Credit Acceptance(CACC) - 2022 Q2 - Quarterly Report

PART I. — FINANCIAL INFORMATION This part provides the unaudited consolidated financial statements, including balance sheets, income statements, cash flows, and detailed notes on accounting policies and financial instruments ITEM 1. FINANCIAL STATEMENTS This section presents the unaudited consolidated financial statements, including balance sheets, income statements, cash flows, and comprehensive notes on accounting policies and financial instruments Consolidated Balance Sheets The consolidated balance sheet shows a slight decrease in total assets and shareholders' equity, with an increase in total liabilities from December 2021 to June 2022 Consolidated Balance Sheet Highlights (in millions) | Metric | June 30, 2022 | December 31, 2021 | | :----- | :------------ | :---------------- | | Total Assets | $6,978.5 | $7,050.9 | | Loans receivable, net | $6,323.7 | $6,336.3 | | Total Liabilities | $5,458.4 | $5,226.7 | | Revolving secured line of credit | $220.7 | $2.6 | | Total Shareholders' Equity | $1,520.1 | $1,824.2 | Consolidated Statements of Income Net income significantly declined for both three and six months ended June 30, 2022, due to increased credit loss provisions and operating expenses Consolidated Statements of Income Highlights (in millions, except per share data) | Metric | 3 Months Ended June 30, 2022 | 3 Months Ended June 30, 2021 | 6 Months Ended June 30, 2022 | 6 Months Ended June 30, 2021 | | :----- | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Total Revenue | $457.4 | $471.7 | $913.1 | $922.7 | | Provision for credit losses | $147.5 | $(30.5) | $170.8 | $(9.2) | | Total costs and expenses | $315.3 | $92.0 | $486.5 | $278.7 | | Net income | $107.4 | $288.6 | $321.7 | $490.7 | | Diluted Net income per share | $7.94 | $17.18 | $23.10 | $28.96 | Consolidated Statements of Comprehensive Income Comprehensive income for both periods ended June 30, 2022, was negatively impacted by unrealized losses on securities, net of tax Consolidated Statements of Comprehensive Income (in millions) | Metric | 3 Months Ended June 30, 2022 | 3 Months Ended June 30, 2021 | 6 Months Ended June 30, 2022 | 6 Months Ended June 30, 2021 | | :----- | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Net income | $107.4 | $288.6 | $321.7 | $490.7 | | Unrealized loss on securities, net of tax | $(0.7) | — | $(2.4) | $(0.7) | | Comprehensive income | $106.7 | $288.6 | $319.3 | $490.0 | Consolidated Statements of Shareholders' Equity Shareholders' equity significantly decreased from December 2021 to June 2022, mainly due to common stock repurchases and accumulated other comprehensive loss Consolidated Statements of Shareholders' Equity Highlights (in millions) | Metric | June 30, 2022 | December 31, 2021 | | :----- | :------------ | :---------------- | | Balance, beginning of period (Six Months) | $1,824.2 | $2,302.5 | | Net income (Six Months) | $321.7 | $490.7 | | Repurchase of common stock (Six Months) | $(652.7) | $(389.7) | | Accumulated other comprehensive income (loss) (Six Months) | $(2.2) | $1.6 | | Balance, end of period (June 30, 2022) | $1,520.1 | $2,393.0 (June 30, 2021) | Consolidated Statements of Cash Flows Net cash from operating activities decreased, investing activities used cash, and financing activities significantly increased cash usage for the six months ended June 30, 2022 Consolidated Statements of Cash Flows Highlights (in millions) | Metric | 6 Months Ended June 30, 2022 | 6 Months Ended June 30, 2021 | | :----- | :--------------------------- | :--------------------------- | | Net cash provided by operating activities | $625.6 | $668.5 | | Net cash provided by (used in) investing activities | $(166.4) | $21.6 | | Net cash used in financing activities | $(462.6) | $(225.4) | | Repurchase of common stock | $(652.7) | $(389.7) | | Borrowings under revolving secured line of credit | $3,876.1 | $994.2 | | Repayments under revolving secured line of credit | $(3,658.0) | $(1,090.1) | Notes to Consolidated Financial Statements This section provides detailed notes explaining the basis of financial statement presentation, business description, significant accounting policies, and other financial instrument details 1. BASIS OF PRESENTATION Unaudited consolidated financial statements are prepared under GAAP for interim reporting, using management estimates, with no subsequent events requiring disclosure - The accompanying unaudited consolidated financial statements are prepared in accordance with GAAP for interim financial information, including normal recurring accruals[23] - Management makes estimates and assumptions that affect the amounts reported, and actual results could differ from these estimates[24] - No events or transactions occurring subsequent to June 30, 2022, were identified that would require disclosure or adjustment[25] 2. DESCRIPTION OF BUSINESS Credit Acceptance provides auto financing programs to dealers, serving consumers across various credit histories through Portfolio and Purchase programs - Credit Acceptance has offered financing programs since 1972, enabling automobile dealers to sell vehicles to consumers regardless of their credit history[26] Consumer Loan Assignment Volume - Percentage with FICO® scores below 650 or no FICO® scores | Period | 2022 | 2021 | | :----- | :--- | :--- | | Three Months Ended June 30 | 84.6% | 92.7% | | Six Months Ended June 30 | 86.3% | 93.6% | - The company has two programs: the Portfolio Program (advances money to Dealers for servicing rights) and the Purchase Program (buys Consumer Loans from Dealers)[32] - In Q4 2021, the company made available an option to all Dealers that expanded financing programs to consumers with higher credit ratings, contributing to a reduction in the percentage of total unit volume with lower FICO scores[29] 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES This section details key accounting policies, including business segment, cash, restricted securities, loan recognition, CECL, finance charges, reinsurance, and new accounting updates Business Segment Information The company operates as a single reportable segment, providing financing programs to automobile dealers - The company operates in one reportable segment, representing its core business of offering financing programs to Dealers[45] Cash and Cash Equivalents and Restricted Cash and Cash Equivalents Cash equivalents are highly liquid, while restricted cash is pledged collateral for financings and held in trust for service contract claims - Cash equivalents consist of readily marketable securities with original maturities of three months or less[46] - Restricted cash and cash equivalents are pledged as collateral for secured financings and held in a trust for future vehicle service contract claims[47] Cash and Cash Equivalents and Restricted Cash (in millions) | Metric | June 30, 2022 | December 31, 2021 | | :----- | :------------ | :---------------- | | Cash and cash equivalents | $4.1 | $23.3 | | Restricted cash and cash equivalents | $426.7 | $410.9 | | Total | $430.8 | $434.2 | Restricted Securities Available for Sale Restricted securities available for sale are held in trust for service contract claims, valued at fair value with unrealized gains/losses in comprehensive income - Restricted securities available for sale consist of amounts held in a trust for future vehicle service contract claims[51] - These debt securities are classified as available for sale and stated at fair value, with unrealized gains and losses, net of income taxes, included in comprehensive income and reported as a component of shareholders' equity[51] Loans Receivable and Allowance for Credit Losses The loan portfolio includes Dealer and Purchased Loans, with CECL adopted in 2020, and credit quality is monitored monthly against forecasted collection rates - The Loan portfolio consists of two segments: Dealer Loans (lender to Dealers) and Purchased Loans (purchaser of Consumer Loans), which have different levels of risk in relation to credit losses[54] - On January 1, 2020, the company adopted the current expected credit loss model (CECL). Loans outstanding prior to adoption use the PCD Method, while subsequent assignments use the Originated Method[58][60] - Under the Originated Method, at the time of assignment, an allowance for credit losses is recorded equal to the difference between the initial Loan receivable balance and the present value of expected future net cash flows[61] - The allowance for credit losses represents the amount required to reduce the net carrying amount of Loans to the present value of expected future net cash flows discounted at the effective interest rate[68] - Credit quality is monitored and evaluated monthly by comparing current forecasted collection rates to initial expectations, with adjustments made for recent trends and economic conditions[74] - During Q1 2022, the company removed the COVID forecast adjustment and enhanced its methodology for forecasting future net cash flows, which impacted the provision for credit losses[76] Finance Charges Finance charges include interest income, administrative fees from ancillary products, and program fees, recognized on a level-yield basis over loan life - Finance charges are comprised of interest income on Loans, administrative fees from ancillary products, program fees charged to Dealers, Consumer Loan assignment fees, and direct origination costs[77] - The company provides Dealers the ability to offer vehicle service contracts (VSC) and Guaranteed Asset Protection (GAP) to consumers through Third Party Providers (TPPs), retaining administrative fees[78][81] - Finance charges are recognized on a level-yield basis over the life of the Loan by applying the effective interest rate to the net carrying amount[83] Reinsurance VSC Re, a subsidiary, reinsures vehicle service contracts, recognizing premiums over policy life and consolidating trust assets and liabilities - VSC Re, a wholly owned subsidiary, reinsures coverage under vehicle service contracts sold to consumers by Dealers[87] - Premiums from reinsurance are recognized over the life of the policy in proportion to expected costs, and claims are expensed through a provision for claims in the period incurred[88] - The trust assets and related reinsurance liabilities are consolidated within the financial statements because the company is the primary beneficiary of the variable interest entity[89] New Accounting Update Not Yet Adopted The company is assessing the impact of ASU 2022-02 on troubled debt restructurings and vintage disclosures, effective after December 15, 2022 - ASU 2022-02, 'Troubled Debt Restructurings and Vintage Disclosures,' is effective for fiscal years, and interim periods, beginning after December 15, 2022[90] - The company has not yet adopted ASU 2022-02 and is currently assessing its impact on consolidated financial statements and related disclosures[90] 4. FAIR VALUE OF FINANCIAL INSTRUMENTS Fair values of financial instruments are estimated using Level 1, 2, or 3 methods, with net loans receivable being a Level 3 measurement - The carrying amounts of Cash and Cash Equivalents and Restricted Cash and Cash Equivalents approximate their fair value due to short maturity[93] - The fair value of Loans Receivable, net, is determined by calculating the present value of expected future net cash flows using the discount rate from the non-GAAP floating yield methodology[95] - Fair value measurements are grouped into three levels: Level 1 (quoted prices in active markets), Level 2 (observable inputs), and Level 3 (unobservable assumptions)[101][102][103] Fair Value Measurement Levels (in millions) as of June 30, 2022 | Asset/Liability | Level 1 | Level 2 | Level 3 | Total Fair Value | | :-------------- | :------ | :------ | :------ | :--------------- | | Cash and cash equivalents | $4.1 | — | — | $4.1 | | Restricted cash and cash equivalents | $426.7 | — | — | $426.7 | | Restricted securities available for sale | $52.5 | $13.5 | — | $66.0 | | Loans receivable, net | — | — | $6,643.1 | $6,643.1 | | Revolving secured line of credit | — | $220.7 | — | $220.7 | | Secured financing | — | $3,660.2 | — | $3,660.2 | | Senior notes | $761.0 | — | — | $761.0 | | Mortgage note | — | $9.2 | — | $9.2 | 5. RESTRICTED SECURITIES AVAILABLE FOR SALE Restricted securities available for sale, primarily corporate and government bonds, had a fair value of $66.0 million with $2.8 million in unrealized losses as of June 30, 2022 Restricted Securities Available for Sale (in millions) | Type | Amortized Cost (June 30, 2022) | Estimated Fair Value (June 30, 2022) | Gross Unrealized Losses (June 30, 2022) | | :--- | :----------------------------- | :----------------------------------- | :-------------------------------------- | | Corporate bonds | $28.6 | $27.1 | $(1.5) | | U.S. Government and agency securities | $26.4 | $25.4 | $(1.0) | | Asset-backed securities | $11.8 | $11.5 | $(0.3) | | Commercial paper | $1.7 | $1.7 | — | | Mortgage-backed securities | $0.3 | $0.3 | — | | Total | $68.8 | $66.0 | $(2.8) | Contractual Maturity of Debt Securities (in millions) as of June 30, 2022 | Maturity Period | Amortized Cost | Estimated Fair Value | | :-------------- | :------------- | :------------------- | | Within one year | $6.3 | $6.2 | | Over one year to five years | $60.4 | $57.8 | | Over five years to ten years | $2.0 | $1.9 | | Over ten years | $0.1 | $0.1 | | Total | $68.8 | $66.0 | 6. LOANS RECEIVABLE AND ALLOWANCE FOR CREDIT LOSSES Net loans receivable slightly decreased to $6,323.7 million, with a significant increase in provision for credit losses due to declining loan performance and forecasting changes Loans Receivable and Allowance for Credit Losses (in millions) | Metric | June 30, 2022 | December 31, 2021 | | :----- | :------------ | :---------------- | | Loans receivable | $9,190.6 | $9,349.8 | | Allowance for credit losses | $(2,866.9) | $(3,013.5) | | Loans receivable, net | $6,323.7 | $6,336.3 | Provision for Credit Losses (in millions) | Component | 3 Months Ended June 30, 2022 | 3 Months Ended June 30, 2021 | 6 Months Ended June 30, 2022 | 6 Months Ended June 30, 2021 | | :-------- | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | New Consumer Loan assignments | $97.5 | $91.6 | $200.1 | $223.4 | | Forecast changes | $50.0 | $(122.1) | $(29.3) | $(232.6) | | Total | $147.5 | $(30.5) | $170.8 | $(9.2) | - The increase in provision for credit losses related to forecast changes was primarily due to a decline in Consumer Loan performance during Q2 2022 compared to an improvement in Q2 2021[268] - During Q1 2022, the company removed the COVID forecast adjustment and enhanced its forecasting methodology, which increased forecasted net cash flows by $95.7 million and reduced provision for credit losses by $70.6 million[140][298] Credit Quality Consumer Loan collection rates are monitored monthly, showing declines for recent assignments in Q2 2022, with risk decreasing as loans age - Credit quality of Consumer Loans is monitored and evaluated monthly by comparing current forecasted collection rates to prior forecasts and initial expectations[130] - For the three months ended June 30, 2022, forecasted collection rates declined for Consumer Loans assigned in 2020 through 2022[230] - For the six months ended June 30, 2022, forecasted collection rates improved for Consumer Loans assigned in 2014, 2016, 2017, and 2019 through 2021, but declined for 2022 Consumer Loans[230] - The risk of a material change in forecasted collection rates declines as Consumer Loans age; for 2017 and prior assignments, over 90% of expected collections have been realized[240] 7. REINSURANCE VSC Re's reinsurance activity shows decreased net premiums earned and increased claims provision, with rising trust assets and reserves Reinsurance Activity (in millions) | Metric | 3 Months Ended June 30, 2022 | 3 Months Ended June 30, 2021 | 6 Months Ended June 30, 2022 | 6 Months Ended June 30, 2021 | | :----- | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Net assumed written premiums | $19.1 | $15.1 | $36.8 | $33.8 | | Net premiums earned | $15.4 | $15.8 | $29.2 | $30.2 | | Provision for claims | $12.2 | $10.3 | $21.1 | $19.3 | Trust Assets and Reinsurance Liabilities (in millions) as of June 30, 2022 | Metric | Balance Sheet Location | Amount | | :----- | :--------------------- | :----- | | Restricted cash and cash equivalents | Restricted cash and cash equivalents | $1.0 | | Restricted securities available for sale | Restricted securities available for sale | $66.0 | | Unearned premium | Accounts payable and accrued liabilities | $52.2 | | Claims reserve | Accounts payable and accrued liabilities | $2.9 | 8. OTHER INCOME Other income significantly increased for both periods ended June 30, 2022, primarily due to higher ancillary product profit sharing Other Income (in millions) | Source | 3 Months Ended June 30, 2022 | 3 Months Ended June 30, 2021 | 6 Months Ended June 30, 2022 | 6 Months Ended June 30, 2021 | | :----- | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Ancillary product profit sharing | $12.9 | $7.2 | $27.6 | $15.4 | | Remarketing fees | $1.9 | $1.9 | $3.9 | $4.1 | | Dealer enrollment fees | $0.7 | $0.7 | $1.1 | $1.1 | | Interest | $0.7 | $0.4 | $1.0 | $0.7 | | Total | $16.4 | $10.5 | $34.2 | $22.2 | - The increase in other income was primarily due to an increase in ancillary product profit sharing income, driven by a decrease in average claim rates on Guaranteed Asset Protection contracts[264] Other Income by Timing of Revenue Recognition (in millions) for Six Months Ended June 30, 2022 | Timing of Revenue Recognition | Amount | | :---------------------------- | :----- | | Over time | $29.7 | | At a point in time | $4.5 | | Total | $34.2 | 9. DEBT Total debt increased to $4,792.2 million as of June 30, 2022, utilizing diverse financing sources, with the company in compliance with all debt covenants Debt Composition (in millions) | Debt Type | Principal Outstanding (June 30, 2022) | Carrying Amount (June 30, 2022) | Principal Outstanding (Dec 31, 2021) | Carrying Amount (Dec 31, 2021) | | :-------- | :------------------------------------ | :------------------------------ | :----------------------------------- | :----------------------------- | | Revolving secured line of credit | $220.7 | $220.7 | $2.6 | $2.6 | | Secured financing | $3,786.4 | $3,768.9 | $3,830.4 | $3,811.5 | | Senior notes | $800.0 | $793.4 | $800.0 | $792.5 | | Mortgage note | $9.2 | $9.2 | $9.7 | $9.7 | | Total debt | $4,816.3 | $4,792.2 | $4,642.7 | $4,616.3 | - On June 16, 2022, the company completed a $350.0 million Term ABS financing[290] - On June 16, 2022, the revolving maturity date for Warehouse Facility IV was extended from November 17, 2023, to May 20, 2025[291] - On June 22, 2022, the maturity of the revolving secured line of credit facility was extended from June 22, 2024, to June 22, 2025, and the facility amount was adjusted from $435.0 million to $410.0 million[292] - As of June 30, 2022, the company was in compliance with all covenants under its revolving secured line of credit facility, Warehouse facilities, Term ABS financings, and senior notes[191][192] Revolving Secured Line of Credit Facility The $410.0 million revolving secured line of credit facility was extended to June 2025, subject to borrowing-base limitations and asset collateralization - The company has a $410.0 million revolving secured line of credit facility, which will decrease by $25.0 million on June 22, 2023[171][292] - The maturity date of the facility was extended from June 22, 2024, to June 22, 2025[292] - Borrowings are subject to an 80% borrowing-base limitation on the value of Loans and are secured by most of the company's assets[171] Warehouse Facilities The company operates five Warehouse facilities with $1,100.0 million borrowing capacity, using pledged loans as collateral for non-recourse financing - The company has five Warehouse facilities with a total borrowing capacity of $1,100.0 million[172] - Under these facilities, Loans are contributed to wholly owned subsidiaries and pledged as collateral to lenders for non-recourse financing[172][173] - Financing is generally limited to the lesser of 80% of the value of contributed Loans plus restricted cash and cash equivalents, or the facility limit[172] Term ABS Financings Term ABS financings involve pledging loans as collateral for notes issued to institutional investors, with non-recourse indebtedness and revolving periods - The company utilizes wholly owned subsidiaries (Funding LLCs) to complete secured financing transactions with qualified institutional investors or lenders[179] - Each financing has a specified revolving period for contributing additional Loans, after which the debt outstanding will begin to amortize[180] - The financings create indebtedness for which the trusts or Funding LLCs are liable, secured by their assets, and such indebtedness is non-recourse to the company[181] Senior Notes The company holds $400.0 million in 5.125% senior notes due 2024 and $400.0 million in 6.625% senior notes due 2026, both subsidiary-guaranteed - The company issued $400.0 million aggregate principal amount of 5.125% senior notes due 2024[185] - The company issued $400.0 million aggregate principal amount of 6.625% senior notes due 2026[187] - Both the 2024 and 2026 senior notes are guaranteed on a senior basis by Buyers Vehicle Protection Plan, Inc. and Vehicle Remarketing Services, Inc[185][187][189] Mortgage Note A $12.0 million mortgage note, secured by a building and its leases, matures August 6, 2023, with interest at LIBOR plus 150 basis points - On August 6, 2018, the company entered into a $12.0 million mortgage note with a commercial bank[190] - The note matures on August 6, 2023, and bears interest at LIBOR plus 150 basis points[190] - The mortgage note is secured by a first mortgage lien on a building acquired by the company and an assignment of all leases, rents, revenues, and profits[190] Debt Covenants As of June 30, 2022, the company complied with all debt covenants across its various financing facilities and senior notes - As of June 30, 2022, the company was in compliance with all covenants under its revolving secured line of credit facility, Warehouse facilities, Term ABS financings, and senior notes indentures[191][192] - Covenants include maintaining certain financial ratios (e.g., net earnings to fixed charges, funded debt to tangible net worth) and measuring the performance of contributed assets[191][192] 10. DERIVATIVE AND HEDGING INSTRUMENTS The company uses non-hedging interest rate cap agreements to manage interest rate risk, with their fair value significantly increasing due to rising market rates - The company utilizes interest rate cap agreements to manage the interest rate risk on certain secured financings[195] - These interest rate caps have not been designated as hedging instruments[196] Fair Value of Interest Rate Caps (in millions) | Date | Fair Value | | :--- | :--------- | | June 30, 2022 | $1.6 | | December 31, 2021 | $0.2 | The increase in fair value was the result of an increase in market rates 11. INCOME TAXES The effective income tax rate increased for both periods ended June 30, 2022, primarily due to higher non-deductible executive compensation Effective Income Tax Rate | Period | 2022 | 2021 | | :----- | :--- | :--- | | Three Months Ended June 30 | 24.4% | 24.0% | | Six Months Ended June 30 | 24.6% | 23.8% | - The increase in the effective income tax rate was primarily due to an increase in non-deductible executive compensation expenses, mainly from stock options granted under the Incentive Plan[200] 12. NET INCOME PER SHARE Basic and diluted net income per share significantly decreased for both periods ended June 30, 2022, due to lower net income and reduced shares outstanding Net Income Per Share | Metric | 3 Months Ended June 30, 2022 | 3 Months Ended June 30, 2021 | 6 Months Ended June 30, 2022 | 6 Months Ended June 30, 2021 | | :----- | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Basic | $7.99 | $17.19 | $23.23 | $28.99 | | Diluted | $7.94 | $17.18 | $23.10 | $28.96 | Weighted Average Shares Outstanding | Metric | 3 Months Ended June 30, 2022 | 3 Months Ended June 30, 2021 | 6 Months Ended June 30, 2022 | 6 Months Ended June 30, 2021 | | :----- | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Basic | 13,435,507 | 16,790,189 | 13,849,711 | 16,924,014 | | Diluted | 13,517,979 | 16,794,279 | 13,927,372 | 16,944,900 | 13. STOCK REPURCHASES The company repurchased a significant number of common shares during Q2 and H1 2022, reducing outstanding shares under board authorizations Stock Repurchases (in millions, except share data) | Period | Number of Shares Repurchased (2022) | Cost (2022) | Number of Shares Repurchased (2021) | Cost (2021) | | :----- | :---------------------------------- | :---------- | :---------------------------------- | :---------- | | Three Months Ended June 30 | 403,953 | $229.7 | 598,163 | $254.5 | | Six Months Ended June 30 | 1,207,688 | $652.7 | 991,571 | $389.7 | - As of June 30, 2022, the company had authorization to repurchase an additional 419,607 shares of common stock under the September 28, 2021, board authorization[204] 14. STOCK-BASED COMPENSATION PLANS Stock-based compensation expense significantly increased for both periods ended June 30, 2022, contrasting with a 2021 reversal due to a former CEO's retirement Stock-Based Compensation Expense (in millions) | Metric | 3 Months Ended June 30, 2022 | 3 Months Ended June 30, 2021 | 6 Months Ended June 30, 2022 | 6 Months Ended June 30, 2021 | | :----- | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Stock options | $8.5 | — | $17.0 | — | | Restricted stock units | $0.6 | $(2.6) | $1.2 | $(1.9) | | Restricted stock | — | $(8.3) | — | $(7.9) | | Total | $9.1 | $(10.9) | $18.2 | $(9.8) | - The reversal of stock-based compensation expense for the three and six months ended June 30, 2021, was primarily due to an $11.5 million reversal upon the retirement of the former Chief Executive Officer in May 2021[208] - The increase in 2022 expense is partly due to the accounting grant date of 770,500 stock options (granted Dec 2020-June 2021) being July 21, 2021, after shareholder approval[207] Total Projected Stock-Based Compensation Expense (in millions) | Year | Amount | | :--- | :----- | | Remainder of 2022 | $18.2 | | 2023 | $35.7 | | 2024 | $34.9 | | 2025 | $4.7 | | 2026 | $0.5 | | Total | $94.0 | 15. COMMITMENTS AND CONTINGENCIES The company faces various consumer claims, litigation, and regulatory investigations, including a $12.0 million class action settlement and multiple state and federal inquiries - On December 1, 2021, the company received a subpoena from the California Attorney General seeking documents and information regarding GAP products, administration, and refunds. The eventual scope, duration, or outcome cannot be predicted[213] - On June 14, 2022, the company reached an agreement in principle to settle a putative class action lawsuit for an aggregate cash payment of $12.0 million, which was recognized as a contingent loss during Q2 2022[214] - The Office of the New York State Attorney General has an ongoing investigation (since May 2019) into the company's origination and collection policies and procedures and securitizations. The eventual scope, duration, or outcome cannot be predicted[215] - The Bureau of Consumer Financial Protection (BCFP) has an ongoing investigation (since April 2019) into the company's consumer loan origination practices, with a NORA letter received in December 2021 alleging CFPA violations. The eventual scope, duration, or outcome cannot be predicted[218] - The Attorney General of the State of Maryland is leading a multi-state inquiry (expanded August 2020 to 41 other states and D.C.) into the company's repossession, sale, origination, and collection policies. The eventual scope, duration, or outcome cannot be predicted[219] ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This section analyzes financial performance, critical success factors, consumer loan metrics, capital access, liquidity, and critical accounting estimates for the periods ended June 30, 2022 - Consolidated net income for the three and six months ended June 30, 2022, decreased significantly compared to 2021, primarily due to increases in provision for credit losses and operating expenses, and a decrease in finance charges[225][226] - Critical success factors include accurately forecasting Consumer Loan performance, accessing capital on acceptable terms, and maintaining or growing Consumer Loan volume to maximize economic profit[227] - During Q1 2022, the company removed the COVID forecast adjustment and enhanced its forecasting methodology, which increased forecasted net cash flows by $95.7 million and reduced provision for credit losses by $70.6 million[233][234] - Total balance sheet indebtedness increased to $4,792.2 million as of June 30, 2022, from $4,616.3 million as of December 31, 2021, primarily due to stock repurchases[293] Overview Credit Acceptance provides auto financing, with Q2 and H1 2022 net income significantly decreasing due to higher credit loss provisions and operating expenses - Credit Acceptance offers financing programs that enable automobile dealers to sell vehicles to consumers, regardless of their credit history[224] Net Income and Diluted EPS (in millions, except per share data) | Period | Net Income (2022) | Net Income (2021) | Diluted EPS (2022) | Diluted EPS (2021) | | :----- | :---------------- | :---------------- | :----------------- | :----------------- | | Three Months Ended June 30 | $107.4 | $288.6 | $7.94 | $17.18 | | Six Months Ended June 30 | $321.7 | $490.7 | $23.10 | $28.96 | - For the three months ended June 30, 2022, Consumer Loan assignment unit volume grew 5.1% and dollar volume grew 22.0% compared to the same period in 2021[225] Critical Success Factors Key success factors include accurate Consumer Loan performance forecasting, acceptable capital access, and maintaining loan volume for long-term economic profit - Critical success factors include the ability to accurately forecast Consumer Loan performance, access capital on acceptable terms, and maintain or grow Consumer Loan volume at anticipated levels and terms[227] - The objective is to maximize economic profit over the long term, which is a non-GAAP financial measure used to evaluate financial results and business decisions[227] Consumer Loan Metrics Consumer Loan collection rates are forecasted using a statistical model, with Q2 2022 showing declines for recent assignments and a decreased collection-to-advance rate spread - A statistical model is used to estimate the expected collection rate for each Consumer Loan at the time of assignment, with continuous evaluation as loans age[230] - For the three months ended June 30, 2022, forecasted collection rates declined for Consumer Loans assigned in 2020 through 2022[230] - For the six months ended June 30, 2022, forecasted collection rates improved for Consumer Loans assigned in 2014, 2016, 2017, and 2019 through 2021, but declined for 2022 Consumer Loans[230] - The spread between the forecasted collection rate and the advance rate decreased from 21.6% in 2021 to 19.2% in 2022 for total loans, primarily due to 2021 loans exceeding initial estimates and 2022 loans performing lower than initial estimates, coupled with higher advance rates[240] - The risk of a material change in forecasted collection rates declines as Consumer Loans age; for 2017 and prior assignments, over 90% of expected collections have been realized[240] Access to Capital Capital strategy relies on consistent performance, modest leverage (funded debt to equity ratio of 3.2 to 1), and diverse funding sources - The strategy for accessing capital involves maintaining consistent financial performance, modest financial leverage, and multiple funding sources[248] - The funded debt to equity ratio was 3.2 to 1 as of June 30, 2022[248] - Primary forms of debt financing include a revolving secured line of credit, Warehouse facilities, Term ABS financings, and senior notes[248] Consumer Loan Volume Q2 2022 Consumer Loan unit volume grew 5.1% and dollar volume grew 22.0%, but H1 2022 unit volume declined due to low dealer inventories and high used vehicle prices Consumer Loan Volume Changes (Year over Year) | Period | Unit Volume % Change | Dollar Volume % Change | | :----- | :------------------- | :--------------------- | | March 31, 2021 | -7.5% | -2.2% | | June 30, 2021 | -28.7% | -20.5% | | September 30, 2021 | -29.4% | -17.9% | | December 31, 2021 | -22.6% | -12.7% | | March 31, 2022 | -22.1% | -10.5% | | June 30, 2022 | 5.1% | 22.0% | - Unit and dollar volumes grew 5.1% and 22.0%, respectively, during Q2 2022, driven by a 1.9% increase in active Dealers and a 2.4% increase in average unit volume per active Dealer[251] - For the six months ended June 30, 2022, Consumer Loan unit volume decreased by 10.5%, while dollar volume grew by 3.7%[254] - Low dealer inventories and elevated used vehicle prices continue to have a negative impact on unit volumes[251] Results of Operations This section details financial performance for Q2 and H1 2022, highlighting significant changes in revenue, expenses, net income, and the impact of credit loss provisions - The net Loan income recognized over the life of a Loan equals the cash collected from the underlying Consumer Loan less the cash paid to the Dealer[259] - The GAAP CECL methodology is believed to not provide sufficient transparency into the economics of the business due to its asymmetry in recognizing provision for credit losses at assignment and finance charge revenue in subsequent periods[259] Three Months Ended June 30, 2022 Compared to Three Months Ended June 30, 2021 Net income decreased by 62.8% to $107.4 million due to a $178.0 million increase in credit loss provision and $46.5 million higher operating expenses Financial Performance (Three Months Ended June 30, in millions) | Metric | 2022 | 2021 | $ Change | % Change | | :----- | :--- | :--- | :------- | :------- | | Total Revenue | $457.4 | $471.7 | $(14.3) | -3.0% | | Operating Expenses | $116.7 | $70.2 | $46.5 | 66.2% | | Provision for Credit Losses | $147.5 | $(30.5) | $178.0 | -583.6% | | Net Income | $107.4 | $288.6 | $(181.2) | -62.8% | - The increase in operating expenses was primarily due to a $27.0 million increase in salaries and wages (driven by stock-based compensation and technology department growth) and a $15.4 million increase in general and administrative expenses (including a $12.0 million legal settlement contingent loss)[265] - The $178.0 million increase in provision for credit losses was primarily due to a decline in Consumer Loan performance during Q2 2022 compared to an improvement in Q2 2021[267][268] - Other income increased by $5.9 million (56.2%), mainly due to an increase in ancillary product profit sharing[264] - Interest expense decreased by $3.1 million (7.4%) due to a decrease in the average cost of debt from 3.5% in 2021 to 3.2% in 2022[270][271] Six Months Ended June 30, 2022 Compared to Six Months Ended June 30, 2021 Net income decreased by 34.4% to $321.7 million due to a $180.0 million increase in credit loss provision and $36.4 million higher operating expenses Financial Performance (Six Months Ended June 30, in millions) | Metric | 2022 | 2021 | $ Change | % Change | | :----- | :--- | :--- | :------- | :------- | | Total Revenue | $913.1 | $922.7 | $(9.6) | -1.0% | | Operating Expenses | $219.2 | $182.8 | $36.4 | 19.9% | | Provision for Credit Losses | $170.8 | $(9.2) | $180.0 | -1,956.5% | | Net Income | $321.7 | $490.7 | $(169.0) | -34.4% | - The increase in operating expenses was primarily due to a $42.1 million increase in salaries and wages (driven by stock-based compensation and growth in support/servicing functions), partially offset by an $11.8 million decrease in general and administrative expense (due to a $27.2 million legal settlement in 2021, partially offset by a $12.0 million contingent loss in 2022)[277] - The $180.0 million increase in provision for credit losses was due to a smaller improvement in Consumer Loan performance and the impact of forecasting methodology changes (removal of COVID adjustment)[278][279] - Other income increased by $12.0 million (54.1%)[274] - Interest expense decreased by $10.4 million (12.1%) due to a decrease in the average cost of debt from 3.6% in 2021 to 3.2% in 2022[282][283] Properties The company's "remote first" strategy created excess office space, with owned buildings' market value potentially below carrying value, risking impairment charges - The company has adopted a "remote first" strategy, leading to excess space in its two owned office buildings in Southfield, Michigan, and leased office space in Henderson, Nevada (lease expires December 2022)[285][286] - The market value of the owned buildings and related assets is believed to be significantly less than their combined carrying value of $40.2 million[286] - Reclassifying a building as held for sale would require recording an impairment charge to reduce its carrying value to estimated market value less costs to sell[286] Liquidity and Capital Resources Liquidity is supported by operating cash flows and diverse debt financings, with total indebtedness at $4,792.2 million and substantial unused credit lines - Primary sources of capital are cash flows from operating activities, collections of Consumer Loans, and borrowings under a revolving secured line of credit, Warehouse facilities, Term ABS financings, and senior notes[289] - Total balance sheet indebtedness increased to $4,792.2 million as of June 30, 2022, from $4,616.3 million as of December 31, 2021, primarily due to stock repurchases[293] - As of June 30, 2022, the company had $1,239.3 million in unused and available lines of credit[293] Scheduled Principal Debt Maturities (in millions) as of June 30, 2022 | Year | Amount | | :--- | :----- | | Remainder of 2022 | $1,034.6 | | 2023 | $1,626.6 | | 2024 | $1,243.8 | | 2025 | $508.2 | | 2026 | $403.1 | | Over five years | — | | Total | $4,816.3 | - Management believes anticipated cash flows from operations and various financing alternatives will provide sufficient financing for debt maturities and future operations, but borrowing ability may be impacted by economic and financial market conditions[295] Critical Accounting Estimates Critical accounting estimates involve significant judgment in forecasting loan cash flows, with Q1 2022 methodology changes increasing net cash flows by $95.7 million and reducing credit loss provision by $70.6 million - The preparation of financial statements requires management to make estimates and judgments, particularly concerning the amount and timing of future net cash flows from the Loan portfolio[297] - During Q1 2022, the company removed the COVID forecast adjustment and enhanced its forecasting methodology[297] Impact of Forecasting Methodology Changes (in millions) | Change | Forecasted Net Cash Flows (Increase / (Decrease)) | Provision for Credit Losses (Increase / (Decrease)) | | :----- | :------------------------------------------------ | :-------------------------------------------------- | | Removal of COVID forecast adjustment | $149.5 | $(118) | | Implementation of enhanced forecasting methodology | $(53.8) | $47 | | Total | $95.7 | $(70) | Forward-Looking Statements Forward-looking statements are subject to various industry, operational, macroeconomic, and regulatory risks, with the company claiming safe harbor protection - The company makes forward-looking statements and claims the protection of the safe harbor for such statements contained in the Private Securities Litigation Reform Act of 1995[299][300] - Forward-looking statements are subject to risks and uncertainties, including industry, operational, macroeconomic, capital and liquidity, information technology and cybersecurity, and legal and regulatory risks[300][302][303][304][305] - The company expressly disclaims any obligation to update or alter its statements whether as a result of new information, future events or otherwise, except as required by applicable law[307] ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK No material changes occurred in the market risk information previously disclosed in the 2021 Annual Report on Form 10-K - There have been no material changes to the market risk information included in the 2021 Annual Report on Form 10-K[308] ITEM 4. CONTROLS AND PROCEDURES Disclosure controls and procedures were effective as of June 30, 2022, with no material changes to internal control over financial reporting during the quarter - Management, with the participation of the principal executive and principal financial officer, evaluated and concluded that disclosure controls and procedures were effective as of June 30, 2022[309] - There have not been any changes in internal control over financial reporting during the fiscal quarter that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting[310] PART II. — OTHER INFORMATION This part includes information on legal proceedings, risk factors, equity security sales, exhibits, and required signatures ITEM 1. LEGAL PROCEEDINGS The company is routinely involved in consumer claims, litigation, and regulatory investigations, with significant details referenced from Note 15 of the financial statements - The company is frequently subject to various consumer claims, litigation, and regulatory investigations seeking damages, fines, and statutory penalties[313] - An adverse ultimate disposition in any action could have a material adverse impact on the company's financial position, liquidity, and results of operations[313] - A description of significant litigation is incorporated by reference from Note 15 to the consolidated financial statements[314] ITEM 1A. RISK FACTORS This section updates risk factors, highlighting potential material adverse effects of the Russia-Ukraine conflict on business, financial condition, and liquidity - The current conflict between Russia and Ukraine could have a material adverse effect on the company's business, financial condition, liquidity, and results of operations[315][316] - The conflict may lead to diminished liquidity and credit availability, reduced consumer confidence, disruptions to energy and food supplies, decreased economic growth, higher unemployment rates, increased inflation, and political and social upheaval[316] - Expansion of the military conflict or retaliatory actions could broaden and intensify the negative impact on financial markets, economic conditions, and geopolitical stability[316] ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS The company repurchased 403,953 common shares for $229.7 million in Q2 2022, with 419,607 shares remaining authorized for repurchase Issuer Purchases of Equity Securities (Three Months Ended June 30, 2022) | Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | :----- | :------------------------------- | :--------------------------- | :------------------------------------------------------------------------------- | | April 1 to April 30, 2022 | 224,204 | $557.52 | 224,204 | | May 1 to May 31, 2022 | 179,749 | $582.80 | 179,749 | | June 1 to June 30, 2022 | — | — | — | | Total | 403,953 | $568.77 | 403,953 | - Repurchases were made under the September 28, 2021, board authorization for up to two million shares of common stock[319] - As of June 30, 2022, 419,607 shares remained authorized for repurchase under the September 2021 Authorization[319] ITEM 6. EXHIBITS This section lists various exhibits filed with the 10-Q report, including legal agreements and certifications - The exhibits include various legal and financial documents such as indentures, sale and servicing agreements, trust agreements, intercreditor agreements, and amendments to credit agreements[321] - Certifications of the principal executive officer and principal financial officer pursuant to the Sarbanes-Oxley Act of 2002 are also included[321] SIGNATURES The report is signed by Jay D. Martin, Senior Vice President, Finance and Accounting (Chief Accounting Officer), on August 1, 2022 - The report was signed by Jay D. Martin, Senior Vice President, Finance and Accounting (Chief Accounting Officer) of Credit Acceptance Corporation[325] - The signature date is August 1, 2022[325]