Earnings Call: Q4 2017

Jan 30, 2018

Good day, everyone, and welcome to the Credit Acceptance Corporation 4th Quarter 2017 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, Andrew. Good afternoon, and welcome to the Credit Acceptance Corporation's 4th quarter 2017 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 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 and I will take your questions. Our first question comes from Moshe Orenbuch with Credit Suisse. Your line is now open. Great, thanks. I guess I was sort of hoping that you could expand a little bit on the discussion in the press release about the changes kind of in the timing of the receipt of the cash flows and your new estimates? And maybe if you could just relate that to the fact that now you've got kind of negative variances on 3 years relative to your initial forecast and how we should kind of think about that? Okay, sure. So two different things. We have, as you know, a number of models that statistical models that we use for forecasting. We use the models not only to run the business, but to support our financial statements. One of the models, the timing model, which predicts or forecasts the timing of future net cash flows was revised this quarter. So a couple of things we described kind of the reasons for the revision and the impact in the release. So I won't necessarily repeat that, answer any specific questions you have on it, but just let me make a couple of points. The first is it's a timing change. So it doesn't change the amount of revenue that we'll recognize in the future for adjusted earnings. And for GAAP, it's the same concept. You just have to include the provision for credit losses in as well. So if you look at kind of net revenue or revenue minus the provision in our GAAP statements, including the Q4 and going forward, the total amount that we'll recognize is unchanged. The only thing that changes is the timing of when that revenue will be recognized. The second thing I'll highlight is it's a large estimate, dollars 6,300,000,000 dollars of undiscounted net cash flows spanning 120 months. So it's a large estimate. It covers a long period of time. To forecast the timing, we have to forecast the customer payments, including any prepayments, the amount timing of repossession proceeds, deficiency balance collections and then outflows for portfolio profit and portfolio profit express. So not only is it a large estimate, but it's got a lot of moving pieces. Now even though it doesn't impact the amount of revenue on the loan portfolio going forward, it does impact the economics of the loans, particularly the longer term loans. So based on our revised model, the longer term loans are less attractive than they were before. The shorter term loans are the opposite. Now the longer term loans are still very attractive given the price that we paid for them. They're just less attractive than they were before. I guess I'm going to have to come back to that because when you talk about this is level yield accounting and so determining that yield the factors that determine that yield, the two factors are the total amount of cash and the timing. So if the timing is longer, then the yield is lower and that is an ongoing effect, correct? The yield is lower, you're correct. But that's true. But it's also true that the total amount of revenue in our adjusted statements or the net revenue as I referred to it in our GAAP statements is unaffected. It's just the timing of when it's recorded. I guess I'm missing how the net revenue or GAAP statements can't be lower that The revenue if you think about it is just the outflows the inflows that we expect in the future minus the outflows that occurred as a result of us acquiring the loan. So the difference between those two numbers is our revenue. We didn't change the amount that we're expecting on that. Right. But in any given year, it would be lower, wouldn't it, Doug? Well, it would either be lower or higher. That's what we're saying is the timing changed. So it could work both ways. What you're thinking about But this change Sorry, go ahead. This change would mean that in any given year that you're now going to be applying those new standards to it would be lower than it would have been before, correct, under your prior models? Correct. Right. Okay. That's all. Thanks. Thank you. Our next question comes from David Scharf with JMP Securities. Your line is now open. Hi, good afternoon. Thanks for taking my questions as well. Maybe switching away from the accounting for a moment. You obviously saw a pretty material surge in volume this quarter and I think an acceleration in the year over year growth in active dealers. Can you give us a little bit of a sense of what you're seeing from competitors that's perhaps driving this surge? Any sense that they're easing up? Or by the same token, it looks like you've been continuing to extend the loan term. It was 56 months on average this quarter. Is the volume more a function of actions you're taking as opposed to what competitors are doing? Yes. I think it's always difficult to separate those two factors. The best number you can look at in the release, I think, if you want to try to get a sense for the competitive environment is the change in volume per dealer. That was up 2.1%. That's a positive change in the trend line there. We've been running negative numbers there for I think 7 consecutive quarters. So that's a positive data point. It's just 1 quarter. So I think it's probably a little bit early to draw any very hypothetical question, but this is a very hypothetical question, but are you willing to venture sort of maybe what some of those volume metrics would have looked like had, let's say, either the average size of the loan remained maybe at levels that we saw earlier in the year or that the average term had remained the same? Trying to get a sense whether those two metrics, number of months and average loan size are more a function of the type of customer, the type of vehicle or if it's in response to competitive issues? Yes. I can't give you a figure there. When I think we've changed our program to make it more attractive offering longer terms. No question that's had a positive impact on volume. Got it. And maybe one follow-up. Can you expand a little more explaining the language in the press release regarding, I guess, the reclassification of some dealer loans into purchase loans. Number 1, is this something that you've historically done in the past, but maybe not as greater degree? And for our purposes, are there any implications about how the yields going forward on those loans are going to be treated? Yes. I don't think I would worry about that too much. The reason we put that in the release, I mean, the answer is we do reclassify loans from dealer loans to purchase loans. If the dealers don't meet their performance obligations, we're entitled to do that under the terms of the agreement. It's typically small dollars. What happened this quarter is we had a catch up. We hadn't been reclassifying those loans on a timely basis and so we caught that up this quarter. The reason it's in the release is that it impacts some of the numbers in the collection and spread tables. So we changed the way we do those tables. This point forward, the tables will reflect the way the loan was initially recorded. And that will just allow us to keep those numbers consistent over time. So we highlighted it in case you had a record somewhere. What was in prior releases, you wouldn't be wondering why they didn't tie out. Got it. Got it. And then just lastly, anything in the Q4 to report from the hurricanes, any residual impacts and so forth that we might take note of? No. Got it. Got it. Thank you. Thank you. Our next question comes from John Rowan with Janney. Your line is now open. Good afternoon, guys. So I'm trying to tie together a few comments that you made. So durations up 56 months from 55 last quarter, but you're also talking about the economics of the loan being substantially less attractive on the longer term loans versus the shorter term loans, but you're still increasing duration from, I guess, due to a competitive standpoint. Is there any impact on the dealer partners as far as their advance rate or hold back that's credit acceptance platform based on the changes that you're making to the collection patterns? I don't think the changes are big enough that the dealers would notice. I mean if our new forecast is accurate, it means the cash flows will come in a bit later, But I don't think an individual dealer would notice the difference. But would that I mean just for if you took Loan A, give us an idea of how much longer the collection period is. I mean, is it 10 months additional, 5 months, 20 months? I'm just curious to know how much longer the collection period lasts to get you to the same forecasted collections? Yes. You're talking about a very small difference there when you're thinking about it in those terms. So it's a 1% to 2% type adjustment, not 20%, 30%, 40%. Okay. And then just to switch gears a little bit, you talked about a holdback forfeiture in the press release. Was there any gain reported from holdback forfeitures? No, it's taken over time. We just account for that loan as a purchase loan going forward. Okay. Any impacts from the changes in the sales force you guys have made over the past year? Is that driving the higher dealer partner productivity numbers? Yes. We're starting to see some positive momentum there. It's early, but we're seeing a nice progression. We started expanding the sales force, I'm sorry, in mid-twenty 16. The group that we hired sort of the last 6 months of 2016 grew faster than our overall average this quarter. The group we hired during the 1st 6 months of 2017 also grew faster than the overall average. They didn't grow as fast as the first group, but still higher than average. So we're starting to see a nice progression. And then the ones we hired in the last 6 months of 2017 grew slower than our average. So some positive change there. The average size of the sales force in Q4 was up, I think, 27% over the prior year same period. Unit volume was up just short of 11%. You'd like to see unit volume growing faster than the size of the sales force. We're not quite there yet, but we're seeing, like I said, some small move in the right direction. Okay. Two more quick questions. Repurchases, any plans there? It doesn't seem like you repurchased any stock this quarter. We didn't buy back any stock this quarter and we'll continue to think about it the same way going forward. We bought back a lot of stock over time, though the repurchase patterns have been lumpy and they will likely be lumpy in the future. Okay. Last question. We don't have a K yet, so I just want to know if there's going to be any changes to the regulation or contingent liability section? I mean, we'll release the 10 ks in another week, 10 days or so, so we can talk about it at that time. All right. Thanks. Thank you. Our next question comes from Vincent Caintic with Stephens. Your line is now open. Hey, thanks very much. Just wanted to get maybe the practical drivers of maybe some of the questions that were asked. So on the provisioning and the timing adjustment for the provisioning, is there maybe something that would drive that from the customer perspective? So I'm just thinking of a potential example of maybe you're doing more workouts with your customers, where you might restructure some of the loans and that would drive a timing change? I'm just trying to think of examples of what would cause timing to be different than to be for the provision to be higher? Yes. As I mentioned, it's a large complex estimate covering a long period of time, lots of moving parts. It was very small adjustment in the scheme of things to a large number. We highlighted the most important thing that changed, which was our estimate for the longer term loans. When we built the model, we had less than a full data set for those longer term loans. We now have more data, which we use to update our estimate and attempt to make it more precise. Okay, got it. And then for the forfeiture of the dealer holdback, could you maybe just give us a background on the types of performance obligations the dealers have to meet and so what would cause the forfeiture of the holdback? Yes. The simplest one is that you have to do 100 loans in order to be eligible for the dealer holdback. So they have closed their 1st pool loans, which is, they have to get to 100 to close it. If they don't make it to that 100 milestone, then we're entitled to retain the dealer holdback. So that's what that is. Okay. Got it. So would there be a mix of new relatively new dealers that would be under this the forfeiture? It would be all dealers that hadn't got to 100 would be included in that. Okay. Okay, got it. Thank you. Just one more question. Any updates on competition that you're seeing in an environment we're hearing of maybe some folks pulling back or maybe other folks getting more competitive? And just what's your sense? Thanks. Not a lot to add to what we said already. I don't see a big change in the environment at this point. As I said, we had one positive data point for the quarter, which was the increase in volume per dealer, but I think it's just one data point. Okay, got it. Thank you. Thank you. Our next question comes from Jack Micenko with SIG. Your line is now open. Hi, good afternoon. Looking at the positive variance that continues in 2017 and I guess in particular in the purchase loan portfolio, I guess my question is, is that are you seeing better underwriting and better quality in the purchase book or is that more a function of going in your estimate might have been maybe more severe than actual or some combination of both? Just trying to get a sense of why the purchase numbers keep driving some better positive variance overall in recent quarters? I think the best way to think about loan performance is the number that we provide that shows you the change in our net cash flow forecast for the quarter. It's $13,700,000 So it's a positive number, which is nice, but that's again on $6,300,000,000 of undiscounted net cash flow. So $13,700,000,000 divided by 6.3 $1,000,000,000 is a number that's pretty close to 0. I think the most reasonable conclusion to draw from that is that loan performance was stable for the quarter and it's been stable for the last several quarters. That's good news, but I don't think there's really a lot more you can say about changes in the forecasted collection rate because it just didn't change that much. Okay. And then I think back in June, there was a the CFPB reached out with some inquiries. Is there any update on the status of that? No update at this time. We'll file our K, as Doug said, in a short period of time and you can look for any updates in there. Okay. Thanks guys. Thank you. Our next question comes from Leslie Vandegrift with Raymond James. Your line is now open. Hi, good afternoon. A quick question on the change in net cash flow timing. I know you discussed it earlier in the call, but does any of that have to do with the upcoming accounting standard changes, specifically the ASU 20 sixteen-thirteen change? No. Okay. So no. And then any update on those changes coming forward? No. We're continuing to work on it. But at this point, we don't expect to reach a conclusion until late 2018 or into 2019. So when we've determined the methodology and quantified the impact, we'll disclose it. Okay. And then for this quarter on the adjustments to the floating yield, it was a positive $37,900,000 adjustment and in the breakout about $12,000,000 of that was due to those one time estimate changes. What about the other $27,000,000 approximately? What was built into that? I don't think we follow the question. Can you I'm sorry, can you repeat that? I didn't really understand it. Okay, sorry. The floating yield adjustment for the quarter was $37,900,000 when you looked at adjusted revenue from GAAP. About $12,000,000 of it seemed to be to do with the timing of the changing change in estimates due to timing of net cash flows. What about the other 27,000,000 dollars Like what else is in that? I don't know you stumped us on that one. Okay. All right. And then on I'm sorry, go ahead. I think it's just the difference because the GAAP provision for the adjustment is taken one time. Okay. Maybe you can call Doug tomorrow and he'll answer for you. Yes. Okay. That's fine. Follow-up on that. And then last question, you discussed earlier in the call that the longer term loans are becoming a bit less attractive out there. So does that mean in the near term we could see those terms start to pull back? So 56 months average term in Q4, could we be heading back the other direction? I think we'll just have to wait and see. I mean, it's certainly one factor. Again, I think one of the questioners said, I said it was a substantial revision. I don't think it's a substantial revision. They're just less attractive than they were before, but still very attractive. So we can continue to write longer term loans and we find the pricing attractive, we'll continue to do that. Okay. And then I guess a follow-up on that is as you've seen, obviously, you got the dealer hold back this quarter for the ones that didn't meet the pool requirements. Have you seen the ones who are close? Are we seeing those dealers who get close to 100 with the pool doing more of the longer term? So maybe they're less attractive than the quarter before, but they're still willing to do them in order to ensure that holdback is paid to them? No, I don't think those two things are related. Okay. All right. Well, thank you for answering my questions. Thank you. Our next question comes from Kyle Joseph with Jefferies. Your line is now open. Hey, guys. Thanks for taking my questions. Sorry, I had to hop on a little late. So apologies if these were already asked. But in terms of tax rate going forward, have you guys what do you anticipate that 37% moving towards in terms for adjusted EPS? We say 23% on the release. Okay. Thanks. And then just as a follow-up on the provision and the changes there, Is this just a one time item you see or do you anticipate there being a future impact as well? Well, I mean, the revision in the quarter was fully reflected in the quarter. Okay. That answers my question. Okay. All right. Thanks very much. Thank you. Our next question comes from Jason Han with Principal Global Investors. Your line is now open. Yes, thank you. I guess maybe to explore that last question just a bit further. As we think about the performance of the business going forward, how should we think about provision expense as a percentage of the loan book or net revenues? Is it was the 4th quarter provision a bit of a catch up? Or is this something we should be viewing as more of a normalized level of provision for the future? Thank you. Yes. I think the best way to think about the provision for credit losses is to focus on the adjusted results. Where there is no provision for credit losses, that's the way that we think about it internally. The provision, we've talked about it in prior calls. We described why we think that makes it difficult to assess the economics of the business and there's lots been written on that. So I would just refer you to that. We do say in the press release on Page 3, we talk about the impact of the revision on both the GAAP and adjusted yields. The impact on the GAAP yield was 90 basis points on the adjusted yield was 140 basis points. Okay. Thank you. I will have to look at that a little bit closer. Thank you. Our next question comes from Daniel Smith with Tieton Capital. Your line is now open. Hi, guys. Do you feel like loan durations have kind of reached a limit? Or is it just that you think that you should be paying like a little bit lower advance rate against the long duration stuff? I mean the advance rate we paid during the quarter is the advance rate we thought was optimal. Otherwise we write loan terms from 24 months out to 72 and the average initial loan term that's in the press release is just a function of the mix. So we're happy to write 72 month loans. We're happy to write 24 month loans. It's whatever the dealer and the customer desire. So the Q4 the loans that you purchased in Q4, Was that with the knowledge of the later collection timing? I mean, they both happened at the same time. We bought the loans during Q4 and we revised our timing during Q4. So there was some overlap there, but it was a period where the our knowledge was somewhat fluid. Okay. So going forward, you don't feel any differently towards 72 month loans or potentially longer duration in the future? It's just that all else equal, your advance rate should be a little lower and probably volumes a little bit lower? Yes, correct. We'll take what we learned from this from the revision and we'll apply that to future pricing. Okay. But I mean going out I mean looking out a couple of years, do you see duration continuing to increase or do you feel like it's kind of reached a limit? I think it's impossible to forecast what the average duration would be 2 years from now. But like I said, we're happy to write 72 month loans. We're happy to write 24 and whatever the mix is just really depends on what the opportunities are in the market and what the dealers and customers desire. But like in the next year or so, do you see yourself going out beyond 72 months on any loans or I don't know how you normally test these things? Yes. We don't have any plans right now to go beyond 72. Do you have like in the next year, do you have a plan to like increase the mix of like 72 month loans? I think I covered that. I don't know how to answer it any other way than the way I just did. So let's move on. All right. Thank you. Our next question comes from Clifford Sosin with Katz Investment Partners. Your line is now open. Hi, guys. Thanks for taking my question. So, sorry to be back on the timing of cash flows question. But my question is, I recognize that the change in your timing model adjusted the yield on an adjusted basis by 1.4% in the quarter. If I were able to look at just the forecasted levelized yield of new originations, by how much would this change in forecasted timing of longer duration loans impact that yield? Pretty close to the same number. Okay. So there's no sense that a loan that was originated a couple of years ago where you've been collecting revenue at the old sort of forecasting revenue at the old schedule, so to speak, would have a larger variance if the change in timing was done only in the back half of the loan to life? You lost me there. So if you originated $100 loan 2 years ago and you've been recognizing revenue according to the levelized deal that you forecast at the time. And let's say things aren't exactly according to plan. There'd be some smaller principal balance outstanding today, but the timing difference would then be added. And so in theory, the changes in timing would be sort of recognized over a shorter both a shorter amount of remaining time and a smaller principal balance. And so in theory, it would drive I follow you, Cliff. So I think the piece there, to fill in the blank is that the old timing model it adjusts over time. So as the loan ages, if our timing is off, the yield gradually adjusts over time. So it's not like everything just fell off a cliff. The loans were gradually adjusting over time. And what this revision does is sort of anticipate that going forward rather than letting it occur over time. So I think that's why you have a different company. Got it. And then what roughly when you talk about longer term loans having a slightly longer duration and I realize that in all likelihood all of the loans had some adjustment to the duration, but roughly what portion of your balances are you thinking of as the longer term portion, which whose levelized yields are going to be lower and account for the 1.4% overall change? So the 72 month loans is where we have the least amount of data. 72 month loans are about 12% of our forecast at the end of 2017. 66 month loans, we have quite a bit of data on those. We don't quite have a full 66 months of data, but we're close. And 66 month loans are about 26% of the overall forecast. So you have those two components together are where we have the largest changes. Great. Thank you so much. We do have a follow-up question from David Scharf with JMP Securities. Your line is now open. Hi, thank you. I think my question was asked in one fashion or another. I guess, Doug, I was trying to get at how to think about forecasting the level yield going forward. And on a GAAP basis, given the 90 basis point correction, I was just trying to get a sense for how much of that is arguably captured in the Q3 to the Q4 kind of simple average yield that's calculated? Or should we be taking the finance charge and then Q4 divided by the average balance as a yield and then reducing that by a full ninety basis points going forward? No. Take the actual yield for Q4 and use that as your starting point going forward. Okay. So the allowance charge that hit the provision is captured in that full yield adjustment in the quarter. Got it. Thank you very much. With no further questions in the queue, I would now 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 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.