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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 SEPTEMBER 30, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________.
COMMISSION FILE NUMBER: 1-11416
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: (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 an accelerated filer (as defined by Rule 12b-2 of the Exchange
Act). Yes [ ] No [X]
As of October 26, 2005 the registrant had 21,725,510 common shares outstanding.
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CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2005 and
December 31, 2004............................................................................ 3
Unaudited Condensed Consolidated Statements of Operations for the three-month and
nine-month periods ended September 30, 2005 and 2004 ........................................ 4
Unaudited Condensed Consolidated Statements of Cash Flows for the nine-month
periods ended September 30, 2005 and 2004.................................................... 5
Notes to Unaudited Condensed Consolidated Financial Statements.................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...........13
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................................27
Item 4. Controls and Procedures.........................................................................27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...............................................................................28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.....................................28
Item 6. Exhibits .......................................................................................29
Signatures......................................................................................................30
Certifications..................................................................................................31
2
ITEM 1. FINANCIAL STATEMENTS
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- -------------
ASSETS
Cash $ 11,576 $ 14,366
Restricted cash 152,452 125,113
Finance receivables 872,268 592,806
Less: Allowance for finance credit losses (56,128) (42,615)
------------- -------------
Finance receivables, net 816,140 550,191
Servicing fees receivable 1,406 2,791
Residual interest in securitizations 30,057 50,430
Furniture and equipment, net 1,195 1,567
Deferred financing costs 6,163 5,096
Tax assets, net 1,932 --
Accrued interest receivable 9,540 6,411
Other assets 10,945 10,634
------------- -------------
$ 1,041,406 $ 766,599
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Accounts payable and accrued expenses $ 18,104 $ 18,153
Warehouse lines of credit 69,633 34,279
Taxes liabilities, net -- 2,978
Notes payable 250 1,421
Residual interest financing -- 22,204
Securitization trust debt 804,118 542,815
Senior secured debt 59,829 59,829
Subordinated renewable notes 3,041 --
Subordinated debt 14,000 15,000
------------- -------------
968,975 696,679
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;
3,415,000 shares issued; none outstanding -- --
Common stock, no par value; authorized
30,000,000 shares; 21,678,560 and 21,471,478
shares issued and outstanding at September 30, 2005 and
December 31, 2004, respectively 66,358 66,283
Additional paid in capital, warrants 718 --
Retained earnings 6,808 5,104
Accumulated other comprehensive loss (1,202) (1,017)
Deferred compensation (251) (450)
------------- -------------
72,431 69,920
------------- -------------
$ 1,041,406 $ 766,599
============= =============
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- --------------------------------
2005 2004 2005 2004
------------- ------------- ------------- -------------
REVENUES:
Interest income $ 45,321 $ 27,964 122,015 74,108
Servicing fees 1,432 3,031 5,492 9,864
Other income 2,621 3,918 11,477 11,151
------------- ------------- ------------- -------------
49,374 34,913 138,984 95,123
------------- ------------- ------------- -------------
EXPENSES:
Employee costs 9,506 9,905 29,657 29,352
General and administrative 4,923 4,785 16,689 15,220
Interest 13,510 8,388 35,842 21,800
Provision for credit losses 15,818 7,560 43,354 20,610
Impairment loss on residual asset -- 2,650 -- 2,650
Marketing 3,168 2,585 8,647 5,901
Occupancy 858 900 2,490 2,651
Depreciation and amortization 193 201 601 581
------------- ------------- ------------- -------------
47,976 36,974 137,280 98,765
------------- ------------- ------------- -------------
Income (loss) before income tax expense 1,398 (2,061) 1,704 (3,642)
Income tax expense -- -- -- --
------------- ------------- ------------- -------------
Net income (loss) $ 1,398 $ (2,061) $ 1,704 $ (3,642)
============= ============= ============= =============
Earnings (loss) per share:
Basic $ 0.06 $ (0.10) $ 0.08 $ (0.17)
Diluted 0.06 (0.10) 0.07 (0.17)
Number of shares used in computing
earnings (loss) per share:
Basic 21,658 21,345 21,603 21,001
Diluted 23,419 21,345 23,435 21,001
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)
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------------
2005 2004
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 1,704 $ (3,642)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Inpairment loss on residual asset -- 2,650
Amortization of deferred acquisition fees (8,169) (4,483)
Amortization of discount on Class B Notes 1,115 115
Depreciation and amortization 601 581
Amortization of deferred financing costs 2,673 1,872
Provision for credit losses 43,354 20,610
Deferred compensation 150 210
Releases of cash from Trusts to Company 19,329 17,175
Net deposits to Trusts to increase Credit Enhancement (5,131) (2,106)
Interest income on residual assets (4,340) (1,984)
Cash received from residual interest in securitizations 24,714 15,191
Impairment charge against non-auto finance receivable assets 1,882 --
Changes in assets and liabilities:
Payments on restructuring accrual (1,068) (1,070)
Restricted cash (41,537) (46,539)
Other assets (3,820) 10,374
Tax assets (1,932) --
Accounts payable and accrued expenses 1,333 1,161
Tax liabilities (2,978) 181
------------- -------------
Net cash provided by operating activities 27,880 10,296
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of finance receivables held for investment (503,143) (374,717)
Proceeds received on finance receivables held for investment 202,009 134,374
Purchase of furniture and equipment (129) (838)
------------- -------------
Net cash used in investing activities (301,263) (241,181)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of residual financing debt -- 44,000
Proceeds from issuance of securitization trust debt 451,425 363,300
Proceeds from issuance of senior secured debt -- 25,000
Proceeds from issuance of retail notes payable 3,041 --
Net proceeds (repayments) from warehouse lines of credit 35,354 (17,188)
Repayment of residual interest financing debt (22,204) (16,689)
Repayment of securitization trust debt (191,237) (130,527)
Repayment of senior secured debt -- (15,136)
Repayment of subordinated debt (1,000) (20,000)
Repayment of notes payable (1,171) (1,826)
Repayment of related party debt -- (16,500)
Payment of financing costs (3,740) (6,338)
Repurchase of common stock (546) (25)
Exercise of options and warrants 671 557
------------- -------------
Net cash provided by financing activities 270,593 208,628
------------- -------------
Decrease in cash (2,790) (22,257)
Cash at beginning of period 14,366 33,209
------------- -------------
Cash at end of period $ 11,576 $ 10,952
============= =============
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 31,000 $ 19,534
Income taxes $ 4,910 $ (181)
Supplemental disclosure of non-cash financing activities:
Stock-based compensation $ 50 $ 35
Value of warrants issued $ 718 $ --
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
Consumer Portfolio Services, Inc. ("CPS") was incorporated in California on
March 8, 1991. CPS and its subsidiaries (collectively, the "Company") specialize
primarily in purchasing, selling and servicing retail automobile installment
sale contracts ("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 its
purchases, the Company provides indirect financing to Dealer customers for
borrowers with limited credit histories, low incomes or past credit problems
("Sub-Prime Customers"). The Company serves as an alternative source of
financing for Dealers, allowing sales to customers who otherwise might not be
able to obtain financing. The Company does not lend money directly to consumers.
Rather, it purchases installment Contracts from Dealers based on its financing
programs (the "CPS Programs").
BASIS OF PRESENTATION
The unaudited Condensed Consolidated Financial Statements of the Company 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 the opinion of management, necessary for a fair
presentation of the results for the interim periods presented. All such
adjustments are, in the opinion of management, 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
nine-month period ended September 30, 2005 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 the Company's Annual Report on Form 10-K for the year ended December
31, 2004.
OTHER INCOME
Other Income consists primarily of recoveries on previously charged off MFN
contracts, fees paid to the Company by Dealers for certain direct mail services
the Company provides, and proceeds from sales of deficiency balances to
independent third parties.
STOCK BASED COMPENSATION
As permitted by Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS No. 123"), the Company accounts for
stock-based employee compensation plans in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations, whereby stock options are recorded at intrinsic value equal to
the excess of the share price over the exercise price at the date of grant. The
Company provides the pro forma net income (loss), pro forma earnings (loss) per
share, and stock based compensation plan disclosure requirements set forth in
SFAS No. 123. The Company accounts for repriced options as variable awards.
Compensation cost has been recognized for certain stock options in the Unaudited
Condensed Consolidated Financial Statements in accordance with APB Opinion No.
25. Had the Company determined compensation cost based on the fair value at the
grant date for its stock options under Statement of Financial Accounting
Standards No. 123 ("SFAS 123"), "Accounting for Stock Based Compensation," the
Company's net income (loss) and earnings (loss) per share would have been
reduced to the pro forma amounts indicated below.
6
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ---------------------------------
2005 2004 2005 2004
------------- ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income (loss), as reported ................ $ 1,398 $ (2,061) $ 1,704 $ (3,642)
Stock-based employee compensation expense,
fair value method, net of tax ............... (265) (231) (845) (626)
Previously recorded stock-based employee
compensation expense, intrinsic value
method, net of tax .......................... 33 36 87 122
------------- ------------- ------------- -------------
Pro forma net income (loss) ................... $ 1,166 $ (2,256) $ 946 $ (4,146)
============= ============= ============= =============
Net income (loss) per share
Basic, as reported .......................... $ 0.06 $ (0.10) $ 0.08 $ (0.17)
Diluted, as reported ........................ $ 0.06 $ (0.10) $ 0.07 $ (0.17)
Pro forma Basic ............................. $ 0.05 $ (0.11) $ 0.04 $ (0.20)
Pro forma Diluted ........................... $ 0.05 $ (0.11) $ 0.04 $ (0.20)
PURCHASES OF COMPANY STOCK
During the nine-month periods ended September 30, 2005 and 2004, the Company
purchased 115,753 and 6,738 shares, respectively, of its common stock at an
average price of $4.72 and $3.75, respectively.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") published
FASB Statement No. 123 (revised 2004), "Share-Based Payment" ("FAS 123(R)" or
the "Statement"). FAS 123 (R) requires that the compensation cost relating to
share-based payment transactions, including grants of employee stock options, be
recognized in financial statements. That cost will be measured based on the fair
value of the equity or liability instruments issued. FAS 123(R) permits entities
to use any option-pricing model that meets the fair value objective in the
Statement. Modifications of share-based payments will be treated as replacement
awards with the cost of the incremental value recorded in the financial
statements.
During 2005 the SEC amended the effective date of FAS 123(R) which will now
require the Company to adopt the Statement beginning January 1, 2006. As of the
effective date, the Company will apply the Statement using a modified version of
prospective application. Under that transition method, compensation cost is
recognized for (1) all awards granted after the required effective date and to
awards modified, cancelled, or repurchased after that date and (2) the portion
of prior awards for which the requisite service has not yet been rendered, based
on the grant-date fair value of those awards calculated for pro forma
disclosures under SFAS 123.
The impact of this Statement on the Company in 2006 and beyond will depend upon
various factors, among them being our future compensation strategy. The pro
forma compensation costs presented (in the table above) and in prior filings for
the Company have been calculated using a Black-Scholes option pricing model and
may not be indicative of amounts which should be expected in future periods.
7
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(2) FINANCE RECEIVABLES
The following table presents the components of Finance Receivables, net of
unearned interest and deferred acquisition fees:
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- -------------
(IN THOUSANDS)
Finance Receivables
Automobile
Simple Interest ............................................ $ 826,069 $ 522,346
Pre-compute, net of unearned interest ...................... $ 62,711 86,932
------------- -------------
Finance Receivables, net of unearned interest .............. $ 888,780 609,278
Less: Unearned acquisition fees and discounts .............. $ (16,512) (16,472)
------------- -------------
Finance Receivables ........................................ $ 872,268 $ 592,806
============= =============
The following table presents a summary of the activity for the allowance for
credit losses for the nine-month periods ended September 30, 2005 and 2004:
SEPTEMBER 30, SEPTEMBER 30,
2005 2004
------------- -------------
(IN THOUSANDS)
Balance at beginning of period ................................. $ 42,615 $ 35,889
Provision for credit losses on finance receivables ............. $ 42,472 20,610
Charge offs .................................................... $ (37,456) (23,907)
Recoveries ..................................................... $ 8,497 6,436
------------- -------------
Balance at end of period ....................................... $ 56,128 $ 39,028
============= =============
(3) RESIDUAL INTEREST IN SECURITIZATIONS
The residual interest in securitizations represents the discounted sum of
expected future cash flows from securitization trusts. The following table
presents the components of the residual interest in securitizations and are
shown at their discounted amounts:
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- -------------
(IN THOUSANDS)
Cash, commercial paper, United States government securities
and other qualifying investments (Spread Accounts) ........... $ 14,563 $ 17,776
Receivables from Trusts (NIRs) ................................. $ 5,373 $ 12,483
Overcollateralization .......................................... $ 7,918 $ 16,644
Investment in subordinated certificates ........................ $ 2,203 $ 3,527
------------- -------------
Residual interest in securitizations ........................... $ 30,057 $ 50,430
============= =============
8
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The following table presents estimated remaining undiscounted credit losses
included in the fair value estimate of the Residuals as a percentage of the
Company's managed portfolio held by non-consolidated subsidiaries subject to
recourse provisions:
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------ ------------
(DOLLARS IN THOUSANDS)
Undiscounted estimated credit losses ......................... $ 8,361 $ 23,588
Managed portfolio held by non-consolidated subsidiaries ...... 130,979 233,621
Undiscounted estimated credit losses as percentage of
managed portfolio held by non-consolidated subsidiaries .... 6.4% 10.1%
The key economic assumptions used in measuring all residual interest in
securitizations as of September 30, 2005 and December 31, 2004 are included in
the table below. The pre-tax discount rate remained constant from previous
periods at 14%, except for certain cash flows from charged off receivables
related to the Company's securitizations from 2001 to 2003 where the Company has
used a discount rate of 25%, which is also consistent with previous periods.
SEPTEMBER 30, DECEMBER 31,
2005 2004
--------------- ---------------
Prepayment speed (Cumulative) ........................... 22.2% - 36.5% 20.0% - 30.5%
Net credit losses (Cumulative) .......................... 11.7% - 20.2% 13.0% - 20.5%
(4) SECURITIZATION TRUST DEBT
The Company has 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 the Company's Unaudited Condensed
Consolidated Balance Sheets as "Securitization Trust Debt," and the components
of such debt are summarized in the following table:
9
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
WEIGHTED
FINAL OUTSTANDING OUTSTANDING AVERAGE
SCHEDULED PRINCIPAL AT PRINCIPAL AT INTEREST RATE AT
PAYMENT INITIAL SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
SERIES ISSUE DATE DATE (1) PRINCIPAL 2005 2004 2005
- ------------ ----------------------- ----------------- ------------- -------------- ------------- ---------------
MFN 2001-A June 28, 2001 June 15, 2007 $ 301,000 $ - $ 3,382 N/A
TFC 2002-1 March 19, 2002 August 15, 2007 64,552 - 2,574 N/A
TFC 2002-2 October 9, 2002 March 15, 2008 62,589 - 9,152 N/A
TFC 2003-1 May 20, 2003 January 15, 2009 52,365 8,754 17,703 2.69%
CPS 2003-C September 30, 2003 March 15, 2010 87,500 35,420 53,456 3.44%
CPS 2003-D December 16, 2003 October 15, 2010 75,000 34,025 50,722 3.39%
CPS 2004-A May 5, 2004 October 15, 2010 82,094 46,232 66,737 3.53%
PCR 2004-1 June 24, 2004 March 15, 2010 76,257 28,512 52,633 3.43%
CPS 2004-B August 2, 2004 February 15, 2011 96,369 60,283 84,185 4.17%
CPS 2004-C September 30, 2004 April 15, 2011 100,000 69,953 93,071 3.82%
CPS 2004-D December 21, 2004 December 15, 2011 120,000 92,713 109,200 4.44%
CPS 2005-A March 31, 2005 October 15, 2011 125,124 121,588 N/A 4.87%
CPS 2005-B June 29, 2005 February 15, 2012 130,625 123,338 N/A 4.47%
CPS 2005-C September 30, 2005 March 15, 2012 183,300 183,300 N/A 4.60%
------------- -------------- -------------
$ 1,556,775 $ 804,118 $ 542,815
============== ============== =============
- -----------------
(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
$73.9 MILLION IN 2005, $332.2 MILLION IN 2006, $167.3 MILLION IN 2007, $114.5
MILLION IN 2008, $84.5 MILLION IN 2009, AND $31.7 MILLION IN 2010.
All of the securitization trust debt was sold in private placement transactions
to qualified institutional buyers. The debt was issued through wholly-owned
bankruptcy remote subsidiaries of CPS, TFC or MFN, and is secured by the assets
of such subsidiaries, but not by other assets of the Company. Principal of
$766.4 million, and the related interest payments, are guaranteed by financial
guaranty insurance policies issued by third party financial institutions.
Certain of the Company's securitization transactions and the warehouse credit
facilities contain various financial covenants requiring certain minimum
financial ratios and results. Such covenants include maintaining minimum levels
of liquidity and net worth and not exceeding maximum leverage levels and maximum
financial losses. As of September 30, 2005, the Company was in compliance with
all such financial covenants.
The Company is responsible for the administration and collection of the
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 September
30, 2005, restricted cash under the various agreements totaled approximately
$152.3 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. Deferred financing costs 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.
The wholly-owned, bankruptcy remote subsidiaries of CPS, MFN and TFC were formed
to facilitate the above asset-backed financing transactions. Similar bankruptcy
remote subsidiaries issue the debt outstanding under the Company's 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 the Company or its
affiliates.
10
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(5) INTEREST INCOME
The following table presents the components of interest income:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
(IN THOUSANDS)
Interest on Finance Receivables .................................. $ 43,399 27,695 115,823 68,405
Residual interest income ......................................... $ 1,180 -- 4,340 4,634
Other interest income ............................................ $ 742 269 1,852 1,069
------------ ------------ ------------ ------------
Net interest income .............................................. $ 45,321 27,964 122,015 74,108
============ ============ ============ ============
(6) EARNINGS (LOSS) PER SHARE
Earnings (loss) per share for the three-month and nine-month periods ended
September 30, 2005 and 2004 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 (loss)
per share for the three-month and nine-month periods ended September 30, 2005
and 2004:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
(IN THOUSANDS)
Weighted average number of common shares outstanding during
the period used to compute basic earnings (loss) per share .... 21,658 21,345 21,603 21,001
Incremental common shares attributable to exercise of
outstanding options and warrants .............................. 1,761 -- 1,832 --
------------ ------------ ------------ ------------
Weighted average number of common shares used to compute
diluted earnings (loss) per share ............................. 23,419 21,345 23,435 21,001
============ ============ ============ ============
If the anti-dilutive effects of common stock equivalents were considered,
additional shares included in the diluted earnings (loss) per share calculation
for the three-month and nine-month periods ended September 30, 2004 would have
included an additional 1.9 million and 1.8 million shares, respectively,
attributable to the exercise of outstanding options and warrants. No such
anti-dilution existed for the three-month and nine-month periods ended September
30, 2005.
11
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(7) INCOME TAXES
As of December 31, 2004, the Company had net deferred tax assets of $9.9
million, which included a valuation allowance of $43.9 million against gross
deferred tax assets of $53.8 million. There were also offsetting gross deferred
tax liabilities of $9.9 million. Net tax assets at September 30, 2005 were $1.9
million compared with net tax liabilities at December 31, 2004 of $3.0 million.
The Company decreased its valuation allowance by the income tax expense for the
period to result in no net income tax provision for the three-month and
nine-month period ended September 30, 2005. The Company has evaluated its
deferred tax assets and believes that it is more likely than not that certain
deferred tax assets will not be realized due to limitations imposed by the
Internal Revenue Code and expected future taxable income.
(8) LEGAL PROCEEDINGS
The Company is routinely involved in various legal proceedings resulting from
its consumer finance activities and practices, both continuing and discontinued.
The Company believes that there are substantive legal defenses to such claims,
and intends to defend them vigorously. There can be no assurance, however, as to
the outcome.
(9) EMPLOYEE BENEFITS
The Company sponsors 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 and nine months ended September
30, 2005 and 2004.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
(IN THOUSANDS)
Components of net periodic benefit cost
Service cost ..................................................... $ -- $ -- $ -- $ --
Interest Cost .................................................... 210 205 630 616
Expected return on assets ........................................ (276) (261) (828) (781)
Amortization of transition (asset)/obligation .................... (9) (8) (26) (26)
Amortization of prior service cost ............................... -- -- -- --
Recognized net actuarial loss .................................... 27 18 81 52
------------ ------------ ------------ ------------
Net periodic benefit .......................................... $ (48) $ (46) $ (143) $ (139)
============ ============ ============ ============
(10) COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss) are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
(IN THOUSANDS)
Net income (loss) ................................................ $ 1,398 $ (2,061) $ 1,704 $ (3,642)
Minimum pension liability, net of tax ............................ -- -- (185) --
------------ ------------ ------------ ------------
Comprehensive income (loss) ................................... $ 1,398 $ (2,061) $ 1,519 $ (3,642)
============ ============ ============ ============
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Consumer Portfolio Services, Inc. ("CPS," and together with its subsidiaries,
the "Company") is a consumer finance company specializing in purchasing, selling
and servicing retail automobile installment purchase contracts ("Contracts")
originated by licensed motor vehicle dealers ("Dealers") in the sale of new and
used automobiles, light trucks and passenger vans. Through its purchases, the
Company provides indirect financing to Dealer customers with limited credit
histories, low incomes or past credit problems ("Sub-Prime Customers"). The
Company serves as an alternative source of financing for Dealers, allowing sales
to customers who otherwise might not be able to obtain financing. The Company
does not lend money directly to consumers. Rather, it purchases installment
Contracts from Dealers.
CPS was incorporated and began its operations in 1991. In March 2002, CPS
acquired by merger (the "MFN Merger") MFN Financial Corp. and its subsidiaries.
In May 2003, CPS acquired by merger (the "TFC Merger") TFC Enterprises Inc. and
its subsidiaries. Both MFN Financial Corp and TFC Enterprises Inc., through
their respective subsidiaries, were engaged in businesses substantially similar
to that of CPS, and in each merger CPS acquired a portfolio of receivables that
had been held by the acquired company. Each merger was accounted for as a
purchase. The indirect financing programs of subsidiaries of TFC Enterprises,
Inc. were directed principally to members of the United States armed forces. The
Company has continued to offer such financing programs (the "TFC Programs")
subsequent to the TFC merger, in addition to its other financing programs (the
"CPS Programs").
On April 2, 2004, the Company purchased a portfolio of Contracts and certain
other assets (the "SeaWest Asset Acquisition") from SeaWest Financial
Corporation ("SeaWest"). In addition, the Company was named the successor
servicer for three term securitization transactions originally sponsored by
SeaWest (the "SeaWest Third Party Portfolio"). The Company does not intend to
offer financing programs similar to those previously offered by SeaWest.
SECURITIZATION
GENERALLY
Throughout the periods for which information is presented in this report, the
Company has purchased Contracts with the intention of repackaging them in
securitizations. All such securitizations have involved identification of
specific Contracts, sale of those Contracts (and associated rights) to a special
purpose subsidiary of the Company, and issuance of asset-backed securities to
fund the transactions. Depending on the structure of the securitization, the
transaction may be properly accounted for as a sale of the Contracts, or as a
secured financing.
When the transaction is structured as a secured financing, the subsidiary is
consolidated with the Company. Accordingly, the sold Contracts and the related
securitization trust debt appear as assets and liabilities, respectively, of the
Company on its Unaudited Condensed Consolidated Balance Sheet. The Company then
periodically (i) recognizes interest and fee income on the receivables (ii)
recognizes interest expense on the securities issued in the securitization, and
(iii) records as expense a provision for credit losses on the receivables.
When structured as a sale, the subsidiary is not consolidated with the Company.
Accordingly, the securitization removes the sold Contracts from the Company's
Unaudited Condensed Consolidated Balance Sheet, the asset-backed securities
(debt of the non-consolidated subsidiary) do not appear as debt of the Company,
and the Company shows as an asset a retained residual interest in the sold
Contracts. The residual interest represents the discounted value of what the
Company expects to receive from these transactions which includes the excess of
future collections on the Contracts over principal and interest due on the
asset-backed securities. The residual interest appears on the Company's balance
sheet as "Residual interest in securitizations," and the determination of its
value is dependent on estimates of the future performance of the sold Contracts.
13
CHANGE IN POLICY
In August 2003, the Company announced that it would structure its future
securitization transactions related to Contracts purchased under the CPS
Programs as secured financings for financial accounting purposes. Its subsequent
term securitizations of finance receivables have been so structured. Prior to
August 2003, the Company had structured its term securitization transactions
related to the CPS Programs as sales for financial accounting purposes. In the
MFN Merger and in the TFC Merger the Company acquired finance receivables that
had been previously securitized in term securitization transactions that were
reflected as secured financings. As of September 30, 2005, the Company's
Unaudited Condensed Consolidated Balance Sheet included net finance receivables
of approximately $37.9 million and securitization trust debt of $8.8 million
related to finance receivables acquired in the two mergers and the SeaWest Asset
Acquisition, out of totals of net finance receivables of approximately $816.1
million and securitization trust debt of approximately $804.1 million.
CREDIT RISK RETAINED
Whether a securitization is treated as a secured financing or as a sale for
financial accounting purposes, the related special purpose subsidiary may be
unable to release excess cash to the Company if the credit performance of the
securitized Contracts falls short of pre-determined standards. Such releases
represent a material portion of the cash that the Company uses to fund its
operations. An unexpected deterioration in the performance of securitized
Contracts could therefore have a material adverse effect on both the Company's
liquidity and its results of operations, regardless of whether such Contracts
are treated as having been sold or as having been financed. For estimation of
the magnitude of such risk, it may be appropriate to look to the size of the
Company's "managed portfolio," which represents both financed and sold Contracts
as to which such credit risk is retained. The Company's managed portfolio as of
September 30, 2005 was approximately $1,055.9 million (this amount includes
$24.3 million related to the SeaWest Third Party Portfolio on which the Company
earns only servicing fees and has no credit risk).
RESULTS OF OPERATIONS
EFFECTS OF CHANGE IN SECURITIZATION STRUCTURE
The Company's decision in the third quarter of 2003 to structure securitization
transactions as borrowings secured by receivables for financial accounting
purposes, rather than as sales of receivables, has affected and will affect the
way in which the transactions are reported. The major effects are these: (i) the
finance receivables are shown as assets of the Company on its balance sheet;
(ii) the debt issued in the transactions is shown as indebtedness of the
Company; (iii) cash deposited to enhance the credit of the securitization
transactions ("Spread Accounts") is shown as "Restricted cash" on the Company's
balance sheet; (iv) cash collected from borrowers and other sources related to
the receivables prior to making the required payments under the Securitization
Agreements is also shown as "Restricted cash" on the Company's balance sheet;
(v) the servicing fee that the Company receives in connection with such
receivables is recorded as a portion of the interest earned on such receivables
in the Company's statements of operations; (vi) the Company has initially and
periodically recorded as expense a provision for estimated credit losses on the
receivables in the Company's statements of operations; and (vii) of scheduled
payments on the receivables and on the debt issued in the transactions, the
portion representing interest is recorded as interest income and expense,
respectively, in the Company's statements of operations.
These changes collectively represent a deferral of revenue and acceleration of
expenses, and thus a more conservative approach to accounting for the Company's
operations compared to the previous term securitization transactions, which were
accounted for as sales at the consummation of the transaction. The changes have
resulted in the Company's reporting lower earnings than it would have reported
if it had continued to structure its securitizations to require recognition of
gain on sale. As a result, reported earnings have been less than they would have
14
been had the Company continued to structure its securitizations to record a gain
on sale. It should also be noted that growth in the Company's portfolio of
receivables in excess of current expectations would result in an increase in
expenses in the form of provision for credit losses, and would initially have a
negative effect on net earnings. The Company's cash availability and cash
requirements should be unaffected by the change in structure.
The change in the securitization structure became effective in the third quarter
of 2003. In each quarterly period subsequent to the third quarter of 2003, the
Company's results have been more impacted by receivables owned by consolidated
subsidiaries, and less impacted by receivables in non-consolidated subsidiaries.
From September 30, 2004 to September 30, 2005, receivables owned by
non-consolidated subsidiaries decreased from 30.7% to 12.4% of the Company's
Total Managed Portfolio. During that same period, receivables owned by
consolidated subsidiaries increased from 61.7% to 85.3% of the Company's Total
Managed Portfolio. Ultimately, receivables in non-consolidated subsidiaries will
have no material effect on the Company's results of operations.
The Company has conducted several term securitizations of Contracts originated
under the CPS Programs structured as secured financings. In March 2004, the
Company completed a securitization of its retained interest in securitization
transactions previously sponsored by the Company and its affiliates, which was
also structured as a secured financing. The notes issued in connection with this
securitization of the Company's retained interest in other securitization were
fully repaid in August 2005. In addition, in June 2004, the Company completed a
term securitization of Contracts purchased in the SeaWest Asset Acquisition and
under the TFC Programs, which was structured as a secured financing. The
Company's MFN and TFC subsidiaries completed term securitizations structured as
secured financings prior to their becoming subsidiaries of the Company.
THE THREE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2004
REVENUES. During the three months ended September 30, 2005, revenues were $49.4
million, an increase of $14.5 million, or 41.4%, from the prior year period
revenue of $34.9 million. The primary reason for the increase in revenues is an
increase in interest income. Interest income for the three months ended
September 30, 2005 increased $17.4 million, or 62.1%, to $45.3 million from
$28.0 million in the prior year period. The primary reason for the increase in
interest income is the change in securitization structure implemented during the
third quarter of 2003 as described above (an increase of $17.8 million), and an
increase in residual interest income (an increase of $1.2 million). This
increase was partially offset by the decline in the balance of the portfolios of
Contracts acquired in the SeaWest Asset Acquisition (resulting in a decrease of
$806,000 in interest income), a decline in the balance of the portfolio of
Contracts acquired in the MFN Merger (resulting in a decrease of $230,000 in
interest income), a decline in the balance of the portfolio of Contracts
acquired in the TFC Merger (resulting in a decrease of $624,000 in interest
income).
Servicing fees totaling $1.4 million in the three months ended September 30,
2005 decreased $1.6 million, or 52.8%, from $3.0 million in the same period a
year earlier. The decrease in servicing fees is the result of the change in
securitization structure and the consequent decline in the Company's managed
portfolio held by non-consolidated subsidiaries. As a result of the decision to
structure future securitizations as secured financings, the Company's managed
portfolio held by non-consolidated subsidiaries will continue to decline in
future periods, and servicing fee revenue is anticipated to decline
proportionately. As of September 30, 2005 and 2004, the Company's managed
portfolio owned by consolidated vs. non-consolidated subsidiaries and other
third parties were as follows:
15
SEPTEMBER 30, 2005 SEPTEMBER 30, 2004
-------------------------------- -------------------------------
AMOUNT % AMOUNT %
----------------- ------------- --------------- -------------
($ IN MILLIONS)
Total Managed Portfolio
Owned by Consolidated Subsidiaries....... $ 900.7 85.3% $ 553.9 61.7%
Owned by Non-Consolidated Subsidiaries... 130.9 12.4% 276.2 30.7%
SeaWest Third Party Portfolio............ 24.3 2.3% 68.2 7.6%
----------------- ------------- --------------- -------------
Total.................................... $ 1,055.9 100.0% $ 898.3 100.0%
================= ============= =============== =============
At September 30, 2005, the Company was generating income and fees on a managed
portfolio with an outstanding principal balance approximating $1,055.9 million
(this amount includes $24.3 million related to the SeaWest Third Party Portfolio
on which the Company earns only servicing fees), compared to a managed portfolio
with an outstanding principal balance approximating $898.3 million as of
September 30, 2004. As the portfolios of Contracts acquired in the MFN Merger,
the TFC Merger and the SeaWest Asset Acquisition decrease, the portfolio of
Contracts originated under the CPS Programs continues to expand. At September
30, 2005 and 2004, the managed portfolio composition was as follows:
SEPTEMBER 30, 2005 SEPTEMBER 30, 2004
-------------------------------- -------------------------------
AMOUNT % AMOUNT %
----------------- ------------- --------------- -------------
($ IN MILLIONS)
Originating Entity
CPS...................................... $ 934.3 88.5% $ 660.5 73.5%
TFC...................................... 73.3 6.9% 93.2 10.4%
MFN...................................... 4.3 0.4% 26.7 3.0%
SeaWest.................................. 19.7 1.9% 49.7 5.5%
SeaWest Third Party Portfolio............ 24.3 2.3% 68.2 7.6%
----------------- ------------- --------------- -------------
Total.................................... $ 1,055.9 100.0% $ 898.3 100.0%
================= ============= =============== =============
Other income decreased $1.3 million, or 33.1%, to $2.6 million in the
three-month period ended September 30, 2005 from $3.9 million during the same
period a year earlier. The period over period decrease resulted primarily from
decreased revenue on the Company's direct mail products ($113,000), decreases in
recoveries on MFN and certain other Contracts ($1.2 million) and decreases in
revenue on certain leased property ($35,000).
EXPENSES. The Company's operating expenses consist primarily of employee costs
and other operating expenses, which are incurred as applications and 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 warrants
and stock options, and are one of the Company's most significant operating
expenses. These costs (other than those relating to stock options) generally
fluctuate with the level of applications and Contracts processed and serviced.
Other operating expenses consist primarily of interest expense, provisions for
credit losses, facilities expenses, telephone and other communication services,
credit services, computer services (including employee costs associated with
information technology support), professional services, marketing and
advertising expenses, and depreciation and amortization.
Total operating expenses were $48.0 million for the three months ended September
30, 2005, compared to $37.0 million for the same period a year earlier, an
increase of $11.0 million, or 29.8%. The increase is primarily due to increases
in provision for credit losses and interest expense, which increased by $8.3
million and $5.1 million, or 109.2% and 61.1% respectively. Both interest
expense and provision for credit losses are directly impacted by the growth in
the Company's portfolio of Contracts held by consolidated affiliates.
16
Employee costs decreased slightly to $9.5 million during the three months ended
September 30, 2005, representing 19.8 % of total operating expenses, from $9.9
million for the same period a year earlier, or 26.8% of total operating
expenses. The decrease as a percentage of total operating expenses reflects the
higher total of operating expenses, primarily a result of the increased
provision for credit losses and interest expense.
General and administrative expenses increased slightly by $138,000, or 2.9% and
represented 10.3% of total operating expenses in the three-month period ending
September 30, 2005, as compared to the prior year period when general and
administrative expenses represented 12.1% of total operating expenses. The
decrease as a percentage of total operating expenses reflects the higher
operating expenses primarily a result of the provision for credit losses and
interest expense.
Interest expense for the three month period ended September 30, 2005 increased
$5.1 million, or 61.1%, to $13.5 million, compared to $8.4 million in the same
period of the previous year. The increase is primarily the result of changes in
the amount and composition of securitization trust debt carried on the Company's
Consolidated Balance Sheet. Such debt increased as a result of the change in
securitization structure implemented beginning in July 2003 (an increase of
approximately $5.6 million), partially offset by the decrease in the balance of
the securitization trust debt acquired in the MFN Merger and the TFC Merger
(resulting in a decrease of approximately $402,000 in interest expense).
Marketing expenses increased by $583,000, or 22.6%, and represented 6.6% of
total operating expenses. The increase is primarily due to the increase in
Contracts purchased by the Company during the three months ended September 30,
2005 as compared to the prior year period.
Occupancy expenses increased by $42,000, or 4.7%, and represented 1.9% of total
operating expenses.
Depreciation and amortization expenses decreased by $8,000, or 4.0%, to $193,000
from $201,000.
THE NINE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2004
REVENUES. During the nine months ended September 30, 2005, revenues were $139.0
million, an increase of $43.9 million, or 46.1%, from the prior year period
revenue of $95.1 million. The primary reason for the increase in revenues is an
increase in interest income. Interest income for the nine months ended September
30, 2005 increased $47.9 million, or 64.6%, to $122.0 million from $74.1 million
in the prior year period. The primary reason for the increase in interest income
is the change in securitization structure implemented during the third quarter
of 2003 as described above (an increase of $52.1 million). This increase was
partially offset by the decline in the balance of the portfolios of Contracts
acquired in the SeaWest Asset Acquisition (resulting in a decrease of $1.7
million in interest income), a decline in the balance of the portfolio of
Contracts acquired in the MFN Merger (resulting in a decrease of $2.4 million in
interest income) and a decrease in residual interest income (a decrease of
$294,000) as a result of the decline in the residual interest in securitizations
between the periods presented.
Servicing fees totaling $5.5 million in the nine months ended September 30, 2005
decreased $4.4 million, or 44.3%, from $9.9 million in the same period a year
earlier. The decrease in servicing fees is the result of the change in
securitization structure and the consequent decline in the Company's managed
portfolio held by non-consolidated subsidiaries. As a result of the decision to
structure future securitizations as secured financings, the Company's managed
portfolio held by non-consolidated subsidiaries will continue to decline in
future periods, and servicing fee revenue is anticipated to decline
proportionately.
17
Other income increased $326,000, or 2.9%, to $11.5 million in the nine-month
period ended September 30, 2005 from $11.2 million during the same period a year
earlier. The period over period increase resulted primarily from the sale of
certain receivables that consisted primarily of charged off receivables acquired
in the MFN Merger, the TFC Merger and the SeaWest Asset Acquisition ($2.4
million), increased revenue on the Company's direct mail products ($658,000),
and fees generated from electronic check payments ($105,000). This increase was
offset in part by decreases in recoveries on MFN and certain other Contracts
($2.7 million) and decreased revenue on certain leased property ($114,000).
EXPENSES. The Company's operating expenses consist primarily of employee costs
and other operating expenses, which are incurred as applications and 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 warrants
and stock options, and are one of the Company's most significant operating
expenses. These costs (other than those relating to stock options) generally
fluctuate with the level of applications and Contracts processed and serviced.
Other operating expenses consist primarily of interest expense, provisions for
credit losses, facilities expenses, telephone and other communication services,
credit services, computer services (including employee costs associated with
information technology support), professional services, marketing and
advertising expenses, and depreciation and amortization.
Total operating expenses were $137.3 million for the nine months ended September
30, 2005, compared to $98.8 million for the same period a year earlier, an
increase of $38.5 million, or 39.0%. The increase is primarily due to increases
in provision for credit losses and interest expense, which increased by $22.7
million and $14.0 million, or 110.4% and 64.4% respectively. Both interest
expense and provision for credit losses are directly impacted by the growth in
the Company's portfolio of Contracts held by consolidated affiliates.
Employee costs increased by $305,000, or 1.0%, to $29.7 million during the nine
months ended September 30, 2005, representing 21.6% of total operating expenses,
from $29.4 million for the same period a year earlier, or 29.7% of total
operating expenses. The decrease as a percentage of total operating expenses
reflects the higher total of operating expenses, primarily a result of the
increased provision for credit losses and interest expense.
General and administrative expenses increased $1.5 million, or 9.7% and
represented 12.2% of total operating expenses in the nine-month period ending
September 30, 2005, as compared to the prior year period when general and
administrative expenses represented 15.4% of total operating expenses. The
decrease as a percentage of total operating expenses reflects the higher
operating expenses primarily a result of the provision for credit losses and
interest expense. During the nine-month period ended September 30, 2005 the
Company recognized what management believes will be a one-time, non-cash
impairment charge of $1.9 million against certain non-auto finance receivable
assets.
Interest expense for the nine-month period ended September 30, 2005 increased
$14.0 million, or 64.4%, to $35.8 million, compared to $21.8 million in the same
period of the previous year. The increase is primarily the result of changes in
the amount and composition of securitization trust debt carried on the Company's
Consolidated Balance Sheet. Such debt increased as a result of the change in
securitization structure implemented beginning in July 2003 (an increase of
approximately $14.8 million), partially offset by the decrease in the balance of
the securitization trust debt acquired in the MFN Merger and the TFC Merger
(resulting in a decrease of approximately $1.5 million in interest expense).
Marketing expenses increased by $2.7 million, or 46.5%, and represented 6.3% of
total operating expenses. The increase is primarily due to the increase in
Contracts purchased by the Company during the nine months ended September 30,
2005 as compared to the prior year period.
18
Occupancy expenses decreased by $161,000, or 6.1%, and represented 1.8% of total
operating expenses.
Depreciation and amortization expenses increased by $20,000, or 3.4%, to
$601,000 from $581,000.
CREDIT EXPERIENCE
The Company's financial results are dependent on the performance of the
Contracts in which it retains an ownership interest. The table below documents
the delinquency, repossession and net credit loss experience of all Contracts
that the Company was servicing (excluding Contracts from the SeaWest Third Party
Portfolio) as of the respective dates shown. Credit experience for CPS, MFN
(since the date of the MFN Merger), TFC (since the date of the TFC Merger) and
SeaWest (since the date of the SeaWest Asset Acquisition) is shown on a combined
basis in the table below. The Company attributes the decrease in charge offs
during the nine-month period ended September 30, 2005 to lower delinquencies
during the nine months ended September 30, 2005 as compared to delinquencies and
charge off levels during the twelve months ended December 31, 2004, and also to
the increase in the average servicing portfolio outstanding as of September 30,
2005 compared to December 31, 2004.
DELINQUENCY EXPERIENCE (1)
CPS, MFN, TFC AND SEAWEST COMBINED
SEPTEMBER 30, 2005 DECEMBER 31, 2004
--------------------------- ---------------------------
NUMBER OF NUMBER OF
CONTRACTS AMOUNT CONTRACTS AMOUNT
------------ ------------ ------------ ------------
(Dollars in thousands)
DELINQUENCY EXPERIENCE
Gross servicing portfolio (1) ......................... 91,238 $ 1,046,416 83,018 $ 873,880
Period of delinquency (2)
31-60 days ......................................... 2,175 20,854 2,106 19,010
61-90 days ......................................... 1,074 9,751 1,069 8,051
91+ days ........................................... 990 7,474 1,176 7,758
------------ ------------ ------------ ------------
Total delinquencies (2) ............................... 4,239 38,079 4,351 34,819
Amount in repossession (3) ............................ 1,270 13,298 1,408 14,090
------------ ------------ ------------ ------------
Total delinquencies and amount in repossession (2) .... 5,509 $ 51,377 5,759 $ 48,909
============ ============ ============ ============
Delinquencies as a percentage of gross servicing
portfolio ........................................... 4.6 % 3.6 % 5.2 % 4.0 %
Total delinquencies and amount in repossession as a
percentage of gross servicing portfolio ............ 6.0 % 4.9 % 6.9 % 5.6 %
- -------------------
(1) ALL AMOUNTS AND PERCENTAGES ARE BASED ON THE AMOUNT REMAINING TO BE REPAID
ON EACH CONTRACT, INCLUDING, FOR PRE-COMPUTED CONTRACTS, ANY UNEARNED INTEREST.
THE INFORMATION IN THE TABLE REPRESENTS THE GROSS PRINCIPAL AMOUNT OF ALL
CONTRACTS PURCHASED BY THE COMPANY ON AN OTHER THAN FLOW BASIS, INCLUDING
CONTRACTS SUBSEQUENTLY SOLD BY THE COMPANY IN SECURITIZATION TRANSACTIONS THAT
IT CONTINUES TO SERVICE. THE TABLE DOES NOT INCLUDE CONTRACTS FROM THE SEAWEST
THIRD PARTY PORTFOLIO.
(2) THE COMPANY CONSIDERS A 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. CONTRACTS LESS THAN 31 DAYS DELINQUENT ARE NOT INCLUDED.
(3) AMOUNT IN REPOSSESSION REPRESENTS FINANCED VEHICLES THAT HAVE BEEN
REPOSSESSED BUT NOT YET LIQUIDATED.
19
NET CHARGE-OFF EXPERIENCE (1)
CPS, MFN, TFC AND SEAWEST COMBINED
SEPTEMBER 30, DECEMBER 31,
2005 2004
---------------- ----------------
(DOLLARS IN THOUSANDS)
Average servicing portfolio outstanding ......... $ 927,707 $ 796,436
Annualized net charge-offs as a percentage of
average servicing portfolio (2) ............... 4.9 % 7.8 %
- --------------------
(1) ALL AMOUNTS AND PERCENTAGES ARE BASED ON THE PRINCIPAL AMOUNT SCHEDULED TO
BE PAID ON EACH CONTRACT, NET OF UNEARNED INCOME ON PRE-COMPUTED CONTRACTS. THE
INFORMATION IN THE TABLE REPRESENTS ALL CONTRACTS SERVICED BY THE COMPANY
(EXCLUDING 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. SEPTEMBER 30, 2005 PERCENTAGE REPRESENTS NINE MONTHS ENDED SEPTEMBER
30, 2005, ANNUALIZED. DECEMBER 31, 2004 REPRESENTS TWELVE MONTHS ENDED DECEMBER
31, 2004.
LIQUIDITY AND CAPITAL RESOURCES
The Company's business requires substantial cash to support its purchases of
Contracts and other operating activities. The Company's primary sources of cash
have been cash flows from operating activities, including proceeds from sales of
Contracts, amounts borrowed under various revolving credit facilities (also
sometimes known as warehouse credit facilities), servicing fees on portfolios of
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 Contracts in which the Company has
retained a residual ownership interest and from the Spread Accounts associated
with such pools. The Company's primary uses of cash have been the purchases of
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 Accounts and
initial overcollateralization, if any, 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 the
Company's 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 Accounts), the rate of expansion or
contraction in the Company's managed portfolio, and the terms upon which the
Company is able to acquire, sell, and borrow against Contracts.
Net cash provided by operating activities for the nine-month period ended
September 30, 2005 was $27.9 million compared to net cash provided by operating
activities for the nine-month period ended September 30, 2004 of $10.3 million.
Cash from operating activities is generally provided by the net releases from
the Company's securitization Trusts held by consolidated subsidiaries and cash
received from residual interests in securitizations.
Net cash used in investing activities for the nine-month periods ended September
30, 2005 and 2004 was $301.3 million and $241.2 million, respectively. Cash used
in investing activities has generally related to purchases of Contracts.
Net cash provided by financing activities for the nine months ended September
30, 2005 and 2004, was $270.6 million and $208.6 million respectively. Cash used
or provided by financing activities is primarily attributable to the repayment
or issuance of debt.
Contracts are purchased from Dealers for a cash price generally approximating
their principal amount, and generate cash flow over a period of years. As a
result, the Company has been dependent on warehouse credit facilities to
purchase Contracts, and on the availability of cash from outside sources in
order to finance its continuing operations, as well as to fund the portion of
Contract purchase prices not financed under warehouse credit facilities.
20
During the nine months ended September 30, 2005 the Company operated with up to
$225 million in warehouse credit capacity, in the form of a $125 million
facility and a $100 million facility. The first facility provided funding for
Contracts purchased under the TFC Programs while both warehouse facilities
provided funding for Contracts purchased under the CPS Programs.
The $125 million warehouse facility was structured to allow the Company to fund
a portion of the purchase price of Contracts by drawing against a floating rate
variable funding note issued by CPS Warehouse Trust. This facility was
established on March 7, 2002, in the maximum amount of $100 million. Such
maximum amount was increased to $125 million in November 2002. Up to 77.0% of
the principal balance of Contracts could have been advanced to the Company under
this facility, subject to collateral tests and certain other conditions and
covenants. Notes under this facility bore interest at a rate of one-month
commercial paper plus 1.50% per annum. This facility was due to expire on April
11, 2006, but the Company elected to terminate it on June 29, 2005.
The Company's other warehouse facility was increased from $100 million to $125
million on June 29, 2005 and was further amended to provide funding for
Contracts purchased under the TFC Programs in addition to the CPS Programs. The
facility was subsequently increased to $200 million on August 31, 2005. The
facility is structured to allow CPS to fund a portion of the purchase price of
Contracts by drawing against a floating rate variable funding note issued by
Page Funding LLC. A financial institution, who is also the controlling party on
the facility, purchases the note. Up to 77.0% of the principal balance of
Contracts may be advanced to the Company under this facility, subject to
collateral tests and certain other conditions and covenants. Notes under this
facility accrue interest at a rate of one-month LIBOR plus 1.50% per annum. This
facility was entered into on June 30, 2004 and expires on June 30, 2007. The
Company and the lender each have annual termination options at each parties sole
discretion on each June 30, through 2007, at which time the agreement expires.
For the portfolio owned by consolidated subsidiaries, cash used to increase
Credit Enhancement amounts to required levels for the nine-month periods ended
September 30, 2005 and 2004 was $5.1 million and $2.1 million, respectively.
Cash released from Trusts and their related Spread Accounts to the Company for
the nine-month periods ended September 30, 2005 and 2004, was $19.3 million and
$17.2 million, respectively. Changes in the amount of Credit Enhancement
required for term securitization transactions and releases from Trusts and their
related Spread Accounts are affected by the relative size, seasoning and
performance of the various pools of Contracts securitized that make up the
Company's managed portfolio to which the respective Spread Accounts are related.
The Company did not make any initial deposits to Spread Accounts or fund initial
overcollateralization related to term securitization transactions owned by
non-consolidated subsidiaries during the nine months ended September 30, 2005 or
September 30, 2004.
The acquisition of Contracts for subsequent sale in securitization transactions,
and the need to fund 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 the Company's 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 Accounts either release cash to the
Company or capture cash from collections on securitized Contracts. The Company
is limited in its ability to purchase Contracts by its available cash and the
capacity of its warehouse facilities. As of September 30, 2005, the Company had
unrestricted cash on hand of $11.6 million and available capacity from its
warehouse credit facility of $130.4 million, subject to collateral availability.
The Company's plans to manage its need for liquidity include the completion of
additional term securitizations that would provide additional credit
availability from the warehouse credit facilities, and matching its levels of
Contract purchases to its availability of cash. There can be no assurance that
the Company will be able to complete term securitizations on favorable economic
terms or that the Company will be able to complete term securitizations at all.
If the Company is unable to complete such securitizations, interest income and
other portfolio related income would decrease.
21
The Company's primary means of ensuring that its cash demands do not exceed its
cash resources is to match its levels of Contract purchases to its availability
of cash. The Company's ability to adjust the quantity of Contracts that it
purchases and securitizes 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 Contract acquisition can be maintained or
increased. While the specific terms and mechanics of each Spread Account vary
among transactions, the Company's Securitization Agreements generally provide
that the Company 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 Contracts in the pool are below certain predetermined
levels. In the event delinquencies, defaults or net losses on the 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 the Company 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 Contracts to another
servicer. There can be no assurance that collections from the related Trusts
will continue to generate sufficient cash.
Certain of the Company's securitization transactions and the warehouse credit
facilities contain various financial covenants requiring certain minimum
financial ratios and results. Such covenants include maintaining minimum levels
of liquidity and net worth and not exceeding maximum leverage levels and maximum
financial losses. As of September 30, 2005, the Company was in compliance with
all such covenants. 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.
The Securitization Agreements of the Company's term securitization transactions
are terminable by the Note Insurers in the event of certain defaults by the
Company and under certain other circumstances. Similar termination rights are
held by the lender in the other warehouse credit facility. Were a Note Insurer
(or the lender in such warehouse facility) in the future to exercise its option
to terminate the Securitization Agreements, such a termination would have a
material adverse effect on the Company's liquidity and results of operations.
The Company continues to receive Servicer extensions on a monthly and/or
quarterly basis, pursuant to the Securitization Agreements.
One of the covenants within six of the 17 currently outstanding term
securitizations requires that the Company maintain at least two warehouse
facilities with aggregate borrowing capacity of at least $200 million. With the
termination of the Company's $125 million facility as described above, the
Company is in breach of such covenant. The Company has until November 28, 2005
(as extended from October 27, 2005) to cure such breach prior to it becoming an
event of default under the six term securitizations. While the Company is
currently in discussions with several parties about an additional facility and
believes that it will be successful in obtaining one within the required time
frame, there can be no assurances that it will do so. If the Company is
unsuccessful in these efforts, the Note Insurer under the six securitizations
that include this covenant will have the right to declare an event of default.
Remedies available to the Note Insurer in such event include, among other
things, transferring the servicing rights to the portfolio that it insures to
another servicer and trapping excess cash releases that would otherwise go to
the Company. If the Note Insurer would pursue either of these remedies, it would
have a material adverse effect on the liquidity and operations of the Company.
CRITICAL ACCOUNTING POLICIES
(a) ALLOWANCE FOR FINANCE CREDIT LOSSES
In order to estimate an appropriate allowance for losses incurred on finance
receivables held on the Company's Unaudited Condensed Consolidated Balance
Sheet, the Company uses a loss allowance methodology commonly referred to as
"static pooling," which stratifies its finance receivable portfolio into
separately identified pools. Using analytical and formula-driven techniques, the
Company estimates an allowance for finance credit losses, which management
believes is adequate for probable credit losses that can be reasonably estimated
22
in its portfolio of finance receivable Contracts. Provision for losses is
charged to the Company's 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, the Company's level of provisioning and/or allowance may
change as well.
(b) TREATMENT OF SECURITIZATIONS
Gain on sale may be recognized on the disposition of Contracts either outright
or in securitization transactions. In those securitization transactions that
were treated as sales for financial accounting purposes, the Company, or a
wholly-owned, consolidated subsidiary of the Company, retains a residual
interest in the Contracts that were sold to a wholly-owned, unconsolidated
special purpose subsidiary. The Company's securitization transactions include
"term" securitizations (the purchaser holds the Contracts for substantially
their entire term) and "continuous" or "warehouse" securitizations (which
finance the acquisition of the Contracts for future sale into term
securitizations).
As of September 30, 2005 and December 31, 2004 the line item "Residual interest
in securitizations" on the Company's Unaudited Consolidated Balance Sheet
represents the residual interests in certain term securitizations that were
accounted for as sales. Warehouse securitizations accounted for as secured
financings are accordingly reflected in the line items "Finance receivables" and
"Warehouse lines of credit" on the Company's Unaudited Condensed Consolidated
Balance Sheet, and the term securitizations accounted for as secured financings
are reflected in the line items "Finance receivables" and "Securitization trust
debt." The "Residual interest in securitizations" represents the discounted sum
of expected future releases from securitization trusts. Accordingly, the
valuation of the residual is heavily dependent on estimates of future
performance.
(c) INCOME TAXES
The Company and its subsidiaries file consolidated federal income and combined
state franchise tax returns. The Company utilizes 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. The Company has estimated a valuation
allowance against that portion of the deferred tax asset whose utilization in
future periods 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 periods in which net operating
losses might otherwise expire.
FORWARD LOOKING STATEMENTS
This report on Form 10-Q includes certain "forward-looking statements,"
including, without limitation, the statements or implications to the effect that
prepayments as a percentage of original balances will approximate 22.2% to 36.5%
cumulatively over the lives of the related Contracts, that net credit losses as
a percentage of original balances will approximate 11.7% to 20.2% cumulatively
over the lives of the related Contracts. Other forward-looking statements may be
identified by the use of words such as "anticipates," "expects," "plans,"
"estimates," or words of like meaning. As to the specifically identified
forward-looking statements, 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 Contracts,
changes in laws respecting consumer finance, which could affect the ability of
the Company to enforce rights under Contracts, and changes in the market for
23
used vehicles, which could affect the levels of recoveries upon sale of
repossessed vehicles. Factors that could affect the Company's revenues in the
current year include the levels of cash releases from existing pools of
Contracts, which would affect the Company's ability to purchase Contracts, the
terms on which the Company is able to finance such purchases, the willingness of
Dealers to sell Contracts to the Company on the terms that it offers, and the
terms on which the Company is able to complete term securitizations once
Contracts are acquired. Factors that could affect the Company's expenses in the
current year include competitive conditions in the market for qualified
personnel, and interest rates (which affect the rates that the Company pays on
Notes issued in its securitizations). The statements concerning the Company
structuring future securitization transactions as secured financings and the
effects of such structures on financial items and on the Company's future
profitability also are forward-looking statements. Any change to the structure
of the Company's securitization transaction could cause such forward-looking
statements not to be accurate. Both the amount of the effect of the change in
structure on the Company's profitability and the duration of the period in which
the Company's 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 the Company purchases and sells Contracts, any changes in that
rate, the credit performance of such Contracts, the financial terms of future
securitizations, any changes in such terms over time, and other factors that
generally affect the Company's profitability.
Additional risk factors, any of which could have a material effect on the
Company's performance, are set forth below:
DEPENDENCE ON WAREHOUSE FINANCING. The Company's primary source of day-to-day
liquidity is continuous securitization of Contracts, under which it sells or
pledges Contracts, as often as once a week, to special-purpose affiliated
entities. Such transactions function as a "warehouse" in which Contracts are
held. The Company expects to continue to effect similar transactions (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 structure or is unable to arrange new warehouse
facilities, 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 and liquidity. One of the covenants within six of the 17
currently outstanding term securitizations requires that the Company maintain at
least two warehouse facilities with aggregate borrowing capacity of at least
$200 million. With the termination of the Company's $125 million facility as
described above, the Company is in breach of such covenant. The Company has
until November 28, 2005 (as extended from October 27, 2005) to cure such breach
prior to it becoming an event of default under the six term securitizations.
While the Company is currently in discussions with several parties about an
additional facility and believes that it will be successful in obtaining one
within the required time frame, there can be no assurances that it will do so.
If the Company is unsuccessful in these efforts, the Note Insurer under the six
securitizations that include this covenant will have the right to declare an
event of default. Remedies available to the Note Insurer in such event include,
among other things, transferring the servicing rights to the portfolio that it
insures to another servicer and trapping excess cash releases that would
otherwise go to the Company. If the Note Insurer would pursue either of these
remedies, it would have a material adverse effect on the liquidity and
operations of the Company.
DEPENDENCE ON SECURITIZATION PROGRAM. The Company is dependent upon its ability
to continue to finance pools of Contracts in term securitizations 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 monoline financial guaranty insurers. The Company
believes that financial guaranty insurance policies reduce the costs of
securitizations relative to alternative forms of credit enhancements available
to the Company. No insurer is required to insure Company-sponsored
securitizations and there can be no assurance that any will continue to do so.
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
24
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.
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,
repossessions and losses generally increase during economic slowdowns or
recessions. Because of the Company's focus on Sub-Prime Customers, the actual
rates of delinquencies, repossessions and losses on such Contracts could be
higher under adverse economic conditions than those 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.
DEPENDENCE ON PERFORMANCE OF SECURITIZED CONTRACTS. Under the financial
structures the Company has used to date in its term securitizations, certain
excess cash flows generated by the Contracts sold in the term securitizations
are used to increase overcollateralization or are retained in a Spread Account
within the securitization trusts to provide liquidity and credit enhancement.
While the specific terms and mechanics of each Spread Account vary among
transactions, the Company's Securitization Agreements generally provide that the
Company will receive excess cash flows only if the amount of Credit Enhancement
has reached specified levels 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: (i) may require increased Credit Enhancement to be accumulated
for the particular pool; (ii) may restrict the distribution to the Company of
excess cash flows associated with other pools; or (iii) in certain
circumstances, may permit the insurers to require the transfer of servicing on
some or all of the Contracts to another servicer. Any of these conditions could
materially adversely affect the Company's liquidity, financial condition and
operations.
CREDITWORTHINESS OF CONSUMERS. The Company specializes in the purchase, sale and
servicing of Contracts to finance automobile purchases by Sub-Prime Customers,
which entail a higher risk of non-performance, higher delinquencies and higher
losses than Contracts with more creditworthy customers. 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 Customers,
no assurance can be given that such criteria and methods will afford adequate
protection against such risks. The Company has experienced fluctuations in the
delinquency and charge-off performance of its Contracts. In the event that
portfolios of Contracts sold and serviced by the Company experience greater
defaults, higher delinquencies or higher net losses than anticipated, the
Company's income could be negatively affected. 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 a requirement of increased
cash collateral or other Credit Enhancement in such transactions.
PROBABLE 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 rate of interest payable to
purchasers of Notes issued in securitizations. The Contracts purchased by the
Company generally bear finance charges close to or at the maximum permitted by
applicable state law. The interest rates payable on such Notes are fixed, 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 interest rates required by investors and, thus,
the potential operating profits to the Company from the purchase, securitization
and servicing of Contracts. Operating profits expected to be earned by the
Company on portfolios of Contracts previously securitized are insulated from the
adverse effects of increasing interest rates because the interest rates on the
related Notes were fixed at the time the Contracts were sold. It is reasonable
to expect that interest rates may increase in the near to intermediate term. Any
future increases in interest rates would likely increase the interest rates on
Notes issued in future term securitizations and could have a material adverse
effect on the Company's results of operations and liquidity.
25
PREPAYMENTS AND CREDIT LOSSES. Gains from the sale of Contracts in the Company's
past securitization transactions structured as sales for financial accounting
purposes have constituted a significant portion of the revenue of the Company. A
portion of the gains is based in part on management's estimates of future
prepayments and credit losses 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 credit losses are greater than projected at the
time such Contracts were sold, a charge to income may be required and would be
recorded in the period of adjustment. If actual prepayments occur more slowly or
if net losses are lower than estimated with respect to Contracts sold, total
revenue would exceed previously estimated amounts.
Provisions for credit losses are recorded in connection with the origination and
throughout the life of Contracts that are held on the Company's Unaudited
Condensed Consolidated Balance Sheet. Such provisions are based on management's
estimates of future credit losses in light of then-current conditions. If actual
credit losses in a given period exceed the allowance for credit losses, a bad
debt expense during the period would be required.
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 and Ford Motor Credit 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.
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. Although the Company is not involved in
any such material consumer protection litigation, a significant judgment against
the Company or within the industry in connection with any such litigation, or an
adverse outcome in the litigation identified under the caption "Legal
Proceedings" in this report and in the Company's most recently filed report on
Form 10-K, could have a material adverse effect on the Company's financial
condition, results of operations and liquidity.
DEPENDENCE ON DEALERS. The Company is dependent upon establishing and
maintaining relationships with unaffiliated Dealers to supply it with Contracts.
During the nine months ended September 30, 2005, no Dealer accounted for as much
as 2.0% 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, results of operations and liquidity.
GOVERNMENT REGULATIONS. 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, or the failure to comply with such laws and
regulations could have a material adverse effect on the Company's financial
condition, results of operations and liquidity.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
The Company is subject to interest rate risk during the period between when
Contracts are purchased from Dealers and when such Contracts become part of a
term securitization. Specifically, the interest rates on the warehouse
facilities are adjustable while the interest rates on the Contracts are fixed.
Historically, the Company's term securitization facilities have had fixed rates
of interest. To mitigate some of this risk, the Company has in the past, and
intends to continue to, structure certain of its securitization transactions to
include pre-funding structures, whereby the amount of Notes issued exceeds the
amount of Contracts initially sold to the Trusts. In pre-funding, the proceeds
from the pre-funded portion are held in an escrow account until the Company
sells the additional Contracts to the Trust in amounts up to the balance of the
pre-funded escrow account. In pre-funded securitizations, the Company locks in
the borrowing costs with respect to the Contracts it subsequently delivers to
the Trust. However, the Company incurs 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 Contracts and the interest rate
paid on the Notes outstanding, the amount as to which there can be no assurance.
There have been no material changes in market risks since December 31, 2004.
ITEM 4. CONTROLS AND PROCEDURES
CPS maintains a system of internal controls and procedures designed to provide
reasonable assurance as to the reliability of its published financial statements
and other disclosures included in this report. As of the end of the period
covered by this report, CPS 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 (Robert E. Riedl) concluded that the disclosure
controls and procedures are effective in recording, processing, summarizing and
reporting, on a timely basis, material information relating to CPS that is
required to be included in its 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.
27
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information provided under the caption "Legal Proceedings" in the Company's
Annual Report on Form 10-K for the year ended December 31, 2004, is incorporated
herein by reference. In addition, the reader should be aware of the following:
In August and September 2005, two plaintiffs represented by the same law firm
filed substantially identical lawsuits in the federal district court for the
northern district of Illinois, each of which purports to be a class action, and
each of which alleges that CPS improperly accessed consumer credit information.
CPS believes that it has one or more defenses to each of the claims made in
these lawsuits, but the cases have just commenced, and no discovery has yet been
conducted. Accordingly, there can be no assurance as to their outcomes.
The Company is routinely involved in various legal proceedings resulting from
its consumer finance activities and practices, both continuing and discontinued.
The Company believes that there are substantive legal defenses to such claims,
and intends to defend them vigorously. There can be no assurance, however, as to
the outcome.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the three months ended September 30, 2005, the Company purchased a total
of 85,803 shares of its common stock, as described in the following table:
ISSUER PURCHASES OF EQUITY SECURITIES
TOTAL NUMBER OF SHARES APPROXIMATE DOLLAR VALUE
TOTAL NUMBER AVERAGE PURCHASED AS PART OF OF SHARES THAT MAY YET
OF SHARES PRICE PAID PUBLICLY ANNOUNCED BE PURCHASED UNDER THE
PERIOD (1) PURCHASED PER SHARE PLANS OR PROGRAMS(2) PLANS OR PROGRAMS
July 2005 20,050 $4.59 20,050 1,273,225
August 2005 34,156 $4.92 34,156 1,105058
September 2005 31,597 $5.01 31,597 946,715
Total 85,803 $4.88 85,803
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(1) EACH MONTHLY PERIOD IS THE CALENDAR MONTH.
(2) THE COMPANY ANNOUNCED IN AUGUST 2000 ITS INTENTION TO PURCHASE UP TO $5
MILLION OF ITS OUTSTANDING SECURITIES, INCLUSIVE OF ANNUAL $1 MILLION SINKING
FUND REDEMPTIONS ON ITS RISING INTEREST REDEEMABLE SUBORDINATED SECURITIES DUE
2006. IN OCTOBER 2002, THE JULY 2000 PROGRAM HAVING BEEN EXHAUSTED, THE
COMPANY'S BOARD OF DIRECTORS AUTHORIZED THE PURCHASE OF UP TO AN ADDITIONAL $5
MILLION OF SUCH SECURITIES, WHICH PROGRAM WAS FIRST ANNOUNCED IN THE COMPANY'S
ANNUAL REPORT FOR THE YEAR 2002, FILED ON MARCH 26, 2003. ALL PURCHASES
DESCRIBED IN THE TABLE ABOVE WERE UNDER THE PLAN ANNOUNCED IN MARCH 2003, WHICH
HAS NO FIXED EXPIRATION DATE.
28
ITEM 6. EXHIBITS
The exhibits listed below are filed with this report. The Company disclaims any
implication that disclaims any implication that the agreements filed as exhibits
10.1 and 10.2 are other than agreements entered into in the ordinary course of
its business.
10.1 Amendment No. 1 to Amended and Restated Sale and Servicing Agreement
dated as of June 29, 2005, by and among Page Funding LLC ("PFLLC"), the
Company and Wells Fargo Bank, National Association ("WFBNA").
(Incorporated by reference to exhibit 10.1 filed with the Company's
report on Form 8-K filed September 1, 2005,)
10.2 Supplement as of August 31, 2005 to Indenture dated as of September
30, 2004 by and among PFLLC, UBS Real Estate Securities, Inc.
("UBSRES") and WFBNA. (Incorporated by reference to exhibit 10.2 filed
with the Company's report on Form 8-K filed September 1, 2005.)
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.
29
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: November 2, 2005
/s/ CHARLES E. BRADLEY, JR.
-------------------------------------
Charles E. Bradley, Jr.
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(Principal Executive Officer)
Date: November 2, 2005
/s/ ROBERT E. RIEDL
-------------------------------------------------
Robert E. Riedl
SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
(Principal Financial Officer)
30