CACC - Credit Acceptance Corp

[ItsAValueTrap]

wknecht:  I found the New York Times article very interesting.  However, it focuses a lot on cases of fraud which are atypical.  All of the lenders generally do some form of income verification.  Now there are probably some ways for people to commit loan fraud and to game the loan compliance departments.  But that seems to be the exception rather than the rule.  This is not like the subprime housing bubble where people with no job could buy multiple houses.

 

CACC for example does a lot of loan compliance work:

- AutoCheck to see if the car is ok.

- They may be using Equifax's income verification.

- They will verify job information.

- They will verify that the time on the job is correct.

- They will verify rent/mortgage payments.

- Residence verification, e.g. utility bill.  The utility bill cannot be too old- CACC is more strict than prime lenders.

- The stipulations (stips) are extensive.  With CACC, 75% of loans don't get approved right away.

- Dealers have individual ratings.  If they push through a lot of bad loans, CACC will reduce advances.

 

All the lenders in the subprime space generally have extensive stipulations.  Prime lenders have much looser stipulations.  The looser stipulations in prime help deals get done and help salespeople close sales.  If the customer has to drive home and get a newer utility bill or whatever, the salesperson can potentially lose a sale if the customer changes his/her mind after talking to their friends/family about their new purchase.

[writser]

Large article in the New York Times about subprime car loans: link . Gist of the thing: car loan sharks are ripping of consumers and there might be problems up ahead.

 

In another sign of trouble ahead, repossessions, while still relatively low, increased nearly 78 percent to an estimated 388,000 cars in the first three months of the year from the same period a year earlier, according to the latest data provided by Experian. The number of borrowers who are more than 60 days late on their car payments also jumped in 22 states during that period.

 

As a result, some rating agencies, even those that had blessed auto loan securitizations with high ratings, are starting to question the quality of the loans backing those securities, and warn of losses that investors could suffer if the bonds start to sour. Describing the potential trouble ahead, Kevin Cole, an analyst with Standard & Poor’s, said, “We believe these trends could lead to higher losses and weakened profitability in a few years.”

 

Not sure how relevant all of this to CACC but it might partially explain the decline of the stock in the past few months.

[rayfinkle]

http://dealbook.nytimes.com/2014/07/19/in-a-subprime-bubble-for-used-cars-unfit-borrowers-pay-sky-high-rates/?_php=true&_type=blogs&smid=tw-share&_r=0

[wknecht]

More generally than the recent headlines, I'm curious folks thoughts on the regulatory front.  The CFPB seems mainly concerned with fair lending at the moment. The FTC also recently fined CPS 5.5mm for debt collection activities. To me, while raising the cost of doing business, this doesn't seem like a serious threat to the thesis. Others see meteor risk here?

 

Some interesting reading below:

 

http://m.autodealermonthly.com/news/155497/cfpb-engaged-in-fair-lending-actions-against-six-auto-lenders

 

http://m.fi-magazine.com/article/105023/defending-the-cfpb

 

http://consumerfsblog.com/2014/05/ftcs-recent-enforcement-action-sets-new-debt-collection-standards-lenders-collectors/

[ItsAValueTrap]

Some if it has to do with racial discrimination, which is mainly caused by salespeople at the dealership.

 

From

http://m.autodealermonthly.com/news/155497/cfpb-engaged-in-fair-lending-actions-against-six-auto-lenders

This past December, the DOJ and CFPB reached the largest auto loan discrimination settlement in the federal government’s history. It resolved allegations that Ally Financial and Ally Bank engaged in discriminatory lending practices since April 2011. At issue was the finance source’s practice of allowing dealers to mark up interest rates on finance contracts, a policy the two regulators alleged caused 100,000 African-American, 125,000 Hispanics and 10,000 Asian/Pacific Islanders to pay Ally higher interest rates and white car buyers.

[HJ]

For a read of the battle between CFPB and auto dealers, which may shine some light of the nature of these legislative boundaries CFPB has to tread when make rules.

 

http://www.mcdonaldhopkins.com/documents/attorney/Bloomberg%20article.pdf

[Liberty]

Bearish view:

 

http://y0ungmoney.blogspot.ca/2014/07/credit-acceptance-and-subprime-auto.html

 

(Not saying I agree with it, just posting it)

[jay21]

Yeah, it's useful to get a perspective of the market then.  I was involved in structuring some of the earlier subprime auto ABS's.  So here's my take for what it's worth, not that dissimilar to Moodys':

 

The entire subprime market (mortgages, credit cards and auto loan) developed in conjunction with the private label securitization market, which got started on the heel of the S&L crisis.  You have these non-bank lenders who are able to directly access capital market, and compete with banks, who historically have the reputation of being very conservative, not extending any credits to subprime.  The new players aggressively expanded the lending market, in credit card space, you had Capital One, First USA, in subprime mortgages you had guys like Aames, Delta Financial (Countrywide back then played a bit safer in the Alt-A sand lot, which was a rung above the subprime), and in Autos you had players like Olympic Financial (subsequently bankrupt) and Western Financial (bought by Wachovia, which is today, the core of Wells' auto lending platform).  With accounting rules permitting "gain on sale", all these specialty finance companies are able to show healthy accounting gains, but constantly in need of plugging the capital hole for expansion.  In many ways the underlying lending market was much more competitive, where the mantra was all about showing growth, which you can then take to the equity or high yield market to get more capital.  Through the magic of gain on sale accounting, you are able to book an accounting gain the minute you do a securitization.  The subprime market was always shady, because that's the nature of the borrowers you are dealing with.  And the shadiest of characters are always the middle man, the mortgage brokers and auto dealers, whose only incentive is to push a loan through.  Late 90's / early 2000's, bond markets had notable interruptions caused by the Asian crisis and then the telecom bubble.  Most of these players either folded or got absorbed onto stronger balance sheets, Capital One went on to buy banks to stabilize funding.  We all know the story of mortgages since then.  The subprime auto ABS market have been much more "sane" since then, and the most recent crisis only cleansed the market further.  GMAC and all the captive financing companies were never really subprime.  But since the crisis, there have been more of these non deposit funded players entering, notably Santander and Exeter.  To get good valuation on IPO, they probably all pushed origination volume pretty hard.  The overall market structure today is probably the most competitive since the late 90's.  But with all these loans now consolidated, and no more gain on sale magic, I'd still argue that it is saner today than back then.  CACC was actually around back then, and if you examine their loss rates, etc. origination today is probably still of higher quality.

 

Thanks for posting.  Enjoy your insight.

 

When reading All the Devils are Here, found it interesting that Countrywide was safer in the 90s and started pushing subprime volume much later compared to other finance companies.

[wknecht]

For a read of the battle between CFPB and auto dealers, which may shine some light of the nature of these legislative boundaries CFPB has to tread when make rules.

 

http://www.mcdonaldhopkins.com/documents/attorney/Bloomberg%20article.pdf

Thanks for posting this and your insight into the market in the '90s. Are you still involved in the structured market?

 

The push to move to a fixed fee arrangement, rather than participation from markups, is a little confusing from the standpoint of CACC's somewhat unique model. I guess the CFPB is concerned about the markup part of the participation (where discrimination can enter the picture) rather than the 80/20 form of participation. 

 

On conference calls (after the Bulletin 2013-02 was released), management has stated they do not expect this to have a large impact on their program.

[HJ]

Thanks for posting this and your insight into the market in the '90s. Are you still involved in the structured market?

 

The push to move to a fixed fee arrangement, rather than participation from markups, is a little confusing from the standpoint of CACC's somewhat unique model. I guess the CFPB is concerned about the markup part of the participation (where discrimination can enter the picture) rather than the 80/20 form of participation. 

 

On conference calls (after the Bulletin 2013-02 was released), management has stated they do not expect this to have a large impact on their program.

 

I am now in the world of CLO's, have been involved in the securitization of corporate credits since the late 90's when the first generation subprime market blew out.  I have followed the auto finance market mostly as an uninterested observer, so don't really have a strong view of the industry today.  It is interesting to see that some of the old guards of the specialty auto financing guys are today at the core of auto lending platforms of some of these major banks.  As I alluded to in the previous post, the platform at Wells is really the old Western Financial, which bought Olympic Financial, today one of the largest lenders.  The platform at Capital One was a small start up back then called Onyx.

 

I also don't have a strong view on how the CFPB will impact the industry on the regulatory front.  For now, it's quite marginal.  The competitive dynamic in the industry certainly is not quite as self destructive as it was in the late 90's.  But we are also certainly past the peak in ROA in this cycle, which could have generally benign credit for quite a bit longer.

 

 

[ItsAValueTrap]

Looking at this company a little differently... how can CACC go to zero?  I'm thinking that it'd be difficult due to the low leverage employed.  Their assets/loans would have to lose ~33% for the company to flirt with death (assuming that leverage magnifies losses 3X).

 

1- The worst case scenario for an individual loan is the borrower moving somewhere else with the car.  On top of that, CACC fails to skip trace the borrower as none of the references divulge information about where the borrower is.  This would lead to massive losses.  However, it's hard to imagine that large numbers of CACC borrowers decide to move and become delinquent on their loans.  Perhaps if there was a massive natural disaster across large areas of the US, then CACC could be in a bad position (e.g. cars destroyed and borrowers have no income).

 

2- If used car prices plummet 50%... CACC would probably survive.  Of the cars that CACC repos, the recoveries will be much lower.  However, CACC can sue the debtors and garnish their wages for the remaining balance on the loan.

 

3- Massive unemployment is a plausible scenario.  Delinquencies will go up dramatically and cause lots of loan losses for CACC.  But suppose unemployment jumps 15% and all of those delinquencies result in zero recovery on the loan.  Each loan will lose 15%.  Multiply that by 3X to account for CACC's leverage... CACC loses 45% of its equity.  It still survives.

 

4- If CACC underwrites poorly for some reason... it could lose a lot of money.  I think that competitors would have to become fairly irrational for CACC to end up in a position where it has catastrophic losses.

 

5- If gasoline prices skyrocketed... perhaps borrowers would give up their cars en masse if they can't afford gas and don't want to pay for something they can't use.

[peter1234]

Looking at this company a little differently... how can CACC go to zero?  I'm thinking that it'd be difficult due to the low leverage employed.  Their assets/loans would have to lose ~33% for the company to flirt with death (assuming that leverage magnifies losses 3X).

 

Perhaps if there was a massive natural disaster across large areas of the US, then CACC could be in a bad position (e.g. cars destroyed and borrowers have no income).

 

 

Wouldn't they be insured?

;)

[writser]

ItsAValueTrap: you are right, they are conservatively capitalized, but there is also leverage in the stock price itself. The company is trading at 4x book. They don't have to go broke for you to experience a huge loss.

 

Suppose there are some tough years up ahead: a slight decrease in earnings, a 5% haircut on their loans combined with the market assigning a 2x TBV multiple to the shares instead could easily mean the stock declines ~60% or more. My main issue with this company.

 

Really nice series of blogposts btw.

[ItsAValueTrap]

Looking at this company a little differently... how can CACC go to zero?  I'm thinking that it'd be difficult due to the low leverage employed.  Their assets/loans would have to lose ~33% for the company to flirt with death (assuming that leverage magnifies losses 3X).

 

Perhaps if there was a massive natural disaster across large areas of the US, then CACC could be in a bad position (e.g. cars destroyed and borrowers have no income).

 

 

Wouldn't they be insured?

;)

 

I suppose they would be.  If the cars are destroyed then CACC would still suffer huge loan losses because many of the borrowers would default.  The repo auction proceeds would be for far less than the total principal + interest.  Many of the buyers may not have purchased GAP insurance.  The insurance company could also potentially go bust or find an excuse not to pay.

[wknecht]

A little worrisome:

On June 6, 2014, we received a civil investigative demand from the Federal Trade Commission relating to our various practices regarding consumers. We are cooperating with the inquiry.

[wknecht]

A little worrisome:

On June 6, 2014, we received a civil investigative demand from the Federal Trade Commission relating to our various practices regarding consumers. We are cooperating with the inquiry.

Forgot the call was also today. When asked about this in the context of the share repurchases (occurred after the FTC inquiry), Brett Roberts replied: "We discussed the matter internally. We did discuss it with council; the contents of Civil Investigative Demand are relatively straightforward and benign. And after discussing internally and with council, we didn’t think really there was anything to disclose."

[wknecht]

Another recent times article on subprime auto. I found this one to be more interesting than the prior ones. For one I was unaware of the situations at World Acceptance and Conn's. It also contains some other interesting data points.

 

http://dealbook.nytimes.com/2014/09/11/stressed-borrowers-rattle-resurgent-subprime-lending-industry

 

At this point, nothing in the article concerns me from CACC's perspective.

[ItsAValueTrap]

Between 2009-2012 Conn's saw declining revenues.  I think they tried to fight that decline by loosening their underwriting and encouraging their employees to increase volume.  (Which means that employees will start gaming the company's underwriting.)  Their free cash flow starting looking bad because the company took on a huge number of new loans.  So I think that's why Conn's has big problems with bad loans.  It's their own fault.

[wknecht]

Sounds about right. I imagine mostly discretionary purchases also, which will be lower on a customer's payment priority. Their static loss assumption of 8% seems optimistic to me on the surface. Granted the FICO of their customers (592) is probably higher than what CACC lends to on average.

 

I noticed Einhorn has a 2.5% position in Conn's.

[mike]

wknecht, thanks for starting the thread! I enjoy reading the Q&As and shareholder letters.

 

Just want to share a Q&A from 2004.

 

Q: What is the future of CACC as a public company? Does the company intend to

stay public, or is the company exploring the option of going private? Management

owns a significant portion of this highly illiquid stock and the buybacks, while

admirable, will most likely exacerbate this issue.

 

A: We intend to continue to repurchase shares when we have excess capital and the share

price is attractive. We believe it is unlikely this strategy, given the number of unrestricted

shares outstanding and the capital needs of our business, will result in us repurchasing all

the publicly owned shares.

 

Our goal is to create the most valuable business possible, in per share terms. We believe

our historical share repurchases have been beneficial in this regard. Creating liquidity in

our shares has never been and is not likely to be a priority for us.

[LC]

Tender offer for about 4.5% of s/o:

 

http://www.sec.gov/Archives/edgar/data/885550/000119312514346367/d788529dex99a1i.htm

[ItsAValueTrap]

Sounds about right. I imagine mostly discretionary purchases also, which will be lower on a customer's payment priority. Their static loss assumption of 8% seems optimistic to me on the surface. Granted the FICO of their customers (592) is probably higher than what CACC lends to on average.

 

I noticed Einhorn has a 2.5% position in Conn's.

 

Ok so here's an excellent blog post that explains Conn's lending:

http://banktalk.org/content/skirting-ability-repay-catches-conns

 

Um.  It sort of looks like a loan product designed to be toxic.

 

Also read this SEC filing, where the company promises to provide more transparency:

http://www.sec.gov/Archives/edgar/data/1223389/000119312514003228/filename1.htm

[wknecht]

Q3 earnings came out yesterday:

http://www.ir.creditacceptance.com/releasedetail.cfm?ReleaseID=879040

 

9m adusted return on capital of 13.3% compared to peak of 18.7% in 2010, and last cycle trough of 11.2% in 2008.

 

Spread on originations 24.8%, compared to 2009 peak of 35.3%, and last cycle trough of 21.4% in 2007.

 

The market still quite competitive. Loan unit volume up 4.7% 3m YoY and 8.2% 9m YoY, compared to around 6.5% for 2012 and 2013.

 

Forecast variances are positive. No change in FTC inquiry situation.

[wknecht]

CACC received a civil investigative subpoena from the DOJ and Massachusetts AG.  A concerning trend:

http://www.sec.gov/Archives/edgar/data/885550/000088555014000070/a8-k20141212ciddoj.htm

[PB]

Btw, why do I think I am able to predict future growth for the businesses I invest in?

Nowhere does history indulge in repetitions so often or so uniformly as in Wall Street. The game does not change and neither does human nature.

Edwin Lefevre, Reminiscences of a Stock Operator

 

The businesses I invest in generate safe and steady free cash that is used by their owner/manager to buy new assets, either outright or through the stock market. It is by their ability to use free cash intelligently that I predict future growth… because neither the game nor human nature change.

Instead, I almost never count on growth coming from operating earnings… That would be too difficult for me to predict… And it is exactly the difficulty I find right now in trying to value CACC.

 

Gio

 

Just reading through this thread...don't post much but wanted to say...that is beautiful Gio.