Credit Acceptance Corp (CACC) 2012 Q4 法說會逐字稿

Good day, everyone and welcome to the Credit Acceptance Corporation fourth-quarter 2012 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's, Senior Vice President and Treasurer, Doug Busk.

Thank you, Saeed. Good afternoon and welcome to the Credit Acceptance Corporation fourth-quarter 2012 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 the 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.

Consistent with last quarter, we will no longer be doing an overview of the quarter as part of the earnings call and we will use this call to answer your questions. At this time, Brett Roberts, our Chief Executive Officer; Ken Booth, our Chief Financial Officer; and I will take your questions.

(Operator Instructions). Nick Zulovich, SubPrime Auto Finance.

Good afternoon, gentlemen. Thank you for the time today. Just to start off, I just wanted to get your overall assessments on the full-year financial performance of the Company. What metrics stood out to you as performing well in the calendar year?

Well, we are certainly pleased with the credit quality and the profitability of the business that we have originated, not only in 2012 but in 2011 and prior years. Our financial performance continued to be very strong.

On the other side of the ledger, origination volume was lower than it had been in primary years and we believe this reflects the more intense competitive environment that we operated in during 2012.

I also noticed from the release this afternoon that both the levels of active dealers, as well as new dealers, increased in the fourth quarter. What factors do you attribute those positive gains?

We operate in a very large and fragmented market. There are over 50,000 dealers in the United States. As you can see from our press release, we do business with a fraction of those. So there has been an opportunity that we have taken advantage of over the last several years to increase our active dealer base by enrolling new dealers in the program.

And finally, you touched on it briefly, but what is your assessment of the competitive landscape that [operated now], be it other companies dipping into the subprime market or established lenders potentially reaching down further into the credit spectrum? What is your assessment of the landscape that we operate in nowadays and how is Credit Acceptance prepared to handle it?

Well, as I mentioned before, the environment that we are in today is very competitive. There are hundreds of companies that serve the subprime auto space across the country. We have historically found that the primary factor that impacts how competitive the environment is is the availability of capital of the industry. At the current time, capital is readily available and due to the low interest rate environment, capital is very cheap. That has led to an increase in competition.

We are responding in much the same way that we did in 2006 and 2007, which was the last competitive period in our industry. We are letting our loans per active dealer decline as the competition heats up and continuing to grow our business by adding new dealers to the program.

Very good. Thank you, gentlemen.

(Operator Instructions). John Hopkins, Chartwell Investment.

Good afternoon. I see that in your expense write-up, you had an incremental fee for a third-party vendor termination. What was that related to?

We have a relationship with a third-party that provides the GPS SID devices that are included in about half the loans that we write. They are installed on the vehicles. We switched providers and the expense will cover servicing those devices in the future.

Okay. When we talk about that competitive pressure that you are obviously under, I mean your spreads have come in quite a bit in the last few years.

Can you speak up just a little bit? We are having trouble hearing you.

Sure. Absolutely. In regards to that competitive pressure, are there other services or other ways that you can actually try to recapture some of the spread that you have obviously lost in the last couple years?

Not at this time. We are focused on our core product, which is what we are good at. We have been working on this product for a long, long time. We know what we are good at. We are just going to continue to offer our product. As Doug mentioned, we have a very small marketshare, so there is plenty of dealers that could benefit from our product that don't have it today and so we are going to focus on expanding our business that way.

What is the principal way that you reach out to those dealers? I see that your origination expenses haven't increased significantly in the last kind of year?

We have a field salesforce.

Okay, so it is out through the salesforce?

Yes and actually those expenses have increased considerably.

Yes, I did see that, yes, absolutely.

(multiple speakers) salesforce year-over-year.

But just internally, I see you haven't added much in the way of originations. Let me ask if I'm looking at this right. It seems to me that you deployed about $350 million of additional average capital during the quarter and your economic profit only rose $3.3 million in the same time period. So that is kind of less than a 1% return on that average capital.

No, I think the way to look at it is average capital quarter-over-quarter, so forth quarter over the same period last year, increased by about 23%.

Yes, $353 million.

Pardon me?

$353 million.

That's correct.

And in percentile terms, let me just frame the answer that way, 23%; earnings per share, up 17.5%. The difference between the two is lower returns. But if you look at it over a long period of time, our returns are still at the high end of the historical range. Obviously our return on equity and returns on capital are very, very healthy at this point.

Yes, they are down 400 basis points, if I look at -- if I look at your adjusted return on capital of 14.5% in the most recent quarter, that is obviously down from what I see as a peak. I don't have all of the run here, but March 31, 2011 quarter was 18%.

Right.

Yes.

But I am still looking at -- the fact is you deployed $350 million worth of capital, but you have only earned an economic profit of $3.3 million on that? That looks like a pretty low return for the incremental capital versus prior periods.

Yes, I don't think that is the way to look at it.

Well, I know, but it is dollars, right? I mean that is the way to look at it; it's cash.

We earned 14.5% on $1.9 billion roughly in capital, which is -- and if you look at our returns over a long period of time, although they did spike as we went through the financial crisis, which is an unusual period, our returns today are at the high end of the historical range primarily due to lower expenses as we have grown the business. But no question, it is more competitive out there than it was just following the financial crisis, which means the returns we earned in those years probably aren't sustainable.

No, right. And obviously part of the 14.5% return on capital incorporates prior periods that are still returning and earn at a rate of return on capital that was better previously than it is now.

Correct.

Yes.

Right. Tell me, and forgive me for not remembering this, are there regions of the country where you are particularly stronger than others?

Yes.

Yes, I mean we have -- certainly we have a very strong presence in Michigan, other strong states for us would be New York, Ohio, Texas. We are strong in the Southeast, Alabama and Mississippi.

Are you seeing a concerted effort by one or two of your competitors in your markets or are a bunch of little guys just chipping at you everywhere?

It's a huge market. I mean, as Doug mentioned, there are hundreds of companies that play in this space, but not important to what any single or handful of competitors do. It is really the entire market is getting more competitive.

Okay, so you are not really seeing a concerted effort by one or two of your largest competitors?

No, I mean there is certainly marketshare statistics out there. DC was growing the fastest, but even the largest participant in our spaces still has a very small marketshare.

Okay, great. Thanks, gentlemen.

(Operator Instructions). Kevin O'Keefe, Brown Advisory.

Hey, guys. Thanks for taking my question. A couple questions for you. First, I was hoping you could just frame the market a little further for me. So you mentioned there is 50,000 dealers, and if I am reading your release correctly, you penetrated only 4000 of those, is that right?

Correct.

Okay. And then are you the largest player in the market?

It depends on how you define the market, but we are certainly in the top five depending on what Beacon score cut-off you use.

Okay. So say like, on a dollar loans basis, I am trying to understand like how big the subprime auto market is now and what your share is.

Again, it depends on what -- give me a Beacon score cut-off and we could answer that question. It is somewhere in the 2% to 5% depending on what sort of definitional metric you use.

There are about 40 million used vehicles sold annually thereabout, 70 million adults with credit scores of 640 and below. About half of those have credit scores with 550 and below. So again, you can chop the market up a lot of ways, but it is a pretty big market and we have a small share of it anyway you look at it.

Okay, and so as you think about -- you mentioned that you have a foot salesforce. How is your expansion strategy? Like what specifically are you guys doing to grow the share to where you have increased your active dealers by 25%? It seems like you are trying to spread out to mitigate some of the market risk. And I am just curious is that just -- do you just open up shop in a submarket and start hiring people or how does that work?

We have covered the entire country for quite a while, so every ZIP code in the country was assigned to a salesperson. So all we did was shrink the size of the territories in order to more effectively cover the geography. So we went from roughly 150 sales people to 250 and we did that just by changing the size of the territories. I mean what we find is that the larger the territory, there is just areas where the salesperson wasn't effectively covering his entire territory. So with smaller territories, we were able to reach more dealerships.

Do you have a plan for '13 as far as salesforce expansion?

We do. 2013, we will probably sort of consolidate where we are today in terms of the total number. We went through a very rapid expansion and so naturally, we are going to have some attrition and some -- we are going to have to rehire in certain areas for people that don't work out. So we are probably going to be right around where we are today, maybe a little bit more.

And then as you think about that, is there a lag effect from your hires where you still see that your production should mirror to some extent -- like the growth that you have been able to put up these last few years should be able to mirror recent years? Like are some of these employees just now ramping up?

No question about it. It takes a while for a salesperson to hit the ground and then become productive. Over a long period of time, so if you pick up a 5 or 10-year period, the growth in unit volume has been roughly the same as the growth in the size of the salesforce. Obviously, that is not holding true this year because of the competitive environment, but we are -- certainly the plan is for those numbers to come in line over a long period of time.

Okay. And then just one more question if I could, just thinking about the spread that you guys are putting up, you mentioned it is starting to get towards that a '06, '07 type competitive environment. I am just curious, given how much lower prevailing rates are now, should we think about that the baseline spread would actually be lower than where we were in '06, '07? So i.e., like there is still a lot more spread to give up given where the rest of the market is relative to where we were in '06, '07.

That is one way to think about it. I would say it a little bit definitely. The cost of capital is low, capital is available, so we are going to see more competition. I mean we are going to price it to achieve the maximum amount of economic profit. So we balance unit volume and profit per loan in order to optimize that equation. And at the point where it is optimized is going to be a more aggressive price -- more money out the door than it would have been in 2007 to achieve the same result just because the cost of capital is lower.

Got you. Okay, cool. Thanks, guys.

John Hopkins, Chartwell Investment.

A follow-up actually on that point just a bit. Is there a spread level -- given that your expense base is significantly higher than it was in 2006, 2007, is there a spread level where you're going to have to be forced to walk away from business? I mean materially reduce your activity?

Our expenses, the way we look at it, would be as a percentage of capital. So obviously, we have improved our position relative to the '06, '07 periods that you referenced. But there clearly is a point where business is unprofitable and we certainly don't plan to write any unprofitable business.

If we look at the forecasted collections, and I see, in 2009, you were almost at an 80% forecasted collection and it has come down materially since then. Is that also a result of the competitive pressure or are you forced to write business that is less, I will say, robust than it was three years ago?

I think the thing to focus on there is the performance relative to our initial expectation. So we don't really care what the absolute collection rate is as long as it is what we thought it was going to be when we wrote the loan.

Right.

Because we are varying the amount of the advance to the dealer based on the expected performance of the loan. So the key isn't just the absolute collection rate; it is whether our forecasted origination proves to be accurate.

So obviously, what happened in 2009 is we saw a very large positive variance relative to what we thought when we wrote the loan --

Yes.

-- but we were perhaps in retrospect too conservative and we also know that, during -- with business that is originated with little competition tends to perform better than business that is originated with lots of competition. So we had that working for us on the '09 originations.

Are you seeing any material tickup in your charge-offs? I didn't really notice a significant, but you probably have a better look through than I do.

Because we booked the loan initially at the expected performance, charge-offs really aren't an important metric for us. Really the important metric would be the one that's on page 2 of the release that just shows the actual performance relative to our expectations.

Right, right. So let me ask you another question real quick just so I can understand these numbers well. The spread obviously excludes any holdback or accelerated holdback. So the fact that the holdback numbers or the accelerated holdback numbers may actually be higher, the spread that is shown here may actually be lower, is that correct?

Well holdback is money that goes out the door after the advance has been repaid. So I wouldn't deduct holdback from the spread necessarily. I mean the spread is just an indicator of -- a rough indicator of how we price loans to give the investors an idea of which way the market is going, which way our pricing is going.

Right. So if I theoretically created a net spread column, I would actually deduct a percentage of those holdback and dealer holdbacks that go back to the dealer after the fact, right?

It's not -- I mean we have been doing this a long time. And it is not something we have ever looked at. I mean we can certainly look at it that way, but it is not something the Company saw useful.

Okay. Thanks, gentlemen.

Kevin O'Keefe, Brown Advisory.

Hey, guys, just one more follow-up. You give some great stats on the used vehicle market and I would just be curious if you had any comment on the whole rolling junkyard theme and if you feel like your borrowers have extended the life of their autos to any sort of level that makes you think that either there is a huge buildup in demand. Ultimately when we see a more broad-based economic recovery or if your type of borrower is more kind of a just in time, shorter, auto life kind of borrower to where the whole rolling junkyard 11-year average life of cars thing doesn't really play into your borrowing base?

I mean I don't think that is going to be an important thing to watch in terms of our results. I mean typically our results are determined more by the competitive environment, the cost of capital, those types of overall sort of macro indicators. Things like the price of used cars or somebody's theories about, like you mentioned, they haven't been important to us over time.

Okay, cool. And just last one -- if you could comment just on your thoughts about capital management. You were pretty aggressive in buying back stock last year. Just any incremental thoughts on how you are thinking about that heading into the new year?

We continue to think about it the same way. Our primary objective from a capital management perspective is to make sure that we have the capital that we need to fund and anticipate origination levels. So the answer to that question is yes and we have the opportunity to buy stock back at less than what we believe the intrinsic value is. We will return cash to shareholders. So no change there from the historical way in which we have managed it.

Okay, cool. Thanks, guys.

John Hopkins, Chartwell Investment.

Given kind of where we are in the cost of capital cycle, I was kind of wondering what steps you may be considering to kind of potentially lock in the current cost of capital if, in fact, we are kind of about to move up the cycle and that cost of capital is about to change for the negative for you?

Well, we already have in excess of 50% of our debt that is fixed rate in nature. So we are already reasonably protected from that perspective. We also employ less financial leverage than most others in the industry. So our exposure to a rising rate environment is less than most others in the industry. So we feel pretty good about the liability side of our balance sheet at the current time.

Thank you.

With no further questions in queue, I would like to turn the conference back over to Mr. Busk for any additional or closing remarks.

We would like to thank, everyone, for their support 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.

Once again this does conclude today's conference. We thank you for your participation.