Credit Acceptance Corporation

Good day, everyone, and welcome to the Credit Acceptance Corporation fourth 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 Buck.

Thank you. Good afternoon and welcome to the Credit Acceptance Corporation fourth 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 25.6% and 26.2%, respectively, as compared to the fourth quarter of 2021. A decrease in forecasted collection rates for loans originated in 2021 and 2022, which decreased forecasted net cash flows from our loan portfolio by $41 million, or 0.5%. Adjusted net income decreased 26.6% from the fourth quarter of 2021 to $156 million. Adjusted earnings per share decreased 17.7% from the fourth quarter of 2021 to $11.74. Stock repurchases are approximately 208,000 shares, which represented 1.6% of the shares outstanding at the beginning of the quarter. At this time, Ken Booth, our Chief Executive Officer, Jay Martin, our Senior Vice President, Finance and Accounting, and I will take your questions.

Thank you. At this time, if you would like to ask a question, please press star one, one on your telephone. The first call questions I have is coming from Moshe Orangebush of Credit Suisse. Your line is open.

Great, thanks. I'm hoping you could give us a little bit of kind of a help understanding. You know, you've had, after several quarters of, you know, kind of write-ups of your cash flow expectations, the last three they've been down in the mid-40s, 80s, and now 41 again. How do we think about, like, where you're sitting in this process? Like, how is that, and how should we think about how that affects the yield on the adjusted earnings basis?

Mm-hmm.

Well, we update our forecasts based on primarily loan performance and how loans with the same attributes have performed historically. So what we've seen, I believe, for the last three quarters is that loan performance was actually a little bit worse than expected at the end of the preceding quarter. That's caused our forecast of future net cash flows to decline a little bit. Where we're at, I think, is impossible to say. What happens to our forecasting collections and therefore the adjusted yield on our portfolio is really dependent on how low performance is in the future.

Right. I don't think you gave any update in the release for January or anything like that, right?

We did not. We have volume in there for the first 28 days of the month, but we don't have anything for January.

You know, and then, Doug, the other element is that, you know, the level of originations you just mentioned, I mean, it was up a little bit in January in units, but was kind of flattish to slightly down a little bit in terms of where it was in the fourth quarter. and the spreads don't look like they got any better. Can you kind of characterize it for us, you know, sort of the competitive environment? You know, I think there are some people that would have expected by now to see, you know, that competitive, you know, kind of balance shift away from some other originators. So, I guess, what are you seeing, and can you kind of talk about that a little bit?

Well, I mean, I think we had a strong fourth quarter from an origination perspective, and you know, through the first 28 days of January, you know, we had strong originations as well. So I think that, you know, the numbers we put up to an origination perspective, you know, really the third and fourth quarter and thus far in January indicate that the competitive environment has improved. Gotcha.

And you know, the spreads that you're able to achieve, in other words, the difference between what your forecasted collections and what you pay for the loans?

You know, the spread, we modified a table in the press release, you know, this year to show you, or this quarter to show you what the spread was based on the initial forecast and what the spread is as of December 31st, 2020. And, you know, really since 2017, you know, the spread's been, you know, approximately, the initial spread has been approximately 20%. You know, the variability you've seen there has been primarily due to loan performance being different than expected. In 19 and 20, it was loan performance was better than expected. That had a positive impact on the spread. And then in 2022, you know, with long performance, you know, crossfire being worse than expected, that's put a little bit of pressure on the spread. Our initial spread in Q4, you know, was certainly better than it was in the first three quarters of the year. But that's a relatively unseasoned book of business. We'll just have to see what happens to loan performance.

Got it. Thanks. The last one for me, I mean, in the first three quarters of every year, you file the Q along with the earnings release. Obviously, in the fourth quarter, the 10K takes a little while longer. You know, given all the activity this quarter, any chance that we'll get an update on kind of the legal and regulatory situation before the K is out?

I mean, I can talk a little bit about it right now. We generally don't comment on active litigation, but I'll say we disagree with the allegations and the complaint. We intend to strongly defend ourselves in the pending lawsuit. There was a time when the regulatory expectations were more clear and enforcement was for companies that didn't take compliance seriously. Now, this lawsuit, in my opinion, reflects a different approach. As a company, we strive to comply with the extensive framework of laws and regulations that govern our industry, and we work hard to do us right. When you think about our industry, we provide financing options to dealers nationwide that enable dealers to offer opportunities to millions of consumers who are credit impaired or credit invisible. Approximately 30% of all consumers, which is 67 million adults, have a credit score below 670, which is credit payer. There's millions more that are credit invisible. If the allegations in the lawsuit are credited, there'd be a significant impact on the finance industry and all these consumers across the country. So we'll be addressing that with the court during the course of litigation. But again, we disagree with the allegations and we intend to vigorously defend ourselves.

Okay. Thanks very much.

Thank you.

One moment while we prepare for the next question.

And our next question will be coming from John Rowan of Janie. Your line is open.

Good afternoon, guys. Hey, John. Well, since you're willing to speak about the lawsuit a little bit, I figured I would just ask or just make sure that everyone understands and maybe just get your take on it. Obviously, you can read the complaint. We can see what the main tenants of it are. When you settled with Massachusetts, I just want to make sure, there was nothing in that settlement that had anything to do with usury laws, right? The settlement isn't totally clear, but it looked like it was two technical issues that One was a Massachusetts-specific requirement, and another one was about posting some resale value on a repossession. There was nothing that you settled in Massachusetts from the main charge of usury that you settled for, if I'm not mistaken.

Yeah, the settlement agreement revolved around the two issues that you mentioned principally.

Okay, so... Moving past that, obviously there was a little bit of a jump up in G&A expense. Was that ever anything to do with legal expenses?

G&A expense increased due to increased expenses in the technology area and in legal.

Okay. The provision expense, is it safe to assume that excluding forecast changes that it's in the $90 million run rate based on the growth that you're putting on?

It was less than that in the fourth quarter. You know, the new loan provision was $60 million. But, you know, again, keep in mind that, you know, unit volumes in the fourth quarter are typically at kind of a seasonal low.

Okay. And then just, you know, again, to go back to the competitive environment, you know, obviously fourth quarter – The funding markets for most subprime ABS were kind of in disarray, or at least the spreads were really, really wide. But we've seen a little bit of a retrenchment here in January. There are a lot of subprime ABS deals that have come out. Spreads are quite a bit lower than they were late last year. I mean, is there anything that we can read through to the competitive environment? And how do you help us think of how this fits with you guys and a cycle that bring some spread back to you guys, you know, if this would be any indication of more competition with less risk-adverse funding markets. Thank you.

Yeah, I mean, you know, potentially that causes the market to be a little bit more competitive. I mean, you're right, the market tone this year has been more constructive. You still have a situation where, you know, base rates are elevated and, you know, credit spreads, though not as high as they were in Q4, are certain higher than they were for a number of years. So we'll have to see what happens, but it's conceivable that the competitive environment could become a little bit more intense if the funding markets continue to be constructive. We'll just have to see how it plays out.

All right. Thank you.

Thank you. One moment while we prepare for the next question. The next question will be coming from Rob Wildhack of Economist Research. Your line is open.

Hi, guys. Just one more on the funding market. Given your origination growth and the better spreads now, why not tap the ABS market yourselves?

Well, we certainly intend to, but at the end of the year, we had about $1.6 billion in unused availability at our, you know, committed revolving credit facilities. So, you know, we're in a very strong liquidity position. But, you know, I mean, that's something we'll do at the appropriate time.

Okay. So, safe to assume, and to tie it back to New York State, there's nothing in that lawsuit that would preclude you from continuing to tap the ABS market, right?

Correct. You know, the complaint's a complaint, but, you know, there's nothing in there that would prohibit us from accessing the securitization market.

Got it. And then to switch over, in the press release you called out forecasted profitability on a few different vintages. Can you define that for us? And then I'm kind of wondering why forecasted profitability is for the 22 vintage would be significantly lower, but the forecasting collections are only like a percentage point lower than initial.

Yeah. I mean, in forecast and profitability, the way we're defining it there is, you know, really, you know, forecast economic profit, the non-gap financial measure we refer to in the press release. You know, relative to 2022, it just, you know, we're using a pretty low standard for significantly it's you know basically of a tenth of a percent in the collection rate which is it's arguable whether that's significant or not but that's the standard we've chosen to use I'm sorry one percent okay so one percent on collections for

Todd was significantly lower in 22.

Okay.

I got it. I got it. Yep. And then one more, um, yeah, past calls. You've said that when you're, you're growing originations, you probably buy that less stock this quarter. You're able to kind of do both. Um, what what's going on there and how should we think about share repurchases if you do continue to grow in 23?

You know, as we've said before, you know, the first priority is always to make sure we have the capital that we need to fund anticipated levels of loan regulations. So that's going to be, you know, the first priority. In terms of share repurchases, I think it, you know, it just depends on, you know, how the capital markets function, you know, what our growth rates are. you know, and things like that. But the first priority will always be to fund new level loan originations.

Okay, thank you. Thank you. One moment while we prepare for the next question. Our next question is coming from John Heck of Jefferies. Your line is open.

afternoon guys thanks for taking my question um we touched on earlier with a set of questions about the last three quarters write downs and cash flows i'm just wondering what do you like do you guys think about an attribution for that i mean is it tied to structural you know factors on the loans recently is it tied to inflation is it because asset values are declining do you like you have a sense for the causation of that over the recent quarters

You know, it's tough to say precisely, but, you know, I think it's, you know, likely primarily, you know, the impact of inflation on a subprime consumer and then, you know, declining vehicle values for the last, you know, six, seven, eight months.

And then, I mean, I don't know if you'd be willing to do this, but I mean, obviously you guys are probably in communication with your dealer partners all the time. and hear comments about inventory levels and purchase kind of volumes. Is it your perspective that kind of the worst is behind the dealers, meaning that the system's starting to stabilize, or do you guys think there's more to come in terms of reduction of demand and reduction of car prices? How do you think about this? What's your kind of forward perspective?

You know, used car prices have declined. which has helped address affordability issues. The inventory situation is better than it was, but it's not where it was pre-pandemic, and used car prices are still elevated. Where it goes from here, I think, is anyone's guess. We don't have the ability to predict the future, so we'll just have to see.

So with that in mind, maybe it seems like a more confusing picture. Would you consider yourself more selective? Or is there ways for you to tighten, given that uncertainty? Or is it just sort of just keep eyes wide open and it's a day-to-day thing?

I mean, we always build a very significant margin of safety into the way we price our loans. We recognize that if you're writing a 60-month loan, you know, there's a whole host of things you can't predict that will occur over the next 60 months. You know, what will inflation do? What will unemployment do? What will used car prices do? So the way that we address all those uncertainties is by, you know, building a significant margin of safety in the way that we price. We're writing business that It generally produces very high returns, and we price our business so that if loan performance is worse than expected, our loans are still highly likely to be profitable.

I appreciate the comment. Thank you guys very much.

Thank you. One moment while we prepare for the next question. The next question will be coming from Ray Chesman of Anfield Capital. Your line is open.

Thank you. Doug, just following up on John's question, as you look forward now, I'm guessing you have a model of what you expect the world to do. I'm wondering if you would be willing to share any of your modeling assumptions, like where do you think unemployment will be at the end of the year, or where do you think the, you know, tenure will be at the end of the year, the things that would drive that CECL model?

I mean, you know, like I just said in the last question, there's a whole bunch of things that are, you know, unforecastable, you know, so we We don't attempt to forecast the things that are unforecastable. We just address those uncertainties by pricing our loans with a big margin of safety. So when we put together our forecasts of future cash flows, they're based on actual loan performance and the historical performance of loans with similar attributes. You know, those forecasts historically have been pretty accurate.

As we proceed into 2023, and we read a lot of the press from the various talking heads about lower tax rebates and exhaustion of savings, is your expectation that your pricing and risk adjustments are underway to protect you? So you're adjusting your terms on the fly and you're maintaining margins and maintaining profitability. And it's just that over the course of the last couple of quarters, the water seems that the tide is going out on the economy. And I just want to make sure that I'm confident you guys are as greedy as historically. I'm sorry to say it that way, but you're a highly profitable company. And I just want to make sure that CACC stays that way.

Yeah, I mean, we, you know, when we're making decisions about, you know, how to price our loans, we are certainly considering what we are experiencing from a loan performance perspective.

And then just one more. The fact that the used car market is dropping significantly You know, I guess I saw recently Ally expects 13% and other people expect between 10 and 20%. That's not great news for prior vintages, but it actually should be good for growth of future vintages, right? I would agree with that. Okay. Then thank you very much. You've given me some confidence, Doug. Thank you.

Thank you. One moment while we prepare for the next question. As a reminder, if you would like to ask a question, please press star 11 on your telephone. Our next question will be coming from Shanna Q of Bank of America. Your line is open.

Hi, Doug. This is Shanna from Bank of America. Thanks for taking my question. So I just, you know, I think your bonds now are kind of trading in the low 90s. And, you know, you talked about your capital allocation with a focus on investing and maintaining enough to originate your growth in volumes next year or this year. But with the bonds in the low 90s, could you look to maybe, you know, be opportunistically addressing some of the maturities before they come due in 2024?

You know, conceivably, we've explored it retiring some of the bonds early. Obviously haven't elected to do anything, you know, thus far, but we've, you know, we've taken a look at that. And, you know, we'll just, you know, have to weigh the attractiveness of that alternative with, you know, the need to invest in new loans.

Thanks. And then I guess You know, previously you had filed the 8 expecting the New York lawsuit. I guess have you had any or seen anything from any of the other states potentially suggesting that they are moving forward with, you know, lawsuits or you haven't really seen anything new come across yet?

You know, we're not going to say anything about the existing lawsuit other than what Ken mentioned earlier in the call.

Okay, thank you.

Thank you.

One moment while we prepare for the next question. Our next question is coming from

Christopher Ryan of Redcliffe. Your line is open.

Hi, thanks for taking my question. Is there any timeline known right now about the New York CFPB lawsuit they can give us?

I can answer that one, no.

Okay. And then what was the average price paid for the share repurchase in the quarter?

You know, it was 208,000 shares at an average price of, I believe, $455,000. So that's around $100 million.

Got it. Thank you. That's all my questions.

Thank you. That concludes today's Q&A session. I would like to turn the call back over to Mr. Busk for any further additional comments 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 concludes today's conference. We thank you for your participation.

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