Earnings Call: Q1 2018

May 4, 2018

Good day, everyone, and welcome to the Credit Acceptance Corporation's First Quarter 2018 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 morning and welcome to the Credit Acceptance Corporation First quarter 2018 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 light of those and other risks and uncertainties. Additionally, I should mention that 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 and I will take your questions. Our first question or comment comes from the line of Moshe Orenbuch from Credit Suisse. Your line is open. Great, thanks. I've got a couple of questions. I guess one is just about the purchase program. In the past, you guys have said that there are certain requirements for dealers to be in that program. Are those requirements the same because that volume has kind of increased pretty significantly over the last year and a half and kind of continues to increase in most of the past few quarters. So has that changed at all? Is there anything that's different about that? No. Nothing's changed. Okay. Second thing is, in terms of the discussion and we talked about this on the last call a little bit, in terms of the discussion about CECL, clearly CECL would require you to take purchase credit impaired loans and kind of revalue them and set up a loan loss reserve and all the related disclosures. And you talked about the fact that the impact could be material in the last couple of releases. This time you mentioned to possibly go to fair value accounting. Could you maybe talk through the thought process of how the 2 of those alternatives might work? Well, we're still assessing both alternatives. And our objective there would be to end up with accounting that most closely reflects the economic reality of our business if possible. So we're in the process of assessing both of those things. Once we have something material to report, we'll disclose it in our public filings. If neither of those methods lines up with the underlying economics of our business, we'll continue to include non GAAP information in our press release to give shareholders better insight into how the business is actually performing. Right. But I guess my question is you did add that to the discussion. You must have some sense as to how it would present itself relative to your current presentation. I mean, we saw one of your competitors announce a change for at least the next 2 years in terms of going to fair value accounting and the impact that had on their earnings. I guess any kind of thoughts you could offer there? I mean we're really not we're obviously working on it. We're working on it hard. But we're not in a position to really disclose anything until we've completed our work and fully understand all the issues. I mean, I hate to keep coming back to this, but it seems to me that if you think about your current accounting method that you're kind of taking into account all of the expected losses, I guess it's just not clear why CECL would present a problem. In fact, it could I guess that's what I'm struggling with. I'm trying to understand what about it would be problematic that would make you think of doing some other methodology? Yes. I mean, maybe we do end up doing CECL work. Again, as we said in the Q, we're assessing both CECL and fair value and we have something material to report, we will. Okay. Thank you. Thank you. Our next question or comment comes from the line of David Scharf from JMP Securities. Your line is open. Hi, good morning. Thanks for taking my questions. A couple. One is a question on the network size and dealer count growth, which was quite substantial in the quarter. I'm wondering, is there any way based on the investment in new salespeople over the past year and your history with how long it takes them to become productive in your mind. Is there any sense you can give us for how we should think about the growth in the dealer network this year? No, I think it's tough to say. The Q1 was a strong data point. The Q4 last year was also a strong data point. So we've had 2 good quarters in a row. We expanded the sales force in hopes that we would generate more unit volume and so far it seems to be working out pretty well. But again hard to forecast the future. Got it. And I know the active dealer metric obviously moves around quarter to quarter based on who actually participated in that quarter. Are you able to provide active and inactive just the total number of dealers that are participating in your program today and kind of what the percentage growth is versus a year ago this time? I think the active dealer number we provide is probably the most relevant number to look at. I mean that's those are obviously the ones that are participating if they're active. And as you pointed out, it was a very strong quarter for active dealer growth. Got it. Okay. And 2 other things. One is, the average yield on the portfolio just as we calculate obviously came down from last quarter and I imagine that's a result of the recalibration, the allowances that were taken in the Q4. Based on where your the anticipated yield you booked stuff in Q1 and just the trends you're expecting in the market this year, Should we expect average yield to pretty much remain at Q1 levels for the rest of the year? Or do you see any other downward pressure there? I mean, I think that depends on a lot of things. It depends on 1st and foremost, it depends on loan performance. And that's a considerable variable. It depends on the pricing we're able to garner on new originations. That will have a big impact as well. So it's tough to it's really tough to say there are some big variables there. And we disclose quite a bit of information about our yields and the loans we originate in our public filings and that probably ought to give you enough information to make a reasonable estimate. Got it. And then lastly, I apologize, I'm going to repeat something Moshe had asked about maybe in a different way. Can you just help me understand how fair value accounting from a revenue recognition standpoint technically differs from level yield accounting that you employ now because it seems to be very, very similar? Well, I think in substance, there's a difference between the yield or the discount rate you've used. 1 is our current accounting is a function of what we paid for the loan and the amount and timing of the amounts we expect to collect on the loan. The other discount rate incorporates kind of market elements as determined by conceivably a 3rd party. So you have a big difference just in that alone. Okay. We can follow-up later. Thanks very much. Thank you. Our next question or comment comes from the line of Jack Micenko from SIG. Your line is open. Good morning. You talked about the 2015 and 2016 vintages causing some of the negative development we saw in the quarter, not surprising given the trend throughout the industry in those over the years. But as those vintages, I guess, come to age and then pay off, I think your 14% is like 90% paid down. Do you expect increased volatility on the adjustment? Meaning as you get closer to final and actual, will that number swing more? Or have the adjustments do you think been adequate along the way, just given that vintage of loans has been lower performing than others? Yes. I think the history there is that in the early stages, it's more volatile and as the loans age, it gets less volatile. Okay. That's helpful. And then, the New York, I know you probably can't say much, but is that is there anything different? Mean, you have other states talking about starter interrupts. Is that new development consistent with what other inquiries have been related to? I think it's hard to compare at this point. It's very early. I think what we disclose is really what we know at this point. We had a call. The substance of the call is what's described in the Q and we're waiting for something in writing. Okay. Thank you. Thank you. Our next question or comment comes from the line of Vincent Caintic from Stephens. Your line is open. Thanks. Good morning, Doug. So just a few questions. On the spreads, I just saw it kind of tick down again. I'm just wondering where you think it can go and what you would be comfortable both relative with the growth that you are getting? So we don't really price to generate a specific spread. As we've talked about in prior calls, we our pricing strategy is to try to maximize economic profit. And so we set our advance rates so that we as much as possible balanced profit per unit times unit volume. So mix of business can determine what the spread is, but we really don't have a target there that we're shooting for. Okay, got it. And then I guess from the growth perspective, the unit growth perspective, there's also overall growth is, I mean, certainly strong. This quarter 18%. I guess if you can give us a flavor maybe broadly where that's coming from and if anything has changed to drive that? And I guess from maybe the specifically on a dealer perspective, anything you're seeing there that's different maybe from the behavior of dealers? Just seems like maybe same store sales on the dealership part might be waning, which maybe, for example, might maybe driving more engagement from the dealers. Just kind of any thoughts on broadly what's driving growth and anything specific from the dealers? Yes. I mean it was a strong quarter. We had increases in volume per dealer, increases in active dealers. And again, it continued the trend we saw in the Q4. The expansion of the sales force is clearly helping. We're seeing salespeople that we hired as part of that expansion grow faster than the overall average. So we know that they're adding to the total. We're seeing a nice progression there as the salespeople age. So all good things there. It was a very positive quarter from a volume perspective. Okay, great. And nothing particularly different from the dealer side of things? No, no. It can be really continuation of the trends we've seen. So strong growth in the purchase program, solid growth in the portfolio program, but less so than the purchase. Okay, got it. And last one for me. I'm sorry, I'm going to have to ask another CECL question. And my question is going to be even more basic to Moshe and David's question. But if you could just really discuss what the alternatives are with CECL? And I mean what is fair value option accounting? Just apologies for my ignorance, but if you could just explain it on basic terms. I mean CECL is an accounting methodology where as opposed to recognizing a loss when some event occurs, a certain amount of delinquency or repossession of a sale of a car, you anticipate that loss at the time you originate the loan and then book a loss upfront. The flip side of that is, I mean, over time cash equals accounting. So you'd end up reporting some loss at loan origination and then this is conceptually here then recognizing more revenue over time. The fair value option is you're looking at the coming up with an estimate of the forecasted cash flows that the portfolio would generate and you're basically calculating an exit price which represents the fair value of the portfolio at that point, which as I mentioned earlier, would include an estimate of a discount rate which would represent the return associated with exiting the portfolio. Okay, got it. Very helpful. Thanks so much. Thank you. Our next question or comment comes from the line of Randy Heck from Good Now Investment Group. Your line is open. Thank you. Brett, the 18% unit volume growth or 33 percent dollar growth, and also you had I see you had 25% volume growth in the month of April. How much of that is from the larger sales force versus perhaps easing competitive environment? Yes, it's a tough one. I think it's hard to break out the internal and the external factors. I mean, we have we can see the growth that came from the people that we've hired since the expansion started. In rough terms, they grew about twice as fast as the overall book did. So that still leaves decent growth in the sales reps that have been here or were here before the expansion started. So we're seeing faster growth from the new group, but strong growth from everywhere. Okay. Second question, the adjustments to estimated collections, there was I think a $10,000,000 reduction in estimated cash flow over the life of a $5,000,000,000 loan portfolio. So $10,000,000 less over the next 3 or 4 years. Would you consider that a rounding error given that it's $10,000,000 on $5,000,000,000 Yes, it's a rounding error. So I think probably the right denominator to use is the future revenue that's embedded in the portfolio, the accretable yield we call it in the Q. That's about a $1,700,000,000 number. So $10,000,000 on $1,700,000,000 is still a very small percentage and it's probably less meaningful if you look at it over a period of time. I think we had 4 positive quarters in a row before this quarter. So if you take a 6 month average, the number is basically 0. And if you take a longer average than that, you start to get a small positive number. But your point is well taken. No matter how you look at it, it's pretty close to 0. Okay. The third question I have, if I may, this regulatory stuff, it's you've got 5 or 6 states that have asked for information over the last up to 4 years ago without any development that we can see. You've been regulated by the CFPB for the last is it 3 years in August, I think? So most of that time under Richard Cordray's watch, meaning that pretty well, under Richard Cordray's watch and yet nothing's come of that. I assume you've been audited too. I don't know if you can disclose that, but by the CFEB. But my point is the CFEB presumably has rules that are similar to New York and pretty much every other state. I know there's some little differences, but by and large, the rules of fair lending and so on are the same or very similar. Is that a fair comment? Yes. I'd say there are state differences, but they're not huge differences. I think maybe the main point here is we've got 4 years ago or in the last 4 years as you point out we have I don't know 7, 8, 9 things that we've disclosed now. I think in the 24 years I was with the company before that, I don't think we had any. So clearly, something's changed in the regulatory environment. We're under a lot of scrutiny. We have been for quite a while now. The regulators have a job to do. We respect that. They certainly have their it's their prerogative to ask questions and challenge the things that we're doing. And it's our job to operate in a highly compliant way. And we take that seriously. And what's disclosed in the queue is just where all those matters stand at this point. As you said, I just want to generalize. We've been asked a lot of questions. We've provided a lot of answers and that's where it stands at this point. Okay. Yes, terrific. And just if I may, one last point. I want to say your letter to shareholders is terrific for anyone that hasn't read it, you ought to. And also congratulations on 25 years of compounding earnings at north of 20%. Thanks Randy. Well done. Appreciate it. Thank you. Our next question or comment comes from the line of John Hecht from Jefferies. Your line is open. Good morning and thanks for taking my questions. Actually most of my questions have been asked. I guess one question is, we've seen your loan size grow, your term moving out. I know some of that's just predicated on continuing to increase the dealer purchase stuff. But I'm wondering, is there a threshold where we might see some of those either the term advance or loan size increase slowdown? Number 1. And the second question is, I guess, it's kind of related to that is just if you could comment on the overall competitive environment at this point in time as well? Yes. I think we talked about the competitive environment. Volume per dealer is the number to look at there. It was up this quarter that could cause you to conclude that the environment was easier. But at the same time, we've made a big investment in our sales force, which could also be driving that number. It's hard to break out what's internal and what's external there. In terms of the average term or the size of the loans, again difficult to forecast that. We offer loan terms from 24 months up to 72 months. The average that's in the press release just reflects the mix. We offer a kind of a broad array of alternatives there and it's up to the dealers and customers to choose which alternative they like best. So we've seen an increase in the average term. It's just a function of the mix. Okay. Thanks. Thank you. Our next question or comment comes from the line of Ken Bruce from Bank of America Merrill Lynch. Your line is open. Thank you. Good morning. My question relates to the ABS market. I noticed that there was a $500,000,000 securitization completed in the Q1. Could you talk about what the if there's been any changes to the terms of the ABS market relative to credit acceptance. We've heard that there's been a little bit of choppiness in the auto ABS market. Just wondering if that's impacting you at all? The structure of our ABS hasn't changed in any meaningful way for a number of years. The market in subprime auto has been pretty good really since about the Q1 of 2016. Obviously some periods are a little bit better than others. But it's been a pretty healthy market. So nothing really material report there in terms of differences. And in either spreads or in-depth of the book, have there been any changes in terms of the market itself? Maybe it's not necessarily reflected in structure, but is there any changes in pricing or depth in the buyers of the paper? I mean, our last deal, we issued at the tightest credit spreads we had in a number of years. That was offset by an increase in base rates. So the all in costs actually went up a tighter end of the historical range. And when you look at the tighter end of the historical range. In terms of depth of the book, I'd say over time as people get more familiar with our program, the depth of the book has generally increased. Okay, great. Thank you for your comments this morning. That was it. Thank you. We have a follow-up question from Mr. Moshe Orenbusch from Credit Suisse. Your line is open. Great, thanks. I just wanted to revisit the comment you made about the volatility going down as the securitization as you see as the vintages kind of age. And while it's obviously true that as the vintage is paid down, each one successfully has a smaller impact on the total. But I guess, it hasn't really happened that most of the 14 to 16 vintages you've written them up in the 1st year and then kind of subsequently written them down after that? And didn't I mean, it seems like it's starting to happen on the 2017 vintage this quarter. You wrote them up during the quarters of 2017 and now ticked down again. So I guess maybe could you address that? Yes. We disclose it every quarter, so you can certainly see the trend. I would probably just go back to the answer I gave Randy. It's the total for the quarter in dollar terms is minus $10,800,000 Is that a big number or a small number? I think the appropriate denominator to use is the accretable yield that's in the portfolio, which is $1,700,000,000 So $10,800,000 divided by $1,700,000,000 is a very small number. And then again, if you look at that over more than 1 quarter, it gets even smaller. So you can take that very small number and parse it by year or parse it over time, but it still doesn't change the fact that it's a very small number. That is a small number, but that number is not discounted, correct? So that if there were changes to the timing like you exhibited in the Q4 that wouldn't be encompassed in that change? It's not discounted, but if we discount it, it would get even smaller. Yes. I'm saying that if you Discounting it doesn't make it larger. Just that your changes if you look at the changes in the Q and the K, you report what percentage of your loans actually have estimates that have changed to be better or worse than your original estimates. Those numbers through 2016 were roughly 50% and at the end of 2017, they were 75. This quarter it went down a little bit to 70 or so. So that includes where there are changes both to the dollar amount, which is that $10,000,000 whatever you were referring to as well as the timing of those cash flows. So I guess that's my point is that it's not just the $10,600,000 it's also the timing of when that one $7,000,000,000 would be realized. Right. And we talked about that last quarter. We did change the timing estimate last quarter. We didn't make any further changes this quarter. Okay. Thank you. Thank you. 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'd like to thank everyone for their support and for joining us on our TAPPERS call today. If you have any additional follow-up questions, please direct them to our Investor Relations mailbox at ircreditacceptance.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. You may now disconnect. Everyone have a wonderful day.