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LEAP Puts on Sub Prime Auto Lenders


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I was curious about purchasing Put LEAPs in publicly traded sub-prime auto lenders like Credit Acceptance Corp and Santander Consumer USA,  CACC and SC respectively. I’m usually too early and I don’t claim to be able to time the market, that’s why long term expiration puts are the only instrument I would consider and it would be a tiny portion of my portfolio. It would be too expensive to short outright so LEAPs look better. My only concern is that there is not a specific event or date driven thesis which would make the payout more rewarding and make volatility not follow a normal distribution like a court ruling on a specific date. I have a couple main reasons:

 

- Defaults are increasing

https://www.bloomberg.com/amp/news/articles/2018-02-02/never-mind-defaults-debt-backed-by-subprime-auto-loans-is-hot

Both SC and CACC are increasing their provisioning for these defaults and analysts asked why they were provisioning at a higher tick without a clear answer.

 

- The used auto index is decreasing

http://www.nada.com/b2b/NADAOutlook/Guidelines.aspx

This matters a lot because folks purchasing a new car depend on the trade in value of their used car. If they can’t trade in for value then new car dealers get desperate and offer more discounts which pushes down used car value more. When subprime lenders repossess autos they depend on the value of those vehicles to make themselves whole and if you look at CACC’s portfolio from 2015 to today based on their 10K they are owning more and more of these loans outright rather than handing off the risk to the dealer due to competitive pressure. When borrowers finish their lease and the remaining payments are more than the market value of their vehicle they will return the car leading to more used cars on the market. https://www.kbb.com/car-news/all-the-latest/this-week-in-car-buying-inventories-grow-used-cars-flood-market/2100004210/amp/

 

- Interest rates are increasing

If the spread between the Fed rate and high interest sub prime auto bonds decrease then lenders will have to increase interest rates to entice bond purchasers or take a margin hit.

 

- The quality of new dealers is likely decreasing

If you look at Credit Acceptance 10K they are increasing dealership footprint but are seeing some market saturation. I believe there are 35000 used car dealerships in the US and they are in 9000. So what you see is that their per dealer deals are decreasing per year. Also if you see the analyst questions from their last quarterly it appears that their new dealers are not meeting the minimum 100 deal quota in order to gain access to up front lending. I am speculating that it is their new dealers responsible for the downtrend in loan rates and that they are pushing into new territory where subprime isn’t as viable in the hopes for the same growth. Companies like CACC have had amazing compounding growth but I think maintaining that growth will be very difficult given their size now. You can see the analysts inquiring about new dealer performance and a non-answer on page 4.

https://seekingalpha.com/article/4141501-credit-acceptances-cacc-ceo-brett-roberts-q4-2017-results-earnings-call-transcript?page=4

 

- Business Model Shift

I applaud Credit Acceptance in their early days for crafting a business model that shared the underwriting risk with the dealers. In their original business model the dealers would get an up-front loan from Credit Acceptance that was short of the full purchase price. The dealer would then recoup the difference over time as the loan continued to perform. This would incentivize dealers to practice good underwriting. Now however for the past few years CA has shifted from sharing the risk to owning more of the loans, see the chart on percentage growth from "Dealer" loans to "Purchased" loans.

https://globenewswire.com/news-release/2018/01/30/1314630/0/en/Credit-Acceptance-Announces-Fourth-Quarter-and-Full-Year-2017-Earnings.html

I imagine this is because dealers would rather take more upfront and use that to cycle through more inventory rather than wait a few years to collect payments. This is a misalignment of incentives and risk where dealers are offloading the default risk to the lender without any fear of losing their source of cash because they have multiple online options to choose from.

 

- Unemployment at all time low

How can defaults be increasing when unemployment in the US is at an all time low. Imagine if that unemployment regressed to the mean. Since there is so much competition now between subprime lenders and dealers have the pick of the litter often the fastest pre-approval wins. So the lenders are incentivized to decrease underwriting standards and beat out the next lender. The question is who is the fastest and worst underwriter? I don’t think I know that answer yet, I think historically Credit Acceptance has been more prudent and outlived the competition but the business model is changing.

 

- Loan duration is increasing

The average duration of these auto loans are at all time highs of 65 months and max of 85 to 94 months. If used car prices continue to decrease then these vehicles are more likely to be underwater compared to a scenario where they had been on a traditional payment term. I am curious as to the correlation between longer loan periods in a downward vehicle price environment and defaults. My hypothesis is that if the vehicle is underwater and I can no longer make payments then I will just let the lender repossess the vehicle.

 

- What are consumers actually buying?

Right now the market leader in the US is without a doubt luxury SUVs and pickup trucks.

https://mobile.nytimes.com/2018/02/15/automobiles/wheels/luxury-trucks-suv.html?referer=https://www.google.com/

These are vehicles with higher maintenance and gas costs. Pick any street in your area and count how many lifted trucks or SUVs with a new dealer tag on the plate that weren’t there a few months ago. I’m not sure your neighbor will keep that Ford Raptor if times get tough.

 

My calculations in excel were showing me a 1.6X Payoff for Santander Consumer USA using a two year out of the money strike price 40 percent lower than market. I would hope for at least a 2X payout, this was one of the rules Cornwall Capital had for investing. CACC used to be run by owner operators who have a lot of experience surviving multiple up and down environments, however their founder has since sold a lot of his shares and their business model is shifting from sharing the risk to owning the risk.

https://www.bloomberg.com/news/articles/2017-05-04/as-inventor-of-subprime-car-loans-exits-critics-smell-a-lemon

Santander might be a better opportunity though they aren't as richly priced for growth.

 

In summary I think this market has enjoyed a lot of tailwinds for the past 8 years and people made a lot of money in this industry. I think there are a lot of headwinds ahead while these companies are being priced for perfection. Because the duration of auto loans continues to increase out to 65 months or greater in an environment where the used price index is decreasing provides heightened odds of borrowers being caught in a down job market with a luxury vehicle that is underwater. While lenders are incentivized to increase loan duration to make monthly payments more palatable today they are relying on the resale value of those vehicles in the event of default in the future.

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Great write up!

 

Very interested in this. The model seems to be make the loan and securitize it which makes shorting Santander consumer a bit less attractive.  I'm trying to find auto loan lenders or investors that keep the loans on the books but Google finance is gone and I'm struggling.

Also I can't find a sub prime auto loan index.

 

With sub prime mortgages though the trigger was teaser rates ending and higher rates kicking in. What do you think the trigger will be here?

 

 

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Just reading the CACC AR. They are clearly going after growth through the purchase program where the dealer has less skin in the game. Couple that with a lender who lends with no questions asked to poor to no credit borrowers and you have a recipe for disaster. I can't see a dealer turning down a sale here.

Losses all depends on what they charge for the loans and the softening of the resale market value.

More to do but if I can work out a catalyst there could be something here.

Thanks for sharing.

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Wfearful_Bgreedy,

 

-I like your post too and agree with the potential.

-Cycles are cycles and subprime auto lending appears to form a top.

-However, as with all these opportunities, timing is an important factor.

 

So, even if I like your thesis, here are three moderating factors.

 

1-Resilience of the subprime auto lending market

 

I have done some work to compare the « state » of the auto subprime market before the 2007-9 episode to now (interest rates, credit score, lending origination by credit tier, LTV to loan, term length, delinquency rates). IMO, auto finance lenders are only in a slightly worse position (I think banks exposed to this segment are, in fact, in a better position).  The auto finance lenders have a relatively larger piece of the subprime pie but I think that the creditworthiness of customers is comparable. Also, the auto finance companies ratio of subprime debt over total outstanding auto debt is actually lower. This is a cyclical business and CACC has had its share of problems (more familiar with CACC than SC) but it has been around for a long time. Even if the the terms of loans have gotten longer, those loans do season fairly rapidly.  If you are quasi-autistic , you may want to look at the link below (slightly outdated but relevant). The link also shows that going through the Great Recession (certainly a significant real life stress test), not a single securitization issue was downgraded (at least by S&P). Despite the severity of the recession, the auto ABS market rebounded quite nicely after a relatively short period. The US Treasury came to the rescue of GMAC but my understanding is that the rescue was more directed to GM, the manufacturer itself. It may take more than a usual credit cycle adjustment to really hurt the underlying business.

 

https://www.capitaliq.com/CIQDotNet/CreditResearch/RenderArticle.aspx?articleId=1817685&SctArtId=420028&from=CM&nsl_code=LIME&sourceObjectId=10010733&sourceRevId=1&fee_ind=N&exp_data-ipsquote-timestamp=20270320-23:12:27

 

2-Relative advantage to CACC and SC if/when the auto credit cycle turns

 

I see that many newer and smaller players have appeared on the scene and these entrants likely have been/are using loosened standards and those players may absorb first a significant portion of the losses if credit dries up as larger players such as CACC and SC suffer relatively less, use their relative scale and maintain access to credit.

 

3-The auto subprime financing market, by itself, is not large enough to precipitate its own demise.

 

If you can identify a catalyst, it would be then reasonable to run various time-weighted scenarios. What was interesting with the subprime mortgage segment leading to 2007 was that the worsening lending standards were way more significant than what is happening now in the auto subprime market and formed a large enough market to trigger a wholesale liquidity crisis in the mortgage prime segment, then in the general economy triggering a recession and then sustaining the self-fulfilling prophecy of a massive decline in the mortgage subprime segment that started the whole thing. I don’t think that the auto subprime segment is large enough to cause that type of vicious circle. There are plenty of potential catalysts in our markets now but, for your thesis to play out, you have to rely on a large increase in interest rates or a recession in order to make a large profit. A simple cyclical adjustment would do the trick to some degree but IMO expected profits would be less with names like CACC or SC compared to weaker players and timing remains an issue.

 

Thanks for sharing. Will follow.

 

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Cigarbutt

 

I'm close to the same conclusion. It feels like there's something here but trying to find it is difficult.

 

For instance I've read that some of these loans have an interest rate as high as 25% and charge offs happen in the first 120 days. But then the car is sold at auction and losses made up.

One reason that high interest rates have been charged is to protect investors buying the abs (according to an analyst) so I don't think securities demand will fall to business failing levels as defaults may rise but that wouldn't mean huge abs losses. Same goes for loans on the balance sheet.

 

Might be worth checking the capital structure and maturity schedule of some of these businesses to predict some pinch points.  I think cacc has issued equity and sold some bonds recently will have to check.

 

Worst case I see is that this is the top of the cycle and mortgage rates are rising

which together bring elevated losses and lower loan demand that'll hurt top and bottom lines.

 

There doesn't seem to be a catalyst that will crater the abs and cripple the businesses that we need for the short, like a funding term mis-match or variable rate change.

 

Autos as a whole may soften. Karmax (KMX) may get interesting, but that'll take an extreme scenario. Anything with low operating leverage in a down market might be interesting.

 

Going to keep an eye on kmx cacc and sc but dont think this will be for me.

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Follow-up

The link provided above may no longer be available or may have an availability time-dependent feature for access.

 

Here's a more generic access to the research with more recent data.

 

https://www.spratings.com/ca_AD/structured-finance?catSelected=88212

 

---)Subprime auto loan tracker, 2017 review...14/03/18

 

https://www.spratings.com/ca_AD/structured-finance?p_p_id=122_INSTANCE_w5mTyRwrkVAV&p_p_lifecycle=0&p_p_state=normal&p_p_mode=view&p_p_col_id=column-1&p_p_col_count=2&p_r_p_564233524_resetCur=true&p_r_p_564233524_categoryId=88211,88212,88228,88240,88319,88340,88352,88359

 

 

---)Subprime auto loan tracker, January 2018...19/03/18

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I had put this topic aside but came across:

https://www.plainsite.org/realitycheck/creditacceptance.html

 

I spent some time on the three part series.

They explore many valid points but:

-Don't know anything about the author/group making the research/report, what is the intent, the motives?

-The auto subprime leasing industry is messy and a relatively easy target.

-The muckracking style is hard to differentiate from true investigative work

 

Any thoughts?

 

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I am interested in how this plays out.  It smells (and I have heard) auto lenders are going into deep subprime territory and pushing out the Buy Here Pay Here operators.  So if the easy lending reverses then a huge chunk of consumers can't buy cars.  Rough guess ~90% of Carmax buyers finance (includes Non KMX finance guess). 

 

So if financing suddenly becomes tight for subprime and near subprime that eliminates a big chunk of demand and buyers.  Then used vehicle prices fall and lenders lose more.  Typical credit cycle. 

 

See used vehicle price chart

https://publish.manheim.com/en/services/consulting/used-vehicle-value-index.html

 

Could mean that prices tank and stay lower than normal. 

 

I think this cycle has happened a bunch of times as the new subprime autolenders learn about credit risk and get wiped out.  Not an easy industry dealing with a lot of yoyos who you are loaning cars to.

 

Thoughts on how this plays out?

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I had put this topic aside but came across:

https://www.plainsite.org/realitycheck/creditacceptance.html

 

I spent some time on the three part series.

They explore many valid points but:

-Don't know anything about the author/group making the research/report, what is the intent, the motives?

-The auto subprime leasing industry is messy and a relatively easy target.

-The muckracking style is hard to differentiate from true investigative work

 

Any thoughts?

 

Other than CACC dealing with a possibly dubious warranty company that got bought out, what is the smoking gun or fraud?  I didn't see or detect it from reading the 1st 2 reports. 

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"See used vehicle price chart

https://publish.manheim.com/en/services/consulting/used-vehicle-value-index.html

 

Could mean that prices tank and stay lower than normal. 

 

I think this cycle has happened a bunch of times as the new subprime autolenders learn about credit risk and get wiped out.  Not an easy industry dealing with a lot of yoyos who you are loaning cars to."

 

Some additional comments:

 

-The private indices are quite different among themselves and compared to the BLS numbers.

-The used car index has tracked the new car index quite strongly, but not always.

-Long term, used car prices do not decrease necessarily during recessions (may need recessions and very low inflation).

-The used car market is not homogeneous (some segments prices move up while others go down; the average may mask large differences).

 

Some buyers just buy cars that they cannot really afford. Then the cars tend to be more recent, larger and relatively more expensive.

However other buyers are simply people who have difficulty getting by. Then the cars tend to be older and less expensive.

 

Perhaps relevant as used car prices may eventually go down in some segments but, if the credit cycle does turn, used cars may become susbtitutes for new cars and there will continue to be a market for people who need a used car to replace a used car.

 

Have to remember that, since 2008-9, the age of the car fleet has increased and I suggest that this may not be a choice.

The average age of light vehicles is now about 11,6 years!

https://www.statista.com/statistics/261881/average-age-of-light-vehicles-in-the-united-states/

 

IMO, when the cycle turns, new car sales will suffer more than auto finance companies and more than used car sales.

 

 

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I remember looking at buying puts for CACC a while ago.  I came across the company when reading a write-up by John Huber.  If you look at insider trades, the owners (Foss family) started massively dumping shares starting from September 2016 at $198/share all the way to December 2017 at $326/share.

 

Also, something from their 10-K seemed really weird:

 

"An allowance for credit losses is maintained at an amount that reduces the net asset value (Dealer Loan balance less the allowance) to the value of forecasted future cash flows discounted at the yield established at the time of assignment. This allowance calculation is completed for each individual Dealer. Future cash flows are comprised of estimated future collections on the Consumer Loans, less any estimated Dealer Holdback payments. We write off Dealer Loans once there are no forecasted future cash flows on any of the associated Consumer Loans, which generally occurs 120 months after the last Consumer Loan assignment."

 

They write off Dealer Loans after 120 months or 10 years?  That sounds ridiculous.  If you recall, the Great Recession started in 2008 and I believe CACC benefited greatly from the "cash for clunkers" program.  Does that mean that Dealer Loans originated in 2008 are going to be written off starting this year?

 

I've been watching this stock from when the Foss' first started selling and it's gone up by over 50% so I have no idea where the price is heading.

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I remember looking at buying puts for CACC a while ago.  I came across the company when reading a write-up by John Huber.  If you look at insider trades, the owners (Foss family) started massively dumping shares starting from September 2016 at $198/share all the way to December 2017 at $326/share.

 

Also, something from their 10-K seemed really weird:

 

"An allowance for credit losses is maintained at an amount that reduces the net asset value (Dealer Loan balance less the allowance) to the value of forecasted future cash flows discounted at the yield established at the time of assignment. This allowance calculation is completed for each individual Dealer. Future cash flows are comprised of estimated future collections on the Consumer Loans, less any estimated Dealer Holdback payments. We write off Dealer Loans once there are no forecasted future cash flows on any of the associated Consumer Loans, which generally occurs 120 months after the last Consumer Loan assignment."

 

They write off Dealer Loans after 120 months or 10 years?  That sounds ridiculous.  If you recall, the Great Recession started in 2008 and I believe CACC benefited greatly from the "cash for clunkers" program.  Does that mean that Dealer Loans originated in 2008 are going to be written off starting this year?

 

I've been watching this stock from when the Foss' first started selling and it's gone up by over 50% so I have no idea where the price is heading.

 

 

Nice Catch - Nell.  So let me understand this - they write off loans generally after 10 YEARS.  This is totally nuts.

So basically if writeoffs only occur after 10 years (perhaps 5 years after the borrow defaults then who knows what the earnings are.  Wow.  Who knows how long this one can go on.

 

writeup on the writeoffs

https://www.hvst.com/attachments/13770/Credit-Acceptance-Corporation_Thesis_11-Feb-18.pdf

 

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I would take a look at the asset lifecycle specifically any modifications if u can find the info. Lend car-->buyer goes into default-->repo car-->loan terms modified (outstanding balance is added to loan amount)-->buyer gets car back-->modified terms can't even then cover interest.

 

My guess is the above flow is how many of these loans will evolve. Regulators should be providing guidance or enforcing limits to this behavior.

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I remember looking at buying puts for CACC a while ago.  I came across the company when reading a write-up by John Huber.  If you look at insider trades, the owners (Foss family) started massively dumping shares starting from September 2016 at $198/share all the way to December 2017 at $326/share.

 

Also, something from their 10-K seemed really weird:

 

"An allowance for credit losses is maintained at an amount that reduces the net asset value (Dealer Loan balance less the allowance) to the value of forecasted future cash flows discounted at the yield established at the time of assignment. This allowance calculation is completed for each individual Dealer. Future cash flows are comprised of estimated future collections on the Consumer Loans, less any estimated Dealer Holdback payments. We write off Dealer Loans once there are no forecasted future cash flows on any of the associated Consumer Loans, which generally occurs 120 months after the last Consumer Loan assignment."

 

They write off Dealer Loans after 120 months or 10 years?  That sounds ridiculous.  If you recall, the Great Recession started in 2008 and I believe CACC benefited greatly from the "cash for clunkers" program.  Does that mean that Dealer Loans originated in 2008 are going to be written off starting this year?

 

I've been watching this stock from when the Foss' first started selling and it's gone up by over 50% so I have no idea where the price is heading.

 

 

Nice Catch - Nell.  So let me understand this - they write off loans generally after 10 YEARS.  This is totally nuts.

So basically if writeoffs only occur after 10 years (perhaps 5 years after the borrow defaults then who knows what the earnings are.  Wow.  Who knows how long this one can go on.

 

writeup on the writeoffs

https://www.hvst.com/attachments/13770/Credit-Acceptance-Corporation_Thesis_11-Feb-18.pdf

 

Borrowers basically never (cannot) default on Dealer Loans - the dealer effectively has no obligation to pay the money back. So I think this specific accounting practice means much less than you think it does. The important thing is the evaluation of the underlying Consumer Loans. The company's stated practice on that front is "We monitor and evaluate the credit quality of Consumer Loans on a monthly basis by comparing our current forecasted collection rates to our initial expectations." Variances then flow through the income statement on a quarterly basis.

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Thanks for the link, Longhaul.  I'm following Antonio on Twitter now.

 

Morningstar, I basically don't trust my own interpretation of accounting.  That's the biggest reason I didn't buy puts.

 

Irrespective, what's the bull thesis at this point?  Who's bidding this stock up?

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- Holding Off

I am holding off on buying puts although based on that article by Antonio there might be a catalyst or event driven thesis.

I think this will be a long developing story and unfortunately I wasn't having much luck finding public data on auto loan modifications or even which dealers use CACC out of the population of dealers.

Was hoping to correlate census income demographics surrounding current used auto dealers using CACC vs. the remaining used auto dealers to estimate runway left and the extra resources needed to gain only marginal dealer presence.

 

- Future Catalyst

With regards to the bad write off policy per Antonio's article:

 

"The implementation of the new Financial Accounting Standards Board (FASB) Current Expected Credit Loss (CECL) model due

before Dec-19 puts a theoretical hard stop date to this practice. In 2018, analysts are likely to question management regarding

the impact of implementing such accounting standards."

 

I'm not an expert on credit loss modeling standards and what the new standards will mean.

 

- Public Data and Analysis

The current situation just seems odd for any new growth investors in an environment where the dealer market is saturated, competition is high, interest rates are rising, defaults are increasing, unemployment at all time low, consumer debt is tapped, used auto indexes point to lower residuals, and new accounting standards that appear to me more rigorous are coming in 2018. While I like the macro case I really wish there was more public data available at the loan level.

 

I think one interesting data option might actually be lending club. Although they don't service "sub-prime" 600 or lower they go down to 640. Also I think their loans cover auto refinancing at the moment so not sure how this piece adds value yet to the puzzle.

Their accepted and rejected loan data is available at:

https://www.lendingclub.com/info/download-data.action

 

Will most likely need to open this in python or import into a database as the row size will crash most spreadsheet software.

 

 

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Morningstar - I didn't understand your comment on why writing off the loan was not important.  Can you please elaborate.

 

2 data points for people to consider on CACC.  I will lay out the dots.

1.  ~35% ROE since 2009 in a brutally competitive business.

2.  Apparently only fully write off loans after 10 years.  (do say that if forecasted difference is unfavorable a provision for credit losses is established).

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Morningstar - I didn't understand your comment on why writing off the loan was not important.  Can you please elaborate.

 

2 data points for people to consider on CACC.  I will lay out the dots.

1.  ~35% ROE since 2009 in a brutally competitive business.

2.  Only write off loans after 10 years.

 

The dealer doesn't owe them money at any point in their business model; CCAC pays dealers. So writing off the Dealer Loan is writing off a cash liability, not a cash asset - waiting longer is more conservative.

 

If CACC is going to lose money, it will be on the consumer loans where they are owed money by questionable counterparties, not on the Dealer Loans where they owe holdback to auto dealers.

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Morningstar, did you read this write-up? https://www.hvst.com/attachments/13770/Credit-Acceptance-Corporation_Thesis_11-Feb-18.pdf

 

Author calls out that Loans Receivable (an asset) are written off after 10 years.

 

I went to CACC 10-K and found the following passage:

We record the amount advanced to the Dealer as a Dealer Loan, which is classified within Loans receivable in our consolidated balance sheets. 

 

Am I missing something?

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Morningstar, did you read this write-up? https://www.hvst.com/attachments/13770/Credit-Acceptance-Corporation_Thesis_11-Feb-18.pdf

 

Author calls out that Loans Receivable (an asset) are written off after 10 years.

 

I went to CACC 10-K and found the following passage:

We record the amount advanced to the Dealer as a Dealer Loan, which is classified within Loans receivable in our consolidated balance sheets. 

 

Am I missing something?

 

I saw the same thing.  Pg 52 of the 2017 10-K

 

I have to correct something I wrote earlier regarding 10 year writeoffs.

As far as recording provisions in the 10-K  (pg 52) they do say: "If such difference is unfavorable, a provision for credit losses is recorded immediately as a current period expense."

 

I must admit I was really confused by how they account for the loans with the NAV, discounting at yields at the time of assignment, accretion, etc.  I didn't understand it.  Maybe I am dumb or maybe one just cannot fully understand it and one just has to trust mgmt.

 

The other interesting thing is in 2017 Finance charges divided by average gross loans receivable was ~22%. 

So to me these dealers were willing to borrow money for 22% from CACC.  That is a steep interest rate.  You can quibble with the 22% rate as CACC has some collections expense and write offs but it still seems like the dealers are borrowing at a very high rate.  Doesn't make any sense to me why they would do that.

 

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"The other interesting thing is in 2017 Finance charges divided by average gross loans receivable was ~22%. 

So to me these dealers were willing to borrow money for 22% from CACC.  That is a steep interest rate.  You can quibble with the 22% rate as CACC has some collections expense and write offs but it still seems like the dealers are borrowing at a very high rate.  Doesn't make any sense to me why they would do that."

 

My understanding is that the financial incentives that drive dealers to enroll with CACC are based on:

1-dealers would not realize the sale absent the financing option.

2-dealers probably figure that they will make more with CACC with the upfront advance and the eventual recovery after CACC is made whole (80%-20% split) than the more traditional selling of the loan receivable at a small discount.

 

1-above is compounded on the probable proposition that the price tag for the financed option ends up somehow higher than the cash option (even with the interest component removed).

 

I understand also that CACC has seen increased competition at the dealer level and that may signal looser standards across the board but not necessarily more so with CACC. To let go of market share at this point may not be a bad thing.

 

CACC has done this "dealer loan/advance program" for some time and I submit that the underlying individual loans is the area to look for potential weakness.

 

 

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There probably should be a CACC thread.. (there may be one.. havent checked).

 

For those new to the company - dealer loans and purchase loans are both loans to consumers. In both cases, CACC is buying an auto loan from a dealer.  The difference is in a purchase loan, CACC buys the loan and that ends the dealers involvement. In a dealer loan, CACC buys the loan but also agrees to share profits with the dealer once it has recouped its investment.  Because it has this "profit share" component, it pays less for a dealer loan.. the idea being dealer is going to get some back-end payments (dealer holdbacks). Purchase loans are what all the other auto lenders do for the most part. In good times the proportion of purchase loans increases. These are higher risk (no profit share) and likely have lower returns (more competition)

 

The accounting is confusing because unlike the vast vast majority of companies, CACC uses level yield accounting. What this means is that the company projects out future cash-flows on loans and adjusts the amount of finance charges booked in each period. Basically, it makes an assumption when loan is made and then adjusts it throughout its life. Given the moving parts, comparisons to other auto lenders are hard / impossible.  Don't understand every little nuance of this but thats the jist.

 

In terms of the interest rate.. yes the 22% sounds about right.. might even be lower than actual interest rate charged as they are only booking the cash-flows they expect to receive. Keep in mind, CACC is lending to ppl who have no other choice. In general default / repossession rates are probably around 45-50% of loans (by number of loans) so the interest rate tends to be high

 

The business is ripe for abuse because the borrowers are the bottom of the economic ladder, typically unsophisticated and unlikely to have resources to fight them. Some have argued that CACC is a collection company, disguised as a lender.. others say its providing cars for ppl who have no other alternative so a great company.  The right comp might be a payday lender. Yes the ROE's etc look great but there is a ton of regulatory risk (esp if the CFPB / State AGs actually want to act).

 

 

 

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