Good day everyone. Welcome to the Credit Acceptance Corporation second quarter 2016 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 website. At this time, I would turn the call over to Credit Acceptance's Senior Vice President and Treasurer, Doug Busk.
Thank you, Jamie. Good afternoon. Welcome to the Credit Acceptance Corporation second 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 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 adjusted 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.
Ladies and gentlemen, if you would like to ask a question at this time, please press star and then one on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from Tanu Chauhan from Credit Suisse. Your line is now open.
Hi. Thanks for taking my question. I see that you've expanded your Purchase Program. Just a quick question on purchase loans. How do you reserve for them?
We reserve for them the same way we reserve for the dealer loans, except for purposes of evaluating impairment. Dealer loans are grouped by dealer, and purchase loans are grouped by month of purchase. We evaluate the performance of each pool of loans relative to our initial expectations. If our current expectations are lower than our expectations from a return perspective at origination, we record a provision and establish an allowance to reduce the net carrying value to the point where the yield expected at origination would be maintained going forward.
Okay, thank you.
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. First one is just a very high-level question, which is, how's business?
I think the quarter probably summarizes that pretty well. If you have anything specific, we'll address it.
Listen, it's a variant of the usual, explain the competitive environment, so on and so forth. On a relative basis, curious to get your sense for what both end demand looks like, dealer receptivity looks like, and your assessment of overall consumer health relative to perhaps at the beginning of the year.
I think from an environment standpoint, pretty much consistent with what we would've said last quarter. Volume per dealer is probably the easiest number to look at, just to get a sense for the competitive environment. It was down this quarter. Not down a lot, but 1.8%. Looking at that number, I don't think you conclude that the environment got a lot easier. I would say probably more the same, a difficult environment, but not changing a lot from last quarter.
Okay, sounds like relatively stable. Hey, question on active dealer count. I think it looked like it may have been down sequentially.
That's correct.
Which is, I think that may have occurred once in the last three, four years. Is just an anomaly? Is there something just attributed to seasonality, or should we be looking for a new normal in sort of the low 7,000 range as we think about the next four quarters?
We had nice growth in active dealers, yeah, sequentially, second quarter tends to be a little bit tougher quarter to grow. I think you're right that having a sequential decline isn't something that has happened in a long time. Attrition was higher this quarter. Again, we'd probably attribute that to the competitive environment.
Mm-hmm. Got it. Lastly, maybe this is just putting some quantification around your comments about the competitive environment. It looked like this was the biggest variance we've seen in quite a while in terms of the growth in origination volume growing so much more than the unit volume. It looks like the advance rate per unit went up. Looks like the average term went out a couple of months. Are you finding that because of the competitive environment, you have to price a little more aggressively? Should we use sort of the Q2 levels for average term and advance rate as a good benchmark for the near term?
We look at pricing, we look at loan performance, we look at where our volume's coming from every quarter or every month.
We make changes where we see opportunities. There was a change in the mix of loans in the second quarter. We did more purchase loans, which tend to be larger. Both within dealer and purchase loans, we did a little bit larger loan, a little bit longer term. Again, that's just based on our pricing algorithms and where we think the best opportunities are.
Got it. Thank you very much.
Thank you. Our next question comes from Kyle Joseph with Jefferies. Your line is now open.
Afternoon, guys, and thanks for answering my questions. I just want to see if your outlook for used car prices from an equity sell side perspective, we see the Manheim has been relatively stable. We track NADA as well, and it looks like there's a lot of moving pieces there where you're seeing relatively strength in SUVs and trucks, whereas sedans and whatnot are weaker. I don't know, can you give us maybe your sense of pricing for trucks and SUVs versus sedans, and then maybe your outlook on a blended basis as well?
Yeah, I don't think we really have an outlook for used vehicle prices going forward. We take into consideration anything that's happened to date, but we really think it's very difficult to predict where the prices are going to be. If you think about it, you write a loan today, it's a 50-month loan. The price of the vehicle over the next 50 months is really almost impossible for us to predict. Instead of trying to be experts at predicting the future, what we try to do is just structure our business so that in the event we have periods where our loans don't perform as well as we'd like, whether it's because of macro factors or used vehicle prices or the competitive cycle, that the loans that we did write are likely to be very profitable. That's more how we approach it.
All right. Then I guess I'll bridge that to another question. For some of the vintages where the forecasted collections came down a little bit from March to June, would you attribute that to either used car prices, or is that more consumer payback behavior?
I think used car prices is probably a factor there. I think the competitive environment is the other factor, as we talked about last quarter. If you look at that table where we show the variance by year of origination, the best performance versus our initial forecast was in 2009. That was a year that was very favorable from a competitive perspective. Since 2009, the environment's gotten more competitive. You can see that variance, that positive variance, has narrowed. Now in 2015, we have, for the first time in a while, a negative variance. It's really just following the competitive cycle, which is pretty much expected.
Great. Thanks very much for answering my questions.
Thank you. Our next question comes from Robert Dodd with Raymond James. Your line is now open.
Hi, guys. Just on the upward revision in 2016 on expected collectibility, obviously up 40 basis points from last quarter. Digging through the numbers, it looks like the vast majority of that, if not more than all of that, comes from the purchased loan pool from Q1, where expected collectibility went up something north of 200 basis points, it looks like. Can you give us any color on what was so positive about that Q1 purchased pool or the mix in there, or any additional color on that improvement? Since it seems like such an outlier compared to some of the other periods where there were some modest downward reductions.
Yeah, you're correct. The purchased loans performed better than the dealer loans for that period. I think it's probably too early to draw any conclusions about how 2016 loans are going to perform. We'll probably need another quarter or two of seasoning before we start to see numbers that we would want to give you further insight on.
Okay. Thank you. Just one more. In the 10-Q, there's an update in the new accounting updates about ASU 2016-13, which is obviously the credit losses on financial instruments. You note in the 10-Q that the adoption of that, which doesn't kick in until 2020, or mandatory until 2020, is expected to have a material impact on consolidated financial statements. Can you give us any color on what you mean by material impact?
At this point, we've only been able to do a preliminary review of the guidance that, as you mentioned, is effective in 2020. Any comments we make here are obviously subject to change as we go through a more detailed evaluation. Based on our initial review, we think the new guidance is going to be an improvement over the current guidance because both positive or favorable and unfavorable forecast changes are going to be treated the same.
Okay.
You will recall that in our current accounting, there's asymmetry with positive forecast changes accounted for over time and negative forecast changes treated as a current period expense. I think it's going to be an improvement. Exactly what it means for the timing of revenue recognition and impairment, we're still studying that at this point. I think just our initial take is theoretically it's going to be better accounting, lines up better with the economics of the business.
Okay, perfect. Thank you.
Thank you. Our next question comes from Vincent Caintic with Macquarie. Your line is now open.
Hi. Good Friday afternoon, guys. Just have kind of a broad question and maybe a historical perspective. Your forecasted collection rates have been coming down by vintage for a couple of years. So has the spreads. I was just wondering, historically, how low has that gone, and what sort of spreads are you willing to go down to and originate at that spread?
How low has the spread been historically?
Right.
In the last 10 years, the lowest the spread's been was 2007, about 21.5%. That doesn't go back to the beginning of time, but it goes back a considerable period of time. We look at it slightly differently than just looking at the spread. We're looking at the combination of economic profit per loan and the volume that we'll write, and we're looking to maximize that equation. Theoretically, I guess we'd be willing to write business as long as it had a return north of our weighted average cost of capital. Obviously, we've never been close to that hasn't been a practical consideration, but that's the theoretical answer.
Got it. That makes sense. Maybe to add another dimension to it, between maybe the spread declining and instead taking your capital and buying back stock, how do you think about that?
I think the first priority is to invest our capital in the business. The returns today are still very strong. They're still well ahead of our cost of capital. That would be our first priority. To the extent we have more capital than we think we can invest in the business, we consider a share buyback and, for that purpose, we have to look at the price of the stock at the time we have that excess capital.
Okay. Got it. Makes sense. Thanks very much. Have a good weekend.
Thank you. Our next question comes from John Rowan with Janney. Your line is now open.
Good afternoon, guys. Just wanted to follow up on, actually, Vincent's question. Instead of talking about the spread, what I wanted to discuss, Doug, you just mentioned this. You said, as long as our adjusted return on capital is positive. We're talking about the 7% adjusted return on capital in excess of your capital costs, what you reported for this quarter. I know that number's been trending down for quite some time, how do you look at that? Where is the point at which you pull back on volume? Is anything north of 0%, that number, enough to keep you guys pumping out loans?
I guess two different questions. If the question is at what point would we stop originating, I think Doug was referring to the weighted average cost of capital as the point at which we'd say it's not profitable for us to originate any loans, this is the best we can do. In terms of how we price, though, we're trying to maximize the amount of economic profit that we create in any period. We look at the sensitivity of volume and the impact of a pricing change on profit per unit, and we try to optimize that equation in any given period.
Okay. Just maybe one question on the competitive outlook. Did you guys see any bump up in the deals that were coming through when some of the other competitors who really tried to mimic your model, like Go Finance, they started closing up shop. There are others, too, that seem to be pulling back from the loan sharing market, if you will. Was there a discernible shift in competition at some point surrounding those exits?
I don't think so. It's such a big market that what one player does really doesn't impact us so much. It's really just such a large market that as long as the flows of capital are there's going to be plenty of competition, and what one player does isn't going to impact us too much.
Okay. All right. Thank you. Have a good weekend.
Thank you. As a reminder, ladies and gentlemen, if you would like to ask a question at this time, please press star and then one on your touch-tone telephone. We do have a follow-up question from David Scharf with JMP Securities. Your line is now open.
David?
I'm sorry. I had you muted. Just a quick follow-up on the dealer base. Can you remind me the general mix between franchised and independent?
Yeah, it's approximately 70% independents, the remainder franchise.
Okay. The attrition in the quarter, was that proportional, or was it felt more broadly in the independent base?
I don't know that. I certainly haven't looked at that. At this point, I'm not prepared to answer that question, sorry.
Okay. Got it. Thank you. Have a great weekend.
Thank you. Our next question comes from Ken Bruce with Bank of America. Your line is now open.
Thanks. Good evening, gentlemen. I'm hoping you might be willing to discuss what's driving the dynamic behind the higher purchase loan volume versus the dealer loans. What's making that shift occur?
Yeah. As we've talked about before, we really view that as a separate channel. We have our traditional Portfolio Program with the risk sharing. That's the program that we prefer. There are certain dealers, typically larger franchise dealers, some of the largest dealers in the country that we just couldn't penetrate with our traditional program. The Purchase Program is really a separate channel to target dealers that we know we can't penetrate with our traditional program. What's driving it is we just have a lot of demand for that program today. We're having a lot of success expanding that program, and that's showing up in the numbers.
Is that an outbound strategy from Credit Acceptance, or is that just more of where the demand happens to be coming from on the part of these larger dealers? Is this something specific that you've kind of set out to do, or is it just by way of the way that the market has played out?
No, I think it's something we've set out to do. We identified it as a separate channel, and we started to work on ways to penetrate that channel. We're just starting to have more success than maybe we thought we would at this point.
Okay, great. That was it. Thank you.
Thank you. Our next question comes from Andrew McQuilling with UBS O'Connor. Your line is now open.
Thank you very much for the time. As you extend the loan duration from, let's say, 48 months to 53, is there a linear relationship between how the collection comes down? Is it pretty linear, collection rates?
I think that's probably fair.
Can you give us a sense, five months, like how big a difference there is? Just some kind of benchmark.
How big a difference there is in what?
Well, let's say, a loan at 48 months, you plan to collect 70. A loan at 53, you collect 68, 67, something like that. Does that explain a lot of the decline in loan collections?
It's certainly a factor. Typically, when you go out to a longer term, a lot of other things change as well. Like you probably have a different vehicle. I think it's hard to say. There's other variables that change as well. Generally speaking, the longer the loan, if nothing else changes, the collection rate's going to be lower. You see that in some of the estimates.
The difference in duration, the returns to Credit Acceptance between a 48-month loan and a 53, all good? All pretty happy? Pretty consistent, I guess?
Generally speaking, well, let me answer it this way. The yield that we would expect, the revenue yield on a larger loan is going to be a little bit less.
Got it.
The expenses are also less. All in, we probably end up in about the same place.
All right, terrific. One more, if I could. Just the percentage of purchased loans through franchise dealers, is it 100% or pretty close to it?
No.
I know you only give purchased loans to independents once they've demonstrated that they're good citizens. Do you have a mixed split?
Nothing that we're going to disclose. You're correct in your assumption that franchise dealers have greater access to it than the independents.
Terrific. Nice quarter. Thank you.
Thank you. Our next question comes from Michael Tarkan with Compass Point. Your line is now open.
Hi. Thanks for taking my question. Just a two quick ones. Can you help us with the average age of your vehicles right now, where that's been trending? How have repo rates been trending? Thanks.
Neither of those are numbers that we disclose at this point.
Okay. Thank you.
Thank you. With no further questions in the queue, I would like to turn the conference back 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 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.