Credit Acceptance Corporation — Q3 2016 Form 10-Q
Business context and reporting period. The company provides financing programs through automobile dealers, principally for consumers with impaired or limited credit histories. This unaudited report covers the quarter and nine months ended September 30, 2016; comparisons are with the same periods in 2015 unless otherwise stated. More than 95% of assigned loans were to consumers with FICO scores below 650 or no FICO score.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $246.6 million | $210.2 million | $713.0 million | $607.5 million |
| Income before taxes | $136.5 million | $117.9 million | $389.6 million | $348.6 million |
| Net income | $85.9 million | $74.0 million | $245.2 million | $219.7 million |
| Diluted EPS | $4.21 | $3.53 | $12.01 | $10.49 |
| Net margin | 34.9% | 35.2% | 34.4% | 36.2% |
- Revenue drivers: Finance charges were $223.9 million in Q3, up 20.2%, and $641.9 million for nine months, up 19.7%. Growth came mainly from a larger average loan portfolio; lower yields on newer assignments partly offset the benefit. Portfolio yield fell to 24.5% from 25.8% in Q3 and to 24.9% from 25.9% for nine months.
- Credit costs and expenses: Credit-loss provision rose to $22.8 million in Q3 from $13.2 million and to $62.8 million for nine months from $27.8 million. Total costs and expenses increased 19.3% in Q3 and 24.9% for nine months. Interest expense rose to $25.1 million in Q3 and $71.5 million for nine months.
- Cash flow: Operating activities generated $363.5 million in the first nine months, versus $300.3 million. Investing activities used $793.0 million, largely reflecting loan assignments and increased restricted cash; financing activities provided $428.9 million. Cash and cash equivalents ended at $5.7 million. Restricted cash of $232.8 million is not equivalent to unrestricted cash.
- Debt and liquidity: Debt carrying value was $2.510 billion at September 30, versus $2.068 billion at year-end 2015; principal outstanding was $2.528 billion. Unused and available credit lines were $862.8 million. Funded debt to equity was 2.2:1. The company reported compliance with debt covenants.
- Balance sheet: Loans receivable, net, grew to $3.764 billion from $3.102 billion at year-end; the allowance for credit losses increased to $296.8 million from $243.6 million. Total assets were $4.093 billion and shareholders’ equity $1.166 billion.
Material changes and management commentary
- Net income increased 16.1% in Q3 and 11.6% for nine months, primarily due to portfolio growth. Diluted EPS growth also benefited from fewer weighted-average shares.
- Loan assignment dollar volume rose 33.4% in Q3, while unit volume rose 12.0%; active dealers increased 14.3%, but average volume per active dealer declined 1.7%. Management reported unit volume down 8.3% year over year for October 2016, the latest month cited.
- The Purchase Program’s share of unit assignments increased to 23.8% in Q3 2016 from 12.7% a year earlier. Management said growth was slowing amid competition, dealer attrition and lower volume per dealer.
- Management reported weaker-than-expected overall loan performance during the first nine months. Forecasted collection rates for 2015 assignments declined to 66.7%, one percentage point below the initial forecast; the 2016 forecast was 66.0%, versus 65.9% initially. Third-quarter 2016 assignments had a 64.9% forecast collection rate and a 20.6% spread between forecast collections and advance rate. Newer-loan estimates remain less certain because less of the forecast has been realized.
- Management cited longer average loan terms and assignment mix as factors in lower initial forecasts: 2016 loans averaged 52.6 months versus 49.8 months for 2015 assignments; Q3 2016 assignments averaged 53.6 months.
Outlook, risks, contingencies and unusual items
- No specific earnings or operating guidance was provided. Management said it expects operating cash flows and financing alternatives to fund maturities and operations, but warned that reduced access to borrowing could materially harm liquidity and results.
- Scheduled principal maturities were $182.3 million for the remainder of 2016, $738.2 million in 2017 and $758.4 million in 2018. These include estimates based on forecast collections.
- On October 27, 2016, the company completed a $350 million Term ABS financing, with expected annualized cost of approximately 2.9%, to repay outstanding debt. It is a subsequent event, after the reporting date.
- Key risks include forecasting collections on high-risk consumer loans, competition, funding availability and cost, leverage, interest rates, regulation, consumer litigation and economic or auto-market deterioration. The filing says the expected adoption of the CECL credit-loss standard is expected to have a material impact on the financial statements and disclosures.
- Regulatory inquiries included Maryland repossession and sale practices, New York loan origination and collections, a federal inquiry into subprime auto finance and securitization, and a Massachusetts inquiry. The company could not estimate reasonably possible losses for these matters. A competitor’s antitrust lawsuit also remained pending; the company said it could not estimate possible losses and intended to defend itself. One dealer arbitration was resolved in the company’s favor; four remained.
- The company disclosed that its chairman reported selling affiliated dealerships and a related leasing business effective June 7, 2016; the company was still working to verify transaction terms and whether the sale resolved potential conflicts. Affiliated dealer balances were $18.5 million, or 0.6% of consolidated Dealer Loans.
- Stock repurchases and related share withholding totaled $40.8 million for the nine-month period; no repurchases occurred in Q3. The filing also notes adoption of debt-issuance-cost presentation guidance, which reclassified prior-period balance-sheet amounts without changing underlying debt economics.
Most important facts for investors to verify
- Whether newer loan cohorts’ collection forecasts stabilize or deteriorate further, and how that affects credit-loss provisions and portfolio yield.
- Whether unit-volume growth, dealer retention and volume per dealer recover, particularly after the October year-over-year unit decline.
- Funding capacity, refinancing costs and scheduled maturities; distinguish restricted cash and facility availability from unrestricted liquidity.
- Developments and potential financial exposure from the regulatory inquiries, antitrust case and remaining dealer arbitrations.
- Whether the chairman’s reported business sale is verified and resolves the disclosed potential conflict concerns.