CREDIT ACCEPTANCE CORP quarterly report, Q2 FY2018

Credit Acceptance Corporation — Q2 2018 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2018. Amounts are in U.S. dollars; financial figures are in millions unless noted. The company provides auto-financing programs through dealers, primarily for consumers with impaired or limited credit histories. More than 95% of assigned loans had FICO scores below 650 or no score.

Financial performance

Metric	Q2 2018	Q2 2017	First half 2018	First half 2017
Total revenue	$315.4	$276.0	$611.0	$538.8
Income before taxes	$198.0	$157.1	$355.7	$301.3
Net income	$151.0	$99.1	$271.1	$192.4
Diluted EPS	$7.75	$5.09	$13.92	$9.81
Net margin	47.9%	35.9%	44.4%	35.7%

• Q2 revenue rose 14.3% and net income rose 52.4% year over year; first-half revenue rose 13.4% and net income rose 40.9%.
• Finance charges increased 15.1% in Q2 and 14.3% in the first half, mainly as the average net loan balance grew. Average portfolio yield declined to 22.3% in Q2 from 23.9%, and to 22.4% for the first half from 23.9%, reflecting lower yields on newer assignments.
• Credit-loss provision was $1.8 in Q2 versus $21.8 a year earlier; first-half provision was $25.2 versus $42.3. Q2 included a $1.4 reversal for Purchased Loans, partly offset by $3.2 provision for Dealer Loans. Loan-pool performance overall exceeded management’s expectations during both comparison periods.
• Interest expense increased 29.4% in Q2 and 27.3% for the first half, primarily due to higher average debt balances. Average cost of debt was 4.3% in Q2 versus 4.1% a year earlier.
• The effective tax rate fell to 23.7% in Q2 and 23.8% in the first half, versus 36.9% and 36.1%, respectively, mainly due to the 2017 Tax Act reducing the federal statutory rate from 35% to 21%.

Balance sheet, cash flow and funding

• At June 30, loans receivable, net, were $5,344.4, up from $4,619.6 at year-end 2017; total assets were $5,874.3 and shareholders’ equity was $1,809.6.
• Total debt carrying value was $3,665.8, up from $3,070.8 at December 31, 2017. Funded debt to equity was 2.0 to 1. The revolving credit line had no balance at quarter-end; the $350 facility is scheduled to decline to $315 in June 2019.
• Cash and cash equivalents were $55.7. Restricted cash and cash equivalents were $338.0, bringing total cash, cash equivalents and restricted cash to $393.7; restricted amounts should not be treated as freely available liquidity. The company reported $1,325.0 of unused and available lines of credit, subject to borrowing-base and collateral limits.
• First-half operating cash flow was $310.0; investing cash use was $764.2 and financing cash provided was $584.1. Investing activity included $1,956.2 of new loan assignments, offset by $1,301.7 of principal collections and other items.
• Debt maturities are scheduled at $429.2 for the remainder of 2018, $998.5 in 2019, $1,228.1 in 2020 and $784.4 in 2021. Management expects operating cash flows and financing alternatives to provide sufficient funding, while noting that constrained funding access could adversely affect liquidity and operations.

Material changes, outlook and risks

• Q2 unit assignment volume increased 19.8% year over year and dollar volume increased 34.7%. Active dealers increased 13.0%; average unit volume per active dealer rose 5.9%. The company attributed faster dollar growth to larger loans, longer initial terms, higher vehicle selling prices and a higher Purchase Program mix.
• Average loan size and term have increased: the 2018 average consumer loan was $21,995, with a $9,542 average advance and a 57-month initial term. Purchased Loans rose to 30.3% of Q2 unit volume, compared with 27.7% a year earlier.
• Forecasted collection rates for 2015 and 2016 assignments remained below initial forecasts by 2.3 and 1.0 percentage points, respectively; 2017 assignments were 1.6 points above initial forecasts. Management said newer cohorts are less certain because less of their forecast collections have been realized. The company identifies accurate collection forecasting, capital access and loan volume at anticipated terms as key success factors.
• Management expects a long-term effective tax rate of approximately 23%. No specific revenue, earnings or volume guidance is provided in the filing.
• The company completed $500.0 and $450.0 Term ABS financings in February and May, respectively, and extended the revolving credit facility maturity to June 2021. It also increased Warehouse Facility IV capacity from $100 to $250. These financings were used to repay outstanding indebtedness.
• The company is evaluating adoption of the expected-credit-loss standard (CECL), which it expects to materially affect its financial statements and disclosures; it is also considering the fair-value option for future loans. The ultimate accounting approach and impact were not yet determined.
• Regulatory and legal matters include inquiries or investigations involving New York DFS, Massachusetts and Mississippi attorneys general, the CFPB, FTC, Maryland authorities, the U.S. Department of Justice and New York authorities. The company says it is cooperating and cannot estimate reasonably possible losses for the cited inquiries. A separate antitrust case was dismissed in the company’s favor, but the plaintiff appealed.
• Other stated risks include subprime borrower credit performance, competition, substantial debt and interest-rate exposure, funding-market access, regulation, litigation, and consumer repossession and collection practices. Management reported compliance with applicable debt covenants and effective disclosure controls.

Important facts for investors to verify

• Whether subsequent collections support forecasts, particularly for 2015–2016 loan cohorts and newer, less-seasoned assignments.
• Whether assignment growth, larger loan sizes and the greater Purchase Program mix sustain returns as portfolio yield declines and funding costs rise.
• Availability and cost of funding, collateral requirements, scheduled maturities and the distinction between restricted cash and usable liquidity.
• Developments and potential financial or operational consequences of regulatory investigations and litigation, especially the New York DFS inquiry and CFPB matter.
• Potential effects of CECL or a fair-value election, and any changes to the company’s tax accounting under the 2017 Tax Act.