Earnings Call Transcript - CACC Q2 2024

Operator, Operator

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’s 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 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 second quarter results.

Ken Booth, CEO

Thanks, Jay. We had a mixed quarter 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’ve made an additional $147 million adjustment to forecasted net cash flows on top of our normal loan forecast model, but just for our loans originated in 2022, 2023, and the first half of 2024, where we believe the ultimate collection rate will be based on trending data over the last several years. Historically, our model has been very good at predicting loan performance in aggregate, but our model worked faster in 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, etc., 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 that 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 of the industry. We price to maximize economic profit over the long term, and we seek the best position when access to capital becomes limited. Ultimately, we are glad we have the discipline to maintain underwriting standards during easy money times of 2021 and especially 2022. Our market share was lower during those years, but 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 a new record high of $8.6 billion on an adjusted basis. Our market share in our core segment continues to increase to 6.6% as of May 31, 2024. Beyond these two key drivers, we continued making progress during the quarter toward our mission of creating intrinsic value and positively changing the lives of our 5Cs 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, allowing for incremental sales for the roughly 55% of adults with less-than-prime credit. This enables them to obtain a vehicle to get to their jobs, take their kids to school, etc., but also gives them the opportunity to improve or build their credit. During the quarter, we originated 1,057 contracts for our dealers and consumers. We collected $1.3 billion overall and paid $84 million in portfolio profit from our dealers. We added 1,080 new dealers in 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 to try 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 team performs work with the goal of increasing the speed at 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 Practices Institute recognizing us as a Great Place to Work. We continue to focus on making our workplace even better to support our team members in making a difference in what matters to them in connection with their efforts. They contribute to organizations such as the Make-A-Wish Foundation, St. Jude Children’s Research Hospital, the Shades of Pink Foundation, and the Versiti Blood Center of Michigan, among others. Now Doug Busk, our Chief Treasury Officer, Jay, and I will take your questions.

Operator, Operator

Our first question comes from Moshe Orenbuch of TD Cowen. Your line is now open.

Moshe Orenbuch, Analyst

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

Doug Busk, Chief Treasury Officer

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 have done simplistically is to assume that the ‘23 and ‘24 originations are going to exhibit similar trends in terms of variance from the initial forecast and the slope of the collection curve, which we provided color over time. We are assuming those percentage changes will be similar to what we have seen in 2022. Those trends that we are seeing in ‘23 and ‘24 are there, but they are less severe than the ‘22 loans. Since both books of business are also performing better from an absolute perspective, the adjustments in percentage terms are less significant than the misses we are going to have on the ‘22 business. So, it was really just assuming that the ‘23 and ‘24 originations will behave similarly on a percentage basis to what we have seen on ‘22.

Moshe Orenbuch, Analyst

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

Doug Busk, Chief Treasury Officer

Well, I think that 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 will behave similarly. All else equal, if we have loan performance exactly as expected, we would expect the yield or revenue, if you want to look at it similarly, 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 whether loan performance is better or worse than expected. But all else equal, we would expect revenue or the yield on the portfolio to decline.

Moshe Orenbuch, Analyst

Last one for me. I’m honestly struggling to phrase this, but given that this is the second of these in basically a year, I guess why is it a good thing that you are originating more loans? Shouldn’t you be doing the opposite? Should you be pulling back and saying maybe we are doing something wrong here?

Doug Busk, Chief Treasury Officer

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 are going to see from others in the industry. So, we think it’s adding shareholder value to continue to originate the business that we are originating. As I have said, we feel better about the ‘23 and ‘24 loans than we did about the ‘22 loans, which were obviously very disappointing to us.

Operator, Operator

Thank you. Our next question comes from John Rowan of Janney Montgomery Scott. Your line is now open.

John Rowan, Analyst

Good afternoon, guys. I guess I am going to 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 are putting into the prior forecast revisions? And I guess just trying to figure out if there is more risk of continuing to write the portfolio down if we are aggressive on some of the assumptions that are still writing to relatively high spreads historically speaking.

Doug Busk, Chief Treasury Officer

I mean we are – as I have said, we are basing our current estimate for ‘23 and ‘24 on the absolute performance to date of those vintages. Then we are applying a similar degradation in the collection rate over time to what we have seen in 2022. Now, we are using history as our guide there, and forecasting consumer loans, especially in recent years, has been challenging. So, we are putting our best number on it, but there is always a chance we could be wrong.

John Rowan, Analyst

Okay. And then just for 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 real diluted share count would be, or how many dilutive shares you have, so going forward, we get that in the model?

Ken Booth, CEO

Yes. I think if you look at our 10-Q, in the earnings per share footnote, it will show you how many shares were anti-dilutive for the quarter. Since it was a loss, we need to stick with the basic shares. Just taking a quick look here to see what was excluded as anti-dilutive. It was around 217,000 shares for the quarter.

Operator, Operator

Thank you. Our next question comes from Rob Wildhack of Autonomous Research. Your line is now open.

Rob Wildhack, Analyst

Hi guys. One more on the ‘23 vintage. Some other lenders have talked about the early part of that year, perhaps the first quarter of 2023 loans, originating then are driving underperformance for that vintage. Would you echo that, or is the underperformance that you are seeing in 2023 pretty broad-based across originations throughout the year?

Doug Busk, Chief Treasury Officer

No, I would say that’s a fair comment. We see a situation where the early ‘21 loans performed better than the last half of ‘21. The first part of ‘22 was kind of the bottom from a performance perspective. Things got somewhat better at the end of ‘22 and improved in the first part of ‘23, but the underperformance of the second half of ‘23 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, Analyst

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, July looks pretty strong at plus 28%. Anything to call out there? Is July benefiting from an easy compare or anything like that, or do you think you can continue to grow at that pace going forward?

Ken Booth, CEO

I think it’s always difficult to predict. There are a lot of macro uncertainties regarding the competitive environment, inflation, interest rates, things like that. And you are right that it improved throughout the quarter and into July; whether that continues or not, it’s really tough to say. We will have tougher comparables going forward. That being said, we have made improvements to our product, and we are hoping that’s making a difference as well, which we believe is having a positive impact. So, if you look at buying from the dealer itself, that’s a good sign for us, which means our product is probably better and that our competitive environment is better, and hopefully that continues.

Doug Busk, Chief Treasury Officer

Yes. I think the other point I would add to what Ken said is it’s hard to draw any conclusions from just looking at one month at a time. 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, when you break it down into smaller units, you obviously get more variability.

Operator, Operator

Our next question comes from Ryan Shelley of Bank of America. Your line is now open.

Ryan Shelley, Analyst

Hi 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. Can you just explain the rationale there? And yes, like what definition changes are all about? Thanks.

Doug Busk, Chief Treasury Officer

Yes. I mean as we have 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, we are looking at the forecasted amount and timing of the cash flows and discounting that back, which gives you a yield. We are using that yield for revenue recognition. If every month you reforecast the loans, and if your forecast goes up or down, you adjust your forecast accordingly. The adjustments that we made to the definitions and 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 achieve level yield revenue recognition based on forecasted cash flows.

Ryan Shelley, Analyst

Got it. Thanks. Thanks for the time.

Operator, Operator

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. 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.