Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
EXHIBIT 99.1
Persons evaluating the Company and its securities should bear in mind
the following considerations:
LIQUIDITY. The Company requires significant operating cash to purchase
Contracts. As a result of the Company's expansion since inception and its
program of securitizing and selling Contracts, the Company's cash requirements
have in the past exceeded cash generated from operations. The Company's primary
operating cash requirements include the funding of (a) purchases of Contracts
pending their pooling and sale, (b) Spread Accounts in connection with sales or
securitizations of Contracts, (c) fees and expenses incurred in connection with
its sales and securitizations of Contracts, (d) tax payments and (e) ongoing
administrative and other operating expenses. Net cash used in operating
activities during the nine-month period ended December 31, 1995, and the years
ended December 31, 1996 and 1997, was $18.5 million, $8.4 million and $26.1
million, respectively. The Company has obtained these funds in three ways: (a)
loans and warehouse financing arrangements, pursuant to which Contracts are
financed on a temporary basis; (b) securitizations or sales of Contracts,
pursuant to which Contracts are sold; and (c) external financing. At December
31, 1997 the Company had cash of approximately $1,745,200.
CASH REQUIREMENTS ASSOCIATED WITH SECURITIZATION TRUSTS. Under the financial
structures the Company has used to date in its twenty-one securitizations,
certain excess servicing cash flows generated by the Contracts are retained in a
Spread Account within the securitization trusts to provide liquidity and credit
enhancement. While the specific terms and mechanics of the Spread Account vary
slightly among transactions, the Company's agreements with Financial Security
Assurance, Inc. ("FSA"), the financial guaranty insurer that has provided credit
enhancements in connection with the Company's securitizations since June 1994,
generally provide that the Company is not entitled to receive any excess
servicing cash flows unless certain Spread Account balances have been attained
and/or the delinquency or losses related to the Contracts in the pool are below
certain predetermined levels. In the event delinquencies and losses on the
Contracts exceed such levels, the terms of the securitization may require
increased Spread Account balances to be accumulated for the particular pool; may
restrict the distribution to the Company of excess cash flows associated with
other pools in which asset-backed securities are insured by FSA; or, in certain
circumstances, may require the transfer of servicing on some or all of the
Contracts in FSA-insured pools to another servicer. The imposition by FSA of any
of these conditions could materially adversely affect the Company's liquidity
and financial condition. In the past, delinquency and loss levels on ten of the
FSA-insured pools have attained levels which temporarily resulted in increased
Spread Account requirements for those pools. As of December 31, 1997, the Spread
Accounts for eight of the Company's 21 securitized pools were at higher than
requisite levels due to delinquency, repossession or net loss performance. Such
Spread Account balances therefore included approximately $7.0 million more
than would have been required at the original requisite levels.
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Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
DEPENDENCE ON WAREHOUSE FINANCING. The Company's primary sources of
financing for its day-to-day operations are its warehouse lines of credit (the
"Warehouse Lines of Credit"), under which the Company borrows against Contracts
held for sale, pending their sale in securitization transactions. The Company
has two Warehouse Lines of Credit, one of which permits maximum borrowings of
$100 million, and the other of which permits maximum borrowings of $150 million.
Both Warehouse Lines of Credit expire in November 1998. The Company expects to
be able to maintain existing warehouse arrangements (or to obtain replacement or
additional financing) as current arrangements expire or become fully utilized;
however, there can be no assurance that such financing will be obtainable on
favorable terms. To the extent that the Company is unable to maintain its
existing Warehouse Lines of Credit or is unable to arrange new warehouse lines
of credit, the Company may have to curtail Contract purchasing activities, which
could have a material adverse effect on the Company's financial condition,
results of operations or liquidity.
DEPENDENCE ON SECURITIZATION PROGRAM. The Company is dependent upon its
ability to continue to pool and sell Contracts in order to generate cash
proceeds for new purchases. Adverse changes in the market for securitized
Contract pools, or a substantial lengthening of the warehousing period, would
burden the Company's financing capabilities, could require the Company to
curtail its purchase of Contracts, and could have a material adverse effect on
the Company. In addition, as a means of reducing the percentage of cash
collateral that the Company would otherwise be required to deposit and maintain
in Spread Accounts, all of the Company's securitizations since June 1994 have
utilized credit enhancement in the form of financial guaranty insurance policies
issued by FSA to achieve "AAA/Aaa" ratings for the asset-backed securities that
have been sold to investors. The Company believes that financial guaranty
insurance policies reduce the costs of securitizations relative to alternative
forms of credit enhancements available to the Company. FSA is not required to
insure Company-sponsored securitizations and there can be no assurance that it
will continue to do so or that future securitizations will be similarly rated.
Similarly, there can be no assurance that any securitization transaction will be
available on terms acceptable to the Company, or at all. The timing of any
securitization transaction is affected by a number of factors beyond the
Company's control, any of which could cause substantial delays, including,
without limitation, market conditions and the approval by all parties of the
terms of the securitization. Any delay in the sale of a pool of Contracts beyond
a quarter-end could reduce the gain on sale recognized in such quarter and could
result in decreased earnings or possible losses for such quarter being reported
by the Company.
RISK OF GENERAL ECONOMIC DOWNTURN. The Company's business is directly
related to sales of new and used automobiles, which are affected by employment
rates, prevailing interest rates and other domestic economic conditions.
Delinquencies, foreclosures and losses generally increase during economic
slowdowns or recessions. Because of the Company's focus on Sub-Prime Borrowers,
the actual rates of delinquencies, repossessions and losses on such Contracts
could be higher under adverse economic conditions than those currently
experienced in the automobile finance industry in general. Any sustained period
of economic slowdown or recession could adversely affect the Company's ability
to sell or securitize pools of Contracts. The timing of any economic changes is
uncertain, and sluggish sales of automobiles and weakness in the economy could
have an adverse effect on the Company's business and that of the Dealers from
which it purchases Contracts.
CREDITWORTHINESS OF BORROWERS. The Company specializes in the purchase, sale
and servicing of Contracts to finance automobile purchases by Sub-Prime
Borrowers, which entail a higher risk of non-performance, higher delinquencies
and higher losses than Contracts with more creditworthy borrowers. While the
Company believes that the underwriting criteria and collection methods it
employs enable it to control the higher risks inherent in Contracts with Sub-
Prime Borrowers, no assurance can be given that such criteria and methods will
afford adequate protection against such risks. Since inception, the Company has
expanded its operations significantly and has rapidly increased its servicing
portfolio. Because there is limited performance data available with respect to
that portion of the Company's servicing portfolio purchased most recently,
historical delinquency and loss statistics are not necessarily indicative of
future performance. The Company has experienced fluctuations in the delinquency
and charge-off performance of its Contracts, including an upward trend for each.
The Company believes, however, that such fluctuations are normal and that the
upward trend is the result of the seasoning of the servicing portfolio. In the
event that portfolios of Contracts sold and serviced by the Company experience
greater defaults, higher delinquencies or higher losses than anticipated, the
Company's earnings could be negatively impacted. In addition, the Company
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Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
bears the entire risk of loss on Contracts it holds for sale. A larger number of
defaults than anticipated could also result in adverse changes in the structure
of the Company's future securitization transactions, such as increased interest
rates on the asset-backed securities issued in those transactions.
CONTRACTS MAY BE ONLY PARTIALLY SECURED. Although the Contracts are each
secured by a lien on the purchased vehicle, a repossession in the event of
default generally does not yield proceeds sufficient to pay all amounts owing
under a Contract. The actual cash value of the vehicle may be less than the
amount financed at inception of the Contract, and also thereafter, because the
amount financed may be as much as 115% of the wholesale book value in the case
of used vehicles or 110% of manufacturer's invoice in the case of new vehicles,
plus sales tax, licensing fees, and any service contract or credit life or
disability policy purchased by the borrower, less the borrower's down payment
and/or trade-in allowance (generally not less than 10% of the vehicle sales
price). In addition, the proceeds available upon resale are reduced by statutory
liens, such as those for repairs, storage, unpaid taxes and unpaid parking
fines, and by the costs incurred in the repossession and resale. Unless the
Contract is sufficiently seasoned that the borrower has substantial equity in
the vehicle, the proceeds of sale are generally insufficient to pay all amounts
owing. For that reason, the Company's collection policies aim to avoid
repossession to the extent possible.
GEOGRAPHIC CONCENTRATION OF BUSINESS. For the year ended December 31, 1997,
the Company purchased 18.1% of its Contracts from Dealers located in California,
and its prospects are dependent, in part, upon economic conditions prevailing in
this state. Such geographic concentration increases the potential impact of
collection disruptions and casualty losses on the financed vehicles which could
result from regional economic or catastrophic events. Although the percentage of
the servicing portfolio purchased from Dealers in California has been declining
as the Company's volume of Contract purchases has increased, at December 31,
1997, 23.9% of the servicing portfolio represents obligations of automobile
purchasers in California. Accordingly, an economic slowdown in California could
result in a decline in the availability of Contracts for purchase by the Company
as well as an increase in delinquencies and repossessions. Such conditions could
have a material adverse effect on the Company's financial condition, results
of operations or liquidity.
POSSIBLE INCREASE IN COST OF FUNDS. The Company's profitability is
determined by, among other things, the difference between the rate of interest
charged on the Contracts purchased by the Company and the pass-through rate of
interest (the "Pass-Through Rate") payable to investors on portfolios of
Contracts sold by the Company. The Contracts purchased by the Company generally
bear the maximum finance charges permitted by applicable state law. The fixed
Pass-Through Rates payable to investors on portfolios of Contracts sold by the
Company are based on interest rates prevailing in the market at the time of
sale. Consequently, increases in market interest rates tend to reduce the
"spread" or margin between Contract finance charges and the Pass-Through Rates
required by investors and, thus, the potential operating profits to the Company
from the purchase, sale and servicing of Contracts. Operating profits expected
to be earned by the Company on portfolios of Contracts previously sold are
insulated from the adverse effects of increasing interest rates because the
Pass-Through Rates on such portfolios were fixed at the time the Contracts were
sold. Any future increases in interest rates would likely increase the Pass-
Through Rates for future portfolios sold and could have a material adverse
effect on the Company's results of operations.
PREPAYMENT AND DEFAULT RISK. Gains from the sale of Contracts in the
Company's 21 securitization transactions have constituted a significant
portion of the net earnings of the Company and are likely to continue to
represent a significant portion of the Company's net earnings. A portion of the
gains are based in part on management's estimates of future prepayment and
default rates and other considerations in light of then-current conditions. If
actual prepayments with respect to Contracts occur more quickly than was
projected at the time such Contracts were sold, as can occur when interest rates
decline, or if default rates are greater than projected at the time such
Contracts were sold, a charge to earnings may be required and would be taken in
the period of adjustment. If actual prepayments occur more slowly or if default
rates are lower than estimated with respect to Contracts sold, total revenue
would exceed previously estimated amounts. Actual default and prepayment
performance, both in the aggregate and as to each securitization trust, has been
materially consistent with management's estimates. No material charges to
earnings have occurred as a result of default and prepayment performance.
However, there can be no assurance that charges to earnings will not occur in
the future as a result of actual default and prepayment performance exceeding
management's estimates.
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Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
COMPETITION. The automobile financing business is highly competitive. The
Company competes with a number of national, local and regional finance
companies. In addition, competitors or potential competitors include other types
of financial services companies, such as commercial banks, savings and loan
associations, leasing companies, credit unions providing retail loan financing
and lease financing for new and used vehicles and captive finance companies
affiliated with major automobile manufacturers such as General Motors Acceptance
Corporation, Ford Motor Credit Corporation, Chrysler Credit Corporation and
Nissan Motors Acceptance Corporation. Many of the Company's competitors and
potential competitors possess substantially greater financial, marketing,
technical, personnel and other resources than the Company. Moreover, the
Company's future profitability will be directly related to the availability and
cost of its capital relative to that of its competitors. The Company's
competitors and potential competitors include far larger, more established
companies that have access to capital markets for unsecured commercial paper and
investment grade rated debt instruments, and to other funding sources which may
be unavailable to the Company. Many of these companies also have long-standing
relationships with Dealers and may provide other financing to Dealers, including
floor plan financing for the Dealers' purchases of automobiles from
manufacturers, which is not offered by the Company. There can be no assurance
that the Company will be able to continue to compete successfully.
MANAGEMENT OF RAPID GROWTH. The Company has experienced rapid growth and
expansion of its business. The Company's ability to support and manage continued
growth is dependent upon, among other things, its ability to hire, train,
supervise and manage the increased personnel. Furthermore, the Company's ability
to manage portfolio delinquency and loss rates is dependent upon the maintenance
of efficient collection procedures, adequate collection staffing, internal
controls, and automated systems. There can be no assurance that the Company's
personnel, procedures, staff, internal controls, or systems will be adequate to
support such growth.
RESTRICTIONS IMPOSED BY THE TERMS OF THE COMPANY'S INDEBTEDNESS. The
Warehouse Lines of Credit and the indentures governing the notes ("1997 Notes")
that the Company issued in April 1997("1997 Indenture") and the notes ("1995
Notes") that the Company issued in December 1995 ("1995 Indenture") contain
covenants limiting, among other things, the nature and amount of additional
indebtedness that the Company may incur. These covenants could limit the
Company's ability to withstand competitive pressures or adverse economic
conditions, make acquisitions or take advantage of business opportunities that
may arise. Failure to comply with these covenants could, as provided in the
Warehouse Lines of Credit, permit the lenders under the Warehouse Lines of
Credit to accelerate payment of the amounts borrowed under the facility or
permit the indenture trustee thereunder to accelerate payment of the 1995 Notes
or the 1997 Notes.
POTENTIAL FOR ADDITIONAL SENIOR INDEBTEDNESS. Under the 1997 Indenture and
the 1995 Indenture, the Company will be permitted to incur substantial
additional senior indebtedness. The potential interest expense associated with
any permitted additional Senior Indebtedness could substantially increase the
Company's fixed charge obligations and could potentially limit the Company's
ability to meet its obligations.
ABILITY TO REPAY NOTES UPON ACCELERATED REDEMPTION. Upon the occurrence of a
Special Redemption Event (certain events or transactions that result in a change
in control of the Company), each holder of the 1997 Notes or the 1995 Notes will
have the right to require that the Company purchase the holder's notes at 100%
of the principal amount plus accrued interest. If a Special Redemption Event
should occur, there can be no assurance that the Company will have available
funds sufficient to pay that purchase price for all of the notes that might be
delivered by holders seeking to exercise such rights. In the event the Company
is required to purchase outstanding notes pursuant to a Special Redemption
Event, the Company expects that it would seek third party financing to the
extent it does not have available funds to meet its purchase obligations.
However, there can be no assurance that the Company would be able to obtain
such financing, and, if obtained, the terms of any such financing may be less
favorable than the terms of the notes.
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Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
LITIGATION. Because of the consumer-oriented nature of the industry in which
the Company operates and the application of certain laws and regulations,
industry participants are regularly named as defendants in class-action
litigation involving alleged violations of Federal and state laws and
regulations and consumer law torts, including fraud. Many of these actions
involve alleged violations of consumer protection laws. A significant judgment
against the Company or within the industry in connection with any such
litigation could have a material adverse effect on the Company's financial
condition and results of operations. Two legal actions in particular are
discussed in the body of this report.
DEPENDENCE ON DEALERS. The Company is dependent upon establishing and
maintaining relationships with unaffiliated Dealers to supply it with Contracts.
As of December 31, 1997 the Company was a party to Dealer Agreements with 3,193
Dealers. During the year ended December 31, 1997, no Dealer accounted for more
than 1.0% of the Contracts purchased by the Company. The Dealer Agreements do
not require Dealers to submit a minimum number of Contracts for purchase by the
Company. The failure of Dealers to submit Contracts that meet the Company's
underwriting criteria would have a material adverse effect on the Company's
financial condition and results of operations.
CONTRACTUAL RECOURSE BY PURCHASERS OF CONTRACTS. Purchasers of Contracts have
recourse against the Company in the event of the Company's breach of its
representations and warranties to the purchaser (relating to the enforceability
and validity of the Contracts) or certain defaults with respect to the
Contracts. In such cases, recourse is limited to requiring the Company to
repurchase the Contracts in question. In the event the Company is required to
repurchase a Contract, the Company will generally have similar recourse against
the Dealer from which it purchased the Contract; however, there can be no
assurance that any Dealer will have the financial resources to satisfy its
repurchase obligations to the Company. Subject to any recourse against Dealers,
the Company will bear any loss on repossession and resale of vehicles financed
under Contracts repurchased by it from investors, which could have a material
adverse effect on the financial condition and results of operations of the
Company.
GOVERNMENT REGULATION. The Company's business is subject to numerous Federal
and state consumer protection laws and regulations, which, among other things:
(i) require the Company to obtain and maintain certain licenses and
qualifications; (ii) limit the interest rates, fees and other charges the
Company is allowed to charge; (iii) limit or prescribe certain other terms of
its Contracts; (iv) require the Company to provide specified disclosures; and
(v) regulate certain servicing and collection practices and define its rights to
repossess and sell collateral. An adverse change in existing laws or
regulations, or in the interpretation thereof, the promulgation of any
additional laws or regulations, the failure to comply with such laws and
regulations or the expansion of the Company's business into jurisdictions with
more stringent requirements could have a material adverse effect on the
Company's financial condition and results of operations.
CONTROL OF THE COMPANY. As of December 31, 1997, Charles E. Bradley, Jr.,
his father, Charles Bradley, Sr., and other members of his family beneficially
owned 5,061,178 shares of outstanding Common Stock. Such shares represent
approximately 33% of the outstanding Common Stock of the Company. As a result of
their ownership of Common Stock, they and the other directors of the Company
collectively are able, as a practical matter, to elect a majority of the
Company's Board of Directors, to cause an increase in the authorized capital or
the dissolution, merger or sale of the assets of the Company, and generally to
direct the affairs of the Company.
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