Credit Acceptance Corporation — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012; balance sheet compared with December 31, 2011. Amounts are in U.S. dollars. Financial statements are unaudited.
Business context
Credit Acceptance provides automobile dealers with financing programs for consumers who may not qualify for traditional credit. Its Portfolio Program advances funds to dealers and shares certain collections with them; its Purchase Program buys consumer loans. The business operates as one reportable segment and also reinsures vehicle service contracts.
Financial performance and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total revenue | $155.7 million | $133.7 million | $449.9 million | $387.2 million |
| Income before taxes | $83.9 million | $78.7 million | $251.8 million | $216.6 million |
| Net income | $53.0 million | $50.0 million | $159.8 million | $138.0 million |
| Diluted EPS | $2.12 | $1.91 | $6.22 | $5.19 |
| Net margin | 34.0% | 37.4% | 35.5% | 35.6% |
Q3 revenue rose 16.4% and net income 6.1% year over year; nine-month revenue rose 16.2% and net income 15.8%. Management attributed earnings growth primarily to a larger loan portfolio. Finance charges increased 16.6% in Q3 and 17.5% year to date, principally from higher average net loans receivable, partly offset by lower portfolio yields. Average yield was 29.8% in Q3 versus 31.9%, and 30.1% year to date versus 32.7%.
Q3 operating expenses (salaries, general and administrative, and sales and marketing) increased 33.0%, faster than revenue. Salary expense included higher stock compensation, largely related to a 15-year CEO award. Credit-loss provision increased 114.5% in Q3 to $9.8 million, but declined 20.9% for the nine-month period to $17.7 million. Interest expense rose 11.6% in Q3 and 11.8% year to date as average debt increased; average borrowing cost declined to 5.4% in Q3 and 5.6% year to date.
Operating cash flow was $218.5 million for the first nine months, compared with $202.4 million a year earlier. Investing activities used $365.2 million, reflecting loan funding and other portfolio activity; financing activities provided $147.7 million. Cash and cash equivalents were $5.7 million at September 30, versus $4.7 million at year-end; restricted cash was $167.7 million, up from $104.7 million and not generally available for unrestricted use.
Net loans receivable were $1.877 billion, up from $1.599 billion at December 31, 2011; the allowance for credit losses was $170.8 million, up from $154.3 million. Total balance-sheet debt was approximately $1.262 billion, up $264.3 million from year-end. Funded debt to equity was 2.1:1. The revolving credit line had $115.8 million outstanding and $119.2 million shown as available, subject to borrowing-base limits. The company reported compliance with debt covenants.
Material changes versus comparable periods
- Loan portfolio expansion drove most revenue and earnings growth, while average loan yield declined.
- Q3 consumer-loan assignment growth slowed: unit volume increased 5.4% year over year and dollar volume 3.1%, compared with much higher growth in earlier quarters. Active dealers rose 26.6%, while average volume per active dealer fell 16.5%; management cited increased competition.
- For the first nine months, unit volume increased 8.0%, active dealers increased 32.7%, and average volume per active dealer declined 18.6%.
- Stock repurchases totaled approximately $112.9 million in cash during the first nine months, including a 1.0 million-share tender offer at $84.45 per share. Repurchases reduced shares outstanding and were partly financed with debt.
- Other income declined 12.5% year to date, mainly because GAP profit-sharing income was lower following a change to recognizing that income over contract lives. GPS-SID fee income partly offset the decline.
- The allowance increased, and the Q3 credit-loss provision rose, reflecting deterioration in certain individual loan pools despite overall performance being described as generally consistent with expectations for the quarter.
Outlook, commentary, and risks
No specific earnings or revenue guidance is provided. Management said it expects operating cash flows and available financing alternatives to be sufficient for debt maturities and future operations, while warning that restricted or unavailable funding could materially harm liquidity and results. In Q3, the company completed a $252.0 million Term ABS financing with an expected annualized cost of approximately 2.0%; it also extended and increased its revolving credit facility earlier in 2012 and extended Warehouse Facility III.
Management increased dealer advance rates in April and September to respond to competition. It said the increases supported assignment volume but reduced expected returns on new loans, and believed the volume benefit outweighed the lower return on capital. Forecasted collection rates for 2012 assignments were 71.6% overall; loans assigned in Q3 alone were forecast at 70.6%. Forecasts remain less certain for newer vintages because relatively little of their expected collections has been realized. Vintages from 2006 and 2007 remained below initial collection forecasts; 2009–2011 vintages were above them.
Key risks include accurately forecasting collections on high-risk consumer loans; competition and economic conditions; access to funding and substantial debt; interest-rate exposure; regulation and litigation; and reliance on technology, third parties, and protection of consumer information. The filing updates its cybersecurity risk disclosure and notes prior incidents had not materially affected the business. A Missouri Attorney General matter was being resolved through an assurance of voluntary compliance, with terms still being finalized and no admission of wrongdoing. A separate group of dealer arbitration claims was deemed not properly filed after the company’s objection to consolidated proceedings; the filing cautions that adverse outcomes in litigation could materially affect results, liquidity, or financial position.
Unusual items include elevated stock-based compensation from the CEO award and the substantial tender-offer repurchase. Management reported no material changes to critical accounting estimates or loan-collection forecast methodology that materially affected results.
Investor verification priorities
- Track loan assignment growth, dealer activity, competitive advance rates, and the resulting yield and return on new loans.
- Monitor collection performance by loan vintage, allowance adequacy, and the effect of individual pool impairments on provisions.
- Assess liquidity using unrestricted cash and borrowing availability after collateral and borrowing-base restrictions, and review debt maturities and covenant headroom.
- Verify the ongoing effect of share repurchases and CEO stock awards on leverage, diluted share count, and compensation expense.
- Follow the final Missouri settlement terms, other litigation or regulatory developments, and cybersecurity incidents.