Earnings Call: Q4 2016

Jan 31, 2017

Good day, everyone, and welcome to the Credit Acceptance Corporation 4th 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, and welcome to the Credit Acceptance Corporation 4th quarter 2016 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 meanings of federal securities laws. 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. 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 Q3, 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 or are they independent dealers perhaps losing share to franchise dealers or is it thirdly more consumer related? Any sense that we're starting to see a peaking of consumer demand? 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. So I think what you saw in the Q4 is as we've talked about in prior calls, our strategy when the environment is competitive is to focus on growing the number of active dealers, difficult to grow volume per dealer when it's very competitive. But 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. So that's what we're seeing right now. It's just we're having difficulty signing up enough dealers to offset those other two factors. And I think in the Q4, 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 collection forecast our initial collection forecast to decline, which means we advance the dealers less money. So it has sort of a one time impact on volume per dealer and also on attrition. Got it. And Brett, your comment about is 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 the ceiling or is that just a reflection of the competitive environment? And 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. But 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 at this ceiling. Got it. Got it. Just a couple more. Just curious, switching to the provision side, look like the allowance picked 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, but 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. 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 $14,000,000 for the quarter. That's on a base of $5,000,000,000 or so in undiscounted cash flows. So a very modest decline in the quarter, $14,000,000 that's really the economic impact. And then 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. Got it. And one last one, I'll get back in queue. It looks like your spread actually picked up a bit sequentially. Obviously, you're pricing your advanced levels in accordance with maybe your revised thinking about collection patterns. Is a 21% to 22% spread generally based on your internal models and your target returns? Should we be thinking about that is 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, but 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 as we try to maximize the total economic profit we generate, so unit volume times economic profit per unit and 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, but that's how we price. We don't really price based on that spread. Right, right. Got it. Okay. Thank you. You are correct. There was a favorable change in Q4 with respect to Yes. No, we're obviously just looking for shortcuts in terms of how to model it using it as a proxy for yield, but understood. Thank you very much. Thank you. Our next question will come from the line of John Rowan with Janney. Please proceed. Good afternoon, guys. So kind of going back to the commentary on volume. So unit volume was down 6% year over year. Dollar volume was up because the loan 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? So 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. And obviously, the loan portfolio is growing pretty rapidly right now and the dollar volume increased in Q4. So I think you're a ways away from contraction, but it just depends on what assumptions you make regarding unit volume going forward. But is that increase in loan growth mostly a function of the loan portfolio being up? The loan 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? Yes. I think you're right. Unit volume declined 5.6% for the quarter. So 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. And then the 11.7% return on capital that you noted, can you I mean, just historically speaking, I only have a few years here, but is that the lowest you guys 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 end? From memory, our returns were in the 11% range back in 2,007 or 2,008, I believe. Okay. On an annual basis, we're at low 11s in 'eight was the lowest it's been. Obviously, 2,001, 2,003 were single digits, but since 2004, this is we're in the 11% range in 'eight and then again this year. Okay. And then just to go back to the dealer partners, you guys give some numbers on the new dealer partner participation, consumer loan volumes from new dealer partners, new active dealers, and 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. So the decrease in the new dealer partner volume consumer loan volumes from new dealer partners are down 30% year over year. Is that because of pricing changes in the Q4 or is that because we're hitting a resistance level in the dealer partner base? Well, I think 2 things. 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. But there have been no changes in the sales force? No. Okay. And then 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. And it looked like this quarter we actually started to see that turnaround a little bit. Maybe give us any indication why we started to see more go back into the portfolio program? I mean, the change was pretty modest. It was 23.8% in unit terms last quarter and it was 21.4% in the 4th quarter. So a couple of 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 Orenreich with Credit Suisse. Great. Thanks. Can you talk a little bit about the changes that the change that you made in the forecasting process? Like what new variables or data do you have? And I guess it's interesting, I mean, because the earlier periods, I mean, 2 of those 3 years, you had substantial portions that already been paid back. So I guess, how does that I mean, does that have a noticeable impact? Could you just talk a little bit about those changes? Yes. We've periodically refreshed the model. So it's based on all the information we collect both at loan origination as the loan moves through the servicing process. So it's really just mostly an update of the data, a refresh there and then also we redo the actual scorecard and reweight the variables based on what seems to be the most predictive. So some we do periodically more I think a routine update and really the numbers weren't all that different from what we had before. Got it. And you talked you had mentioned that your newer loans have a lower advance rate. Is I guess, can you talk a little bit about how that has had if I should say, if that has had an impact kind of as you kind of go to market to dealers, How should we think about that? And is that something that's likely to continue? Does it level off? Does it turn around? Well, it's not even difficult to say. I mean, we react to what we've seen so far. We saw some negative variances that you see in the table that we provide and we obviously look at those as well and we have to react to those and we don't want to see negative variances continue. So as we make changes to adjust for that, that has a negative impact on loan volume. Okay. All right. And 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 attrides if a dealer leaves and has kind of earned some of that? I mean, our contractual arrangement with the dealers is if they become inactive prior to doing 100 loans with us, then they forfeit their rights to that dealer hold back. Other than that, it works exactly the same. We continue to collect and pay back the advance and remit the holdback to the dealer in the normal course. So whether they're active or not, we could still continue to service the loans and pay them their hold back that they're entitled to. Right. And I guess I'm just trying to get my head around if there are any other impacts from dealer attrition rising. And 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, something we're focused on. We'd like see the dealers continue with the program for as long as possible. But I think the primary impact is just on loan volume. And how should at what point I mean, it looked like you bought back a modest amount of stock in the quarter. I mean, 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 deploy it? We bought back about 450,000 shares of stock during the quarter, total cost of about $80,000,000 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 and 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. But the 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 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. So we're not going to count on that, but that gives you the trajectory during the quarter. Yes. Thanks very much. And then 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. Can you I mean, 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? Or is your sensitivity more to I guess is it more to frequency or severity? And if you have to the extent you are exposed or you're sensitive to declining used car prices, you quantify that? Is it material, is it meaningful or is it something you really account for when you're buying a loan? Yes. I think we talked about this last quarter. The way we look at it is we finance the used vehicle. So that's a depreciating asset. So we just focus on and track the depreciation and book values over time. And we have a metric to 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 2,008. 2,008 was a little bit worse than 2016, but not much. So, in terms of vehicle depreciation, we're at the unfavorable end of the spectrum compared to where we've been in the last 12 years. The 4th quarter was worse than the full year. So it depreciated faster in Q4 than it is in Q1, Q2 and Q3. But the magnitude isn't something that we really worry about that much. The difference between, I think there was 1 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. So what that means is that the contracts we wrote in 2,009 those vehicles by the time we got around to selling them to the extent we repossessed them, they were 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 vehicles have depreciated quite a bit. The difference in terms of the highs and lows about 300 basis points in terms of the collection rate. So it's significant, but 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 is about a 300 basis point change. Now unfortunately, we can't really predict what it's going to be over the next 24 months. So even if we wanted to, it would 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 grow 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 Dood with Raymond James. Please proceed. Hi, guys. This is actually Leslie Vandegrift this afternoon. Quick question on the forecast change for Q4 2016 in the press release. You guys split it out for the 1st 3 quarters and then the 4th quarter. And the initial forecast for 4th quarter vintage was 63.7%, but and it increased up to 65% by the end of the quarter. Can you talk to me about how there's that significant change in that 3 month period? I'd rather have a positive number there than a negative number. But early in the loan life, I think there is some variation there. So I don't I wouldn't get too excited about that number until we get another quarter or 2 under a belt. So it's more of what's coming in rather than actual changes to what you're 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 1 month in, we adjust that forecast based on whatever happened in the 1st month. Mostly did they make their payment or not and any change in the value of the vehicle. But 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. So given those loans are only at the most 3 months old and at least 1 month old, I just wouldn't put a lot of emphasis on that number. Okay. All right. Thank you. And then on the Chairman Foss' retirement and I know in the original press release there was an announcement of someone replacing him. Do you guys have is there a plan for that to occur to that 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 and we have no plans to replace him. And then do you have an estimate for the amount of shares that were he was, I guess, a beneficiary of for that he sold back in 2016? I know there was the $500,000 that were registered, but we can't see when those sales come through. I mean, Don would file Form 4s when he sold shares. So those Form 4s would be out there. From memory, I don't believe he sold any material shares of STACK during 2016. Okay. All right. That's all for me. Thank you. Thank you. 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 senior more seasoned dealers, 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 mean, I don't have anything to add there. I think attrition is up. I'm assuming it's probably up for both, but 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 Gustafson with 10 60 Capital. Please proceed. Hi, there. I'm just looking at the initial loan term, it's gone from, call it, 47 to 53 in the last 3 or 4 years. I'm wondering what your thoughts on that, does that keep on ticking up or do you see that coming down and maybe that and 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 6 months to 72 months. So the average term is just a function of the mix. We don't have any current plans to increase the maximum term beyond 72. So 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, we've over a long period of time, when I first started, we only run 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. So, 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. But we build that into our forecast. So that doesn't necessarily a reason why you saw the variances that you did in the 2015 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 CapEx 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. Have a good day.