CREDIT ACCEPTANCE CORP 10-Q

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes included in Item 8 - Financial Statements and Supplementary Data, of our 2021 Annual Report on Form 10-K, as well as Part I - Item 1 - Financial Statements, of this Form 10-Q, which is incorporated herein by reference. Overview We offer financing programs that enable automobile dealers to sell vehicles to consumers, regardless of their credit history. Our financing programs are offered through a nationwide network of automobile dealers who benefit from sales of vehicles to consumers who otherwise could not obtain financing; from repeat and referral sales generated by these same customers; and from sales to customers responding to advertisements for our financing programs, but who actually end up qualifying for traditional financing. For the three months ended June 30, 2022, consolidated net income was $107.4 million, or $7.94 per diluted share, compared to consolidated net income of $288.6 million, or $17.18 per diluted share, for the same period in 2021, primarily due to increases in provision for credit losses and operating expenses and a decrease in finance charges. Our results for the three months ended June 30, 2022 included: • A decrease in forecasted collection rates for Consumer Loans assigned in 2020 through 2022, which decreased forecasted net cash flows from our Loan portfolio by $43.4 million. • Forecasted profitability per Consumer Loan assignment that has significantly exceeded our initial estimates for Consumer Loans assigned in 2018 through 2021. • Growth in Consumer Loan assignment volume, as unit and dollar volumes grew 5.1% and 22.0%, respectively, as compared to the second quarter of 2021. • Stock repurchases of approximately 404,000 shares, which represented 3.0% of the shares outstanding at the beginning of the quarter. • A $12.0 million expense related to an agreement in principle to settle a previously-disclosed putative class action lawsuit, and a $20.0 million increase in stock-based compensation expense primarily due to the retirement of our former Chief Executive Officer in May 2021 and the timing of shareholder approval for 2020 and 2021 stock option grants. For the six months ended June 30, 2022, consolidated net income was $321.7 million, or $23.10 per diluted share, compared to consolidated net income of $490.7 million, or $28.96 per diluted share, for the same period in 2021, primarily due to increases in provision for credit losses and operating expenses and a decrease in finance charges. Our results for the six months ended June 30, 2022 included: • An increase in forecasted collection rates for Consumer Loans assigned in 2014, 2016, 2017 and 2019 through 2021 and a decrease in forecasted collection rates for Consumer Loans assigned in 2022, which increased forecasted net cash flows from our Loan portfolio by $66.8 million. • Forecasted profitability per Consumer Loan assignment that has significantly exceeded our initial estimates for Consumer Loans assigned in 2018 through 2021. • A decline in Consumer Loan assignment unit volume of 10.5%, while dollar volume grew 3.7%, as compared to the same period in 2021. • Stock repurchases of approximately 1.2 million shares, which represented 8.5% of the shares outstanding at the beginning of the year. • A $12.0 million expense compared to a $27.2 million expense in the prior year related to previously-disclosed legal matters, and a $28.0 million increase in stock-based compensation expense primarily due to the retirement of our former Chief Executive Officer in May 2021 and the timing of shareholder approval for 2020 and 2021 stock option grants. Critical Success Factors Critical success factors include our ability to accurately forecast Consumer Loan performance, access capital on acceptable terms, and maintain or grow Consumer Loan volume at the level and on the terms that we anticipate, with the objective to maximize economic profit over the long term. Economic profit is a non-GAAP financial measure we use to evaluate our financial results and determine certain incentive compensation. We also use economic profit as a framework to evaluate business decisions and strategies. Economic profit measures how efficiently we utilize our total capital, both debt and equity, and is a function of the return on capital in excess of the cost of capital and the amount of capital invested in the business. 44 Table of Contents Consumer Loan Metrics At the time a Consumer Loan is submitted to us for assignment, we forecast future expected cash flows from the Consumer Loan. Based on the amount and timing of these forecasts and expected expense levels, an advance or one-time purchase payment is made to the related Dealer at a price designed to maximize economic profit. We use a statistical model to estimate the expected collection rate for each Consumer Loan at the time of assignment. We continue to evaluate the expected collection rate of each Consumer Loan subsequent to assignment. Our evaluation becomes more accurate as the Consumer Loans age, as we use actual performance data in our forecast. By comparing our current expected collection rate for each Consumer Loan with the rate we projected at the time of assignment, we are able to assess the accuracy of our initial forecast. The following table compares our forecast of Consumer Loan collection rates as of June 30, 2022 with the forecasts as of March 31, 2022, as of December 31, 2021 and at the time of assignment, segmented by year of assignment: Forecasted Collection Percentage as of (1) Current Forecast Variance from Consumer Loan Assignment Year June 30, 2022 March 31, 2022 December 31, 2021 Initial Forecast March 31, 2022 December 31, 2021 Initial Forecast 2013 73.4 % 73.4 % 73.4 % 72.0 % 0.0 % 0.0 % 1.4 % 2014 71.7 % 71.6 % 71.5 % 71.8 % 0.1 % 0.2 % -0.1 % 2015 65.2 % 65.2 % 65.1 % 67.7 % 0.0 % 0.1 % -2.5 % 2016 63.8 % 63.8 % 63.6 % 65.4 % 0.0 % 0.2 % -1.6 % 2017 64.6 % 64.6 % 64.4 % 64.0 % 0.0 % 0.2 % 0.6 % 2018 65.1 % 65.1 % 65.1 % 63.6 % 0.0 % 0.0 % 1.5 % 2019 66.7 % 66.8 % 66.5 % 64.0 % -0.1 % 0.2 % 2.7 % 2020 68.4 % 68.8 % 67.9 % 63.4 % -0.4 % 0.5 % 5.0 % 2021 67.6 % 68.4 % 66.5 % 66.3 % -0.8 % 1.1 % 1.3 % 2022 (2) 67.1 % 66.9 % — 67.6 % 0.2 % — -0.5 % (1) Represents the total forecasted collections we expect to collect on the Consumer Loans as a percentage of the repayments that we were contractually owed on the Consumer Loans at the time of assignment. Contractual repayments include both principal and interest. Forecasted collection rates are negatively impacted by canceled Consumer Loans as the contractual amount owed is not removed from the denominator for purposes of computing forecasted collection rates in the table. (2) The forecasted collection rate for 2022 Consumer Loans as of June 30, 2022 includes both Consumer Loans that were in our portfolio as of March 31, 2022 and Consumer Loans assigned during the most recent quarter. The following table provides forecasted collection rates for each of these segments: Forecasted Collection Percentage as of Current Forecast Variance from 2022 Consumer Loan Assignment Period June 30, 2022 March 31, 2022 Initial Forecast March 31, 2022 Initial Forecast January 1, 2022 through March 31, 2022 66.4 % 66.9 % 67.2 % -0.5 % -0.8 % April 1, 2022 through June 30, 2022 67.8 % — 68.0 % — -0.2 % Consumer Loans assigned in 2013 and 2018 through 2021 have yielded forecasted collection results significantly better than our initial estimates, while Consumer Loans assigned in 2015 and 2016 have yielded forecasted collection results significantly worse than our initial estimates. For all other assignment years presented, actual results have been close to our initial estimates. For the three months ended June 30, 2022, forecasted collection rates declined for Consumer Loans assigned in 2020 through 2022 and were generally consistent with expectations at the start of the period for all other assignment years presented. For the six months ended June 30, 2022, forecasted collection rates improved for Consumer Loans assigned in 2014, 2016, 2017 and 2019 through 2021, declined for Consumer Loans assigned in 2022, and were generally consistent with expectations at the start of the period for all other assignment years presented. The changes in forecasted collection rates for the three and six months ended June 30, 2022 and 2021 impacted forecasted net cash flows (forecasted collections less forecasted Dealer Holdback payments) as follows: (In millions) For the Three Months Ended June 30, For the Six Months Ended June 30, Increase (Decrease) in Forecasted Net Cash Flows 2022 2021 2022 2021 Dealer Loans $ (14.0) $ 32.9 $ 19.9 $ 59.6 Purchased Loans (29.4) 71.6 46.9 152.3 Total $ (43.4) $ 104.5 $ 66.8 $ 211.9 45 Table of Contents The COVID-19 pandemic created conditions that increased the level of uncertainty associated with our estimate of the amount and timing of future net cash flows from our Loan portfolio. During the first quarter of 2020, we applied a subjective adjustment to our forecasting model to reflect our best estimate of the future impact of the COVID-19 pandemic on future net cash flows (“COVID forecast adjustment”), which reduced our estimate of future net cash flows by $162.2 million. We continued to apply the COVID forecast adjustment through the end of 2021 as it continued to represent our best estimate. During the first quarter of 2022, we determined that we had sufficient Consumer Loan performance experience since the lapse of federal stimulus payments and enhanced unemployment benefits to refine our estimate of future net cash flows. Accordingly, during the first quarter of 2022, we removed the COVID forecast adjustment and enhanced our methodology for forecasting the amount and timing of future net cash flows from our Loan portfolio through the utilization of more recent data and new forecast variables. Under CECL, changes in the amount and timing of forecasted net cash flows are recorded as a provision for credit losses in the period of change. The removal of the COVID forecast adjustment and the implementation of the enhanced forecasting methodology during the first quarter of 2022 impacted forecasted net cash flows and provision for credit losses as follows: (In millions) Increase / (Decrease) in Forecasting Methodology Changes Forecasted Net Cash Flows Provision for Credit Losses Removal of COVID forecast adjustment $ 149.5 $ (118.5) Implementation of enhanced forecasting methodology (53.8) 47.9 Total $ 95.7 $ (70.6) The following table presents information on the average Consumer Loan assignment for each of the last 10 years: Average Consumer Loan Assignment Year Consumer Loan (1) Advance (2) Initial Loan Term (in months) 2013 $ 15,445 $ 7,344 47 2014 15,692 7,492 47 2015 16,354 7,272 50 2016 18,218 7,976 53 2017 20,230 8,746 55 2018 22,158 9,635 57 2019 23,139 10,174 57 2020 24,262 10,656 59 2021 25,632 11,790 59 2022 (3) 27,118 12,995 59 (1) Represents the repayments that we were contractually owed on Consumer Loans at the time of assignment, which include both principal and interest. (2) Represents advances paid to Dealers on Consumer Loans assigned under our Portfolio Program and one-time payments made to Dealers to purchase Consumer Loans assigned under our Purchase Program. Payments of Dealer Holdback and accelerated Dealer Holdback are not included. (3) The averages for 2022 Consumer Loans include both Consumer Loans that were in our portfolio as of March 31, 2022 and Consumer Loans assigned during the most recent quarter. The following table provides averages for each of these segments: Average 2022 Consumer Loan Assignment Period Consumer Loan Advance Initial Loan Term (in months) January 1, 2022 through March 31, 2022 $ 26,504 $ 12,677 58 April 1, 2022 through June 30, 2022 27,731 13,312 60 46 Table of Contents Forecasting collection rates accurately at Loan inception is difficult. With this in mind, we establish advance rates that are intended to allow us to achieve acceptable levels of profitability, even if collection rates are less than we initially forecast. The following table presents forecasted Consumer Loan collection rates, advance rates, the spread (the forecasted collection rate less the advance rate), and the percentage of the forecasted collections that had been realized as of June 30, 2022. All amounts, unless otherwise noted, are presented as a percentage of the initial balance of the Consumer Loan (principal + interest). The table includes both Dealer Loans and Purchased Loans. As of June 30, 2022 Consumer Loan Assignment Year Forecasted Collection % Advance % (1) Spread % % of Forecast Realized (2) 2013 73.4 % 47.6 % 25.8 % 99.7 % 2014 71.7 % 47.7 % 24.0 % 99.4 % 2015 65.2 % 44.5 % 20.7 % 98.9 % 2016 63.8 % 43.8 % 20.0 % 98.1 % 2017 64.6 % 43.2 % 21.4 % 95.7 % 2018 65.1 % 43.5 % 21.6 % 88.9 % 2019 66.7 % 44.0 % 22.7 % 77.1 % 2020 68.4 % 43.9 % 24.5 % 59.6 % 2021 67.6 % 46.0 % 21.6 % 33.8 % 2022 (3) 67.1 % 47.9 % 19.2 % 6.4 % (1) Represents advances paid to Dealers on Consumer Loans assigned under our Portfolio Program and one-time payments made to Dealers to purchase Consumer Loans assigned under our Purchase Program as a percentage of the initial balance of the Consumer Loans. Payments of Dealer Holdback and accelerated Dealer Holdback are not included. (2) Presented as a percentage of total forecasted collections. (3) The forecasted collection rate, advance rate and spread for 2022 Consumer Loans as of June 30, 2022 include both Consumer Loans that were in our portfolio as of March 31, 2022 and Consumer Loans assigned during the most recent quarter. The following table provides forecasted collection rates, advance rates, and spreads for each of these segments: As of June 30, 2022 2022 Consumer Loan Assignment Period Forecasted Collection % Advance % Spread % January 1, 2022 through March 31, 2022 66.4 % 47.8 % 18.6 % April 1, 2022 through June 30, 2022 67.8 % 48.0 % 19.8 % The risk of a material change in our forecasted collection rate declines as the Consumer Loans age. For 2017 and prior Consumer Loan assignments, the risk of a material forecast variance is modest, as we have currently realized in excess of 90% of the expected collections. Conversely, the forecasted collection rates for more recent Consumer Loan assignments are less certain as a significant portion of our forecast has not been realized. The spread between the forecasted collection rate and the advance rate has ranged from 19.2% to 25.8%, on an annual basis, over the last 10 years. The spreads in 2019 and 2020 were positively impacted by Consumer Loan performance, which has exceeded our initial estimates by a greater margin than the other years presented. The decrease in the spread from 2021 to 2022 was primarily due to Consumer Loan performance, as the performance of 2021 Consumer Loans has significantly exceeded our initial estimates while the performance of 2022 Consumer Loans has been lower than our initial estimates, and a lower initial spread on 2022 Consumer Loans due to the advance rate increasing by a greater margin than the initial forecast. 47 Table of Contents The following table compares our forecast of Consumer Loan collection rates as of June 30, 2022 with the forecasts at the time of assignment, for Dealer Loans and Purchased Loans separately: Dealer Loans Purchased Loans Forecasted Collection Percentage as of (1) Forecasted Collection Percentage as of (1) Consumer Loan Assignment Year June 30, 2022 Initial Forecast Variance June 30, 2022 Initial Forecast Variance 2013 73.4 % 72.1 % 1.3 % 74.3 % 71.6 % 2.7 % 2014 71.6 % 71.9 % -0.3 % 72.5 % 70.9 % 1.6 % 2015 64.5 % 67.5 % -3.0 % 68.9 % 68.5 % 0.4 % 2016 63.0 % 65.1 % -2.1 % 66.1 % 66.5 % -0.4 % 2017 64.0 % 63.8 % 0.2 % 66.3 % 64.6 % 1.7 % 2018 64.6 % 63.6 % 1.0 % 66.3 % 63.5 % 2.8 % 2019 66.4 % 63.9 % 2.5 % 67.3 % 64.2 % 3.1 % 2020 68.3 % 63.3 % 5.0 % 68.6 % 63.6 % 5.0 % 2021 67.4 % 66.3 % 1.1 % 68.0 % 66.3 % 1.7 % 2022 66.9 % 67.5 % -0.6 % 67.6 % 67.7 % -0.1 % (1) The forecasted collection rates presented for Dealer Loans and Purchased Loans reflect the Consumer Loan classification at the time of assignment. The forecasted collection rates represent the total forecasted collections we expect to collect on the Consumer Loans as a percentage of the repayments that we were contractually owed on the Consumer Loans at the time of assignment. Contractual repayments include both principal and interest. Forecasted collection rates are negatively impacted by canceled Consumer Loans as the contractual amount owed is not removed from the denominator for purposes of computing forecasted collection rates in the table. The following table presents forecasted Consumer Loan collection rates, advance rates, and the spread (the forecasted collection rate less the advance rate) as of June 30, 2022 for Dealer Loans and Purchased Loans separately. All amounts are presented as a percentage of the initial balance of the Consumer Loan (principal + interest). Dealer Loans Purchased Loans Consumer Loan Assignment Year Forecasted Collection % (1) Advance % (1)(2) Spread % Forecasted Collection % (1) Advance % (1)(2) Spread % 2013 73.4 % 47.2 % 26.2 % 74.3 % 51.5 % 22.8 % 2014 71.6 % 47.2 % 24.4 % 72.5 % 51.8 % 20.7 % 2015 64.5 % 43.4 % 21.1 % 68.9 % 50.2 % 18.7 % 2016 63.0 % 42.1 % 20.9 % 66.1 % 48.6 % 17.5 % 2017 64.0 % 42.1 % 21.9 % 66.3 % 45.8 % 20.5 % 2018 64.6 % 42.7 % 21.9 % 66.3 % 45.2 % 21.1 % 2019 66.4 % 43.1 % 23.3 % 67.3 % 45.6 % 21.7 % 2020 68.3 % 43.0 % 25.3 % 68.6 % 45.5 % 23.1 % 2021 67.4 % 45.1 % 22.3 % 68.0 % 47.7 % 20.3 % 2022 66.9 % 47.0 % 19.9 % 67.6 % 50.3 % 17.3 % (1) The forecasted collection rates and advance rates presented for Dealer Loans and Purchased Loans reflect the Consumer Loan classification at the time of assignment. (2) Represents advances paid to Dealers on Consumer Loans assigned under our Portfolio Program and one-time payments made to Dealers to purchase Consumer Loans assigned under our Purchase Program as a percentage of the initial balance of the Consumer Loans. Payments of Dealer Holdback and accelerated Dealer Holdback are not included. Although the advance rate on Purchased Loans is higher as compared to the advance rate on Dealer Loans, Purchased Loans do not require us to pay Dealer Holdback. 48 Table of Contents The spread on Dealer Loans decreased from 22.3% in 2021 to 19.9% in 2022 primarily as a result of Consumer Loan performance, as the performance of 2021 Consumer Loans in our Dealer Loan portfolio has significantly exceeded our initial estimates while the performance of 2022 Consumer Loans in our Dealer Loan portfolio has been lower than our initial estimates, and a lower initial spread on 2022 Consumer Loans in our Dealer Loan portfolio, due to the advance rate increasing by a greater margin than the initial forecast in our Dealer Loan portfolio. The spread on Purchased Loans decreased from 20.3% in 2021 to 17.3% in 2022 primarily as a result of the performance of the 2021 Consumer Loans in our Purchased Loan portfolio, which has significantly exceeded our initial estimates, and a lower initial spread on 2022 Consumer Loans in our Purchased Loan portfolio, due to the advance rate increasing by a greater margin than the initial forecast in our Purchased Loan portfolio. Access to Capital Our strategy for accessing capital on acceptable terms needed to maintain and grow the business is to: (1) maintain consistent financial performance; (2) maintain modest financial leverage; and (3) maintain multiple funding sources. Our funded debt to equity ratio was 3.2 to 1 as of June 30, 2022. We currently utilize the following primary forms of debt financing: (1) a revolving secured line of credit; (2) Warehouse facilities; (3) Term ABS financings; and (4) senior notes. Consumer Loan Volume The following table summarizes changes in Consumer Loan assignment volume in each of the last six quarters as compared to the same period in the previous year: Year over Year Percent Change Three Months Ended Unit Volume Dollar Volume (1) March 31, 2021 -7.5 % -2.2 % June 30, 2021 -28.7 % -20.5 % September 30, 2021 -29.4 % -17.9 % December 31, 2021 -22.6 % -12.7 % March 31, 2022 -22.1 % -10.5 % June 30, 2022 5.1 % 22.0 % (1) Represents advances paid to Dealers on Consumer Loans assigned under our Portfolio Program and one-time payments made to Dealers to purchase Consumer Loans assigned under our Purchase Program. Payments of Dealer Holdback and accelerated Dealer Holdback are not included. Consumer Loan assignment volumes depend on a number of factors including (1) the overall demand for our financing programs, (2) the amount of capital available to fund new Loans, and (3) our assessment of the volume that our infrastructure can support. Our pricing strategy is intended to maximize the amount of economic profit we generate, within the confines of capital and infrastructure constraints. Unit and dollar volumes grew 5.1% and 22.0%, respectively, during the second quarter of 2022 as the number of active Dealers grew 1.9% and the average unit volume per active Dealer grew 2.4% . Unit volume for July 2022 grew 19.3% compared to unit volume for July 2021. The comparable 2021 periods reflected significant declines in unit volume, which we believe were primarily due to low dealer inventories and elevated used vehicle prices, which we believe were primarily due to the downstream impact of supply chain disruptions in the automotive industry. We believe low dealer inventories and elevated used car prices continue to have a negative impact on unit volumes. Dollar volume grew more than unit volume during the second quarter of 2022 due to an increase in the average advance paid per unit. This increase was the result of increases in both the average size of the Consumer Loans assigned, primarily due to an increase in the average vehicle selling price, and the average advance rate. 49 Table of Contents The following table summarizes the changes in Consumer Loan unit volume and active Dealers: For the Three Months Ended June 30, For the Six Months Ended June 30, 2022 2021 % Change 2022 2021 % Change Consumer Loan unit volume 73,340 69,809 5.1 % 146,456 163,683 -10.5 % Active Dealers (1) 8,494 8,333 1.9 % 9,815 10,165 -3.4 % Average volume per active Dealer 8.6 8.4 2.4 % 14.9 16.1 -7.5 % Consumer Loan unit volume from Dealers active both periods 60,132 60,572 -0.7 % 127,283 147,109 -13.5 % Dealers active both periods 5,890 5,890 — 7,382 7,382 — Average volume per Dealer active both periods 10.2 10.3 -0.7 % 17.2 19.9 -13.5 % Consumer Loan unit volume from Dealers not active both periods 13,208 9,237 43.0 % 19,173 16,574 15.7 % Dealers not active both periods 2,604 2,443 6.6 % 2,433 2,783 -12.6 % Average volume per Dealer not active both periods 5.1 3.8 34.2 % 7.9 6.0 31.7 % (1) Active Dealers are Dealers who have received funding for at least one Consumer Loan during the period. The following table provides additional information on the changes in Consumer Loan unit volume and active Dealers: For the Three Months Ended June 30, For the Six Months Ended June 30, 2022 2021 % Change 2022 2021 % Change Consumer Loan unit volume from new active Dealers 2,328 1,601 45.4 % 8,517 7,263 17.3 % New active Dealers (1) 682 449 51.9 % 1,370 1,155 18.6 % Average volume per new active Dealer 3.4 3.6 -5.6 % 6.2 6.3 -1.6 % Attrition (2) -13.2 % -15.9 % -10.1 % -11.3 % (1) New active Dealers are Dealers who enrolled in our program and have received funding for their first Loan from us during the period. (2) Attrition is measured according to the following formula: decrease in Consumer Loan unit volume from Dealers who have received funding for at least one Loan during the comparable period of the prior year but did not receive funding for any Loans during the current period divided by prior year comparable period Consumer Loan unit volume. The following table shows the percentage of Consumer Loans assigned to us as Dealer Loans and Purchased Loans for each of the last six quarters: Unit Volume Dollar Volume (1) Three Months Ended Dealer Loans Purchased Loans Dealer Loans Purchased Loans March 31, 2021 65.4 % 34.6 % 62.7 % 37.3 % June 30, 2021 66.9 % 33.1 % 64.0 % 36.0 % September 30, 2021 69.9 % 30.1 % 66.8 % 33.2 % December 31, 2021 71.8 % 28.2 % 68.0 % 32.0 % March 31, 2022 72.7 % 27.3 % 68.6 % 31.4 % June 30, 2022 74.0 % 26.0 % 70.4 % 29.6 % (1) Represents advances paid to Dealers on Consumer Loans assigned under our Portfolio Program and one-time payments made to Dealers to purchase Consumer Loans assigned under our Purchase Program. Payments of Dealer Holdback and accelerated Dealer Holdback are not included. As of June 30, 2022 and December 31, 2021, the net Dealer Loans receivable balance was 63.1% and 61.3% , respectively, of the total net Loans receivable balance. 50 Table of Contents Results of Operations The net Loan income (finance charge revenue less provision for credit losses expense) that we recognize over the life of a Loan equals the cash we collect from the underlying Consumer Loan less the cash we pay to the Dealer. We believe the economics of our business are best exhibited by recognizing net Loan income on a level-yield basis over the life of the Loan based on expected future net cash flows. We do not believe the GAAP methodology we employ (known as CECL) provides sufficient transparency into the economics of our business due to its asymmetry requiring us to recognize a significant provision for credit losses expense at the time of assignment for contractual net cash flows we never expect to realize and to recognize in subsequent periods finance charge revenue that is significantly in excess of our expected yields. For additional information, see Note 3 and Note 6 to the consolidated financial statements contained in Part I - Item 1 of this Form 10-Q, which is incorporated herein by reference. Three Months Ended June 30, 2022 Compared to Three Months Ended June 30, 2021 The following is a discussion of our results of operations and income statement data on a consolidated basis. (Dollars in millions, except per share data) For the Three Months Ended June 30, 2022 2021 $ Change % Change Revenue: Finance charges $ 425.6 $ 445.4 $ (19.8) -4.4 % Premiums earned 15.4 15.8 (0.4) -2.5 % Other income 16.4 10.5 5.9 56.2 % Total revenue 457.4 471.7 (14.3) -3.0 % Costs and expenses: Salaries and wages (1) 65.4 38.4 27.0 70.3 % General and administrative (1) 32.3 16.9 15.4 91.1 % Sales and marketing (1) 19.0 14.9 4.1 27.5 % Provision for credit losses 147.5 (30.5) 178.0 -583.6 % Interest 38.9 42.0 (3.1) -7.4 % Provision for claims 12.2 10.3 1.9 18.4 % Total costs and expenses 315.3 92.0 223.3 242.7 % Income before provision for income taxes 142.1 379.7 (237.6) -62.6 % Provision for income taxes 34.7 91.1 (56.4) -61.9 % Net income $ 107.4 $ 288.6 $ (181.2) -62.8 % Net income per share: Basic $ 7.99 $ 17.19 $ (9.20) -53.5 % Diluted $ 7.94 $ 17.18 $ (9.24) -53.8 % Weighted average shares outstanding: Basic 13,435,507 16,790,189 (3,354,682) -20.0 % Diluted 13,517,979 16,794,279 (3,276,300) -19.5 % (1) Operating expenses $ 116.7 $ 70.2 $ 46.5 66.2 % 51 Table of Contents Finance Charges. The decrease of $19.8 million, or 4.4%, was the result of a decrease in the average net Loans receivable balance, partially offset by an increase in the average yield on our Loan portfolio, as follows: (Dollars in millions) For the Three Months Ended June 30, 2022 2021 Change Average net Loans receivable balance $ 6,328.7 $ 6,856.9 $ (528.2) Average yield on our Loan portfolio 26.9 % 26.0 % 0.9 % The following table summarizes the impact each component had on the overall decrease in finance charges for the three months ended June 30, 2022: (In millions) Year over Year Change Impact on finance charges: For the Three Months Ended June 30, 2022 Due to an increase in the average yield $ 14.5 Due to a decrease in the average net Loans receivable balance (34.3) Total decrease in finance charges $ (19.8) The decrease in the average net Loans receivable balance was primarily due to the principal collected on Loans receivable exceeding the dollar volume of new Consumer Loan assignments. The average yield on our Loan portfolio for the three months ended June 30, 2022 increased as compared to the same period in 2021 primarily due to the adoption of CECL on January 1, 2020, which requires us to recognize finance charges on new Consumer Loan assignments using effective interest rates based on contractual future net cash flows, which are significantly in excess of our expected yields. Other Income . The increase of $5.9 million, or 56.2%, was primarily due to an increase in ancillary product profit sharing income primarily due to a decrease in average claim rates on Guaranteed Asset Protection contracts. Operating Expenses. The increase of $46.5 million, or 66.2%, was primarily due to: • An increase in salaries and wages expense of $27.0 million, or 70.3%, primarily due to: • An increase of $20.0 million in stock-based compensation expense, primarily due to: • An $11.5 million reversal of expense during the second quarter of 2021 due to the forfeiture of unvested restricted stock and restricted stock units upon the retirement of our former Chief Executive Officer in May 2021. • An increase of $8.5 million primarily related to stock options. From December 2020 through June 2021, we granted stock options, subject to shareholder approval of an amendment to our incentive compensation plan. Because stock-based awards subject to shareholder approval are not considered granted for accounting purposes until that approval is received, no stock-based compensation expense could be recognized with respect to those stock options until we received shareholder approval at the annual meeting on July 21, 2021. • An increase of $7.0 million, excluding stock-based compensation expense, primarily related to an increase in the number of team members in our technology department. • An increase in general and administrative expense of $15.4 million, or 91.1%, primarily due to an increase in legal expenses, which included the recognition of a $12.0 million contingent loss during the second quarter of 2022 related to the Company reaching an agreement in principle to settle a previously-disclosed putative class action lawsuit. 52 Table of Contents Provision for Credit Losses . The increase of $178.0 million, or 583.6%, was primarily due to an increase in provision for credit losses on forecast changes. We recognize provision for credit losses on new Consumer Loan assignments for contractual net cash flows that are not expected to be realized at the time of assignment. We also recognize provision for credit losses on forecast changes in the amount and timing of expected future net cash flows subsequent to assignment. The following table summarizes the provision for credit losses for each of these components: (In millions) For the Three Months Ended June 30, Provision for Credit Losses 2022 2021 Change New Consumer Loan assignments $ 97.5 $ 91.6 $ 5.9 Forecast changes 50.0 (122.1) 172.1 Total $ 147.5 $ (30.5) $ 178.0 T he increase in provision for credit losses related to forecast changes was primarily due to a decline in Consumer Loan performance during the second quarter of 2022 compared to an improvement in Consumer Loan performance during the second quarter of 2021. During the second quarter of 2022, we reduced our estimate of future net cash flows by $43.4 million to reflect a decline in Consumer Loan performance during the period. During the second quarter of 2021, we increased our estimate of future net cash flows by $104.5 million to reflect an improvement in Consumer Loan performance during the period. The increase in provision for credit losses related to new Consumer Loan assignments was primarily due to a 5.1% increase in Consumer Loan assignment unit volume. Interest. The decrease of $3.1 million, or 7.4%, was primarily due to a decrease in our average cost of debt, as follows: (Dollars in millions) For the Three Months Ended June 30, 2022 2021 Change Interest expense $ 38.9 $ 42.0 $ (3.1) Average outstanding debt principal balance (1) 4,795.4 4,780.7 14.7 Average cost of debt 3.2 % 3.5 % -0.3 % (1) Includes the unamortized debt discount and excludes deferred debt issuance costs. The decrease in our average cost of debt was primarily the result of lower interest rates on recently-completed secured financings. Provision for Income Taxes . For the three months ended June 30, 2022, the effective income tax rate increased to 24.4% from 24.0% for the three months ended June 30, 2021. The increase was primarily due to an increase in non-deductible executive compensation expenses. For additional information, see Note 11 to the consolidated financial statements contained in Part I - Item 1 of this Form 10-Q, which is incorporated herein by reference. 53 Table of Contents Six Months Ended June 30, 2022 Compared to Six Months Ended June 30, 2021 The following is a discussion of our results of operations and income statement data on a consolidated basis. (Dollars in millions, except per share data) For the Six Months Ended June 30, 2022 2021 $ Change % Change Revenue: Finance charges $ 849.7 $ 870.3 $ (20.6) -2.4 % Premiums earned 29.2 30.2 (1.0) -3.3 % Other income 34.2 22.2 12.0 54.1 % Total revenue 913.1 922.7 (9.6) -1.0 % Costs and expenses: Salaries and wages (1) 129.8 87.7 42.1 48.0 % General and administrative (1) 51.2 63.0 (11.8) -18.7 % Sales and marketing (1) 38.2 32.1 6.1 19.0 % Provision for credit losses 170.8 (9.2) 180.0 -1,956.5 % Interest 75.4 85.8 (10.4) -12.1 % Provision for claims 21.1 19.3 1.8 9.3 % Total costs and expenses 486.5 278.7 207.8 74.6 % Income before provision for income taxes 426.6 644.0 (217.4) -33.8 % Provision for income taxes 104.9 153.3 (48.4) -31.6 % Net income $ 321.7 $ 490.7 $ (169.0) -34.4 % Net income per share: Basic $ 23.23 $ 28.99 $ (5.76) -19.9 % Diluted $ 23.10 $ 28.96 $ (5.86) -20.2 % Weighted average shares outstanding: Basic 13,849,711 16,924,014 (3,074,303) -18.2 % Diluted 13,927,372 16,944,900 (3,017,528) -17.8 % (1) Operating expenses $ 219.2 $ 182.8 $ 36.4 19.9 % Finance Charges. The decrease of $20.6 million, or 2.4%, was primarily the result of a decrease in the average net Loans receivable balance, partially offset by an increase in the average yield on our Loan portfolio, as follows: (Dollars in millions) For the Six Months Ended June 30, 2022 2021 Change Average net Loans receivable balance $ 6,317.7 $ 6,820.6 $ (502.9) Average yield on our Loan portfolio 26.9 % 25.5 % 1.4 % The following table summarizes the impact each component had on the overall decrease in finance charges for the six months ended June 30, 2022: (In millions) Year over Year Change Impact on finance charges: For the Six Months Ended June 30, 2022 Due to an increase in the average yield $ 43.6 Due to a decrease in the average net Loans receivable balance (64.2) Total decrease in finance charges $ (20.6) 54 Table of Contents The decrease in the average net Loans receivable balance was primarily due to the principal collected on Loans receivable exceeding the dollar volume of new Consumer Loan assignments. The average yield on our Loan portfolio for the six months ended June 30, 2022 increased as compared to the same period in 2021 primarily due to the adoption of CECL on January 1, 2020, which requires us to recognize finance charges on new Consumer Loan assignments using effective interest rates based on contractual future net cash flows, which are significantly in excess of our expected yields. Operating Expenses. The increase of $36.4 million, or 19.9%, was primarily due to: • An increase in salaries and wages expense of $42.1 million, or 48.0%, primari ly due to: • An increase of $28.0 million in stock-based compensation expense, primarily related to: • An increase of $17.0 million primarily related to stock options. From December 2020 through June 2021, we granted stock options, subject to shareholder approval of an amendment to our incentive compensation plan. Because stock-based awards subject to shareholder approval are not considered granted for accounting purposes until that approval is received, no stock-based compensation expense could be recognized with respect to those stock options until we received shareholder approval at the annual meeting on July 21, 2021. • An $11.5 million reversal of expense during the second quarter of 2021 due to the forfeiture of unvested restricted stock and restricted stock units upon the retirement of our former Chief Executive Officer in May 2021. • An increase of $14.1 million, excluding stock-based compensation expense, primarily related to increases of $9.7 million for our support function and $4.4 million for our servicing function. The increase in our support function was primarily related to an increase in the number of team members in our technology department. • A decrease in general and administrative expense of $11.8 million, or 18.7%, primarily due to a decrease in legal expenses. Legal expenses for the six months ended June 30, 2022 included the recognition of a $12.0 million contingent loss related to the Company reaching an agreement in principle to settle a previously-disclosed putative class action lawsuit. Legal expenses for the six months ended June 30, 2021 included a $27.2 million settlement with the Commonwealth of Massachusetts to settle and fully resolve the claims asserted against the Company. Provision for Credit Losses . The increase of $180.0 million, or 1,956.5%, was due to an increase in provision for credit losses on forecast changes, partially offset by a decrease in provision for credit losses on new Consumer Loan assignments. We recognize provision for credit losses on new Consumer Loan assignments for contractual net cash flows that are not expected to be realized at the time of assignment. We also recognize provision for credit losses on forecast changes in the amount and timing of expected future net cash flows subsequent to assignment. The following table summarizes the provision for credit losses for each of these components: (In millions) For the Six Months Ended June 30, Provision for Credit Losses 2022 2021 Change New Consumer Loan assignments $ 200.1 $ 223.4 $ (23.3) Forecast changes (29.3) (232.6) 203.3 Total $ 170.8 $ (9.2) $ 180.0 The smaller reversal of provision for credit losses related to forecast changes was primarily due to a smaller improvement in Consumer Loan performance. During the first six months of 2022 and 2021, we increased our estimate of future net cash flows by $66.8 million and $211.9 million, respectively, to reflect improvements in Consumer Loan performance during the periods. The results for the first six months of 2022 include the impact of forecasting methodology changes implemented during the first quarter, which upon implementation increased our estimate of future net cash flows by $95.7 million and reduced our provision for credit losses by $70.6 million. The forecasting methodology changes included the removal of the COVID forecast adjustment from our estimate of future net cash flows and an enhancement to our methodology for forecasting the amount and timing of future net cash flows from our Loan portfolio through the utilization of more recent data and new forecast variables. For additional information, see Note 6 to the consolidated financial statements contained in Part I - Item 1 of this Form 10-Q, which is incorporated herein by reference. The decrease in provision for credit losses related to new Consumer Loan assignments was primarily due to a 10.5% decrease in Consumer Loan assignment unit volume. 55 Table of Contents Interest. The decrease o f $10.4 million, or 12.1%, was primarily due to a decrease in our average cost of debt, as follows: (Dollars in millions) For the Six Months Ended June 30, 2022 2021 Change Interest expense $ 75.4 $ 85.8 $ (10.4) Average outstanding debt principal balance (1) 4,704.8 4,755.7 (50.9) Average cost of debt 3.2 % 3.6 % -0.4 % (1) Includes the unamortized debt discount and excludes deferred debt issuance costs. The decrease in our average cost of debt was primarily the result of lower interest rates on recently-completed secured financings. Provision for Income Taxes. For the six months ended June 30, 2022, our effective income tax rate increased to 24.6% from 23.8% for the six months ended June 30, 2021. The increase was primarily due to an increase in non-deductible executive compensation expenses. For additional information, see Note 11 to the consolidated financial statements contained in Part I - Item 1 of this Form 10-Q, which i s incorporated herein by reference. Properties The COVID-19 pandemic had a significant impact on our work environment, as the vast majority of our team members began working remotely. Because our remote operations and processes proved successful early on, we now pursue a “remote first” strategy to take advantage of the national talent pool and an increased rate of team member satisfaction. While remote work has become the primary experience for most of our team members, we do have team members that, due to their personal preference or the nature of their responsibilities, have continued to work primarily in one of our office properties. Additionally, we have various on-site meetings, events and team building activities for which in-person attendance is encouraged. Therefore, we believe we will always have a need for some amount of office space. As a result of the “remote first” strategy, we have excess space in the two office buildings that we own in Southfield, Michigan and the office space that we lease in Henderson, Nevada. Our Henderson lease, which we will not renew, expires in December 2022. We are currently considering options to further reduce our office space, which could result in the sale of one of our buildings. As there is currently a significant amount of unoccupied office space in Southfield, we believe the market value of our buildings and improvements, land and land improvements, and office furniture and equipment is significantly less than their combined carrying value of $40.2 million. If we were to reclassify one of these buildings as held for sale, we would be required to record an impairment charge to reduce the carrying value of the building held for sale to its estimated market value less costs to sell. 56 Table of Contents Liquidity and Capital Resources We need capital to maintain and grow our business. Our primary sources of capital are cash flows from operating activities, collections of Consumer Loans and borrowings under: (1) a revolving secured line of credit; (2) Warehouse facilities; (3) Term ABS financings; and (4) senior notes. There are various restrictive covenants to which we are subject under each financing arrangement and we were in compliance with those covenants as of June 30, 2022. For information regarding these financings and the covenants included in the related documents, see Note 9 to the consolidated financial statements contained in Part I - Item 1 of this Form 10-Q, which is incorporated herein by reference. On June 16, 2022, we completed a $350.0 million Term ABS financing, which was used to repay outstanding indebtedness and for general corporate purposes. The financing has an expected annualized cost of approximately 5.4% (including the initial purchasers’ fees and other costs), and it will revolve for 24 months, after which it will amortize based upon the cash flows on the contributed Loans. On June 16, 2022, we extended the date on which our $300.0 million Warehouse Facility IV will cease to revolve from November 17, 2023 to May 20, 2025. On June 22, 2022, we extended the maturity of our revolving secured line of credit facility from June 22, 2024 to June 22, 2025. Prior to this amendment, the amount of the facility was set to decrease by $35.0 million on June 22, 2022; however, this amendment increased the amount of the facility by $10.0 million, resulting in a net decrease of $25.0 million, from $435.0 million to $410.0 million. As previously reported, the amount of the facility will further decrease by $25.0 million on June 22, 2023. Additionally, this amendment removed the covenant that required us to maintain consolidated net income of not less than $1 for the two most recently ended fiscal quarters. Cash and cash equivalents as of June 30, 2022 and December 31, 2021 was $4.1 million and $23.3 million, respectively. As of June 30, 2022 and December 31, 2021, we had $1,239.3 million and $1,532.4 million, respectively, in unused and available lines of credit. Our total balance sheet indebtedness increased to $4,792.2 million as of June 30, 2022 from $4,616.3 million as of December 31, 2021, primarily due to stock repurchases. A summary of our scheduled principal debt maturities as of June 30, 2022 is as follows: (In millions) Year Scheduled Principal Debt Maturities (1) Remainder of 2022 $ 1,034.6 2023 1,626.6 2024 1,243.8 2025 508.2 2026 403.1 Over five years — Total $ 4,816.3 (1) The principal maturities of certain financings are estimated based on forecasted collections. Based upon anticipated cash flows, management believes that cash flows from operations and our various financing alternatives will provide sufficient financing for debt maturities and for future operations. Our ability to borrow funds may be impacted by economic and financial market conditions. If the various financing alternatives were to become limited or unavailable to us, our operations and liquidity could be materially and adversely affected. 57 Table of Contents Critical Accounting Estimates Our consolidated financial statements are prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we review our accounting policies, assumptions, estimates and judgments to ensure that our financial statements are presented fairly and in accordance with GAAP. Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021 discusses several critical accounting estimates, which we believe involve a high degree of judgment and complexity. There have been no material changes to the estimates and assumptions associated with these accounting estimates from those discussed in our Annual Report on Form 10-K for the year ended December 31, 2021, except as described below: The COVID-19 pandemic created conditions that increased the level of uncertainty associated with our estimate of the amount and timing of future net cash flows from our Loan portfolio. During the first quarter of 2020, we applied a subjective adjustment to our forecasting model to reflect our best estimate of the future impact of the COVID-19 pandemic on future net cash flows (“COVID forecast adjustment”), which reduced our estimate of future net cash flows by $ 162.2 million. We continued to apply the COVID forecast adjustment through the end of 2021 as it continued to represent our best estimate. During the first quarter of 2022, we determined that we had sufficient Consumer Loan performance experience since the lapse of federal stimulus payments and enhanced unemployment benefits to refine our estimate of future net cash flows. Accordingly, during the first quarter of 2022, we removed the COVID forecast adjustment and enhanced our methodology for forecasting the amount and timing of future net cash flows from our Loan portfolio through the utilization of more recent data and new forecast variables. Under CECL, changes in the amount and timing of forecasted net cash flows are recorded as a provision for credit losses in the period of change. The removal of the COVID forecast adjustment and the implementation of the enhanced forecasting methodology during the first quarter of 2022 impacted forecasted net cash flows and provision for credit losses as follows: (In millions) Increase / (Decrease) in Forecasting Methodology Changes Forecasted Net Cash Flows Provision for Credit Losses Removal of COVID forecast adjustment $ 149.5 $ (118.5) Implementation of enhanced forecasting methodology (53.8) 47.9 Total $ 95.7 $ (70.6) Forward-Looking Statements We make forward-looking statements in this report and may make such statements in future filings with the Securities and Exchange Commission (“SEC”). We may also make forward-looking statements in our press releases or other public or shareholder communications. Our forward-looking statements are subject to risks and uncertainties and include information about our expectations and possible or assumed future results of operations. When we use any of the words “may,” “will,” “should,” “believe,” “expect,” “anticipate,” “assume,” “forecast,” “estimate,” “intend,” “plan,” “target” or similar expressions, we are making forward-looking statements. We claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 for all of our forward-looking statements. These forward-looking statements represent our outlook only as of the date of this report. While we believe that our forward-looking statements are reasonable, actual results could differ materially since the statements are based on our current expectations, which are subject to risks and uncertainties. Factors that might cause such a difference include, but are not limited to, the factors set forth in Item 1A of our Form 10-K for the year ended December 31, 2021 and Item 1A in Part II of this report, other risk factors discussed herein or listed from time to time in our reports filed with the SEC and the following: Industry, Operational and Macroeconomic Risks • The outbreak of COVID-19 has adversely impacted our business, and the continuance of this pandemic, or any future outbreak of any contagious diseases or other public health emergency, could materially and adversely affect our business, financial condition, liquidity and results of operations. • Our inability to accurately forecast and estimate the amount and timing of future collections could have a material adverse effect on results of operations. 58 Table of Contents • Due to competition from traditional financing sources and non-traditional lenders, we may not be able to compete successfully. • Reliance on third parties to administer our ancillary product offerings could adversely affect our business and financial results. • We are dependent on our senior management and the loss of any of these individuals or an inability to hire additional team members could adversely affect our ability to operate profitably. • Our reputation is a key asset to our business, and our business may be affected by how we are perceived in the marketplace. • The concentration of our dealers in several states could adversely affect us. • Reliance on our outsourced business functions could adversely affect our business. • Our ability to hire and retain foreign information technology personnel could be hindered by immigration restrictions. • We may be unable to execute our business strategy due to current economic conditions. • Adverse changes in economic conditions, the automobile or finance industries, or the non-prime consumer market could adversely affect our financial position, liquidity and results of operations, the ability of key vendors that we depend on to supply us with services, and our ability to enter into future financing transactions. • Natural disasters, climate change, acts of war, terrorist attacks and threats or the escalation of military activity in response to these attacks or otherwise may negatively affect our business, financial condition and results of operations. • Governmental or market responses to climate change and related environmental issues could have a material adverse effect on our business. • Consequences of the current conflict between Russia and Ukraine could have a material adverse effect on our business, financial condition, liquidity and results of operations. • A small number of our shareholders have the ability to significantly influence matters requiring shareholder approval and such shareholders have interests which may conflict with the interests of our other security holders. Capital and Liquidity Risks • We may be unable to continue to access or renew funding sources and obtain capital needed to maintain and grow our business. • The terms of our debt limit how we conduct our business. • A violation of the terms of our asset-backed secured financing facilities or revolving secured warehouse facilities could have a material adverse impact on our operations. • Our substantial debt could negatively impact our business, prevent us from satisfying our debt obligations and adversely affect our financial condition. • We may not be able to generate sufficient cash flows to service our outstanding debt and fund operations and may be forced to take other actions to satisfy our obligations under such debt. • Interest rate fluctuations may adversely affect our borrowing costs, profitability and liquidity. • The phaseout of the London Interbank Offered Rate (“LIBOR”), or the replacement of LIBOR with a different reference rate, could result in a material adverse effect on our business. • Reduction in our credit rating could increase the cost of our funding from, and restrict our access to, the capital markets and adversely affect our liquidity, financial condition and results of operations. • We may incur substantially more debt and other liabilities. This could exacerbate further the risks associated with our current debt levels. • The conditions of the U.S. and international capital markets may adversely affect lenders with which we have relationships, causing us to incur additional costs and reducing our sources of liquidity, which may adversely affect our financial position, liquidity and results of operations. Information Technology and Cybersecurity Risks • Our dependence on technology could have a material adverse effect on our business. • Our use of electronic contracts could impact our ability to perfect our ownership or security interest in Consumer Loans. • Failure to properly safeguard confidential consumer and team member information could subject us to liability, decrease our profitability and damage our reputation. Legal and Regulatory Risks • Litigation we are involved in from time to time may adversely affect our financial condition, results of operations and cash flows. • Changes in tax laws and the resolution of uncertain income tax matters could have a material adverse effect on our results of operations and cash flows from operations. • The regulations to which we are or may become subject could result in a material adverse effect on our business. 59 Table of Contents Other factors not currently anticipated by management may also materially and adversely affect our business, financial condition and results of operations. We do not undertake, and expressly disclaim any obligation, to update or alter our statements whether as a result of new information, future events or otherwise, except as required by applicable law. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Refer to our Annual Report on Form 10-K for the year ended December 31, 2021 for a complete discussion of our market risk. There have been no material changes to the market risk information included in our 2021 Annual Report on Form 10-K.