Summary
Bleecker Street Research publishes a critical short report on Credit Acceptance Corporation (CACC), a major subprime auto lender in the U.S. The report highlights concerns about deteriorating fundamentals, capital position, and loan loss reserves amid an economic downturn.
Who is Credit Acceptance Corporation (CACC)
Credit Acceptance Corporation is one of the largest subprime auto lenders in the U.S., with gross receivables of $9.2 billion. The company specializes in providing auto loans to high-risk borrowers through a network of over 11,000 dealers, representing a significant share—up to 30%—of the addressable subprime market. Founded in 1972, CACC has built a strong track record of compound growth but faces challenges in a changing economic environment.
Key Points from Report
Financial Fundamentals and Accounting Concerns
- Since adopting the CECL accounting model in 2020, CACC’s reported GAAP net income has consistently been lower than adjusted net income, with GAAP income being about 14% lower cumulatively.
- CECL accounting shifts credit loss provisions to the inception of loans, making income statements appear lumpier and leading management to present adjusted earnings significantly higher than GAAP.
- Reported return on equity (ROE) under GAAP is 12-20%, much lower than the previously perceived 40% ROE based on pro-forma figures.
- The adjusted net income presentation is criticized as misleading because it effectively ignores the largest expense—credit loss provisions.
Deteriorating Capital and Credit Metrics
- Equity capital, while adequate for the business model, has shown a declining trend due to share buybacks and other factors.
- Loan loss reserves have decreased as a percentage of gross loans over recent quarters, with reserves covering only 87% of past-due loans as of Q3 2022, down from 110% in Q1 2021.
- A high level of delinquencies is noted: 19% of loans were 11-90 days past due and 17% were over 90 days past due in Q3 2022.
- Net charge-offs increased from 9.6% in 2020 to 15.1% annualized in Q3 2022, signaling increasing credit losses.
Market Position and Valuation Risks
- CACC is perceived to have largely saturated its addressable market, with market share estimates ranging from 19% to over 30% of subprime dealer loans.
- Used car prices, serving as collateral for loans, have declined about 14% from their 2022 highs, which may exacerbate charge-offs and credit losses.
- The company’s stock is considered overvalued, trading at approximately 27 times 2023 EPS based on GAAP estimates versus the consensus adjusted EPS multiple of about 8.7 times.
- Projected fair value range is $206 to $260 per share, implying a potential downside of 35-50% from current levels.
- The long-term forecast anticipates mid-single digit revenue growth with normalized returns on assets of 2.5% to 5% and return on equity of 13% to 20%.
Activ8 Finance Analysis
The report from Bleecker Street Research raises significant questions about the sustainability of Credit Acceptance’s profitability and growth, particularly highlighting how changes in accounting standards have obscured the true credit risks inherent in subprime lending. The deteriorating loan loss reserves and rising charge-offs coincide with market conditions that may place increased pressure on the company’s financial health. Investors should be mindful of these factors as they consider the company’s current valuation against its fundamental risks.
While Credit Acceptance has demonstrated robust historical returns, signs of market saturation and economic headwinds underscore the challenges that lie ahead. The cautious outlook presented calls for a careful evaluation of the company’s financial disclosures and economic environment, suggesting a period of increased volatility and potential financial adjustments in the near term.