Credit Acceptance Corp (CACC) 2022 Q2 法說會逐字稿

Good day, everyone, and welcome to Credit Acceptance Corporation Second Quarter 2022 Earnings Call. Today's call is being recorded. A webcast and transcript of today's earnings call will be made available on Credit Acceptance website. At this time, I would like to turn the call over to Credit Acceptance Chief Treasury Officer, Doug Busk.

Thank you. Good afternoon, and welcome to the Credit Acceptance Corporation Second Quarter 2022 Earnings Call.

As you read our news release posted on the Investor Relations section of our website at ir.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 financial results section of our news release, which provides tables showing how non-GAAP measures reconcile to GAAP measures.

Our GAAP and adjusted results for the quarter include:

Unit and dollar volumes grew 5.1% and 22%, respectively, as compared to the second quarter of 2021.

A decrease in forecasted collection rates for loans originated in 2020 through 2022, which decreased the forecasted net cash flows from our loan portfolio by $43 million.

Adjusted net income decreased 18% from the second quarter of 2021 to $188 million.

Adjusted earnings per share increased 1.5% from the second quarter of 2021 to $13.92.

Stock repurchases of approximately 404,000 shares, which represented 3% of the shares outstanding at the beginning of the quarter; and

A $12 million expense related to an agreement in principle to settle a previously-disclosed class action lawsuit and a $20 million increase in stock-based compensation expense primarily due to the retirement of our former CEO in May 2021 and the timing of shareholder approval for 2020 and 2021 stock option grants.

At this time, Ken Booth, our Chief Executive Officer; Jay Martin, our Senior Vice President, Finance and Accounting, and I will take your questions.

(Operator Instructions) And our first question comes from Moshe Orenbuch from Credit Suisse.

Last quarter, you guys talked a little bit about your results and what you were doing with respect to the higher credit quality. I'm trying to understand--how your adjusted revenue, or the yield as a percentage of your average capital, did go up in the quarter.

Could you just kind of square for us how to think about that? What's happening in terms of the actual yield on the portfolio? Or is that a function of the denominator, could you talk about that a little bit?

Yes. The adjusted yield on the portfolio increased this quarter, and that was primarily due to loan performance in Q1 being quite a bit better than we would expect, or we expected.

As you can see in the press release, loan performance slightly underperformed our expectations this quarter—all else equal, that will have a negative impact on the yield in future periods.

Got it. You're saying it's separate and distinct from the mix in terms of the higher quality loans that you're originating.

Correct. Yes. It's all relative to our initial expectations and what happened during the period.

Got you. And when you think about that, because sometimes you talk about a change in methodology that results in that. There was no mention of that this time. So is there anything you could kind of point to as the root cause of that underperformance changing from first quarter to second quarter; you said it was better than expected in the first quarter.

It's tough to say precisely why it occurred, but it's likely due to a few factors. Obviously, the end of stimulus and supplemental unemployment benefits, and perhaps it took a little while for consumers to work through the savings that they had accumulated during those programs.

And then I think the other thing that's impacting the consumer out there is just the inflationary environment.

So is it reasonable to expect that that would continue into future quarters?

I can't predict the future any better than anyone else, but I guess my expectation is that as long as inflation remains elevated and nothing else changes in a material way, I think that's probably a reasonable assumption.

We had a 2-year period where loan performance was significantly better than expected, and those tailwinds are no longer present and there are some potential headwinds such as inflation.

Got you. And then last one for me is that, it also just does seem that it kind of rolled through the second quarter, same sort of pace that your capital return was slowing and it's been June, July, probably pretty much de minimis. Thoughts there as we go forward?

Like we've said on prior...

Please remain online. Your conference will resume shortly. (technical difficulty)

I think you're back on. Yes.

Okay. We're back on. Moshe, I'm not sure how much of my response you heard or didn't hear. But I guess I'll just assume you didn't hear very much of it. As we've said on prior calls, historically we returned less capital to shareholders the higher our leverage is, and the more we're growing, and in recent periods, our leverage has been at the high end of the historical range. And in the second quarter, we started to see some more positive results from a loan growth perspective. Sorry about the interruption.

(Operator Instructions) And our next question comes from Ray Cheesman from Anfield Capital Management.

Doug, you mentioned inflation as a headwind. Is the Manheim Index finally showing some softness in the used car market, where I believe most of your portfolio exists.

Is that an impact that also will be a headwind going forward versus the terrific lift it gave over the last 8 or 10 quarters?

We haven't seen any material move in used car prices relative to the vehicles that we're disposing of at auction.

But it certainly is a potential headwind. Used car prices continue to be at elevated levels. I can't predict the future, but at some point, it seems reasonable to expect that they will revert to more normal levels, but how quickly and how dramatically that occurs is anyone's guess.

Okay. Also, you guys took off the COVID overlay, I guess, in the first quarter. And as we look forward, and I know you're not a big fan of looking -- telling us forward, but when I have guys like AT&T telling me that they got customers who can't pay for their cell phones, that's new news.

Then you clearly see the bottom portion of the FICO scale struggling, as you mentioned, inflation amongst other things, less government support programs, et cetera. You also said that the last two years have been a different time. When do we get back to old normal where performance, say, from 2015 to 2020 prior to COVID is what we would expect to see going forward? And these weird two years kind of flows through and finishes. Does it take two quarters, six quarters, 12 quarters?

I don't think anyone really knows. I mean, I guess it depends on what you define as normal. But we're a little more normal in that we no longer have stimulus and unemployment benefits.

But we're definitely abnormal and we're experiencing the highest inflation since the '80s. So we continue to be in an unusual environment. And when that returns to normal is anyone's guess.

Are there any -- I'll give you an example, OneMain, the Springleaf lenders that also lend to lower FICO customers has changed the credit box and "tightened" things up. Are there adjustments that Credit Acceptance is making to its ongoing business model to try to stay ahead of any changes that they expect to occur in the couple of quarters ahead?

We're always attempting to forecast collection rates as accurately as possible. And to the extent that we need to make changes to do so, we do that. It's our practice not to provide details relative to any adjustments that we do make.

And congratulations, by the way, on finding middle ground on that lawsuit and putting it aside.

Thank you.

And our next question comes from Matthew Hurwit from Jefferies.

Actually, it's John Hecht from Jefferies. I guess, just broadly speaking, just because I think most of us are aware that the capital markets are a little bit in disarray, spreads widening. Just how does that impact management's thinking there in terms of volumes and so forth.

You guys have been serial issuers with a big buyer base. But does the current state of the capital markets affect your thinking at all?

Certainly. We completed a deal recently and the capital markets are functioning differently than they were six to 12 months ago. So we're aware of it, and we're monitoring it closely. So we're factoring it into the way we're running the business for sure.

Okay. And then the spread, as you guys kind of highlight the spread in the different cohorts, I mean it's on both the purchase and the dealer program; one of the spreads, certainly, as long as I can remember at a low level. Any commentary on that? Or should we think that we're bottoming out here, the way you're underwriting and issuing, how do we think about where the spread might go.

We typically don't discuss our pricing strategy other than to say we're always trying to maximize the amount of economic profit that we originate. And so that would be economic profit per loan times the number of loans we originate. So if we felt that it made sense to pay more, have a lesser spread, but write more business, we'd do that. Conversely, if we thought it made sense to pay a little less and have a larger spread, but do a little less volume, we'd do that, too. So we're trying to price the product optimally.

Okay. And then last question, I know there's some seasonal elements to this and that, but you had a pretty big inflow of new dealerships. How do we think about that?

I think a lot of that is probably just due to the fact that the sales team has been able to get out and have a lot more face-to-face dialogue with dealers than they were over the last year or two.

You've also had what appears to be somewhat of an improvement in the competitive landscape, which generally seems to increase dealers' interest in our program as well. So I think it's likely a combination of those two things.

And our next question comes from Diogo Vaz da Silva, PSquared Asset Management.

I have three of them, please. The first one is following up on the previous one. One thing I've noticed is that over the last two years, we've seen both the spreads going down, but at the same time, the average loan term going up. Is this just related with the car, especially on the term, may be the car prices being at much higher levels? I'm just trying to understand, is this the model being very different or just the industry getting more competitive?

I think the loan size has gone up because of the elevated used car prices; the term has remained about the same, and that's just due to the fact that we're financing a slightly different vehicle to address consumers' affordability concerns.

Your other question related to the spread; the spread has declined over the last couple of years, but a pretty significant reason for that was the better-than-expected performance for the loans originated in '19, '20 and to a lesser extent, 2021.

Got it. Got it. And then on my last question, which has two parts, but related with your existing disclosures on potential legal risks. I guess the first part is, is there any part of your recent settlements on state losses; did you guys have to introduce any sort of affordability test? Or do you have to change the way that you conduct your business in those states by any form?

Because when I was reading through the settlement, I only saw that there was the penalties, but I didn't see if there was anything—any changes in the business itself.

You're basically correct. No material changes. We made some changes back in 2018 to modify business practices in light of some court rulings. But other than that, the settlements themselves didn't require significant modifications in business practices.

Perfect. And then the last part of the question, if I may, is there any update on the discussions and interactions you guys are having with the CFPB regarding the notice that they served to you in the beginning of this year.

I mean, we can't really comment beyond what we've disclosed in our 10-Q.

Understood.

And our next question comes from Robert Wildhack from Autonomous Research.

Doug, can you expand on that point you made a moment ago about the improved competitive landscape?

The way that we conclude that it's improved is we look at our volume per dealer, which improved a little bit in the quarter. We also get anecdotal feedback from our sales team and from dealers.

It seems like the competitive environment has improved some, exactly why it's difficult to say, but I think likely candidates are increases in interest rates, the choppiness in the capital markets that we discussed earlier, and potentially operators being concerned about future trends in credit due to things like inflation and potentially declining used car prices.

It's tough to know precisely, but those seem like good candidates for any improvement that might be out there.

Okay. Got it. And then I also wanted to ask you about the leverage level. First, do you have any firm caps on leverage, whether that's management or covenant driven?

We don't have firm caps from a management perspective. We obviously have financial covenants that we need to adhere to.

Can you just let us know what those covenants are?

Yes. They're public in our debt documents. So under our current accounting that has existed since January 1 of 2020, we have a net funded debt-to-equity ratio of 5.6:1. Under our senior notes, we can't make a restricted payment, which is basically a buyback. If the effect of such payment would be to cause our net funded debt to equity, so debt less unrestricted cash to exceed 3.25:1 on the accounting that existed at the time of issuance, so pre 1/1/20 accounting.

Okay. That's a good segue to my next question, actually. So that cap might not be impacted so much by the GAAP provision as you start to grow again, where the GAAP provision was weighing on you building retained earnings, equity, is that right?

That's correct. The timing of income recognition under CECL is significantly different than it was under our prior basis of accounting.

Okay. And then if I could just ask one more quick one. I noticed that for the past few quarters, Other Income has been benefiting from a decrease in average claim rates on the GAP contracts.

If I think about the elevated cost of replacing a car, I'd expect folks to be pretty eager to make a claim on those contracts. So what do you think is the driver of the decrease in claim rates lately?

Well actually, the Provision for Claims that is included in our income statement is on one of our vehicle service contract products. And I believe that claim rates, or claims as a percent of premiums earned, were actually up this quarter. So two different products.

You have guaranteed asset protection, which is included in Other Income as ancillary product profit sharing, and then you have the provision for claims on one vehicle service contract product that goes through the Provision for Claims line.

And our next question comes from John Rowan from Janney.

Doug, I just want to make sure I understood your earlier comment on inflation and how it impacts your consumers, because it sounded like you were talking about whether or not it impacted the vehicle prices. And obviously, for a long time, we've had a conversation about vehicle prices not having a big impact on your company. Were you really only talking about payment rates, or are we talking about repossession and a change in repossession rates and severity?

No, I was talking about it impacting the customers' ability to pay. If they've got to spend money for gas and their food bills cost more, that's what I was talking about.

Okay. Because there's a whole conversation with the Manheim in there as well. So I just want to make sure I understood what you were talking about. That's my only question.

(Operator Instructions) And we have a follow-up from Ray Cheesman from Anfield Capital Management.

Doug, one of the other people who also is in the lending business that you're in, indicated recently from a competitive standpoint that the credit unions were—he used some words that merged on out of control, where everybody else was raising rates to accommodate changes in the market rate structure and credit unions were in his opinion, very much more aggressive than they should be.

I was just wondering if you see anything like that, or if—you've said to me in the past that generally, when economic conditions get less great, some of the easy, the lazy capital pulls back and lets you guys do better. Any comment on that thought?

Credit unions have generally written a lot of subprime auto finance business over time. I'm not close enough to the data to really say whether they've gotten materially more aggressive in the current environment or not. I'm sure our Analytics people know the answer to that, but I haven't asked them that question.

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'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.

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