Earnings Call Transcript - CACC Q3 2024

Operator, Operator

Good day, everyone, and welcome to the Credit Acceptance Corporation Third 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’s website. At this time, I’d like to turn the call over to Credit Acceptance’s Chief Financial Officer, Jay Martin.

Jay Martin, CFO

Thank you. Good morning, and welcome to the Credit Acceptance Corporation third 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 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 third quarter results.

Ken Booth, CEO

Thanks, Jay. Overall, we had another mixed quarter as it relates to collections and originations, two key drivers of our business. Our 2022 vintage continued to underperform our expectations and 2021, 2023, and 2024 also declined. Overall, a modest decline of 0.6% or $62.8 million in forecasted net cash flows. As we have previously communicated, historically our models are very good at predicting loan performance in aggregate, but our models work best during less volatile times. The pandemic and its ripple effects created volatile conditions, such as federal stimulus, enhanced unemployment benefits, and supply chain disruptions like vehicle shortages and inflation, all of which impacted competitive conditions. We had larger-than-average forecast misses, both high and low during this volatile period. But because we understand forecasting and collection rates is challenging, our business model is designed to produce acceptable returns in the aggregate, even if loan performance is less than forecasted. Despite the decline in forecasted collections this quarter, we believe we will continue to produce substantial economic profit per share in the future. Given our worst vintage, 2022, is still forecasted to produce economic profit. As I explained in the past, we are less reactive to changes in competitive economic cycles than others in the industry, because we take a long view in the industry; we price to maximize economic profit over the long-term and seek the best position in the company if access to capital becomes limited. Ultimately, we are happy with our discipline to maintain underwriting standards during the easier money times of 2021 and especially 2022. While our market share was lower during those years, we believe this 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 Q3 unit and dollar volume ever, growing our loan unit and dollar volume by 17.7% and 12.2% respectively. This is our ninth quarter in a row with double-digit unit volume growth. Our loan portfolio is now at a new record high of $8.9 billion on an adjusted basis, up 18.6% from Q3 2023. Our market share in our core segment was 6.2% as of August 31, 2024. Our growth did slow during the quarter, likely impacted by our Q2 forecast changes that resulted in lower advance rates during Q3. Beyond these two key drivers, we continue 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. This allows dealers to make incremental sales for roughly 55% of adults with non-prime credit. For these adults, it enables them to obtain a vehicle to get to their jobs, take their kids to school, etc. It also gives them the opportunity to improve or build their credit. We recognize that it's been a challenging time for our consumers impacted by recent hurricanes. As we have for many years, we are working with these consumers, including suspending some of our collection efforts, to allow these customers to prioritize their safety and most urgent needs. During the quarter, we financed 95,670 contracts for our dealers and consumers. We collected $1.3 billion overall and paid $71 million in portfolio profit to our dealers. We added 1,038 new dealers for the quarter and now have our largest number of active dealers ever for a third quarter with 10,678 dealers. From an initiative perspective, we are committed to improvement through our go-to-market approach, aimed at providing product innovation and support to our dealers faster and more effectively than ever before. This requires teamwork, attention to detail, and an iterative process that attempts to make improvements every step of the way. This is a work in progress, but we are getting better. We are also continuing to invest in our technology team. We've improved our team's capabilities and are focused on modernizing both our key technology architecture and how our teams perform work with the goal of increasing the speed at which we enhance our products for dealers and consumers. During the quarter, we received four awards from Fortune, USA Today, and People Magazine recognizing us as 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 in what makes a difference to them in connection with their efforts. We contributed to organizations such as 42 Strong, the American Foundation for Suicide Prevention, the Atlanta Area School District, Children's Hospital of Michigan, and the Pure Heart Foundation. Now, Jay Martin and I will take your questions along with Doug Busk, our Chief Treasury Officer; Jay Brinkley, our Senior Vice President and Treasurer; and Jeff Soutar, our Vice President and Assistant Treasurer.

Operator, Operator

Our first question comes from Moshe Orenbuch with TD Cowen.

Moshe Orenbuch, Analyst

I appreciate your confidence that the returns exceed your hurdle rates, but could you elaborate on that idea? All of these are based on estimates, which have been revised downward for six consecutive quarters. The real question is, how can you be sure, and will we be having the same discussion in 90 days? How should we approach that?

Ken Booth, CEO

Our estimates in the third quarter release reflect our best predictions on how we believe these loans will perform in the future, taking into account the underperformance observed so far with post-pandemic vintages. Regarding future expectations, our forecasting models are most accurate during stable economic times, but as Jay mentioned, their accuracy diminishes during volatile periods like those experienced since the pandemic. The most significant declines this quarter were seen in the '21 to '22 cohorts. It is difficult to pinpoint exactly why these cohorts continue to underperform, but we suspect several factors at play, such as the loans being originated during a highly competitive period, which tends to negatively impact loan performance. Consumers acquired vehicles at peak prices, which later decreased, along with the effects of inflation. We are aware that other companies in our sector have faced similar or even worse performance concerning these cohorts, indicating this trend is not exclusive to Credit Acceptance. Concerning the '21 to '22 business, it's important to note this business is now more seasoned; we have collected 81% of our expected total for the '21 business and 61% for the '22 business. In the future, these cohorts will impact our financial results less significantly. Instead, the performance of our '23 and '24 loans will have a greater effect since we originated more business during those years, and those loans are also becoming seasoned. Looking ahead to next year, our results will be even more influenced by what we write in '25.

Moshe Orenbuch, Analyst

I guess I would just maybe tack on to that the idea that, it isn't so much about volatility, it's about different factors affecting what has driven consumer behavior in this cycle versus previous cycles. And I guess it just pushes me to this question of, is it an estimation problem or is it an actual underwriting problem? Have you thought about changing the way you actually underwrite these loans?

Ken Booth, CEO

Let's say our forecast, we continue to consider recent performance. So, as we're originating new loans, we've considered the underperformance that we've seen in these '21 and '22 loans. So we've adjusted and lowered our initial estimates on those future loans to consider that. So we believe we are considering the underperformance there. And as I mentioned before, we don't believe this is a problem unique to Credit Acceptance. We believe we're seeing this across the industry. That's accordingly moving forward.

Moshe Orenbuch, Analyst

And then just last one for me. You didn't buy back any stock in the third quarter or in October to date from the filing of the Q, it looks like. So can you just talk a little bit about capital? It looks like loan growth is strong, but decelerated a little. Can you just talk about that?

Jay Martin, CFO

Sure. As we said many times over the years, our first priority is to make sure we have the capital that we need to fund the business. If we feel we have excess capital, then we'll take a look at the stock price, and if we think we can buy it for less than intrinsic value, we'll return capital to shareholders. For most of Q4, we had higher outstanding balances on our revolving credit facilities than we customarily do. Now that situation was remedied at the very end of September when we did a relatively large ABS deal. So given the fact, we had more revolver usage and the leverage at the end of Q3 is at the high end of the historical range and given uncertainties about collection performance and capital market conditions in light of the election, we took a bit more of a conservative approach. As you know, we've repurchased a significant number of shares over a long period of time, over 30 million shares since the late '90s. But we don't do it consistently; some periods we buy back a lot, some periods we buy back very little. So I don't think that you can take a look at one quarter and assume that's the basis for a new trend line.

Operator, Operator

Our next question comes from the line of John Hecht with Jefferies.

John Hecht, Analyst

Good morning, guys.

Operator, Operator

John, you may have muted your line. We have a question from the line of John Rowan with Janney Montgomery Scott.

John Rowan, Analyst

I want to explore what lower consumer prepayments really mean. We have previously asked if this relates to fewer repossessions or lower wholesale activity after repossession. I would like to clarify whether it involves not obtaining the judgments necessary when suing for a deficiency, if it’s about consumers failing to pay older debts, or if there has been a significant increase in the number of consumers defaulting on loans. I'm seeking a clearer understanding of this somewhat vague term.

Ken Booth, CEO

Yes, it's primarily referring to consumers refinancing their loans and moving on to either traditional forms of financing or purchasing a new car. In periods where there's limited availability of credit to consumers, we tend to see lower levels of prepayments, and that's what we're currently seeing now.

John Rowan, Analyst

But that's driving a lot of forecast revisions. But I mean, look, I've covered the company for a long time. There have been periods in which there's been absolutely no credit availability, right? And to consumers even, I mean even much worse than right now. How does that compare historically to those periods?

Ken Booth, CEO

I would say we're near historical lows there currently. So we have seen similar low periods, but this is one of the lower periods that we've seen, and our forecast uses more of a historical average of what we've seen with prepayments, and we've seen that come down, which pushes our cash flows out into the future, which lowers the yield that we'll realize on the loans.

Jay Martin, CFO

I would just add that forecasting the timing of cash flows is challenging since it's dependent on the competitive environment, and no one can really forecast how a competitive environment is going to behave in the future. So it is challenging; I think we take our best track at it, but it's tough.

John Rowan, Analyst

But actually, let me ask you another question. So if people aren't refinancing their cars, why is that? Is that a function of used car prices that they're sitting on a negative equity position and they don't want to refinance the car and owe some money? Or what is driving that lower level of refinancing activity?

Jay Martin, CFO

Yes, I think that certainly could be a factor. And I think just the general availability of credit to the consumer is also a factor. But I think the factors you mentioned are contributing factors.

Operator, Operator

Our next question comes from John Hecht with Jefferies.

John Hecht, Analyst

Apologize for the technical issue earlier. I just kind of follow on questions for both of the preceding questions. I know this cycle's unique, but in historical cycles where your capital was scarce and maybe there was disruption in the environment, those tended to be favorable environments for you. As an example, thinking about post the great financial crisis, this one continues to be challenged. I guess the question is, what do you guys think has to happen to clear the market out to the point where it isn't an opportunistic environment for you? Is it simply just work through the ‘22 vintage? Do residual prices need to come down further? Or what other factors might we look out for?

Jay Martin, CFO

I believe it is mainly about adjusting our loan forecasts when we are originating new loans to reflect the performance we have observed. This process will continue. I previously noted that the loans from 2022 will have a reduced impact on our financial results moving forward; our outcomes will be more influenced by the performance of our 2023 and 2024 businesses and, looking ahead to next year, how our 2025 business performs. However, as Ken pointed out, we understand that predicting collection rates is challenging. Therefore, we have developed a business model that aims to deliver acceptable overall returns, even if loan performance falls short of expectations. We will maintain this approach as we progress.

Operator, Operator

Our next question comes from the line of Rob Wildhack with Autonomous Research.

Rob Wildhack, Analyst

Question on the '23 and '24 vintages specifically. The second quarter earnings, I think you mentioned that you expected '23 and '24 to behave similarly to '22. As it stands today though, forecasted collections are 4% and 6% points higher for ‘23 and '24, respectively, versus '22. How should we square that difference? Do you think there's another shoe to drop with respect to '23 and '24? And if so, when do you think that could happen?

Jay Martin, CFO

Yes. I think it's difficult to look at just the absolute collection rate because we've originated different mixes of business during those years. I think we need to look at our variance to our initial forecast, and you'll see that's currently lower on the '23 and '24 loans. Part of that is due to us having lowered our initial estimates on the '23 and '24 loans when we have originated that because we had started to see some underperformance on the '21 to '22 loans we considered that. And then we're also looking at the trends of what '23 has done so far versus '22, and we know those loans are performing better. So based on those two factors, we believe that the '23 business and the '24 business performed better than the '22 business. But I would also point out especially the '24 business is not very seasoned at this point.

Ken Booth, CEO

Yes. And I would just add that we said in prior calls that we were observing a similar trend in underperformance on the '23 and '24 loans, though that trend was less severe on the '22 loans. So we are seeing a similar pattern, but less severe. And then to Jay's point, we've adjusted our forecast or forecast on '23 and '24 was more conservative than '21 and '22.

Rob Wildhack, Analyst

How do the recent hurricanes, how will those impact forecasted collections, if at all?

Jay Martin, CFO

The hurricanes impacted mainly Florida and North Carolina. Those two states are about 4.2% and 1.5% of our portfolio. But obviously, the hurricanes did impact the entire state. Overall, there is really not that material impact to our portfolio. That said, they've been incredibly impactful for the people in the direct path. So consistent with our approach for many years, we're working to get those impacted by the hurricanes in ways to help them get back on their feet.

Rob Wildhack, Analyst

If I could just sneak one more in and ask Ken about something you highlighted earlier, specifically that the '22 vintage would still generate economic profit. I was wondering if you could give some more context there, like, how much more economic profit does a good vintage like, say, 2019, generate versus 2022?

Ken Booth, CEO

I mean, we've got wide variance of the economic profit. Obviously, 2019 was buoyed by stimulus payments and it over collected. I don't really want to get into details of our kind of profitability by vintage. But I guess what I would say is 2019 was a highly profitable vintage and 2022 is a lesser profitable one, but they all produce economic profit, which means they're all profitable vintages.

Operator, Operator

Our next question comes from Ryan Shelley with Bank of America. Ken Booth, CEO, mentioned that there is significant variance in economic profit. He noted that 2019 benefited from stimulus payments, which contributed to its higher profitability. While he didn't want to discuss profitability by vintage in detail, he indicated that 2019 was very profitable, whereas 2022 was less so; however, all vintages still generated economic profit, meaning they were all profitable.

Ryan Shelley, Analyst

Quick question here. So the active dealer count has come down a few quarters now. Can you just touch on what's driving that? Is that like a function of the softer market? Or being more selective? Just any color there would be great.

Ken Booth, CEO

I think active dealer counts were fairly flat to be honest. It was higher in the first quarter due to seasonality. I would say in terms of the competitive environment for a while it seemed like a lot of people were pulling back. It seems like that subsided somewhat, and maybe the competitive environment's returning more to a normal environment. However, that being said, we've still been able to grow our market share, and we're on pace for our highest buying meter ever. So I feel good about where we're at in terms of the competitive environment and how we're being able to grow the business.

Ryan Shelley, Analyst

And then just one more quickly if I could. So you have a bond maturity in March ‘26, but it's callable at par now. How should investors think about your thought process around addressing that?

Ken Booth, CEO

Right, yes. We're watching market conditions there very closely. Two good facts with that bond tranche: first, we have plenty of time; it doesn't mature until March of 2026, so we have a year and a half to do something. The other good fact there is relatively small, $400 million, so it's small relative to the size of our balance sheet and our liquidity. So we have plenty of options. We can refinance it in the senior note market, we can refinance it using securitization, or we can just draw on our existing liquidity. Rates for a new bond issue would probably be higher than that coupon on those notes today. So we're not in a rush to do anything with it. So we'll continue just to monitor it and do something appropriate before the maturity.

Operator, Operator

Our next question comes from the line of John Rowan with Janney Montgomery Scott.

John Rowan, Analyst

Hey guys, just one follow up. The 2022 vintage is now sitting at a 13.2% spread versus an initial of 20.1. Obviously, it's a relatively big decline, but how do we think about where the level of economic profit doesn't become justifiable, right? I mean, 13.2% spread if that's a proxy for the internal rate of return to that pool. I mean, or do we just look at that number to go down to your funding costs, or where does that number become uneconomical to you?

Jay Martin, CFO

I mean, it depends on which program you're talking about. So on the purchase program, a 1% decline in the forecasted collection rate, you tax-effect that, and you have to account for timing. But that ends up driving a reduction in our return. The portfolio program is a little bit more complicated to think about because the shortfall of collections is shared on an 80/20 basis with the dealer up to a certain point. The portfolio program insulates us from variations of consumer loan performance, where the purchase program doesn't. So the purchase program is obviously a lot more sensitive. Our profitability on the purchase program is more sensitive to declines in forecasted collection rates than is the portfolio program.

Operator, Operator

With no further questions in queue, I would like to turn the conference back over to Mr. Martin for any 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 ir.creditacceptance.com. We look forward to talking to you again next quarter. Thank you.

Operator, Operator

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