Credit Acceptance Q2 2023 Earnings Call Transcript

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August 1, 2023

There are 8 speakers on the call.

Operator

Good day, everyone, and welcome to the Credit Acceptance Corporation Second Quarter 2023 Earnings Call. Today's call is being recorded. A webcast and transcript of today's earnings call will be made available on Credit Acceptance website. At this time, I would like to turn the call over to Credit Acceptance, Chief and Treasury Officer, Doug Busk.

Speaker 1

Thank you. Good afternoon, and welcome to Credit Acceptance Corporation's 2nd quarter 2023 earnings call. As you read our news release posted on the Investor Relations section of our website at ir.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, These risks and uncertainties include those spelled out in the cautionary statement regarding forward looking information included in the news release.

Speaker 1

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 our non GAAP measures reconcile with GAAP measures. Our GAAP adjusted results for the quarter include A decrease in forecasted collection rates, which decreased forecasted net cash flows by $89,000,000 were 0.9% compared to a decrease in forecasted collection rates during the Q2 of 2022, which decreased forecasted net cash flow by $43,000,000 or 0.5%. The $89,000,000 decrease this quarter included the impact of an adjustment to our forecasting methodology, which decreased our estimate by $45,000,000 or 0.5%. In addition, Forecasted net cash flow timing slowed, run early as a result of the decrease in consumer loan repayments to below average levels.

Speaker 1

Changes in the amount and timing of forecasted net cash flows are recognized in our GAAP results in the period of change through provision for credit losses and our adjusted results respectively over the remaining forecast period of the loans through finance charges. Unit and dollar volumes grew 12.8% and 8.3%, respectively, as compared to the Q2 of 2022. The average balance of our loan portfolio on a GAAP and adjusted basis Increased 4.3% and 8.6%, respectively, as compared to the Q2 of 2022. The initial spread on consumer loans assigned increased to 21.2% compared to 20% on consumer loans assigned in the Q2 of 2022. Adjusted net income decreased 26 percent in the Q2 of 2022 to $140,000,000 Adjusted earnings per share decreased 23% from the Q1 of 2022 to $10.69 At this time, Ken Boot, Our Chief Executive Officer, Jay Martin, our Senior Vice President, Finance and Accounting and I will take your questions.

Operator

Our first question comes from the line of Arjun Tuteja from Jarislowsky Fraser. Your line is open.

Speaker 2

Hey, Ken. You assumed the CEO position approximately 2 years ago. Could you discuss a couple of things? First being, what has been your Strategic focus during the past 2 years? And second, what are your expectations regarding your areas of focus for the upcoming years.

Speaker 3

Yes. Our long term strategy here really This has been the same as it was even before I took over. We're trying to build a better business. We're trying to increase intrinsic value. We do that really by Just be growing our dealer base and our loan base and doing that in a way that we get acceptable returns on those loans.

Speaker 3

So I wouldn't say much has changed. There's obviously different strategies that we use to try to do that. I'm not going to go into the actual strategy we use, but ultimately It's the same thing we've been trying to do

Speaker 4

for a number of years here.

Speaker 2

I agree. I mean, I agree here. But I'm just thinking that with Direct leaving and you coming on, there have been some changes maybe culturally or strategically or do you think kind of nothing has changed at all?

Speaker 3

I mean, we're investing more in technology. We're trying to do some things that make our product more valuable to the dealers and to consumers. But right now we're in the investment stage. I'm not really sure we've seen any returns on that yet. We're hoping to in the future.

Operator

So I would say that's probably one of the bigger things

Speaker 3

that we've done is investing in technology.

Speaker 5

Okay. Thank you.

Operator

One moment for our next question. Our next question comes from the line of John Rowan from Jamie Montgomery. Scott, your line is open.

Speaker 1

Good evening. Hello, John.

Speaker 6

Can you guys discuss a little bit more just What the change in forecasting methodology means? Trying to get a handle on if it's just a change in the Slope of the collection curve or if it's something else that is away from the historical model?

Speaker 1

Yes. The change to the absolute amount of forecasted collections was really just due to us Incorporating more recent loan performance data in our forecasts. We're always looking at the historical performance Loans with similar attributes and this quarter we updated our forecast enhancement by Including in that more recent loan performance data.

Speaker 6

Okay. So there was like no like real wholesale shift though?

Speaker 1

No, I don't think so. I mean, it's similar methodology, just updated data.

Speaker 6

Okay. And then I guess just Kind of trying to read between the lines. You talked about some collections being below average. I mean, where are the loans marked now? Would you consider Kind of the cash that you're looking to come out of the portfolios, kind of reverting to the mean over time and the current marks are below average.

Speaker 6

I'm just trying to understand If you were being cautious enough previously and how cautious you are going forward, are you below historical averages now on the portfolio marks Going forward?

Speaker 1

Well, I think we use the term below average relative to prepayment rates. That's another thing that happened during the quarter. The timing of our collections slowed and it was really just due to Continued decline in prepayment rates and prepayment rates in fact for the quarter were below the historical average. So the word Yes, below average really relates to the timing of the cash flows, not the absolute amount. I will say Every quarter, we try to put our best estimate on it.

Speaker 1

And so I think that forecasted cash flows What we have on the books at June 30th is our best estimate of what's ultimately going to transpire.

Speaker 6

Okay. And then just to touch on the competitive environment a little bit. I was hoping you guys would kind of talk a little bit about What you're seeing out of the smaller competitors in your space? Are they retrenching? And again, I want to go down market a little bit here With the guys that you compete with, how is their funding looking?

Speaker 6

And just trying to understand where you sit competitively speaking?

Speaker 1

The market for used vehicles for the end to subprime consumers It is very large and very fragmented. The top 5 industry participants account for maybe 25% of the business, The top 20 is somewhere around 50%, but the other 50% consists of 100, if not 1,000 of firms. So I don't really have terribly insightful observations about What's happening at any individual competitor, I think it's still fair to say that the competitive environment is more favorable than it was 12 or 15 months ago.

Speaker 6

Okay. All right. That's it for me. Thank you.

Operator

One moment for our next question. Our next question will come from the line of Robert Wildhack from Autonomous Research. Your line is open.

Speaker 5

Hi, guys. Doug, just on that last point, when you say the competitive environment is more favorable than it was 12 or 15 months ago, that means more favorable, I. E. Better for credit acceptance?

Speaker 1

Correct.

Speaker 5

Okay, great. And then, I wanted to ask about the 2022 vintage. Expected collections there now 3.2 percentage points below the initial forecast, which is a very significant delta for you historically. So what is it about that vintage that's performing so poorly?

Speaker 1

I mean, simply put, the loans are just We are performing worse than loans with similar characteristics have historically. What we saw this quarter is a continuation of the trend that we observed in the last three quarters of 2022. We didn't see that trend in the Q1. It's difficult to say why. It could be unique seasonal factors that occur during tax season.

Speaker 1

But it's a continuation of a trend that we saw for most of 2022. It's impossible to say exactly why this has occurred, but it's probably due to a few factors. The early 'twenty two loans were originated in a pretty intense competitive environment, which generally hurts loan performance. We've seen some decline in used car prices. And as we know, I think inflation, though it is moderated, It has an impact on the subprime consumer.

Speaker 1

So I think that all those things are probably contributing to the

Speaker 5

Sorry, just one more if I could. The provision for new loans This quarter was less than $1,000 per unit and that's the 2nd quarter in a row where that's been pretty low historically because I think it's usually like $1300,000 $1400,000 $1500,000 And does that mean you've tightened the underwriting criteria at all?

Speaker 1

No. Just due to the mechanics of the calculation, What drives the upfront provision is just the difference between the Contractual and expected yield. So the expected yield would be what we expect to earn based on the forecasted cash flows of origination. The contractual yield is just what the yield would be if the customer made all the payments on time. We've seen a higher initial spread on the recent loan originations, which has reduced the difference between the contractual and expected yields and that's resulted in a decline in the Provision that we report when we originate a loan, a bit of a mechanical answer.

Speaker 5

Okay. And lower Difference between contractual and expected equals a lower provision, all else equal?

Speaker 1

That's correct.

Speaker 7

Okay. Thank you.

Operator

One moment for our next question. Our next question comes from the line of Vincent Caintic from Stephens. Your line is open.

Speaker 4

Hey, good afternoon. Thanks for taking my questions. First one on the prepayment rates and The change the adjustment there. I guess you highlighted that the It had to be primarily with the timing of the cash flows and not the change in the absolute amount. I would think that Lower prepayment speeds may be a positive in the sense that if the loan lasts for longer, you're able to charge You're able to get more interest income and so there might be a higher lifetime value to that loan.

Speaker 4

I'm just curious How that works? Your thoughts on that and how that maybe works mechanically where maybe you're collecting more interest income, but your forecast to collections comes down. Thank you.

Speaker 1

Yes. I mean that may in fact occur where if a loan doesn't prepay, you end up collecting more than you otherwise would because generally the people that Prepaid are the ones that were fairly likely to repay their loan in full anyway, I. E. They're the more creditworthy customers. But the amount of the provision is the amount required To reduce the net asset value, so gross loan less the allowance for credit losses to the discounted value of future net cash flows, so collections or dealer holdback.

Speaker 1

And that discount rate is in the neighborhood of 20%. So if you have a longer stream of cash flows and you're discounting it back at 20%, it's easy to see how that could result And increase in provision, even if on certain loans you might be forecasting more total collections.

Speaker 4

Okay. That's helpful. That illustrates the timing differences. So I appreciate that. Second question On the spreads or the yields, in terms of you thought a little bit earlier about competitive easing a bit.

Speaker 4

Are you able to talk about the pricing that you're able to charge the consumer? Any change on that in terms of improvement spreads?

Speaker 1

I mean, we don't really price our product by bearing the interest rate on the retail installment contract With the consumer, we price our product to maximize the amount of economic profit that our loans originate. So economic profit per loan times the number of loans we originate. Obviously, one of the things that The amount of economic profit per loan is just the relationship between what we expect to collect and what we pay for the loan at origination. So as you can see, we had a little higher initial spread this year than we did last year, but that's We're pricing to maximize economic profit and there's a lot of things that go into that, including our cost of capital and

Speaker 4

And then last one for me. It's nice to see the active dealer counts and the activity growing year over year. Anything you can share in terms of the discussions you're having with Your dealer customers in terms of maybe what might be driving the increased engagement and increased Volume you're getting from the dealers?

Speaker 1

Yes. I mean, I think it's the competitive environment that I mentioned earlier Likely has something to do with it. I think the fact that we're Originating more higher quality loans has something to do with it as well. So I think it's fair to say that Increase from dealers has increased over the course of the last 12 months. And I think it's primarily due to those two factors.

Speaker 4

Okay, great. That's helpful. Thanks very much.

Operator

One moment for our next question. Our next question comes from the line of Ray Cheesman from Enfield Capital Management. Your line is open.

Speaker 7

Doug, when you just mentioned a minute ago, higher quality loans, Does the better competitive environment referenced earlier mean that you get more volume at, let's call it, a static FICO score or has it allowed you to actually move up market slightly while maintaining your economics?

Speaker 1

I mean, that's a complicated question, especially after 3 years of the pandemic. We are originating a higher credit score customer. Part of that is just due to On the fact that elevated used car prices and inventory shortages Have caused it to be very difficult for the deeper subprime consumer to purchase a vehicle in certain respects. So we've seen an increase in the credit quality of kind of our bread and butter business, if you will, due to that phenomena. Those returns are expected to be consistent with What we would have affected 5 years ago or so.

Speaker 1

The other thing that's Contributing to an increase in credit quality is we've intentionally rolled out a program targeted at a little higher credit quality borrower. The idea between that Program is to provide us with incremental volume. Now that incremental volumes at a return that's Somewhat lower than our bread and butter business, but still above our cost of capital. I mean, that's the conceptual Thinking behind it, obviously, whether those statements about returns or not prove to be true will be dependent on loan performance.

Speaker 7

Along the same lines, I believe I saw in the press release that it said that When consumer credit tightens, prepayments slow and then we also have the phenomena that the 2022 class Was the last group that bought with kind of the 68% used car value surge that gets talked Got it. And now of course that's rolling over. When you say that you updated for your loan assumptions During the quarter, I'm guessing those were some of the things you took into account so that we shouldn't see another one of those in say Q3 or Q4 Or do you kind of rejigger, rethink things every single quarter? You said you make your best guess.

Speaker 1

Yes. I mean, we think we've put our best guess forward here. We're Like I said, we're using more recent loan performance data and we're comfortable with our forecast. But obviously,

Speaker 3

if you

Speaker 1

look at our track record, we're never perfectly accurate. Sometimes the loans perform better than expected and Some before worst. So we'll periodically adjust our models and update our assumptions, but We're putting our best foot forward here.

Operator

Can I ask just

Speaker 7

one more? Do you guys do Electric vehicles or have any plans to?

Speaker 1

We do electric vehicles, Not a significant amount of them and the chief barrier there is just price. It's Yes, it creates affordability issues for our entire customer.

Speaker 7

Okay. Thank you very much, Doug.

Speaker 1

You bet.

Operator

Thank you. And 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.

Speaker 1

We would 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.

Operator

Once again, this does conclude today's conference. We thank you for your participation. Everyone have a great

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Key Takeaways

  • Adjusted net income for Q2 fell 26% year-over-year to $140 million and adjusted EPS declined 23% to $10.69, despite unit volume growth of 12.8% and dollar volume growth of 8.3%.
  • A decrease in forecasted collection rates reduced net cash flows by $89 million (0.9%), including a $45 million impact from updated forecasting inputs, as prepayment speeds slowed to below-average levels.
  • The initial spread on assigned consumer loans rose to 21.2% from 20%, which helped lower the upfront provision for new loans to under $1,000 per unit versus historical levels of $1,300–$1,500.
  • Management reiterated its long-term strategy to grow the dealer and loan base with acceptable returns and highlighted increased investment in technology to enhance product value for both dealers and consumers.
  • Executives cited a more favorable competitive environment than 12–15 months ago, noting rising dealer engagement driven by higher-quality loan originations in a highly fragmented subprime auto market.
AI Generated. May Contain Errors.
Earnings Conference Call
Credit Acceptance Q2 2023
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