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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2008
Commission file number: 0-51027
CONSUMER PORTFOLIO SERVICES, INC.
(Exact name of registrant as specified in its charter)
California 33-0459135
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
16355 Laguna Canyon Road, Irvine, California 92618
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, Including Area Code: (949) 753-6800
Former name, former address and former fiscal year, if changed
since last report: N/A
Indicate by check mark whether the registrant (1) filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer a non-accelerated filer or a smaller reporting company. See
definition of "accelerated filer", "large accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer [ ] Accelerated Filer [ X ]
Non-Accelerated Filer [ ] Smaller Reporting Company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of July 31, 2008 the registrant had 19,698,001 common shares outstanding.
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CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
For the Quarterly Period Ended June 30, 2008
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of June 30,
2008 and December 31, 2007......................................... 3
Unaudited Condensed Consolidated Statements of Operations for the
three-month and six-month periods ended June 30, 2008 and 2007 .... 4
Unaudited Condensed Consolidated Statements of Cash Flows for
the six-month periods ended June 30, 2008 and 2007................. 5
Notes to Unaudited Condensed Consolidated Financial Statements..... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 28
Item 4. Controls and Procedures........................................... 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................. 30
Item 1A. Risk factors...................................................... 30
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds....... 31
Item 4. Submission of Matters to a Vote of Security Holders............... 31
Item 6. Exhibits.......................................................... 32
Signatures........................................................ 33
2
Item 1. Financial Statements
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
June 30, December 31,
2008 2007
----------- -----------
ASSETS
Cash and cash equivalents $ 21,799 $ 20,880
Restricted cash and equivalents 177,716 170,341
Finance receivables 1,915,351 2,068,004
Less: Allowance for finance credit losses (88,610) (100,138)
----------- -----------
Finance receivables, net 1,826,741 1,967,866
Furniture and equipment, net 1,319 1,500
Deferred financing costs, net 13,636 15,482
Deferred tax assets, net 58,845 58,835
Accrued interest receivable 20,053 24,099
Other assets 23,708 23,810
----------- -----------
$ 2,143,817 $ 2,282,813
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Accounts payable and accrued expenses $ 24,344 $ 18,391
Warehouse lines of credit 148,052 235,925
Income taxes payable 20,181 17,706
Residual interest financing 86,836 70,000
Securitization trust debt 1,712,164 1,798,302
Senior secured debt, related party 5,693 --
Subordinated renewable notes 28,775 28,134
----------- -----------
2,026,045 2,168,458
COMMITMENTS AND CONTINGENCIES
Shareholders' Equity
Preferred stock, $1 par value;
authorized 5,000,000 shares; none issued -- --
Series A preferred stock, $1 par value;
authorized 5,000,000 shares; none issued -- --
Common stock, no par value; authorized
30,000,000 shares; 19,852,266 and 19,525,042
shares issued and outstanding at June 30, 2008 and
December 31, 2007, respectively 55,030 55,216
Additional paid in capital, warrants 794 794
Retained earnings 64,397 60,794
Accumulated other comprehensive loss (2,449) (2,449)
----------- -----------
117,772 114,355
----------- -----------
$ 2,143,817 $ 2,282,813
=========== ===========
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
3
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
2008 2007 2008 2007
-------- -------- -------- --------
Revenues:
Interest income $ 94,856 $ 89,448 $194,218 $169,938
Servicing fees 280 113 708 395
Other income 3,645 6,239 7,156 11,961
-------- -------- -------- --------
98,781 95,800 202,082 182,294
-------- -------- -------- --------
Expenses:
Employee costs 12,886 11,335 26,368 22,139
General and administrative 7,574 6,082 14,921 12,051
Interest 40,955 32,992 79,989 61,637
Interest, related party -- 722 -- 1,581
Provision for credit losses 30,894 32,670 65,803 62,159
Marketing 2,622 4,705 6,242 8,925
Occupancy 1,043 934 2,039 1,865
Depreciation and amortization 98 123 237 290
-------- -------- -------- --------
96,072 89,563 195,599 170,647
-------- -------- -------- --------
Income before income tax expense 2,709 6,237 6,483 11,647
Income tax expense 1,220 2,749 2,880 4,928
-------- -------- -------- --------
Net income $ 1,489 $ 3,488 $ 3,603 $ 6,719
======== ======== ======== ========
Earnings per share:
Basic $ 0.08 $ 0.16 $ 0.19 $ 0.31
Diluted 0.08 0.15 0.18 0.29
Number of shares used in computing
earnings per share:
Basic 18,830 21,539 19,063 21,533
Diluted 19,411 23,405 19,692 23,562
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
4
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Six Months Ended
June 30,
----------------------
2008 2007
--------- ---------
Cash flows from operating activities:
Net income $ 3,603 $ 6,719
Adjustments to reconcile net income to net cash
provided by operating activities:
Write up on residual asset (125) (3,620)
Amortization of deferred acquisition fees (8,572) (7,002)
Amortization of discount on Class B Notes 5,845 2,218
Depreciation and amortization 237 290
Amortization of deferred financing costs 5,047 4,378
Provision for credit losses 65,803 62,159
Stock-based compensation expense 654 488
Interest income on residual assets (358) (1,686)
Changes in assets and liabilities:
Accrued interest receivable 4,046 (2,694)
Other assets 586 2,814
Tax assets (10) (1,207)
Accounts payable and accrued expenses 4,846 2,029
Tax liabilities 2,474 2,839
--------- ---------
Net cash provided by operating activities 84,076 67,725
--------- ---------
Cash flows from investing activities:
Purchases of finance receivables held for investment (255,924) (676,303)
Proceeds received on finance receivables held for investment 339,818 278,655
Increases in restricted cash and equivalents (7,375) (54,326)
Purchase of furniture and equipment (57) (479)
--------- ---------
Net cash provided by (used in) investing activities 76,462 (452,453)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of securitization trust debt 285,389 709,171
Proceeds from issuance of subordinated renewable notes 2,982 7,271
Proceeds from issuance of senior secured debt, related party 10,000
Payments on subordinated renewable notes (2,341) (1,079)
Net proceeds from warehouse lines of credit (87,872) 6,773
Proceeds (repayment) of residual interest financing debt 16,836 (3,504)
Repayment of securitization trust debt (377,370) (316,750)
Repayment of senior secured debt, related party -- (10,000)
Payment of financing costs (4,602) (7,270)
Repurchase of common stock (2,719) (1,549)
Tax benefit from exercise of stock options -- 167
Exercise of options and warrants 78 720
--------- ---------
Net cash provided by (used in) financing activities (159,619) 383,950
--------- ---------
Increase (decrease) in cash and cash equivalents 919 (778)
Cash and cash equivalents at beginning of period 20,880 14,215
--------- ---------
Cash and cash equivalents at end of period $ 21,799 $ 13,437
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 69,104 $ 55,558
Income taxes $ 416 $ 3,129
Non cash financing activities:
Common stock issued in connection with new senior
secured debt, related party $ 1,801 $ --
Warrants issued in connection with new senior
secured debt, related party $ 1,107 $ --
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
5
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
We were formed in California on March 8, 1991. We specialize in purchasing and
servicing retail automobile installment sale contracts ("automobile contracts"
or "finance receivables") originated by licensed motor vehicle dealers located
throughout the United States ("dealers") in the sale of new and used
automobiles, light trucks and passenger vans. Through our purchases, we provide
indirect financing to dealer customers for borrowers with limited credit
histories, low incomes or past credit problems ("sub-prime customers"). We serve
as an alternative source of financing for dealers, allowing sales to customers
who otherwise might not be able to obtain financing. In addition to purchasing
installment purchase contracts directly from dealers, we have also (i) acquired
installment purchase contracts in three merger and acquisition transactions,
(ii) purchased immaterial amounts of vehicle purchase money loans from
non-affiliated lenders, and (iii) began lending money directly to consumers for
an immaterial amount of vehicle purchase money loans. In this report, we refer
to all of such contracts and loans as "automobile contracts."
BASIS OF PRESENTATION
Our Unaudited Condensed Consolidated Financial Statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America, with the instructions to Form 10-Q and with Article 10 of Regulation
S-X of the Securities and Exchange Commission, and include all adjustments that
are, in our opinion, necessary for a fair presentation of the results for the
interim period presented. All such adjustments are, in our opinion, of a normal
recurring nature. In addition, certain items in prior period financial
statements may have been reclassified for comparability to current period
presentation. Results for the six-month period ended June 30, 2008 are not
necessarily indicative of the operating results to be expected for the full
year.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted from these
Unaudited Condensed Consolidated Financial Statements. These Unaudited Condensed
Consolidated Financial Statements should be read in conjunction with the
Consolidated Financial Statements and Notes to Consolidated Financial Statements
included in our Annual Report on Form 10-K for the year ended December 31, 2007.
OTHER INCOME
Other income consists primarily of gains recognized on our Residual interest in
securitizations, recoveries on previously charged off CPS and MFN contracts,
convenience fees charged to obligors for certain types of payment transaction
methods and fees paid to us by dealers for certain direct mail services we
provide. The gain recognized related to the residual interest was $125,000 and
$3.6 million for the six months ended June 30, 2008 and 2007, respectively. The
recoveries on the charged-off CPS and MFN contracts were $1.2 million and $1.7
million for the six months ended June 30, 2008 and 2007, respectively. The
convenience fees charged to obligors, which can be expected to increase or
decrease in conjunction with increases or decreases in our managed portfolio,
were $2.8 million and $1.4 million for the same periods, respectively. The
direct mail revenues were $2.7 million and $2.6 million for the six months ended
June 30, 2008 and 2007, respectively. In addition, other income for the six
months ended June 30, 2007 included $1.7 million in proceeds from the sale of
previously charged-off receivables to independent third parties. There were no
similar sales of charged-off receivables in 2008.
6
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
STOCK-BASED COMPENSATION
We recognize compensation costs in the financial statements for all share-based
payments granted subsequent to January 1, 2006 based on the grant date fair
value estimated in accordance with the provisions of Statement of Financial
Accounting Standards No. 123(R), "Share-Based Payment, revised 2004" ("SFAS
123R").
For the six months ended June 30, 2008, we recorded stock-based compensation
costs in the amount of $654,000. As of June 30, 2008, unrecognized stock-based
compensation costs to be recognized over future periods equaled $4.3 million.
This amount will be recognized as expense over a weighted-average period of 3.8
years.
The following represents stock option activity for the six months ended June 30,
2008:
Weighted
Weighted Average
Number of Average Remaining
Shares Exercise Contractual
(in thousands) Price Term
------------ -------- ------------
Options outstanding at the beginning of period ... 6,196 $ 4.47 N/A
Granted ....................................... 565 3.18 N/A
Exercised ..................................... (27) 1.50 N/A
Forefeited .................................... (104) 5.59 N/A
------------ -------- ------------
Options outstanding at the end of period ......... 6,630 $ 4.36 6.64 years
============ ======== ============
Options exercisable at the end of period ......... 4,466 $ 3.84 5.91 years
============ ======== ============
At June 30, 2008, the aggregate intrinsic value of in-the-money options
outstanding and exercisable was $10,000. The total intrinsic value of options
exercised was $32,000 and $746,000 for the six months ended June 30, 2008 and
2007, respectively. New shares were issued for all options exercised during the
six-month periods ended June 30, 2008 and 2007. At our annual meeting of
shareholders held on June 4, 2008, the shareholders approved an amendment to our
2006 Long-Term Equity Incentive Plan that increased the number of shares
issuable from 3,000,000 to 5,000,000. There were 2,255,000 shares available for
future stock option grants under existing plans as of June 30, 2008.
We use the Black-Scholes option valuation model to estimate the fair value of
each option on the date of grant, using the assumptions noted in the following
table. The expected term of options granted is computed as the mid-point between
the vesting date and the end of the contractual term. The risk-free rate is
based on U.S. Treasury instruments in effect at the time of grant whose terms
are consistent with the expected term of our stock options. Expected volatility
is based on historical volatility of our stock. The dividend yield is based on
historical experience and the lack of any expected future changes.
Six Months Ended
June 30,
----------------
2008
----------------
Risk-free interest rate ........................... 3.22%
Expected term, in years ........................... 6.0
Expected volatility ............................... 48.92%
Dividend yield .................................... 0%
PURCHASES OF COMPANY STOCK
During the six-month periods ended June 30, 2008 and 2007, we purchased 925,276
and 247,605 shares, respectively, of our common stock, at average prices of
$2.94 and $6.26, respectively.
7
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NEW ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS No. 157"). SFAS No. 157 clarifies the principle that fair value should be
based on the assumptions market participants would use when pricing an asset or
liability and establishes a fair value hierarchy that prioritizes the
information used to develop those assumptions. Under the standard, fair value
measurements would be separately disclosed by level within the fair value
hierarchy. In February 2008, the FASB issued FASB Staff Position (FSP) No.
157-2, "Effective Date of FASB Statement No. 157", to partially defer FASB
Statement No. 157 for nonfinancial assets and nonfinancial liabilities, except
those that are recognized or disclosed at fair value in the financial statements
on a recurring basis. SFAS 157 is effective for us on January 1, 2008, except
for nonfinancial assets and nonfinancial liabilities that are not recognized or
disclosed at fair value on a recurring basis for which our effective date is
January 1, 2009. The adoption of this statement did not have a material effect
on our financial position or results of operations.
In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial
Assets and Financial Liabilities-Including an Amendment of FASB Statement No.
115. SFAS 159 permits an entity to choose to measure many financial instruments
and certain other items at fair value. Most of the provisions of SFAS 159 are
elective, however, the amendment to SFAS 115, Accounting for Certain Investments
in Debt and Equity Securities, applies to all entities with available for sale
or trading securities. SFAS 159 is elective as of the beginning of an entity's
first fiscal year that begins after November 15, 2007. We are currently
assessing this Statement to determine whether or not we would elect to measure
any financial instruments acquired upon adoption of this statement at their fair
value.
RECENT DEVELOPMENTS
UNCERTAINTY OF CAPITAL MARKETS
We are dependent upon the continued availability of warehouse credit facilities
and access to long-term financing through the issuance of asset-backed
securities collateralized by our automobile contracts. Since 1994, we have
completed 48 term securitizations comprising approximately $6.4 billion in
contracts. We conducted four term securitizations in 2006, four in 2007, and one
in 2008. However, since the fourth quarter of 2007, we have observed
unprecedented adverse changes in the market for securitized pools of automobile
contracts. These changes include reduced liquidity, increased financial guaranty
premiums and reduced demand for asset-backed securities, including for
securities carrying a financial guaranty and for securities backed by sub-prime
automobile receivables. We believe that these adverse changes in the capital
markets are primarily the result of widespread defaults of sub-prime mortgages
securing a variety of term securitizations and related financial instruments,
including instruments carrying financial guarantees similar to those we
typically obtain for our own term securitizations.
The terms of our most recent securitization, completed in April 2008, required
substantially greater credit enhancement than recent past securitizations,
including a larger spread account and a greater portion of subordinated bonds.
Greater credit enhancement requirements reduce the amount of cash available to
us, both at inception of the securitization, and over the life of the
transaction. Moreover, the recently completed securitization resulted in
significantly higher costs to us in the form of higher premiums for financial
guaranty insurance, higher interest rates paid on bonds sold by the
securitization trust and greater discounts given to purchasers of such bonds.
Due to current conditions in the capital markets, we believe that any additional
securitization transactions that we may execute during 2008 are likely to be
structured to include similar credit enhancement levels and result in similar
costs to the recently completed transaction.
The adverse changes that have taken place in the market to date have caused us
to curtail our purchases of automobile contracts in order to extend the time
when our warehousing financing capacity would require us to conduct a term
securitization. If the current adverse circumstances that have affected the
capital markets should worsen such that we are precluded from completing a
future securitization of our receivables, we may exhaust the capacity of our
warehouse credit facilities which would cause us to further curtail or cease our
purchases of new automobile contracts. Further adverse changes in the capital
markets might result in our inability to securitize automobile contracts, which
could lead to a material adverse effect on our operations.
8
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Although we believe that such reductions in contract purchases would allow us to
continue operations, such reductions have resulted in a decrease in the size of
our portfolio of automobile contracts. A continuing decrease in portfolio size
could have a material adverse effect on our cash flows and results of
operations. However, continuing cashflows otherwise available to us would be
sufficient to meet our remaining operating needs in the near term.
(2) FINANCE RECEIVABLES
The following table presents the components of Finance Receivables, net of
unearned interest and deferred acquisition fees and originations costs:
June 30, December 31,
2008 2007
----------- -----------
Finance Receivables (In thousands)
Automobile finance receivables, net of unearned interest .... 1,940,013 2,091,892
Less: Unearned acquisition fees and originations costs ... (24,662) (23,888)
----------- -----------
Finance Receivables ...................................... $ 1,915,351 $ 2,068,004
=========== ===========
The following table presents a summary of the activity for the allowance for
credit losses for the six-month periods ended June 30, 2008 and 2007:
June 30, June 30,
2008 2007
--------- ---------
(In thousands)
Balance at beginning of period ....................... $ 100,138 $ 79,380
Provision for credit losses on finance receivables ... 65,803 62,159
Charge offs .......................................... (93,671) (56,339)
Recoveries ........................................... 16,340 10,397
--------- ---------
Balance at end of period ............................. $ 88,610 $ 95,597
========= =========
Excluded from finance receivables are contracts that were previously classified
as finance receivables but were reclassified as other assets because we have
repossessed the vehicle securing the contract. The following table presents a
summary of such repossessed inventory together with the adjustment for losses in
repossessed inventory that is not included in the allowance for credit losses.
This adjustment results in the repossessed inventory being valued at the
estimated fair value less selling costs.
June 30, June 30,
2008 2007
--------- ---------
(In thousands)
Gross balance of repossessions in inventory .............. $ 39,350 $ 24,606
Adjustment for losses on repossessed inventory ........... (26,903) (15,383)
--------- ---------
Net repossessed inventory included in other assets ....... $ 12,447 $ 9,223
========= =========
9
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(3) SECURITIZATION TRUST DEBT
We have completed a number of securitization transactions that are structured as
secured borrowings for financial accounting purposes. The debt issued in these
transactions is shown on our Unaudited Condensed Consolidated Balance Sheets as
"Securitization trust debt," and the components of such debt are summarized in
the following table:
Weighted
Average
Final Receivables Outstanding Outstanding Contractual
Scheduled Pledged at Principal at Principal at Interest Rate
Payment June 30, Initial June 30, December 31, at June 30,
Series Date (1) 2008 Principal 2008 2007 2008
----------- --------------- ------------ ------------ ------------ ------------- ------------
(Dollars in thousands)
CPS 2003-C March 2010 $ 2,699 $ 87,500 $ 2,822 $ 5,683 3.57%
CPS 2003-D October 2010 3,737 75,000 3,758 6,695 3.91%
CPS 2004-A October 2010 5,882 82,094 6,071 9,849 4.32%
CPS 2004-B February 2011 9,521 96,369 9,814 14,937 4.17%
CPS 2004-C April 2011 12,396 100,000 12,644 18,763 4.24%
CPS 2004-D December 2011 18,142 120,000 18,199 25,994 4.44%
CPS 2005-A October 2011 26,276 137,500 24,633 34,154 5.30%
CPS 2005-B February 2012 31,604 130,625 29,674 39,008 4.67%
CPS 2005-C March 2012 54,216 183,300 50,955 67,834 5.14%
CPS 2005-TFC July 2012 17,994 72,525 17,426 24,654 5.76%
CPS 2005-D July 2012 48,132 145,000 47,430 61,857 5.69%
CPS 2006-A November 2012 95,634 245,000 94,292 120,667 5.32%
CPS 2006-B January 2013 117,033 257,500 114,540 144,941 6.30%
CPS 2006-C June 2013 128,848 247,500 126,771 159,308 5.60%
CPS 2006-D August 2013 131,947 220,000 128,958 159,384 5.57%
CPS 2007-A November 2013 197,849 290,000 191,973 233,092 5.55%
CPS 2007-TFC December 2013 65,760 113,293 64,813 84,685 5.79%
CPS 2007-B January 2014 238,345 314,999 232,649 277,878 5.98%
CPS 2007-C May 2014 275,070 327,498 267,988 308,919 6.02%
CPS 2008-A October 1, 2014 293,193 310,359 266,754 n/a 6.63%
------------ ------------ ------------ -------------
$ 1,774,278 $ 3,556,062 $ 1,712,164 $ 1,798,302
============ ============ ============ =============
-----------------
(1) THE FINAL SCHEDULED PAYMENT DATE REPRESENTS FINAL LEGAL MATURITY OF THE
SECURITIZATION TRUST DEBT. SECURITIZATION TRUST DEBT IS EXPECTED TO BECOME
DUE AND TO BE PAID PRIOR TO THOSE DATES, BASED ON AMORTIZATION OF THE
FINANCE RECEIVABLES PLEDGED TO THE TRUSTS. EXPECTED PAYMENTS, WHICH WILL
DEPEND ON THE PERFORMANCE OF SUCH RECEIVABLES, AS TO WHICH THERE CAN BE NO
ASSURANCE, ARE $374.2 MILLION IN 2008, $626.4 MILLION IN 2009, $396.3
MILLION IN 2010, $220.7 MILLION IN 2011, $83.5 MILLION IN 2012 AND $11.1
MILLION IN 2013.
All of the securitization trust debt was sold in private placement transactions
to qualified institutional buyers. The debt was issued through our wholly-owned
bankruptcy remote subsidiaries and is secured by the assets of such
subsidiaries, but not by our other assets. Principal of $1.5 billion, and the
related interest payments, are guaranteed by financial guaranty insurance
policies issued by third party financial institutions.
The terms of the various securitization agreements related to the issuance of
the securitization trust debt and the warehouse credit facilities require that
certain delinquency and credit loss criteria be met with respect to the
collateral pool, and require that we maintain minimum levels of liquidity and
net worth and not exceed maximum leverage levels and maximum financial losses.
In addition, certain securitization and non-securitization related debt contain
cross-default provisions, which would allow certain creditors to declare a
default if a default were declared under a different facility. As of June 30,
2008, we were in compliance with all such financial covenants.
10
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
We are responsible for the administration and collection of the automobile
contracts. The securitization agreements also require certain funds be held in
restricted cash accounts to provide additional collateral for the borrowings or
to be applied to make payments on the securitization trust debt. As of June 30,
2008, restricted cash under the various agreements totaled approximately $177.7
million. Interest expense on the securitization trust debt is composed of the
stated rate of interest plus amortization of additional costs of borrowing.
Additional costs of borrowing include facility fees, insurance and amortization
of deferred financing costs and discounts on notes sold. Deferred financing
costs and discounts on notes sold related to the securitization trust debt are
amortized using a level yield method. Accordingly, the effective cost of
borrowing of the securitization trust debt is greater than the stated rate of
interest.
Our wholly-owned, bankruptcy remote subsidiaries were formed to facilitate the
above asset-backed financing transactions. Similar bankruptcy remote
subsidiaries issue the debt outstanding under our warehouse lines of credit.
Bankruptcy remote refers to a legal structure in which it is expected that the
applicable entity would not be included in any bankruptcy filing by its parent
or affiliates. All of the assets of these subsidiaries have been pledged as
collateral for the related debt. All such transactions, treated as secured
financings for accounting and tax purposes, are treated as sales for all other
purposes, including legal and bankruptcy purposes. None of the assets of these
subsidiaries are available to pay other creditors of ours.
(4) INTEREST INCOME
The following table presents the components of interest income:
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
2008 2007 2008 2007
-------- -------- -------- --------
(In thousands)
Interest on Finance Receivables .... $ 93,732 $ 86,560 $191,474 $163,768
Residual interest income ........... 162 740 359 1,686
Other interest income .............. 962 2,148 2,385 4,484
-------- -------- -------- --------
Net interest income ................ $ 94,856 $ 89,448 $194,218 $169,938
======== ======== ======== ========
11
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(5) EARNINGS PER SHARE
Earnings per share for the six-month periods ended June 30, 2008 and 2007 were
calculated using the weighted average number of shares outstanding for the
related period. The following table reconciles the number of shares used in the
computations of basic and diluted earnings per share for the three-month and
six-month periods ended June 30, 2008 and 2007:
Three Months Ended Six Months Ended
June 30, June 30,
--------------- ---------------
2008 2007 2008 2007
------ ------ ------ ------
(In thousands) (In thousands)
Weighted average number of common shares outstanding during
the period used to compute basic earnings per share ........ 18,830 21,539 19,063 21,533
Incremental common shares attributable to exercise of
outstanding options and warrants ........................... 581 1,866 629 2,029
------ ------ ------ ------
Weighted average number of common shares used to compute
diluted earnings per share ................................. 19,411 23,405 19,692 23,562
====== ====== ====== ======
(6) INCOME TAXES
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN
48"), which clarifies the accounting and disclosure for uncertainty in tax
positions, as defined. FIN 48 seeks to reduce the diversity in practice
associated with certain aspects of the recognition and measurement related to
accounting for income taxes. We are subject to the provisions of FIN 48 as of
January 1, 2007, and have analyzed filing positions in all of the federal and
state jurisdictions. As a result of adoption, we recognized a charge of
approximately $1.1 million to the January 1, 2007 retained earnings balance. As
of the date of adoption and after the effect of recognizing the increase in
liability noted above, our gross unrecognized tax benefits totaled $11.6
million. Included in the balance at January 1, 2007, are $1.3 million of
unrecognized tax benefits, the disallowance of which would not affect the annual
effective income tax rate.
We file numerous consolidated and separate income tax returns in the United
States Federal jurisdiction and in many state jurisdictions. With few
exceptions, we are no longer subject to US Federal income tax examinations for
years before 2003 and are no longer subject to state and local income tax
examinations by tax authorities for years before 2002.
We have subsidiaries in various states that are currently under audit for years
ranging from 1998 through 2005. To date, no material adjustments have been
proposed as a result of these audits.
We recognize potential interest and penalties related to unrecognized tax
benefits in income tax expense. In conjunction with the adoption of FIN 48 on
January 1, 2007, we recognized approximately $230,000 for interest and penalties
which is included as a component of the $11.6 million gross unrecognized tax
benefits noted above. During the six months ended June 30, 2008, we did not
recognize a significant amount of potential interest and penalties. To the
extent interest and penalties are not assessed with respect to uncertain tax
positions, amounts accrued will be reduced and reflected as a reduction of the
overall income tax provision.
We do not anticipate that total unrecognized tax benefits will significantly
change due to the settlement of audits and the expiration of statute of
limitations prior to September 30, 2008.
12
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(7) LEGAL PROCEEDINGS
STANWICH LITIGATION. We were for some time a defendant in a class action (the
"Stanwich Case") brought in the California Superior Court, Los Angeles County.
The original plaintiffs in that case were persons entitled to receive regular
payments (the "Settlement Payments") under out-of-court settlements reached with
third party defendants. Stanwich Financial Services Corp. ("Stanwich"), an
affiliate of our former chairman of the board of directors, is the entity that
was obligated to pay the Settlement Payments. Stanwich had defaulted on its
payment obligations to the plaintiffs and in June 2001 filed for reorganization
under the Bankruptcy Code, in the federal Bankruptcy Court of Connecticut. By
February 2005, we had settled all claims brought against us in the Stanwich
Case.
In November 2001, one of the defendants in the Stanwich Case, Jonathan Pardee,
asserted claims for indemnity against us in a separate action, which is now
pending in federal district court in Rhode Island. We have filed counterclaims
in the Rhode Island federal court against Mr. Pardee, and have filed a separate
action against Mr. Pardee's Rhode Island attorneys, in the same court. Each of
these actions in the court in Rhode Island is stayed, awaiting resolution of an
adversary action brought against Mr. Pardee in the bankruptcy court, which is
hearing the bankruptcy of Stanwich.
We have reached an agreement in principle with the representative of creditors
in the Stanwich bankruptcy to resolve the adversary action. Under the agreement
in principle, we would pay the bankruptcy estate $625,000 and abandon our claims
against the estate, while the estate would abandon its adversary action against
Mr. Pardee. The bankruptcy court has rejected that proposed settlement, and the
representative of creditors has appealed that rejection. If the agreement in
principle were to be approved upon appeal, we would expect that the agreement
would result in (i) limitation of our exposure to Mr. Pardee to no more than
some portion of his attorneys fees incurred and (ii) the stays in Rhode Island
being lifted, causing those cases to become active again. We are unable to
predict whether the ruling of the bankruptcy court will be sustained or reversed
on appeal. There can be no assurance as to the ultimate outcome of these
matters.
The reader should consider that any adverse judgment against us in these cases
for indemnification, in an amount materially in excess of any liability already
recorded in respect thereof, could have a material adverse effect on our
financial position.
OTHER LITIGATION. In December 2006 an individual resident of Ohio, Agborebot
Bate-Eya, filed a purported class counterclaim to a collection lawsuit brought
by SeaWest Financial Corp. ("SeaWest") in Ohio state court. The counterclaim
alleged that a form notice sent by SeaWest to counterplaintiff in December 2000,
and used then and at other times, was not compliant with Ohio law. In August
2007, the counterplaintiff added us as an additional defendant, noting that we
in April 2004 had purchased from SeaWest a number of consumer receivables,
including that of the counterplaintiff. We filed a motion to dismiss the
counterclaim, which has been granted. All claims against us have been dismissed
with prejudice.
We have recorded a liability as of June 30, 2008 that we believe represents a
sufficient allowance for legal contingencies, including those described above.
Any adverse judgment against us, if in an amount materially in excess of the
recorded liability, could have a material adverse effect on our financial
position.
We are routinely involved in various legal proceedings resulting from our
consumer finance activities and practices, both continuing and discontinued. We
believe that there are substantive legal defenses to such claims, and intend to
defend them vigorously. There can be no assurance, however, as to the outcome.
13
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(8) EMPLOYEE BENEFITS
We sponsor the MFN Financial Corporation Benefit Plan (the "Plan"). Plan
benefits were frozen September 30, 2001. The table below sets forth the Plan's
net periodic benefit cost for the three-month and six-month periods ended June
30, 2008 and 2007.
Three Months Ended Six Months Ended
June 30, June 30,
2008 2007 2008 2007
------- ------- ------- -------
(In thousands) (In thousands)
------------------ ------------------
Components of net periodic cost (benefit)
Service cost .................................... $ -- $ -- $ -- $ --
Interest Cost ................................... 236 223 473 446
Expected return on assets ....................... (305) (327) (610) (654)
Amortization of transition (asset)/obligation ... -- (3) -- (5)
Amortization of net (gain) / loss ............... 41 20 82 39
------- ------- ------- -------
Net periodic cost (benefit) .................. $ (28) $ (87) $ (55) $ (174)
======= ======= ======= =======
We did not make any contributions to the Plan during the six-month period ended
June 30, 2008 and we do not anticipate making any contributions for the
remainder of 2008.
(9) COMPREHENSIVE INCOME
The components of comprehensive income are as follows:
Three Months Ended Six Months Ended
June 30, June 30,
(In thousands) (In thousands)
2008 2007 2008 2007
------- ------- ------- -------
Net income ...................................... $ 1,489 3,488 $ 3,603 $ 6,719
Minimum pension liability, net of tax ........... -- -- -- --
------- ------- ------- -------
Comprehensive income ......................... $ 1,489 $ 3,488 $ 3,603 $ 6,719
======= ======= ======= =======
(10) SUBSEQUENT EVENT
In July 2007, we established a combination term and revolving residual credit
facility and used a portion of our initial draw under that facility to repay our
remaining outstanding debt under the December 2006 $35 million residual
facility.
Under the combination term and revolving residual credit facility, we have used
and intend to use eligible residual interests in securitizations as collateral
for floating rate borrowings. The amount that we were able to borrow was
computed using an agreed valuation methodology of the residuals, subject to an
overall maximum principal amount of $120 million, represented by (i) a $60
million Class A-1 variable funding note (the "revolving note"), and (ii) a $60
million Class A-2 term note (the "term note"). The term note was fully drawn in
July 2007 and was due in July 2009. As of June 30, 2008, we had drawn $26.8
million on the revolving note. The facility's revolving feature expired in July
2008. On July 10, 2008 we amended the terms of the combination term and
revolving residual credit facility, (i) eliminating the revolving feature and
increasing the interest rate, (ii) consolidating the amounts then owing on the
Class A-1 note with the Class A-2 note, (iii) establishing an amortization
schedule for principal reductions on the Class A-2 note, and (iv) providing for
14
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
an extension, at our option if certain conditions are met, of the Class A-2 note
maturity from June 2009 to June 2010. In conjunction with the amendment, we
reduced the principal amount outstanding to $70,000,000, by delivering to the
lender (i) warrants valued as being equivalent to 2,500,000 common shares, or
$4,071,429 and (ii) cash of $12,765,244. The warrants represent the right to
purchase 2,500,000 CPS common shares at a nominal exercise price, at any time
prior to July 10, 2018.
On June 30, 2008, we entered into a series of agreements pursuant to which a
lender purchased a $10 million five-year, fixed rate, senior secured note issued
by the Company. The indebtedness is secured by substantially all of the
Company's assets, though not by the assets of the Company's special-purpose
financing subsidiaries. In July 2008, in conjunction with the amendment of the
combination term and revolving residual credit facility as discussed above, the
lender purchased an additional $15 million note with substantially the same
terms as the $10 million note. Pursuant to the June 30, 2008 securities purchase
agreement, we issued to the lender 1,225,000 shares of common stock. In
addition, we issued the lender two warrants: (i) warrants that we refer to as
the FMV Warrants, which, upon the approval of our shareholders, would become
exercisable for up to 1,500,000 shares of our common stock, at a then-exercise
price of $2.573 per share, and (ii) warrants that we refer to as the N Warrants,
exercisable upon the approval of our shareholders for up to 275,000 shares of
our common stock, at a nominal exercise price. Both the FMV Warrants and the N
Warrants are exercisable in whole or in part and at any time up to and including
June 30, 2018, to the extent permitted by applicable law and regulation. We
valued the warrants using the Black-Scholes valuation model and have recorded
their value as a liability on our balance sheet since the terms of the warrants
also include a provision whereby the lender may require us to purchase the
warrants for cash.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We are a specialty finance company engaged in purchasing and servicing new and
used retail automobile contracts originated primarily by franchised automobile
dealerships and, to a lesser extent, by select independent dealers of used
automobiles in the United States. We serve as an alternative source of financing
for dealers, facilitating sales to sub-prime customers, who have limited credit
history, low income or past credit problems and who otherwise might not be able
to obtain financing from traditional sources. In addition to purchasing
installment purchase contracts directly from dealers, we have also (i) acquired
installment purchase contracts in three merger and acquisition transactions
described below, (ii) purchased immaterial amounts of vehicle purchase money
loans from non-affiliated lenders, and (iii) began lending money directly to
consumers for an immaterial amount of vehicle purchase money loans. In this
report, we refer to all of such contracts and loans as "automobile contracts."
We are headquartered in Irvine, California and have three additional
strategically located servicing branches in Virginia, Florida and Illinois.
On March 8, 2002, we acquired MFN Financial Corporation and its subsidiaries in
a merger. On May 20, 2003, we acquired TFC Enterprises, Inc. and its
subsidiaries in a second merger. Each merger was accounted for as a purchase.
MFN Financial Corporation and its subsidiaries and TFC Enterprises, Inc. and its
subsidiaries were engaged in businesses similar to ours: buying automobile
contracts from dealers and servicing those automobile contracts. MFN Financial
Corporation and its subsidiaries ceased acquiring automobile contracts in May
2002; we suspended purchases of automobile contracts under our "TFC programs" in
July 2008.
On April 2, 2004, we purchased a portfolio of automobile contracts and certain
other assets from SeaWest Financial Corporation and its subsidiaries. In
addition, we were named the successor servicer of three term securitization
transactions originally sponsored by SeaWest. We do not intend to offer
financing programs similar to those previously offered by SeaWest.
SECURITIZATION AND WAREHOUSE CREDIT FACILITIES
Throughout the period for which information is presented in this report, we have
purchased automobile contracts with the intention of financing them on a
long-term basis through securitizations, and on an interim basis through our
warehouse credit facilities. All such financings have involved identification of
specific automobile contracts, sale of those automobile contracts (and
associated rights) to one of our special-purpose subsidiaries, and issuance of
asset-backed securities to fund the transactions. Depending on the structure,
these transactions may properly be accounted for under generally accepted
accounting principles as sales of the automobile contracts or as secured
financings.
When structured to be treated as a secured financing for accounting purposes,
the subsidiary is consolidated with us. Accordingly, the sold automobile
contracts and the related debt appear as assets and liabilities, respectively,
on our consolidated balance sheet. We then periodically (i) recognize interest
and fee income on the contracts, (ii) recognize interest expense on the
securities issued in the transaction and (iii) record as expense a provision for
credit losses on the contracts.
Since the third quarter 2003 through June 2008, we have conducted 23 term
securitizations. Of these 23, 18 were quarterly securitizations of automobile
contracts that we purchased from automobile dealers under our regular programs.
In addition, in March 2004 and November 2005, we completed securitizations of
our retained interests in other securitizations that we and our affiliates
previously sponsored. The debt from the March 2004 transaction was repaid in
August 2005 and the debt from the November 2005 transaction was repaid in May
2007. In September 2004, we completed a securitization of automobile contracts
purchased in the SeaWest asset acquisition and under our TFC programs. In
December 2005 and again in May 2007 we completed securitizations that included
automobile contracts purchased under the TFC programs, automobile contracts
purchased under the CPS programs and automobile contracts we repurchased upon
termination of prior securitizations. All such securitizations since the third
quarter of 2003 have been structured as secured financings.
16
UNCERTAINTY OF CAPITAL MARKETS
We are dependent upon the continued availability of warehouse credit facilities
and access to long-term financing through the issuance of asset-backed
securities collateralized by our automobile contracts. Since 1994, we have
completed 48 term securitizations comprising approximately $6.4 billion in
contracts. We conducted four term securitizations in 2006, four in 2007, and one
in 2008. However, since the fourth quarter of 2007, we have observed
unprecedented adverse changes in the market for securitized pools of automobile
contracts. These changes include reduced liquidity, increased financial guaranty
premiums and reduced demand for asset-backed securities, including for
securities carrying a financial guaranty and for securities backed by sub-prime
automobile receivables. We believe that these adverse changes in the capital
markets are primarily the result of widespread defaults of sub-prime mortgages
securing a variety of term securitizations and related financial instruments,
including instruments carrying financial guarantees similar to those we
typically obtain for our own term securitizations.
The terms of our most recent securitization, completed in April 2008, required
substantially greater credit enhancement than recent past securitizations,
including a larger spread account and a greater portion of subordinated bonds.
Greater credit enhancement requirements reduce the amount of cash available to
us, both at inception of the securitization, and over the life of the
transaction. Moreover, the recently completed securitization resulted in
significantly higher costs to us in the form of higher premiums for financial
guaranty insurance, higher interest rates paid on bonds sold by the
securitization trust and greater discounts given to purchasers of such bonds.
Due to current conditions in the capital markets, we believe that any additional
securitization transactions that we may execute during 2008 are likely to be
structured to include similar credit enhancement levels and result in similar
costs to the recently completed transaction.
The adverse changes that have taken place in the market to date have caused us
to curtail our purchases of automobile contracts in order to extend the time
when our warehousing financing capacity would require us to conduct a term
securitization. If the current adverse circumstances that have affected the
capital markets should worsen such that we are precluded from completing a
future securitization of our receivables, we may exhaust the capacity of our
warehouse credit facilities which would cause us to further curtail or cease our
purchases of new automobile contracts. Further adverse changes in the capital
markets might result in our inability to securitize automobile contracts, which
could lead to a material adverse effect on our operations.
Although we believe that such reductions in contract purchases would allow us to
continue operations, such reductions have resulted in a decrease in the size of
our portfolio of automobile contracts. A continuing decrease in portfolio size
could have a material adverse effect on our cash flows and results of
operations. However, continuing cashflows otherwise available to us would be
sufficient to meet our remaining operating needs in the near term.
RESULTS OF OPERATIONS
COMPARISON OF OPERATING RESULTS FOR THE THREE-MONTHS ENDED JUNE 30, 2008 WITH
THE THREE-MONTHS ENDED JUNE 30, 2007
REVENUES. During the three months ended June 30, 2008, revenues were $98.8
million, an increase of $3.0 million, or 3.1%, from the prior year revenue of
$95.8 million. The primary reason for the increase in revenues is an increase in
interest income. Interest income for the three months ended June 30, 2008
increased $5.4 million, or 6.0%, to $94.9 million from $89.5 million in the
prior year. The primary reason for the increase in interest income is the
increase in finance receivables held by consolidated subsidiaries (resulting in
an increase of $7.2 million in interest income). This increase was partially
offset by decreased interest earned on restricted cash balances and a decrease
in interest earned on our residual interest in securitizations.
17
Servicing fees totaling $280,000 in the three months ended June 30, 2008
increased $167,000, or 148.1%, from $113,000 in the prior year. The increase in
servicing fees is the result of recoveries on the SeaWest Third Party portfolio.
Such recoveries have been treated as servicing fees since September 2007; prior
to that time they were applied to an outstanding note obligation of SeaWest to
CPS, in accordance with the terms of the related agreements. We expect servicing
fees generally to decrease as the SeaWest Third Party portfolio and related
recoveries decline.
As of June 30, 2008 and 2007, our managed portfolio owned by consolidated vs.
non-consolidated subsidiaries and other third parties was as follows:
June 30, 2008 June 30, 2007
------------------ ------------------
Amount % Amount %
---------- ----- ---------- -----
TOTAL MANAGED PORTFOLIO ($ in millions)
Owned by Consolidated Subsidiaries ....... $ 1,979.4 100.0% $ 1,889.4 99.4%
Owned by Non-Consolidated Subsidiaries ... -- 0.0% 9.6 0.5%
SeaWest Third Party Portfolio ............ 0.1 0.0% 1.3 0.1%
---------- ----- ---------- -----
Total .................................... $ 1,979.5 100.0% $ 1,900.3 100.0%
========== ===== ========== =====
At June 30, 2008, we were generating income and fees on a managed portfolio with
an outstanding principal balance of $1,979.5 million (this amount includes
$128,000 of automobile contracts securitized by SeaWest, on which we earn only
servicing fees), compared to a managed portfolio with an outstanding principal
balance of $1,900.3 million as of June 30, 2007. At June 30, 2008 and 2007, the
managed portfolio composition was as follows:
June 30, 2008 June 30, 2007
------------------ ------------------
Amount % Amount %
---------- ----- ---------- -----
ORIGINATING ENTITY ($ in millions)
CPS ...................................... $ 1,920.1 97.0% $ 1,834.6 96.5%
TFC ...................................... 59.0 3.0% 62.1 3.3%
MFN ...................................... 0.0 0.0% 0.2 0.0%
SeaWest .................................. 0.3 0.0% 2.1 0.1%
SeaWest Third Party Portfolio ............ 0.1 0.0% 1.3 0.1%
---------- ----- ---------- -----
Total .................................... $ 1,979.5 100.0% $ 1,900.3 100.0%
========== ===== ========== =====
Other income decreased $2.6 million, or 41.6%, to $3.6 million in the three
months ended June 30, 2008 from $6.2 million during the prior year. The year
over year decrease is the result of a variety of factors. In the prior year
period, we sold a portfolio of charged off receivables for a gain of $1.7
million. In addition, prior year other income includes $1.1 million resulting
from an increase in the carrying value of our residual interest in
securitizations. The carrying value was increased primarily as a result of the
underlying receivables having incurred fewer losses than we had previously
estimated, which in turn resulted in actual cash flows exceeding cash flows that
were estimated in our valuation of the residual asset at March 31, 2007. We do
not expect that future cash flows will significantly exceed the estimates we are
currently using for the valuation of our residual interest. In addition,
recoveries on MFN and certain other automobile contracts decreased by $265,000
compared to the 2007 period. Partially offsetting these declines in other
income, in 2008 we experienced increases in convenience fees charged to obligors
for certain transaction types (an increase of $662,000). The level of
convenience fees we earn is closely related to the size of our managed
portfolio. Consequently, increases or decreases in convenience fees will result
from increases or decreases in our managed portfolio.
The adverse changes that have taken place in the market to date have caused us
to curtail our purchases of automobile contracts in order to extend the time
when our warehousing financing capacity would require us to conduct a term
securitization. As a result, our managed portfolio has decreased from $2,126.2
million at December 31, 2007 to $1,979.5 at June 30, 2008. If the adverse
conditions continue and our managed portfolio continues to decline, our revenues
will decline proportionately.
18
EXPENSES. Our operating expenses consist largely of provisions for credit
losses, interest expense, employee costs and general and administrative
expenses. Provisions for credit losses and interest expense are significantly
affected by the volume of automobile contracts we purchased during a period and
by the outstanding balance of finance receivables held by consolidated
subsidiaries. Employee costs and general and administrative expenses are
incurred as applications and automobile contracts are received, processed and
serviced. Factors that affect margins and net income include changes in the
automobile and automobile finance market environments, and macroeconomic factors
such as interest rates and the unemployment level.
Employee costs include base salaries, commissions and bonuses paid to employees,
and certain expenses related to the accounting treatment of outstanding stock
options, and are one of our most significant operating expenses. These costs
(other than those relating to stock options) generally fluctuate with the level
of applications and automobile contracts processed and serviced.
Other operating expenses consist largely of facilities expenses, telephone and
other communication services, credit services, computer services, marketing and
advertising expenses, and depreciation and amortization.
Total operating expenses were $96.1 million for the three months ended June 30,
2008, compared to $89.6 million for the prior year, an increase of $6.5 million,
or 7.3%. The increase is primarily due to an increase in interest expense of
$7.2 million, or 21.5%.
Employee costs increased by 13.7% to $12.9 million during the three months ended
June 30, 2008, representing 13.4% of total operating expenses, from $11.3
million for the prior year, or 12.7% of total operating expenses. During and
through the end of 2007, we gradually increased our number of employees,
generally throughout all areas of the Company, to accommodate greater volumes of
contract purchases and the resulting higher balance of our managed portfolio.
For the three-month period ended June 30, 2008 we averaged 872 employees
compared to 858 employees for the same period of the prior year.
General and administrative expenses increased by 24.5% to $7.6 million and
represented 7.9% of total operating expenses in the three months ending June 30,
2008. General and administrative expenses include costs associated with
purchasing and servicing our portfolio of finance receivables including expenses
for facilities, credit services, telecommunications and marketing.
Interest expense for the three months ended June 30, 2008 increased $7.2
million, or 21.5%, to $41.0 million, compared to $33.7 million in the previous
year. The increase is primarily the result of changes in the amount and
composition of securitization trust debt carried on our consolidated balance
sheet. Interest on securitization trust debt increased by $7.2 million in the
three months ended June 30, 2008 compared to the prior year. We also experienced
increases in residual interest financing interest expenses of $1.6 million. A
portion of the increase in interest expense can also be attributed to a gradual
increase in market interest rates during 2007 during which time new
securitization trust debt was added at fixed rates that were generally higher
than the fixed rates on older securitization trust debt that was fully or
partially repaid. Moreover, due to the securitization market disruption
discussed above, the interest rates and discounts on the securitization trust
debt from our April 2008 securitization transaction were significantly higher
than those on our September 2007 transaction, which also contributed to the
increase. Increases in interest expense for securitization trust debt and
residual interest financing were somewhat offset by a decrease of $333,000 in
interest expense for subordinated debt and a decrease of $1.3 million for
warehouse debt interest expense. The decrease in the warehouse debt interest
expense can be attributed to our lower level of new contract purchases in 2008
as compared to 2007.
At June 30, 2008 we borrowed $10 million in new senior secured debt.
Subsequently, and prior to this filing, we borrowed an additional $15 million in
senior secured debt and amended our existing residual financing indebtedness
resulting in a higher interest rate on that indebtedness. As a result, we can
expect that our interest expense on these components of debt will increase in
future periods although such increases may be somewhat offset by decreases in
our securitization trust debt should our portfolio of managed receivables
continue to decline.
19
Marketing expenses consist primarily of commission-based compensation paid to
our employee marketing representatives and decreased by $2.1 million, or 44.3%,
to $2.6 million, compared to $4.7 million in the previous year. These expenses
represented 2.7% of total operating expenses. The decrease is primarily due to
the decrease in automobile contracts we purchased during the three months ended
June 30, 2008 as compared to the prior year. During the three months ended June
30, 2008, we purchased 5,268 automobile contracts aggregating $79.8 million,
compared to 22,327 automobile contracts aggregating $346.0 million in the prior
year. The adverse changes that have taken place in the securitization market
since the fourth quarter of 2007 have caused us to curtail our purchases of
automobile contracts in order to preserve liquidity.
Occupancy expenses increased slightly by $109,000 or 11.6%, to $1.0 million
compared to $934,000 in the previous year and represented 1.2% of total
operating expenses.
Depreciation and amortization expenses decreased by $25,000, or 20.0%, to
$98,000 from $123,000 in the previous year.
For the three months ended June 30, 2008, we recorded tax expense of $1.2
million or 45.0% of income before income taxes. For the three months ended June
30, 2007, we recorded income taxes of $2.7 million or 44.1% of income before
income taxes. The increased effective tax rate is primarily related to the
impact of 2008 projected permanent differences from various items including
stock based compensation. As of June 30, 2008, we had net deferred tax assets of
$58.8 million.
COMPARISON OF OPERATING RESULTS FOR THE SIX-MONTHS ENDED JUNE 30, 2008 WITH THE
SIX-MONTHS ENDED JUNE 30, 2007
REVENUES. During the six months ended June 30, 2008, revenues were $202.1
million, an increase of $19.8 million, or 10.9%, from the prior year revenue of
$182.3 million. The primary reason for the increase in revenues is an increase
in interest income. Interest income for the six months ended June 30, 2008
increased $24.3 million, or 14.3%, to $194.2 million from $169.9 million in the
prior year. The primary reason for the increase in interest income is the
increase in finance receivables held by consolidated subsidiaries (resulting in
an increase of $27.7 million in interest income). This increase was partially
offset by decreased interest earned on restricted cash balances and a decrease
in interest earned on our residual interest in securitizations.
Servicing fees totaling $708,000 in the six months ended June 30, 2008 increased
$313,000, or 79.3%, from $395,000 in the prior year. The increase in servicing
fees is the result of recoveries on the SeaWest Third Party portfolio. Such
recoveries have been treated as servicing fees since September 2007; prior to
that time they were applied to an outstanding note obligation of SeaWest to CPS,
in accordance with the terms of the related agreements. We expect servicing fees
generally to decrease as the SeaWest Third Party portfolio and related
recoveries decline.
At June 30, 2008, we were generating income and fees on a managed portfolio with
an outstanding principal balance of $1,979.5 million (this amount includes
$128,000 of automobile contracts securitized by SeaWest, on which we earn only
servicing fees), compared to a managed portfolio with an outstanding principal
balance of $1,900.3 million as of June 30, 2007.
Other income decreased $4.8 million, or 40.2%, to $7.2 million in the six months
ended June 30, 2008 from $12.0 million during the prior year. The year over year
decrease is the result of a variety of factors. In the prior year period, we
sold a portfolio of charged off receivables for a gain of $1.7 million. In
addition, prior year other income includes $3.6 million resulting from an
increase in the carrying value of our residual interest in securitizations. The
carrying value was increased primarily as a result of the underlying receivables
having incurred fewer losses than we had previously estimated, which in turn
resulted in actual cash flows exceeding cash flows that were estimated in our
valuation of the residual asset at December 31, 2006. We do not expect that
future cash flows will significantly exceed the estimates we are currently using
for the valuation of our residual interest. In addition, recoveries on MFN and
certain other automobile contracts decreased by $515,000 compared to the 2007
period. Partially offsetting these declines in other income, in 2008 we
experienced increases in convenience fees charged to obligors for certain
transaction types (an increase of $1.4 million). The level of convenience fees
we earn is closely related to the size of our managed portfolio. Consequently,
increases or decreases in convenience fees will result from increases or
decreases in our managed portfolio.
20
The adverse changes that have taken place in the securitization market since the
fourth quarter of 2007 have caused us to curtail our purchases of automobile
contracts in order to preserve liquidity. As a result, our managed portfolio has
decreased from $2,126.2 million at December 31, 2007 to $1,979.5 at June 30,
2008. If the adverse conditions continue and our managed portfolio continues to
decline, our revenues will decline proportionately.
EXPENSES. Our operating expenses consist largely of provisions for credit
losses, interest expense, employee costs and general and administrative
expenses. Provisions for credit losses and interest expense are significantly
affected by the volume of automobile contracts we purchased during a period and
by the outstanding balance of finance receivables held by consolidated
subsidiaries. Employee costs and general and administrative expenses are
incurred as applications and automobile contracts are received, processed and
serviced. Factors that affect margins and net income include changes in the
automobile and automobile finance market environments, and macroeconomic factors
such as interest rates and the unemployment level.
Employee costs include base salaries, commissions and bonuses paid to employees,
and certain expenses related to the accounting treatment of outstanding stock
options, and are one of our most significant operating expenses. These costs
(other than those relating to stock options) generally fluctuate with the level
of applications and automobile contracts processed and serviced.
Other operating expenses consist largely of facilities expenses, telephone and
other communication services, credit services, computer services, marketing and
advertising expenses, and depreciation and amortization.
Total operating expenses were $195.6 million for the six months ended June 30,
2008, compared to $170.6 million for the prior year, an increase of $25.0
million, or 14.6%. The increase is primarily due to an increase in interest
expense of $16.8 million, or 26.5%.
Employee costs increased by 19.1% to $26.4 million during the six months ended
June 30, 2008, representing 13.5% of total operating expenses, from $22.1
million for the prior year, or 13.0% of total operating expenses. The increase
in employee costs is the result of additions to our staff, generally throughout
all areas of the Company, to accommodate greater volumes of contract purchases
and the resulting higher balance of our managed portfolio. For the six-month
period ended June 30, 2008 we averaged 911 employees compared to 835 employees
for the same period of the prior year.
General and administrative expenses increased by 23.8% to $14.9 million and
represented 7.6% of total operating expenses in the six months ending June 30,
2008. General and administrative expenses include costs associated with
purchasing and servicing our portfolio of finance receivables including expenses
for facilities, credit services, telecommunications and marketing.
Interest expense for the six months ended June 30, 2008 increased $16.8 million,
or 26.5%, to $80.0 million, compared to $63.2 million in the previous year. The
increase is primarily the result of changes in the amount and composition of
securitization trust debt carried on our consolidated balance sheet. Interest on
securitization trust debt increased by $13.8 million in the six months ended
June 30, 2008 compared to the prior year. We also experienced increases in
warehouse interest expense and residual interest financing interest expenses of
$710,000 and $3.0 million, respectively. A portion of the increase in interest
expense can also be attributed to a gradual increase in market interest rates
during 2007 during which time new securitization trust debt was added at fixed
rates that were generally higher than the fixed rates on older securitization
trust debt that was fully or partially repaid. Moreover, due to the
securitization market disruption discussed above, the interest rates and
discounts on the securitization trust debt from our April 2008 securitization
transaction were higher than those on our September 2007 transaction, which also
contributed to the increase. Increases in interest expense for securitization
trust debt, warehouse and residual interest financing were somewhat offset by a
decrease of $711,000 in interest expense for subordinated debt.
21
At June 30, 2008 we borrowed $10 million in new senior secured debt.
Subsequently, and prior to this filing, we borrowed an additional $15 million in
senior secured debt and amended our existing residual financing indebtedness
resulting in a higher interest rate on that indebtedness. As a result, we can
expect that our interest expense on these components of debt will increase in
future periods although such increases may be somewhat offset by decreases in
our securitization trust debt should our portfolio of managed receivables
continue to decline.
Marketing expenses consist primarily of commission-based compensation paid to
our employee marketing representatives and decreased by $2.7 million, or 30.1%,
to $6.2 million, compared to $8.9 million in the previous year and represented
3.2% of total operating expenses. The decrease is primarily due to the decrease
in automobile contracts we purchased during the six months ended June 30, 2008
as compared to the prior year. During the six months ended June 30, 2008, we
purchased 17,051 automobile contracts aggregating $255.9 million, compared to
43,897 automobile contracts aggregating $676.3 million in the prior year. The
adverse changes that have taken place in the securitization market since the
fourth quarter of 2007 have caused us to curtail our purchases of automobile
contracts in order to preserve liquidity.
Occupancy expenses increased slightly by $174,000 or 9.3%, to $2.0 million
compared to $1.9 million in the previous year and represented 1.0% of total
operating expenses.
Depreciation and amortization expenses decreased by $53,000, or 18.2%, to
$237,000 from $290,000 in the previous year.
For the six months ended June 30, 2008, we recorded tax expense of $2.9 million
or 44.4% of income before income taxes. For the six months ended June 30, 2007,
we recorded income taxes of $4.9 million or 42.3% of income before income taxes.
The increased effective tax rate is primarily related to the impact of 2008
projected permanent differences from various items including stock based
compensation. As of June 30, 2008, we had net deferred tax assets of $58.8
million.
22
CREDIT EXPERIENCE
Our financial results are dependent on the performance of the automobile
contracts in which we retain an ownership interest. The table below documents
the delinquency, repossession and net credit loss experience of all automobile
contracts that we were servicing (excluding automobile contracts from the
SeaWest Third Party Portfolio) as of the respective dates shown. Credit
experience for CPS, MFN (since the date of the MFN transaction), TFC (since the
date of the TFC transaction) and SeaWest (since the date of the SeaWest
transaction) is shown on a combined basis in the table below.
DELINQUENCY EXPERIENCE (1)
CPS, MFN, TFC AND SEAWEST COMBINED
June 30, 2007 June 30, 2008 December 31, 2007
------------------------ ----------------------- -----------------------
Number of Number of Number of
Contracts Amount Contracts Amount Contracts Amount
---------- ---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Delinquency Experience
Gross servicing portfolio (1) ........................ 162,673 $1,981,134 150,900 $1,903,233 168,260 $2,128,656
Period of delinquency (2)
31-60 days ........................................ 3,950 44,740 3,495 40,267 4,227 48,134
61-90 days ........................................ 2,122 24,408 1,511 17,049 2,370 27,877
91+ days .......................................... 1,203 12,754 909 9,229 2,039 24,888
---------- ---------- ---------- ---------- ---------- ----------
Total delinquencies (2) .............................. 7,275 81,902 5,915 66,545 8,636 100,899
Amount in repossession (3) ........................... 3,410 39,346 2,228 25,716 3,049 33,400
---------- ---------- ---------- ---------- ----------
Total delinquencies and amount in repossession (2) ... 10,685 $ 121,248 8,143 $ 92,261 11,685 $ 134,299
========== ========== ========== ========== ========== ==========
Delinquencies as a percentage of gross servicing
portfolio ............................................ 4.5% 4.1 % 3.9 % 3.5 % 5.1 % 4.7 %
Total delinquencies and amount in repossession as
a percentage of gross servicing portfolio ............ 6.6 % 6.1 % 5.4 % 4.8 % 6.9 % 6.3 %
------------------------------------
(1) ALL AMOUNTS AND PERCENTAGES ARE BASED ON THE AMOUNT REMAINING TO BE REPAID
ON EACH AUTOMOBILE CONTRACT, INCLUDING, FOR PRE-COMPUTED AUTOMOBILE CONTRACTS,
ANY UNEARNED INTEREST. THE INFORMATION IN THE TABLE REPRESENTS THE GROSS
PRINCIPAL AMOUNT OF ALL AUTOMOBILE CONTRACTS PURCHASED BY US, INCLUDING
AUTOMOBILE CONTRACTS SUBSEQUENTLY SOLD BY US IN SECURITIZATION TRANSACTIONS THAT
WE CONTINUE TO SERVICE. THE TABLE DOES NOT INCLUDE AUTOMOBILE CONTRACTS FROM THE
SEAWEST THIRD PARTY PORTFOLIO.
(2) WE CONSIDER AN AUTOMOBILE CONTRACT DELINQUENT WHEN AN OBLIGOR FAILS TO MAKE
AT LEAST 90% OF A CONTRACTUALLY DUE PAYMENT BY THE FOLLOWING DUE DATE, WHICH
DATE MAY HAVE BEEN EXTENDED WITHIN LIMITS SPECIFIED IN THE SERVICING AGREEMENTS.
THE PERIOD OF DELINQUENCY IS BASED ON THE NUMBER OF DAYS PAYMENTS ARE
CONTRACTUALLY PAST DUE. AUTOMOBILE CONTRACTS LESS THAN 31 DAYS DELINQUENT ARE
NOT INCLUDED.
(3) AMOUNT IN REPOSSESSION REPRESENTS FINANCED VEHICLES THAT HAVE BEEN
REPOSSESSED BUT NOT YET LIQUIDATED.
NET CHARGE-OFF EXPERIENCE (1)
CPS, MFN, TFC AND SEAWEST COMBINED
June 30, June 30, December 31,
2008 2007 2007
---------- ---------- ----------
(Dollars in thousands)
Average servicing portfolio outstanding ....... $2,067,917 $1,752,458 $1,905,162
Annualized net charge-offs as a percentage of
average servicing portfolio (2) ............... 6.8 % 4.6 % 5.3 %
-------------------------
(1) ALL AMOUNTS AND PERCENTAGES ARE BASED ON THE PRINCIPAL AMOUNT SCHEDULED TO
BE PAID ON EACH AUTOMOBILE CONTRACT, NET OF UNEARNED INCOME ON PRE-COMPUTED
AUTOMOBILE CONTRACTS. THE INFORMATION IN THE TABLE REPRESENTS ALL AUTOMOBILE
CONTRACTS SERVICED BY US (EXCLUDING AUTOMOBILE CONTRACTS FROM THE SEAWEST THIRD
PARTY PORTFOLIO).
(2) NET CHARGE-OFFS INCLUDE THE REMAINING PRINCIPAL BALANCE, AFTER THE
APPLICATION OF THE NET PROCEEDS FROM THE LIQUIDATION OF THE VEHICLE (EXCLUDING
ACCRUED AND UNPAID INTEREST) AND AMOUNTS COLLECTED SUBSEQUENT TO THE DATE OF
CHARGE-OFF, INCLUDING SOME RECOVERIES WHICH HAVE BEEN CLASSIFIED AS OTHER INCOME
IN THE ACCOMPANYING INTERIM FINANCIAL STATEMENTS. JUNE 30, 2008 AND JUNE 30,
2007 PERCENTAGE REPRESENTS SIX MONTHS ENDED JUNE 30, 2008 AND JUNE 30, 2007
ANNUALIZED. DECEMBER 31, 2007 REPRESENTS 12 MONTHS ENDED DECEMBER 31, 2007.
23
LIQUIDITY AND CAPITAL RESOURCES
Our business requires substantial cash to support our purchases of automobile
contracts and other operating activities. Our primary sources of cash have been
cash flows from operating activities, including proceeds from sales of
automobile contracts, amounts borrowed under various revolving credit facilities
(also sometimes known as warehouse credit facilities), servicing fees on
portfolios of automobile contracts previously sold in securitization
transactions or serviced for third parties, customer payments of principal and
interest on finance receivables, and releases of cash from securitized pools of
automobile contracts in which we have retained a residual ownership interest and
from the spread account associated with such pools. Our primary uses of cash
have been the purchases of automobile contracts, repayment of amounts borrowed
under lines of credit and otherwise, operating expenses such as employee,
interest, occupancy expenses and other general and administrative expenses, the
establishment of spread account and initial overcollateralization, and the
increase of credit enhancement to required levels in securitization
transactions, and income taxes. There can be no assurance that internally
generated cash will be sufficient to meet our cash demands. The sufficiency of
internally generated cash will depend on the performance of securitized pools
(which determines the level of releases from those pools and their related
spread account), the rate of expansion or contraction in our managed portfolio,
and the terms upon which we are able to acquire, sell, and borrow against
automobile contracts.
Net cash provided by operating activities for the six-month period ended June
30, 2008 was $84.1 million compared to net cash provided by operating activities
for the six-month period ended June 30, 2007 of $67.7 million. Cash provided by
operating activities is affected by our increased net earnings before the
significant increase in the provision for credit losses.
Net cash provided by investing activities for the six-month period ended June
30, 2008 was $76.5 million compared to net cash used in investing activities of
452.5 million in the prior year period. Cash flows from investing activities has
primarily related to purchases of automobile contracts less principal
amortization on our consolidated portfolio of automobile contracts. The adverse
changes that have taken place in the securitization market since the fourth
quarter of 2007 have caused us to curtail our purchases of automobile contracts
in order to preserve liquidity.
Net cash used by financing activities for the six months ended June 30, 2008 was
$159.6 million compared to net cash provided by financing activities of $384.0
million in the prior year period. Cash provided by financing activities is
generally related to the issuance of new securitization trust debt. We issued
$285.4 million in new securitization trust debt in the six months ended June 30,
2008 compared to $709.2 million in the prior year period. Cash used in financing
activities also includes the repayment of securitization trust debt of $377.4
million and $316.8 million for the six-month periods ended June 30, 2008 and
2007, respectively.
We purchase automobile contracts from dealers for cash prices approximating
their principal amounts, adjusted for acquisition fees that may either increase
or decrease the automobile contract purchase price. Those automobile contracts
generate cash flow, however, over a period of years. As a result, we have been
dependent on warehouse credit facilities to purchase automobile contracts, and
on the availability of cash from outside sources in order to finance our
continuing operations, as well as to fund the portion of automobile contract
purchase prices not financed under revolving warehouse credit facilities. As of
June 30, 2008, we had $400 million in warehouse credit capacity, in the form of
two $200 million senior facilities. One $200 million senior facility provides
funding for automobile contracts purchased under the TFC programs while both
senior facilities provide funding for automobile contracts purchased under the
CPS programs.
The first of two warehouse facilities mentioned above is provided by Bear,
Stearns International Limited and is structured to allow us to fund a portion of
the purchase price of automobile contracts by drawing against a floating rate
variable funding note issued by our consolidated subsidiary Page Three Funding,
LLC. This facility was established on November 15, 2005, and expires on November
6, 2008, although it is renewable with the mutual agreement of the parties. On
November 8, 2006 the facility was increased from $150 million to $200 million
and the maximum advance rate was increased to 83% from 80% of eligible
contracts, subject to collateral tests and certain other conditions and
covenants. The advance rate is subject to the lender's valuation of the
24
collateral, which in turn is affected by factors such as the credit performance
of our managed portfolio and the terms and conditions of our term
securitizations, including the expected yields required for bonds issued in our
term securitizations, and is currently at less than the maximum advance rate.
Notes under this facility accrue interest at a rate of one-month LIBOR plus
2.50% per annum. At June 30, 2008, $77.2 million was outstanding under this
facility.
The second of two warehouse facilities is provided by UBS Real Estate Securities
Inc. and is similarly structured to allow us to fund a portion of the purchase
price of automobile contracts by drawing against a floating rate variable
funding note issued by our consolidated subsidiary Page Funding LLC. This
facility was entered into on June 30, 2004. On June 29, 2005 the facility was
increased from $100 million to $125 million and further amended to provide for
funding for automobile contracts purchased under the TFC programs, in addition
to our CPS programs. The available credit under the facility was increased again
to $200 million on August 31, 2005. In April 2006, the terms of this facility
were amended to allow advances to us of up to 80% of the principal balance of
automobile contracts that we purchase under our CPS programs, and of up to 70%
of the principal balance of automobile contracts that we purchase under our TFC
programs, in all events subject to collateral tests and certain other conditions
and covenants. On June 30, 2006, the terms of this facility were amended to
allow advances to us of up to 83% of the principal balance of automobile
contracts that we purchase under our CPS programs, in all events subject to
collateral tests and certain other conditions and covenants. The advance rate is
subject to the lender's valuation of the collateral which, in turn, is affected
by factors such as the credit performance of our managed portfolio and the terms
and conditions of our term securitizations, including the expected yields for
bonds issued in our term securitizations, and is currently at less than the
maximum advance rate. Notes under this facility accrue interest at a rate of
one-month LIBOR plus 2.00% per annum. The facility expires on September 30,
2008, unless renewed by us and the lender before that time. At June 30, 2008,
$70.9 million was outstanding under this facility.
The balance under these warehouse facilities generally will increase as we
purchase additional automobile contracts, until we effect a securitization
utilizing automobile contracts pledged to the warehouse facilities. Proceeds
from the securitization are then used to pay down the outstanding balance of the
warehouse facilities.
The acquisition of automobile contracts for subsequent sale in securitization
transactions, and the need to fund the spread accounts and initial
overcollateralization, if any, and increase credit enhancement levels when those
transactions take place, results in a continuing need for capital. The amount of
capital required is most heavily dependent on the rate of our automobile
contract purchases, the advance rate on the warehouse facilities, the required
level of initial credit enhancement in securitizations, and the extent to which
the previously established trusts and their related spread account either
release cash to us or capture cash from collections on securitized automobile
contracts. We are limited in our ability to purchase automobile contracts by our
available cash and the capacity of our warehouse facilities. As of June 30,
2008, we had unrestricted cash on hand of $21.8 million and available capacity
from our warehouse credit facilities of $251.9 million, subject to the
availability of suitable automobile contracts to serve as collateral and of
sufficient cash to fund the portion of such automobile contracts purchase price
not advanced under the warehouse facilities. Our plans to manage our liquidity
include the completion of additional term securitizations that may result in
additional unrestricted cash through repayment of the warehouse facilities, and
matching our levels of automobile contract purchases to our availability of
cash. There can be no assurance that we will be able to complete term
securitizations on favorable economic terms or that we will be able to complete
term securitizations at all. If we were unable to complete such securitizations,
interest income and other portfolio related income would decrease.
Our primary means of ensuring that our cash demands do not exceed our cash
resources is to match our levels of automobile contract purchases to our
availability of cash. Our ability to adjust the quantity of automobile contracts
that we purchase and securitize will be subject to general competitive
conditions and the continued availability of warehouse credit facilities. There
can be no assurance that the desired level of automobile contract acquisition
can be maintained or increased. While the specific terms of our securitization
transactions vary, our securitization agreements generally provide that we will
receive excess cash flows only if the amount of credit enhancement has reached
specified levels and/or the delinquency, defaults or net losses related to the
automobile contracts in the pool are below certain predetermined levels. In the
25
event delinquencies, defaults or net losses on the automobile contracts exceed
such levels, the terms of the securitization: (i) may require increased credit
enhancement to be accumulated for the particular pool; (ii) may restrict the
distribution to us of excess cash flows associated with other pools; or (iii) in
certain circumstances, may permit the note insurers to require the transfer of
servicing on some or all of the automobile contracts to another servicer. There
can be no assurance that collections from the related Trusts will continue to
generate sufficient cash.
In November 2005, we completed a securitization in which a wholly-owned
bankruptcy remote consolidated subsidiary of ours issued $45.8 million of
asset-backed notes secured by its retained interest in ten term securitization
transactions. At December 31, 2006 there was $19.6 million outstanding on this
facility and in May 2007 the notes were fully repaid. In December 2006 we
entered into a $35 million residual credit facility that was secured by our
retained interests in additional term securitizations. At December 31, 2006,
there was $12.2 million outstanding under this facility. In July 2007, we
established a combination term and revolving residual credit facility and used a
portion of our initial draw under that facility to repay our remaining
outstanding debt under the December 2006 $35 million residual facility.
Under the combination term and revolving residual credit facility, we have used
and intend to use eligible residual interests in securitizations as collateral
for floating rate borrowings. The amount that were able to borrow was computed
using an agreed valuation methodology of the residuals, subject to an overall
maximum principal amount of $120 million, represented by (i) a $60 million Class
A-1 variable funding note (the "revolving note"), and (ii) a $60 million Class
A-2 term note (the "term note"). The term note was fully drawn in July 2007 and
was due in July 2009. As of June 30, 2008, we had drawn $26.8 million on the
revolving note. The facility's revolving feature expired in July 2008. On July
10, 2008 we amended the terms of the combination term and revolving residual
credit facility, (i) eliminating the revolving feature and increasing the
interest rate, (ii) consolidating the amounts then owing on the Class A-1 note
with the Class A-2 note, (iii) establishing an amortization schedule for
principal reductions on the Class A-2 note, and (iv) providing for an extension,
at our option if certain conditions are met, of the Class A-2 note maturity from
June 2009 to June 2010. At the time of the amendment the aggregate indebtedness
under this facility was $70.0 million.
On June 30, 2008, we entered into a series of agreements pursuant to which a
lender purchased a $10 million five-year, fixed rate, senior secured note issued
by the Company. The indebtedness is secured by substantially all of the
Company's assets, though not by the assets of the Company's special-purpose
financing subsidiaries. In conjunction with the amendment of the combination
term and revolving residual credit facility as discussed above, the lender
purchased an additional $15 million note with substantially the same terms as
the $10 million note.
The terms of the various securitization agreements related to the issuance of
the securitization trust debt and the warehouse credit facilities require that
certain delinquency and credit loss criteria be met with respect to the
collateral pool, and require that we maintain minimum levels of liquidity and
net worth and not exceed maximum leverage levels and maximum financial losses.
In addition, certain securitization and non-securitization related debt contain
cross-default provisions, which would allow certain creditors to declare a
default if a default were declared under a different facility. As of June 30,
2008, we were in compliance with all such financial covenants.
The securitization agreements of our term securitization transactions are
terminable by the note insurers in the event of certain defaults by us and under
certain other circumstances. Similar termination rights are held by the lenders
in the warehouse credit facilities. Were a note insurer (or the lenders in such
warehouse facilities) in the future to exercise its option to terminate the
securitization agreements, such a termination would have a material adverse
effect on our liquidity and results of operations. We continue to receive
servicer extensions on a monthly and/or quarterly basis, pursuant to the
securitization agreements.
26
CRITICAL ACCOUNTING POLICIES
(a) ALLOWANCE FOR FINANCE CREDIT LOSSES
In order to estimate an appropriate allowance for losses incurred on finance
receivables held on our Unaudited Condensed Consolidated Balance Sheet, we use a
loss allowance methodology commonly referred to as "static pooling," which
stratifies our finance receivable portfolio into separately identified pools.
Using analytical and formula-driven techniques, we estimate an allowance for
finance credit losses, which management believes is adequate for probable credit
losses that can be reasonably estimated in our portfolio of finance receivable
automobile contracts. Provision for losses is charged to our Unaudited
Consolidated Statement of Operations. Net losses incurred on finance receivables
are charged to the allowance. Management evaluates the adequacy of the allowance
by examining current delinquencies, the characteristics of the portfolio and the
value of the underlying collateral. As conditions change, our level of
provisioning and/or allowance may change as well.
(b) CONTRACT ACQUISITION FEES AND ORIGINATIONS COSTS
Upon purchase of a contract from a dealer, we generally charge or advance the
dealer an acquisition fee. For contracts securitized in pools which were
structured as sales for financial accounting purposes, the acquisition fees
associated with contract purchases were deferred until the contracts were
securitized, at which time the deferred acquisition fees were recognized as a
component of the gain on sale.
For contracts purchased and securitized in pools which are structured as secured
financings for financial accounting purposes, dealer acquisition fees and
deferred originations costs are reduced against the carrying value of finance
receivables and are accreted into earnings as an adjustment to the yield over
the estimated life of the contract using the interest method.
(c) INCOME TAXES
We and our subsidiaries file consolidated federal income and combined state
franchise tax returns. We utilize the asset and liability method of accounting
for income taxes, under which deferred income taxes are recognized for the
future tax consequences attributable to the differences between the financial
statement values of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred
taxes of a change in tax rates is recognized in income in the period that
includes the enactment date. A valuation allowance is recorded against that
portion of the deferred tax asset whose utilization in future period is not more
than likely.
In determining the possible realization of deferred tax assets, future taxable
income from the following sources are considered: (a) the reversal of taxable
temporary differences; (b) future operations exclusive of reversing temporary
differences; and (c) tax planning strategies that, if necessary, would be
implemented to accelerate taxable income into a period in which net operating
losses might otherwise expire.
(d) STOCK-BASED COMPENSATION
We recognize compensation costs in the financial statements for all share-based
payments granted subsequent to December 31, 2005 based on the grant date fair
value estimated in accordance with the provisions of Statement of Financial
Accounting Standards No. 123(R), "Share-Based Payment, revised 2004" ("SFAS
123R").
In December 2005, the Compensation Committee of the Board of Directors approved
accelerated vesting of all the outstanding stock options issued by us. Options
to purchase 2,113,998 shares of our common stock, which would otherwise have
vested from time to time through 2010, became immediately exercisable as a
result of the acceleration of vesting. The decision to accelerate the vesting of
the options was made primarily to reduce non-cash compensation expenses that
would have been recorded in our income statement in future period upon the
adoption of Financial Accounting Standards Board Statement No. 123(R) in January
2006.
27
For the six months ended June 30, 2008, we recorded $654,079 in stock-based
compensation costs, resulting from grants of options during the period and
vesting of previously granted options. As of June 30, 2008, there were $4.3
million in unrecognized stock-based compensation costs to be recognized over
future periods.
FORWARD LOOKING STATEMENTS
This report on Form 10-Q includes certain "forward-looking statements."
Forward-looking statements may be identified by the use of words such as
"anticipates," "expects," "plans," "estimates," or words of like meaning. Our
provision for credit losses is a forward-looking statement, as it is dependent
on our estimates as to future chargeoffs and recovery rates. Factors that could
affect charge-offs and recovery rates include changes in the general economic
climate, which could affect the willingness or ability of obligors to pay
pursuant to the terms of automobile contracts, changes in laws respecting
consumer finance, which could affect our ability to enforce rights under
automobile contracts, and changes in the market for used vehicles, which could
affect the levels of recoveries upon sale of repossessed vehicles. Factors that
could affect our revenues in the current year include the levels of cash
releases from existing pools of automobile contracts, which would affect our
ability to purchase automobile contracts, the terms on which we are able to
finance such purchases, the willingness of dealers to sell automobile contracts
to us on the terms that we offer, and the terms on which we are able to complete
term securitizations once automobile contracts are acquired. Factors that could
affect our expenses in the current year include competitive conditions in the
market for qualified personnel and interest rates (which affect the rates that
we pay on notes issued in our securitizations). The statements concerning our
structuring future securitization transactions as secured financings and the
effects of such structures on financial items and on our future profitability
also are forward-looking statements. Any change to the structure of our
securitization transaction could cause such forward-looking statements not to be
accurate. Both the amount of the effect of the change in structure on our
profitability and the duration of the period in which our profitability would be
affected by the change in securitization structure are estimates. The accuracy
of such estimates will be affected by the rate at which we purchase automobile
contracts, any changes in that rate, the credit performance of such automobile
contracts, the financial terms of future securitizations, any changes in such
terms over time, and other factors that generally affect our profitability.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
We are subject to interest rate risk during the period between when automobile
contracts are purchased from dealers and when such automobile contracts become
part of a term securitization. Specifically, the interest rates on the warehouse
facilities are adjustable while the interest rates on the automobile contracts
are fixed. Historically, our term securitization facilities have had fixed rates
of interest. To mitigate some of this risk, we have in the past structured
certain of our securitization transactions to include pre-funding structures, in
which the amount of notes issued exceeds the amount of automobile contracts
initially sold to the trusts. In pre-funding, the proceeds from the pre-funded
portion are held in an escrow account until we sell the additional automobile
contracts to the trust in amounts up to the balance of the pre-funded escrow
account. In pre-funded securitizations, we lock in the borrowing costs with
respect to the automobile contracts it subsequently delivers to the trust.
However, we incur an expense in pre-funded securitizations equal to the
difference between the money market yields earned on the proceeds held in escrow
prior to subsequent delivery of automobile contracts and the interest rate paid
on the notes outstanding, as to the amount of which there can be no assurance.
We have historically mitigated, but not eliminated, interest rate risk by
generally holding such contracts for less than four months before obtaining
permanent fixed rate financing. The reader should note that extraordinary events
in the market for securitized receivables have materially increased the cost of
obtaining permanent financing through securitization. To minimize the extent to
which we incur such increased costs, we have chosen to accept increased interest
rate risk, and we are holding fixed rate automobile contracts in floating rate
warehouse credit facilities beyond four months, approaching the 180-day maximums
that apply to each of our two warehouse credit facilities.
28
ITEM 4. CONTROLS AND PROCEDURES
We maintain a system of internal controls and procedures designed to provide
reasonable assurance as to the reliability of our published financial statements
and other disclosures included in this report. As of the end of the period
covered by this report, we evaluated the effectiveness of the design and
operation of such disclosure controls and procedures. Based upon that
evaluation, the principal executive officer (Charles E. Bradley, Jr.) and the
principal financial officer (Jeffrey P. Fritz) concluded that the disclosure
controls and procedures are effective in recording, processing, summarizing and
reporting, on a timely basis, material information relating to us that is
required to be included in our reports filed under the Securities Exchange Act
of 1934. There have been no significant changes in our internal controls over
financial reporting during our most recently completed fiscal quarter that
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
29
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information provided under the caption "Legal Proceedings" in our Annual
Report on Form 10-K for the year ended December 31, 2007, is incorporated herein
by reference.
Such information included a reference to an individual resident of Ohio,
Agborebot Bate-Eya, having filed against us a purported class counterclaim to a
collection lawsuit. The claims against us have since been dismissed with
prejudice.
ITEM 1A. RISK FACTORS
We remind the reader that risk factors are set forth in Item 1A of our report on
Form 10-K, filed with the U.S. Securities and Exchange Commission on March 9,
2007. Material changes from such risk factors as previously disclosed are set
forth below.
One of the risk factors discussed in our annual report on Form 10-K advised that
our financial and operational performance depends upon a number of factors, many
of which are beyond our control. The reader should note that among such factors
is the ability to execute securitization transactions on acceptable terms, as to
which there can be no assurance.
Another of the risk factors discussed in our annual report on Form 10-K noted
that we are dependent on warehouse financing facilities, pointed out that the
lender in one of our two warehouse financing facilities is an affiliate of Bear
Stearns, and noted that liquidity issues or changes in business strategy on the
part of that lender could affect whether that lender may continue to do business
with us. Subsequent to filing of our annual report, Bear Stearns has been
acquired by JPMorgan Chase. We cannot predict whether JPMorgan Chase will agree
to a renewal of that warehouse facility, which will expire in November 2008
unless earlier renewed or terminated upon the occurrence of certain events, nor
the terms on which any renewal may be available.
The same risk factor included in our annual report on Form 10-K described the
issuance of subordinated debt under each of our two warehouse credit facilities,
noted that the obligation of subordinated lenders to purchase such debt was to
expire by its terms on January 15, 2008, noted that we had entered into a series
of short-term extensions, and warned that there could be no assurance as to our
ability to come to terms regarding further extensions. In April 2008, we paid
all outstanding subordinated debt issued under such warehouse facilities. We
were not able to come to terms that would allow us to continue to issue
subordinated debt under the warehouse facilities, and we no longer have the
ability to issue subordinated debt under either warehouse credit facility.
Another of the risk factors discussed in our annual report on Form 10-K noted
that we are subject to interest rate risk related to our holding fixed rate
automobile contracts, from the time that we acquire such contracts to the time
that we obtain fixed rate permanent financing for such contracts, historically
in securitizations. We stated there that we have mitigated, but not eliminated,
that interest rate risk by generally holding such contracts for less than four
months before obtaining permanent fixed rate financing. The reader should note
that extraordinary events in the market for securitized receivables have
materially increased the cost of obtaining permanent financing through
securitization. To minimize the extent to which we incur such increased costs,
we have chosen to accept increased interest rate risk, and we are holding fixed
rate automobile contracts in floating rate warehouse credit facilities beyond
four months, approaching the 180-day maximums that apply to each of our two
warehouse credit facilities.
30
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the three months ended June 30, 2008, we purchased a total of 411,038
shares of our common stock, as described in the following table:
ISSUER PURCHASES OF EQUITY SECURITIES
Total Number of Approximate Dollar
Total Shares Purchased as Value of Shares that
Number of Average Part of Publicly May Yet be Purchased
Shares Price Paid Announced Plans or Under the Plans or
Period(1) Purchased per Share Programs(2) Programs
-------------------------------------- -------- ---------------- --------------------
April 2008 .............. 137,539 $ 2.98 137,539 $ 4,071,771
May 2008 ................ 140,136 2.95 140,136 3,657,953
June 2008 ............... 133,363 2.82 133,363 3,282,403
---------- -------- ----------------
Total ................... 411,038 $ 2.92 411,038 --
========== ======== ================
--------------------
(1) EACH MONTHLY PERIOD IS THE CALENDAR MONTH.
(2) OUR BOARD OF DIRECTORS IN JANUARY 2008 AUTHORIZED THE PURCHASE OF UP TO AN
ADDITIONAL $5 MILLION OF OUR OUTSTANDING SECURITIES.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our annual meeting of shareholders was held on June 4, 2008. At the meeting,
each of the eight nominees to the Board of Directors was elected for a one-year
term by the shareholders, with votes cast as follows:
NOMINEE VOTES FOR VOTES WITHHELD
------- --------- --------------
Charles E. Bradley, Jr. 15,173,753 741,661
Chris A. Adams 14,807,737 1,107,677
E. Bruce Fredrikson 15,170,993 744,421
Brian J. Rayhill 14,807,737 1,107,677
William B. Roberts 15,014,649 900,765
John C. Warner 15,160,283 755,131
Gregory S. Washer 14,650,158 1,265,256
Daniel S. Wood 15,014,899 900,515
The shareholders also approved the three other proposals placed before the
annual meeting. Those proposals were (i) to ratify the appointment of McGladrey
& Pullen LLP as independent auditors of the Company for the fiscal year ending
December 31, 2008, (ii) to approve an amendment to our 2006 Long-Term Equity
Incentive Plan that increased by from 3,000,000 to 5,000,000 the number of
shares of common stock that may be made the subject of plan awards, and (iii) to
approve the material terms of the Company's Executive Management Bonus Plan,
including an amendment that increased the maximum bonuses that may be paid under
such Plan. Votes on the proposals were cast as follows:
31
Ratification of Amendment of our 2006 Approval of the material terms
Selection of Long-Term Equity of the Company's Executive
Independent Auditors Incentive Plan Management Bonus Plan
----------------------- ---------------------- ------------------------------
For 15,678,953 5,221,652 14,683,074
Against 54,640 3,874,799 1,048,537
Abstain 181,821 142,882 183,800
Broker Non-votes 0 6,676,081 0
ITEM 6. EXHIBITS
The Exhibits listed below are filed with this report.
4.14 Instruments defining the rights of holders of long-term debt of
certain consolidated subsidiaries of the registrant are omitted
pursuant to the exclusion set forth in subdivisions (b)(iv)(iii)(A)
and (b)(v) of Item 601 of Regulation S-K (17 CFR 229.601). The
registrant agrees to provide copies of such instruments to the United
States Securities and Exchange Commission upon request.
4.27 Indenture dated as of March 1, 2008, respecting notes issued by CPS
Auto Receivables Trust 2008-A (Incorporated by reference to exhibit
4.27 to Form 8-K filed by the registrant on April 15, 2008)
4.28 Sale and Servicing Agreement dated as of March 1, 2008, re CPS Auto
Receivables Trust 2008-A (Incorporated by reference to exhibit 4.28
to Form 8-K filed by the registrant on April 15, 2008)
10.15 Securities Purchase Agreement between the registrant and Levine
Leichtman Capital Partners IV, L. P. ("LLCP"), relating to the sale
of an aggregate of $25 million of Notes. (Incorporated by reference
to exhibit 99.2 to Schedule 13D filed by LLCP on July 10, 2008)
10.15.1 Am. No. 1 dated July 10, 2008 to Securities Purchase Agreement dated
June 30, 2008 between the registrant and LLCP
10.16 Registration Rights Agreement between the registrant and LLCP.
(Incorporated by reference to exhibit 99.6 to Schedule 13D filed by
LLCP on July 10, 2008)
10.17 Investor Rights Agreement between the registrant and LLCP.
(Incorporated by reference to exhibit 99.7 to Schedule 13D filed by
LLCP on July 10, 2008)
10.18 FMV Warrant dated June 30, 2008, issued to LLCP. (Incorporated by
reference to the FMV warrant appearing as pages A-1 through A-13 of
the preliminary proxy statement filed by the registrant on July 28,
2008.)
10.19 N Warrant dated June 30, 2008, issued to LLCP. (Incorporated by
reference to the FMV warrant appearing as pages B-1 through B-13 of
the preliminary proxy statement filed by the registrant on July 28,
2008.)
10.20 Amended and Restated Note Purchase Agreement dated July 10, 2008
among the registrant, its subsidiary Folio Funding II, LLC, and
Citigroup Financial Products Inc.
10.21 Amended and Restated Indenture dated July 10, 2008 among Folio
Funding II, LLC, Citigroup Financial Products Inc. and Wells Fargo
Bank, N.A.
10.22 Performance Guaranty dated July 10, 2008 issued by the registrant in
favor of Citigroup Financial Products Inc.
10.23 Warrant dated July 10, 2008, issued to Citigroup Global Markets Inc.
31.1 Rule 13a-14(a) Certification of the Chief Executive Officer of the
registrant.
31.2 Rule 13a-14(a) Certification of the Chief Financial Officer of the
registrant.
32 Section 1350 Certifications.*
* These Certifications shall not be deemed "filed" for purposes of
Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise
subject to the liability of that section. These Certifications shall not be
deemed to be incorporated by reference into any filing under the Securities
Act of 1933, as amended, or the Exchange Act, except to the extent that the
registration statement specifically states that such Certifications are
incorporated therein.
32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
CONSUMER PORTFOLIO SERVICES, INC.
(Registrant)
Date: August 8, 2008
By: /s/ CHARLES E. BRADLEY, JR.
-----------------------------------------
Charles E. Bradley, Jr.
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(Principal Executive Officer)
Date: August 8, 2008
By: /s/ JEFFREY P. FRITZ
-----------------------------------------
Jeffrey P. Fritz
SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
(Principal Financial Officer)
33