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CACC > SEC Filings for CACC > Form 10-K on 14-Feb-2014All Recent SEC Filings

Show all filings for CREDIT ACCEPTANCE CORP

Form 10-K for CREDIT ACCEPTANCE CORP


14-Feb-2014

Annual Report


ITEM 7. 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 contained in Item 8 of this Form 10-K, 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 year ended December 31, 2013, consolidated net income was $253.1 million, or $10.54 per diluted share, compared to $219.7 million, or $8.58 per diluted share, for the same period in 2012 and $188.0 million, or $7.07 per diluted share, for the same period in 2011. The growth in 2013 and 2012 consolidated net income was primarily due to an increase in the average balance of our Loan portfolio.

Critical Success Factors

Critical success factors include our ability to accurately forecast Consumer Loan performance, access capital on acceptable terms, 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.

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 December 31, 2013, with the forecasts as of December 31, 2012, as of December 31, 2011, and at the time of assignment, segmented by year of assignment:

                                                                                 Variance in Forecasted Collection
                         Forecasted Collection Percentage as of                           Percentage from
  Consumer
    Loan
 Assignment    December 31,    December 31,    December 31,     Initial     December 31,    December 31,      Initial
    Year           2013            2012            2011         Forecast        2012            2011         Forecast
    2004               73.0 %          73.0 %          73.0 %        73.0 %          0.0 %           0.0 %          0.0 %
    2005               73.7 %          73.6 %          73.6 %        74.0 %          0.1 %           0.1 %         -0.3 %
    2006               70.0 %          69.9 %          70.0 %        71.4 %          0.1 %           0.0 %         -1.4 %
    2007               67.9 %          68.0 %          68.1 %        70.7 %         -0.1 %          -0.2 %         -2.8 %
    2008               70.1 %          70.3 %          70.0 %        69.7 %         -0.2 %           0.1 %          0.4 %
    2009               79.2 %          79.5 %          79.4 %        71.9 %         -0.3 %          -0.2 %          7.3 %
    2010               77.0 %          77.3 %          76.8 %        73.6 %         -0.3 %           0.2 %          3.4 %
    2011               74.1 %          74.1 %          73.2 %        72.5 %          0.0 %           0.9 %          1.6 %
    2012               73.5 %          72.2 %             -          71.4 %          1.3 %             -            2.1 %
    2013               73.3 %             -               -          72.0 %            -               -            1.3 %


Table of Contents

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 year ended December 31, 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 implemented an enhanced forecasting methodology that contributed to these collection rate variances.

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 December 31, 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 December 31, 2013
                                   Forecasted                                                % of Forecast
 Consumer Loan Assignment Year    Collection %        Advance % (1)         Spread %         Realized (2)
             2004                           73.0 %              44.0 %             29.0 %              99.9 %
             2005                           73.7 %              46.9 %             26.8 %              99.7 %
             2006                           70.0 %              46.6 %             23.4 %              99.3 %
             2007                           67.9 %              46.5 %             21.4 %              98.8 %
             2008                           70.1 %              44.6 %             25.5 %              98.4 %
             2009                           79.2 %              43.9 %             35.3 %              98.3 %
             2010                           77.0 %              44.7 %             32.3 %              93.0 %
             2011                           74.1 %              45.5 %             28.6 %              76.1 %
             2012                           73.5 %              46.3 %             27.2 %              50.8 %
             2013                           73.3 %              47.6 %             25.7 %              17.1 %

(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 December 31, 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).

                       Consumer Loan         Forecasted
                      Assignment Year       Collection %        Advance % (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                      74.0 %              45.2 %             28.8 %
                            2012                      73.5 %              46.1 %             27.4 %
                            2013                      73.2 %              47.2 %             26.0 %

Purchased Loans             2007                      68.2 %              49.1 %             19.1 %
                            2008                      69.4 %              46.7 %             22.7 %
                            2009                      79.3 %              45.2 %             34.1 %
                            2010                      76.9 %              46.2 %             30.7 %
                            2011                      74.5 %              47.5 %             27.0 %
                            2012                      74.1 %              48.0 %             26.1 %
                            2013                      74.0 %              51.4 %             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.

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 1.9:1 as of December 31, 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 Volume

The following table summarizes changes in Consumer Loan assignment volume in
each of the last three years as compared to the same period in the previous
year:
                                         Year over Year Percent Change
 For the Year Ended December 31,    Unit Volume            Dollar Volume (1)
2011                                         30.2 %                      43.5 %
2012                                          6.7 %                       7.1 %
2013                                          6.4 %                       8.7 %

(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.


Table of Contents

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 grew 6.4% and 8.7%, respectively, during 2013 as the number of active Dealers grew 20.2% and average volume per active Dealer declined 11.5%. We believe the decline in volume per Dealer is the result of increased competition.

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

                                       For the Years Ended December 31,                 % Change
                                       2013            2012         2011      2013 to 2012    2012 to 2011
Consumer Loan unit volume               202,250         190,023     178,074             6.4 %           6.7 %
Active Dealers (1)                        6,394           5,319       3,998            20.2 %          33.0 %
Average volume per active Dealer           31.6            35.7        44.5           -11.5 %         -19.8 %

(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 Years Ended December 31,              For the Years Ended December 31,
                             2013             2012         % Change        2012             2011         % Change

Consumer Loan unit
volume from Dealers
active both periods            170,219          176,680         -3.7 %       157,735          168,314         -6.3 %
Dealers active both
periods                          3,965            3,965            -           3,192            3,192            -
Average volume per
Dealers active both
periods                           42.9             44.6         -3.7 %          49.4             52.7         -6.3 %

Consumer Loan unit
volume from new
Dealers                         31,414           31,705         -0.9 %        31,705           22,419         41.4 %
New active Dealers (1)           2,382            2,070         15.1 %         2,070            1,403         47.5 %
Average volume per new
active Dealers                    13.2             15.3        -13.7 %          15.3             16.0         -4.4 %

Attrition (2)                     -7.0 %           -5.5 %                       -5.5 %           -6.0 %

(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 Years Ended December 31,
                                                         2013           2012           2011
Dealer Loan unit volume as a percentage of total
unit volume                                                  93.5 %         93.7 %         92.5 %
Dealer Loan dollar volume as a percentage of total
dollar volume (1)                                            91.6 %         92.0 %         90.4 %

(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 year ended December 31, 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 and 2011.

As of December 31, 2013 and 2012, the net Dealer Loans receivable balance was 89.0% and 88.0%, respectively, of the total net Loans receivable balance.


Table of Contents

Results of Operations

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)                                                                        % Change
                                        For the Years Ended December 31,         2013 to      2012 to
                                       2013           2012           2011          2012         2011
Revenue:
Finance charges                    $      590.4   $      538.2   $      460.6          9.7 %       16.8 %
Premiums earned                            51.5           47.1           40.0          9.3 %       17.8 %
Other income                               40.2           23.9           24.6         68.2 %       -2.8 %
Total revenue                             682.1          609.2          525.2         12.0 %       16.0 %
Costs and expenses:
Salaries and wages                         87.3           82.2           63.0          6.2 %       30.5 %
General and administrative                 34.4           30.5           25.6         12.8 %       19.1 %
Sales and marketing                        34.5           31.2           23.6         10.6 %       32.2 %
Provision for credit losses                21.9           24.0           29.0         -8.8 %      -17.2 %
Interest                                   65.0           63.4           57.2          2.5 %       10.8 %
Provision for claims                       40.8           34.8           30.4         17.2 %       14.5 %
Total costs and expenses                  283.9          266.1          228.8          6.7 %       16.3 %
Income before provision for
income taxes                              398.2          343.1          296.4         16.1 %       15.8 %
Provision for income taxes                145.1          123.4          108.4         17.6 %       13.8 %
Net income                         $      253.1   $      219.7   $      188.0         15.2 %       16.9 %

Net income per share:
Basic                              $      10.61   $       8.65   $       7.15         22.7 %       21.0 %
Diluted                            $      10.54   $       8.58   $       7.07         22.8 %       21.4 %
Weighted average shares
outstanding:
Basic                                23,850,789     25,409,655     26,302,289         -6.1 %       -3.4 %
Diluted                              24,009,593     25,598,956     26,600,855         -6.2 %       -3.8 %


Table of Contents

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

The following table highlights changes in net income for the year ended December
31, 2013, as compared to 2012:

(In millions)                                      Change
 Net income for the year ended December 31, 2012   $ 219.7
 Increase in finance charges                          52.2
 Increase in premiums earned                           4.4
 Increase in other income                             16.3
 Increase in operating expenses (1)                  (12.3 )
 Decrease in provision for credit losses               2.1
 Increase in interest                                 (1.6 )
 Increase in provision for claims                     (6.0 )
 Increase in provision for income taxes              (21.7 )
 Net income for the year ended December 31, 2013   $ 253.1

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

Finance Charges. For the year ended December 31, 2013, finance charges increased $52.2 million, or 9.7%, as compared to 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 Years Ended December 31,
                                           2013            2012        Change
Average net Loans receivable balance    $    2,088.4    $   1,797.0   $  291.4
Average yield on our Loan portfolio             28.3 %         30.0 %     -1.7  %

The following table summarizes the impact each component had on the overall increase in finance charges for the year ended December 31, 2013:

(In millions)                                                        For the Year Ended
Impact on finance charges:                                            December 31, 2013
Due to an increase in the average net Loans receivable balance       $              87.3
Due to a decrease in the average yield                                             (35.1 )
Total increase in finance charges                                    $              52.2

The increase in the average net Loans receivable balance was primarily due to 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 2012 and 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 year ended December 31, 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 2012 and 2013.

Premiums Earned. For the year ended December 31, 2013, premiums earned increased $4.4 million, or 9.3%, as compared to 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 2012 and 2013.

Other Income. For the year ended December 31, 2013, other income increased $16.3 million, or 68.2%, as compared to 2012. The increase was primarily due to:

A $7.6 million increase in GPS-SID fee income due to an increase in the fee earned per unit purchased by Dealers from TPPs.

A $6.0 million increase in vehicle service contract profit sharing income primarily as a result of a new profit sharing arrangement we entered into with one of our TPPs during 2012.


Table of Contents

Operating Expenses. For the year ended December 31, 2013, operating expenses increased $12.3 million, or 8.5%, as compared to 2012. The change in operating expenses was primarily due to the following:

An increase in salaries and wages expense of $5.1 million, or 6.2%, comprised of the following:

An increase of $8.8 million, excluding stock-based compensation, primarily related to increases of $4.9 million for our servicing function and $4.2 million for our support function.

A decrease of $3.7 million in stock-based compensation expense primarily due to a change in the expected vesting period of performance-based stock awards.

An increase in general and administrative expenses of $3.9 million, or 12.8%, primarily as a result of an increase related to legal fees.

An increase in sales and marketing expense of $3.3 million, or 10.6%, primarily as a result of an increase in the size of our field sales force and an increase in Dealer support products and services.

Provision for Credit Losses. For the year ended December 31, 2013, the provision for credit losses decreased $2.1 million, or 8.8%, as compared to 2012. Under accounting principles generally accepted in the United States of America ("GAAP"), when the present value of forecasted future cash flows decline relative to our expectations at the time of assignment, a provision for credit losses is recorded immediately as a current period expense and a corresponding allowance for credit losses is established. For purposes of calculating the required allowance, Dealer Loans are grouped by Dealer and Purchased Loans are grouped by month of purchase. As a result, regardless of the overall performance of the portfolio of Consumer Loans, a provision can be required if any individual Loan pool performs worse than expected. Conversely, a previously recorded provision can be reversed if any previously impaired individual Loan pool experiences an improvement in performance.

During the year ended December 31, 2013, overall Consumer Loan performance exceeded our expectations at the start of the year. However, the performance of certain Loan pools declined from our expectations during the year, resulting in a provision for credit losses of $21.9 million for the year ended December 31, 2013, of which $21.3 million related to Dealer Loans and $0.6 million related to Purchased Loans. The provision for credit losses included $3.0 million in expense related to our implementation of an enhanced forecasting methodology during the second quarter of 2013, of which $1.2 million related to Dealer Loans and $1.8 million related to Purchased Loans. For additional information, see Note 5 to the consolidated financial statements contained in Item 8 of this Form 10-K, which is incorporated herein by reference. During the year ended December 31, 2012 overall Consumer Loan performance exceeded our expectations at the . . .

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