Good day, everyone, welcome to the Credit Acceptance Corporation fourth quarter 2016 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 fourth quarter 2016 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 meanings 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, at this time, if you would like to ask a question over the phone, please press star and then one on your telephone keypad. If your questions have been answered or you do wish to remove yourself from the queue, please press the pound key. Again, ladies and gentlemen, that is star and then one to ask a question. Our first question will come from the line of David Scharf with JMP Securities. Please proceed.
Hi, good afternoon. Thanks for taking my questions. Wondering if we could start just addressing volumes and demand to close out the year. As we think about the dealership count holding kind of steady from the third quarter, setting aside usual seasonal drop-off in Q4, looks like average volume per dealer declined a little more. Just wondering, as we think about some of the volume metrics, are the biggest factors affecting it competitive terms from other lenders? Are they independent dealers perhaps losing share to franchise dealers? Is it thirdly, more consumer-related, any sense that we're starting to see a peaking of consumer demand?
Yeah, I think the first factor I'd look at is the competitive environment. That certainly makes things challenging. We're not getting any improvement there, but I don't think it got any worse either. I think what you saw in the fourth quarter is, as we talked about in prior calls, our strategy when the environment is competitive is to focus on growing the number of active dealers. It's difficult to grow volume per dealer when it's very competitive. As I think we alluded to several quarters ago, as the base of dealers gets bigger, it becomes more difficult to grow that at a fast enough rate in order to offset the decline in volume per dealer and to a lesser extent, attrition. That's what we're seeing right now is just we're having difficulty signing up enough dealers to offset those other two factors.
I think in the fourth quarter, the other thing that came into play is we addressed some of the negative variances that we've seen in recent originations. When we do that, it causes our initial collection forecast to decline, which means we advance the dealers less money. That has sort of a one-time impact on volume per dealer and also on attrition.
Got it. Brett, your comment about as the size of your dealer count gets larger, it's harder to grow off that base. Should we be thinking about, call it the 7,500 active dealer figure? Are we bumping up against a ceiling, or is that just a reflection of the competitive environment? If competition were to ease and dealers had fewer funding options, is there still a lot of upside to that 7,500 number?
I think it's too early to call it a ceiling. It's definitely a point of resistance. The competitive environment, obviously, if that changes, that will change everything. If we assume that the current state continues for the foreseeable future, I would look at it at this point as a point of resistance and a ceiling.
Got it. Just a couple more. Just curious, switching to the provision side, looked like the allowance ticked up a bit to close out the year. I think it was 7.6%, and you already noted some of the collection patterns. As we think about modeling 2017, I know you don't give explicit guidance, is that kind of high 7% allowance rate a reasonable target for us?
As I think you probably know from prior calls, we tend to look at the adjusted numbers internally. I think the best number in the release, if you want to sort of get your arms around the economic impact of forecast changes on the second page of the release. The net cash flow number declined $14 million for the quarter. That's on a base of $5 billion or so in undiscounted cash flows. A very modest decline in the quarter, $14 million. That's really the economic impact. As you know, the way that GAAP handles that from a provision standpoint, I think makes it difficult to see the economics. The adjusted numbers we provide, we think do the best job of sorting all that out and giving you a number that you can focus on.
Got it. One last one, I'll get back in queue. It looks like your spread actually ticked up a bit sequentially. Obviously you're pricing your advance levels in accordance with maybe a revised thinking about collection patterns. Is a 21%-22% spread generally based on your internal models and your target returns? Should we be thinking about that as in effect, a floor at which you wouldn't underwrite if the spread was below that? I mean, we don't have access to obviously all your loan-by-loan return targets, is this a good way of thinking about a floor in terms of the spread over the advance rate?
No, I don't really have any guidance on that number. As we've talked about in prior calls, the way we price is we try to maximize the total economic profit we generate. Unit volume times economic profit per unit. We make adjustments all the time based on the models that we run. At times, that means we get a little bit more aggressive, advance a little bit more. At times it means we do the opposite, that's how we price. We don't really price based on that spread.
Right. Got it. Okay. Thank you.
You are correct. It was a favorable change in Q4 with respect to-
Yeah. No, we're obviously just looking for shortcuts in terms of how to model it, using it as a proxy for yield. Understood. Thank you very much.
Yep.
Thank you. Our next question will come from the line of John Rowan with Janney. Please proceed.
Good afternoon, guys. Kind of going back to the commentary on volume. Unit volume was down 6% year-over-year. Dollar volume was up because the average loan is bumping up near $20,000, which is considerably higher over the last couple of years. If we're getting to a point where there's resistance in this current environment at the current dealer partner number, at what point do we start to see the loan portfolio actually contracting? I would think unless we continue to see very big increases in duration and average loan size per consumer, with unit volume coming down, we're going to have to start seeing some contraction in the loan portfolio at some point in the near future.
It just depends on your assumptions for unit volume going forward. I mean, obviously the loan portfolio's growing pretty rapidly right now, and the dollar volume increased in Q4. I think you're a ways away from contraction, it just depends on what assumptions you make regarding unit volume going forward.
Is that increase in loan growth mostly a function of the loan portfolio being up? I mean, you have it in the press release here, the almost $19,000 average loan per consumer, which is up from $16,000 in 2015. Is that really what's driving a lot of the dollar volume gains on a per dealer basis as opposed to the increase in dealer partner numbers?
Yeah, I think you're right. Unit volume declined 5.6% for the quarter. To the extent there was an increase in dollar volume, it was all related to a change in the average size of the transaction.
Okay. What was the increased legal fees that you guys noted in the press release?
I mean, nothing specific there. We just have a bunch of issues ongoing that are consuming increased amounts of legal resources.
Okay. The 11.7% return on capital that you noted. I mean, just historically speaking, I only have a few years here, but is that the lowest you guys have seen in a while? Maybe if there was another point in time where that number had been that low, kind of compare where we were in a competitive cycle versus then.
From memory, our returns were in the 11% range back in 2007 or 2008, I believe.
Okay.
On an annual basis, we were low 11s in 2008 was the lowest it's been. Obviously, 2001, 2002, and 2003 were single digits. Since 2004, we were in the 11% range in 2008, and then again this year.
Okay. Just to go back to the dealer partners, you guys give some numbers on the new dealer partner on participation. Consumer loan volumes from new dealer partners, new active dealers, those were all pretty solidly negative. Again, is that just a point of this resistance level that you're talking about in the dealer partner program, in the current environment, just given that you're just not offsetting any attrition and that all those numbers are down pretty solidly?
I think the volume per dealer, I would attribute that mostly to the changes we made to address the negative variances we were seeing in the recent origination.
The decrease in the new dealer partner volume, because consumer loan volumes from new dealer partners are down 30% year-over-year. Is that because of pricing changes in the fourth quarter, or is that because we're hitting a resistance level in the dealer partner base?
I think two things there. If you're just focused on new dealers, it's the changes we made that I just talked about related to the variance, and we signed up fewer new active dealers this quarter than we did same period last year.
There have been no changes in the sales force?
No.
Okay. Just one other thing. I noticed, the last few years, we've seen this shifting of volume out of the Portfolio Program and into the Purchase Program. It looked like this quarter, we actually started to see that turn around a little bit. Maybe give us any indication why we started to see more volume go back into the Portfolio Program.
The change was pretty modest. It was 23.8% in unit terms last quarter, and it was 21.4% in the fourth quarter. A couple percentage points, not a real big change.
Okay. Thanks for answering my questions.
Thank you. Our next question will come from the line of Moshe Orenbuch with Credit Suisse. Please proceed.
Great, thanks. Can you talk a little bit about the changes that you made in the forecasting process? What new variables or data do you have? I guess, it's interesting because the earlier periods, two of those three years, you had substantial portions that had already been paid back. I guess, does that have a noticeable impact? Could you just talk a little bit about those changes?
Yeah. We periodically refresh the model. It's based on all the information we collect, both at loan origination, as the loan moves through the servicing process. It's really just mostly an update of the data, a refresh there. Then also, we redo the actual scorecard and re-weight the variables based on what seems to be the most predictive. It's something we do periodically. It's more, I think, a routine update. Really, the numbers weren't all that different from what we had before.
Got it. You'd mentioned that your newer loans have a lower advance rate. I guess, can you talk a little bit about how that has had, if, I should say, if that has had an impact, as you go to market to dealers. How should we think about that? Is that something that's likely to continue? Does it level off? Does it turn around?
Well, I think it's difficult to say. We react to what we've seen so far. We saw some negative variances that you see in the table that we provide. We obviously look at those as well. We have to react to those. We don't want to see negative variances continue. As we make changes to adjust for that has a negative impact on loan volume.
Okay. All right. Then just, is there an impact on, from the perspective of the way you think about the cash flows with respect to dealer holdback when a dealer attrites, if a dealer leaves and has kind of earned some of that?
Our contractual arrangement with the dealers is if they become inactive prior to doing 100 loans with us, they forfeit their rights to that dealer holdback. Other than that, it works exactly the same. We continue to collect it and pay back the advance and remit the holdback to the dealer in the normal course. Whether they're active or not, we still continue to service the loans and pay them their holdback that they're entitled to.
Right. I guess I'm just trying to get my head around if there are any other impacts from dealer attrition rising. I guess that was one that kind of jumped out that could happen. Are there others that we should be aware of?
Other than the obvious. I think the obvious impact is on loan volume, which obviously we prefer to see attrition lower. That's something we're focused on. We'd like to see the dealers continue with the program for as long as possible. I think the primary impact is just on loan volume.
At what point, it looked like you bought back a modest amount of stock in the quarter. Is there any kind of thought as to how we should be thinking about the interaction between the capital you're generating and how you'd deploy it?
We bought back about 450,000 shares of stock during the quarter, total cost of about $80 million. I don't think we really have any change in the way we're thinking about that. We've talked about how we approach that decision in the past. Our thinking hasn't really changed there.
Got it. Thank you.
Thank you. Our next question will come from the line of John Hecht with Jefferies. Please proceed.
Actually, I think all my prepared questions were answered. A couple just that came to mind is that you guys gave us the, if I recall, you gave us the October volume, or how it was trending when you last reported. Maybe can you tell us, like, November, December and January just to give a sense for more recent volume trajectories?
Sure. In unit terms, as you mentioned, October was down 8%, November down 5%, December down 2%. January is not complete, we're not going to count on that, but that gives you the trajectory during the quarter.
Yep. Thanks very much. Maybe just because there's been a lot of, I guess, increasing investor focus on residual values and used car price trends and so forth. Given you buy substantially different than others do and you're buying at a big discount rate, can you maybe just give us a sense of how to think about sensitivity to declining residual values? Is your sensitivity more to, I guess, is it more to frequency or severity? If, to the extent you are exposed or you're sensitive to declining used car prices, can you quantify that? Is it material? Is it meaningful or is it something you really account for when you're buying a loan?
Yeah, I think we talked about this last quarter. The way we look at it is we finance the used vehicle. That's a depreciating asset. We just focus on and track the depreciation and book values over time. We have a metric we look at every month on that. As many people have written about, vehicles are depreciating faster this year than they have, I think, faster than any time back to 2008. I think 2008 was a little bit worse than 2016, but not much. In terms of vehicle depreciation, we're at the unfavorable end of the spectrum compared to where we've been the last 12 years. The fourth quarter was worse than the full year. Vehicles depreciated faster in Q4 than they did in Q1, two, and three. The magnitude isn't something that we really worry about that much.
The difference between, I think there was one year out of the last 12 where vehicles hardly depreciated at all. I think it was 2011. If you kind of look at it on a trailing 24-month basis. What that means is the contracts we wrote in 2009, those vehicles, by the time we got around to selling them, to the extent we repossessed them, they were worth about as much as they were when we wrote the loans, which is unusual. Today, you're in a much different position to that. Over 24 months, the vehicle's depreciated quite a bit. The difference in terms of the highs and lows is about 300 basis points in terms of the collection rate. It's significant, that's between over the last 12 years, the absolute best market we've been in and the absolute worst market we've been in.
It's about a 300 basis point change. Unfortunately, we can't really predict what it's going to be over the next 24 months. Even if we wanted to, it'd be difficult to build that into our model. As we talked about in the past, the way we address that is we shoot for a return. That means if our loans underperform our forecast, it still means the business we wrote was very, very profitable. We prefer to address it that way than trying to be experts at predicting used car values over the next 24 months.
Great. I really appreciate that color. Thanks.
Thank you. Our next question will come from the line of Robert Dude with Raymond James. Please proceed.
Hi. This is actually Leslie Vandergrift this afternoon. Quick question on the forecast change for fourth quarter 2016 and the press release. You guys split it out for the first three quarters and then the fourth quarter on. The initial forecast for fourth quarter vintage was 63.7%, and it increased up to 65% by the end of the quarter. Can you talk to me about how there's that significant of a change in that three-month period?
Yeah. I'd rather have a positive number there than a negative number. Early in the loan life, I think there is some variation there. I wouldn't get too excited about that number until we get another quarter or two under our belt.
Okay. It's more of what's coming in rather than actual changes to what you were first thinking about it, or?
Well, I think just early in the loan's life, when we have an initial forecast when we pay the dealer the advance, and then one month in, we adjust that forecast based on whatever happened in the first month. Mostly did they make the payment or not, and any change in the value of the vehicle. There's quite a bit of volatility. There's more volatility in that collection forecast at the start, and then it starts to level off and be a little bit more stable. Given those loans are only at the most three months old, and it's at least one month old, I just wouldn't put a lot of emphasis on that number.
Okay. All right. Thank you. Then on the Chairman Foss' retirement, and I know in the original press release, there was an announcement of someone replacing him. Is there a plan for that to occur, for that position to be refilled?
No, there's no plans at this point to have a chairman. We have a lead director but we don't need a chairman, we have no plans to replace him.
Do you have an estimate for the amount of shares that he was, I guess, a beneficiary of that he sold back in 2016? I know that there was the 500,000 that were registered, we can't see when those sales come through.
Don would file Form 4s when he sold shares. Those Form 4s would be out there. From memory, I don't believe he sold any material shares of stock during 2016.
Okay. All right. That's all for me. Thank you.
Thank you. Ladies and gentlemen, as a reminder, if you would like to ask a question over the phone at this time, please press star then one on your telephone keypad. Our next question will come from the line of Clifford Sosin with CAS Investment Partners. Please proceed.
Hi, guys. Thank you. Can you characterize attrition among your more seasoned dealers who've done at least 100 loans or dealers who have maybe been around for some period of time, however you want to sort of define the cutoff, but not just the level of attrition, but the trend. Has there been a meaningful step up in attrition amongst your more tenured dealers?
I don't have anything to add there. I think attrition's up. I'm assuming it's probably up for both. There's nothing that's come to my attention that would give you any more color on that.
Okay, thank you.
Thank you. Our next question will come from the line of Brian Gustavson with 1060 Capital. Please proceed.
Hi there. I'm just looking at the initial loan term. It's gone from called 47-53 in the last three or four years. I'm wondering what your thoughts on that. Does that keep on ticking up, or do you see that coming down? Do you think that might be a reason that collections have ticked down more recently? Thank you.
When we write terms all across the spectrum from six months to 72 months. The average term is just a function of the mix. We don't have any current plans to increase the maximum term beyond 72. The average will just be a function of our pricing strategies and where we see the most opportunity. I don't have a forecast there, but as we've talked about in prior calls, over a long period of time, when I first started, we only wrote a 24-month loan, and we accumulated data and extended it out to 30 and accumulated more data, and we walked our way out to 72 months over a period of about 25 years. We've been careful about it, and we're comfortable with the terms that we offer now.
For a given loan, if you don't change anything else and you increase the term, the collection rate is going to be lower. We build that into our forecast, so that isn't necessarily a reason why you saw the variances that you did in the 2015 and 2016 originations. I don't think it was related to term, more related to just the overall market adverse selection, the decline in used car values that we talked about.
Got you. 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 closing or comment 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. Have a good day.