Good day everyone, welcome to the Credit Acceptance Corporation first quarter 2019 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 Senior Vice President and Treasurer, Doug Busk.
Thank you. Good afternoon, welcome to the Credit Acceptance Corporation first quarter 2019 earnings call. As you read our news release posted on the investor relations section of our website at creditacceptance.com, 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. At this time, Brett Roberts, our Chief Executive Officer, Ken Booth, our Chief Financial Officer, I will take your questions.
Thank you. Ladies and gentlemen, if you'd like to ask a question, please press star then one on your touchtone telephone. Again, if you'd like to ask a question, please press star then one. One moment for our first question. Our first question comes from Hugh Miller of Buckingham. Your line is open.
Hi, thanks for taking my questions. Just had one on the tax rate and was wondering if you could provide some color on kind of what was driving it this quarter and how we should think about that on a go-forward basis.
Sure. The tax rate was a little lower this quarter than it was in either the fourth quarter of last year or the first quarter of last year. The reason for that is that we get a tax deduction when restricted stock vests or restricted stock units are converted into common shares. The amount of the deduction is based on the fair value of the shares. If that amount exceeds the fair value of the awards on the grant date, that's something called excess tax benefit and gets recorded as a reduction to our tax rate.
Yep. Okay, great. Just in terms of, as we think about assessing the collectibility trends and also the spread trends, is it fair to compare the 2019 vintage relative to, let's say, the 2018 vintage on where it was initially booked? Or is it a better assessment to kind of look at that where it's currently booked, as a fair comparison to where you set initial expectations for 2019?
I think both are relevant numbers. I think the '19 business has a slightly higher initial forecast. It's too new to know where that's going to settle in. The '18 vintage has been around a little while longer, and it's settled in at a higher collection forecast than where it started. We'll watch 2019 and see where it goes. I think it's a little bit early to decide whether one vintage is better than the other.
Okay. Last for me, just in terms of where we stand with CECL, fair value decision, have you made any progress in terms of just how things are shaking out and where you might kind of see things for 2020?
We've continued to assess our alternatives internally. We think we've made progress. As I've said in prior quarters, that when we do make a decision, we'll update our disclosures appropriately and make an announcement at that time. Really nothing further to report today.
Thank you very much.
Thank you. Our next question comes from John Rowan of Janney. Your line is open.
Is 24% still the correct tax rate going forward, though?
I think that we estimate our long-term tax rate to be 23%. Obviously, that is a long-term number. That factors in things like that that happened this quarter, which again, isn't going to happen every quarter.
Okay. I know obviously people always ask about the competitive environment, and you oftentimes cite the volume per active dealer partner. Are we supposed to draw similar conclusions this quarter versus prior quarters that the environment's probably a little bit tough just given the decline in the volume per active dealer partner?
We don't have another reason for the decline. In quarters where we don't have another reason for it, we usually attribute it to the competitive environment.
Okay. Was there anything one-time in nature in the other income line? Or is there something seasonal in there? I'm just trying to remember, because it was a little higher than I was anticipating.
I don't think there's anything one-time. We have a disclosure comparing the first quarter of this year to the first quarter of last year in the 10-Q, most of the increase was related to ancillary product profit sharing. We also had a larger amount of interest income, that was offset a bit by decreases in a couple other line items.
Okay. Just lastly, is there any information that you can give us? It seemed like you disclosed the new CID in the 10-Q. Is there any information that you can share with us regarding that?
Not really anything other than what's disclosed in the Q. Obviously, the regulatory environment's been much different for the last five, six, seven years. I think this is just part of what we can expect in the environment we operate in.
All right. Thank you.
Thank you. Our next question comes from Vincent Caintic of Stephens. Your line is open.
Hey, thanks. Good afternoon. A couple of questions. First couple will focus on the purchased loans. You've had some nice growth there over the past couple of quarters, and it's becoming increasingly a bigger part of the business. Just kind of wondering. First, you had your forecast for the spreads increase significantly, and historically it's exceeded your initial forecast. I'm just kind of wondering how you initially anticipate the purchase loan spread forecast and how they've been increasing over time. When I look at the difference in spreads between the purchase loans versus the dealer loans, the spreads are lower for purchase loans. I'm wondering if that's true after accounting for the dealer holdback. If it is true, are purchase loans generally less risky than dealer loans so you can have a lower spread on that?
How do I think about the risk-adjusted returns between the two products you offer?
Well, as we've said before, we prefer the Portfolio Program because it aligns our interests. It also shares the risk on the consumer loan with the dealer. If we collect a dollar less than what we expect on the Portfolio Program, 80% of that is borne by the dealer in the form of a reduction in dealer holdback. On the Purchase Loan Program, if we miss our forecast by a dollar, all of that comes out of our pocket. We would characterize, for that reason, the Portfolio Program as being less risky than the Purchase Program. Having said all that, the Purchase Loan business has performed very well. It's actually generated a larger positive variance on average than has the Portfolio Program over the last 10 years. We think that writing those Purchase Loans with a big margin of safety is a good use of our capital.
Okay, that's helpful. Thank you. I guess looking from 2018 versus 2019, spreads versus your initial estimates are better in 2018. Is 2019 sort of the right spread that you're targeting if that's kind of your initial estimate? If so, is there room because we're seeing such good performance with the Purchase Loans, is there room for more volume that you could capture there?
We try to price our business to maximize economic profit, which is just economic profit per loan times the number of loans originated. With the benefit of hindsight, you could argue that the way we've priced the Purchase Loans historically has been too conservative. Those loans have performed nicely better than expected, knowing what we know now, we could have priced those loans a bit more aggressively. We do try to put our best number forward, and we try to, like I said, maximize that equation and try to be accurate with our forecasts.
Okay, great. Very helpful. Last one from me, completely separate. A nice increase in the new dealers, or I guess the dealers not active in both periods. Just wondering if there was any particular driver there. I know people will cite competition maybe goes away, or if there's anything else there that might shed light on that, it'd be appreciated. Thank you.
I think the first quarter is usually a good quarter for enrolling new dealers. We got a larger sales force than we had a year ago. Those are probably a couple reasons why new dealer enrollments were pretty good. Attrition was also pretty good. The number that hurt us this quarter, the same as last quarter, was volume per dealer.
Very helpful. Thank you.
Thank you. Our next question comes from Moshe Orenbuch of Credit Suisse. Your line is open.
Great, thanks. I did notice that for 2016 and 2017, the reductions were small, but you started to see some reductions in your forecasts. Anything that's going on that would be driving that?
I think when you look at the forecast, the best number to start with is the one on the second page of the release where we show you the increase in forecasted net cash flows. Positive number this quarter, $16.7 million. It's nice to have a positive number there. That's a very small number relative to the amount of cash flows that we're trying to forecast. I think that tells the story better than looking at a 10 basis point change for any individual vintage. Overall forecast was generally in line with what we expected. A little bit better than that. I think that's probably a fair conclusion.
Okay. On the CECL idea, I know that you don't have any further info, but could you talk a little bit about how Fair value would work and how variability in kind of estimates and revenue and provision recognition would work under that construct?
Fair value, conceptually, would be like, well, it'd just be marking our Portfolio to market each period. The value of the Portfolio would represent not only the expected cash flows from the Portfolio, the expenses a third party would need to incur to service the Portfolio, and the third party's required rate of return. At a high level, that's how it would work.
Right. I guess, the question is, from the perspective of variability, is there a way to compare it to the current construct?
I would say it has the potential to be more volatile. The current earnings that we have today could be volatile, but that volatility would directly have to do with the performance of the underlying loans. With fair value, you could have some variability associated with the performance of the loans, but you could also have variability associated with things that have nothing to do with the loans.
Got it. Thanks so much.
Thank you. Our next question comes from Dominick Gabriele of Oppenheimer. Your line is open.
Hi, thanks so much for taking my questions. Can we just talk about how much of the book is moving towards younger cars as we make a portfolio mix change to more purchase loans? Can you just talk about the impacts there between the average car age versus in the dealer portfolio loans versus the purchase loans and how that could be affecting your interest rates that you collect over the average life of the loan or the interest income rather? That'd be great. Thanks.
We have seen a shift of the mix of business that we've originated over the last four or five years. Not only are we originating a larger percentage of purchase loans, but we are financing newer, more expensive vehicles than we were three, four, or five years ago. Those phenomena have resulted in an increase in the average amount of the retail installment contract, principal plus interest, and therefore an increase in the average advance. That phenomena has contributed to dollar growth being greater than unit volume growth in recent periods.
Great, thanks. Then as you think about what gets a dealer to provide more applications over time and have a stronger relationship with Credit Acceptance, what are some of those attributes? What's the timeframe, would you say, that it takes for a brand-new relationship for you to get five applications a month to 10 to 20, whatever it may be? What's the strategy there and the timeframe it takes typically, would you say?
How much business a dealer sends us, how many applications, how many contracts we book really reflects everything we do as a company. The dealers on the Portfolio Program, at least, get 80% of whatever we collect. Even our loan servicing function affects how satisfied the dealer is with our product. It's really all-encompassing. It's everything we do. The better product we offer the dealer, the more business they're going to write. In general, if you take a particular month's vintage of new dealers, the amount of business they do increases over time. Also dealers in that vintage will drop out. There's two effects there that offset each other. I don't know if there's a typical timeframe that someone ramps up that's going to be useful to you in terms of trying to forecast future loan volume.
Great, thanks. Then just one more, if I could. When you think about the strategy among targeting franchise dealers, let's say, and non-franchise dealers, what are some of the big differences there? What makes maybe one better than the other, or not even better, but perhaps just the differences in trying to obtain those long-term relationships? Thanks.
In general, our program works very well at a small independent dealer. It works very well at a larger franchise dealer. Sometimes the selling process can be different. The larger organizations, typically, there's more people that need to sign off on a new lender, so it can be a little bit more complex. When you get into stores that have multiple locations and maybe a corporate office, there's another selling process that occurs there. Other than that, the program works in all kinds of environments.
Thanks for taking my questions.
Our next question comes from Nick McGibbon of Briwen Financial. Your line is open.
Hi. I have kind of a broad question. I was hoping you guys could help me understand how you think about the amount of leverage that you employ from kind of a downside risk perspective. I guess just on the overall amount, also how you structure it secured versus unsecured.
Yeah. The way that we determine how much leverage to employ is we run series of financial projections looking at different leverage, different funding mix, different maturity management strategies. What we're trying to do is utilize a funding strategy that produces a cost-effective result when the capital markets are open and readily available, but also produces an acceptable result when the capital markets are closed for an extended period of time. We do that analysis. We look at different funding strategies, different leverage, et cetera, and pick the approach that works well in both good and bad capital market environments.
Okay. I don't know if this will be easy to answer knowing that all the ABS structures you have are probably a little different. Are there any kind of major covenants across the board on your ABSs that, in kind of a worst case scenario, you would think could get close to getting triggered or anything like that?
I mean, we obviously have performance triggers in our ABS, like any issuer does. None of them are particularly concerning.
Okay. Thank you.
Thank you. Our next question comes from John Hecht of Jefferies. Your line is open.
Thanks, guys. I understand that in the grand scheme of things, the increase in expected cash flows in the purchase loans isn't a huge number. I'm wondering, can you characterize what changed over the quarter? Was it something tied to frequency or severity in terms of the increase there?
I really can't break it down any further than what's in the release. I mean, it's a pretty small number. It's nice to have a positive variance. We don't have a breakdown for you.
Okay. Similar to other first quarters, you guys had a big increase in the new dealerships. I'm wondering, is there any geographical kind of trend there? Can you tell us how many of those are franchised versus independents and so forth? Any characteristics of the new dealerships?
The franchise versus independent really hasn't changed a lot. We've been having better success in recent years signing up sort of larger franchise stores on the Purchase Program. That's where the growth's coming from. In terms of I forgot the other part of your question.
Geography.
Geography, yeah. In general, we've been doing better in areas where we're strong and we're struggling in areas where we've historically struggled. If you look at our SEC filings, you'll see the states where we have the biggest concentrations. We continue to do well in those states, and we continue to struggle in the states where we have lower penetrations.
Okay. Similar to last year, is there something seasonally we should think about in terms of net attrition in the dealerships in Q2? Is that just something that happened the last couple of years, and it's not necessarily a seasonal thing?
No, there's a seasonal component there. A lot of dealers will come on during tax season, write business, and then fall off in the second quarter. If you look at that seasonal pattern, that's probably a good place to start.
Okay. Thanks, guys, very much.
Thank you. Again, if you'd like to ask a question, please press star then one on your touchtone telephone. Our next question comes from Giuliano Bologna. Your line is open.
I guess starting off with one question on the dealer loan side. Looks like there was a decrease in unit volume versus the prior year, and Purchase volume really made up the balance. How should we kind of think about the dynamic there? Should we expect that to continue going forward?
I don't have a forecast there, but that's been the trend over the last several quarters. We've been growing the Purchase Program, and the dealer loan program has been less successful.
That makes sense. Thinking about kind of a little bit different question. Obviously, the 2018 vintage had positive revisions on the forecasted collection. Is there any way of framing where those increases came from? There are 2 different theories out there around repossessions being higher with newer vehicles or wage garnishments being higher potentially with lower payroll taxes. Is there any one driver that kind of had an outsized impact in the year?
No, I don't think so. We're talking about small changes here. I think the prior question was essentially the same one. No, we don't have a breakdown for you. It's a small variance. We're happy to see it, but we don't have any further detail for you.
Just one other quick one. One of the things I noticed was the increase in restricted cash. Looks like restricted cash went up about $114 million. Is that tied to any specific transaction?
I mean, the bulk of the reason for that is we have restricted cash rather, that relates to collections on securitizations. That is in the collection account and is used to reduce debt on the subsequent distribution date. The increase in the amount of securitization debt, together with the higher than normal collections that occur during the first quarter of the year, account for the increase there.
Yeah, makes sense. Thank you. Thank you for taking my questions.
Thank you. Our next question comes from Dominick Gabriele of Oppenheimer. Your line is open.
Hey. Sorry about that. Just if I can follow up on one more. You guys had a forecast for the year on interest expense up 50 basis points in the previous quarter for 2019. Also, do you think that the $20 million in the first quarter of other income, is that a good run rate going forward? Or was that a little higher in the first quarter and we expect that to come back down towards that 15, 16, 17 level? Thanks.
Relative to the interest expense, I think when I offered that last quarter, I had a qualifier about constant mix of debt, based on the shape of the forward LIBOR curve. A couple pretty big assumptions there. I still think that we see rates increasing going forward, but there's probably more uncertainty relative to the magnitude of those increases today than there was 90 days ago. I think, a lot of it just depends on just what happens with base rates. If base rates go up over time, our cost of debt's going to go up, and if base rates stay more flat, the same will happen to us. In terms of other income, I don't really have any guidance to share there. There hasn't been a huge amount of seasonality in other income historically.
You can take a look at the quarterly numbers to see the trend line.
Perfect. Thanks so much.
Thank you. With no further questions in queue, I'd 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.