Earnings Call: Q3 2016

Nov 1, 2016

Everyone, and welcome to the Credit Acceptance Corporation Third Quarter 2015 Earnings Call. Today's call is being recorded. A webcast and transcript of today's earnings call will be made available on Credit Acceptance's WebBank. At this time, I would like to turn the call over to Credit Acceptance's Senior Vice President and Treasurer, Doug Buck. Thank you, Jesse. Good afternoon and welcome to the Credit Acceptance Corporation Q3 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 meaning 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 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, Brent Roberts, our Chief Executive Officer Ken Booth, our Chief Financial Officer and I will take your questions. Your first question comes from John Rowan from Janney. Your line is open. Good afternoon, guys. I just want to make sure I understand your commentary here around unit volume growth. Obviously, it peaked in September of 2015 at 41%. The unit volume growth has come down and then now 12% for the quarter, in the Q3 of 2016. But then in the subsequent paragraph, you say that it declined 8.3%. I just want to make sure the unit volume is down 8.3% and not growth has come down to 8.3%. Am I reading that correctly? That's correct. So year over year unit volumes were 8.3% less in October than the same period of the prior year. Okay. And then later on in the paragraph there, you talk about forecasted collection rates coming down. And that you believe that the reduction in forecasted collections has impacted the unit volumes for the year. Can you discuss that a little bit? I mean, are we at a point where forecasted collections are starting to really hurt dealer holdback payments? I mean, and that could be what's causing some tepid unit volume numbers for you? No, I don't think that's what we're saying. We're just saying we've seen the trends in loan performance throughout the last four quarters. We've reacted to those trends. The amount that we pay the dealers at loan inception is a function of the collections that we expect. So, if we expect lower collection levels, then we're going to pay the dealers less money and that's what impacts load volume in our opinion. Okay. It doesn't look like you guys purchased repurchased any stock during the quarter, correct? Correct. Okay. Is that just a function that I haven't looked through the Q yet. Is that a function of not having an authorization or liquidity? Just is do you think you'll get back in the market to repurchase stock? We continue to approach it the same way. The first thing we look at is do we have excess capital and if we do then the Board makes a decision when it's appropriate to buy it back. So we'll continue to use the same criteria and over time you can probably expect we'll repurchase more shares. Okay. And then just last question, just obviously asking about the provision expense. I know in the past, we've talked about it and whether or not it's the accounting noise in the portfolio or to whether or not it seems like there is actual pressure in the underlying fundamentals of the auto loan book. Can you just give us an idea of how you look at the provision expense of $22,800,000 this quarter? Yes. As we've said before, we really focus on the adjusted results. We don't really look at the provision internally. We have GAAP statements that we prepare and we release and you are welcome to look at those. But internally, we focus on the adjusted results for the reasons we talked about in prior calls. All right. Thank you. Your next question comes from John Hecht from Jefferies. Your line is open. Afternoon, guys. Thanks so much. Just going a little bit back to the volumes, volumes down, unit volumes down in October. Can you tell us what's going on with the loan volume kind of as we go through the Q4 and maybe you could even flavor in some of that your thoughts on the competitive environment and what that might mean for the loan volume in the quarter? Well, it's November 1 and we gave you volumes through yesterday. So that's about as current as we can get. Yes, but unit volume, but your average loan size has gone up fairly a lot over the past year. So that can offset the unit decline. So I'm wondering if you can give us a little bit more color about the total volumes, including the average size? We don't have dollar volume at this point. We just have unit volume. I mean, you're right, the dollar volume has grown more significantly than unit volumes in the last two quarters for sure. Okay. And so maybe we can talk about that a little bit then. I've seen your purchase loan business is growing at a much greater rate than the dealership business. Maybe you could talk about is that influenced by something internal, is that influenced by the competitive environment? How should we see the balance of that play out going forward? Yes. I think the primary driver that you see throughout the release is we continue to be in a difficult competitive environment. It's one that's been in place for quite some period of time. Our strategy in prior cycles like this has been to grow the number of active dealers. It's pretty hard to grow volume per dealer in the environment that's as competitive as it is today. And we've had some success with that strategy in the past. And I think what we allude to in the release that, that strategy gets more difficult as the number of active dealers grows, it becomes tougher to grow that active dealer base at the same rate. And so we're starting to run into a situation where our existing sales force is signing up as many dealers as they're capable, but it's not enough to offset attrition and the impact of the competitive environment on buying per dealer and still leave us with rapid growth. So, I think that's where we are today. The purchase loan program has helped. That's as we've talked about a separate channel for us. We've had probably more success in growing that segment of the business than we thought we would. And so that certainly helped. And as the prior caller mentioned, the average size of the contract is up as well. So you have some dollar volume growth. But ultimately, if we want to be a lot larger company than we are today, we have to figure out how to grow unit volume and certainly been challenging in the existing competitive environment. Okay. And then when it comes can you is there any way you can give us sort of what's the average loan, maybe yield and size and duration or anything like that to just help us kind of forecast for what that might look like going forward? We don't have I'm not going to give you any additional numbers than what's in the Q and the release. There's quite a bit of information, particularly in the Q on the average loan size, average advances, etcetera. The purchase loans are larger. They're longer term. They're obviously we acquire those in a different way. We give the dealer one payment upfront instead of dealer hold back payments at the end. But other than that, they have similar characteristics, a little bit lower yield, a little bit larger size, but we're happy with the profitability of loans we're right, right now. And then last question I'll ask you is do you buy those similar to the dealer loans? Do you buy the purchase loans at a net discount on average? Yes. Thank you guys very much. We have information in the press release in the Q that shows what percent of the underlying consumer loan principal plus interest we are acquiring those at. All right. Thanks very much. Your next question comes from Moshe Orenbuch from Credit Suisse. Your line is open. Great. Thanks. To stay on that purchase program, I mean, you buy them at a discount to the principal plus interest, but what at what price do you buy them relative to the actual principal amount? Again, there's a lot of information in the Q and in the release on advanced rates and the average size of the purchase loans and how much we give the dealers relative to the expected cash flows, I would just point you to the information that's already been disclosed. I guess the question that I'm kind of struggling with is, to the extent that the purchase program becomes a larger piece of the total company, at what point does the level yield accounting no longer seem appropriate or at least appropriate for that piece of the business? I don't follow you. What would the purchase loans have any to do with the accounting? In other words, purchase loans, I mean, are similar to the way other finance companies conduct their business. And they record those loans at the purchase price and then they kind of accrue losses based upon a loan loss reserve methodology. It's a different accounting methodology. I guess, when this was under 10% of the company, it's I guess, I kind of struggle because it's very hard for us to follow the quality of that underlying book of business, because you don't have the protections that you have in the portfolio program. Let me just answer it this way. The accounting we follow is the required accounting. I can tell you that when we adopted the accounting, they didn't say, well, purchase loans are small, so you account for them anyway you want to. They looked at our accounting treatment for both dealer loans and purchase loans and the accounting treatment that we follow is what was prescribed at the time for both of those. So I think both our auditors and the SEC when they looked at it both agree that the accounting we use is the accounting we should be using. Using. Okay. All right. Thank you. Your next question comes from Leslie Vandegrift from Raymond James. Your line is open. Good afternoon. Hi. First question, we talked about this last quarter a bit on the forecasted collections for earlier 2016. They changed positively a little bit this quarter, although not as much as Q1 to Q2. And I was curious if we had some more information now that we've got a little bit of time between now and then on that Q1 2016 pull write up that we had just in a 1 quarter change and a little bit this quarter as well? I mean, they continue to perform a little bit better than we expected at origination. So when you update the actual performance experience that you've incurred to date into your forecasting models that results in a little bit of improvement in the all in forecasted collection rate. So it's just reflecting the better experience we've seen thus far. So the ones that were originated earlier in the year, you're actually seeing cash collections above what you originally expected on that, at least earlier? Yes. Okay. And then on when we talk about you guys already talked about the purchase volume, but kind of on the recovery value side, I know you look at your own portfolios rather than an industry and was curious what your take right now is and for the next few months going forward on how you guys feel about when you repo the recovery value for the cars you're seeing, especially since it's on the older used vehicle side on these terms? Yes, there's obviously been a lot written about predictions of what used vehicle values are going to do in the future. We're certainly aware of all that. We track all the vehicles in our portfolio and the change in the black book value every month. Obviously, it's a used vehicle, so it's a depreciating asset. So it goes down every month. What we've seen so far this year is a steeper decline in terms of the depreciation on the vehicles in our portfolio than we've typically seen. Probably the steepest declines this year going back to, I think, 2008 was the last time we saw depreciation this steep. So that's certainly impacting the loan performance to date, and it's something that we've included in our forecast. As we talked about last time, we don't the actual amount that we receive at auction from the repossessed vehicles isn't a huge percentage of our total expected cash flows. So, we don't necessarily have a prediction of what those used vehicle values are going to do in the future. It's not as important to us as it is to potentially other more traditional lenders. You write a loan today, it's a 50 month loan, trying to predict what used vehicle values are going to be over the next 50 months is obviously very difficult. So instead what we do is we try to build a margin of safety into our business model, so that we know that predicting collection rates is very difficult. So, we try to set up a situation where even if our collection forecast come in a little shy of what we expected, the loans will still be very profitable. And that strategy has worked for us very well over time. Okay. All right. And then on the just the overall loan portfolio side, when you look at not just the undiscounted collection rate that you guys have in there with the forecasted collections, but on actual net present value of total loan portfolio purchase and portfolio program, how is that looking right now? I'm sorry, I didn't quite follow that. Could you The net present value of the loan portfolio, how has that changed last quarter? I mean, I think we have a fair value disclosure in the 10 Q that will answer that question. Okay. So I got that. Sorry, I didn't have a chance to go through it all right before. And then BSO, but then I guess on the same direction there and I apologize if it's right beside that chart, the restructurings that you guys have had on the portfolio rather on loans done this year or in 2015, etcetera, the more recent vintages, how much of that have you had to restructure already? And people going in to extend the term or reduce rates, we've seen a lot of term changes across the industry. So just curious what you guys have seen? We don't extend or rewrite contracts except where we're required to by law bankruptcy, FCRA, things like that. So we don't we just don't do that as the answer. Okay. All right. Perfect. And then last question, and I apologize if this was asked at the beginning of the call. I got in 2 minutes late here. But for the last few months, we have seen the same number of shares registered to sell by the Chairman. Now we haven't seen that volume come through and they haven't been sold according to filings. But is there a regulatory reason why he has to register that specific number of shares each quarter even if he has no intent to sell them? I know that the Chairman has filed a notice of intent to sell under Rule 144. Unfortunately, I'm not intimately familiar with the requirements under that rule, whether that's something that he needs to refile periodically or just what the details are. I do know that that notice has to be filed for the 1st sale, but unfortunately can't tell you a lot more than that. Okay. No, I understand. Perfect. That's all my questions. Thank you. Your next question comes from David Scharf from JMP. Your line is open. Good afternoon. I hopped on late as well, so I apologize if these were asked. One was just a point of clarification. Am I correct in assuming that the last couple of quarters, the increase in the average loan size is primarily a mix issue with purchase loans generally being larger? Or is it actually something else that's more related to the type of vehicle being bought in the extended term that allows the consumer to afford it on a monthly basis? I think the average loan size is up slightly in both segments and then the mix accounts for the rest of it. Got it. Got it. And another question and this is more qualitative, but I'm wondering, do you have any insights into just general discussions of dealer health lately. This is more of an industry macro question for you, if you don't want to comment that that's fine. But as we read more about used car values, obviously declining, signs that the consumer may be losing a little bit of steam. As you gauge the overall health and profitability of your dealer network, particularly those independents, which are 2 thirds or more, any sense that we may see more attrition over the next few quarters as some of the dealers run into more profit constraints? Or is it too early to tell? No, I don't think that's a question I have much insight on. You don't. Got it. And then lastly, we obviously have the unit volume metrics and the commentary in October. I'm curious, what about overall application volume? Meaning, are you seeing a change in the number? Is the decline in applications being submitted commensurate with the increases and decreases in October of the actual unit volumes you're closing? Or are you finding that your approval rates are changing? Speaking just for October, the application volume was grew, but not as quickly as it had prior. But I think it's more a function of the number of applications that we're converting into deals. Okay. So your underwriting is conforming to the environment and tightening a bit in October. Got it. Thank you very much. Your next question comes from Daniel Smith with Tietam Capital. Your line is open. Hi, guys. I wanted to clarify your most recent collection estimates. Do they incorporate the higher rate of depreciation that you called out in collateral values? Yes. Okay. Thank you. Your next question comes from Randy Heck with Goodnow Investment. Your line is open. Thanks. First, I just want to say very nice quarter. Pretty much say that every quarter. First question I have is the ABS deal you guys announced last week, what was the all in cost was, I don't know what it was, 3%. I guess, there's 3 tranches. But how does the cost of that compare to recent, the prior one that you did earlier this year or last year? Is it comparable? It was the all in rate, including issuance fees, was 2.9%. That was about 30 basis points less than the deal we did in May of this year. Less, okay. Because I thought the cost okay, the cost of the capital has been going up. So this was even lower. Okay. There was a period early in the year when rates have gotten wider, but in recent months, the opposite has occurred. Okay. And then this there were a couple of questions earlier about purchase loans versus dealer loans and I'm not quite sure what the confusion was about, but it says it right here on the press release, your advance rate for purchase loans was roughly $0.49 to the dollar versus your dealer loans at $0.42 to the dollar. And correct me if I'm wrong, but the only difference is or the major difference is purchase loans, you're just not you don't have to share the back end with the dealers. So therefore, you pay more upfront, but you get to keep everything you collect. Correct. Is that essentially correct? And perhaps Brett or Doug, you can share with us why some dealers prefer a purchase loan where they're probably in the end getting lower economics than a dealer loan, other things being equal. Why do they choose to sell you a loan? Sure. So I think the primary reason and the reason we identified this as a separate channel is there are dealers out there, which is are not interested in our traditional program. They don't they want all their money upfront. Typically large dealer groups, some of the largest dealers in the country, typically what happens is you run-in to processes in the dealership that just don't allow our traditional program to work. Sometimes it's accounting related. If they're publicly traded, they don't want to deal with the contingent payment at the end. Other times, it's just the process at a large dealership or the commission structure, the way they pay their salespeople is an obstacle. Over the years, we've tried to overcome those obstacles and stick with the traditional portfolio program. In more recent times, we've decided to say, okay, what the dealer doesn't want our traditional program, is there still a way we can get some business done with that dealership? And so that's really was the genesis of the purchase program. And what we found out there is, there's a pretty large group of dealers, primarily franchise dealers, primarily larger franchise dealers that are interested in our purchase program. And like I said earlier, we just had a lot more success with it this year and latter part of last year than we would have expected. Okay. And how many years have you been doing these purchase loans? We've been doing them for over 10 years. Okay. And it's gone pretty well so far. Is that a fair conclusion? I think it's gone pretty well. We like our traditional program. We like the alignment of interest. We like to share in the proceeds from the loan with the dealer. We think that creates a good relationship and aligns everyone's motivation. So we really like that program, but we have to be realistic as well. I mean, we're having trouble growing that program right now that shows up in the numbers. The purchase program, it's a different program for us. We've been doing it a long time. It's been been at times a significant portion of our business and at other times a lower portion. We'd love to be able to grow both programs, but right now the purchase loan program is the one that we're having more success with. Okay. All right. Thanks so much. 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 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.