hello.

The other income line seemed to drop a bit in the quarter. Any reason for that? Or what would be a good run rate going forward?

Are you asking why it dropped from the last quarter, or--?

Yes.

Last quarter, if you recall, we had about $3.5 million in income related to a vehicle service contract provider. That program was discontinued in 2008, and that income was received periodically based on the performance of the underlying vehicle service contracts. So last quarter had an unusually large amount of that income.

Okay. And going back to the competition comments it seems as if -- when I look at the advance rate that you had at least through the first six months of the year, it was about 44.9%, and now you're showing 44.7%. Was there actually a little bit of a letup of competition in the quarter versus the first half of the year?

I wouldn't conclude that. It's still a favorable environment for us now, based on the returns that we're generating and the volume growth that we're seeing. The advance rate depends on a number of things other than just how aggressive we are, like the term of the loan has something to do with it. The average contract size is higher, so we're running longer term, larger loans, which that decreases the advance rate somewhat.

Okay. Two more questions. What was the blended rate of debt at the end of the quarter?

Approximately 7%.

7%. Okay. And just one last question. I was flipping through the Q that was filed, and maybe I'm missing something. But it seems as if the depreciation, running through the cash flow, jumped up quite a bit in the quarter. Am I right, or am I looking at this wrong?

Yes, there's a change in the cash flow that we point out in the first footnote. We broke out debt issuance costs into two pieces, the actual cash payments for it, and then the depreciation and the amortization line. So that's what is driving the increase.

Okay. All right. Thank you.

Thank you. (Operator Instructions) Our next question comes from David Burtzlaff from Stephens. Your line is open.

Good afternoon, guys. Loan volume in October up 36%. Does that mean October -- I mean, how do you view that? Was October really bad last year? Or has credit declined at dealer partners? And how does that performance compare to your expectations for the month as you headed into it?

I think we thought it was a good month. It's higher than the growth rate had been. I don't think there's anything unusual about last year's comparison. It was a good solid month, the way we saw it.

Okay. And then the interest expense declined sequentially from the second quarter. But your debt increased with the buyback. Is -- did the yield come down because of -- you're actually using the cash at different rates? Or how do you explain that?

That's part of it. We have unused fees on one of our facilities, so when our usage goes up, our unused fees go down. An increase in debt utilization accounts for part of the decrease in the effective interest rate. The other part of it is that when we renewed our $325 million warehouse line and our $170 million syndicated line of credit, we were able to obtain a reduction in pricing on those facilities. That would account for the remainder.

Okay. All right. And then portfolio yields have been increasing throughout the year. Is this really just a function of better performance? Because, with the higher advance rates, I thought you said a few quarters ago, you kind of expected overall yields to decline going forward?

That's correct. We're pricing the business -- if it performs exactly as we have forecast, we'll see the yield start to come down. But we have been beating those forecasts, which gives you the increase that you're seeing on the income statement.

Okay. Thank you very much.

Thank you. Our next question comes from Randy Heck from Goodnow Investment. Your line is open.

Thank you. Hi, Brett, Doug.

Hey, Randy.

Another outstanding quarter. Doug, just to follow up on a couple of those questions. You said your ended the quarter at a 7% average cost of debt?

Yes, approximately.

So is that a good proxy for the fourth quarter and looking forward, other things being equal?

Yes, other things being equal.

Okay. Well, I guess I'm -- the new -- the various new debt deals that you struck, that wasn't in for the entire third quarter? In place -- I'm just wondering why it ended the quarter at 7%? Or is that just the floating rate? The benchmarks coming down.

The new pricing on two of our three revolving credit facilities was in place for the entire quarter. There was one facility that was renewed in early September. So that wouldn't have been in place for the entire quarter.

The biggest reason that the pre-tax cost to debt at the end of the quarter was different than the average for the quarter is that we completed the stock buyback on July 26. So we had a material change in usage, and a material change in the amount of outstanding debt partway through the quarter.

Okay. So I can't just take the 50 basis point improvement and say you should have earned another -- or, could have earned another $0.07 a share or so, other things being equal? Because you're going to have greater debt outstanding; is that right?

No, I don't think so.

Okay. So other things being equal I can -- at least in my mind, in my little model -- I can adjust earnings in addition to the -- the software writeoff that was $0.03, $0.04 and also share count going forward is going to be more like 27.5, right? Rather than 28 and change?

Yes. The effect of the buyback occurring partway through the quarter impacted diluted shares outstanding by a little less than 800,000 shares, or about $0.04 a share.

Okay. So adding those three things up gets me to -- well, gets me north of $1.50 without any growth from here. Okay.

One thing that caught my eye was dealer attrition. It's the lowest number I've seen in a long time. Can you talk about that? Is there anything you're doing there, or any changes in the sales force? And can you also talk about the addressable market in terms of applicable dealers out there relative to the 2,400 you worked with during the quarter.

Attrition is lower. We've been focused on that internally. We're being more careful about the dealers we sign up, having much more thorough conversations with the dealers before we enroll them, trying to increase the success rate of the guys that do enroll in the program. That's helping.

When loan volume increases, typically, that comes with lower attrition. So, our program is seen as relatively attractive to the dealers right now, compared do other things they're seeing. That makes them stick with the program. The attrition obviously in '08 and '09 was higher than it would have been because we were restricting origination growth. Because of the capital situation. Those are some of the factors that are driving the improved results there.

In terms of the addressable market, we have roughly 2000 dealers on the program. There's 60,000 dealers out there. Obviously, not all of those would work on our program. But certainly we have a very small market share right now. I think at one point some of our other competitors had 15,000, 20,000 dealers on their program. That's probably a fair number that we talk about internally as being a goal for us sometime in the future.

Okay. One last thing. If I look at your -- your loan originations are up on a dollar basis, 38% year-to-date for the nine months. And yet your net debt balance, if you back out the buyback, is basically unchanged. So in other words, the buyback added $200 million of debt, and that's roughly what your net debt is up. And yet, you grew your originations by 38%. So, essentially, that's -- you haven't increased your debt level essentially as a result of the growth in the business.

Correct.

Am I doing that correctly?

Yes. A little better than that isn't it. The third quarter last year the debt balance was -- $544 million is the number I had. Is that right, Doug?

Yes.

And now we're at $679 million. So you got $200 million in buybacks. You're $70 million better than what you just said.

Okay. And your net loans are up year-to-date $125 million? That's not year-over-year, that's just for nine months. Okay. Terrific. That's all I have.

Okay.

Thank you.

Thank you. (Operator Instructions) The next question comes from John Rowan of Sidoti & Company. Your line is open.

Just two follow-up questions. And just -- in light of the last question. The diluted shares outstanding at the end of the period were 27.5 or somewhere around there?

The actual number of shares outstanding at the end of the quarter was a little over 27.1. The weighted average for the quarter was 28.4.

But the 27.1 at the end of the quarter, it doesn't include dilution, correct?

Correct.

Okay. And then also just again, to follow up my last question -- the depreciation addback on the cash flow -- I'll go and track down the footnotes, but is it going to be closer to $6 million per quarter, or $1 million or $2 million per quarter, as it had been prior to how you changed the way you were reporting it?

I mean that obviously depends on what sort of new financing arrangements that we enter into going forward. But I think that based on where we're at right now, the third quarter -- or the higher number is more reflective of where we'll be in the near term.

Okay. And is that a function of the new debt that you issued in the quarter? Or is that just a function -- I'm just curious as to what the delta is there.

Well, as Ken mentioned, we presented it differently this quarter for the first time. The reason that debt issuance costs are more material than they have been in the past is the debt issuance activity we've had over the course of the last year. We did a securitization last December, senior note issuance in February, and have renewed all of our credit facilities on a multiyear basis in recent months. So, there's been a lot of activity there. That activity, particularly the senior notes, has caused the amortization of debt issuance costs to be more material than it has in the past.

Have you changed the time frame in which you're amortizing it? Or, how long will this increased level amortize off?

We have not changed the time frame in which we're amortizing it. We would, for revolving credit facilities, we would amortize the amount paid for issuance fees on a straight line basis over the life of the facility.

So, if you have a facility over -- that has a three year duration -- we would record expense on a straight line basis over three years. For term securitizations and senior notes, we would record the debt issuance costs on an effective yield basis over the life of the debt instrument.

And again -- that's consistent with how we've done it previously.

Okay. Thanks.

Thank you. And I have one more question in queue at this time from William Matthews of Post Advisory Group. Your line is open.

Hey, guys, you may have covered this already. I apologize if I'm going over ground that we've already talked about. The provision for the credit losses, it's a very small number for the three months ended September 30. Can you just tell me how that number is arrived at? And I assume that that number increases the allowance for credit losses. So maybe you feel like your previous provisions were enough to cover what you are now booking. Can I have a little bit of color why that number is as low as it, given how much growth you guys are showing?

The provision for credit losses is a concept that's only applicable to our GAAP earnings, which is what you're looking at. We look at the adjusted earnings internally because the provision is -- makes our results more complicated than they need to be.

Okay.

If we have two dealer pools and we expect X performance, and our performance is exactly what we expect in total, we would still record a provision if one pool outperformed our expectation by 5% and another pool underperformed our expectation by 5%.

So, even though the cash flows that we expect from those two pools haven't changed at all in total, GAAP would require us to record a provision today and then -- on the pool that underperformed, and then the overperformance or the better than expected performance on the other pool would be taken in over time.

If you think about the complexity that causes, we just take away all that and say, Let's just look at the adjusted numbers when we're trying to figure out how we're doing. The provision will increase if we have -- if our overall results lag what we expect, the provision will go up. If the results are better than we expect, as they have been, you're going to see a relatively smaller provision, although you can still have a provision even if things are exactly as we thought.

And the provision is basically -- it's 100% mechanical. It's comparing the expected collection rate and the yield on a given portfolio to the expected collection rate and the yield expected at loan origination for purposes of determining whether there's underperformance or overperformance as Brett mentioned. And again, for doing that analysis, dealer loans are aggregated by dealer. Purchase loans are aggregated by month of origination.

The other point to make is that the -- unlike other finance companies that you'll see, our loan receivable balance is stated at the present value of future cash flows. And that's true for GAAP and for the adjusted results. So it already bakes in our forecasted uncollectible accounts.

Even on a brand new account, it is stated at the present value of future cash flows. So there's not this lag where you put it on the books at the full value and then wait 90 days before you write it off. Or wait six months before you write it off. We originally put it on our books at the present value of future cash flows. The only difference between GAAP and adjusted is the discount rate that's being used, and the allowance is just the account on the balance sheet that allows you to adjust that discount rate. Doug would be happy to spend all day tomorrow talking to you about that if you want.

Doug, that sounds fantastic. Let's schedule that.

You've got my number. Let's do it at 7:00 Eastern.

So in terms of looking at what you feel is a true representation of the numbers, maybe we should be looking at what you're collecting versus the initial forecast, that kind of data that you give us?

I think that's good useful data to look at and all those results have been pretty favorable lately.

That's great. I appreciate the answer. Thank you.

Okay.

Thank you. And I do have one more question in queue now from Randy Heck of Goodnow Investment. Your line is open.

Brett, sorry. I forgot to ask one thing. And that is-What is your best explanation for why collections have been so strong, for what -- a year, or four quarters straight, or six quarters straight, better than expected collections despite what one would expect to be a tough environment?

Right. We don't know is the answer. We have some theories on it, which would be--Number

one is, we came out of the financial crisis, as we were going through the financial crisis, we adjusted our expectations based on what we were seeing. Obviously, in hindsight, we were too conservative when we did that.

The second thing we might point to is the impact of adverse selection when you're in a very competitive environment like we were through '07. You're competing with other lenders and that can cause your scorecard to be too optimistic. We may have seen some of that. And we may be seeing the opposite effect today. So, there's fewer lenders who are picking through the applications before they get to us. So, all other things being equal, you're going to see better performance than your scorecard might indicate in that environment.

Apart from that there's -- we continue to work on our servicing operation. And hopefully, we think we're doing a good job. We might be doing a little bit better job than we were two or three years ago. It's hard to say. But certainly the results are very, very good.

Okay. And, again, I don't know if I asked this before. Are you making any changes to the salesforce? Are you growing your salesforce? Or is it status quo?

No. We're still growing the salesforce.

Okay. Thank you.

Thank you. And at this time I show no other questions in queue. I would now like to turn the program back to our presenters for any concluding comments.

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.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program and you may now disconnect.