State AGs Target Credit Acceptance’s Deep Subprime Model

The attorneys general are likely to push for “ability to repay” analyses, which would be a material negative for Credit Acceptance.

September 17, 2020 – Capstone believes state attorneys general (AGs), as part of their ongoing investigations into Credit Acceptance Corp.’s (CACC) business practices, will attempt to force the company to conduct an “ability to repay” (ATR) analysis before offering each loan. An ATR requirement would have a material negative impact on the company’s profitability and underlying business model, eliminating one of the company’s key competitive advantages: “approval for everyone.” Our review of CACC’s portfolio shows uniquely poor consumer outcomes, gauged by basic metrics such as portfolio loan delinquencies and a high average interest rate. These factors make CACC a more attractive target for consumer advocates than other subprime lenders, such as Santander Consumer USA (SC), likely resulting in greater headwinds from an ATR requirement.

Capstone has previously written about the regulatory challenges emerging for CACC, including recent lawsuits by the Massachusetts and Mississippi AGs and the apparent multi-state AG investigation into the company. We have noted the investigations appear aimed at the core of CACC’s business model and believe conduct provisions from any legal resolution are likely to be materially impactful to the company, despite manageable financial penalties for other subprime lenders in state AG settlements.

Santander, a CACC competitor, agreed to an ATR analysis in its 2020 settlement with 35 state AGs, which is unlikely to disrupt its core business model. In this note, we highlight the significant differences in the typical loans for the two companies, which account for CACC’s outsized risk if AGs require an ATR analysis. We believe if CACC is forced to act like a more “typical” subprime auto lender, it would likely have to reinvent its business model or at least refuse credit to its riskiest borrowers. We estimate, based on the company’s repossession rates, that CACC borrowers default on loans over twice as often as Santander borrowers, who more closely reflect the subprime industry’s average.

Below, we highlight key data disclosed by CACC and Santander regarding outstanding loans. When available, we utilized company data from the end of 2019 to not be skewed by the impact of COVID-19, which included voluntary and government-mandated deferrals and limits on repossessions. CACC does not regularly disclose its repossession rate, but it did so in its earnings conference call for the third quarter of 2015.

Exhibit 1: Credit Acceptance and Santander Key Performance Metrics

As shown in Exhibit 1, CACC operates in a deeper subprime portion of the auto market than competitors such as Santander, which contributes to a higher rate of repossessions (~35% for CACC versus mid-teen percentages for competitors such as Santander, Exeter Finance, DriveTime, and American Credit Acceptance) and delinquent loans. We expect it also results in a higher interest rate for the consumers. While CACC does not disclose its average annual percentage rate, Santander had an average APR for its retail installment contracts (auto loans) of 16.3% in 2019 and 17.3% in 2020. The recent Massachusetts lawsuit against CACC claims the “vast majority” of loans in the state have interest rates of 20.99%, just below the state limit of 21%.

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