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CACC > SEC Filings for CACC > Form 10-Q on 30-Oct-2013All Recent SEC Filings

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Form 10-Q for CREDIT ACCEPTANCE CORP


30-Oct-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes included in Item 8 - Financial Statements and Supplementary Data, of our 2012 Annual Report on Form 10-K, as well as Item 1- Consolidated Financial Statements, of this Form 10-Q, which is incorporated herein by reference.

Overview

We offer automobile dealers financing programs that enable them to sell vehicles to consumers regardless of their credit history. Our financing programs are offered through a nationwide network of automobile dealers who benefit from sales of vehicles to consumers who otherwise could not obtain financing; from repeat and referral sales generated by these same customers; and from sales to customers responding to advertisements for our product, but who actually end up qualifying for traditional financing.

For the three months ended September 30, 2013, consolidated net income was $65.1 million, or $2.75 per diluted share, compared to $52.9 million, or $2.12 per diluted share, for the same period in 2012. For the nine months ended September 30, 2013, consolidated net income was $187.2 million, or $7.78 per diluted share, compared to $159.8 million, or $6.22 per diluted share, for the same period in 2012. The increase in consolidated net income for the three and nine months ended September 30, 2013 was primarily due to an increase in the average balance of our Loan portfolio.

Critical Success Factors

Critical success factors include our ability to access capital on acceptable terms, accurately forecast Consumer Loan performance, and maintain or grow Consumer Loan volume at the level and on the terms that we anticipate, with an objective to maximize economic profit. Economic profit is a financial metric we use to evaluate our financial results and determine incentive compensation. Economic profit measures how efficiently we utilize our total capital, both debt and equity, and is a function of the return on capital in excess of the cost of capital and the amount of capital invested in the business.

Access to Capital

Our strategy for accessing capital on acceptable terms needed to maintain and grow the business is to: (1) maintain consistent financial performance; (2) maintain modest financial leverage; and (3) maintain multiple funding sources. Our funded debt to equity ratio is 2.1:1 as of September 30, 2013. We currently utilize the following primary forms of debt financing: (1) a revolving secured line of credit; (2) Warehouse facilities; (3) Term ABS financings; and
(4) Senior Notes.

Consumer Loan Performance

At the time a Consumer Loan is submitted to us for assignment, we forecast future expected cash flows from the Consumer Loan. Based on the amount and timing of these forecasts and expected expense levels, an advance or one-time purchase payment is made to the related Dealer at a price designed to achieve an acceptable return on capital. If Consumer Loan performance equals or exceeds our initial expectation, it is likely our target return on capital will be achieved.

We use a statistical model to estimate the expected collection rate for each Consumer Loan at the time of assignment. We continue to evaluate the expected collection rate of each Consumer Loan subsequent to assignment. Our evaluation becomes more accurate as the Consumer Loans age, as we use actual performance data in our forecast. By comparing our current expected collection rate for each Consumer Loan with the rate we projected at the time of assignment, we are able to assess the accuracy of our initial forecast. The following table compares our forecast of Consumer Loan collection rates as of September 30, 2013, with the forecasts as of June 30, 2013, as of December 31, 2012, and at the time of assignment, segmented by year of assignment:

                                                                                Variance in Forecasted Collection
                        Forecasted Collection Percentage as of                           Percentage from
  Consumer
    Loan                                                                     June         December
 Assignment    September 30,     June 30,     December 31,     Initial        30,           31,             Initial
    Year            2013           2013           2012         Forecast      2013           2012           Forecast
    2004                73.0 %       73.0 %           73.0 %       73.0 %       0.0 %          0.0 %               0.0 %
    2005                73.7 %       73.7 %           73.6 %       74.0 %       0.0 %          0.1 %              -0.3 %
    2006                70.0 %       70.0 %           69.9 %       71.4 %       0.0 %          0.1 %              -1.4 %
    2007                67.9 %       67.9 %           68.0 %       70.7 %       0.0 %         -0.1 %              -2.8 %
    2008                70.1 %       70.1 %           70.3 %       69.7 %       0.0 %         -0.2 %               0.4 %
    2009                79.2 %       79.2 %           79.5 %       71.9 %       0.0 %         -0.3 %               7.3 %
    2010                77.0 %       77.0 %           77.3 %       73.6 %       0.0 %         -0.3 %               3.4 %
    2011                74.1 %       74.2 %           74.1 %       72.5 %      -0.1 %          0.0 %               1.6 %
    2012                73.5 %       73.4 %           72.2 %       71.4 %       0.1 %          1.3 %               2.1 %
   2013 (1)             73.2 %       73.1 %              -         72.0 %       0.1 %            -                 1.2 %


Table of Contents

(1) The forecasted collection rate for 2013 Consumer Loans as of September 30, 2013 includes both Consumer Loans that were in our portfolio as of June 30, 2013 and Consumer Loans assigned during the most recent quarter. The following table provides forecasted collection rates for each of these segments:

                                                       Forecasted Collection
                                                         Percentage as of
                                                                       June
                                                      September         30,
 2013 Consumer Loan Assignment Period                 30, 2013         2013       Variance
January 1, 2013 through June 30, 2013                      73.9 %        73.1 %        0.8 %
July 1, 2013 through September 30, 2013                    71.8 %           -            -

Consumer Loans assigned in 2009 through 2013 have yielded forecasted collection results materially better than our initial estimates, while Consumer Loans assigned in 2006 and 2007 have yielded forecasted collection results materially worse than our initial estimates. For all other assignment years presented, actual results have been very close to our initial estimates. For the three months ended September 30, 2013, forecasted collection rates improved for Consumer Loans assigned in 2013 and were generally consistent with expectations at the start of the period for all other assignment years presented.

For the nine months ended September 30, 2013, forecasted collection rates improved for Consumer Loans assigned in 2012 and 2013, declined for Consumer Loans assigned in 2008 through 2010 and were generally consistent with expectations at the start of the period for all other assignment years presented. During the second quarter of 2013, we enhanced our forecasting methodology. Implementation of this enhanced forecast contributed to these collection rate variances and reduced our net income by $2.1 million for the second quarter of 2013.

Forecasting collection rates accurately at Loan inception is difficult. With this in mind, we establish advance rates that are intended to allow us to achieve acceptable levels of profitability, even if collection rates are less than we currently forecast.

The following table presents forecasted Consumer Loan collection rates, advance rates, the spread (the forecasted collection rate less the advance rate), and the percentage of the forecasted collections that had been realized as of September 30, 2013. All amounts, unless otherwise noted, are presented as a percentage of the initial balance of the Consumer Loan (principal + interest). The table includes both Dealer Loans and Purchased Loans.

                                                        As of September 30, 2013
                                                                                      % of
                                            Forecasted                              Forecast
                                            Collection     Advance                  Realized
      Consumer Loan Assignment Year             %           % (1)      Spread %       (2)
                  2004                            73.0 %      44.0 %       29.0 %       99.8 %
                  2005                            73.7 %      46.9 %       26.8 %       99.6 %
                  2006                            70.0 %      46.6 %       23.4 %       99.3 %
                  2007                            67.9 %      46.5 %       21.4 %       98.7 %
                  2008                            70.1 %      44.6 %       25.5 %       98.2 %
                  2009                            79.2 %      43.9 %       35.3 %       98.0 %
                  2010                            77.0 %      44.7 %       32.3 %       90.7 %
                  2011                            74.1 %      45.5 %       28.6 %       71.1 %
                  2012                            73.5 %      46.3 %       27.2 %       43.6 %
                  2013                            73.2 %      47.4 %       25.8 %       12.6 %

(1) Represents advances paid to Dealers on Consumer Loans assigned under our Portfolio Program and one-time payments made to Dealers to purchase Consumer Loans assigned under our Purchase Program as a percentage of the initial balance of the Consumer Loans. Payments of Dealer Holdback and accelerated Dealer Holdback are not included.

(2) Presented as a percentage of total forecasted collections.

The risk of a material change in our forecasted collection rate declines as the Consumer Loans age. For 2010 and prior Consumer Loan assignments, the risk of a material forecast variance is modest, as we have currently realized in excess of 90% of the expected collections. Conversely, the forecasted collection rates for more recent Consumer Loan assignments are less certain as a significant portion of our forecast has not been realized.

The spread between the forecasted collection rate and the advance rate declined during the 2005 through 2007 period as we increased advance rates during this period in response to a more difficult competitive environment. During 2008 and 2009, the spread increased as the competitive environment improved, and we reduced advance rates. In addition, during 2009, the spread was positively impacted by better than expected Consumer Loan performance. During the 2010 through 2013 period, the spread decreased as we again increased advance rates in response to the competitive environment.


Table of Contents

The following table presents forecasted Consumer Loan collection rates, advance rates, and the spread (the forecasted collection rate less the advance rate) as of September 30, 2013 for Dealer Loans and Purchased Loans separately. All amounts are presented as a percentage of the initial balance of the Consumer Loan (principal + interest).

                                                             Forecasted
                                                             Collection     Advance
                             Consumer Loan Assignment Year       %           % (1)      Spread %
Dealer Loans                             2007                      67.9 %      45.8 %       22.1 %
                                         2008                      70.6 %      43.3 %       27.3 %
                                         2009                      79.2 %      43.5 %       35.7 %
                                         2010                      77.0 %      44.4 %       32.6 %
                                         2011                      74.1 %      45.2 %       28.9 %
                                         2012                      73.5 %      46.1 %       27.4 %
                                         2013                      73.1 %      47.1 %       26.0 %

Purchased Loans                          2007                      68.2 %      49.1 %       19.1 %
                                         2008                      69.3 %      46.7 %       22.6 %
                                         2009                      79.2 %      45.3 %       33.9 %
                                         2010                      76.9 %      46.4 %       30.5 %
                                         2011                      74.5 %      47.9 %       26.6 %
                                         2012                      74.3 %      48.9 %       25.4 %
                                         2013                      73.7 %      51.1 %       22.6 %

(1) Represents advances paid to Dealers on Consumer Loans assigned under our Portfolio Program and one-time payments made to Dealers to purchase Consumer Loans assigned under our Purchase Program as a percentage of the initial balance of the Consumer Loans. Payments of Dealer Holdback and accelerated Dealer Holdback are not included.

The advance rates presented for each Consumer Loan assignment year change over time due to the impact of transfers between Dealer and Purchased Loans. Under our Portfolio Program, certain events may result in Dealers forfeiting their rights to Dealer Holdback. We transfer the Dealer's Consumer Loans from the Dealer Loan portfolio to the Purchased Loan portfolio in the period this forfeiture occurs.

Although the advance rate on Purchased Loans is higher as compared to the advance rate on Dealer Loans, Purchased Loans do not require us to pay Dealer Holdback.

Consumer Loan Volume

The following table summarizes changes in Consumer Loan assignment volume in
each of the last seven quarters as compared to the same period in the previous
year:

                       Year over Year Percent Change
Three Months Ended   Unit Volume      Dollar Volume (1)
March 31, 2012              10.6 %                 10.7 %
June 30, 2012                7.3 %                  7.9 %
September 30, 2012           5.4 %                  3.1 %
December 31, 2012            2.4 %                  6.0 %
March 31, 2013              -2.9 %                 -0.4 %
June 30, 2013                8.4 %                 10.5 %
September 30, 2013          11.0 %                 15.9 %

(1) Represents advances paid to Dealers on Consumer Loans assigned under our Portfolio Program and one-time payments made to Dealers to purchase Consumer Loans assigned under our Purchase Program. Payments of Dealer Holdback and accelerated Dealer Holdback are not included.

Consumer Loan assignment volumes depend on a number of factors including (1) the overall demand for our product, (2) the amount of capital available to fund new Loans, and (3) our assessment of the volume that our infrastructure can support. Our pricing strategy is intended to maximize the amount of economic profit we generate, within the confines of capital and infrastructure constraints.

Unit and dollar volumes increased 11.0% and 15.9%, respectively, during the third quarter of 2013 as the number of active Dealers grew 18.0% while average volume per active Dealer declined 6.0%. We believe the decline in volume per Dealer is the result of increased competition. In addition, we believe a delay in federal income tax refunds in the current year contributed to both the decline in unit and dollar volumes during the first quarter of 2013 and the increase in unit and dollar volumes during the second quarter of 2013.


Table of Contents

The following table summarizes the changes in Consumer Loan unit volume and active Dealers:

                         For the Three Months Ended September 30,          For the Nine Months Ended September 30,
                                                              %
                            2013             2012          Change         2013              2012             % Change
Consumer Loan unit
volume                       49,762           44,845          11.0 %       155,573           148,580                4.7 %
Active Dealers (1)            4,573            3,874          18.0 %         5,836             4,781               22.1 %
Average volume per
active Dealer                  10.9             11.6          -6.0 %          26.7              31.1              -14.1 %

(1) Active Dealers are Dealers who have received funding for at least one Loan during the period.

The following table provides additional information on the changes in Consumer Loan unit volume and active Dealers:

                           For the Three Months Ended September 30,          For the Nine Months Ended September 30,
                             2013             2012          % Change        2013              2012             % Change
Consumer Loan unit
volume from Dealers
active both periods           36,508           38,853           -6.0 %       126,085           136,063               -7.3 %
Dealers active both
periods                        2,666            2,666              -           3,508             3,508                  -
Average volume per
Dealers active
both periods                    13.7             14.6           -6.0 %          35.9              38.8               -7.3 %

Consumer Loan unit
volume from new Dealers        2,672            2,434            9.8 %        20,117            20,240               -0.6 %
New active Dealers (1)           571              528            8.1 %         1,864             1,556               19.8 %
Average volume per new
active Dealers                   4.7              4.6            2.2 %          10.8              13.0              -16.9 %

Attrition (2)                  -13.4 %          -13.1 %                         -8.4 %            -6.6 %

(1) New active Dealers are Dealers who enrolled in our program and have received funding for their first Loan from us during the period.

(2) Attrition is measured according to the following formula: decrease in Consumer Loan unit volume from Dealers who have received funding for at least one Loan during the comparable period of the prior year but did not receive funding for any Loans during the current period divided by prior year comparable period Consumer Loan unit volume.

Consumer Loans are assigned to us as either Dealer Loans through our Portfolio Program or Purchased Loans through our Purchase Program. The following table summarizes the portion of our Consumer Loan volume that was assigned to us as Dealer Loans:

                                              For the Three Months Ended           For the Nine Months Ended
                                                     September 30,                       September 30,
                                               2013                2012            2013                 2012
Dealer Loan unit volume as a percentage
of total unit volume                               92.9 %              93.8 %         93.8 %               93.6 %
Dealer Loan dollar volume as a percentage
of total dollar volume (1)                         90.8 %              92.1 %         92.1 %               91.8 %

(1) Represents advances paid to Dealers on Consumer Loans assigned under our Portfolio Program and one-time payments made to Dealers to purchase Consumer Loans assigned under our Purchase Program. Payments of Dealer Holdback and accelerated Dealer Holdback are not included.

For the three and nine months ended September 30, 2013, Dealer Loan unit and dollar volume as a percentage of total unit and dollar volume were generally consistent with the same periods in 2012.

As of September 30, 2013 and December 31, 2012, the net Dealer Loans receivable balance was 89.2% and 88.0%, respectively, of the total net Loans receivable balance.


Table of Contents

Results of Operations

Three Months Ended September 30, 2013 Compared to Three Months Ended September
30, 2012

The following is a discussion of our results of operations and income statement
data on a consolidated basis.


(In millions, except share and per share data)       For the Three Months Ended September 30,
                                                      2013                 2012          % Change
Revenue:
  Finance charges                                $         148.7       $       137.5          8.1 %
  Premiums earned                                           13.1                12.2          7.4 %
  Other income                                              10.9                 6.0         81.7 %
    Total revenue                                          172.7               155.7         10.9 %
Costs and expenses:
  Salaries and wages                                        20.1                21.7         -7.4 %
  General and administrative                                 8.7                 6.8         27.9 %
  Sales and marketing                                        8.5                 8.2          3.7 %
  Provision for credit losses                                6.1                 9.8        -37.8 %
  Interest                                                  16.1                16.3         -1.2 %
  Provision for claims                                      11.0                 9.1         20.9 %
    Total costs and expenses                                70.5                71.9         -1.9 %
Income before provision for income taxes                   102.2                83.8         22.0 %
  Provision for income taxes                                37.1                30.9         20.1 %
Net income                                       $          65.1       $        52.9         23.1 %

Net income per share:
  Basic                                          $          2.75       $        2.13         29.1 %
     Diluted                                     $          2.75       $        2.12         29.7 %

Weighted average shares outstanding:
  Basic                                               23,672,635          24,908,247         -5.0 %
  Diluted                                             23,708,043          24,962,054         -5.0 %


Table of Contents

The following table highlights changes in net income for the three months ended September 30, 2013, as compared to 2012:

(In millions)                                              Change
Net income for the three months ended September 30, 2012   $  52.9
Increase in finance charges                                   11.2
Increase in premiums earned                                    0.9
Increase in other income                                       4.9
Increase in operating expenses (1)                            (0.6 )
Decrease in provision for credit losses                        3.7
Decrease in interest                                           0.2
Increase in provision for claims                              (1.9 )
Increase in provision for income taxes                        (6.2 )
Net income for the three months ended September 30, 2013   $  65.1

(1) Operating expenses consist of salaries and wages, general and administrative, and sales and marketing expenses.

Finance Charges. For the three months ended September 30, 2013, finance charges increased $11.2 million, or 8.1%, as compared to the same period in 2012. The increase was primarily the result of an increase in the average net Loans receivable balance partially offset by a decrease in the average yield on our Loan portfolio, as follows:

(Dollars in millions)                      For the Three Months Ended September 30,
                                            2013                 2012            Change
Average net Loans receivable balance   $      2,128.8       $      1,848.5       $ 280.3
Average yield on our Loan portfolio              27.9 %               29.8 %        -1.9 %

The following table summarizes the impact each component had on the overall increase in finance charges for the three months ended September 30, 2013:

                                                                          Year over
(In millions)                                                            Year Change
                                                                           For the
                                                                            Three
                                                                           Months
                                                                            Ended
                                                                          September
Impact on finance charges:                                                30, 2013
Due to an increase in the average net Loans receivable balance           $      20.9
Due to a decrease in the average yield                                          (9.7 )
  Total increase in finance charges                                      $      11.2

The increase in the average net Loans receivable balance was primarily due to the growth in new Consumer Loan assignments in recent years, which resulted in the dollar volume of new Consumer Loan assignments exceeding the principal collected on Loans throughout the last two quarters of 2012 and the first three quarters of 2013. The growth in new Consumer Loan assignments in recent years was the result of an increase in active Dealers, partially offset by a decline in volume per active Dealer. The average yield on our Loan portfolio for the three months ended September 30, 2013 decreased as compared to the same period in 2012 due to higher advance rates on new Consumer Loan assignments, partially offset by improvements in forecasted collection rates throughout the last two quarters of 2012 and the first three quarters of 2013.

Premiums Earned. For the three months ended September 30, 2013, premiums earned increased $0.9 million, or 7.4%, as compared to the same period in 2012. The increase was primarily due to growth in the size of our reinsurance portfolio, which was the result of premiums written on vehicle service contracts from new Consumer Loan assignments throughout the last two quarters of 2012 and the first three quarters of 2013.

Other Income. For the three months ended September 30, 2013, other income increased $4.9 million, or 81.7%, as compared to the same period in 2012. The increase was primarily due to:
A $2.4 million increase in vehicle service contract profit sharing income as a result of a new profit sharing arrangement we entered into with one of our TPPPs during 2012.

A $1.5 million increase in Global Positioning Systems with Starter Interrupt . . .

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