Credit Acceptance Corporation

Good day, everyone, and welcome to the Credit Acceptance Corporation second quarter 2023 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 2023 earnings call. As you read our news release posted on the investor relations section of our website at ir.creditexceptance.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. excuse me, 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 a decrease in forecasted collection rates, which decreased forecasted net cash flows by $89 million, or 0.9%, compared to a decrease in forecasted collection rates during the second quarter of 2022, which decreased forecast and net cash flows by $43 million, or 0.5%. The $89 million decrease this quarter included the impact of an adjustment to our forecasting methodology, which decreased our estimate by $45 million, or 0.5%. In addition, forecast and net cash flow timing slowed, primarily as a result of the decrease in consumer loan prepayments, to below average levels. Changes in the amount and timing of forecasted net cash flows are recognized in our GAAP results in the period of change through provision for credit losses and our adjusted results, respectively, over the remaining forecast period of loans through finance charges. Unit and dollar volumes grew 12.8% and 8.3%, respectively, as compared to the second quarter of 2022. The average balance of our loan portfolio on a GAAP and adjusted basis increased 4.3% and 8.6% respectively as compared to the second quarter of 2022. The initial spread on consumer loans assigned increased to 21.2% compared to 20% on consumer loans assigned in the second quarter of 2022. Adjusted net income decreased 26% in the second quarter of 2022 to $140 million. Adjusted earnings per share decreased 23% from the first quarter of 2022 to $10.69. 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'd like to ask a question, please press star 1-1 on your phone. Once again, that's star 1-1. Until we draw a question, press star 1-1 again. One moment for our first question. Our first question comes from Arjun Tuteja from Jaroslawski-Fraser. Your line is open.

Hey, Ken. You assumed the CEO position approximately two years ago. Could you discuss a couple of things? First being, what has been your strategic focus during the past two years? And second, what are your expectations regarding your areas of focus for the upcoming years?

Yeah. You know, our long-term strategy here really is It's been the same as it was even before I took over. You know, we're trying to build a better business. We're trying to increase intrinsic value. We do that really by basically growing our dealer base and our loan base and doing that in a way that we get acceptable returns on those loans. So I wouldn't say much has changed. You know, there's obviously different strategies we use to try to do that. I'm not going to go into the actual strategies we use, but ultimately, you know, it's the same thing we've been trying to do for a number of years here. I agree.

I mean, I agree here, but I'm just thinking that with Brett leaving and you coming on, there have been some changes, maybe culturally or strategically, or do you think kind of nothing has changed at all?

I mean, we're investing more in technology. We're trying to do some things that make our product more valuable to the dealers and to consumers. But, you know, right now we're in the investment stage. I'm not really sure we've seen any returns on that yet. We're hoping to in the future. So I would say that's probably one of the bigger things that we've done is investing in technology.

Okay. Thank you.

One moment for our next question. Our next question will come from John Rowan from Janie Montgomery. Scott, your line is open.

Good evening.

Hello, John.

Can you guys discuss a little bit more just what the change in forecasting methodology means? Trying to get a handle on if it's just a change in the slope of the collection curve or if it's something else that is away from the historical model.

Yeah, the change to the absolute amount of forecasted collections was really just due to us incorporating more recent loan performance data in our forecast. You know, we're always looking at the historical performance of loans with similar attributes, and this quarter we updated our forecast enhancement by, you know, including in that more recent loan performance data.

Okay, so there was like no like real wholesale shift though?

No, I don't think so. I mean, it's, you know, similar methodology, just updated data.

Okay. And then I guess just kind of trying to read between the lines, you talked about some collections being below average. I mean, where are the loans marked now? Would you consider kind of the cash that you're looking to come out of the portfolios, you know, kind of reverting to the mean over time? And, you know, the current marks are below average. I'm trying to understand, you know, if you were being cautious enough previously and how cautious you are going forward? Are you below historical averages now on the portfolio marks going forward?

Well, I think we use the term below average relative to prepayment rates. That's another thing that happened during the quarter. The timing of our collections slowed, and it was really just due to continued decline in prepayment rates, and prepayment rates, in fact, for the quarter we're below the historical average. So the word below average really relates to the timing of the cash flows, not the absolute amount. I will say every quarter we try to put our best estimate on it. And so I think the forecasted cash flows that we have on the books in June 30th is our best estimate of what's ultimately gonna transpire.

Okay. And then just to touch on the competitive environment a little bit, I was hoping you guys would kind of talk a little bit about the, you know, what you're seeing out of the smaller competitors in your space. Are they retrenching? And again, I want to go down market a little bit here, you know, with the guys that you compete with, you know, how's their funding looking and just trying to understand, you know, where you sit competitively speaking.

You know, the, The market for used vehicles from the ends to subprime consumers is very large and very fragmented. The top five industry participants account for maybe 25% of the business. The top 20, somewhere around 50%. But the other 50% consists of hundreds, if not thousands, of firms. So I don't really have, you know, terribly insightful observations about what's happening at any individual competitor, I think it's still fair to say that the competitive environment is more favorable than it was 12 or 15 months ago.

Okay. All right. That's it for me. Thank you.

One moment for our next question. Our next question will come from Robert Wildhack from Autonomous Research. Your line is open.

Hi, guys. Just on that last point, when you say the competitive environment is more favorable than it was 12 or 15 months ago, that means more favorable, i.e., better for credit acceptance? Correct. Okay. Great. And then I wanted to ask about the 2022 vintage. Expected collections there now, 3.2 percentage points below the initial forecast, which is a very significant delta for you historically. So what is it about that vintage that's performing so poorly?

Simply put, the loans are just performing worse than loans with similar characteristics have historically. You know, what we saw this quarter is a continuation of the trend that we observed in the last three quarters of 2022. We didn't see that trend in the first quarter. It's difficult to say why. It could be, you know, unique seasonal factors that occurred during tax season. But it's a continuation of a trend, you know, that we, you know, we saw for most of 2022. You know, it's impossible to say exactly why this has occurred, but it's probably due to a few factors. You know, the early 22 loans were originated in a pretty intense competitive environment, which generally hurts loan performance. We've seen some decline in used car prices. And, you know, as we know, I think inflation, though it is moderated, has an impact on the subprime consumer. So I think that all those things are probably you know, contributing to the relatively poor performance that we've seen on the 22 originations.

Sorry, just one more if I could.

The provision for new loans this quarter was less than $1,000 per unit, and that's the second quarter in a row where that's been pretty low historically because I think it's usually like $1,300, $1,400, $1,500. Does that mean you've tightened the underwriting criteria at all?

No, it's just due to the mechanics of the calculation. You know, what drives the upfront provision is just the difference between the contractual and expected yield. So the expected yield would be what we expect to earn based on the forecasted cash flows at origination. The contractual yield is just what the yield would be if the customer made all the payments on time. We've seen a higher initial spread on the recent loan originations, which has reduced the difference between the contractual and expected yields, and that's resulted in a decline in the provision that we record when we originate a loan. A bit of a mechanical answer.

Okay, and lower difference between contractual and expected equals a lower provision, all else equal. That's correct. Okay.

Thank you.

One moment for our next question.

Our next question will come from Vincent from Stevens. Your line is open.

Hey, good afternoon. Thanks for taking my questions. First one on the prepayment rates and the the adjustment there. I guess you highlighted that it had to do primarily with the timing of the cash flows and not the change in the absolute amount. I would think that lower prepayment speeds may be a positive in the sense that if the loan lasts for longer, you're able to get more interest income, and so there might be a higher lifetime value to that. to that loan. I'm just curious how that works, your thoughts on that and how that maybe works mechanically where maybe you're collecting more interest income but your forecast collections comes down. Thank you.

Yeah, I mean, that may in fact occur where if a loan doesn't prepay, you end up collecting more than you otherwise would because generally the people that prepay are the ones that were fairly likely to have, you know, repaid their loan in full anyway, i.e. they're the more creditworthy customers. But, you know, the amount of the provision is the amount required to reduce the net asset value, so gross loan less the allowance for credit losses to the discounted value of future net cash flows, so collections or D or holdback. And that discount rate is you know, in the neighborhood at 20%. So if you have a, you know, longer stream of cash flows and you're discounting it back at, you know, 20%, it's easy to see how that could result in an increase in provision, even if on certain loans you might be forecasting more total collections.

Okay, that's helpful. That illustrates the timing differences, so I appreciate that. Second question, on um on this the spreads or the yields in terms of you you thought a little bit earlier about uh competitive um easing a bit um are you able to talk about the pricing that you're able to to charge the consumer any change on that uh in terms of improving spreads i mean we don't really price our product by bearing the interest rate on the retail installment contract with the consumer

You know, we price our product to, you know, maximize the amount of economic profit that our loans originate. So economic profit per loan times the number of loans we originate. You know, obviously, you know, one of the things that determines the amount of economic profit per loan is just the relationship between what we expect to collect and what we pay for the loan at origination. So, you know, as you can see, we have a little higher you know, initial spread this year than we did last year. But, you know, that's, you know, we're pricing to maximize economic profit. And there's, you know, a lot of things that go into that, including our cost of capital and timing of the cash flows and expenses and things like that.

Okay. And then last one from me. It's nice to see the active dealer counts and the activity growing year over year. Anything you can share in terms of the discussions you're having with your dealer customers in terms of maybe what might be driving the increased engagement and increased volume you're getting from the dealers?

Yeah, I mean, I think it's, you know, the competitive environment that I mentioned earlier, you know, likely has something to do with it. You know, I think the fact that we're originating more higher quality loans has something to do with it as well. So I think it's fair to say that, you know, increase from dealers has increased over the course of the last, you know, 12 months. And I think it's, you know, primarily due to those two factors.

Okay, great. That's helpful. Thanks very much. Thank you.

As a reminder, to ask a question, that's star 11. Once again, that's star 11. One moment for our next question. Our next question comes from Ray Cheeseman from Enfield Capital Management. Your line is open.

Doug, when you just mentioned a minute ago higher quality loans, does the better competitive environment referenced earlier mean that you get more volume at, let's call it a static FICO score, or has it allowed you to actually move up market slightly while maintaining your economics?

I mean, that's a complicated question, especially after three years of the pandemic. We are originating a higher credit score customer. Part of that is just due to on the fact that elevated used car prices and inventory shortages have caused it to be very difficult for the deeper subprime consumer to purchase a vehicle in certain respects. So we've seen an increase in the credit quality of kind of our bread and butter business, if you will, due to that phenomena. Those returns are expected to be consistent with what we would have expected five years ago or so. The other thing that's contributing to an increase in credit quality is we've intentionally rolled out a program targeted at a little higher credit quality borrowers. The idea between that program is to provide us with incremental volume. Now that incremental volume's at a return that's somewhat lower than our bread and butter business, but still above our cost of capital. I mean, that's the conceptual thinking behind it. Obviously, whether those statements about returns or not prove to be true, will be dependent on loan performance.

Along the same lines, I believe I saw in the press release that it said that when consumer credit tightens, prepayments slow. And then we also have the phenomena that the 22 class was the last group that bought with kind of the 68% used car value surge that gets talked about in the press a lot. And now, of course, that's rolling over. Um, when you say that you updated for your, uh, loan assumptions, uh, during the quarter, I'm guessing those were some of the things you took into account so that we shouldn't see another one of those in say Q3 or Q4, or, or do you kind of rejigger, you know, rethink things every single quarter? You said you make your best guess.

Yeah. You know, I mean, we think we put our best guess forward here. Um, You know, we're, you know, like I said, we're using more recent loan performance data and we're comfortable in our forecast. But, you know, obviously, you know, if you look at our track record, we're never perfectly accurate. You know, sometimes the loans perform better than expected and some perform worse. So, you know, we'll, you know, periodically, you know, adjust our models and update our assumptions. You know, we're putting our best foot forward here.

Can I ask just one more? Do you guys do electric vehicles or have any plans to?

We do electric vehicles, not a significant amount of them, and the chief barrier there is just price. It's, you know, it creates affordability issues for our target customer.

Okay. Thank you very much, Doug. You bet.

Thank you. And with no further questions in the 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 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 at 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. Everyone have a great day.