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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, 1999
[ ] 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 / /
As of November 12, 1999, the registrant had 20,107,501 common shares
outstanding.
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CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1999
Part I. Financial Information
Item 1. Financial Statements
Condensed consolidated balance sheets as of September 30,
1999 and December 31, 1998. 3
Condensed consolidated statements of operations for the three
and nine month periods ended September 30, 1999 and 1998. 4
Condensed consolidated statements of cash flows for the nine
month periods ended September 30, 1999 and 1998. 5
Notes to 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 21
Part II. Other Information
Item 3. Defaults Upon Senior Securities 22
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 23
-2-
PART I - FINANCIAL INFORMATION
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
September 30, December 31,
------------------- ------------------
1999 1998
---- ----
ASSETS
Cash $ 516 $ 1,940
Restricted cash 1,661 1,619
Contracts held for sale (note 2) 4,564 165,582
Servicing fees receivable 9,711 11,148
Residual interest in securitizations (note 3) 205,984 217,848
Furniture and equipment, net 3,354 4,272
Deferred financing costs 2,653 2,817
Investment in unconsolidated affiliates 1,501 4,145
Related party receivables 1,032 3,268
Other assets 23,951 19,323
------------------- -------------------
$ 254,927 $ 431,962
=================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Accounts payable & accrued expenses $ 14,947 $ 9,267
Warehouse line of credit -- 151,857
Taxes payable 10,484 29,068
Capital lease obligation 1,669 2,132
Notes payable 3,401 2,557
Residual financing 29,563 33,000
Subordinated debt 70,000 65,000
Related party debt 21,500 20,000
------------------- -------------------
151,564 312,881
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; 20,107,501 and 15,658,501 shares
issued and outstanding at September 30, 1999
and December 31, 1998, respectively 62,421 52,533
Retained earnings 40,942 66,548
------------------- -------------------
103,363 119,081
------------------- -------------------
$ 254,927 $ 431,962
=================== ===================
See accompanying notes to condensed consolidated financial statements
-3-
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------------ -------------------------------------
1999 1998 1999 1998
---- ---- ---- ----
REVENUES:
Gain (loss) on sale of contracts,
net (note 4) $ (9,725) $ 15,313 $ (16,161) $ 34,650
Interest income (note 5) (5,312) 12,060 20,019 35,655
Servicing fees 6,288 6,899 22,235 17,891
Other income (loss) (455) 305 (1,066) 886
----------------- ----------------- ----------------- -----------------
(9,204) 34,577 25,027 89,082
----------------- ----------------- ----------------- -----------------
EXPENSES:
Employee costs 7,062 8,333 23,156 20,684
General and administrative 4,084 6,335 14,639 15,911
Interest 5,912 5,958 23,586 14,487
Marketing 1,175 2,362 4,162 4,895
Occupancy 683 522 2,127 1,501
Depreciation and amortization 351 304 1,245 906
Related party consulting fees 88 19 263 56
----------------- ----------------- ----------------- -----------------
19,355 23,833 69,178 58,440
----------------- ----------------- ----------------- -----------------
Income (loss) before income taxes (28,559) 10,744 (44,151) 30,642
Income taxes (11,990) 4,506 (18,545) 12,876
----------------- ----------------- ----------------- -----------------
Net income (loss) $ (16,569) $ 6,238 $ (25,606) $ 17,766
================= ================= ================= =================
Earnings (loss) per share (note 6):
Basic $ (0.82) $ 0.40 $ (1.41) $ 1.16
Diluted $ (0.82) $ 0.38 $ (1.41) $ 1.08
Number of shares used in computing
earnings (loss) per share (note 6):
Basic 20,108 15,557 18,196 15,328
Diluted 20,108 16,948 18,196 16,745
See accompanying notes to condensed consolidated financial statements
-4-
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Nine Months Ended
September 30,
-------------------------------------
1999 1998
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (25,606) $ 17,766
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 1,245 906
Amortization of NIRs 24,222 19,367
Amortization of deferred financing costs 475 243
Provision for credit losses 4,843 12,875
NIR gains recognized -- (36,704)
Gain on sale of subsidiary -- (56)
Equity net (income) loss in unconsolidated affiliates 1,665 (617)
Net deposits into trusts (12,358) (63,834)
Changes in assets and liabilities:
Restricted cash (42) --
Purchases of contracts held for sale (306,725) (895,581)
Liquidation of contracts held for sale 462,901 662,027
Net change in warehouse lines of credit (151,857) 224,922
Other assets 6,358 (10,272)
Accrued taxes and expenses (12,904) 23,781
----------------- -----------------
Net cash used in operating activities (7,783) (45,177)
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of investment in unconsolidated affiliate 979 --
Related party receivables (11) (242)
Repayment of related party receivables 2,248 707
Investment in unconsolidated affiliate -- (65)
Purchases of furniture and equipment (33) (1,833)
Net cash from sale of subsidiary -- 381
----------------- -----------------
Net cash provided by (used in) investing activities 3,183 (1,052)
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in residual financing -- 33,000
Issuance of related party debt 1,500 5,000
Issuance of subordinated debt 5,000 --
Issuance of notes payable 1,395 2,461
Repayment of residual financing debt (3,438) --
Repayment of capital lease obligations (462) (400)
Repayment of notes payable (551) (502)
Payment of financing costs (312) --
Issuance of common stock -- 5,000
Exercise of options and warrants 44 542
----------------- -----------------
Net cash provided by financing activities 3,176 45,101
----------------- -----------------
Decrease in cash (1,424) (1,128)
Cash at beginning of period 1,940 1,745
----------------- -----------------
Cash at end of period $ 516 $ 617
================= =================
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 21,712 $ 13,391
Income taxes $ 43 $ 860
Supplemental disclosure of non-cash investing and
financing activities:
Furniture and equipment acquired through capital leases $ -- $ 839
Issuance and revaluation of common stock warrants 9,844 --
Sale of PIC Leasing, Inc.
Net assets sold $ -- $ 705
Net assets retained -- (155)
Gain on sale of subsidiary -- 56
----------------- -----------------
Cash received from sale of subsidiary -- 606
Less: cash relinquished upon disposition -- (225)
----------------- -----------------
Net cash received from sale of subsidiary $ -- $ 381
================= =================
See accompanying notes to condensed consolidated financial statements
-5-
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The unaudited condensed consolidated financial statements have been
prepared in conformity with generally accepted accounting principles 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 have been
reclassified for comparability to current period presentation. Results for the
three and nine month periods ended September 30, 1999, 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 generally accepted accounting
principles have been condensed or omitted. These condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's annual report
on Form 10-K for the year ended December 31, 1998.
PRINCIPLES OF CONSOLIDATION
The condensed consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries, Alton Receivables Corp., CPS
Receivables Corp., CPS Marketing, Inc., CPS Funding Corporation., and CPS
Warehouse Corp. The consolidated financial statements also include the accounts
of SAMCO Acceptance Corp. ("SAMCO"), LINC Acceptance Company, LLC ("LINC") and
CPS Leasing, Inc., each of which is 80% owned by the Company. All significant
intercompany transactions and balances have been eliminated. Investments in
affiliates that are not majority owned are reported using the equity method.
During the nine month period ended September 30, 1999, the Company terminated
all operations of SAMCO and LINC.
CONTRACTS HELD FOR SALE
Contracts held for sale include automobile installment sales contracts
(generally, "Contracts") on which interest is precomputed and added to the
principal amount financed. The interest on precomputed Contracts is included in
unearned financed charges. Unearned financed charges are amortized over the
remaining period to contractual maturity, using the interest method. Contracts
held for sale are stated at the lower of cost or market value. Market value is
determined by purchase commitments from investors and prevailing market prices.
Gains and losses are recorded as appropriate when Contracts are sold. The
Company considers a transfer of Contracts, where the Company surrenders control
over the Contracts, a sale to the extent that consideration, other than
beneficial interests in the transferred Contracts, is received in exchange for
the Contracts.
CONTRACTS HELD TO MATURITY
Contracts held to maturity are presented at fair market value and are
included in other assets on the September 30, 1999, condensed consolidated
balance sheet. Payments received on the $3.1 million balance of Contracts held
to maturity are restricted to certain securitized pools, and the related
Contracts cannot be resold.
ALLOWANCE FOR CREDIT LOSSES
The Company provides an allowance for credit losses that management
believes provides adequately for known and inherent losses that may develop in
the Contracts held for sale. Provision for losses are charged to gain on sale of
Contracts. Charge-offs, net of recoveries, are charged to the allowance.
Management evaluates the adequacy of the allowance by examining current
delinquencies, the characteristics of the portfolio, the value of underlying
collateral, and general economic conditions and trends.
CONTRACT ACQUISITION FEES AND DISCOUNTS
Upon purchase of a Contract from an automobile dealer ("Dealer"), the
Company generally charges the Dealer an acquisition fee or purchases the
Contract at a discount from its face value (some Contracts are purchased at face
value). The acquisition fees and discounts associated with Contract purchases
are deferred until the Contracts are sold. At that time the deferred acquisition
fee or discount is recognized as a component of the gain on sale.
-6-
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
RESIDUAL INTEREST IN SECURITIZATIONS AND GAIN ON SALE OF CONTRACTS
The Company historically has purchased Contracts with the primary
intention of reselling them in securitization transactions as asset-backed
securities. The Company has not sold Contracts in a securitization transaction
since December of 1998, and there can be no assurance as to when the Company
next will do so. The securitizations generally have been structured as follows:
First, the Company sells a portfolio of Contracts to a wholly owned subsidiary
("SPS"), which has been established for the limited purpose of buying and
reselling the Company's Contracts. The SPS then transfers the same Contracts to
either a grantor trust or an owner trust (the "Trust"). The Trust in turn issues
interest-bearing asset-backed securities (the "Certificates"), generally in an
amount equal to the aggregate principal balance of the Contracts. The Company
typically sells these Contracts to the Trust at face value and without recourse,
except that representations and warranties similar to those provided by the
Dealer to the Company are provided by the Company to the Trust. One or more
investors purchase the Certificates issued by the Trust; the proceeds from the
sale of the Certificates are then used to purchase the Contracts from the
Company. The Company purchases a financial guaranty insurance policy,
guaranteeing timely payment of principal and interest on the senior
Certificates, from an insurance company (the "Certificate Insurer"). In
addition, the Company provides a credit enhancement for the benefit of the
Certificate Insurer and the investors in the form of an initial cash deposit to
an account ("Spread Account") held by the Trust. The agreements governing the
securitization transactions (collectively referred to as the "Servicing
Agreements") require that the initial deposits to the Spread Accounts be
supplemented by a portion of collections from the Contracts until the Spread
Accounts reach specified levels, and then maintained at those levels. The
specified levels are generally computed as a percentage of the principal amount
remaining unpaid under the related Certificates. The specified levels at which
the Spread Accounts are to be maintained will vary depending on the performance
of the portfolios of Contracts held by the Trusts and on other conditions, and
may also be varied by agreement among the Company, the SPS, the Certificate
Insurer and the trustee. Such levels have increased and decreased from time to
time based on performance of the portfolios, and have also been varied by
agreement. The specified levels applicable to the Company's sold pools increased
materially in 1998 and have recently been decreased by agreement. See note 7 -
"Liquidity" for a discussion of certain pre-conditions to the effectiveness of
such decrease.
At the closing of each securitization, the Company removes from its
consolidated balance sheet the Contracts held for sale and adds to its
consolidated balance sheet (i) the cash received and (ii) the estimated fair
value of the ownership interest that the Company retains in Contracts sold in
securitization. That retained interest (the "Residual") consists of (a) the cash
held in the Spread Account and (b) the net interest receivables ("NIRs"). NIRs
represent the estimated discounted cash flows to be received from the Trust in
the future, net of principal and interest payable with respect to the
Certificates, and certain expenses. The excess of the cash received and the
assets retained by the Company over the carrying value of the Contracts sold,
less transaction costs, equals the net gain on sale of Contracts recorded by the
Company.
The Company allocates its basis in the Contracts between the Certificates
and the Residuals retained based on the relative fair values of those portions
on the date of the sale. The Company recognizes gains or losses attributable to
the change in the fair value of the Residuals, which are recorded at estimated
fair value and accounted for as "held-for-trading" securities. The Company is
not aware of an active market for the purchase or sale of interests such as the
Residuals, and accordingly, the Company determines the estimated fair value of
the Residuals by discounting the amount and timing of anticipated cash flows
released from the Spread Account (the cash out method), using a discount rate
that the Company believes is appropriate for the risks involved. For that
valuation, the Company has used an effective discount rate of approximately 14%
per annum.
The Company receives periodic base servicing fees for the servicing and
collection of the Contracts. In addition, the Company is entitled to the cash
flows from the Residuals that represent collections on the Contracts in excess
of the amounts required to pay principal and interest on the Certificates, the
base servicing fees, and certain other fees (such as trustee and custodial
fees). At the end of each collection period, the aggregate cash collections from
the Contracts are allocated first to the base servicing fees and certain other
fees such as trustee and custodial fees for the period, then to the
Certificateholders for interest at the pass-through rate on the Certificates
plus principal as defined in the Servicing Agreements. If the amount of cash
required for the above allocations exceeds the amount collected during the
collection period, the shortfall is drawn from the Spread Account. If the cash
collected during the period exceeds the amount necessary for the above
allocations, and the related Spread Account is at its required level, the excess
is released to the Company or in certain cases is transferred to other Spread
Accounts that may be below their required levels. Pursuant to certain Servicing
Agreements, excess cash collected during the period is used to make accelerated
principal paydowns on certain Certificates to create over-collateralization. If
the Spread Account balance is not at the required credit enhancement level, then
the excess cash collected is retained in the Spread Account until the specified
level is achieved. The cash in the Spread Accounts is restricted from use by the
Company. Cash held in the various Spread Accounts is invested in high quality,
liquid investment securities, as specified in the Servicing Agreements. Spread
Account balances are held by the Trusts on behalf of the Company as the owner of
the Residuals.
-7-
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
The annual percentage rate payable on the Contracts is significantly
greater than the pass through rate on the Certificates. Accordingly, the
Residuals described above are a significant asset of the Company. In determining
the value of the Residuals described above, the Company must estimate the future
rates of prepayments, delinquencies, defaults and default loss severity as they
affect the amount and timing of the estimated cash flows. The Company estimates
prepayments by evaluating historical prepayment performance of comparable
Contracts and the effects of trends in the industry. The Company has used a
constant prepayment estimate of approximately 4% per annum. The Company
estimates defaults and default loss severity using available historical loss
data for comparable Contracts and the specific characteristics of the Contracts
purchased by the Company. In valuing the Residuals, the Company estimates that
losses as a percentage of the original principal balance will total
approximately 14% cumulatively over the lives of the related Contracts.
In future periods, the Company could recognize additional revenue from
the Residuals if the actual performance of the Contracts were to be better than
the original estimate, or the Company could increase the estimated fair value of
the Residuals. If the actual performance of the Contracts were to be worse than
the original estimate, then a downward adjustment to the carrying value of the
Residuals would be required. Due to the inherent uncertainty of the future
performance of the underlying Contracts, the Company during 1998 established a
$7.8 million allowance for losses on the Residuals, which did not change during
the nine month period ended September 30, 1999.
(2) CONTRACTS HELD FOR SALE
The following table presents the components of Contracts held for sale:
September 30, 1999 December 31, 1998
------------------ -------------------
(in thousands)
Gross receivable balance.................................. $ 7,248 $ 183,876
Unearned finance charges.................................. (194) (10,949)
Deferred acquisition fees and discounts................... (313) (4,594)
Allowance for credit losses............................... (2,177) (2,751)
------------------ -------------------
Net contracts held for sale............................... $ 4,564 $ 165,582
================== ===================
(3) RESIDUAL INTEREST IN SECURITIZATIONS
The following table presents the components of the residual interest in
securitizations:
September 30, 1999 December 31, 1998
------------------ ------------------
(in thousands)
Cash, commercial paper, US government securities and other qualifying
investments (Spread Account)............................................ $ 145,057 $ 130,394
NIRs.................................................................... 30,578 54,800
Over collateralization.................................................. 30,187 31,836
Funds held by investor.................................................. -- 480
Investment in subordinated certificates ................................ 162 338
------------------ ------------------
Residual interest in securitizations:................................... $ 205,984 $ 217,848
================== ==================
-8-
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following table presents the activity of the NIRs:
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------------- -------------------------------------
1999 1998 1999 1998
----------------- ----------------- ----------------- -----------------
(in thousands) (in thousands)
Balance, beginning of period........... $ 40,010 $ 57,573 $ 54,800 $ 45,112
NIR gains recognized................... -- 13,819 -- 36,704
Amortization of NIRs................... (9,432) (8,943) (24,222) (19,367)
----------------- ----------------- ----------------- -----------------
Balance, end of period................. $ 30,578 $ 62,449 $ 30,578 $ 62,449
================= ================= ================= =================
The following table presents estimated remaining undiscounted credit
losses included in the fair value estimated of the Residuals as a percentage of
the Company's servicing portfolio subject to recourse provisions:
September 30, 1999 December 31, 1998
------------------ ------------------
(in thousands)
Undiscounted estimated credit losses........................... $ 95,477 $ 169,110
================== ==================
Servicing subject to recourse provisions....................... $ 947,989 $ 1,362,801
================== ==================
Undiscounted estimated credit losses as percentage of
servicing subject to recourse provisions................ 10.07% 12.41%
================== ==================
(4) GAIN ON SALE OF CONTRACTS
The following table presents components of net gain (loss) on sale of
Contracts:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------- --------------------------------
1999 1998 1999 1998
-------------- -------------- -------------- --------------
(in thousands) (in thousands)
Gains (loss) recognized on sale........ $ (8,644) $ 13,820 $ (17,917) $ 36,704
Deferred acquisition fees and discounts 1,745 5,528 7,596 13,839
Expenses related to sales.............. (576) (1,164) (997) (3,018)
Provision for credit losses............ (2,250) (2,871) (4,843) (12,875)
-------------- -------------- -------------- --------------
Net gain (loss) on sale of contracts... $ (9,725) $ 15,313 $ (16,161) $ 34,650
============== ============== ============== ==============
-9-
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(5) INTEREST INCOME
The following table presents the components of interest income:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------- --------------------------------
1999 1998 1999 1998
-------------- -------------- -------------- --------------
(in thousands) (in thousands)
Interest on Contracts held for sale $ 3,695 $ 12,236 $ 28,213 $ 30,868
Residual interest income......... 425 8,766 16,028 24,154
Amortization of NIRs............. (9,432) (8,942) (24,222) (19,367)
-------------- -------------- -------------- --------------
Net interest income (loss)....... $ (5,312) $ 12,060 $ 20,019 $ 35,655
============== ============== ============== ==============
(6) EARNINGS (LOSS) PER SHARE
Diluted loss per share for the three and nine month periods ended
September 30, 1999, was calculated using the weighted average number of shares
outstanding for the related period. Diluted earnings per share for the three and
nine month periods ending September 30, 1998, was calculated using the weighted
average number of diluted common shares outstanding including common stock
equivalents, which consist of certain outstanding dilutive stock options and
warrants and incremental shares attributable to conversion of certain
subordinated debt. The following table reconciles the number of shares used in
the computations of basic and diluted earnings (loss) per share for the three
and nine month periods ended September 30, 1999 and 1998:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------- --------------------------------
1999 1998 1999 1998
-------------- -------------- -------------- --------------
(in thousands) (in thousands)
Weighted average number of common shares outstanding
during the period used to compute basic earnings per
share.................................................. 20,108 15,557 18,196 15,328
Incremental common shares attributable to exercise of
outstanding options and................................ -- 240 -- 535
Incremental common shares attributable to conversion of
subordinated debt......................................... -- 1,151 -- 882
-------------- -------------- -------------- --------------
Number of common shares used to compute diluted earnings
(loss) per share.......................................... 20,108 16,948 18,196 16,745
============== ============== ============== ==============
If the anti-dilutive effects of common stock equivalents were not
considered, additional shares included in diluted loss per share calculation for
the three and nine month periods ended September 30, 1999, would have included
an additional 2,000 and 16,000, respectively, from outstanding stock options and
warrants and an additional 2.4 million from incremental shares attributable to
the conversion of certain subordinated debt, for an aggregate total of
approximately 22.5 million diluted shares for the three month period ending
September 30, 1999 and 20.6 million diluted shares for the nine month period
ending September 30, 1999.
(7) LIQUIDITY
The Company's business requires substantial cash to support its
operating activities. The Company's primary sources of cash from operating
activities have been proceeds from the sales of Contracts, amounts borrowed
under its various warehouse lines, servicing fees on portfolios of Contracts
previously sold, proceeds from the sales of Contracts, customer payments of
principal and interest on Contracts held for sale, fees for origination of
Contracts, and releases of cash from Spread Accounts. The Company's primary uses
of cash have been the purchases of Contracts, repayment of amounts borrowed
under its various warehouse lines, operating expenses such as employee,
interest, and occupancy expenses, the establishment of and further contributions
to Spread Accounts, and income taxes. As a result, the Company has been
dependent on its warehouse lines of credit to purchase Contracts, and on the
availability of capital from outside sources in order to finance its continued
operations. As of the date of this report, the Company is not party to any
warehouse line of credit, and did not receive any material releases of cash from
Spread Accounts from June 1998 through October 1999. The inability to borrow and
the lack of releases have resulted in a liquidity deficiency. The Company has
begun to remedy that deficiency, as is discussed below following a review of the
operating sources and uses of cash for the nine month period ended September 30,
1999.
-10-
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Net cash used in operating activities was $7.8 million during the nine
month period ended September 30, 1999, compared to $45.2 million for the nine
month period ended September 30, 1998. Net cash deposited into trusts was $12.4
million, a decrease of $51.5 million, or 80.6%, over net cash deposited into
trusts in the nine month period ended September 30, 1998.
During the nine month period ended September 30, 1999, the Company did
not complete a securitization transaction, and therefore, did not use any cash
for initial deposits to Spread Accounts, compared to $36.3 million used during
the nine month period ended September 30, 1998. Cash used for subsequent
deposits to Spread Accounts for the nine month period ended September 30, 1999,
was $21.1 million, a decrease of $23.2 million, or 52.4%, over cash used for
subsequent deposits to Spread Accounts in the nine month period ended September
30, 1998. Cash released from Spread Accounts for the nine month period ended
September 30, 1999, was $8.7 million, a decrease of $8.0 million, or 47.9%, over
cash released from Spread Accounts in the nine month period ended September 30,
1998. Changes in deposits to and releases from Spread Accounts are affected by
the relative size, seasoning and performance of the various pools of sold
Contracts that make up the Company's Servicing Portfolio.
As of September 30, 1999, 17 of the 21 Trusts had incurred cumulative
net losses as a percentage of the original Contract balance or average
delinquency ratios in excess of the predetermined levels specified in the
respective Servicing Agreements. Accordingly, pursuant to the Servicing
Agreements, the specified levels applicable to the Company's Spread Accounts
were increased. Due to cross collateralization provisions of the Servicing
Agreements, the increased specified levels have been applicable to 19 of the
Company's 21 Trusts. The higher requisite Spread Account levels ranged from 30%
of the outstanding principal balance of the Certificates issued by the related
Trusts up to an unlimited amount. In addition to requiring higher Spread Account
levels, the Servicing Agreements provide the Certificate Insurer with certain
other rights and remedies, some of which have been waived on a monthly basis by
the Certificate Insurer. Increased specified levels for the Spread Accounts have
been in effect from time to time in the past, including the entire period from
June 1998 to September 1999. As a result of the increased Spread Account
specified levels and cross collateralization provisions, excess cash flows that
would otherwise have been released to the Company instead were retained in the
Spread Accounts to bring the balance of those Spread Accounts up to a higher
level. Due to the increase in the Spread Account requirements, there were no
significant releases of cash from the Trusts from June 1998 through September
1999. Funding such balance increases has materially increased the Company's
capital requirements, while the absence of cash releases has materially
decreased its liquidity. As a result of the increased specified levels
applicable to the Spread Accounts, approximately $51.0 million of cash that
would otherwise have been available to the Company had been delayed and retained
in the Spread Accounts as of September 30, 1999. A portion of such cash was
subsequently released to the Company, as discussed below.
The acquisition of Contracts for subsequent sale in securitization
transactions, and the need to fund Spread Accounts 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 (other
than flow purchases, discussed below) the required level of initial Spread
Account deposits, and the extent to which the Spread Accounts either release
cash to the Company or capture cash from collections on sold Contracts. As noted
above, the absence of any significant releases of cash from Spread Accounts
since June 1998 had materially impaired the Company's ability to meet such
capital requirements. To reduce its capital requirements and to meet those
requirements, the Company in November 1998 began to implement a three-part plan:
the plan includes (i) issuance of debt and equity securities, (ii) agreements
with the Certificate Insurer to reduce the level of initial Spread Account
deposits, and to reduce the maximum levels of the Spread Accounts, and (iii) a
reduction in the rate of Contract purchases.
As the first step in the plan, the Company in November 1998 and April
1999 issued $25.0 million and $5.0 million, respectively, of subordinated
promissory notes (collectively, the "LLCP Notes"), to Levine Leichtman Capital
Partners, L.P. ("LLCP"). The LLCP Notes are due in 2004, and bear interest at
the rate of 14.5% per annum. Net proceeds received from the issuances were
approximately $28.5 million. In conjunction with the LLCP Notes, the Company
issued warrants to purchase up to 4,450,000 shares of common stock at $0.01 per
share, 3,115,000 and 1,334,000 of which were exercised in April 1999 and May
1999, respectively. The effective cost of this new capital represents a material
increase in the cost of capital to the Company. As part of the agreements for
issuance of the LLCP Notes, Stanwich Financial Services Corp. ("SFSC") agreed to
purchase an additional $15.0 million of notes (at least $7.5 million by July 31,
1999 and the remainder by August 31, 1999), and the Company agreed to sell such
notes. The chairman and the president of the Company are the principal
shareholders of SFSC, and the Company's chairman is the chief executive officer
of SFSC. The terms of such additional notes are to be not less favorable to the
Company than (i) those that would be available in a transaction with a
non-affiliate, and (ii) those applicable to the LLCP Notes. Sale of such
additional notes would likely therefore involve some degree of equity
participation, which could be dilutive to other holders of the Company's common
stock. SFSC's commitment in turn has been collateralized by certain assets
pledged by the chairman of the Company's board of directors and the president of
the Company. Additionally, $5.0 million of the LLCP Notes have been personally
guaranteed by the chairman of the Company's board of directors and the president
of the Company. As of the date of this report, SFSC has purchased $1.5 million
of such additional notes, on the same terms applicable to the LLCP notes, but
subordinated to the LLCP Notes and to the Company's outstanding public debt.
-11-
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Also in November 1998, as the second step in its plan, the Company
reached an agreement with the Certificate Insurer regarding initial cash
deposits. In this agreement, the Certificate Insurer committed to insure
asset-backed securities issued by the Trusts with respect to at least $560.0
million of Contracts, while requiring an initial cash deposit of 3% of
principal. The commitment is subject to underwriting criteria and market
conditions. Of the $560.0 million committed, $310.0 million was used in the
Company's December 1998 securitization transaction. The Company's agreement with
the Certificate Insurer also required that the Company issue to the Certificate
Insurer or its designee warrants to purchase 2,525,114 shares of the Company's
common stock at $3.00 per share, exercisable through the fifth anniversary of
the warrants' issuance. The number of shares issuable is subject to standard
anti-dilution adjustments.
The Company has entered into an amendment agreement (the "Amendment"),
which fixes the amount of cash to be retained in the Spread Accounts for 19 of
the Company's 21 securitization Trusts. The amended level is 21% of the
outstanding principal balance of the Certificates issued by such Trusts,
computed on a pool by pool basis. The 21% level is subject to adjustment to
reflect overcollateralization, and with respect to older Trusts that have
amortized the Certificate balance to the extent that minimum levels are
applicable.
In the event of certain defaults by the Company, the specified level
applicable to such Spread Accounts could increase to an unlimited amount, but
such defaults are narrowly defined, and the Company does not anticipate
suffering such defaults. The Amendment by its terms is applicable from September
1999 onward, and on November 3, 1999, the necessary signatures and conditions
were satisfied to make the Amendment effective. The Company on November 4, 1999,
received its first material release of cash from the securitized portfolio
pursuant to the terms of the Amendment. The releases of cash are expected to
continue and to vary in amount from month to month. There can be no assurance
that such releases of cash will continue in the future.
As a third part of its plan, the Company reduced its planned level of
Contract purchases initially to not more than $200.0 million per quarter
beginning November 1998. In the first quarter of 1999, the Company purchased
$158.0 million of Contracts. During the second quarter of 1999, the Company
purchased $59.1 million of Contracts, of which $20.3 million was on a flow
basis, as discussed below. During the third quarter of 1999, the Company
purchased $89.6 million of Contracts, all of which was on a flow basis, and
expects to purchase Contracts only on a flow basis in the remainder of 1999. The
reduction in the amount of Contracts purchased for the Company's own account has
materially reduced the Company's capital requirements.
Since late May 1999, the Company has purchased Contracts from Dealers
without use of warehouse lines of credit, in a "flow purchase" arrangement with
a third party. Under the flow purchase arrangement, the Company purchases
Contracts from Dealers and sells such Contracts outright to the third party.
Purchase of Contracts on a flow basis, as compared with purchase of
Contracts for the Company's own account, has materially reduced the Company's
cash requirements. The Company's plan for meeting its immediate liquidity needs
is (1) to increase the quantity of Contracts that it purchases and sells on a
flow basis, thus increasing the fees that it receives in connection with such
purchases and sales, and (2) to continue to receive releases of cash from its
Spread Accounts, pursuant to the Amendment, which became effective on November
3, 1999. There can be no assurance that this plan will be successful.
During the second and third quarters, the Company sold, on a servicing
released basis, $318.0 million of its Contracts held for sale. The remaining
Contracts held for sale represent Contracts that did not meet the criteria for
the various sales occurring in the second and third quarters. The Company's
ability to increase the quantity of Contracts that it purchases and sells on a
flow basis will be subject to general competitive conditions and other factors.
Although the Company has continued to increase the amount of Contracts purchased
and sold on a flow basis, there can be no assurance that the current level of
flow production can be maintained or increased.
Obtaining release of cash from the Spread Accounts is dependent on
collections from the related Trusts generating sufficient cash in excess of the
amended specified levels. There can be no assurance that collections from the
related trusts will generate cash in excess of the amended specified levels.
(8) COMMITMENTS AND CONTINGENCIES
On July 22, 1999, Bank of America commenced a lawsuit against the
Company in the Superior Court of California, Orange County, seeking repayment of
approximately $3 million advanced to the Company under an overdraft line of
credit, plus interest, costs and attorneys' fees. The Company and Bank of
America have entered into a settlement agreement, pursuant to which the Company
shall repay all amounts owing, in specified installments through November 1999.
The Company is in compliance with the settlement agreement as of the date of
this report.
-12-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Consumer Portfolio Services, Inc. and its subsidiaries (collectively,
the "Company") primarily engage in the business of purchasing, selling and
servicing retail automobile installment sale contracts ("Contracts") originated
by automobile dealers ("Dealers") located throughout the United States. In
recent months, the Company has suspended its solicitation of Contract purchases
in 20 states, and as of the date of this report is active in 29 states. There
can be no assurance as to resumption of Contract purchasing activities in other
states. Through its purchase of Contracts, the Company provides indirect
financing to Dealer customers with limited credit histories, low incomes or past
credit problems, who generally would not be expected to qualify for financing
provided by banks or by automobile manufacturers' captive finance companies.
The major components of the Company's revenue are gains or losses
recognized on the sale or securitization of its Contracts, servicing fees earned
on Contracts sold in securitizations, interest earned on Contracts held for
sale, and fees earned upon sale of Contracts that were purchased on a flow
basis. Because the servicing fees are dependent in part on the collections
received on sold Contracts, the Company's income is affected by losses incurred
on Contracts, whether such Contracts are held for sale or have been sold in
securitizations.
The Company has purchased Contracts with the primary intention of
reselling them in securitization transactions as asset-backed securities. From
late May 1999 to the present, the Company has purchased Contracts on a flow
basis for a third party; that is, the Company purchases a Contract from a
Dealer, and sells the Contract the next day to the third party for the same
price the Company paid. The Company also receives from the third party a fee for
its services. The Company retains no interest in such Contracts, and neither
services such Contracts nor earns a servicing fee. Although the Company has been
unable to sell Contracts in a securitization transaction since December 1998, it
does plan to securitize in the future, as to which there can be no assurance.
The Company's securitization structure has been as follows:
First, the Company sells a portfolio of Contracts to a wholly owned
subsidiary ("SPS"), which has been established for the limited purpose of buying
and reselling the Company's Contracts. The SPS then transfers the same Contracts
to either a grantor trust or an owner trust (the "Trust"). The Trust in turn
issues interest-bearing asset-backed securities (the "Certificates"), generally
in a principal amount equal to the aggregate principal balance of the Contracts.
The Company typically sells these Contracts to the Trust at face value and
without recourse, except that representations and warranties similar to those
provided by the Dealer to the Company are provided by the Company to the Trust.
One or more investors purchase the Certificates issued by the Trust; the
proceeds from the sale of the Certificates are then used to purchase the
Contracts from the Company. The Company purchases a financial guaranty insurance
policy, guaranteeing timely payment of principal and interest on the senior
Certificates, from an insurance company (the "Certificate Insurer"). In
addition, the Company provides a credit enhancement for the benefit of the
Certificate Insurer and the investors in the form of an initial cash deposit to
an account ("Spread Account") held by the Trust. The agreements governing the
securitization transactions (collectively referred to as the "Servicing
Agreements") require that the initial deposits to the Spread Accounts be
supplemented by a portion of collections from the Contracts until the Spread
Accounts reach specified levels, and then maintained at those levels. The
specified levels are generally computed as a percentage of the principal amount
remaining unpaid under the related Certificates. The specified levels at which
the Spread Accounts are to be maintained will vary depending on the performance
of the portfolios of Contracts held by the Trusts and on other conditions, and
may also be varied by agreement among the Company, the SPS, the Certificate
Insurer and the trustee. Such levels have increased and decreased from time to
time based on performance of the portfolios, and have also been varied by
agreement. The specified levels applicable to the Company's sold pools increased
materially in 1998. Effective November 3, 1999, as applied to monthly
measurement dates from September 1999 onward, the specified levels have
decreased, as is discussed under the heading "Liquidity and Capital Resources."
-13-
At the closing of each securitization, the Company removes from its
consolidated balance sheet the Contracts held for sale and adds to its
consolidated balance sheet (i) the cash received and (ii) the estimated fair
value of the ownership interest that the Company retains in the Contracts sold
in the securitization. That retained interest (the "Residual") consists of (a)
the cash held in the Spread Account and (b) the net interest receivables
("NIRs"). NIRs represent the estimated discounted cash flows to be received by
the Trust in the future, net of principal and interest payable with respect to
the Certificates, and certain expenses. The excess of the cash received and the
assets retained by the Company over the carrying value of the Contracts sold,
less transaction costs, equals the net gain on sale of Contracts recorded by the
Company.
The Company allocates its basis in the Contracts between the
Certificates and the Residuals retained based on the relative fair values of
those portions on the date of the sale. The Company recognizes gains or losses
attributable to the change in the fair value of the Residuals, which are
recorded at estimated fair value and accounted for as "held-for-trading"
securities. The Company is not aware of an active market for the purchase or
sale of interests such as the Residuals, and accordingly, the Company determines
the estimated fair value of the Residuals by discounting the amount and timing
of anticipated cash flows released from the Spread Account (the cash out
method), using a discount rate that the Company believes is appropriate for the
risks involved. For that valuation, the Company has used an effective discount
rate of approximately 14% per annum.
The Company receives periodic base servicing fees for the servicing and
collection of the Contracts. In addition, the Company is entitled to the cash
flows from the Residuals that represent collections on the Contracts in excess
of the amounts required to pay principal and interest on the Certificates, the
base servicing fees, and certain other fees (such as trustee and custodial
fees). At the end of each collection period, the aggregate cash collections from
the Contracts are allocated first to the base servicing fees and certain other
fees such as trustee and custodial fees for the period, then to the
Certificateholders for interest at the pass-through rate on the Certificates
plus principal as defined in the Servicing Agreements. If the amount of cash
required for the above allocations exceeds the amount collected during the
collection period, the shortfall is drawn from the Spread Account. If the cash
collected during the period exceeds the amount necessary for the above
allocations, and there is no shortfall in the related Spread Account, the excess
is released to the Company, or in certain cases is transferred to other Spread
Accounts that may be below their specified levels. Pursuant to certain Servicing
Agreements, excess cash collected during the period is used to make accelerated
principal paydowns on certain Certificates to create over-collateralization,
that is, to reduce the aggregate principal balance of outstanding Certificates
below the aggregate principal amount of the related automotive receivables. If
the Spread Account balance is not at the required credit enhancement level, then
the excess cash collected is retained in the Spread Account until the specified
level is achieved. The cash in the Spread Accounts is restricted from use by the
Company. Cash held in the various Spread Accounts is invested in high quality,
liquid investment securities, as specified in the Servicing Agreements. Spread
Account balances are held by the Trusts on behalf of the Company as the owner of
the Residuals.
The annual percentage rate payable on the Contracts is significantly
greater than the rates payable on the Certificates. Accordingly, the Residuals
described above are a significant asset of the Company. In determining the value
of the Residuals described above, the Company must estimate the future rates of
prepayments, delinquencies, defaults and default loss severity as they affect
the amount and timing of the estimated cash flows. The Company estimates
prepayments by evaluating historical prepayment performance of comparable
Contracts and the effect of trends in the industry. The Company has used a
constant prepayment estimate of approximately 4% per annum. The Company
estimates defaults and default loss severity using available historical loss
data for comparable Contracts and the specific characteristics of the Contracts
purchased by the Company. In valuing the Residuals, the Company estimates that
losses as a percentage of the original principal balance will total
approximately 14% cumulatively over the lives of the related Contracts.
In future periods, the Company could recognize additional revenue from
the Residuals if the actual performance of the Contracts were to be better than
originally estimated, or the Company could increase the estimated fair value of
the Residuals. If the actual performance of the Contracts were to be worse than
the original estimate, then a downward adjustment to the carrying value of the
Residuals would be required. Due to the inherent uncertainty of the future
performance of the underlying Contracts, the Company has established a provision
for future losses on the Residuals.
-14-
The structure described above is applicable to securitization
transactions conducted at least once quarterly from June 1994 through December
1998. The Company did not sell any Contracts in securitization transactions
during the nine month period ended September 30, 1999, and there can be no
assurance as to when it will next sell Contracts using the structure described
above.
During the nine months ended September 30, 1999, the Company has
changed its basic system of doing business. Previously, the Company would
acquire Contracts for its own account, borrowing from 88% to 97% of the
principal balance of such Contracts under "warehouse" lines of credit.
Periodically (approximately once every quarter) the Company would then sell most
or all of the recently acquired Contracts in a securitization transaction as
described above. In such a sale, the Company would retain (1) a residual
ownership interest in the Contracts sold, (2) the obligation to service the
Contracts sold, and (3) the right to receive servicing fees. At the end of March
1999, the Company learned that it would be unable to sell Contracts in
securitization transactions for an indeterminate period. Accordingly, the
Company commenced purchasing Contracts for immediate re-sale to a third party,
which third party purchases the Contracts in turn on a daily basis. In this
arrangement, the Company retains no residual interest in the Contracts, has no
servicing obligation, and receives no servicing fee. For its services in
acquiring Contracts for purchase, the Company receives a per-Contract fee from
the third party.
RESULTS OF OPERATIONS
The three month period ended September 30, 1999 compared to the three month
- ---------------------------------------------------------------------------
period ended September 30, 1998
- -------------------------------
REVENUES. During the three months ended September 30, 1999, revenues
decreased $43.8 million, or 126.6%, compared to the three month period ended
September 30, 1998. Gain on sale of Contracts decreased by $25.0 million, or
163.5%, from a $15.3 million gain on sale in the third quarter of 1998 to a $9.7
million loss in the third quarter of 1999. The change in gain on sale from
positive to negative is due to the Company selling Contracts only on a servicing
released basis and thus not recording any NIR gains during the period, as well
as to selling Contracts at a loss. During the three month period ended September
30, 1999, the Company sold $83.8 million of Contracts on a servicing released
basis, that is, with no residual interest retained, with no servicing
obligation, and with no right to receive a servicing fee. Those sales resulted
in a net loss of approximately $11.3 million. Expenses of approximately $576,000
were incurred related to previous securitization transactions, including the
amortization of a warrant issued to the Certificate Insurer in November 1998. In
addition, for the three month periods ended September 30, 1999 and 1998, the
Company charged against gain on sale $2.3 million and $2.9 million,
respectively, of provision for losses on Contracts held for sale.
Interest income decreased by $17.4 million, or 144.1%, from positive
interest income of $12.1 million in the third quarter of 1998 to negative
interest income of $5.3 million in the third quarter of 1999. Interest income
consists of interest earned on Contracts held for sale and residual interest
income earned on the Company's securitized portfolio, and is offset by
amortization of the NIRs. The principal factors leading to the decrease in
interest income were that the Company held fewer Contracts for sale, which
reduces interest earned on such Contracts, and that the Company did not, in the
most recent quarter, securitize any Contracts. It has been the Company's
experience that residual interest income is greatest early in the term of a
securitized pool. An increase in the amortization of NIRs in accordance with the
seasoning of the underlying securitized pools, as compared to the same period in
the prior year, also had an adverse effect on interest income. Due to the
absence of new pools of securitized Contracts that could be expected to
contribute materially to residual interest income, and a further decrease in
Contracts held for sale, interest income can be expected to decrease further in
future quarters.
Servicing fees decreased by approximately $611,000, or 8.9%, and
represented 68.3% of total revenues. The decrease in servicing fees is due to
the decrease in the servicing portfolio. As of September 30, 1999, the Company
was earning servicing fees on 101,383 sold Contracts with aggregate outstanding
principal balances approximating $948.0 million, compared to 110,945 Contracts
with aggregate outstanding principal balances approximating $1,175.7 million as
of September 30, 1998. In addition to the $948.0 million in sold Contracts, on
which servicing fees were earned, the Company was holding for sale and servicing
an additional $7.1 million in Contracts, for an aggregate total servicing
-15-
portfolio of $955.1 million. The Company is not currently acquiring Contracts
for its servicing portfolio. In addition, those Contracts that remain in the
Company's servicing portfolio are self-amortizing, and the aggregate principal
balance of the servicing portfolio therefore decreases over time. Accordingly,
the Company expects that its servicing portfolio will continue to decrease, and
that servicing fees to be earned will therefore also decrease, at least through
the remainder of 1999, and until such time as the Company is again acquiring
Contracts for its own servicing portfolio. There can be no assurance as to when
the Company may be able to do so.
EXPENSES. During the three month period ended September 30, 1999,
operating expenses decreased $4.5 million, or 18.8%, compared to the three month
period ended September 30, 1998. Employee costs decreased by $1.3 million, or
15.3%, and represented 36.5% of total operating expenses. The decrease is due to
reductions in staff in accordance with the decrease in the Company's servicing
portfolio and originations volume. General and administrative expenses decreased
by $2.3 million, or 35.5%, and represented 21.1% of total operating expenses.
Interest expense decreased approximately $46,000, or 0.8%, and
represented 30.6% of total operating expenses. See "Liquidity and Capital
Resources." The decrease is primarily due to the decrease in the Company's
warehouse lines of credit and reduction of the principal balance of senior
secured debt (the "Senior Secured Line"). The warehouse lines of credit were
paid down in their entirety as of September 30, 1999, compared to an outstanding
balance of $286.6 million at September 30, 1998. The outstanding balance of the
Senior Secured Line was $29.6 million at September 30, 1999, compared to $33.0
million at September 30, 1998.
The Company expects to hold for sale fewer Contracts in the remainder
of 1999 and the first part of 2000 than it held, on average, through the first
three quarters of 1999, which would be expected to result in a decrease in
interest earned on Contracts held for sale, and a decrease in interest expense
incurred. Beyond the first two quarters of 2000, it is not possible to estimate
the quantity of Contracts that the Company may hold for sale.
The nine month period ended September 30, 1999, compared to the nine month
- --------------------------------------------------------------------------
period ended September 30, 1998
- -------------------------------
REVENUES. During the nine months ended September 30, 1999, revenues
decreased $64.1 million, or 71.9%, compared to the nine month period ended
September 30, 1998. Net gain on sale of Contracts decreased by $50.8 million, or
146.6%, for the nine month period ended September 30, 1999. The change in gain
on sale from positive to negative is due to the Company selling Contracts only
on a servicing released basis and thus not recording any NIR gains during the
period, as well as to selling Contracts at a loss. During the nine month period
ended September 30, 1999, the Company sold $318.0 million of Contracts on a
servicing released basis, resulting in a loss of $17.6 million.
Interest income decreased by $15.6 million, or 43.9%, and represented
80.0% of total revenues for the nine month period ended September 30, 1999. The
decrease is primarily due to a lower average balance of Contracts held for sale,
decrease in residual interest income primarily due to the absence of any new
securitizations, and an increase in the amortization of NIRs during the nine
month period ending September 30, 1999.
Servicing fees increased by $4.3 million, or 24.3%, and represented
88.9% of total revenues. The increase in servicing fees is due to the increase
in the Company's average servicing portfolio over the prior year's period.
EXPENSES. During the nine month period ended September 30, 1999,
operating expenses increased $10.7 million, or 18.4%, compared to the nine month
period ended September 30, 1998. Employee costs increased by $2.5 million, or
12.0%, and represented 33.5% of total operating expenses. The increase is due to
the fact that on average, there were more staff on hand for the nine month
period ended September 30, 1999, than in the same period in the prior year. The
higher staff levels were necessary to accommodate the increase in the Company's
average servicing portfolio during the first two quarters of 1999. General and
administrative expenses decreased by $1.3 million, or 8.0%, and represented
21.2% of total operating expenses. The decrease in general and administrative
expenses is primarily due to decreases in telecommunications, stationery, credit
reports and other related items as a result of the decrease in the Company's
originations volume.
-16-
Interest expense increased $9.1 million, or 62.8%, and represented
34.1% of total operating expenses. See "Liquidity and Capital Resources." The
increase is primarily due to the interest paid on an additional $35.0 million in
subordinated debt securities and amounts borrowed under the Senior Secured Line.
Most of such debt was issued by the Company at various times after September 30,
1998, or had a higher outstanding balance during 1999. Interest expense has also
been increased by the Company being required to pay higher interest rates on
borrowed money in the current period, as compared with the prior year's period.
LIQUIDITY AND CAPITAL RESOURCES
The Company's business requires substantial cash to support its
operating activities. The Company's primary sources of cash from operating
activities have been proceeds from the sales of Contracts, amounts borrowed
under its various warehouse lines, servicing fees on portfolios of Contracts
previously sold, proceeds from the sales of Contracts, customer payments of
principal and interest on Contracts held for sale, fees for origination of
Contracts, and releases of cash from Spread Accounts. The Company's primary uses
of cash have been the purchases of Contracts, repayment of amounts borrowed
under its various warehouse lines, operating expenses such as employee,
interest, and occupancy expenses, the establishment of and further contributions
to Spread Accounts, and income taxes. As a result, the Company has been
dependent on its warehouse lines of credit to purchase Contracts, and on the
availability of capital from outside sources in order to finance its continued
operations. As of the date of this report, the Company is not party to any
warehouse line of credit, and did not receive any material releases of cash from
Spread Accounts from June 1998 through October 1999. The inability to borrow and
the lack of releases have resulted in a liquidity deficiency. The Company has
begun to remedy that deficiency, as is discussed below following a review of the
operating sources and uses of cash for the nine month period ended September 30,
1999.
Net cash used in operating activities was $7.8 million during the nine
month period ended September 30, 1999, compared to $45.2 million for the nine
month period ended September 30, 1998. Net cash deposited into trusts was $12.4
million, a decrease of $51.5 million, or 80.6%, over net cash deposited into
trusts in the nine month period ended September 30, 1998.
During the nine month period ended September 30, 1999, the Company did
not complete a securitization transaction, and therefore, did not use any cash
for initial deposits to Spread Accounts, compared to $36.3 million used during
the nine month period ended September 30, 1998. Cash used for subsequent
deposits to Spread Accounts for the nine month period ended September 30, 1999,
was $21.1million, a decrease of $23.2million, or 52.4%, from cash used for
subsequent deposits to Spread Accounts in the nine month period ended September
30, 1998. Cash released from Spread Accounts for the nine month period ended
September 30, 1999, was $8.7 million, a decrease of $8.0 million, or 47.9%, from
cash released from Spread Accounts in the nine month period ended September 30,
1998. Changes in deposits to and releases from Spread Accounts are affected by
the relative size, seasoning and performance of the various pools of sold
Contracts that make up the Company's Servicing Portfolio.
As of September 30, 1999, 17 of the 21 Trusts had incurred cumulative
net losses as a percentage of the original Contract balance or average
delinquency ratios in excess of the predetermined levels specified in the
respective Servicing Agreements. Accordingly, pursuant to the Servicing
Agreements, the specified levels applicable to the Company's Spread Accounts
were increased. Due to cross collateralization provisions of the Servicing
Agreements, the increased specified levels have been applicable to 19 of the
Company's 21 Trusts. The higher requisite Spread Account levels ranged from 30%
of the outstanding principal balance of the Certificates issued by the related
Trusts up to an unlimited amount. In addition to requiring higher Spread Account
levels, the Servicing Agreements provide the Certificate Insurer with certain
other rights and remedies, some of which have been waived on a monthly basis by
the Certificate Insurer. Increased specified levels for the Spread Accounts have
been in effect from time to time in the past, including the entire period from
-17-
June 1998 to September 1999. As a result of the increased Spread Account
specified levels and cross collateralization provisions, excess cash flows that
would otherwise have been released to the Company instead were retained in the
Spread Accounts to bring the balance of those Spread Accounts up to a higher
level. Due to the increase in the Spread Account requirements, there were no
significant releases of cash from the Trusts from June 1998 through September
1999. Funding such balance increases has materially increased the Company's
capital requirements, while the absence of cash releases has materially
decreased its liquidity. As a result of the increased specified levels
applicable to the Spread Accounts, approximately $51.0 million of cash that
would otherwise have been available to the Company had been delayed and retained
in the Spread Accounts as of September 30, 1999. A portion of such cash was
subsequently released to the Company, as discussed below.
The acquisition of Contracts for subsequent sale in securitization
transactions, and the need to fund Spread Accounts 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 (other
than flow purchases), the required level of initial credit enhancement in
securitizations, and the extent to which the Spread Accounts either release cash
to the Company or capture cash from collections on sold Contracts. As noted
above, the absence of any significant releases of cash from Spread Accounts
since June 1998 has materially impaired the Company's ability to meet such
capital requirements. To reduce its capital requirements and to meet those
requirements, the Company in November 1998 began to implement a three-part plan:
the plan includes (i) issuance of debt and equity securities, (ii) agreements
with the Certificate Insurer to reduce the level of initial Spread Account
deposits, and to reduce the maximum levels of the Spread Accounts, and (iii) a
reduction in the rate of Contract purchases.
As the first step in the plan, the Company in November 1998 and April
1999 issued $25.0 million and $5.0 million, respectively, of subordinated
promissory notes (collectively, the "LLCP Notes"), to Levine Leichtman Capital
Partners, L.P. ("LLCP"). The LLCP Notes are due in 2004, and bear interest at
the rate of 14.5% per annum. Net proceeds received from the issuances were
approximately $28.5 million. In conjunction with the LLCP Notes, the Company
issued warrants to purchase up to 4,450,000 shares of common stock at $0.01 per
share, 3,115,000 and 1,334,000 of which were exercised in April 1999 and May
1999, respectively. The effective cost of this new capital represents a material
increase in the cost of capital to the Company. As part of the agreements for
issuance of the LLCP Notes, Stanwich Financial Services Corp. ("SFSC") agreed to
purchase an additional $15.0 million of notes (at least $7.5 million by July 31,
1999, and the remainder by August 31, 1999), and the Company agreed to sell such
notes. The chairman and the president of the Company are the principal
shareholders of SFSC, and the Company's chairman is the chief executive officer
of SFSC. The terms of such additional notes are to be not less favorable to the
Company than (i) those that would be available in a transaction with a
non-affiliate, and (ii) those applicable to the LLCP Notes. Sale of such
additional notes would likely therefore involve some degree of equity
participation, which could be dilutive to other holders of the Company's common
stock. SFSC's commitment in turn has been collateralized by certain assets
pledged by the chairman of the Company's board of directors and the president of
the Company. Additionally, $5.0 million of the LLCP Notes have been personally
guaranteed by the chairman of the Company's board of directors and the president
of the Company. As of the date of this report, SFSC has purchased $1.5 million
of such additional notes, on the same terms applicable to the LLCP Notes, but
subordinated to the LLCP Notes and to the Company's outstanding public debt.
Also in November 1998, as the second step in its plan, the Company
reached an agreement with the Certificate Insurer regarding initial cash
deposits. In this agreement, the Certificate Insurer committed to insure
asset-backed securities issued by the Trusts with respect to at least $560.0
million of Contracts, while requiring an initial cash deposit of 3% of
principal. The commitment is subject to underwriting criteria and market
conditions. Of the $560.0 million committed, $310.0 million was used in the
Company's December 1998 securitization transaction. The Company's agreement with
the Certificate Insurer also required that the Company issue to the Certificate
Insurer or its designee warrants to purchase 2,525,114 shares of the Company's
common stock at $3.00 per share, exercisable through the fifth anniversary of
the warrants' issuance. The number of shares issuable is subject to standard
anti-dilution adjustments.
-18-
The Company has entered into an amendment agreement (the "Amendment"),
which fixes the amount of cash to be retained in the Spread Accounts for 19 of
the Company's 21 securitization Trusts. The amended level is 21% of the
outstanding principal balance of the Certificates issued by such Trusts,
computed on a pool by pool basis. The 21% level is subject to adjustment to
reflect overcollateralization, and with respect to older Trusts that have
amortized the Certificate balance to the extent that minimum levels are
applicable.
In the event of certain defaults by the Company, the specified level
applicable to such Spread Accounts could increase to an unlimited amount, but
such defaults are narrowly defined, and the Company does not anticipate
suffering such defaults. The Amendment by its terms is applicable from September
1999 onward, and on November 3, 1999, the necessary signatures and conditions
were satisfied to make the Amendment effective. The Company on November 4, 1999,
received its first material release of cash from the securitized portfolio
pursuant to the terms of the Amendment. The releases of cash are expected to
continue and to vary in amount from month to month. There can be no assurance
that such releases of cash will continue in the future.
As a third part of its plan, the Company reduced its planned level of
Contract purchases initially to not more than $200.0 million per quarter
beginning November 1998. In the first quarter of 1999, the Company purchased
$158.0 million of Contracts. During the second quarter of 1999, the Company
purchased $59.1 million of Contracts, of which $20.3 million was on a flow
basis, as discussed below. During the third quarter of 1999, the Company
purchased $89.6 million of Contracts, all of which was on a flow basis, and
expects to purchase Contracts only on a flow basis for the remainder of 1999,
and until the Company is able to identify appropriate sources of capital to
acquire and hold Contracts for the Company's own account. The reduction in the
amount of Contracts purchased for the Company's own account has materially
reduced the Company's capital requirements.
Since late May 1999, the Company has purchased Contracts from Dealers
without use of warehouse lines of credit, in a "flow purchase" arrangement with
a third party. Under the flow purchase arrangement, the Company purchases
Contracts from Dealers and sells such Contracts outright to the third party.
Purchase of Contracts on a flow basis, as compared with purchase of
Contracts for the Company's own account, has materially reduced the Company's
cash requirements. The Company's plan for meeting its immediate liquidity needs
is (1) to increase the quantity of Contracts that it purchases and sells on a
flow basis, thus increasing the fees that it receives in connection with such
purchases and sales, and (2) to continue to receive releases of cash from its
Spread Accounts, pursuant to the Amendment, which became effective on November
3, 1999. There can be no assurance that this plan will be successful.
During the second and third quarters, the Company sold, on a servicing
released basis, $318.0 million of its Contracts held for sale. The remaining
Contracts held for sale represent Contracts that did not meet the criteria for
the various sales occurring in the second and third quarters. The Company's
ability to increase the quantity of Contracts that it purchases and sells on a
flow basis will be subject to general competitive conditions and other factors.
Although the Company has continued to increase the amount of Contracts purchased
and sold on a flow basis, there can be no assurance that the current level of
flow production can be maintained or increased.
Obtaining release of cash from the Spread Accounts is dependent on
collections from the related Trusts generating sufficient cash in excess of the
amended specified levels. There can be no assurance that collections from the
related trusts will generate cash in excess of the amended specified levels.
-19-
YEAR 2000
OVERVIEW. The Year 2000 issue is predicated on the concept that some
database files may contain date fields that will not support century functions
and that some programs may not support century functions even if the date fields
are present. With the change of millennium, the inability to properly process
century functions may create halts or sort/calculation errors within programs
that use century information in calculation and functions.
The Company predominantly uses accounting and installment loan
application processing software against defined relational database files. Most
financial software has long ago been forced to deal with a four byte date field
due to long term maturity dates, bond yield calculations and mortgage
amortization schedules. The Company has been cognizant of Year 2000
considerations since late 1994, when contracts with maturity dates in the year
2000 were first purchased.
PLAN. The Company's plan to assess the Year 2000 issue consists of a
three-phase process. The first phase of the process, which has been completed,
consisted of assessing all user programs of the Company's mainframe computer.
Those user programs that were not compliant were either corrected or the
necessary software patches have been identified and ordered. There were no
critical user programs identified that could not be modified to be compliant. In
addition, the Company's mainframe computer's operating system was also tested
and was deemed to be compliant as well.
The second phase of the Company's testing consisted of testing all
personal computers for compliance. An outside specialist was engaged to
administer the testing of hardware and software. This testing was completed in
April 1999. Corrective measures have been put into place for any personal
computer and its software not in compliance at that time.
The third and final phase consisted of identifying key vendors of the
Company's operations and requesting that those vendors complete a Year 2000
compliance questionnaire. The Company has collected and confirmed the Y2K
readiness of key vendors. In addition, the Company has established back-up
vendors should the primary vendors have temporary work stoppages.
COSTS. As the majority of the testing was performed internally by the
Company's information systems department, the Company estimates the costs to
complete all phases of testing, including any necessary modifications, to be
insignificant to the results of operations.
At this time, the risks associated with the Company's Year 2000 issues
internally have been identified and corrected. Through the Company's plan of
analysis and identification, it expects to identify substantially all of its
Year 2000 related risks. Although the risks have not been completely identified,
the Company believes that the most realistic worst case scenario would be that
the Company would suffer from full or intermittent power outages at some or all
of its locations. Depending upon the locations affected and estimated duration,
this would entail recovery of the main application server systems at other
locations and or move to manual processes. Manual processes have been developed
as part of the overall contingency plan. In relation to this, complete system
data dumps are scheduled to take place prior to the millennium date change to
ensure access to all Company mission critical data should any system not be
accessible for any reason.
FORWARD-LOOKING STATEMENTS
This report on Form 10-Q contains certain "forward-looking statements,"
including, without limitation, the statements to the effect that the Company (i)
plans to securitize Contracts in the future, and (ii) expects that forbearances
and waivers will be granted, and amendments agreed to, with respect to defaults
under existing indebtedness. Such plans and expectations are based on the
Company's assessment of the decisions likely to be made by third parties, over
which the Company has no control.
Specifically, the reader should bear in mind the following
considerations: As to future securitizations, there can be no assurance that the
Company will have the liquidity or capital resources to enable it to post the
reserves required for credit enhancement of such transactions, or that the
securitization markets will be receptive at the time that the Company seeks to
engage in such transactions.
-20-
As to defaults under existing indebtedness, the Company's ability to
cure such defaults and ultimately repay such debt is dependent on the
willingness of the various lenders to agree to a number of waivers and
amendments. Although the lenders under the Senior Secured Line have agreed to
forbear from exercising their remedies with respect to such indebtedness,
provided that the Company meets the payment schedule and other conditions set
forth in such agreement, it is possible that the Company could fail to meet such
terms. Such a possibility could be realized, for example, if the Company were
forced to pay material unexpected expenses during the repayment period specified
in the agreement with the senior secured lenders. Payment of such expenses, in
turn, could leave the Company unable to repay the senior secured lenders on the
agreed schedule. A material decrease in collections on the Company's securitized
portfolio could also result in the Company being unable to meet that schedule.
With respect to the LLCP Notes, the Company, as of the date of this report, is
in negotiations with LLCP (the holder of such Notes) regarding possible waivers
and amendments that would allow the Company to comply fully with the amended
terms. There can be no assurance that such negotiations will result in an
agreement. Although LLCP may agree to grant such waivers
and execute such amendments, its decisions will be determined by LLCP's
evaluation of its own interest, and there can be no assurance that any such
waivers will be granted or amendments agreed to.
In addition to the statements identified above, descriptions of the
Company's business and activities set forth in this report and in other past and
future reports and announcements by the Company may contain forward-looking
statements and assumptions regarding the future activities and results of
operations of the Company. Actual results may be adversely affected by various
factors including the following: increases in unemployment or other changes in
domestic economic conditions which adversely affect the sales of new and used
automobiles and may result in increased delinquencies, foreclosures and losses
on Contracts; adverse economic conditions in geographic areas in which the
Company's business is concentrated; changes in interest rates, or adverse
changes in the market for securitized receivables pools, either of which could
restrict the Company's ability to obtain cash for new Contract originations and
purchases; increases in the amounts required to be set aside in Spread Accounts
or to be expended for other forms of credit enhancement to support future
securitizations; the unavailability of warehouse lines of credit which the
Company plans to use to accumulate Contracts for securitization transactions;
increased competition from other automobile finance sources; reduction in the
number and amount of acceptable Contracts submitted to the Company by its
automobile Dealer network; changes in government regulations affecting consumer
credit; and other economic, financial and regulatory factors beyond the
Company's control.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
INTEREST RATE RISK
The Company's funding strategy is largely dependent upon acquiring
interest-bearing assets (the Contracts), issuing interest bearing asset-backed
securities and incurring debt. Therefore, upward fluctuations in interest rates
may adversely affect the Company's profitability, while downward fluctuations
may improve the Company's profitability. The Company uses several strategies to
minimize the risk of interest rate fluctuations, including offering only fixed
rate contracts to obligors, regular sales of auto Contracts to the Trusts, and
pre-funding securitizations, whereby the amount of asset-backed securities
issued in a securitization exceeds the amount of Contracts initially sold to the
Trusts. 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 loans 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 asset-backed securities outstanding. As the Company
has not sold any Contracts in a securitization transaction, all strategies
related to securitizations have not been applied in the current period.
-21-
PART II - OTHER INFORMATION
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Company's having incurred a loss in two consecutive quarters, and
other events, have placed it in default under its Senior Secured Line. The
Company's failure to obtain the $15.0 million of capital committed by SFSC, late
payment of monthly interest of $375,000, and certain other events, have placed
it in default under the LLCP Notes.
The Company has reached an agreement with the lenders under the Senior
Secured Line under which such lenders agree to refrain from exercising their
remedies occasioned by such default, and under which the Company and such
lenders agree to a repayment schedule with respect to all indebtedness under the
Senior Secured Line. Such repayment schedule is somewhat less rapid than the
schedule that was required in the original agreement creating the Senior Secured
Line, and the Company anticipates that it will be able to make all required
payments to the lenders under the Senior Secured Line. There can be no assurance
that the Company will be able to make all such payments as scheduled.
The Company is in discussions with LLCP regarding possible waivers of
defaults and amendments of the existing agreements concerning the LLCP Notes.
There can be no assurance that such discussions will result in waivers or in the
cure of all applicable defaults. Failure to obtain such waivers could have a
material adverse effect on the Company's ability to continue its regular
business operations.
A previously reported default with respect to approximately $69 million
of warehouse indebtedness in favor of General Electric Capital Corporation has
been cured. The Company cured that default by selling, in a series of
transactions in August 1999, substantially all of the collateral securing such
indebtedness. To the extent that such sales yielded proceeds in excess of such
indebtedness, the Company has used such excess to meet a portion of its
liquidity requirements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed as a part of this report:
10.41 Amendment and Forbearance Agreement.
27 Financial Data Schedule
(b) During the quarter for which this report is filed, the Company filed two
reports on Form 8-K. Such reports were dated July 15 and August 15, 1999. Each
was filed solely to include, as an exhibit thereto, Item 7, the Company's
monthly Servicer Report with respect to certain securitization trusts. The
assets of such trusts consist of automotive receivables serviced by the Company.
No financial statements were filed with any of such reports.
-22-
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 15, 1999 /s/ Charles E. Bradley, Jr.
------------------------------------------
Charles E. Bradley, Jr., President and
Chief Executive Officer
(PRINCIPAL EXECUTIVE OFFICER)
Date: November 15, 1999 /s/ James L. Stock
------------------------------------------
James L. Stock, Vice President - Finance
(PRINCIPAL FINANCIAL OFFICER AND PRINCIPAL
ACCOUNTING OFFICER)
-23-
EXHIBIT INDEX
10.41 Amendment and Forbearance Agreement.
27 Financial Data Schedule