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Credit Acceptance Corp
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Good day, everyone, and welcome to the Credit Acceptance Corporation's Third Quarter 2019 Earnings Call. Today's call is being recorded. A webcast and transcript of today's earnings call will be made available on the Credit Acceptance's website.
At this time, I would like to turn the call over to Credit Acceptance's Senior Vice President and Treasurer, Doug Busk.
Thank you. Good afternoon, and welcome to the Credit Acceptance Corporation's third quarter 2019 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 contains 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, Brett Roberts, our Chief Executive Officer; Ken Booth, our Chief Financial Officer; and I will take your questions.
[Operator Instructions] Your first response is from John Rowan of Janney. Please go ahead.
Good morning guys.
Good morning.
So, obviously, I think the most concern here is just the disclosure on CECL in the 10-Q. Is it – are you going to have two portfolios when you adopt CECL? Or is this all going to be just one loan portfolio?
I mean, you’re going to have a dealer loan portfolio, and then you'll have the purchase loan portfolio that exists as of 12/31/2019 will be accounted for as it is today, and purchase loans are originated after 1/1/2020 will be accounted for under CECL. Well, let me clarify the purchase loans will be accounted for as prescribed under transition relief.
Okay. Is that a timing issue? It sounds like in the Q, that there’s a big upfront provision to establish the allowance for new loans, right. And obviously, you guys have to generate a lot of new loans given the asymmetrical nature in which you collect loans, a lot of early payment defaults in – not really early payment but there's a lot of losses that are upfront in a typical pool. Is this – like I said, is this a timing issue? Like when we get to a period in which your portfolio kind of has a full duration of CECL-compliant loans within it, does – do the economics moderate out, meaning like just 2021 or 2022, and you get to the back end to where it's conceivably more profitable to CACC so that we get to some type of parity in the reported results?
I mean, CECL is all timing. So we're going to record a provision upfront. And as we say in the Q, we're going to record more revenue, an equivalent amount to the provision upfront in revenue over time. So the impact of CECL will be greatest, as we say, in the period of adoption because you have all of the upfront provision, but a modest amount of revenue recorded at that higher yield.
So we start off, let's just say, we start off with a 60% reduction in comparable net income, and we get down to 30% by the end of the year, sort of the ranges that you provided in the Q. I mean, do they continue to moderate down into 2021 as the revenue catches up to that upfront provision?
I'm trying to figure out if 2021 and 2022 earnings are down 30% to 60% as well or if there's a point in time at which the revenue catches up to the provisioning and you have a full duration portfolio of CECL loans in there, where now your reported results match the economics of the loans, which frankly are probably more appropriate under the current accounting methodology. What point in time does that match?
Well, it all depends on growth. So if you assume a constant growth rate and assume loan performance is exactly as forecast, the difference between CECL net income and net income, as reported under our current accounting, will narrow over time.
So you don't want to give us an idea of how far out that time is when the narrowing gets indiscernible?
No, we are not really going to provide any incremental disclosure in that regard relative to what's in the Q.
Okay, but will your provision expense be – I mean, are we going to get net charge-off and delinquency data like most finance companies provide? Or is that still – or is this just kind of porting your current reporting, which has forecasted collections and advance rate? Are we – is this still going to look the same? Or is this going to be now look like other types of finance companies with the data that we get to build out an allowance, the charge-off and the provision going forward?
We will continue to provide the forecasted collection rate and advance that information we do today, and we'll provide whatever supplemental disclosure is required under CECL.
And then you said that you're going to have to gross up the loan portfolio and then take – basically, net the difference out of the allowance. Why the gross up? Is the gross up because now you're reflecting the loan to the consumer? Or is it still the advance of the dealer- that is your receivable? And if so, why the gross up?
I mean the gross up is basically what's required under the PCD method in CECL. And what the gross up reflects is we'll calculate an effective interest rate based on the expected cash flows and increase both the loan receivable and the related allowance by the PV of the difference between contractual cash flows and expected future cash flows. So CECL has this kind of starting point relative to its accounting relative to contractual cash flows. So we're grossing the balance sheet up to reflect the contractual cash flows and the difference between expected cash flows on a present value basis.
Are we talking about cash flows that the consumers are paying, right? Or is that the cash flow based on the pool?
It will be the pool.
Okay. Alright, thanks. I’ll let someone else hop on.
Thank you. Your next response is from James Ulan of Credit Suisse.
Good morning. Thanks for taking my question. The lifetime loss estimate was pretty good. I was just wondering how much the dealer hold-back and loss-sharing reduces your lifetime loss expectations.
Like I said a minute ago, we're not going to provide any incremental disclosure relative to CECL. But obviously, if we're split in the collections 80-20 with the dealer, and you compare expected future net cash flows to contractual future net cash flows, that dealer hold-back is a significant element.
Got you. And then if I could ask an unrelated second question. Revenue from eliminating the dealer fee, can you just talk about that decision and maybe quantify that?
Well, the disclosure of the amount of dealer enrollment fees is on – in Footnote 8 in the 10-Q. It was $1.4 million in the third quarter of this year, and it was just designed to make the portfolio program more attractive.
Got you. That’s it from me. Thank you.
Thank you. Your next response is from Hugh Miller of Buckingham.
Hi, thanks for taking my questions. Just maybe a couple of follow-ups on the enrollment fee. So you typically have been recognizing about $4 million of that enrollment fee on an annual basis. Is there any runoff to that? Like how do we think about it – the wavering of that fee? Does that $4 million just basically go to zero in 2020? Or is there any kind of runoff on the recognition of that fee?
Yes. There will be some runoff. So it will gradually go from $1.4 million, which is what this quarter is, it will gradually wind down to nothing over the next year or so.
Okay. And then can you give us a sense as to the potential impact on bringing on new dealers to the portfolio program? How often are you seeing kind of that upfront fee being a headwind? I know you provide optionality from which the dealer can pay for that. But what's the potential impact of bringing on new dealers?
And then as you think about kind of the dealers maybe then – would they – would current dealers be able to maybe then come and go from the program as they may want to for a period of time without having to think about paying that upfront re-enrollment fees? So could you – is there a potential that you could see a dealer that takes six to 12 months and doesn't do as much business or any business and then kind of can come back in and re-enroll in the program? What's the potential impact from that standpoint?
So we eliminated the fee, obviously, to get rid of an obstacle to growing the dealer program. But it's hard to say how that will play out in the enrollment metrics going forward.
But it is – would it be a case in a scenario where someone who is an active dealer on the platform could stop participating for a period of time and then come back to the program without any disincentive for re-enrollment fee?
I don't think that's going to be a huge factor going forward. I mean historically, dealers have been able to stop using the program and restart. So that's not going to change.
Okay. And then another question just on the auction lanes. We have seen some reports that indicate kind of some lane pricing weakness that we've – in October. Can you just talk about what you're seeing in the auction lanes so far in October? And have you experienced any uptick and maybe no sales in the auction lanes, if you're not getting the bids that you're expecting?
As we've talked about on prior calls, used vehicle prices are a very small percentage of our overall net cash flows. Historically, the best used car market environment and the worst hasn't had a huge impact on the overall collection rate. So we haven't seen anything to date that would materially affect collection rates.
Okay. Thank you.
Thank you. Your next response is from David Scharf of JMP Securities. Please go ahead.
Yes. Good morning. Thanks for taking my question. Obviously, a lot of moving pieces we're still going to have to work through regarding CECL in refining our forecast. But I'm wondering, just it's more of a practical operational, not accounting level. I know you don't give guidance, but I'm wondering directionally, as you look at kind of where the size of your sales force is now sort of the seasoning and productivity of them.
Given your expectations, I guess, for the growth in the dealer network going forward, based on those assumptions as well as the competitive environment and what's roughly, give or take, 10% year-over-year decline in volume per active dealer. Would we generally expect origination volume to increase in 2020 on a year-over-year basis based on everything you're seeing right now?
It does sound like you're asking for a forecast. We're not going to end up forecasting next year. I mean we have still a small share of a very large market. So we're hoping to continue to expand our share in the future. And we'll just have to see how that plays out.
Okay. Maybe I can try to box you in a little phrasing and a little differently. Based on the competitive environment you see today, which seems pretty similar to what we've been experiencing for the last couple of years, you've had a couple rounds in recent years of escalating sales count hiring to expand the footprint. With the pullback in rates, what are still an attractive ABS market suggestions that there probably may still not be any kind of competitive shakeout on the horizon. Are you foreseeing any incremental hiring above and beyond just sort of the normal year-to-year? And any kind of ramp-up in sales headcount over the next 12, 18 months?
Probably not a material ramp-up. We have established our – the target size of the sales force. So we have every zip code in the country mapped out to a sales territory. We've largely hit our target there. You're never going to have every single territory filled because of turnover. And now it's just a matter of trying to improve the productivity of the sales force we have. That’s the current plan.
Okay, got it. Thank you very much.
Thank you. Your next response is from Giuliano Bologna, BTIG. Please go ahead.
Good morning, and thanks for taking my questions. I guess starting on a similar topic on CECL. Is there a way of thinking about the average duration of the assets? And by that, what I mean is how fast you would recognize the offsetting revenue that you’re taking on the reserve side.
I mean I think the best thing to look at is the table in our press release that shows the percent of forecast realized. I mean I think that will get you in the ballpark.
Okay. That makes a lot of sense. And then I guess, thinking about a similar question about what you’re saying that you’ve cited the largest impact in the first quarter. Obviously, I heard you say that there’s obviously going to be more of an allowance impact and less revenue impact in the first quarter of adoption. Is there any difference in the recognition of the gross-up versus the allowance on the legacy portfolio? Or does that all happen at the same time and is all recognized in full?
I mean the gross-up will happen all at once, and then we would recognize revenue going forward off to expected future net cash flows, off of that yield. So the legacy portfolio really, there won’t be much of a – aside from the balance sheet gross-up, there won’t be that much of a CECL-related impact.
Sounds good. Then kind of shifting a little bit to the competitive environment. Obviously, your unit volume hasn’t been growing as fast you’ve seen – how your dollar volume increased faster than unit volume for a little while. Is there any kind of limitation on your ability to continue increasing dollar volume versus unit volume?
Yes. I don’t think that’s going to be a long-term driver of results. I mean there is a limit to how much you can increase the size of the average transaction. What that is, I don’t know, but I don’t see that being a long-term driver of our results.
That was it. And – well, I guess one last one. One of the things that – obviously, you’ve historically done a great job in terms of going out and pitching a lot of the used car lots, a lot of the buy-here-pay-here-type dealers. At least in some of my checks have heard of a lot of OEM kind of dealers getting calls from your sales force or at least being pitched. Have you had much success in breaking into some of these kind of new car dealerships?
Yes. I think we have. I think we’re – we’ve made a lot of progress there. I think a lot of the increase in the purchased loan penetration rate over the last several years is due to our success writing business with those stores.
That makes sense. Thank you for taking my questions.
Thank you. Your next response is from Benjamin Weinger of 3-Sigma Value. Please go ahead.
Hi. In your CECL disclosures, you say that 2020 earnings will be down approximately 30% to 60%. And I’m looking at consensus for 2019 is about $35 per share. Does that mean that 2020 earnings are going to be between – if I take the 30% and the 60% down range will be between, let’s call it, $14 and $24?
I guess it depends on what your projection for 2020 would have been under current GAAP.
Okay. But based on – if I’m just using consensus for $35, then we should expect 2020 earnings to be somewhere based on our own modeling between $14 and $24.50.
I mean I think if you’re going to do the math there, I mean you see – I’ll start with a number and you apply 30% to 60% to it.
Okay. Second question is just regarding on the buildup of the reserve. If I take the 15% just for simplicity of loan loss amount and I apply that to the grossed up amount of loans, I’m getting a reserve of about $1.4 billion, and your current reserve is about $500 million. So number one, does that mean that the loan loss reserve will increase $900 million? And secondly, is that $900 million going to be deducted from book value so that book value will be down from what was around $2.2 billion, so it should be down to around $1.3 billion?
Ben, are you asking relative to the transition relief portfolio, I presume?
I’m just – I’m looking at what is your book value going to be next year. And if we’re increasing the reserve sits by $900 million, then I’m assuming that book value will go down by $900 million. Is that correct?
Well, the transition relief portfolio will have no impact on book value. The CECL, as it relates to new loans, will require an upfront provision as we’ve described and be offset by an equal amount of revenue earned over the life of the loan.
Okay. So what you’re saying is when CECL is adopted, there won’t be a step-down in the adjustment in book value.
Correct. There will be a difference in the timing of income recognition.
Okay. So just so I understand, so we’re not going to see adoption, we’re not going to see a decrease in book value upon adoption.
Correct.
Okay. Thank you. That’s it.
Thank you. Your next response is from Dominick Gabriele of Oppenheimer. Please go ahead.
Hey, guys. Thanks for taking my questions. Just real quick, when you’re thinking about CECL and you’ve built the dealership, your web of dealers, I should say, has grown quite nicely across the country. And some would say that the real opportunity here given the penetration has been under pressure a little bit would be when others pull back, you can really jump in and really increase the penetration.
But this would be at a time, obviously, when most likely, the – when other people are pulling back, the economic outlook is not the best, potentially. And so when you think about the capital you would have to raise given what you have to reserve because of CECL in that environment, does that create any obstacles to that type of plan of attack? If that would be your plan to increase penetration, this capital an issue during that time period? Or would you change your plans, should I say, given CECL, does that alter your plans?
No. I don’t think we’ve – I don’t think we’d change our plan. We operate the liability side of the balance sheet very conservatively. We have a lot of unused availability under our revolvers. We have modest reliance on short term financing, and we’re lowly leveraged. So I think that, that capital structure sets us up to deal with a stressed capital market scenario pretty well. But obviously, you’d have to see how that plays out.
Okay. Great. And then have you – has there been any difference in the volumes, sort of the penetration this quarter given that a large player had stepped away for quite some time and seems to have had their originations jump up a little bit in this quarter? Have you seen any increased competition because of any large entrants reentering the market? And how do you – and would you expect that to potentially put pressure on the coming quarters?
It’s a very large market. So what one player does usually doesn’t impact our results. What happens going forward, we don’t really have a prediction on that.
Sure, sure. And then maybe I just missed it in the Q. Did you provide the lifetime loss? I might have just missed it. Was there a lifetime loss estimate?
I mean the lifetime loss estimates will just be in our Q or our press release, and they’d be one minus the forecasted collection rate. Obviously, on the portfolio program, you need to think about dealer holdback, too. But…
Great. Thanks so much guys. It really appreciated.
Thank you. Your next response is from Mark Hammond of Bank of America. Please go ahead.
Thanks. Good morning. With the general rally in rates, have you had an opportunity to get or maintain more favorable pricing either on the consumer loan, the advance or the purchase loan?
We haven’t changed pricing in response to rates.
Got it. And a similar question on rates, but more on the liability side. So how are you thinking about addressing the 2021 unsecured bonds? It’s two years away, but is it worth taking advantage of the rate environment and call in the 2021s early at par and extending the maturity?
It's certainly something we've been considering. We haven't made a decision yet.
Understood. Thanks for taking my questions.
Thank you. Your next response is from Randy Heck of Goodnow Investment. Please go ahead.
Thanks for taking my questions. So I just have a few questions on the CECL matter. Brett, is there any change to the economics of the business because of CECL?
No. CECL is just accounting.
Right. Is there any change to the economics of the business because of CECL?
No, there is not.
What will the – what will your lenders focus on? Will they continue to focus to accept adjusted earnings? Or will they focus on CECL?
I think they'll primarily focus on adjusted earnings.
Okay. So will you continue to report adjusted earnings like you have for the last 10 years or whatever the number is?
That’s our plan.
Okay. All right. I got you. Thank you.
Thank you.
Thank you. Your next response is from the line of John Rowan of Janney.
Hey, guys. Just a follow-up here. Just to be clear, so the allowance for loan losses is going – on 1/1/20 will gross up and keep the net number the same. But if you look at your number for that, was it 10% to 15% – or 12% to 15% booked upfront when you make a new loan? That's not the lifetime loss, meaning that, that's not going to be the allowance ratio of the overall pool because that would imply that the net number's going to have to actually go up. Because to me, it looks like you're going to have to have a $3-ish billion allowance on 1/1/20 for your entire consolidated loan pool, which is about right. It would be about 30% of the overall gross balance, meaning that would be the inverse of your forecasted collections. Does that sound right? Because one of the other questioners was focusing on like $1.5 billion number for an allowance, and that sounds kind of low to me.
Yes. The two separate things, the 12% to 15% would be our current estimate of the provision recorded at the time of assignment for new loans originated after 1/1/2020.
Okay. So that's not like a – that's not a full lifetime loss, meaning that's going to be your allowance ratio, right? It's going to have to be closer to 30%, which is…
No. That would – that's the amount of the provision we'd record at origination.
Okay. And then going forward, is the provision just going to be the net differential between the allowance from period to period? Or is that still based on the expected cash flows of the pool?
It will still be adjusted for the expected cash flows of the pool.
But – so – and as time goes on, does the portfolio – so the provision expense jumps at first, but then you said the revenue yield comes up over time. So the provision expense goes up, and that dilutes earnings, but the portfolio yield will come up as well over time. Did I hear that correctly?
Yes. Will – the revenue on loans originated after 1/1 of 2020, the revenue will be recognized at its effective interest rate that is based on contractual future cash flows. So that's how you recognize incremental revenue over time that offset the upfront provision.
Okay, all right. Thank you, very much.
[Operator Instructions] Your next response is from Vincent Caintic of Stephens.
Hey, thanks. Good morning guys. And sorry, some more CECL questions just I know it's a big topic. But just to clarify, so first quarter 2020 EPS or results are going to be the same metrics, the same tables that you have now, it's just you're going to add the CECL disclosures you have to. But the EPS that you're focused on and that presumably what we're going to be modeling on is going to be on what your current methodology for your financials?
Yes. I mean we have always run our business off of the adjusted financial results because we think that, that's the truest reflection of our underlying economic performance. And that's what we're going to continue to focus on, and we'll continue to disclose that.
Okay. That's helpful. And that smooths things out, so very helpful. And so no book value impact on January 1 because you're already – your balance sheet already has net losses, and so you're just basically going to break it out by having the gross – sorry, net loans by having the gross loans and then the allowance broken out separately.
But I guess I'm wondering for the – on the disclosure about the 2020 net income being affected 30% to 60%, with the greatest impact occurring in the quarter of adoption. I guess, what – why is the greatest impact going to be in the first quarter given that you've already, I guess, made the adjustments to book value there and you're just focusing on originated loans going forward?
Well, it relates to the loans originated after 1/1/2020. And it is because that we'll recognize the provision at loan originations on all the loans originated in the first quarter. We'll recognize revenue on those loans at a higher effective interest rate based on contractual future cash flows, but you'll have an upfront provision for each loan, but you'll have a modest amount of income recorded on those loans at that higher yield.
So that's why the impact will be greatest in the quarter of adoption. In subsequent quarters, you'll still have the upfront provisions, but you'll have a larger portfolio on which you're recognizing revenue at that higher contractual future net cash flow-based effective interest rate.
Okay. Got it. So each quarter will look the same, but because you're building up a portfolio of higher revenue, it sort of neutralizes the future quarters. Is that the right way to think about it?
Over time, all else equal.
Okay, perfect. And then – sorry, I also had a question about the 12% to 15%, when we think about that. So that's unrelated to the lifetime loss, which is – which you disclosed in your forecasted tables, is the 12% to 15%, that's I guess, how has that number determined? That's just the offset – the direct offset? Or what would be directly offsetted by the finance charge revenue? I'm just kind of wondering how that's determined.
Now, that’s the difference between what we pay for the loan and the present value of what we expect to collect, discounted at that effective rate associated with the contractual cash flows. So it's outlined under – in our 10-Q, there's a section called application of CECL to future loans that describes how it's done.
Okay. Got it. Okay. Thank you very much. Very helpful.
Your next response is from Dominick Gabriele of Oppenheimer.
Hi, sorry for the follow-up. Just to be clear, when you're going forward then, you're saying your existing book on both the dealer loans? I know this has kind of been asked, but your existing book on the dealer loans and the purchase loans have already been reserved in the way they should be. So going – there's no four year phase-in of any kind of to your reserve. We're just talking about new originations going forward. The rest is staying the way it is. Is that correct?
Well, you're – as we've described in the Q, we're applying transition relief to the existing portfolio, and we're grossing that up as we've discussed. So that portfolio is – will be accounted for under CECL after that gross-up, and then loans originated after 1/1/20, you'll record a provision and origination and then more revenue over time, and you'll end up in the same place where ultimately cash equals accounting.
Okay. Thanks so much. Really appreciate it.
There are no further questions in the queue at this time.
We’d like to thank – sorry.
Go ahead, I’m sorry.
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. We look forward to talking to you again next quarter. Thank you.
Once again, this does conclude today's conference. Thank you for your participation.