Credit Acceptance Corporation (CACC), the subprime auto lending giant, just reported a strong quarter with double-digit loan volume growth and a record-high average loan portfolio balance. On the surface, it's a tale of impressive expansion in a challenging economic climate. The company even repurchased a significant chunk of its shares, signaling confidence in its future. But delve deeper into the Q1 2024 earnings call transcript, and a disquieting narrative begins to emerge, one that seems to have flown under the radar of most analysts.

While the jubilant headlines trumpet CACC's growth, a subtle but significant shift in the company's core financial metrics hints at a potential storm brewing. The issue lies not in the current quarter's performance but in the ominous trajectory of its forecasted collection rates, particularly for loans originated in recent years.

CACC acknowledges the industry-wide trend of declining collection rates in subprime auto loans, attributing it to a confluence of factors: intense competition during origination, inflated vehicle valuations at the time of financing, and the persistent sting of inflation on the pockets of subprime borrowers. These explanations, while valid, don't fully capture the magnitude of the decline revealed in the transcript.

A closer look at the numbers reveals a jarring trend. The forecasted collection percentage for loans originated in 2022 plummeted by a staggering 5.4% compared to the previous forecast. To put that into perspective, the collection rate decrease for the entire loan portfolio was a comparatively modest 0.3%. This disparity suggests that the 2022 vintage, a cohort born in the throes of intense competition and peak vehicle valuations, is displaying significantly worse-than-expected performance.

This data point, seemingly overlooked by most analysts, raises a critical question: is CACC's aggressive share buyback program a strategic maneuver to bolster short-term earnings per share, potentially masking a brewing crisis in loan performance?

The company emphasizes that its loan pricing incorporates a substantial margin of safety, designed to absorb worse-than-anticipated performance. However, the precipitous decline in the 2022 vintage's collection rate begs the question: is this "margin of safety" robust enough to weather the storm if this trend persists across subsequent vintages?

Furthermore, CACC's average cost of debt has surged from 5% to 7%, driven by higher interest rates on recently secured financings. This rising cost of capital, coupled with the dwindling collection rates, squeezes the company's profit margins. The transcript notes that CACC will need to adjust its pricing to maintain acceptable returns, potentially impacting future volume growth.

Hypothesis: Looming Crisis?

CACC's aggressive buyback program, while beneficial for short-term earnings per share, might be diverting crucial capital away from bolstering loan loss reserves. If the declining collection rate trend continues, the company might find itself facing a significant shortfall in reserves, leading to potential earnings disappointments and a downward spiral in share price.

Supporting Data:

5.4% decline in forecasted collection rate for the 2022 loan vintage. 7% average cost of debt, significantly higher than the 5% in the prior year. Subdued share buyback activity in the previous quarter (Q4 2023), indicating a potential shift in capital allocation priorities.

Visualizing the Shift:

The following chart compares the change in forecasted collection rates between the entire loan portfolio and the 2022 vintage.

The transcript offers a compelling case for CACC's continued dominance in the subprime auto lending market. Yet, a discerning eye can spot the unsettling undercurrent of declining collection rates, particularly for recent loan vintages. Whether this is a temporary blip or a harbinger of a deeper issue remains to be seen. But one thing is clear: investors should look beyond the headlines and scrutinize the underlying trends in CACC's core financial metrics. The buyback frenzy might be a compelling narrative, but it could be obscuring a more complex reality.

"Fun Fact: Despite its focus on subprime auto loans, CACC doesn't factor in traditional macroeconomic variables like unemployment or inflation in its forecasting models. This unorthodox approach, while emphasizing the company's unique methodology, could leave it vulnerable to broader economic downturns."

Credit Acceptance Corp. Financial Snapshot: