How does the auto lender Credit Acceptance Corp. uses magic bookkeeping to sweep losses under the rug

Yesterday Credit Acceptance reported that profits fell 96% in the first half to $ 12 million under generally accepted accounting principles, or GAAP. But after waving its accounting magic wand, Credit Acceptance showed that “adjusted” profits actually hit $ 330 million.

This adjustment was a provision of $ 381 million for credit losses. In other words, things are going very well with credit acceptance if you ignore the fact that borrowers cannot repay their loans.

There’s a lot of that kind of wishful thinking going around. Companies regularly report “Adjusted EBITDA,” meaning earnings before interest, taxes, depreciation, amortization, and other items they would prefer you to forget. You even see companies reporting ‘EBITDAC’, which they assume the profits would be without Covid-19.

Credit Acceptance’s blind view of reality goes even further. He argues that the rules of the accounting road do not apply to his business.

The company did not immediately respond to a request for comment.

GAAP changed with the implementation in December of the current expected credit loss rule, or CECL (as in Cecil). The rule, which finance officials knew was happening since 2016, requires lenders to record expected losses as soon as they issue a loan, rather than waiting for the losses to manifest, as they previously did. The idea behind the rule is to create more transparency in the financial statements.

Lenders hate the rule, as do their allies in Congress, who complained in a hearing this year that CECL would increase losses during a recession. And it is so. But the rule is the same for everyone, and many companies live with it.

But the acceptance of credit, like Bartleby the scribe, would prefer not to. He argues that the CECL does not apply because it expects to incur loan losses, just not as much as dictated by the accounting rule.

“We believe that CECL deviates from economic reality”, Credit acceptance noted in its publication of the results.

The business needs the businesses it borrows money from to believe it too, because if they don’t, they could be depriving Credit Acceptance of the money it needs to operate. When an analyst in May asked if the company was at risk of breaching covenants with creditors, the CEO said no and essentially claimed the GAAP change that was causing the angst had not happened.

“The Operational GAAP, there are the GAAP under which we operate last year, ”he said, according to a transcription.

Well no. GAAP is not static and companies cannot ignore impractical accounting rules. Well, they can until their lenders stop them.

But here’s the problem: Banks are okay with what credit acceptance does. The company disclosed this month, that Credit Suisse, Wells Fargo and other banks agreed to modify their loans and let Credit Acceptance operate under the old accounting rules.

Why would the banks do this? Well, remember, they have a lot of their own issues with overdue and delinquent loans. It is in their interests that as many as possible be swept under the rug.

So the magic accounting continues. It never ends well.

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