CREDIT ACCEPTANCE CORP quarterly report, Q2 FY2016

Credit Acceptance Corporation — Q2 2016 Form 10-Q

Reporting period: Three and six months ended June 30, 2016. Amounts are in U.S. dollars; financial statement figures are in millions except per-share data. The company provides dealer financing for vehicle sales, primarily to consumers with impaired or limited credit histories; 95.4% of Q2 assignments were to consumers with FICO scores below 650 or no score.

Financial performance and position

Metric	Q2 2016	Q2 2015	Six months 2016	Six months 2015
Total revenue	$238.5	$203.1	$466.4	$397.3
Income before tax	$134.7	$117.4	$253.1	$230.7
Net income	$84.9	$74.2	$159.3	$145.7
Diluted EPS	$4.17	$3.54	$7.80	$6.95

Revenue grew 17.4% in both the quarter and first half. Finance charges rose 19.4%; premiums earned fell 13.5% in Q2 and 12.1% year to date. Other income increased 20.4% and 18.7%, respectively.
Net income increased 14.4% in Q2 and 9.3% year to date. Approximate net margin was 35.6% for Q2 (36.5% prior year) and 34.2% for the first half (36.7% prior year).
At June 30, loans receivable were $3,812.0 gross and $3,535.1 net, up from $3,345.1 gross and $3,101.5 net at year-end. The allowance for credit losses was $276.9, versus $243.6.
Operating cash flow was $228.5 for the first half, versus $189.5. Investing activities used $540.4, principally reflecting loan assignments and restricted cash movements; financing provided $463.9. Cash and cash equivalents ended at $158.3, compared with $6.3 at year-end; an additional $233.7 was restricted.
Debt carrying value was $2,538.3, versus $2,067.8 at year-end (the MD&A reports year-end indebtedness of $2,084.6). Principal debt outstanding was $2,557.4. The company reported $948.0 of unused and available credit lines and a funded-debt-to-equity ratio of 2.4:1.
Q2 operating margin, calculated as income before tax divided by revenue, was approximately 56.5%, versus 57.8% in Q2 2015. The six-month figures were approximately 54.3% and 58.1%.

Material changes and management commentary

Higher average loan balances drove finance-charge growth, partly offset by lower portfolio yields: 25.0% versus 25.9% in Q2 and 25.1% versus 26.0% year to date. Management attributed lower yields to more recent assignments.
Credit-loss provision increased to $17.9 in Q2 from $8.4, and to $40.0 for the first half from $14.6. Management said overall consumer-loan performance fell below expectations during the 2016 periods; nearly all of the first-half provision related to Dealer Loans.
Q2 assignment unit volume grew 15.1% year over year and dollar volume 27.6%; active dealers increased 18.0%, while average volume per active dealer declined 1.8%. Purchased Loans rose to 22.2% of Q2 unit volume from 12.3% a year earlier.
Management noted weaker collection forecasts for 2015 assignments and a mixed trend across vintages. Q2 forecasted collection rates for 2015 assignments declined 0.4 percentage points from March and were 0.7 points below initial forecasts. The Q2 2016 assignment forecast was 65.7%, 0.4 points below its initial forecast. Forecasts for recent vintages remain less certain because relatively little expected cash has been collected.
Operating expenses rose 12.6% in Q2 and 13.4% year to date, with legal and technology costs contributing to higher general and administrative expense. Interest expense increased as debt funded loan growth and repurchases; first-half average cost of debt rose to 4.0% from 3.6%.

Outlook, risks, contingencies, and unusual items

No specific earnings or volume guidance was provided. Management said anticipated operating cash flows and financing alternatives should fund debt maturities and future operations, but warned that limited or unavailable funding could materially harm operations and liquidity.
Debt maturities included $300.9 for the remainder of 2016, $734.1 in 2017 and $758.3 in 2018. The company reported compliance with its debt covenants at June 30.
During the period, the company completed $385.0 and $350.2 Term ABS financings, extended its $310.0 revolving credit facility maturity to June 2019, and extended Warehouse Facility II’s revolving period to June 2019; its spread over LIBOR increased from 200 to 225 basis points.
Key risks include forecasting collections on high-risk consumer loans, access to capital, debt levels and covenants, interest rates, competition, regulation, and litigation. The filing lists open inquiries by the Maryland, New York, and Massachusetts attorneys general and the U.S. Department of Justice, plus a competitor’s antitrust lawsuit. The company could not estimate reasonably possible losses for these matters; it intends to defend the lawsuit.
The company disclosed a potential conflict concerning the Chairman’s affiliated dealer and leasing business. The Chairman reported selling the active affiliated dealers and related leasing business effective June 7, 2016; the company was still working to verify the sale terms and whether it resolved its concerns.
Adoption of the expected-credit-loss standard (CECL) was expected to have a material financial-statement and disclosure impact; adoption was scheduled for fiscal years beginning after January 1, 2020. Adoption of the debt-issuance-cost presentation standard reclassified $16.8 from assets to debt carrying amounts.
First-half stock repurchases totaled $40.8, including $33.2 of shares surrendered for employee tax withholding and $7.6 open-market purchases. No repurchases occurred in Q2.

Most important facts for investors to verify

Whether recent collection trends, especially for 2015 and 2016 loan vintages, continue to weaken and require additional provisions.
How continued growth in Purchased Loans affects returns and loss exposure; the company says Purchased Loan losses are absorbed directly, unlike Dealer Loans where lower expected Dealer Holdback can partly offset weaker collections.
Availability and cost of funding, upcoming debt maturities, borrowing-base capacity, and compliance with financing covenants.
Developments and potential financial consequences of the regulatory inquiries, antitrust litigation, and Chairman-related conflict review.
The eventual quantified impact of CECL adoption and whether loan-growth economics remain attractive as yields decline and credit costs rise.