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Edited Transcript of CACC earnings conference call or presentation 29-Apr-19 9:00pm GMT

Q1 2019 Credit Acceptance Corp Earnings Call

SOUTHFIELD May 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Credit Acceptance Corp earnings conference call or presentation Monday, April 29, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brett A. Roberts

Credit Acceptance Corporation - CEO & Director

* Douglas W. Busk

Credit Acceptance Corporation - Senior VP & Treasurer

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Conference Call Participants

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* Dominick Joseph Gabriele

Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst

* Giuliano Jude Anderes-Bologna

BTIG, LLC, Research Division - VP for Investment Research

* Hugh Michael Miller

The Buckingham Research Group Incorporated - Director

* John Hecht

Jefferies LLC, Research Division - Equity Analyst

* John J. Rowan

Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance

* Moshe Ari Orenbuch

Crédit Suisse AG, Research Division - MD and Equity Research Analyst

* Nick McGibbon

* Vincent Albert Caintic

Stephens Inc., Research Division - MD and Senior Specialty Finance Analyst

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Presentation

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Operator [1]

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Good day, everyone, and welcome to the Credit Acceptance Corporation First Quarter 2019 Earnings Call. Today's call is being recorded. A webcast and transcript of today's earnings call will be made available on Credit Acceptance's website.

At this time, I would like to turn the call over to Credit Acceptance Senior Vice President and Treasurer, Doug Busk.

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [2]

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Thank you. Good afternoon and welcome to the Credit Acceptance Corporation First Quarter 2019 Earnings Call.

As you read our news release posted on the Investor Relations section of our website at creditacceptance.com and as you listen to this conference call, please recognize that both contain forward-looking statements within the meaning of federal securities law. These forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond our control and which could cause actual results to differ materially from such statements.

These risks and uncertainties include those spelled out in the cautionary statement regarding forward-looking information included in the news release. Consider all forward-looking statements in light of those and other risks and uncertainties.

Additionally, I should mention that to comply with the SEC's Regulation G, please refer to the financial results section of our news release, which provides tables showing how non-GAAP measures reconcile to GAAP measures.

At this time, Brett Roberts, our Chief Executive Officer; Ken Booth, our Chief Financial Officer; and I will take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Hugh Miller of Buckingham.

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Hugh Michael Miller, The Buckingham Research Group Incorporated - Director [2]

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Just had one on the tax rate and was wondering if you can provide some color on kind of what was driving it this quarter and how should we think about that on a go-forward basis?

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [3]

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Sure. The tax rate was a little lower this quarter than it was either in the fourth quarter of last year or the first quarter of last year. And the reason for that is that we get a tax deduction when restricted stock [of VAS] or restricted stock units are converted into common shares. The amount of the deduction is based on the fair value of the shares. If that amount exceeds the fair value of the awards on the grant date, that's something called excess tax benefit and gets recorded as a reduction to our tax rate.

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Hugh Michael Miller, The Buckingham Research Group Incorporated - Director [4]

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Yes. Okay. Great. And then just in terms of as we think about assessing the collectibility trends and also the spread trends, is it fair to compare the 2019 vintage relative to, let's say, the 2018 vintage when and where it was initially booked? Or is it a better assessment to kind of look at that where it's currently booked as a fair comparison to where you set initial expectations for 2019?

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Brett A. Roberts, Credit Acceptance Corporation - CEO & Director [5]

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I think both are relevant numbers. I think the '19 business has a slightly higher initial forecast. It's too new to know whether it's going to settle in. The '18 vintage has been around a little while longer and it settled in at a higher collection forecast than where it started. So we just -- we'll watch 2019 and see where it goes. I think it's a little bit early to decide whether one vintage is better than the other.

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Hugh Michael Miller, The Buckingham Research Group Incorporated - Director [6]

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Okay. And last for me, just in terms of where we stand with CECL fair value decision. Have there been any progress in terms of just how things are shaping out and where you might kind of see things for 2019 -- for 2020, I'm sorry?

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [7]

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We've continued to assess our alternatives internally. I think we've made progress. As I've said in prior quarters that when we do make a decision, we'll update our disclosures appropriately, make an announcement at that time. So really nothing further to report today.

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Operator [8]

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Our next question comes from John Rowan of Janney.

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [9]

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Is 24% still the correct tax rate going forward though?

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [10]

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I think the -- we estimate our long-term tax rate to be 23%. Obviously, that is a long-term number, so you're going to -- that factors in things like that, that happened this quarter which again isn't going to happen every quarter.

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [11]

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Okay. And then I know obviously people always ask about the competitive environment. You obviously often hindsight the volume per active dealer-partner. Are we supposed to draw similar conclusions this quarter versus prior quarters that the environment is probably a little bit tough just given the decline in the active -- in the volume per active dealer-partner?

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Brett A. Roberts, Credit Acceptance Corporation - CEO & Director [12]

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We don't have another reason for the decline so -- [in core] so we don't have another reason for it. We usually attribute it to the competitive environment.

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [13]

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Okay. And then was there anything onetime in nature in the other income line? Or was there something seasonal in there? I'm just trying to remember because it was a little higher than I was anticipating.

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [14]

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I don't think there's anything onetime. We have a disclosure comparing the first quarter of this year to the first quarter of last year in the 10-Q. And most of the increase was related to ancillary product graphic hearing. But we also had a larger amount of interest income and that was offset by decreases in a couple other line items.

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [15]

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Okay. And then just lastly, is there any information that you can give us? It seemed like you disclosed the new CID in the 10-Q. Is there any information that you can share with us regarding that?

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [16]

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I mean not really anything other than what's disclosed in the Q. Obviously, the regulatory environment has been much different for the last 5, 6, 7 years. So I think this is just part of what we can expect in the environment we operate in.

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Operator [17]

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The next question comes from Vincent Caintic of Stephens.

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Vincent Albert Caintic, Stephens Inc., Research Division - MD and Senior Specialty Finance Analyst [18]

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A couple of questions. First couple -- focus on the purchased loan. So you've had some nice growth there over the past couple of quarters. It's becoming an increasingly bigger part of the business. Just kind of wondering, so first, you had your forecast for the spreads increase significantly. And historically, it exceeded your initial forecast. I'm just kind of wondering how you initially anticipate the purchased loan spread forecast and how they've been increasing over time.

And then when I look at the difference in spreads between the purchased loans versus the dealer loans, so the spreads are lower for purchased loans. And I'm wondering if that's true after accounting for the dealer holdback? And if it is true, are purchased loans generally less risky than dealer loans so you can have a lower spread on that? Or how do I think about the risk-adjusted returns between the 2 products you offer?

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [19]

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Well, as we've said before, we prefer the portfolio program because it aligns our interest. It also shares the risk on the consumer loan with the dealer. So if we collect $1 less than what we expect on the portfolio program, 80% of that is borne by the dealer in the form of a reduction in dealer holdback.

On the purchased loan program, if we miss our forecast by $1, all of that comes out of our pocket. So we would characterize, for that reason, the portfolio program as being less risky than the purchase program. Having said all that, the purchased loan business has performed very well. It's actually generated a larger positive variance on average than has the portfolio program over the last 10 years. So we think that writing those purchased loans with a big margin of safety is a good use of our capital.

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Vincent Albert Caintic, Stephens Inc., Research Division - MD and Senior Specialty Finance Analyst [20]

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Okay. That's helpful. Thank you. Is there -- and I guess looking from 2018 versus 2019, so spreads versus your initial estimates are better in 2018. Is 2019 sort of the right spread that you're targeting? If that's kind of your initial estimate? And if so, is there room -- because you're seeing such good performance with the purchased loans, is there room for more volume that you could catch in there?

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [21]

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Well, we try to price our business to maximize economic profit which is just economic profit for loan times the number of loans originated. With the benefit of hindsight, you could argue that the way we price the purchased loans historically has been too conservative. Those loans have performed nicely better than expected. And knowing what we know now, we could have priced those loans a bit more aggressively. But we do try to put our best number forward and we try to, like I said, maximize that equation and try to be accurate was our hope.

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Vincent Albert Caintic, Stephens Inc., Research Division - MD and Senior Specialty Finance Analyst [22]

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Okay. Great. Very helpful. And last one for me and completely separate. But the -- a nice increase in the new dealers or I guess the dealer is not active in both periods. Just wondering if there was any particular driver there. I know people will say competition maybe goes away or if there's anything else there that might shed light on that, that'd be appreciated.

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Brett A. Roberts, Credit Acceptance Corporation - CEO & Director [23]

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I think the first quarter is usually a good quarter for enrolling new dealers. We got a larger sales force than we had a year ago. So those are probably a couple of reasons why new dealer enrollments were pretty good. Attrition was also pretty good. The number that hurt us this quarter, the same as last quarter, was volume per dealer.

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Operator [24]

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Our next question comes from Moshe Orenbuch of Crédit Suisse.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [25]

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I did notice that for 2016 and '17, the reductions were small but you started to see some reductions in the forecast. Anything that's going on that would be driving that?

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Brett A. Roberts, Credit Acceptance Corporation - CEO & Director [26]

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I think when you look at the forecast, the best number to start with is the one on the second page of the release where we show you the increase in forecasted net cash flow. Positive number this quarter, $16.7 million. It's nice to have a positive number there. That's a very small number relative to the amount of cash flows that we're trying to forecast. But I think that tells a story that I've been looking at a 10 basis point change for any individual vintage. Overall, forecast was generally in line with what we expected, a little bit better than that and I think that's probably a fair conclusion.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [27]

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Okay. And then on the CECL idea, I know that you don't have any further info. But could you talk a little bit about how fair value would work and how variability in kind of estimates and revenue and provision contribution would work in the CECL construct?

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [28]

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I mean fair value conceptually would be like, well, it'll be just marking our portfolio to market each period. So the value of the portfolio would represent not only the expected cash flows into the portfolio, the expenses of third party would need to [incur] a service to portfolio and the third parties required rate of return. So the -- as we pointed out, one of the drawbacks to fair value is the value of the portfolio and, thus, our financial performance in any period can be impacted by things that have nothing to do with the underlying performance of the portfolio like changes in interest rate or changes in market-based rates of return. But at a high level, that's how it would work.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [29]

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Right. I guess I mean the question is, I mean from the perspective of variability, how would you [settle with them] in respect to the construct?

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [30]

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I would say there's a potential to be more volatile. The current earnings that we have today, the -- could be volatile, but that volatility would directly have to do with the performance of the underlying loans. With fair value, you could have some variability associated with the performance of the loans. But you could also have variability associated with things that have nothing to do with the loans.

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Operator [31]

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Our next question comes from Dominick Gabriele of Oppenheimer.

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Dominick Joseph Gabriele, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [32]

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Can we just talk about how much of the book is moving towards younger cars as we make a portfolio mix change to more purchased loans? Can you just talk about the impacts there between the average car age versus -- and the dealer portfolio loans versus the purchased loans and how that could be affecting your interest rates that you collect over the average life of the loan and -- or the interest income rather? That would be great.

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [33]

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We have seen a shift of the mix of business that we've originated over the last 4 or 5 years. Not only are we originating a larger percentage of purchased loans, but we are financing newer, more expensive vehicles than we were 3, 4, 5 years ago. Those phenomena have resulted in an increase in the average amount of the retail installment contract, principal plus interest and therefore, an increase in the average advance. So that phenomena has contributed to dollar growth being greater than unit volume growth in recent periods.

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Dominick Joseph Gabriele, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [34]

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Great. And then when you -- as you think about what gets a dealer to provide more applications over time and become a stronger -- or have a stronger relationship with Credit Acceptance, what are some of those attributes? And what's the time frame would you say that it takes for a brand-new relationship for you to get 5 applications a month to 10, to 20, whatever it may be? What's the strategy there and the time frame it takes typically, would you say?

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Brett A. Roberts, Credit Acceptance Corporation - CEO & Director [35]

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How much business a dealer sends us, how many applications, how many contracts you book really reflects everything we do as a company because the dealers on the portfolio program at least get 80% of whatever we collect. Even our loan servicing function affects how satisfied the dealer is with our products.

So it's really all-encompassing. It's everything we do. The better products we offer the dealer, the more business they're going to write. In general, if you take particular months, vintage of new dealers, the amount of business they do increases over time. But also, dealers in that vintage will drop out. So there's 2 effects there that offset each other. But I don't know if there is a typical time frame that someone ramps up that's going to be useful to you in terms of trying to forecast future loan volume.

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Dominick Joseph Gabriele, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [36]

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Great. And then just one more if I could. When you think about the strategy among targeting franchise dealers, let's say non-franchise dealers, what are some of the big differences there? And what makes maybe one dealer -- one better than the other? And not even better, but perhaps just the differences in the -- trying to obtain those long-term relationships.

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Brett A. Roberts, Credit Acceptance Corporation - CEO & Director [37]

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In general, our program works very well at a small independent dealer, it works very well with a larger franchise dealer, sometimes the selling process can be different. The larger organizations, typically, there's more people that need to sign off on a new lender, so it could be a little bit more complex. And then when you get into stores that have multiple locations and maybe a corporate office, there's another selling process that occurs there. But other than that, the program works in all kinds of environments.

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Operator [38]

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Our next question comes from Nick McGibbon of Thrivent Financial.

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Nick McGibbon, [39]

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I have kind of a broad question. I was hoping you guys could help me understand how you think about the amount of leverage that you employ from kind of a downside risk perspective? I guess just on like the overall amount but then also how you structure it secured versus unsecured?

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [40]

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Yes. The way that we determine how much leverage to employ is we run series of financial projections, looking at different leverage, different funding mix, different maturity management strategies. And what we're trying to do is utilize a funding strategy that produces a cost-effective result when the capital markets are open and readily available but also produces an acceptable result when the capital markets are closed for an extended period of time. So we do that analysis, we look at different funding strategies, different leverage, et cetera, and pick the approach that works well in both good and bad capital market environments.

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Nick McGibbon, [41]

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And then I don't know if this will be easy to answer knowing that all the ABS structures you have are probably a little different. But are there any kind of major covenants across the board on your ABSs that -- in kind of a worst-case scenario, you would think, could get close to getting triggered or anything like that?

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [42]

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We obviously have performance triggers in our ABS like any issuer does. None of them are particularly concerning.

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Operator [43]

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Our next question comes from John Hecht of Jefferies.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [44]

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I understand that in the grand scheme of things, the increase in expected cash flows and the purchased loans isn't a huge number. But I'm wondering, can you characterize what changed over the quarter? Was it something tied to frequency or severity in terms of the increase there?

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Brett A. Roberts, Credit Acceptance Corporation - CEO & Director [45]

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I really can't break it down any further than what's in the release. I mean it's a pretty small number. It's nice to have a positive variance, but we don't have a breakdown for you.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [46]

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Okay. And similar to other first quarters, you guys had a big increase in the new dealers -- new dealerships. I'm wondering, is there any geographical kind of trend there? Anything you could -- and then can you tell us how many of those are franchised versus independents or so forth, any characteristics of the new dealerships?

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Brett A. Roberts, Credit Acceptance Corporation - CEO & Director [47]

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The franchised versus independently really hasn't changed a lot. We've been having better success in recent years signing up with the larger franchised stores in the purchase program, that's where the growth is coming from. In terms of -- I forgot the other part of your question.

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [48]

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Geography.

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Brett A. Roberts, Credit Acceptance Corporation - CEO & Director [49]

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Geography. Yes. In general, we've been doing better in areas where we're strong and we're struggling in areas where we've historically struggled. So -- and some of our -- if you look at our SEC filings, you'll see the states where we have the biggest concentrations. We continue to do well on those states and we continue to struggle in the states where we've had -- we have lower penetrations.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [50]

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Okay. And then similar to last year, should -- is there something seasonally we should think about in terms of net attrition in the dealerships in Q2? Or is that just something that happened over the last couple of years and it's not necessarily a seasonal thing?

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [51]

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So there's a seasonal component there. A lot of dealers will come on during tax season, write business and then fall off in the second quarter. So if you look at that seasonal pattern, that's probably a good place to start.

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Operator [52]

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(Operator Instructions) Our next question comes from Giuliano Bologna.

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Giuliano Jude Anderes-Bologna, BTIG, LLC, Research Division - VP for Investment Research [53]

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So I guess starting off with one question on the dealer loan side. Looks like there was a decrease in the unit volume versus the prior year and purchase volume really made up the balance. How should we kind of think about the dynamic there? And should we continue -- should we expect that to continue going forward?

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Brett A. Roberts, Credit Acceptance Corporation - CEO & Director [54]

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The forecast there, that's been the trend. And over the last several quarters we've been growing the purchased loan program and the dealer loan program has been less successful.

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Giuliano Jude Anderes-Bologna, BTIG, LLC, Research Division - VP for Investment Research [55]

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That makes sense. And thinking about kind of -- I have a little bit of a different question. Obviously, the 2018 vintage had positive provisions on the forecasted collection. Is there any way of framing where those increases came from? Is there a couple different theories out there around repossessions being higher with newer vehicles or wage garnishments being higher potentially with lower payroll taxes? Is there any one driver that kind of had an outsized impact in the year?

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Brett A. Roberts, Credit Acceptance Corporation - CEO & Director [56]

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No. I don't think so. It's -- we're talking about small changes here. I think the prior question was essentially the same one. So no, we don't have a breakdown for you. It's a small variance. We're happy to see it, but we don't have any further detail for you.

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Giuliano Jude Anderes-Bologna, BTIG, LLC, Research Division - VP for Investment Research [57]

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And just one other quick one. One of the things I noticed was the increase in restricted cash. Looks like restricted cash went up about $114 million. Is that tied to any specific transaction?

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [58]

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I mean the bulk of the reason for that is we have restricted stock that -- or restricted cash rather that relates to collections on securitizations. That is in the collection account and it's used to reduce debt on the subsequent distribution date. The increase in the amount of securitization debt, together with the higher than normal collections that occurred during the first quarter of the year, account for the increase there.

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Operator [59]

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Our next question comes from Dominick Gabriele of Oppenheimer.

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Dominick Joseph Gabriele, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [60]

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Sorry about that, just if I can follow up on one more. You guys had a forecast for the year on interest expense up 50 basis points in the previous quarter for 2019. Given the new Fed rate path, do you think that's still the same there? And then also, do you think that the $20 million in the first quarter of other income, is that a good run rate going forward? Or was that kind of a little higher in the first quarter and we expect that to come down towards that $15 million, $16 million, $17 million level?

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [61]

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I mean relative to the interest expense, I think when I offered that last quarter, I had a qualifier about constant mix of debt based on the shape of the forward LIBOR curve, a couple of pretty big assumptions there. I still think that we see rates increasing going forward, but there's probably more uncertainty relative to the magnitude of those increases today than there was 90 days ago.

So I think a lot of it just depends on just what happens with base rates. Base rates go up over time, our cost of debt is going to go up and base rates stay more flat. The same will happen to us. In terms of other income, I don't really have any guidance to share there. We -- there hasn't been a huge amount of seasonality in other income historically. You can kind of look -- take a look at the quarterly numbers to see the trend line.

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Operator [62]

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With no further questions in queue, I'd like to turn the conference back over to Mr. Busk for any additional or closing remarks.

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Douglas W. Busk, Credit Acceptance Corporation - Senior VP & Treasurer [63]

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We'd like to thank everyone for their support and for joining us on our conference call today. If you have any additional follow-up questions, please direct them to our Investor Relations mailbox at ir@creditacceptance.com. We look forward to talking to you again next quarter. Thank you.

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Operator [64]

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Once again, this does conclude today's conference. We thank you for your participation.