Good day, everyone, and welcome to the Credit Acceptance Corporation’s Second Quarter 2022 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’s Chief Treasurer Officer, Doug Busk.

Thank you. Good afternoon and welcome to the Credit Acceptance Corporation’s second quarter 2022 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, 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 a table showing how non-GAAP measures reconcile to GAAP measures. Our GAAP and adjusted results for the quarter include: unit and dollar volumes grew 5.1% and 22% respectively as compared to the second quarter of 2021. A decrease in forecasted collection rates for loans originated in 2020 through 2022, which decreased forecasted net cash flows from our loan portfolio by $43 million. Adjusted net income decreased 18% from the second quarter of 2021 to $188 million. Adjusted earnings per share increased 1.5% from the second quarter of 2021 to $13.92. Stock repurchases of approximately 404,000 shares, which represented 3% of the shares outstanding at the beginning of the quarter and a $12 million expense related to an agreement in principle to settle a previously-disclosed class action lawsuit, and a $20 million increase in stock-based compensation expense primarily due to the retirement of our former CEO in May 2021 and the timing of shareholder approval for 2020 and 2021 stock option grants. At this time, Ken Booth, our Chief Executive Officer; Jay Martin, our Senior Vice President, Finance and Accounting and I will take your questions.

And thank you. Our first question comes from Moshe Orenbuch from Credit Suisse. Your line is now open.

Great, thanks. In the last quarter you guys talked a little bit about your results and what you were doing with respect to the higher credit quality. I guess I’m trying to understand you do have your adjusted revenue or the yield as a percentage of your average capital did go up in the quarter. Could you just kind of square for us how to think about that? What’s happening in terms of the actual yield on the portfolio, or is that a function of the denominator? Could you talk about that a little bit? Thanks.

Yes, the adjusted yield on the portfolio increased this quarter and that was primarily due to loan performance in Q1 being quite a bit better than we expected. As you can see in the press release loan performance slightly underperformed our expectations this quarter— all else equal that will have a negative impact on the yield in future periods.

Got it. Thanks. But you’re saying it’s separate and distinct from the mix in terms of kind of higher quality loans that you were originating.

Correct. Yes.

Thanks.

It’s all relative to our initial expectations and what happened during the period.

Got you. And I guess when you think about that, because like sometimes you talk about a change in methodology that results in that, there was no mention of that this time. So, is there anything that you could kind of point to as the root cause of that underperformance kind of changing from the first quarter to the second quarter you had said it was better than expected in the first quarter?

Yes, it’s tough to say precisely why it occurred. But it’s likely due to a few factors. Obviously, the end of stimulus and supplemental unemployment benefits, and perhaps it took a little while for consumers to work through the savings that they had accumulated during those programs. And then I think the other thing that’s impacting the consumer out there is just the inflationary environment.

So is it reasonable to expect that that would continue into future quarters?

I can’t predict the future any better than anyone else, but I guess my expectation is as long as inflation remains elevated and nothing else changes in a material way that I think that’s probably a reasonable assumption. I mean, I think that we had a two-year period where loan performance was significantly better than expected and those tailwinds are no longer present and there are some potential headwinds such as inflation.

Got you. And then last one for me is that it also just does seem that it rolled – kind of rolled through the second quarter, same sort of pace that your capital return was slowing. And it’s been June, July probably pretty much de minimis, kind of thoughts there as we go forward.

Okay. We’re back on, Moshe, I’m not sure how much of my response there you heard or didn’t hear. But I guess, I’ll just assume you didn’t hear very much of it. And I would say that, as we said on prior calls, historically we returned less capital to shareholders, the higher our leverage is and the more we’re growing. And in recent periods, our leverage has been at the high end of the historical range. And in the second quarter we started to see some more positive results from a loan growth perspective.

Great. Thanks Doug and Ken. Thank you.

Sorry about the interruption.

No problem.

And thank you and one moment for questions. And our next question comes from Ray Cheesman from Anfield Capital Management. Your line is now open.

Doug, you mentioned that inflation is a headwind, is the Manheim index finally showing some softness in the used car market where I believe most of your portfolio exists? Is that an impact that also will be a headwind going forward versus the terrific lift it gave over the last eight or 10 quarters?

We haven’t seen any material move in used car prices relative to the vehicles that we were disposing of at auction. But it certainly is a potential headwind. Used car prices continue to be at elevated levels, I can’t predict the future, but at some point it seems reasonable to expect that they’d revert to more normal levels, but how quickly and how dramatically that occurs is anyone’s guess.

Okay. Also, you guys took off the COVID overlay, I guess in the first quarter. And as we look forward and I know, you’re not a big fan of looking – telling us forward, but when I have guys like AT&T telling me that they got customers who can’t pay for their cell phones, that’s new news. And so and then you clearly see the bottom portion of the FICO scale struggling as you mentioned, inflation amongst other things, less government support programs, et cetera. You also said that the last two years have been a different time. When do we get back to old normal where performance say from 2015 to 2020 prior to COVID is what we would expect to see going forward? And these – this weird two years kind of flows through and finishes, does it take two quarters, six quarters, 12 quarters?

I don’t think anyone really knows. I mean I guess it defines – it depends on what you define as normal, but we’re a little more normal in that we no longer have stimulus and unemployment benefits, but we’re definitely abnormal. And we’re experiencing the highest inflation since the 1980s. So we continue to be in an unusual environment. And when that returns to normal is anyone’s guess.

Are there any – I’ll give you an example, one main the spring leaf lenders that also lend to lower FICO customers has changed the credit box and 'tightened things up.' Are there adjustments that Credit Acceptance is making to its ongoing business model to try to stay ahead of any changes that they expect to occur in the couple quarters ahead?

We’re always attempting to forecast collection rates as accurately as possible. And to the extent that, we need to make changes to do so. We do that. It’s our practice not to provide details relative to any adjustments that we do make.

Thank you and congratulations by the way on finding middle ground on that lawsuit and putting it aside.

Thank you.

And thank you. And our next question comes from Matthew Hewitt from Jefferies. Your line is now open.

Actually, it’s John Hecht Jefferies, but thanks for taking my questions. I guess I just broadly speaking, just because they were most of us are aware that the capital markets are a little bit in disarray spreads widening. And just how does that impact kind of the management thinking there in terms of volumes and so forth is, do you – you guys have been serial issuers with a big buyer base, but does the current state of the capital markets affect your thinking at all?

Certainly, we’ve noticed – we completed the deal recently and the capital markets are functioning differently than they were six to 12 months ago. So we’re aware of it. And we’re monitoring it closely, so we’re factoring it into the way we’re running the business for sure.

Okay. And then the spread – as you guys kind of highlight the spread and the different course of its – on both the purchase and the dealer program, as the spreads – certainly as long as I can remember a low level. Any comments are in that or should we think that we’re bottoming out here kind of, I guess, the way you’re underwriting and issuing, how do we think about where the spread might go?

We typically don’t discuss our pricing strategy other than to say, we’re always trying to maximize the amount of economic profit that we originate. And so that would be economic profit per loan times the number of loans we originate. So if we felt that it made sense to pay more, have a lesser spread, but write more business, we do that. Conversely, if we thought it made sense to pay a little less and have a larger spread, but do a little less volume, we’d do that too. So we’re trying to price the product optimally.

Okay. And then last question, and I know there are some seasonal elements to this and that, but you had pretty big info of new dealerships. How do we think about that?

I think a lot of that is probably just due to the fact that the sales team has been able to get out and have a lot more face-to-face dialogue with dealers than they were over the last year or two. You’ve also had, what appears to be a somewhat of an improvement in the competitive landscape, which generally seems to increase dealers’ interest in our program as well. So I think it’s likely a combination of those two things.

Okay. Thanks very much.

You bet.

And thank you and one moment for our next question. And our next question comes from Diogo Vaz da Silva from PSquared Asset Management. Your line is now open.

Hi. Thank you very much for taking my questions. I have three of them please. The first one is then and pulling up on the previous one. One thing I’ve noticed is that over the last two years, we’ve seen both the spread going down, but at the same time, the average long-term going up. Is this just related with the car, especially on the term related with the car prices being at much higher levels or, I mean, I’m just trying to understand, is this the model being very different or is just the industry getting more competitive?

I mean, I think the loan size has gone up because of the elevated used car prices. The term has remained about the same and that’s just due to the fact that we’re financing a slightly different vehicle just to address consumers’ affordability concerns. Your other question related to the spread, the spread has declined over the last couple years, but a pretty significant reason for that was the better than expected performance for the loans originated in 1920 into a lesser extent, 2021.

Got it. And then on my last question, which has two parts with your existing kind of disclosures on potential legal risks. I guess the first part is, is there any part of your recent settlements on state losses, did you guys have to introduce any sort of affordability test? Or did you have to change the way that you conduct your business in those states by any form? Because when I was reading through the settlement, I only saw that there was that the penalties, but I didn’t see that there was anything, any changes in the business itself?

I mean the, you’re basically correct. No material changes, we made some changes back in 2018 to modified business practices in light of some court rulings. But other than that, the settlements themselves didn’t require significant modifications in business practices.

Perfect. And then the last part of the question, if I may just, is there any update on the discussions and interaction you guys are having with the CFPB regarding the notice that they served to you in the beginning of this year?

I mean, we can’t really comment beyond what we’ve disclosed in our 10-Q.

Thank you. And our next question comes from Robert Wildhack from Autonomous Research. Your line is now open.

Hi guys. Doug, can you expand on that point, you made a moment ago about the improved competitive landscape?

I mean, the way that we conclude that it’s improved as we look at our volume per dealer, which improved a little bit in the quarter. We also get anecdotal feedback from our sales team and from dealers. It seems like the competitive environment has improved some exactly why it’s difficult to say, but I think likely candidates are increases in interest rates, the choppiness in the capital markets we discussed earlier and potentially operators being concerned about future trends in credit due to things like inflation and potentially declining used car prices. I mean, it’s tough to know precisely, but those seem like good candidates for any improvement that might be out there.

Okay. Got it. Thanks. And then I also wanted to ask you about the leverage. First, do you have any firm caps on leverage, whether that’s a management or covenant driven?

We don’t have firm caps from a management perspective. We obviously have financial covenants that we need to adhere to.

Can you just let us know what those covenants are?

Yeah. I mean, they’re public in our debt documents. So under our current accounting that has existed since January 1, 2020, we have a net funded debt-to-equity ratio of 5.6:1 under our senior notes. We can’t make a restricted payment, which is basically a buyback, if the effect of such payment would be to cause our net funded debt-to-equity. So debt less unrestricting cash to exceed 3.25:1 on the accounting that existed at the time of issuance, so pre-January 1, 2020 accounting.

Okay. That’s a good segue to my next question actually. So that cap might not be impacted so much by the GAAP provision as you start to grow again, where the GAAP provision was weighing on you building retained earnings equity, is that right?

That’s correct. The timing of income recognition under CECL is significantly different than it was under our prior basis of accounting.

Okay. Thanks. And then if I could just ask one more quick one. I noticed that for the past few quarters, other income has been benefiting from a decrease in average claim rates on the GAP contracts. If I think about the elevated cost of replacing a car, I’d expect folks to be pretty eager to make a claim on those contracts. So what do you think is the driver of the decrease in claim rates lately?

Well, I think, actually the provision for claims that’s included in our income statement is on one of our vehicle service contract products. And I believe that claim rates or claims as a percent of premiums earned were actually up this quarter. So two different products you have guaranteed asset protection which includes – is included in other income and ancillary product profit sharing. And then you have the provision for claims on one vehicle service contract product that goes through the provision for claims line.

Okay. That makes sense. Thank you.

And thank you. Our next question comes from John Rowan from Janney. Your line is now open.

Good afternoon guys. Doug, I just want to – I just want to make sure I understood your earlier comment on inflation and how it impacts your consumers because it sounded like you were talking about whether or not it impacted the vehicle prices. And obviously for a long time we’ve had a conversation about vehicle prices not having a big impact on your company. Were you really only talking about payment rates? Or are we talking about repossession and a change in repossession rates and severity? Thank you.

No, I was talking about it impacting the customer’s ability to pay. If they’ve got to spend money for gas and their food bill costs more, that’s what I was talking about.

Okay. Thank you. Because there was a whole conversation with the Manheim in there as well. So I just wanted to make sure I understood what you were talking about. That’s my only question. Thank you.

Okay. Thanks John.

Thank you. We have a follow-up from Ray Cheesman from Anfield Capital Management. Your line is now open.

Doug, one of the – one of the other people who also is in the lending business that you’re in indicated recently from a competitive standpoint that the credit unions were using some words that verged on out of control where everybody else was raising rates to accommodate changes in the market rate structure, and credit unions were in its opinion very much more aggressive than they should be. I was just wondering if you see anything like that? Or if you’ve said to me in the past that generally when economic conditions get less great, some of the easy, the lazy capital pulls back, and lets you guys do better? Any comment on that thought.

Credit unions have generally written a lot of subprime auto finance business over time. I’m not close enough to the data to really say whether they’ve gotten materially more aggressive in the current environment or not. I’m sure our analytics people know the answer to that, but I haven’t asked them that question.

Thanks very much. And thank you. With no further questions in 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 in our conference call today. If you have any additional follow-up questions, please direct them to our investor relations mail box at [email protected]. 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.