Credit Acceptance - Q2 2024

Transcript

Operator (participant)

Good day, everyone, and welcome to the Credit Acceptance Corporation Second Quarter 2024 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'd like to turn the call over to Credit Acceptance Chief Financial Officer, Jay Martin.

Jay Martin (CFO)

Thank you. Good afternoon, and welcome to the Credit Acceptance Corporation Second Quarter 2024 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, 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, I will turn the call over to our Chief Executive Officer, Ken Booth, to discuss our second quarter results. Thanks, Jay. We had a mixed quarter as it related to collections and originations, two key drivers of our business. Our 2022 vintage continued to underperform our expectations, and our 2023 vintage began to slip as well.

We made an additional $147 million adjustment to forecast the net cash flows on top of our normal loan forecast model, but just our loans originated in 2022, 2023, and the first half of 2024, what we believe the ultimate collection rate will be based upon trending data over the last several years. Historically, our model has been very good at predicting loan performance in aggregate, but our models worked best during less volatile times. The pandemic and its ripple effects created volatile conditions, federal stimulus, enhanced unemployment benefits, and supply chain disruptions led to vehicle shortages, inflation, et cetera, all of which impacted competitive conditions. We have had larger than average forecast misses, both high and low, during this volatile period.

But because we understand forecasting collection rates is challenging, our business model is designed to produce acceptable returns even if loan performance is less than forecasted. Even with our reduction in forecasted collections this quarter, we believe we will continue to produce substantial economic profit per share in the future. As I've explained in the past, we are less reactive to changes in competitive and economic cycles than others in the industry because we take a long view on the industry, we price to maximize economic profit over the long term, and we seek to best position the company if access to capital becomes limited. Ultimately, we are happy we have the discipline to maintain underwriting standards during the easy money times of 2021 and especially 2022. As well, our market share was lower during those years.

We believe it has put us in a better position to take advantage of more favorable market conditions today. During the quarter, we experienced strong growth and had our highest Q2 unit and dollar volume ever, growing our loan unit and dollar volume by 20.9% and 16.3%, respectively. Our loan portfolio is now at new record highs at $8.6 billion on an adjusted basis. Our market share in our core segment continues to increase, being 6.6% as of May 31, 2024. Beyond these two key drivers, we continued making progress during the quarter towards our mission of creating intrinsic value and positively changing the lives of our five key constituents: dealers, consumers, team members, investors, and the communities we operate in.

We do this by providing a valuable product that enables dealers to sell to consumers regardless of their credit history, dealers to make incremental sales to the roughly 55% of adults with other than prime credit. For these adults, it enables them to obtain a vehicle to get to their jobs, take their kids to school, et cetera. It also gives them the opportunity to improve or build their credit. During the quarter, we originated 100,057 contracts for our dealers and consumers. We collected $1.3 billion overall and paid $84 million in portfolio profit from Portfolio Profit Express to our dealers. We added 1,080 new dealers to the quarter and now have our largest number of active dealers ever for a second quarter, with 10,736 active dealers.

From an initiative perspective, we continue trying new go-to-market approaches using a test and learn approach. We believe some of these have been successful and have contributed to our growth. We also continued investing in our technology team. We have ramped up personnel and are focusing on modernizing how our teams perform work with the goal of increasing the speed in which we enhance our product for our dealers and consumers. During the quarter, we received three awards from Fortune, U.S. News, and the Best Practice Institute, recognizing this is a great place to work.

We continue to focus on making our amazing workplace even better. We support our team members in making a difference and would make the difference to them in connection with their efforts. We contribute to organizations such as Make-A-Wish Foundation, St. Jude Children's Research Hospital, the Shades of Pink Foundation, and Versiti Blood Center of Michigan, among others. Now, Doug Busk, our Chief Treasury Officer, Jay, and I will take your questions.

Operator (participant)

Thank you. At this moment, we'll conduct the question-and-answer session. To ask a question, you'll need to press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. Our first question comes from line of Moshe Orenbuch of TD Cowen. Your line is now open.

Moshe Orenbuch (Managing Director)

Great, thanks. Is there any way to kind of explain what changes you made in the forecasting methodology? Did you have misses, more on, you know, the likelihood of default, recoveries on the auto afterwards, or, or any other practice changes that are involved?

Ken Booth (CEO)

Well, the first thing is we now believe that the 2022 originations are seasoned enough for us to enhance our estimate over what we provided previously. What we've done, simplistically, is we have assumed that the 2023 and 2024 originations are going to exhibit similar trends in terms of variance from the initial forecast and the slope of the collection curve, which we plotted out over time. We're assuming that those percentage changes is going to be similar to what we've seen in 2022. Those trends that we're seeing in 2023 and 2024 are there, but they're less severe than the 2022 loans.

And since those books of business are also performing better from an absolute perspective, the adjustment in percentage terms is less significant than the miss we're gonna have on the 2022 business. So it was really just assuming that the 2023 and 2024 originations will behave similarly on a percentage basis to what we've seen on 2022.

Moshe Orenbuch (Managing Director)

Doug, and one of the things that's unique about the way you guys, you know, kind of report your adjusted earnings is you take, you know, you take that hit interest into your provision this quarter, but you spread out the impact on future periods. You had a 19.6% yield, Adjusted Revenue Yield. Like, can you give us some way of thinking about how much of this is going to flow through, and over what period, and how to think about the, the impact on that 19.6%?

Ken Booth (CEO)

Well, I think the, just the yield on the loan asset was 17.7% in the quarter. I think revenue as a percent of average capital was 19.6%. So two slightly different things, but they'll behave similarly. You know, all else equal, if loan performance is exactly as expected, we would expect the yield or revenue, if you want to look at it as a percent of average capital, to decline in Q3. The magnitude of the decline will obviously be dependent on the yield on new originations, and obviously, whether loan performance is better or worse than expected. But all else equal, you know, we would expect revenue or the yield on the portfolio to decline.

Moshe Orenbuch (Managing Director)

Last one for me, and honestly, I'm struggling as to how to phrase this. But, you know, given that this is the second of these in basically a year, you know, I guess why is it a good thing that you're originating more loans? Like, in other words, shouldn't you be doing the opposite? Shouldn't you be pulling back and saying, "Maybe we're doing something wrong here?

Ken Booth (CEO)

It's a, you know, it's a fair question. As Ken said in his intro, we still believe that these loans are producing returns in excess of our weighted average cost of capital. That's generally a higher return than you're going to see from others in the industry. So we think it's adding shareholder value, to continue to originate, you know, the business that we're originating. And as I said, we feel better about the 2023 and 2024 loans than we did about the 2022 loans, which were obviously very disappointing to us.

Moshe Orenbuch (Managing Director)

Okay. Thank you very much.

Operator (participant)

Thank you. We'll move for our next question. Our next question comes from the line of John Rowan of Janney Montgomery Scott. Your line is now open.

John Rowan (Managing Director)

Good afternoon, guys. I guess I'm gonna ask Moshe's question, but a little differently. The implied spreads are still pretty high. The initial implied spreads for 2024 are still high, historically speaking. What gives you confidence that those are the right numbers, given the magnitude of the reductions that you're putting into, you know, prior forecast revisions? You know, and, you know, I guess, just trying to figure out if there's more risk of, you know, continuing to write portfolio down if we're aggressive on, you know, some of the assumptions going in that are, again, still writing to relatively high spreads, historically speaking.

Ken Booth (CEO)

Mm-hmm. I mean, we're, you know, as I said, you know, we're basing our current estimate for 2023 and 2024, you know, based on the absolute performance to date, of those vintages, and then we're applying a similar degradation in the collection rate over time to what we've seen on 2022. You know, we're using history as our guide there, and, you know, forecasting consumer loans, especially in recent years, has been challenging. So we're putting our best number on it, but is there a, you know, chance we could be wrong? There's always a chance.

John Rowan (Managing Director)

Okay. And then just for kind of modeling purposes, obviously, with the GAAP loss in the quarter, I assume the share count that you reported was the basic share count. Can you just give me an idea of what the, like, real diluted share count would be, or, you know, how many diluted shares you'd have so, you know, going forward, we get that in the model?

Jay Martin (CFO)

Yeah, I think if you look at in our 10-Q, there in the earnings per share footnote, it'll show you how many shares were anti-dilutive for the quarter. That is the case. Since it was a loss, we needed to stick with the basic shares. Just taking a quick look here to see what was excluded as anti-dilutive. Looks like it was around, for the quarter, 217,000 shares.

John Rowan (Managing Director)

Okay. That's what I needed to know. Thank you.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of Rob Wildhack of Autonomous Research. Your line is now open.

Rob Wildhack (Partner and Director)

Hey, guys. One more on the 2023 vintage. You know, some other lenders have talked about the early part of that year, maybe the first quarter of 2023, loans originated then is driving underperformance for that vintage. Would you echo that, or is the underperformance that you're seeing in 2023 pretty broad-based across originations throughout the year?

Ken Booth (CEO)

No, I would say that that's a fair comment. You know, we have seen a situation where the early 2021 loans performed better than the last half of 2021. The first part of 2022 was kind of the bottom from a performance perspective. Things got somewhat better at the end of 2022 and, you know, got better in the first part of 2023, but the underperformance on, you know, the performance of the second half of 2023 loans was better than the first half, for sure, and that trend has continued into 2024. So long-winded answer, I would agree with your commentary.

Rob Wildhack (Partner and Director)

Okay, thanks. And then, just on the unit growth, I think April was slower than the quarter was in aggregate, which would imply a step up in growth in May and June. Is there anything specific that was driving the acceleration in May and June? And then to ask the question kind of forward-looking, you know, July looks pretty strong at +28%. Anything to call out there? Is July benefiting from an easy compare, anything like that, or do you think you can continue to grow at that pace, going forward?

Jay Martin (CFO)

I think it's always difficult to predict. You know, there's a lot of macro uncertainties that come from the competitive environment, inflation, interest rates, things like that. You are right that it, you know, improved kind of throughout the quarter and into July. Whether that continues or not, it's really tough to say. We will have tougher comparables going forward. You know, that being said, you know, we have made improvements to our product, and we're hoping that's having a difference as well, and we believe that is a positive impact. So, you know, if you look at buying per dealer, it's up, so that's a good sign for us, and that means our product's probably better, and it means our competitive environment's better. We're hoping that continues.

Ken Booth (CEO)

Yeah. I think the other point I would add to what Ken said is, it's hard to draw any conclusion from just looking at one month at a time. I mean, if I look at the growth rates for the quarter, April was 17%, May was 26%, June was 20%, and then July is back up running at 27%. So, you know, when you break it down into smaller units, you obviously get more variability.

Rob Wildhack (Partner and Director)

Yep. Okay. Thank you.

Operator (participant)

Thank you. One moment for our next question. Again, as a reminder, to ask a question, you'll need to press star one one on your telephone. Our next question comes from the line of Ryan Shelley of Bank of America. Your line is now open.

Ryan Shelly (VP in High Grade and High Yield Credit Research)

Hey, guys, quick question here. So, along with your earnings, you filed amendments to both the Revolving Credit Agreement and one of the Warehouse Agreements around the definition of Consolidated Net Income.

Ken Booth (CEO)

Yep.

Ryan Shelly (VP in High Grade and High Yield Credit Research)

Can you just explain the rationale there? Yeah, like, what that definition change is all about? Thanks.

Ken Booth (CEO)

Yeah. I mean, as we've said for years in our press releases, we think the best way to evaluate our financial performance is on the basis of level yield accounting, based on forecasted cash flows. So, you know, we're looking at the forecasted amount and timing of the cash flows and discounting that back, and that gives you a yield. And, you know, we're using that yield for revenue recognition. And then if, you know, every month, you reforecast the loans, and if your forecast goes up or down, you adjust your forecast respectively. The adjustments that we made to the definitions in those credit facilities basically start with GAAP net income, back out the provision for credit losses, and then apply the floating yield adjustment.

When you do that, you get to level yield revenue recognition based on forecasted cash flows.

Ryan Shelly (VP in High Grade and High Yield Credit Research)

Got it. Thanks. Thanks for the time.

Operator (participant)

With no further questions in the queue, I would like to turn the conference back over to Mr. Martin for additional or closing remarks.

Jay Martin (CFO)

We would like to thank everyone for their support and for joining us on the conference call today. If you have any additional follow-up questions, please direct them to our investor relations mailbox at [email protected]. We look forward to talking to you again next quarter. Thank you.

Operator (participant)

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