Credit Acceptance notes in its filings that it is frequently the subject of consumer lawsuits and regulatory investigations over its loan-making and collection practices. Claims of predatory practices have dogged the industry for many years. Credit Acceptance typically counters that it abides by the terms of the contracts signed by its customers. In February, it disclosed that the Federal Trade Commission was investigating its use of devices that disable vehicles remotely when payments are missed. It said it was cooperating with the inquiry.
Investors looked past all that. Credit Acceptance’s share price more than doubled over the past five years. But now some number crunchers see signs of trouble in its shifting business model. After profiting handsomely from a strategy that emphasized sharing loan risk with dealers, Credit Acceptance is lending more on its own, increasing its exposure to defaults.
“The shift is unhealthy,” says Ben Weinger, portfolio manager of hedge fund 3-Sigma Value LP, which has bet against Credit Acceptance shares. “The whole genius of this company is the risk-sharing program. That is what makes Credit Acceptance unique.”
Foss introduced the risk-sharing system, which the company calls the portfolio program, in the late 1980s. The son of a used-car salesman, Foss opened his first lot in 1967. He appealed to customers in Detroit with cheesy TV commercials promising easy credit. Later he founded Credit Acceptance to handle financing and collections for his growing network of dealerships, and then expanded to working with other dealers.
In the portfolio program, when a cash-strapped customer wants to buy a car, Credit Acceptance will advance the dealer about 40 percent of the total value of the loan. That is typically enough to cover the cost of the car to the dealer plus a small profit. Once that part has been repaid, Credit Acceptance shares any remaining payments with the dealer. The company is shielded from much of the credit risk, because its advance is secured by the car. It can repossess the vehicle while pursuing the defaulting customer in court.
“It was a growth juggernaut,” recalls Richard Beckman, who was Credit Acceptance president in the 1990s and remembers Foss as a hard-nosed businessman. Foss has a $1.3 billion fortune, according to the Bloomberg Billionaires Index. He’s still the largest shareholder in Credit Acceptance with a $700 million stake.
The program’s success attracted competitors, making it harder for Credit Acceptance to draw dealers to its program. So, three years after Foss stepped down as chief executive officer in 2002, the company added another program in an attempt to maintain loan volume. Under the so-called purchase program, Credit Acceptance started to buy some loans outright. The dealers got more money upfront while Credit Acceptance kept all the payments. Since then, the purchase program has constituted about 10 percent of the loans the company has issued, on average.
But that ratio soared last year, with the purchase program making up 21 percent of new loans in 2016. The number of purchase loans underwritten increased 88 percent even as the risk-sharing portfolio program dipped 0.2 percent. A quarter of its $4.5 billion loan book now comprises loans it owns outright, up from 16 percent at the end of 2015.
Detractors contend this shift means Credit Acceptance is more vulnerable to the woes of an industry struggling with a combination of declining used-car values, which make it harder to recoup losses by repossessing vehicles, and higher delinquencies. This year, Wells Fargo & Co. and JPMorgan Chase & Co. have backed away from making new subprime auto loans themselves, tightening standards and reducing loan volume. Still, big banks have continued packaging loans that finance companies then securitize and sell to investors.
Credit Acceptance expects to collect 65 percent of the value of loans it has made so far this year, according to its filings, which is lower than its recovery rates over the last two decades but still better than the rates reported by its peers. That decline is contributing to the short sellers’ argument that the Southfield, Michigan-based company’s share price is too high.
Credit Acceptance has a higher market value relative to a measure of its net assets than its biggest rivals — five times that of Ally Financial Inc. and four times that of Santander Consumer USA Holdings Inc. Steve Eisman, made famous in Michael Lewis’s book “The Big Short” for his bet on the mortgage crash, said in March that he was concerned about the U.S. subprime-auto market.
Some supporters of the company say that Credit Acceptance is merely being targeted by investors looking for a way to get on that bandwagon and that the company’s experience in subprime lending will enable it to ride out any downturn and benefit as competitors exit.
“Right now there’s a big short interest, as everyone wants to play this theme of the auto lender bubble, but Credit Acceptance is the absolute wrong vehicle for this,” says Randy Heck, a general partner at Goodnow Investment Group LLC, who has owned shares in Credit Acceptance for 19 years.
Credit Acceptance has said in filings that the change in its product mix is largely a result of increased competition. It says that even the higher-risk purchase loans have been profitable ever since they were first offered in 2005. Still, the company concedes that the change isn’t welcome. “We recognize that if collections fall short of our forecast, the impact on profitability will be much greater with purchase loans than with portfolio loans,” CEO Brett Roberts wrote in his letter to shareholders last month.
Complicating matters is Credit Acceptance’s broad disclosures on the condition of its portfolio, which doesn’t include some specifics on defaults and delinquencies. That makes it difficult for analysts and investors to dig into the underlying performance of its loan book. “The accounting we follow is the required accounting,” Chief Financial Officer Ken Booth said on a November earnings call when asked about the company’s disclosure practices.
Through it all, Foss’s influence has waned. Last summer, Credit Acceptance compelled him to sell Carite, a dealership chain that leases cars to customers with weak credit, to avoid potential conflicts of interest, Credit Acceptance filings show. An 18-page shareholder agreement accompanying his January retirement from the chairmanship noted that for the next 10 years, Foss had agreed to vote his Credit Acceptance shares in accordance with the board.
The arrangement places Foss in an unfamiliar role, stripping him of influence over his creation just as it faces new risks, while depriving him of the dealership business that was supposed to be his next act. People in the industry don’t see him taking a back seat just yet. Ken Shilson, president and founder of the National Alliance of Buy Here, Pay Here Dealers, says “My sense is he’s got a lot of miles left on his tires.”