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Credit Acceptance (NASDAQ:CACC)

Q1 2013 Earnings Call

April 30, 2013 5:00 pm ET

Executives

Douglas W. Busk - Senior Vice President and Treasurer

Brett A. Roberts - Chief Executive Officer and Executive Director

Analysts

John M. Hopkins - Chartwell Investment Partners

Brian Foran - Autonomous Research LLP

Moshe Orenbuch - Crédit Suisse AG, Research Division

Arieh Coll

Randy Heck

Operator

Good day, everyone, and welcome to the Credit Acceptance Corporation First Quarter 2013 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 like to turn the call over to Credit Acceptance Senior Vice President and Treasurer, Doug Busk.

Douglas W. Busk

Thank you, Ben. Good afternoon, and welcome to the Credit Acceptance Corporation First Quarter 2013 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 the 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.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of John Hopkins of Chartwell.

John M. Hopkins - Chartwell Investment Partners

A couple of questions for you. The decline in the forecasted collections since kind of 2009, is that adverse selection on the part of kind of what's coming into your portfolio?

Brett A. Roberts

Help us out there, I think 2009 originations outperformed our forecast by quite a decent margin?

John M. Hopkins - Chartwell Investment Partners

No, no, just the original forecasted collection amount. The 79.5% in 2009, 77.4%, 74.2%, 72.7%, so the trend is down, in terms of the forecasted collection number. Have you been tweaking your model, or is it just add -- I mean, what is it in the market that you're seeing that's driving you to forecast those numbers lower?

Brett A. Roberts

Got you. Okay. Historically, we've been in the low-70s, typically business of a higher quality than that gets purchased by other lenders; business of a lot lower quality than that is tough to put together, so usually, you end up somewhere around the low-70s. It was higher than typical in the -- during the financial crisis because of the lack of competition. So deals that are getting purchased, are done traditionally today, were falling down to us during those time periods.

John M. Hopkins - Chartwell Investment Partners

And then the decline in the unit and the dollar volume, is that you passing on business, or is that kind of loss to competitors?

Brett A. Roberts

The latter.

John M. Hopkins - Chartwell Investment Partners

The latter. And then you have a pretty sharp increase in your dealer count. Is that kind of a marketing push on your part to expand the base?

Brett A. Roberts

Yes, it's correct. When the competitive environment gets difficult because we operate with -- in a very large market, have a -- do business with a small percentage of the total dealers, our strategy is to increase the dealer count, because we know that volume per dealer is going to be under some pressure as long as the current competitive environment continues.

John M. Hopkins - Chartwell Investment Partners

Right. And is that push deeper penetration within your core markets, or are you expanding geographically?

Brett A. Roberts

Yes. We do business in all 50 states, so it's just deeper penetration in the markets we're already in.

John M. Hopkins - Chartwell Investment Partners

Okay. And it looks like a lot of new dealers where you've done 1 or 2 or how many over loans, is that -- do you think that the dealers are shopping you, in terms of let's bring these guys in, do a couple of loans with them, and see? And on the flip side of that, I mean, this year your attrition rate's pretty high, is that trending upward?

Brett A. Roberts

The first question, the volume that you see per new active dealer is typically a pretty modest number. Part of that is some of those dealers were signed up during the quarter, so you don't have a full 3 months. But I think that relationship between average volume per dealer and average volume per new dealer is pretty typical. I think last year's first quarter, if you're comparing to that, was a little bit higher than it normally is, that 7.4%. In terms of the attrition, it's up versus last year. It's been a lot higher than that. 2010, I think, 2011 it was higher than where we're at now. So nothing alarming there, although a little bit worse than it was a year ago.

John M. Hopkins - Chartwell Investment Partners

And is there, internally, a return on capital cut-off before you begin to slow the capital allocation to the business? I mean, obviously, it's trending down, and it's a competitive situation. But is there -- I don't want to say if there's hard and a fast, but is there kind of a red line that you kind of say, look, let's just walk from this business because it's not worth it, let's not deploy more capital?

Brett A. Roberts

Yes. The absolute hard cut-off, in theory, is our weighted average cost of capital, which is about 5.5%. So we're at -- that's probably -- that's not -- fortunately, that's not been in play.

John M. Hopkins - Chartwell Investment Partners

Right, right. One last question. I see that your increase on premium earned just year-over-year, is that a higher fees on the insurance or is that higher volume, higher penetration per loan?

Douglas W. Busk

Just we have a larger book of vehicle service contracts out there that are reinsured now than we did last year at this point.

John M. Hopkins - Chartwell Investment Partners

Okay. It's not really the increased penetration?

Brett A. Roberts

No. No, just a -- it's pretty consistent with the growth in the portfolio.

Operator

Our next question is from the line of Daniel Smith [ph] of Peyton Capital.

Unknown Analyst

Can you help us understand, just can you give us some kind of number in terms of how the durations of the loans are changing? Loans that you're writing today, is the duration any longer than the duration of loans that you wrote, say, 2 years ago? And if so, how much longer are the durations?

Douglas W. Busk

I think the average terms of the loans are listed in our 10-K which was filed 1 month or 2 ago. The average duration of the loans that we've wrote -- written in recent times has been approximately 4 years. If you go back to 2009, that same number was about 3 years. It's really a mix issue. We've written loans with a wide variety of terms for a long period of time.

Unknown Analyst

Okay. Is 4 years, is it -- is that a long term? I mean, compared to if you look over the last 10 years, is that relatively long, or is that closer to normal than 3 years is?

Brett A. Roberts

No, it's at the higher end of the range.

Unknown Analyst

So what is the reasoning behind that? Is that a response to competitive pressure or what's driving that change in lengthening terms?

Brett A. Roberts

I think if you go back to when I started with the company 20 years ago, I think the longest term we would write was 24 months, and I think everything, if I remember right, had to have 25% down. So we started from that point, and we gradually expanded our policies to be less restrictive as we gathered data over time. And so, over the last 20 years, we've accumulated data on 36-month loans and 48-month loans and 60-month loans, and we've gradually moved our policies out. As we've felt more comfortable, we could price that business properly.

Unknown Analyst

So it's a long -- it's a long, long-term initiative, it's not sort of a cyclical initiative?

Brett A. Roberts

Correct.

Unknown Analyst

Is the IRR on a 4-year loan? Is it the same or different than a 3-year loan?

Brett A. Roberts

It depends on where we're at from a pricing strategy perspective. Today, we have lots of capital, so we'll typically take a smaller return on a larger loan in order to deploy more capital. We kind of look at it on a profit per unit basis, rather than a return basis. When we enter periods where we're restricted in capital, then we think about it differently.

Unknown Analyst

Okay. So if you think of it in terms of profit per loan, if you like, profit, IRR, is it higher for a long-duration loan, or the same?

Brett A. Roberts

No, lower. So we'd accept the lower return if we could deploy more capital.

Unknown Analyst

If you can deploy more capital, so that -- so originations have been kind of anemic for a while and yet, you're continuing to grow the loan base, and I'm guessing the reason is because the loans are rolling off more slowly incrementally; is that a true statement?

Brett A. Roberts

So the lengthening term does work in that direction.

Unknown Analyst

Okay. So if you think about like 1 year ago, you said in '09, the average term was 3 years and now it's 4 years. So 1 year ago, what was the average term?

Brett A. Roberts

I don't know precisely, but I think it was just a hair short of 4 years.

Unknown Analyst

A hair short. Okay, so weighted average term, if you think like in terms of months, it might be up, what, 10% year-over-year or 5%?

Brett A. Roberts

Yes, in that range. But keep in mind that the asset that we put on the books is the amount that we pay to the dealer. So our asset turns over more rapidly than in 48 months.

Unknown Analyst

Because of prepayments, is that what you're saying?

Brett A. Roberts

Yes. Because we don't advance the full amount of the contract; we advance something less than that. So our advance is repaid more quickly than the contractual term.

Unknown Analyst

Because of principal payments, is that what you're saying?

Brett A. Roberts

Well, because the customer is paying a larger obligation than the amount of capital that we put forth at the start of the loan.

Unknown Analyst

Yes. But it would have the same effect on the advance. The advance dollars would stay on the balance sheet longer, given a longer-term, right?

Brett A. Roberts

Yes. Everything else equal.

Operator

Our next question comes from the line of Nick Zulovich from SubPrime Auto Finance News.

Nick Zulovich

Just -- some have already been touched on, but just wanted to follow-up from the release earlier today. You listed several reasons for the economic profit lift that you all enjoyed. What reasons played maybe a little bit larger role this past quarter and why?

Douglas W. Busk

I mean the biggest thing is detailed in our release is that adjusted capital increased 19% due to the growth and the size of our loan portfolio.

Nick Zulovich

Okay. And -- mentions talking about competition for subprime, what elements are you seeing that's revving up competition? Is it getting heater -- high or faster than you've seen in years past?

Douglas W. Busk

I mean it's difficult to compare periods. The thing that we believe contributes most to variability in the competitive environment is just the availability of capital to the industry and the cost of that capital. And we currently find ourselves in a situation where there's a lot of capital available to the industry.

Nick Zulovich

And to follow-up on that, do you see that appetite from the investment community softening whatsoever? Is more money being pushed into this particular automotive segment?

Douglas W. Busk

I mean it's difficult to say for sure, but if you look at the securitization market as a guide, securitization activity in the first 4 months of this year has been pretty robust. So I would say that the competitive environment certainly hasn't become less robust.

Operator

Our next question comes from the line of Brian Foran, Autonomous.

Brian Foran - Autonomous Research LLP

I was wondering if you could touch on the recent CFPB guidance for the banks and anything that might change in your market, as you see it, as a result of kind of some of the guidelines they put out in late March?

Brett A. Roberts

Yes, I think it's too early to say. What you're referring to is the guidance and discriminatory lending. The industry has put out a response to that. We're very much in touch with our industry association. Charlie Pearce who's our Chief Legal Officer is very active in the association. So we'll just continue to work with the CFPB until we get something that's clear, and I don't see it having a large impact on our program.

Brian Foran - Autonomous Research LLP

And then in terms of the competitive environment, I mean, I certainly hear you in terms of availability of capital and what that's doing to pricing. When you look at underwriting terms, whether it's the term of the loan, the LTV people are using, the collateral assumptions or used car price assumptions people are using, is there anything that stands out to you as, I guess, one way to put it would be, it's just normal mid- to late-cycle underwriting, or another way to put it would be, people are starting to get over their skis [ph] a little bit. So is there anything that doesn't go in the normal mid- and late-cycle underwriting and goes in the, "this is a little bit worrying bucket for the industry?"

Brett A. Roberts

I think it's similar to prior cycles. I mean we just -- there's hundreds of companies out there that will write a $550 or lower auto loan. They compete on price, they compete on terms, they compete on policies. It's no different than what we've seen in prior cycles.

Operator

Our next question is from the line of Moshe Orenbuch from Crédit Suisse.

Moshe Orenbuch - Crédit Suisse AG, Research Division

I was just wondering if you could just talk a little bit to the dealer expansion. Do you see that kind of continuing, does that accelerate, does that decelerate from here? And what's the kind of typical maturity where you see dealers kind of reach some level of stability in terms of the of number of contracts per dealer and the like?

Brett A. Roberts

Yes, we do business with about 10% of the total dealers out there, so there's plenty of market out there. How many of those we're able to enroll in our program or how quickly we're able to do that, just depends on execution. So we'll just have to see how those numbers play out, but definitely pleased to see solid dealer growth through the first quarter. Typically, dealers will -- if you take a class of dealers that we sign up in this quarter, for example, the dealers that stick and continue with the program for months and years, typically have their volumes increased. But on the other side on that, you have a lot of dealers that drop out from that class. So you can't count on as those new dealers season, you can't count on average volumes per dealer increasing.

Moshe Orenbuch - Crédit Suisse AG, Research Division

Right, and that seasoning is a couple of years, is that until they sort of collect a fair amount of cash, is that...

Brett A. Roberts

If you look at it on the way I just described, if you take a typical class, the average volume per dealer from that class would continue to increase over a long period of time, 10 years.

Moshe Orenbuch - Crédit Suisse AG, Research Division

10 years, okay. All right, and you had a couple of questions about the competitive environment. I mean, you said it was kind of normal for this, relatively normal comparable to prior cycles, but any kind of -- is it just that the existing competitors have gotten more intense, or are there any -- is there any one new kind of coming in?

Brett A. Roberts

It's both of those. We've seen a lot of new entrants in the market, a lot of companies that have, typically, played at a higher credit tier have dipped down, so we're seeing all those. It's a very large market. Again, hundreds of companies are out there. It's not any 1 or 2 companies that drive the market, it's just, as Doug mentioned, there's a lot of capital out there, so we're going to have a lot of competition until something happens to those capital flows.

Operator

Our next question comes from the line of Arieh Coll from Coll Capital.

Arieh Coll

Question number one, I'm just trying to understand that kind of over the past couple of years, what kind of win rate you tend to have on your originations? I would just kind of presume that when you were in -- had capital available, let's say, in the 2009 time frame, I'm just going to make these numbers up, you might have had a 50% win rate in origination, because so much capital disappeared from the industry. I'm just wondering how dramatically that win rate has declined to today, as there are, as you suggested, hundreds of players as opposed to much fewer number 4 years ago?

Brett A. Roberts

I mean you can probably just look at the average volume per dealer as a guide and just track that from year-to-year. In terms of a win rate, we're typically looking at the loans that everyone else has turned down. So once they decide it's a Credit Acceptance deal, the percentage of those that we convert into actual loans doesn't really vary a lot across cycles, not as much as you might think. It's just we don't get as many looks as we would if it were less competitive.

Arieh Coll

Okay. So today, what you're saying is you're getting fewer looks today than you were before, which is what would impact volume growth?

Brett A. Roberts

Correct.

Arieh Coll

Okay. And so to get more looks, I know you've adjusted your advance rates twice in the past year. What other sorts of things would you consider doing to try and improve the amount of looks you get, so that you can have a better chance to increase your loan volume, but, obviously, do it on a good risk-adjusted basis?

Brett A. Roberts

It's everything we do. I mean, some of the more obvious things are just signing up more dealers, which we work toward that by expanding our field sales force. But how much business we do is a function of everything we do as a company. Of course, the dealers get 80% of what we collect once they pay back the advance. So improving our collections will improve how many deals we get from dealers. Improving our service in the origination side will increase how much business we get. It's really, it's everything we do.

Arieh Coll

Just lastly, clearly, you say in your press release for the past 4 or 5 years, your collections percentage, or is it dollars, has been above what you've been forecasting or estimating. If you look at kind of your unrealized sort of profits on your current book of business, over the next sort of 4 years, assuming the economy is kind of status quo, how many kind of millions of dollars of extra profits would you have coming your way, just by having the business kind of season and come in above your forecasted -- your actuarial estimates?

Brett A. Roberts

Yes. It's hard to say. It's easier to see that our forecasts were conservative in hindsight, but that doesn't mean they'll continue to be. We had 3 areas that -- where we were on the other side of that. So we -- the current estimates are our best guess. So, in theory, the answer to that is there's no unrealized profits, or there's no windfall coming our way because our estimates are conservative.

Arieh Coll

Okay. And just lastly, in terms of demand for subprime auto loans out there, any sort of industry data that kind of suggests by how much that demand is actually growing or maybe even declining the past 4, 6 months for the industry?

Brett A. Roberts

I think the changes in the size of the overall market are small enough that we don't pay much attention to it. It's not going to affect our results. We have a very small share of a huge market, and whether that market is 3% or 4% bigger, or 3% or 4% smaller, isn't going to probably make that much difference.

Arieh Coll

Okay. And you would guess your market share approximately is where of the industry today?

Brett A. Roberts

Depending on how you measure it, 3%, 4%.

Operator

Our next question is a follow-up from the line of John Hopkins of Chartwell.

John M. Hopkins - Chartwell Investment Partners

Just a follow-up to a previous caller; your loans are kind of a longer term and you have a higher advance rate out to dealers. So does that then kind of flow that there's going to be slower portfolio churn? So the portfolio's going to, in essence, is going to continue to lengthen, not only as a function of the longer term, but also as the higher advance rate that you're having to give to a dealer? So it takes you longer to get that back?

Brett A. Roberts

Yes. Both those are true.

Operator

[Operator Instructions] Our next question comes from the line of Randy Heck of Goodnow Investment Group.

Randy Heck

Just to follow up on the question previously about -- or some time ago about duration and length of loans. And could you just walk through the simple math of given that you're first of all, only advancing $0.46, $0.47 on the dollar, and secondly, that you're getting paid back first before the dealer holdback is paid, that 4-year loan, the actual duration to you is -- well, it's not -- probably not 2 years, but it's something between 2 years and 4 years, right? And then to -- and then finally, what does that tell us about the impact of the really strong vintages from 2009, 2010? Are they almost worked out of the portfolio at this point as it -- for Credit Acceptance, the impact on returns and so forth?

Douglas W. Busk

Yes. In the quarter, we had a loan portfolio that was, on average, a little less than $2 billion. If you look at the roll-forward of loans receivable, we collected, on a principal basis, a little less than $350 million. So if you annualized the $350 million, you get to about $1.4 billion. And also, the turnover of the asset is a little less than 2 years. Logically, that would mean that the vast majority of the finance chart revenue on the assets on our balance sheet consists of 2011, '12 and the first quarter of '13 originations.

Brett A. Roberts

But we give you those numbers. Page 2 of the earnings release has the percentage of forecast realized. There's a table. 2009, 96% realized, so obviously, that's almost gone. 2010, 83.4%, you see those numbers. So what Doug said is supported by Page 2 of the release.

Randy Heck

Okay. So it's fair to conclude that the $2.40 -- the $2.42 that you earned this quarter is really a reflection of the returns you -- or the type of -- sorry, the spreads that you locked in, in the last 2 years, for the most part. It's really not a reflection of the good times of 2009, '10?

Brett A. Roberts

Right, that's correct.

Douglas W. Busk

Yes. For the most part, yes.

Operator

And with no further questions in queue, I would like to turn the conference back over to Mr. Busk for any additional or closing remarks.

Douglas W. Busk

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.

Operator

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

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