Good day everyone. Welcome to the Credit Acceptance Corporation first quarter 2017 earnings conference call. Today's call is being recorded. A webcast and transcript of today's earnings call will be made available on the 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, Brian. Good afternoon. Welcome to the Credit Acceptance Corporation first 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.
Thank you, sir. Ladies and gentlemen, at this time, if you would like to ask a question over the phone, please press star then one on your telephone keypad. If your questions have been answered or you wish to remove yourself from the queue, please press the pound key. Again, ladies and gentlemen, that is star then one to ask a question. Our first question will come from the line of Jack Micenko with Sig. Please proceed.
Hi, thanks for taking the question. Looking at the dollar volume, it continues to grow. I'm wondering, is that a function simply of the longer term, and maybe some of the Purchase Program mix shift, or are you doing something strategically where you're maybe looking at maybe a newer collateral or something along those lines around the average loan size, that sort of thing?
Yeah, it's all of those. It's just a mix shift. We've written those loans before. We're just writing more larger, longer-term loans than we had previously.
Okay. The increase in servicing expense, is that portfolio growth driven? Is that compliance driven, or is that sort of a follow on to sort of tightening some standards last quarter?
No, it's just strictly related to the growth of the portfolio.
Okay. Thank you.
Servicing expenses grew slower than the portfolio grew.
Okay, thanks.
Thank you. Our next question will come from the line of David Scharf with JMP Securities. Please proceed.
Hi. Good afternoon. Thanks for taking my questions. Just curious, thinking about the environment you encountered year to date. I think last quarter you made the comment that competition was the biggest hindrance to volumes, not demand. Is that still the case? Would you still rank competition as a bigger headwind, if you will, than overall consumer demand, or are we seeing any changes in the latter?
I think it's hard to separate the factors. I think, in my mind, the two biggest factors are competition and then the changes we made to address the loan performance issues.
Okay. On the competitive side, can you give us maybe some qualitative feedback on whether or not there are any signs that we may be at a peak that it might start to ease? Doug, I know when we talk, you have your hand on the pulse of the ABS markets all the time. Is there anything on the funding side that leads you to believe on the margin that, hey, maybe by the second half of the year, some of these smaller lenders may have a little more difficult time trying to gauge whether or not we're sort of at, in your mind, it's sort of the peak of competitive forces and that maybe things are set to turn around later in the year?
Well, speaking relative to conditions in the capital markets, certainly nothing that we're seeing at this point that would indicate that the ABS market is less available to the industry than it has been. Spreads were very attractive in Q1. They've widened a bit since then, but are still at relatively attractive levels. Certainly, nothing on the funding side.
Okay. Just so I understand it, there's nothing there that indicates some competitors may have a more difficult time accessing capital near-term.
Nothing significant from a capital markets perspective that I'm seeing at this point.
Okay. Got it. A couple just quantitative questions. The tax rate, was there anything, any kind of one-time benefits, state refunds, anything that brought that down this quarter and how we should think about that for the full year?
Yeah. There was a change in the first quarter this year relative to adopting a new accounting standard. Historically, the difference between the tax deduction we get when a restricted stock vests or restricted stock units converts to common stock The difference between that and the amount of the GAAP expense we've recorded has historically just been recorded as a direct entry to equity. Beginning in the first quarter of this year, those excess tax benefits flow through the tax line, and that's what accounted for the difference in the effective rate.
Got it. Was that a true-up? Should we be thinking about roughly 37%-38% going forward?
It wasn't a true-up. It related to the activities that occurred in the quarter. I think you can go back and there's some seasonality or that activity tends to occur most often in the first quarter of each year. Other than that, pending anything that comes out of Washington, I think we're still thinking about our effective tax rate the same way, 35% for federal, a couple points for state, and then, whatever adjustments like this you might have.
Got it. Lastly, just on the collection front. Looks like the forecast revisions in the quarter. The 2015 vintage came down again, 2016 was revised up slightly. I'm not sure what in the first quarter got revised up, but I'm wondering, can you give us a sense in order to interpret this as maybe we've sort of passed through the toughest period. As we think about forecasted collections during this calendar year, what % of those collections will be accounted for by the 2016 and 2017 vintages? Maybe alternatively, how much less of a factor in this year's collections are the 2020 and 2014, 2015 vintages?
That's one way to look at it. I think the simplest way to look at it is the table on page two of the release, where we just quantify the dollar amount of the change in the net cash flow forecast.
It was a positive $8.1 million this quarter, negative $6.7 million same quarter last year. The $8.1 million is on a $5.5 billion of undiscounted net cash flow. A very small move this quarter and a very small move same quarter of last year. You could break it out by year, but you're talking about a very small change in total.
Got it. It looks like the ending allowance rate was unchanged as well, by and large. Okay. Very helpful. Thank you.
Thank you. Our next question will come from the line of John Hecht with Jefferies. Please proceed.
Yeah. Thanks very much. Yeah. I'm wondering if you could tell us either the actual metrics or maybe talk about the changes you've had over the past two or three quarters on the loan to value and duration in both the dealer loans and the purchase loan pools.
The loan term is disclosed. You can see it got a little bit longer this quarter. We don't disclose loan to value. As we've talked about with the term, it's a mix issue. We write terms from 24 months out to 72 months. For about 80% of the loans we write, we have a full amortization period behind us, so we got a full history on how those loans will perform. On the 66-month and the 72-month loans, we don't have a full history. I think we're about 75% of the way through the 66 months. We got 48, 50 months of history there. On the 72, we have about between 24 and 30 months of history on those. We feel like for most loans we write, we've got good data to back it up.
For the 72-month loans, we have to do a little bit of estimation, so there's a little bit more risk there. Because we've got a lot of 60s and a lot of 66-month loans on which to base it, we don't think it's a stretch to be able to forecast those with a high degree of accuracy.
Okay. A lot of discussion and focus now on the changing used car values, residual values, and so forth. I'm wondering just if you could give us your opinions on kind of where you see the pace of that, the trajectory of used car values, and then how that impacts your business overall.
It's no secret that vehicles are depreciating faster than they have. Going back to probably 2008 is the last time we saw an environment like this. It's no surprise to anyone. It's something that's been predicted. It's definitely coming true. Vehicle depreciation is much steeper now than it has been since 2008. As we've talked about in the past, it doesn't have a huge impact on our business. We tend to think about things like this long term. We'll be in periods where vehicle values are helping in terms of the depreciation curves. We'll go through periods where it's more severe like it is today. It'll all even out over time.
The difference for us between kind of the worst end of the spectrum over the last 10 years and the best end of the spectrum is about 300 basis points in terms of the collection rate. That's not insignificant, 300 basis points. In the scheme of things, when you look at the high and the low over a 10-year period, it's really not that significant. What we try to do, instead of trying to put a perfect forecast on where vehicle values will be in the future as we try to originate business with an expected return well above our cost of capital. That even if collection rates come in a little bit lower than we anticipated, the business we're writing is still very profitable.
Okay. I appreciate the color. Thanks very much.
Thank you. Our next question will come from the line of John Rowan with Janney. Please proceed.
Good afternoon, guys. Doug, just to go back to your prior comment that the ABS spread did widen out post Q1. Obviously, one of your competitors was in the market a couple of weeks ago, they had a pretty widening spread in the bottom tranches. Do you think that that's kind of a one-off situation with the placement of that deal, or do you think that it's a trend that we might actually see investors place lower demand on bottom tranches of ABS deals?
It's a good question. It's a little bit tough to say because there hasn't been a lot of subprime auto issuance real deep in the capital stack over the last few weeks. Certainly, spreads have widened out in general a little bit, but the widening has been much more extreme on the double B and triple B tranches than it has the higher-rated tranches. I think at this point it's a little bit premature to conclude on that point. We'll just have to watch subsequent issuance and see what happens.
Okay. Last quarter call, you guys talked about hitting a point of resistance in growing dealer partners. Obviously, you grew them in this quarter. Would you label the same kind of characterization this quarter? Are you getting more bullish messages from your sales staff? I just want to kind of gauge any incremental shift in that opinion.
No, I think the numbers speak for themselves. I mean, we did grow the dealers, but we didn't grow them very rapidly. The growth rate was slower than last quarter. I think the numbers capture how we feel about it. We'd like to be growing a little bit faster than we are. In the last two quarters, that's the best we've been able to do.
Okay. Thank you.
Thank you. Our next question will come the line of Leslie Vandegrift with Raymond James. Please proceed.
Hi, guys. It's actually Robert Wildhack. Just looking at the return on capital that you disclose in there. If we look year-over-year, obviously the adjusted net income plus et cetera, $110.2 versus a year ago, $98.6. I mean, we can do the ratios. When you look at the adjusted return on capital, obviously compressed 100 basis points year-over-year, and that's the average across everything. Looking at the incremental versus last year, looks like it's maybe around 7%, which is obviously compressing, especially as your cost of capital is rising. We saw buybacks. You just mentioned in response to the previous question, you'd like to be growing faster.
I mean, the question is, at this incremental return on capital, which is the thinnest we've seen in some time for you guys, what's your calculus on originating loans versus buying back stock versus holding back on some of the origination activity given the incremental returns you're seeing?
I'm sorry, I didn't really follow you. You made reference to 7% at one point, I didn't understand what you were referring to.
Adjusted net income year over year grew 34. The capital base, $783.9. The ratio there is 7%. That's basically the incremental return on incremental capital. Looks to be about 7%.
I can tell you we expect to make a much higher return than 7% on the business that we're writing. There's something wrong with your math there. In terms of how we price, say the same thing, I think every call. We always price the same way, and that's to maximize unit volume times economic profit per unit. Whether the competitive environment is favorable or whether it's difficult, we always price the same way, and our plan is to continue to do that. If we can't invest all of our capital in the business, then we look to send it back to shareholders, either through repurchasing shares or through a dividend.
Okay. Thank you.
The composition of the capital changes too, obviously. I mean, some of the business that was in the book as of the end of the first quarter of 2016 has run off. I think that's the reason why doing the math that you were suggesting doesn't produce the right answer.
Okay. Appreciate it. Thanks.
Thank you. Our next question will come from the line of Ben Wanger with Three Sigma Value. Please proceed.
Hi. If a dealer drops out of the program before closing a 100-loan pool, what happens to those loans? Are they moved to the Purchase Program?
Yes. If that's their first pool and they fail to complete a pool of 100, they would forfeit their right to the dealer holdback, and those loans would be transferred to Purchase loans.
Thank you. That's all I have.
Thank you. Our next question will come the line of Daniel Smith with Tennant Capital. Please proceed.
Hi, guys. I know some of your competitors have talked about dialing back loan growth. So I guess my question is, one, have you seen that? Two, have you been able to adjust your borrower profile at all, like credit score, debt service ratio, anything as a result?
We've not made any significant changes to our loan policies. It's a very big market. If one or two people say they may be dialing back, we'll see. Through the first quarter, we certainly didn't see that in the numbers.
Okay. Thank you.
Thank you. Our next question will come from the line of David Scharf with JMP Securities. Please proceed.
Yeah. My questions have all been answered. Thank you.
Thank you. As a reminder, ladies and gentlemen, if you would like to ask a question over the phone at this time, please press star then one on your telephone keypad. Again, please press star then one if you have a question. Our next question will come from the line of Clifford Fownes with Gas Investment. Please proceed.
Hi. My question pertains to the increased expenditure in the sales force. The release refers to some increased expenditure and an increasing headcount in the sales force. Can you maybe spend a few moments describing your initiatives there?
Yeah. We're in the process of expanding the number of salespeople that we have. The number at the end of Q1 was higher than the start of Q1, a lot of those salespeople are new. We haven't seen much of an impact yet in terms of the unit volume numbers. Hopefully, as they become more seasoned, we'll see a positive impact from that.
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 comments or 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.