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CONSUMER PORTFOLIO SERVICES, INC. - Quarter Report: 2013 September (Form 10-Q)

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

 SQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2013

 

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 incorporation or organization) (IRS Employer Identification No.)
   
19500 Jamboree Road, Irvine, California 92612
(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including Area Code: (949) 753-6800

 

Former name, former address and former fiscal year, if changed since last report: N/A

 

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes  T     No  £

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  T     No  £

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer £     Accelerated Filer £

Non-Accelerated Filer £     Smaller Reporting Company T

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  £    No  T

 

As of October 22, 2013 the registrant had 22,274,010 common shares outstanding.

 

 

 

 
 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

INDEX TO FORM 10-Q

For the Quarterly Period Ended September 30, 2013

 

 

    Page
PART I. FINANCIAL INFORMATION
     
Item 1. Financial Statements 3
     
  Unaudited Condensed Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012 3
     
  Unaudited Condensed Consolidated Statements of Operations for the three-month and nine-month periods ended September 30, 2013 and 2012 4
     
  Unaudited Condensed Consolidated Statements of Comprehensive Income for the three-month and nine-month periods ended September 30, 2013 and 2012 5
     
  Unaudited Condensed Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 2013 and 2012 6
     
  Notes to Unaudited Condensed Consolidated Financial Statements 7
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 24
     
Item 4. Controls and Procedures 48

 

 

 

PART II. OTHER INFORMATION
     
Item 1. Legal Proceedings 49
     
Item 1A. Risk Factors 49
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 51
     
Item 6. Exhibits 52
     
  Signatures 53

 

 

 

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, 
   2013   2012 
ASSETS          
Cash and cash equivalents  $24,128   $12,966 
Restricted cash and equivalents   129,450    104,445 
           
Finance receivables   1,081,282    764,343 
Less: Allowance for finance credit losses   (34,464)   (19,594)
Finance receivables, net   1,046,818    744,749 
           
Finance receivables measured at fair value   21,217    59,668 
Residual interest in securitizations   1,426    4,824 
Furniture and equipment, net   607    726 
Deferred financing costs   11,163    9,140 
Deferred tax assets, net   66,166    75,640 
Accrued interest receivable   15,146    10,411 
Other assets   17,391    15,051 
   $1,333,512   $1,037,620 
           
LIABILITIES AND SHAREHOLDERS' EQUITY          
Liabilities          
Accounts payable and accrued expenses  $33,817   $17,785 
Warehouse lines of credit   26,959    21,731 
Residual interest financing   20,000    13,773 
Debt secured by receivables measured at fair value   16,888    57,107 
Securitization trust debt   1,094,559    792,497 
Senior secured debt, related party   38,963    50,135 
Subordinated renewable notes   20,640    23,281 
    1,251,826    976,309 
COMMITMENTS AND CONTINGENCIES          
Shareholders' Equity          
Preferred stock, $1 par value; authorized 4,998,130 shares; none issued        
Series A preferred stock, $1 par value; authorized 5,000,000 shares; none issued        
Series B preferred stock, $1 par value; authorized 1,870 shares; none issued        
Common stock, no par value; authorized 75,000,000 shares; 22,150,560 and 19,838,913 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively   71,570    65,678 
Retained earnings   15,753    1,270 
Accumulated other comprehensive loss   (5,637)   (5,637)
    81,686    61,311 
           
   $1,333,512   $1,037,620 

 

 

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, 
                 
    2013    2012    2013    2012 
Revenues:                    
Interest income  $60,462   $45,053   $167,426   $127,210 
Servicing fees   700    502    2,484    1,897 
Other income   2,904    2,365    8,284    7,481 
Gain on cancellation of debt           10,947     
    64,066    47,920    189,141    136,588 
                     
Expenses:                    
Employee costs   11,199    8,730    31,675    25,878 
General and administrative   4,074    3,690    12,346    11,765 
Interest   13,853    19,560    44,800    61,696 
Provision for credit losses   20,220    9,465    52,739    22,012 
Provision for contingent liabilities           9,650     
Marketing   3,378    2,906    10,032    8,086 
Occupancy   695    723    1,921    2,170 
Depreciation and amortization   88    118    345    401 
    53,507    45,192    163,508    132,008 
Income before income tax expense   10,559    2,728    25,633    4,580 
Income tax expense   4,686        11,150     
Net income  $5,873   $2,728   $14,483   $4,580 
                     
Earnings per share:                    
Basic  $0.27   $0.14   $0.69   $0.24 
Diluted   0.19    0.11    0.46    0.19 
                     
Number of shares used in computing earnings per share:                    
Basic   21,795    19,495    20,959    19,406 
Diluted   31,217    25,695    31,550    24,026 

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 

.

4
 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
                 
    2013    2012    2013    2012 
                     
Net income  $5,873   $2,728   $14,483   $4,580 
                     
Other comprehensive income/(loss); change in funded status of pension plan                
Comprehensive income  $5,873   $2,728   $14,483   $4,580 

 

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

 

5
 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

   Nine Months Ended 
   September 30, 
   2013   2012 
Cash flows from operating activities:          
Net income  $14,483   $4,580 
Adjustments to reconcile net income to net cash provided by operating activities:          
Accretion of deferred acquisition fees   (15,543)   (11,370)
Accretion of purchase discount on receivables measured at fair value   (1,247)   (7,272)
Amortization of discount on securitization trust debt   53    1,371 
Amortization of discount on senior secured debt, related party   1,681    2,308 
Accretion of premium on debt secured by receivables measured at fair value   2,079    5,552 
Mark to fair value on debt secured by receivables measured at fair value   (933)   1,953
Mark to fair value of receivables measured at fair value   595    (1,824)
Depreciation and amortization   345    401 
Amortization of deferred financing costs   2,874    3,952 
Provision for credit losses   52,739    22,012 
Provision for contingent liabilities   9,650     
Stock-based compensation expense   2,939    801 
Interest income on residual assets       (458)
Gain on cancellation of debt   (10,947)    
Changes in assets and liabilities:          
Accrued interest receivable   (4,735)   (2,387)
Deferred tax assets, net   9,474     
Other assets   680    1,350 
Accounts payable and accrued expenses   6,965    (4,540)
Net cash provided by operating activities   71,152    16,429 
Cash flows from investing activities:          
Purchases of finance receivables held for investment   (592,327)   (400,908)
Payments received on finance receivables held for investment   253,062    226,395 
Payments on receivables portfolio at fair value   39,103    91,865 
Proceeds received on residual interest in securitizations   3,398     
Change in repossessions held in inventory   (3,020)   (221)
Decreases (increases) in restricted cash and cash equivalents, net   (25,005)   51,988 
Purchase of furniture and equipment   (226)   (326)
Net cash used in investing activities   (325,015)   (31,207)
Cash flows from financing activities:          
Proceeds from issuance of securitization trust debt   595,000    443,500 
Proceeds from issuance of subordinated renewable notes   1,380    2,609 
Payments on subordinated renewable notes   (4,021)   (1,834)
Net proceeds from (repayments of) warehouse lines of credit   5,228    (4,995)
Net proceeds from (repayments of) residual interest financing debt   6,227    (8,111)
Repayment of securitization trust debt   (282,044)   (306,540)
Repayment of debt secured by receivables measured at fair value   (41,365)   (97,703)
Repayment of senior secured debt, related party   (12,852)   (6,200)
Payment of financing costs   (4,898)   (5,638)
Repurchase of common stock   (2,484)   (435)
Exercise of options and warrants   4,854    499 
Net cash provided by financing activities   265,025    15,152 
Increase in cash and cash equivalents   11,162    374 
Cash and cash equivalents at beginning of period   12,966    10,094 
Cash and cash equivalents at end of period  $24,128   $10,468 
           
Supplemental disclosure of cash flow information:          
Cash paid during the period for:          
Interest  $41,936   $63,258 
Income taxes  $2,058   $963 
Non-cash financing activities:          
Derivative warrants reclassified from accounts payable to common stock  $583   $1,307 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

6
 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(1) Summary of Significant Accounting Policies

 

Description of Business

 

We were formed in California on March 8, 1991. We specialize in purchasing and servicing retail automobile installment sale contracts (“automobile contracts” or “finance receivables”) originated by licensed motor vehicle dealers located throughout the United States (“dealers”) in the sale of new and used automobiles, light trucks and passenger vans. Through our purchases, we provide indirect financing to dealer customers for borrowers with limited credit histories, low incomes or past credit problems (“sub-prime customers”). We serve as an alternative source of financing for dealers, allowing sales to customers who otherwise might not be able to obtain financing. In addition to purchasing installment purchase contracts directly from dealers, we have also (i) acquired installment purchase contracts in four merger and acquisition transactions, (ii) purchased immaterial amounts of vehicle purchase money loans from non-affiliated lenders, and (iii) lent money directly to consumers for an immaterial amount of loans secured by vehicles. In this report, we refer to all of such contracts and loans as "automobile contracts."

 

Basis of Presentation

 

Our Unaudited Condensed Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America, with the instructions to Form 10-Q and with Article 8 of Regulation S-X of the Securities and Exchange Commission, and include all adjustments that are, in management’s opinion, 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. Results for the nine-month period ended September 30, 2013 are not necessarily indicative of the operating results to be expected for the full year.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted from these Unaudited Condensed Consolidated Financial Statements. These Unaudited Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2012.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of income and expenses during the reported periods. Specifically, a number of estimates were made in connection with determining an appropriate allowance for finance credit losses, valuing finance receivables measured at fair value and the related debt, valuing residual interest in securitizations, accreting net acquisition fees, amortizing deferred costs, valuing stock options and warrants issued, and recording deferred tax assets and reserves for uncertain tax positions. These are material estimates that could be susceptible to changes in the near term and, accordingly, actual results could differ from those estimates.

 

 

7
 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Other Income

 

The following table presents the primary components of Other Income for the three-month and nine-month periods ending September 30, 2013 and 2012:

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2013   2012   2013   2012 
   (In thousands)   (In thousands) 
Direct mail revenues  $1,691   $1,617   $5,418   $4,468 
Convenience fee revenue   720    715    2,235    2,237 
Recoveries on previously charged-off contracts   49    67    153    312 
Sales tax refunds       59    84    186 
Other   444    (93)   394    278 
Other income for the period  $2,904   $2,365   $8,284   $7,481 

 

 

Stock-based Compensation

 

We recognize compensation costs in the financial statements for all share-based payments based on the grant date fair value estimated in accordance with the provisions of ASC 718 “Stock Compensation”.

 

For the nine months ended September 30, 2013 and 2012, we recorded stock-based compensation costs in the amount of $2,939,000 and $801,000, respectively. As of September 30, 2013, unrecognized stock-based compensation costs to be recognized over future periods equaled $13.5 million. This amount will be recognized as expense over a weighted-average period of 3.6 years.

 

The following represents stock option activity for the nine months ended September 30, 2013:

 

   Number of   Weighted   Weighted Average
   Shares   Average   Remaining
   (in thousands)   Exercise Price   Contractual Term
Options outstanding at the beginning of period   8,652   $1.58    N/A
Granted   3,040    7.43    N/A
Exercised   (1,116)   1.52    N/A
Forfeited   (151)   4.64    N/A
Options outstanding at the end of period   10,425   $3.25    6.63 years
              
Options exercisable at the end of period   5,769   $1.95    4.90 years

 

At September 30, 2013, the aggregate intrinsic value of options outstanding and exercisable was $32.5 million and $23.3 million, respectively. There were 1,116,000 options exercised for the nine months ended September 30, 2013 compared to 356,000 for the comparable period in 2012. There were 4.0 million shares available for future stock option grants under existing plans as of September 30, 2013.

 

Purchases of Company Stock

 

During the nine-month period ended September 30, 2013 and 2012, we purchased 323,674 and 320,154 shares, respectively, of our common stock, at average prices of $7.68 and $1.36, respectively.

 

Reclassifications

 

Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications had no effect on prior year net income or total shareholders’ equity.

 

8
 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Derivative Financial Instruments

 

We do not use derivative financial instruments to hedge exposures to cash flow or market risks. However, from 2008 to 2010, we issued warrants to purchase the Company’s common stock in conjunction with various debt financing transactions. At the time of issuance, five of these warrants issued contained "down round," or price reset, features that are subject to classification as liabilities for financial statement purposes. These liabilities were measured at fair value, with the changes in fair value at the end of each period reflected as current period income or loss. Accordingly, changes to the market price per share of our common stock underlying these warrants with "down round," or price reset, features directly affected the fair value computations for these derivative financial instruments. The effect was that any increase in the market price per share of our common stock would also increase the related liability, which in turn would result in a current period loss. Conversely, any decrease in the market price per share of our common stock would also decrease the related liability, which in turn would result in a current period gain. We used a binomial pricing model to compute the fair value of the liabilities associated with the outstanding warrants. In computing the fair value of the warrant liabilities at the end of each period, we used significant judgments with respect to the risk free interest rate, the volatility of our stock price, and the estimated life of the warrants. The warrant liabilities were included in Accounts payable and accrued expenses on our consolidated balance sheets. On March 29, 2012 we agreed with the holders to amend three of the five warrants that contained the “down round” features, removing those specific price reset terms. On the date of the amendment, we valued each of the three warrants using a binomial pricing model as described above. The aggregate value of the three amended warrants of $1.1 million was then reclassified from Accounts payable to Common Stock. On June 25, 2012 we agreed with the holder to amend one other warrant that contained the “down round” features, removing those specific price reset terms. The $250,000 aggregate value of this amended warrant was reclassified from Accounts payable to Common stock on the date of the amendment. The fifth warrant with the “down round” feature was exercised on February 22, 2013. The $583,000 intrinsic value of this warrant was reclassified from Accounts payable to Common stock on the date of the exercise. As of September 30, 2013 all five of the warrants issued that previously contained price reset features have either been amended or exercised and are no longer subject to quarterly valuations.

 

Financial Covenants

 

Certain of our securitization transactions, our warehouse credit facilities and our residual interest financing contain various financial covenants requiring minimum financial ratios and results. Such covenants include maintaining minimum levels of liquidity and net worth and not exceeding maximum leverage levels. As of September 30, 2013, we were in compliance with all such covenants. In addition, certain securitization and non-securitization related debt agreements contain cross-default provisions that would allow certain creditors to declare a default if a default occurred under a different facility.

 

Finance Receivables and Related Debt Measured at Fair Value

 

In September 2011 we purchased approximately $217.8 million of finance receivables from Fireside Bank. These receivables and the related acquisition debt are recorded on our balance sheet at fair value. There are no level 1 or level 2 inputs (as described by ASC 820) available to us for measurement of such receivables, or for the related debt. Our level 3, unobservable inputs reflect our own assumptions about the factors that market participants use in pricing similar receivables and debt, and are based on the best information available in the circumstances. The valuation method used to estimate fair value may produce a fair value measurement that may not be indicative of ultimate realizable value. Furthermore, while we believe our valuation methods are appropriate and consistent with those used by other market participants, the use of different methods or assumptions to estimate the fair value of certain financial instruments could result in different estimates of fair value. Those estimated values may differ significantly from the values that would have been used had a readily available market for such receivables or debt existed, or had such receivables or debt been liquidated, and those differences could be material to the financial statements.

 

Gain on Cancellation of Debt

 

In April 2013, we repurchased the outstanding Class D notes from our first 2008 securitization for a cash payment of $6.1 million and a new 5% note for $5.3 million due in June 2014. The Class D notes were held by the same related party that holds our senior secured debt. On the date we repurchased the Class D notes, the Class D note holder owned 10.5% of our outstanding common stock and warrants to purchase an additional 1.9 million shares of common stock. We subsequently exercised our “clean-up call” option and repurchased the remaining collateral from the related securitization trust. The aggregate value of our consideration for the Class D notes was $10.9 million less than our carrying value of the Class D notes at the time of the repurchase. As a result of the repurchase of the Class D notes and the termination of the securitization trust, we realized a gain of $10.9 million.

 

9
 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Provision for Contingent Liabilities

 

During the nine months ended September 30, 2013, we recognized $9.7 million in contingent liability expenses to either record or increase the amounts we believe we may incur related to various pending litigation. The amount was allocated in part to a long running case we refer to as the Stanwich litigation, and also to more recent matters including two California class action suits where we are the defendant, and a governmental inquiry, in which the United States Federal Trade Commission (“FTC”) has informally proposed that the we refrain from certain allegedly unfair trade practices, and make restitutionary payments into a consumer relief fund.

 

(2) Finance Receivables

 

Our portfolio of finance receivables consists of small-balance homogeneous contracts comprising a single segment and class that is collectively evaluated for impairment on a portfolio basis according to delinquency status. Our contract purchase guidelines are designed to produce a homogenous portfolio. For key terms such as interest rate, length of contract, monthly payment and amount financed, there is relatively little variation from the average for the portfolio. We report delinquency on a contractual basis. Once a contract becomes greater than 90 days delinquent, we do not recognize additional interest income until the obligor under the contract makes sufficient payments to be less than 90 days delinquent. Any payments received on a contract that is greater than 90 days delinquent are first applied to accrued interest and then to principal reduction.

 

The following table presents the components of Finance Receivables, net of unearned interest:

 

   September 30,   December 31, 
   2013   2012 
Finance Receivables   (In thousands) 
           
Automobile finance receivables, net of unearned interest  $1,111,773   $795,786 
Less: Unearned acquisition fees and originations costs   (30,491)   (31,443)
Finance Receivables  $1,081,282   $764,343 

 

We consider an automobile contract delinquent when an obligor fails to make at least 90% of a contractually due payment by the following due date, which date may have been extended within limits specified in the servicing agreements. The period of delinquency is based on the number of days payments are contractually past due, as extended where applicable. Automobile contracts less than 31 days delinquent are not included. In certain circumstances we will grant obligors one-month payment extensions to assist them with temporary cash flow problems. The only modification of terms is to advance the obligor’s next due date by one month and extend the maturity date of the receivable by one month. In some cases, a two-month extension may be granted. There are no other concessions such as a reduction in interest rate, forgiveness of principal or of accrued interest. Accordingly, we consider such extensions to be insignificant delays in payments rather than troubled debt restructurings. The following table summarizes the delinquency status of finance receivables as of September 30, 2013 and December 31, 2012:

 

    September 30,    December 31, 
    2013    2012 
    (In thousands) 
Delinquency Status          
Current  $1,061,090   $764,741 
31 - 61 days   26,335    16,925 
61 - 90 days   16,084    9,019 
91 + days   8,264    5,101 
   $1,111,773   $795,786 

 

 

10
 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Finance receivables totaling $8.3 million and $5.1 million at September 30, 2013 and December 31, 2012, respectively, including all receivables greater than 90 days delinquent, have been placed on non-accrual status as a result of their delinquency status.

 

We use a loss allowance methodology commonly referred to as "static pooling," which stratifies our finance receivable portfolio into separately identified pools based on the period of origination. Using analytical and formula driven techniques, we estimate an allowance for finance credit losses, which we believe is adequate for probable credit losses that can be reasonably estimated in our portfolio of automobile contracts. The estimate for probable credit losses is reduced by our estimate for future recoveries on previously incurred losses. Provision for losses is charged to our consolidated statement of operations. Net losses incurred on finance receivables are charged to the allowance. For finance receivables originated through December 31, 2010 we established the allowance at the time of the acquisition of the receivable. Beginning January 1, 2011, we establish the allowance for new receivables over the 12-month period following their acquisition.

 

The following table presents a summary of the activity for the allowance for finance credit losses for the three-month and nine-month periods ended September 30, 2013 and 2012:

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2013   2012   2013   2012 
   (In thousands)   (In thousands) 
Balance at beginning of period  $32,101  $14,093   $19,594   $10,351 
Provision for credit losses on finance receivables   20,220    9,465    52,739    22,012 
Charge-offs   (20,952)   (9,578)   (47,229)   (26,158)
Recoveries   3,095    2,966    9,360    10,741 
Balance at end of period  $34,464  $16,946   $34,464   $16,946 

 

Excluded from finance receivables are contracts that were previously classified as finance receivables but were reclassified as other assets because we have repossessed the vehicle securing the Contract. The following table presents a summary of such repossessed inventory together with the allowance for losses in repossessed inventory that is not included in the allowance for finance credit losses:

 

   September 30,   December 31, 
   2013   2012 
   (In thousands) 
Gross balance of repossessions in inventory  $20,718   $12,102 
Allowance for losses on repossessed inventory  (11,980)   (6,384)
Net repossessed inventory included in other assets  $8,738   $5,718 

 

(3) Finance Receivables Measured at Fair Value

 

In September 2011 we purchased approximately $217.8 million of finance receivables from Fireside Bank. These receivables are recorded on our balance sheet at fair value.

 

The following table presents the components of Finance Receivables measured at fair value:

 

   September 30,   December 31, 
   2013   2012 
Finance Receivables Measured at Fair Value   (In thousands) 
           
Finance receivables and accrued interest, net of unearned interest  $21,701   $60,804 
Less: Fair value adjustment   (484)   (1,136)
Finance receivables measured at fair value  $21,217   $59,668 

 

11
 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The following table summarizes the delinquency status of finance receivables measured at fair value as of September 30, 2013 and December 31, 2012:

 

   September 30,   December 31, 
   2013   2012 
   (In thousands) 
Deliquency Status          
Current  $19,795   $57,557 
31 - 60 days   1,218    2,206 
61 - 90 days   436    710 
91 + days   252    331 
   $21,701   $60,804 

 

(4) Securitization Trust Debt

 

We have completed a number of securitization transactions that are structured as secured borrowings for financial accounting purposes. The debt issued in these transactions is shown on our Unaudited Condensed Consolidated Balance Sheets as “Securitization trust debt,” and the components of such debt are summarized in the following table:

 

   Final Scheduled  Receivables Pledged at       Outstanding Principal at   Outstanding Principal at   Weighted
Average Contractual Interest
Rate at
 
   Payment  September 30,   Initial   September 30,   December 31,   September 30, 
Series  Date (1)  2013   Principal   2013   2012   2013 
(Dollars in thousands) 
CPS 2008-A  October 2014  $   $310,359   $   $40,713     
Page Five Funding  January 2018   13,244    46,058    11,500    21,251    9.39% 
CPS 2011-A  April 2018   33,088    100,364    29,533    48,368    3.54% 
CPS 2011-B  September 2018   50,758    109,936    50,286    70,863    4.70% 
CPS 2011-C  March 2019   63,410    119,400    63,429    88,269    5.03% 
CPS 2012-A  June 2019   73,288    155,000    72,964    105,485    3.58% 
CPS 2012-B  September 2019   96,641    141,500    95,324    122,329    3.24% 
CPS 2012-C  December 2019   103,877    147,000    101,575    135,219    2.56% 
CPS 2012-D  March 2020   124,318    160,000    118,237    160,000    2.12% 
CPS 2013-A  June 2020   165,276    185,000    157,015        1.85% 
CPS 2013-B  September 2020   192,628    205,000    189,696        2.28% 
CPS 2013-C  December 2020   137,989    205,000    205,000        2.36% 
      $1,054,517   $1,884,617   $1,094,559   $792,497      

_________________

(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 $104.7 million in 2013, $393.4 million in 2014, $292.0 million in 2015, $181.0 million in 2016, $96.8 million in 2017 and $26.6 million in 2018.

 

 

12
 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

All of the securitization trust debt was sold in private placement transactions to qualified institutional buyers. The debt was issued through our wholly-owned bankruptcy remote subsidiaries and is secured by the assets of such subsidiaries, but not by our other assets.

 

The terms of the securitization agreements related to the issuance of the securitization trust debt and the warehouse credit facilities require that we meet certain delinquency and credit loss criteria with respect to the pool of receivables, and certain of the agreements require that we maintain minimum levels of liquidity and not exceed maximum leverage levels. In addition, certain securitization and non-securitization related debt contain cross-default provisions, which would allow certain creditors to declare a default if a default were declared under a different facility. As of September 30, 2013, we were in compliance with all such covenants.

 

We are responsible for the administration and collection of the automobile contracts. The securitization agreements also require certain funds be held in restricted cash accounts to provide additional collateral for the borrowings, to be applied to make payments on the securitization trust debt or as pre-funding proceeds from a term securitization prior to the purchase of additional collateral. As of September 30, 2013, restricted cash under the various agreements totaled approximately $129.5 million, of which $65.8 million represented pre-funding proceeds. Interest expense on the securitization trust debt consists of the stated rate of interest plus amortization of additional costs of borrowing. Additional costs of borrowing include facility fees, amortization of deferred financing costs and discounts on notes sold. Deferred financing costs and discounts on notes sold related to the securitization trust debt are amortized using a level yield method. Accordingly, the effective cost of the securitization trust debt is greater than the contractual rate of interest disclosed above.

 

Our wholly-owned bankruptcy remote subsidiaries were formed to facilitate the above asset-backed financing transactions. Similar bankruptcy remote subsidiaries issue the debt outstanding under our credit facilities. 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.

 

 

 

 

13
 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(5) Debt

 

The terms and amounts of our other debt outstanding at September 30, 2013 and December 31, 2012 are summarized below:

 

         Amount Outstanding at 
         September 30,   December 31, 
         2013   2012 
         (In thousands) 
Description  Interest Rate  Maturity          
                 
Residual interest financing  12.875% over one month Libor  September 2013  $   $13,773 
                 
   11.75% over one month Libor  April 2018   20,000     
                 
Senior secured debt, related party  13.0% and 16.0% at September 30, 2013 and December 31, 2012, respectively  June 2014   36,816    50,135 
                 
   5.00%  June 2014   2,147     
                 
Subordinated renewable notes  Weighted average rate of 12.7% and 14.4% at September 30, 2013 and December 31, 2012, respectively  Weighted average maturity of July 2016 and June 2015 at September 30, 2013 and December 31, 2012, respectively   20,640    23,281 
                 
Debt secured by receivables measured at fair value  n/a  Repayment is based on payments from underlying receivables. Final payment of the 8.00% note was made in September 2013, with residual payments extending through 2016   16,888    57,107 
         $96,491   $144,296 

 

In April 2013 we entered into a new $20 million five-year residual financing facility secured by eligible residual assets in two previously securitized pools of automobile receivables. We also prepaid $15 million of our senior secured debt in April 2013 and reduced the interest rate on the remaining outstanding amount from 16.00% to 13.00%. The maturity date on the remaining outstanding amount was extended from December 2013 to June 2014.

 

14
 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(6) Interest Income and Interest Expense

 

The following table presents the components of interest income:

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2013   2012   2013   2012 
   (In thousands)   (In thousands) 
         
Interest on Finance Receivables  $60,462   $44,808   $167,416   $126,029 
Residual interest income              458 
Other interest income      245    10    723 
Interest income  $60,462   $45,053   $167,426   $127,210 

 

The following table presents the components of interest expense:

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2013   2012   2013   2012 
   (In thousands)   (In thousands) 
                 
Securitization trust debt  $8,357   $9,398   $25,725   $28,557 
Warehouse lines of credit  1,447    2,179    4,026    5,243 
Senior secured debt, related party  1,599    3,077    6,474    9,873 
Debt secured by receivables at fair value  623    3,275    3,435    13,362 
Residual interest financing  1,079    731    2,666    2,125 
Subordinated renewable notes  748    900    2,474    2,536 
   $13,853   $19,560   $44,800   $61,696 

 

15
 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(7) Earnings Per Share

 

Earnings per share for the three-month and nine-month periods ended September 30, 2013 and 2012 were calculated using the weighted average number of shares outstanding for the related period. The following table reconciles the number of shares used in the computations of basic and diluted earnings per share for the three-month and nine-month periods ended September 30, 2013 and 2012:

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2013   2012   2013   2012 
   (In thousands)   (In thousands) 
Weighted average number of common shares outstanding during the period used to compute basic earnings per share   21,795    19,495    20,959    19,406 
Incremental common shares attributable to exercise of outstanding options and warrants   9,422    6,200    10,591    4,620 
Weighted average number of common shares used to compute diluted earnings per share   31,217    25,695    31,550    24,026 

 

If the anti-dilutive effects of common stock equivalents were considered, shares included in the diluted earnings per share calculation for the three-month and nine-month periods ended September 30, 2013 would have included an additional 3.1 million and 1.9 million shares, respectively, attributable to the exercise of outstanding options and warrants. For the three-month and nine-month periods ended September 30, 2012, the anti-dilutive shares were 1.3 million and 2.3 million, respectively.

 

(8) Income Taxes

 

We file numerous consolidated and separate income tax returns with the United States and with many states. With few exceptions, we are no longer subject to U.S. federal, state, or local examinations by tax authorities for years before 2008.

 

We do not anticipate that total unrecognized tax benefits will significantly change due to any settlements of audits or expirations of statutes of limitations over the next 12 months.

 

The Company and its subsidiaries file a consolidated federal income tax return and combined or stand-alone state franchise tax returns for certain states. We utilize the asset and liability method of accounting for income taxes, under which deferred income taxes are recognized for the future tax consequences attributable to the differences between the financial statement values of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.

 

Deferred tax assets are recognized subject to management’s judgment that realization is more likely than not. A valuation allowance is recognized for a deferred tax asset if, based on the weight of the available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized. In making such judgments, significant weight is given to evidence that can be objectively verified. As a result of the unprecedented adverse changes in the market for securitizations, the recession and the resulting high levels of unemployment that occurred in 2008 and 2009, we incurred substantial operating losses from 2009 through 2011 which led us to establish a valuation allowance against a substantial portion of our deferred tax assets. However, since the fourth quarter of 2011, we have reported eight consecutive quarters of increasing profitability, observed improvement in credit metrics, and produced reliable internal financial projections. Furthermore, we have demonstrated an ability to increase our volumes of contract purchases, grow our managed portfolio and obtain cost effective short-term and long-term financing for our finance receivables. As a result of these and other factors, we determined at December 31, 2012 that, based on the weight of the available objective evidence, it was more likely than not that we would generate sufficient future taxable income to utilize our net deferred tax assets. Accordingly, we reversed the related valuation allowance of $62.8 million in the fourth quarter of 2012.

 

16
 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Although realization is not assured, we believe that the realization of the recognized net deferred tax asset of $66.2 million as of September 30, 2013 is more likely than not based on forecasted future net earnings. Our net deferred tax asset of $66.2 million consists of approximately $54.5 million of net U.S. federal deferred tax assets and $11.7 million of net state deferred tax assets. The major components of the deferred tax asset are $46.4 million in net operating loss carryforwards and built in losses and $19.8 million in net deductions which have not yet been taken on a tax return. We estimate that we would need to generate approximately $165 million of taxable income during the applicable carryforward periods to realize fully our federal and state net deferred tax assets.

 

Income tax expense was $4.7 million and $11.2 million for the three and nine months ended September 30, 2013 and represents an effective income tax rate of 44.4% and 43.5%, respectively.

 

(9) Legal Proceedings

 

Stanwich Litigation. We were for some time a defendant in a class action (the “Stanwich Case”) brought in the California Superior Court, Los Angeles County. The original plaintiffs in that case were persons entitled to receive regular payments (the “Settlement Payments”) pursuant to earlier settlements of claims, generally personal injury claims, against unrelated defendants. Stanwich Financial Services Corp. (“Stanwich”), an affiliate of the former chairman of our board of directors, is the entity that was obligated to pay the Settlement Payments. Stanwich defaulted on its payment obligations to the plaintiffs and in June 2001 filed for reorganization under the Bankruptcy Code, in the federal bankruptcy court in Connecticut. By February 2005, we had settled all claims brought against us in the Stanwich Case.

 

In November 2001, one of the defendants in the Stanwich Case, Jonathan Pardee, asserted claims for indemnity against us in a separate action, which is now pending in federal district court in Rhode Island. We have filed counterclaims in the Rhode Island federal court against Mr. Pardee, and have filed a separate action against Mr. Pardee's Rhode Island attorneys, in the same court. The litigation between Mr. Pardee and us was stayed for several years through September 2011, awaiting resolution of an adversary action brought against Mr. Pardee in the bankruptcy court, which is hearing the bankruptcy of Stanwich.

 

Pursuant to an agreement with the representative of creditors in the Stanwich bankruptcy, that adversary action has been dismissed. Under that agreement, we paid the bankruptcy estate $800,000 and abandoned our claims against the estate, while the estate has abandoned its adversary action against Mr. Pardee. With the dismissal of the adversary action, all known claims asserted against Mr. Pardee have been resolved without his incurring any liability. Accordingly, we believe that this resolution of the adversary action will result in limitation of our exposure to Mr. Pardee to no more than some portion of his attorneys fees incurred. The stay in the action against us in Rhode Island has been lifted, and both we and Mr. Pardee filed motions for summary judgment. The court ruled on those motions in February 2013, denying our motion, and granting Mr. Pardee’s motion as to liability. The issues remaining for trial are the extent of our obligation to indemnify Mr. Pardee. There is no trial date set, but our expectation is that the court may, not earlier than December 2013, set the matter for trial in 2014.

 

Consumer Litigation. We are routinely involved in various legal proceedings resulting from our consumer finance activities and practices, both continuing and discontinued. Consumers can and do initiate lawsuits against us alleging violations of law applicable to collection of receivables, and such lawsuits sometimes allege that resolution as a class action is appropriate. We are currently defending two such class actions. For the most part, we have legal and factual defenses to such claims, which we routinely contest or settle (for immaterial amounts) depending on the particular circumstances of each case. We have recorded a liability as of September 30, 2013 with respect to such matters, in the aggregate.

 

FTC Action. On July 17, 2013, the staff of the Federal Trade Commission (“FTC”) advised us that they are prepared to recommend that the FTC initiate a lawsuit against us relating to allegedly unfair trade practices, and simultaneously advised that settlement of such issues by consent decree may be possible. Based on our review of the FTC’s allegations, of past practices of the FTC, of our records of our collection and servicing activities, and of other companies’ settlements with the FTC, we expect that we will reach such a settlement, and that such a settlement will require that we make restitutionary payments and that we implement procedural changes under a consent decree. There can be no assurance, however, that we will reach agreement regarding any such settlement, and we may choose to contest the allegations of the FTC. Whether we reach such an agreement or not, the cost to us of contesting or settling the matter may be material. We have recorded a liability as of September 30, 2013 with respect to this matter.

 

17
 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

In General. There can be no assurance as to the outcomes of any of the matters referenced above. We have recorded a liability as of September 30, 2013 that we believe represents our best estimate of probable incurred losses for legal contingencies, including all of the matters described or referenced above. The amount of losses that may ultimately be incurred cannot be estimated with certainty. However, based on such information as is available to us, we believe that the range of reasonably possible losses for the legal proceedings and contingencies described or referenced above does not include an amount that would materially exceed the reserves established at September 30, 2013.

 

Accordingly, we believe that the ultimate resolution of such legal proceedings and contingencies, after taking into account our current litigation reserves, should not have a material adverse effect on our consolidated financial condition. We note, however, that in light of the uncertainties inherent in contested proceedings, there can be no assurance that the ultimate resolution of these matters will not significantly exceed the reserves we have accrued; as a result, the outcome of a particular matter may be material to our operating results for a particular period, depending on, among other factors, the size of the loss or liability imposed and the level of our income for that period.

 

(10) Employee Benefits

 

On March 8, 2002 we acquired MFN Financial Corporation and its subsidiaries in a merger. We sponsor the MFN Financial Corporation Benefit Plan (the “Plan”). Plan benefits were frozen June 30, 2001. The table below sets forth the Plan’s net periodic benefit cost for the three-month and nine-month periods ended September 30, 2013 and 2012.

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2013   2012   2013   2012 
   (In thousands)   (In thousands) 
Components of net periodic cost (benefit)                
Service cost  $   $   $   $ 
Interest cost   210    220    630    660 
Expected return on assets   (335)   (234)   (1,005)   (702)
Amortization of transition (asset)/obligation                
Amortization of net (gain) / loss   117    157    351    471 
Net periodic cost (benefit)  $(8)  $143   $(24)  $429 

 

We contributed $112,000 and $277,000 to the Plan during the three and nine-month periods ended September 30, 2013 and we anticipate making contributions in the amount of $112,000 for the remainder of 2013.

 

(11) Fair Value Measurements

 

ASC 820, "Fair Value Measurements" clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy.

 

ASC 820 defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The three levels are defined as follows: level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets; level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument; and level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

18
 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

At the time of issuance, five warrants issued between 2008 and 2010 in conjunction with various debt financing transactions contained features that make them subject to derivative accounting. We valued these warrants using a binomial valuation model using a weighted average volatility assumption of 41%, weighted average term of 8 years and a risk free rate of 3.3%. On March 29, 2012 we agreed with the holders to amend three of the five warrants to remove the price reset features that resulted in derivative accounting. On the date of the amendment, we valued each of the three warrants using a binomial pricing model as described above. The aggregate value of the three amended warrants of $1.1 million was then reclassified from Accounts Payable to Common Stock. On June 25, 2012 we agreed with the holder to amend one other warrant that contained the “down round,” or price reset, features to remove those specific price reset terms. The $250,000 aggregate value of this amended warrant was reclassified from Accounts Payable to Common Stock on the date of the amendment. The fifth warrant with the “down round” feature was exercised on February 22, 2013. The $583,000 intrinsic value of this warrant was reclassified from Accounts Payable to Common Stock on the date of the exercise. As of September 30, 2013 all five of the warrants issued that previously contained price reset features have either been amended or exercised and are no longer subject to quarterly valuations.

 

In September 2008 we sold automobile contracts in a securitization that was structured as a sale for financial accounting purposes. In that sale, we retained both securities and a residual interest in the transaction that are measured at fair value. In September 2010 we took advantage of improvement in the market for asset-backed securities by re-securitizing the underlying receivables from our unrated September 2008 securitization. We also sold the securities retained from the September 2008 transaction. No gain or loss was recorded as a result of the re-securitization transaction described above. We describe below the valuation methodologies we use for the securities retained and the residual interest in the cash flows of the transaction, as well as the general classification of such instruments pursuant to the valuation hierarchy. The residual interest in such securitization is $1.4 million as of September 30, 2013 and $4.8 million as of December 31, 2012 and is classified as level 3 in the three-level valuation hierarchy. We determine the value of that residual interest using a discounted cash flow model that includes estimates for prepayments and losses. We used a discount rate of 20% per annum and a cumulative net loss rate of 15% at September 30, 2013 and 14% at December 31, 2012. The assumptions we used are based on historical performance of automobile contracts we have originated and serviced in the past, adjusted for current market conditions.

 

In September 2011, we acquired $217.8 million of finance receivables from Fireside Bank for a purchase price of $199.6 million. The receivables were acquired by our wholly-owned special purpose subsidiary, CPS Fender Receivables, LLC, which issued a note for $197.3 million, with a fair value of $196.5 million. Since the Fireside receivables were originated by another entity with its own underwriting guidelines and procedures, we have elected to account for the Fireside receivables and the related debt secured by those receivables at their estimated fair values so that changes in fair value will be reflected in our results of operations as they occur. Interest income from the receivables and interest expense on the note are included in interest income and interest expense, respectively. Changes to the fair value of the receivables and debt are included in other income. Our level 3, unobservable inputs reflect our own assumptions about the factors that market participants use in pricing similar receivables and debt, and are based on the best information available in the circumstances. They include such inputs as estimated net charge-offs and timing of the amortization of the portfolio of finance receivables. Our estimate of the fair value of the Fireside receivables is performed on a pool basis, rather than separately on each individual receivable. The table below presents a reconciliation of the acquired finance receivables and related debt measured at fair value on a recurring basis using significant unobservable inputs:

 

 

19
 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2013   2012   2013   2012 
   (in thousands)   (in thousands) 
Finance Receivables Measured at Fair Value:                    
Balance at beginning of period  $30,319  $102,366   $59,668   $160,253 
Payments on finance receivables at fair value   (8,848)   (22,449)   (36,828)   (86,556)
Charge-offs on finance receivables at fair value   (535)   (1,259)   (2,275)   (5,309)
Discount accretion   263    1,870    1,247    7,272 
Mark to fair value   18    (3,044)   (595)   1,824 
Balance at end of period  $21,217  $77,484   $21,217   $77,484 
                     
Debt Secured by Finance Receivables Measured at Fair Value:                    
Balance at beginning of period  $21,907  $104,662   $57,107   $166,828 
Principal payments on debt at fair value   (5,107)   (26,902)   (41,365)   (97,703)
Premium accretion   379    1,687    2,079    5,552 
Mark to fair value   (291)   (2,817)   (933)   1,953 
Balance at end of period   16,888    76,630    16,888    76,630 
Reduction for payments collected and payable   (570)   (7,002)   (570)   (7,002)
Adjusted balance at end of period  $16,318   $69,628   $16,318   $69,628 

 

The table below compares the fair values of the Fireside receivables and the related secured debt to their contractual balances for the periods shown:

 

   September 30, 2013   December 31, 2012 
   Contractual   Fair   Contractual   Fair 
   Balance   Value   Balance   Value 
   (In thousands) 
                 
Fireside receivables portfolio  $21,701   $21,217   $60,804   $59,668 
                     
Debt secured by Fireside receivables portfolio       16,888    41,365    57,107 

 

The fair value of the debt secured by the Fireside receivables portfolio represents the discounted value of future cash flows that we estimate will become due to the lender in accordance with the terms of our financing for the Fireside portfolio.

 

Repossessed vehicle inventory, which is included in Other Assets on our balance sheet, is measured at fair value using level 2 assumptions based on our actual loss experience on sale of repossessed vehicles. At September 30, 2013, the finance receivables related to the repossessed vehicles in inventory totaled $20.7 million. We have applied a valuation adjustment, or loss allowance, of $12.0 million, which is based on a recovery rate of 42%, resulting in an estimated fair value and carrying amount of $8.7 million. The fair value and carrying amount of the repossessed inventory at December 31, 2012 was $5.7 million after applying a valuation adjustment of $6.4 million.

 

20
 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

There were no transfers in or out of level 1 or level 2 assets and liabilities for the three or nine months ended September 30, 2013 and 2012. We have no level 3 assets that are measured at fair value on a non-recurring basis. The table below presents a reconciliation for level 3 assets measured at fair value on a recurring basis using significant unobservable inputs:

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2013   2012   2013   2012 
   (in thousands)   (in thousands) 
Residual Interest in Securitizations:                    
Balance at beginning of period  $2,246   $4,850   $4,824   $4,414 
Cash paid (received) during period   (820)   45    (3,398)   23 
Included in earnings               458 
Balance at end of period  $1,426   $4,895   $1,426   $4,895 
                     
                     
Warrant Derivative Liability:                    
Balance at beginning of period  $   $51   $355   $967 
Included in earnings       44    228    435 
Reclassification to equity           (583)   (1,307)
Balance at end of period  $   $95   $   $95 

 

The following table provides certain qualitative information about our level 3 fair value measurements for assets and liabilities carried at fair value:

 

Financial Instrument  Fair Values as of         Inputs as of 
   September 30,   December 31,   Valuation  Unobservable  September 30,   December 31, 
   2013   2012   Techniques  Inputs  2013   2012 
  (In thousands)               
Assets:                          
                           
Finance receivables measured at fair value  $21,217   $59,668   Discounted cash flows  Discount rate   15.4%    20.4% 
               Cumulative net losses   4.8%    5.5% 
                Monthly average prepayments   0.5%    0.5% 
                           
Residual interest in securitizations   1,426    4,824   Discounted cash flows  Discount rate   20.0%    20.0% 
               Cumulative net losses   15.0%    13.5% 
                Monthly average prepayments   0.5%    0.5% 
                           
Liabilities:                          
Warrant derivative liability  $   $355  Binomial  Stock price   n/a    $5.36/sh 
                Volatility   n/a    40.0% 
                Risk free rate   n/a    1.26% 
                           
Debt secured by receivables measured at fair value   16,888    57,107   Discounted cash flows   Discount rate   12.2%    16.2% 

 

21
 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The estimated fair values of financial assets and liabilities at September 30, 2013 and December 31, 2012, were as follows:

 

   As of September 30, 2013 
Financial Instrument  (In thousands) 
   Carrying   Fair Value Measurements Using:     
   Value   Level 1   Level 2   Level 3   Total 
Assets:                         
Cash and cash equivalents  $24,128   $24,128   $   $   $24,128 
Restricted cash and equivalents   129,450    129,450            129,450 
Finance receivables, net   1,046,818            1,025,398    1,025,398 
Finance receivables measured at fair value   21,217            21,217    21,217 
Residual interest in securitizations   1,426            1,426    1,426 
Accrued interest receivable   15,146            15,146    15,146 
Liabilities:                         
Warehouse lines of credit  $26,959   $   $   $26,959   $26,959 
Accrued interest payable   2,733            2,733    2,733 
Residual interest financing   20,000            20,000    20,000 
Debt secured by receivables measured at fair value   16,888            16,888    16,888 
Securitization trust debt   1,094,559            1,107,865    1,107,865 
Senior secured debt   38,963            38,963    38,963 
Subordinated renewable notes   20,640            20,640    20,640 

 

 

 

   As of December 31, 2012 
Financial Instrument  (In thousands) 
   Carrying   Fair Value Measurements Using:     
   Value   Level 1   Level 2   Level 3   Total 
Assets:                         
Cash and cash equivalents  $12,966   $12,966   $   $   $12,966 
Restricted cash and equivalents   104,445    104,445            104,445 
Finance receivables, net   744,749            740,511    740,511 
Finance receivables measured at fair value   59,668            59,668    59,668 
Residual interest in securitizations   4,824            4,824    4,824 
Accrued interest receivable   10,411            10,411    10,411 
Liabilities:                         
Warrant derivative liability  $355   $   $   $355   $355 
Warehouse lines of credit   21,731            21,731    21,731 
Accrued interest payable   2,795            2,795    2,795 
Residual interest financing   13,773            13,773    13,773 
Debt secured by receivables measured at fair value   57,107            57,107    57,107 
Securitization trust debt   792,497            803,290    803,290 
Senior secured debt   50,135            50,135    50,135 
Subordinated renewable notes   23,281            23,281    23,281 

 

22
 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The following summary presents a description of the methodologies and assumptions used to estimate the fair value of our financial instruments. Much of the information used to determine fair value is highly subjective. When applicable, readily available market information has been utilized. However, for a significant portion of our financial instruments, active markets do not exist. Therefore, significant elements of judgment were required in estimating fair value for certain items. The subjective factors include, among other things, the estimated timing and amount of cash flows, risk characteristics, credit quality and interest rates, all of which are subject to change. Since the fair value is estimated as of September 30, 2013 and December 31, 2012, the amounts that will actually be realized or paid at settlement or maturity of the instruments could be significantly different.

 

Cash, Cash Equivalents and Restricted Cash and Equivalents

 

The carrying value equals fair value.

 

Finance Receivables, net

 

The fair value of finance receivables is estimated by discounting future cash flows expected to be collected using current rates at which similar receivables could be originated.

 

Finance Receivables Measured at Fair Value and Debt Secured by Receivables Measured at Fair Value

 

The carrying value equals fair value.

 

Residual Interest in Securitizations

 

The fair value is estimated by discounting future cash flows using credit and discount rates that we believe reflect the estimated credit, interest rate and prepayment risks associated with similar types of instruments.

 

Accrued Interest Receivable and Payable

 

The carrying value approximates fair value because the related interest rates are estimated to reflect current market conditions for similar types of instruments.

 

Warrant Derivative Liability

 

The method used to estimate fair value is described above.

 

Warehouse Lines of Credit, Residual Interest Financing, Senior Secured Debt and Subordinated Renewable Notes

 

The carrying value approximates fair value because the related interest rates are estimated to reflect current market conditions for similar types of secured instruments.

 

Securitization Trust Debt

 

The fair value is estimated by discounting future cash flows using interest rates that we believe reflects the current market rates.

 

 

23
 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

We are a specialty finance company focused on consumers who have limited credit histories, low incomes or past credit problems, whom we refer to as sub-prime customers. Our business is to purchase and service retail automobile contracts originated primarily by franchised automobile dealers and, to a lesser extent, by select independent dealers in the United States in the sale of new and used automobiles, light trucks and passenger vans. Through our automobile contract purchases, we provide indirect financing to sub-prime customers of dealers. We serve as an alternative source of financing for dealers, facilitating sales to customers who otherwise might not be able to obtain financing from traditional sources, such as commercial banks, credit unions and the captive finance companies affiliated with major automobile manufacturers. In addition to purchasing installment purchase contracts directly from dealers, we have also (i) acquired installment purchase contracts in four merger and acquisition transactions, (ii) purchased immaterial amounts of vehicle purchase money loans from non-affiliated lenders, and (iii) lent money directly to consumers for an immaterial amount of loans secured by vehicles. In this report, we refer to all of such contracts and loans as "automobile contracts."

 

We were incorporated and began our operations in March 1991. From inception through September 30, 2013, we have purchased a total of approximately $10.2 billion of automobile contracts from dealers. In addition, we obtained a total of approximately $822.8 million of automobile contracts in mergers and acquisitions in 2002, 2003, 2004 and 2011. In 2004 and 2009, we were appointed as a third-party servicer for certain portfolios of automobile receivables originated and owned by non-affiliated entities. Beginning in 2008 through the third quarter of 2011, our managed portfolio decreased each year due to our strategy of limiting contract purchases in 2008 and 2009 to conserve our liquidity, as discussed further below. However, since October 2009 we have gradually increased contract purchases, which, in turn has resulted in recent increases to our managed portfolio. Recent contract purchase volumes and managed portfolio levels are shown in the table below:

 

Contract Purchases and Outstanding Managed Portfolio

 

      $ in thousands 
 Period    Contracts Purchased in Period    Managed Portfolio at Period End 
 2008   $296,817   $1,664,122 
 2009    8,599    1,194,722 
 2010    113,023    756,203 
 2011    284,236    794,649 
 2012    551,743    897,575 
 Nine months ended September 30, 2013    592,327    1,166,871 

 

 

We are headquartered in Irvine, California, where most operational and administrative functions are centralized. Credit and underwriting functions are performed in our California headquarters with certain of these functions also performed in our Florida branch. We service our automobile contracts from our California headquarters and our branches in Virginia, Florida and Illinois.

 

We purchase contracts in our own name (“CPS”) and, until July 2008, also in the name of our wholly-owned subsidiary, TFC. Programs marketed under the CPS name are intended to serve a wide range of sub-prime customers, primarily through franchised new car dealers. Our TFC program served vehicle purchasers enlisted in the U.S. Armed Forces, primarily through independent used car dealers. In July 2008, we suspended contract purchases under our TFC program. We purchase automobile contracts with the intention of financing them on a long-term basis through securitizations. Securitizations are transactions in which we sell a specified pool of contracts to a special purpose entity of ours, which in turn issues asset-backed securities to fund the purchase of the pool of contracts from us.

 

24
 

Securitization and Warehouse Credit Facilities

 

Throughout the period for which information is presented in this report, we have purchased automobile contracts with the intention of financing them on a long-term basis through securitizations, and on an interim basis through warehouse credit facilities. All such financings have involved identification of specific automobile contracts, sale of those automobile contracts (and associated rights) to one of our special-purpose subsidiaries, and issuance of asset-backed securities or loans to fund the transactions. Depending on the structure, these transactions may properly be accounted for under generally accepted accounting principles as sales of the automobile contracts or as secured financings.

 

When structured to be treated as a secured financing for accounting purposes, the subsidiary is consolidated with us. Accordingly, the sold automobile contracts and the related debt appear as assets and liabilities, respectively, on our consolidated balance sheet. We then periodically (i) recognize interest and fee income on the contracts, (ii) recognize interest expense on the securities issued in the transaction and (iii) record as expense a provision for credit losses on the contracts.

 

Since the third quarter of 2003, we have conducted 33 term securitizations. Of these 33, 27 were periodic (generally quarterly) securitizations of automobile contracts that we purchased from automobile dealers under our regular programs. In addition, in March 2004 and November 2005, we completed securitizations of our retained interests in other securitizations that we and our affiliates previously sponsored. The debt from the March 2004 transaction was repaid in August 2005, and the debt from the November 2005 transaction was repaid in May 2007. Also, in June 2004, we completed a securitization of automobile contracts purchased under our TFC program and acquired in a bulk purchase. Further, in December 2005 and May 2007 we completed securitizations that included automobile contracts purchased under the TFC programs, automobile contracts purchased under the CPS programs and automobile contracts we repurchased upon termination of prior securitizations. Since July 2003 all such securitizations have been structured as secured financings, except our September 2008 and September 2010 securitizations. These transactions were in substance sales of the underlying receivables and were treated as sales for financial accounting purposes. The September 2010 securitization was our first securitization since 1993 that did not utilize a financial guaranty for the senior asset-backed notes. Since then we have completed 10 senior subordinate securitizations and none have utilized financial guarantees.

 

Since December 2011, our securitizations have included a pre-funding feature in which a portion of the receivables to be sold to the trust were not delivered until after the initial closing. As a result, our restricted cash balance at September 30, 2013 included $65.8 million from the proceeds of the sale of the asset-backed notes that were held by the trustee pending delivery of the remaining receivables. In October 2013, the requisite additional receivables were delivered to the trust and we received the related restricted cash, most of which was used to repay amounts owed under our warehouse credit facilities.

 

Portfolio Acquisitions

 

As stated above, we have acquired approximately $822.8 million in finance receivables through four acquisitions. These transactions took place in 2002, 2003, 2004 and September 2011. The September 2011 acquisition consisted of approximately $217.8 million of finance receivables that we purchased from Fireside Bank of Pleasanton, California.

 

25
 

Uncertainty of Capital Markets and General Economic Conditions

 

We depend upon the availability of warehouse credit facilities and access to long-term financing through the issuance of asset-backed securities collateralized by our automobile contracts. Since 1994, we have completed 60 term securitizations of approximately $8.3 billion in contracts. From the fourth quarter of 2007 through the end of 2009, we observed unprecedented adverse changes in the market for securitized pools of automobile contracts. These changes included reduced liquidity, and reduced demand for asset-backed securities, particularly for securities carrying a financial guaranty and for securities backed by sub-prime automobile receivables. Moreover, during that period many of the firms that previously provided financial guarantees, which were an integral part of our securitizations, suspended offering such guarantees. These adverse changes caused us to conserve liquidity by significantly reducing our purchases of automobile contracts. However, since September 2009 we have established new funding facilities and gradually increased our contract purchases and the frequency and amount of our term securitizations. Our recent history of term securitizations is summarized in the table below:

 

Recent Asset-Backed Term Securitizations
   $ in thousands
Period  Number of Term Securitizations  Amount of Term Securitizations 
2006  4  $957,681 
2007  3   1,118,097 
2008  2   509,022 
2009  0    
2010  1   103,772 
2011  3   335,593 
2012  4   603,500 
Nine months ended September 30, 2013  3   595,000 

 

Our 2012 securitizations included $58.2 million in contracts that were repurchased in 2012 from securitizations closed in 2006 and 2007. Our 2013 securitizations included $7.4 million in contracts that were repurchased from a securitization closed in 2008. Since 2011 all of our securitizations have been structured as secured financings and none have utilized financial guarantees.

 

Our current short-term funding capacity is $200 million, comprising two credit facilities. The first $100 million credit facility was established in December 2010. This facility was renewed in March 2013, extending the revolving period to March 2015, and adding an amortization period through March 2017. Our second $100 million credit facility was established in May 2012. This facility was renewed in June 2013, extending the revolving period to June 2015, and adding an amortization period through June 2016.

 

Financial Covenants

 

Certain of our securitization transactions, our warehouse credit facilities and our residual interest financing 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. As of September 30, 2013 we were in compliance with all such covenants. In addition, certain securitization and non-securitization related debt contain cross-default provisions that would allow certain creditors to declare a default if a default occurred under a different facility.

 

26
 

Results of Operations

 

Comparison of Operating Results for the three months ended September 30, 2013 with the three months ended September 30, 2012

 

Revenues.  During the three months ended September 30, 2013, our revenues were $64.1 million, an increase of $16.1 million, or 33.7%, from the prior year revenue of $47.9 million. The primary reason for the increase in revenues is an increase in interest income. Interest income for the three months ended September 30, 2013 increased $15.4 million, or 34.2%, to $60.5 million from $45.1 million in the prior year. The primary reason for the increase in interest income is the increase in finance receivables held by consolidated subsidiaries, which increased from $807.1 million at September 30, 2012 to $1,154.2 million at September 30, 2013. The table below shows the average balances of our portfolio held by consolidated subsidiaries for the three months ended September 30, 2013 and 2012:

 

   Average Balances for the
Three Months Ended
 
   September 30, 2013   September 30, 2012 
   Amount   Amount 
Finance Receivables Owned by  ($ in millions) 
Consolidated Subsidiaries        
CPS Originated Receivables  $1,098.4   $702.6 
Fireside   25.6    87.7 
Total  $1,124.0   $790.3 

 

Servicing fees totaling $700,000 in the three months ended September 30, 2013 increased $198,000, or 39.5%, from $502,000 in the prior year. We earn base servicing fees on three portfolios that are decreasing in size as we receive customer payments and, consequently, base servicing fees are decreasing also. On one of those portfolios, however, we recently began earning an incentive servicing fee. Such incentive servicing fee was $349,000 for the three months ended September 30, 2013 and more than offset the decrease of $151,000 in base servicing fees. We did not earn any incentive servicing fee in the prior year’s period. As of September 30, 2013 and 2012, our managed portfolio owned by consolidated vs. non-consolidated subsidiaries and other third parties was as follows:

 

   September 30, 2013   September 30, 2012 
   Amount (1)   %(2)   Amount (1)   %(2) 
Total Managed Portfolio  ($ in millions) 
Owned by Consolidated Subsidiaries                    
CPS Originated Receivables  $1,132.5    97.1%   $726.8    86.0% 
Fireside   21.7    1.9%    80.3    9.5% 
Owned by Non-Consolidated Subsidiaries   6.1    0.5%    22.4    2.7% 
Third-Party Servicing Portfolios   6.6    0.6%    15.4    1.8% 
Total  $1,166.9    100.0%   $844.9    100.0% 

_______________

(1) Contractual balances.

(2) Percentages may not add up to 100% due to rounding.

 

27
 

At September 30, 2013, we were generating income and fees on a managed portfolio with an outstanding principal balance of $1,166.9 million (this amount includes $6.1 million of automobile contracts on which we earn servicing fees and own a residual interest and also includes another $6.6 million of automobile contracts on which we earn base and incentive servicing fees), compared to a managed portfolio with an outstanding principal balance of $844.9 million as of September 30, 2012. At September 30, 2013 and 2012, the managed portfolio composition was as follows:

 

   September 30, 2013   September 30, 2012 
   Amount (1)   % (2)   Amount (1)   % (2) 
Originating Entity  ($ in millions) 
CPS  $1,141.1    97.8%   $748.8    88.6% 
Fireside   21.7    1.9%    80.3    9.5% 
TFC  $    0.0%    0.4    0.0% 
Third Party Portfolio  $4.1    0.4%    15.4    1.8% 
Total  $1,166.9    100.0%   $844.9    100.0% 

_______________

(1) Contractual balances.

(2) Percentages may not add up to 100% due to rounding.

 

Other income increased by $539,000, or 22.7%, to $2.9 million in the three months ended September 30, 2013 from $2.4 million during the prior year. The increase is comprised of a net increase of $681,000 in the fair value of the receivables and debt associated with the Fireside portfolio acquisition, and an increase of $5,000 in payments from third-party providers of convenience fees paid by our customers for web based and other electronic payments. These increases were partially offset by decreases of $74,000 in fees associated with direct mail and other related products and services that we offer to our dealers, decreases in sales tax refunds of $59,000, and a decrease of $18,000 in recoveries on receivables from the 2002 acquisition of MFN Financial Corporation.

 

Expenses.  Our operating expenses consist largely of provision for credit losses, interest expense, employee costs and general and administrative expenses. Provision for credit losses and interest expense are significantly affected by the volume of automobile contracts we purchased during the trailing 12-month period and by the outstanding balance of finance receivables held by consolidated subsidiaries. Employee costs and general and administrative expenses are incurred as applications and automobile contracts are received, processed and serviced. Factors that affect margins and net income include changes in the automobile and automobile finance market environments, and macroeconomic factors such as interest rates and changes in the unemployment level.

 

Employee costs include base salaries, commissions and bonuses paid to employees, and certain expenses related to the accounting treatment of outstanding stock options, and are one of our most significant operating expenses. These costs (other than those relating to stock options) generally fluctuate with the level of applications and automobile contracts processed and serviced.

 

Other operating expenses consist largely of facilities expenses, telephone and other communication services, credit services, computer services, marketing and advertising expenses, and depreciation and amortization.

 

Total operating expenses were $53.5 million for the three months ended September 30, 2013, compared to $45.2 million for the prior year, an increase of $8.3 million, or 18.4%. The increase is primarily due to the increase in the amount of new contracts we purchased, the resulting increase in our consolidated portfolio and associated servicing costs, and the related increase in our provision for credit losses. Increases in core operating expenses and provision for credit losses were partially offset by decreases in interest expense.

 

28
 

 

Employee costs increased by $2.5 million or 28.3%, to $11.2 million during the three months ended September 30, 2013, representing 20.9% of total operating expenses, from $8.7 million for the prior year, or 19.3% of total operating expenses. Since 2010, we have added employees in our Originations and Marketing departments to accommodate the increase in contract purchases. More recently, we have also added Servicing staff to accommodate the increase in the number of accounts in our managed portfolio. The table below summarizes our employees by category as well as contract purchases and units in our managed portfolio as of, and for the three-month periods ended, September 30, 2013 and 2012:

 

    September 30, 2013    September 30, 2012 
    Amount    Amount 
    ($ in millions) 
Contracts purchased (dollars)  $206.8   $143.1 
Contracts purchased (units)   13,233    9,367 
Managed portfolio outstanding (dollars)  $1,166.9   $844.9 
Managed portfolio outstanding (units)   96,989    92,908 
           
Number of Originations staff   160    118 
Number of Marketing staff   121    71 
Number of Servicing staff   295    281 
Number of other staff   65    60 
Total number of employees   641    530 

 

General and administrative expenses include costs associated with purchasing and servicing our portfolio of finance receivables, including expenses for facilities, credit services, and telecommunications. General and administrative expenses were $4.1 million, an increase of $384,000, or 10.4%, compared to the previous year and represented 7.6% of total operating expenses.

 

Interest expense for the three months ended September 30, 2013 decreased by $5.7 million to $13.9 million, or 29.2%, compared to $19.6 million in the previous year.

 

Interest expense on the Fireside portfolio credit facility decreased by $2.7 million compared to the prior year period as the Fireside portfolio and the related debt have paid down to significantly lower levels over the last year.

 

Interest on securitization trust debt decreased by $1.0 million for the three months ended September 30, 2013 compared to the prior year. Although the outstanding amount of securitization trust debt increased to $1,094.6 million at September 30, 2013 compared to $721.4 million at September 30, 2012, the blended interest rates on term securitizations completed since 2012 are significantly less than the blended interest rates on securitization trust debt incurred prior to 2012.

 

Interest expense on senior secured debt and subordinated debt decreased by $1.6 million. This was due primarily to the April 2013 repayment of $15.0 million in senior secured debt and to the reduction in the interest rate on the remaining senior secured debt from 16.0% to 13.0%. Interest expense on residual interest financing increased $348,000 in the three months ended September 30, 2013 compared to the prior year. The increase is due to the establishment in April 2013 of a new $20 million residual interest financing. This was partially offset by the September 2013 repayment of the $13.8 million of indebtedness outstanding under the residual facility originally established in 2007.

 

Interest expense on warehouse debt decreased by $732,000 for the three months ended September 30, 2013 compared to the prior year. Although we increased our contract purchases to $206.8 million for the three months ended September 30, 2013 compared to $143.1 million in the prior period, recently we have relied less on warehouse credit facilities and more on unrestricted cash balances to fund receivables prior to securitization.

 

29
 

The following table presents the components of interest income and interest expense and a net interest yield analysis for the three-month periods ended September 30, 2013 and 2012:

 

   Three Months Ended September 30, 
   2013   2012 
  (Dollars In thousands) 
    Average Balance (1)    Interest    Annualized Average Yield/Rate    Average Balance (1)    Interest    Annualized Average Yield/Rate 
Interest Earning Assets                              
Finance receivables gross (2)  $1,076,389   $59,296    22.0%   $693,384   $40,079    23.1% 
Finance receivables measured at fair value  24,588    1,166    19.0%    87,671    4,974    22.7% 
   $1,100,977    60,462    22.0%   $781,055    45,053    23.1% 
                               
Interest Bearing Liabilities                              
Warehouse lines of credit  $55,466    1,447    10.4%   $35,006    2,179    24.9% 
Residual interest financing  29,182    1,079    14.8%    14,030    731    20.8% 
Debt secured by receivables measured at fair value  19,186    623    13.0%    85,713    3,275    15.3% 
Securitization trust debt  989,285    8,357    3.4%    660,659    9,398    5.7% 
Senior secured debt, related party  32,431    1,599    19.7%    54,205    3,077    22.7% 
Subordinated renewable notes  21,170    748    14.1%    21,431    900    16.8% 
   $1,146,720    13,853    4.8%   $871,044    19,560    9.0% 
                               
Net interest income/spread       $46,609             $25,493      
Net interest yield (3)             16.9%              13.1% 
Ratio of average interest earning assets to average interest bearing liabilities   96%              90%           

 

(1) Average balances are based on month end balances except for warehouse lines of credit, which are based on daily balances.

(2) Net of deferred fees and direct costs.

(3) Annualized net interest income divided by average interest earning assets.

 

   Three Months Ended September 30, 2013 
   Compared to September 30, 2012 
   Total   Change Due   Change Due 
   Change   to Volume   to Rate 
  (In thousands) 
Interest Earning Assets               
Finance receivables gross  $19,217   $22,138   $(2,921)
Finance receivables at measured fair value   (3,808)   (3,579)   (229)
    15,409    18,559    (3,150)
Interest Bearing Liabilities               
Warehouse lines of credit   (732)   1,274    (2,006)
Residual interest financing   348    789    (441)
Debt secured by receivables measured at fair value   (2,652)   (2,542)   (110)
Securitization trust debt   (1,041)   4,675    (5,716)
Senior secured debt, related party   (1,478)   (1,236)   (242)
Subordinated renewable notes   (152)   (11)   (141)
    (5,707)  2,949    (8,656)
               
Net interest income/spread  $21,116   $15,610   $5,506 

 

30
 

 

Provision for credit losses was $20.2 million for the three months ended September 30, 2013, an increase of $10.8 million, or 113.6% compared to the prior year and represented 37.8% of total operating expenses. The provision for credit losses maintains the allowance for finance credit losses at levels that we feel are adequate for probable incurred credit losses that can be reasonably estimated. Our approach for establishing the allowance requires greater amounts of provision for credit losses early in the terms of our finance receivables. Consequently, the increase in provision expense is the result of the increase in contract purchases during the last year and the larger portfolio owned by our consolidated subsidiaries compared to the prior year.

 

Marketing expenses consist primarily of commission-based compensation paid to our employee marketing representatives. Our marketing representatives earn a salary plus commissions based on volume of contract purchases and sales of ancillary products and services that we offer our dealers, such as training programs, internet lead sales, and direct mail products. Marketing expenses increased by $472,000, or 16.2%, to $3.4 million during the three months ended September 30, 2013, compared to $2.9 million in the prior year period, and represented 6.3% of total operating expenses. For the three months ended September 30, 2013, we purchased 13,233 contracts representing $206.8 million in receivables compared to 9,367 contracts representing $143.1 million in receivables in the prior year.

 

Occupancy expenses decreased by $28,000 or 4.0%, to $695,000 compared to $723,000 in the previous year and represented 1.3% of total operating expenses.

 

Depreciation and amortization expenses decreased by $30,000 or 25.4%, to $88,000 compared to $118,000 in the previous year and represented 0.2% of total operating expenses.

 

For the three months ended September 30, 2013, we recorded income tax expense of $4.7 million, representing a 44.4% effective income tax rate. In the prior year period, we recorded no income tax expense but we reduced our valuation allowance for our deferred tax assets by $1.1 million.

 

Comparison of Operating Results for the nine months ended September 30, 2013 with the nine months ended September 30, 2012

 

Revenues.  In April 2013, we repurchased the outstanding Class D notes from our first 2008 securitization for a cash payment and a new note. We subsequently exercised our “clean-up call” option and repurchased the remaining collateral from the related securitization trust. The aggregate value of our consideration for the Class D notes was $10.9 million less than our carrying value of the Class D notes at the time of the repurchase. As a result of the repurchase of the Class D notes and the termination of the securitization trust, we realized a gain of $10.9 million, or 5.8% of our total revenues of $189.1 million for the nine months ended September 30, 2013.

 

During the nine months ended September 30, 2013, excluding the gain on cancellation of debt of $10.9 million, our revenues were $178.2 million, an increase of $41.6 million, or 30.5%, from the prior year revenue of $136.6 million. The primary reason for the increase in revenues is an increase in interest income. Interest income for the nine months ended September 30, 2013 increased $40.2 million, or 31.6%, to $167.4 million from $127.2 million in the prior year. The primary reason for the increase in interest income is the increase in finance receivables held by consolidated subsidiaries, which increased from $807.1 million at September 30, 2012 to $1,154.2 million at September 30, 2013. The table below shows the average balances of our portfolio held by consolidated subsidiaries for the nine months ended September 30, 2013 and 2012:

 

   Average Balances for the
Nine Months Ended
 
   September 30, 2013   September 30,
2012
 
   Amount   Amount 
Finance Receivables Owned by  ($ in millions) 
Consolidated Subsidiaries        
CPS Originated Receivables  $984.5   $634.6 
Fireside   36.1    115.8 
Total  $1,020.6   $750.4 

 

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Servicing fees totaling $2.5 million for the nine months ended September 30, 2013 increased $587,000, or 30.9%, from $1.9 million in the prior year. We earn base servicing fees on three portfolios that are decreasing in size as we receive customer payments and, consequently, base servicing fees are decreasing also. On one of those portfolios, however, we recently began earning an incentive servicing fee. Such incentive servicing fee was $1.3 million for the nine months ended September 30, 2013 and more than offset the decrease of $700,000 in base servicing fees. We did not earn any incentive servicing fee in the prior year’s period. As of September 30, 2013 and 2012, our managed portfolio owned by consolidated vs. non-consolidated subsidiaries and other third parties was as follows:

 

   September 30, 2013   September 30, 2012 
   Amount (1)   %(2)   Amount (1)   %(2) 
Total Managed Portfolio  ($ in millions) 
Owned by Consolidated Subsidiaries                    
CPS Originated Receivables  $1,132.5    97.1%   $726.8    86.0% 
Fireside   21.7    1.9%    80.3    9.5% 
Owned by Non-Consolidated Subsidiaries   6.1    0.5%    22.4    2.7% 
Third-Party Servicing Portfolios   6.6    0.6%    15.4    1.8% 
Total  $1,166.9    100.0%   $844.9    100.0% 

_______________

(1) Contractual balances.

(2) Percentages may not add up to 100% due to rounding.

 

At September 30, 2013, we were generating income and fees on a managed portfolio with an outstanding principal balance of $1,166.9 million (this amount includes $6.1 million of automobile contracts on which we earn servicing fees and own a residual interest and also includes another $6.6 million of automobile contracts on which we earn base and incentive servicing fees), compared to a managed portfolio with an outstanding principal balance of $844.9 million as of September 30, 2012. At September 30, 2013 and 2012, the managed portfolio composition was as follows:

 

   September 30, 2013   September 30, 2012 
   Amount (1)   % (2)   Amount (1)   % (2) 
Originating Entity  ($ in millions) 
CPS  $1,141.1    97.8%   $748.8    88.6% 
Fireside   21.7    1.9%    80.3    9.5% 
TFC       0.0%    0.4    0.0% 
Third Party Portfolio   4.1    0.4%    15.4    1.8% 
Total  $1,166.9    100.0%   $844.9    103.4% 

_______________

(1) Contractual balances.

(2) Percentages may not add up to 100% due to rounding.

 

Other income increased by $803,000 or 10.7%, to $8.3 million in the nine months ended September 30, 2013 from $7.5 million during the prior year. The increase includes an increase of $950,000 from fees associated with direct mail and other related products and services that we offer to our dealers and a net increase of $467,000 in the fair value of receivables and debt associated with the Fireside portfolio acquisition. These increases were partially offset by decreases in sales tax refunds of $102,000, and a decrease of $159,000 in recoveries on receivables from the 2002 acquisition of MFN Financial Corporation.

 

32
 

 

Expenses. Our operating expenses consist largely of provision for credit losses, interest expense, employee costs and general and administrative expenses. Provision for credit losses and interest expense are significantly affected by the volume of automobile contracts we purchased during the trailing 12-month period and by the outstanding balance of finance receivables held by consolidated subsidiaries. Employee costs and general and administrative expenses are incurred as applications and automobile contracts are received, processed and serviced. Factors that affect margins and net income include changes in the automobile and automobile finance market environments, and macroeconomic factors such as interest rates and changes in the unemployment level.

 

Employee costs include base salaries, commissions and bonuses paid to employees, and certain expenses related to the accounting treatment of outstanding stock options, and are one of our most significant operating expenses. These costs (other than those relating to stock options) generally fluctuate with the level of applications and automobile contracts processed and serviced.

 

Other operating expenses consist largely of facilities expenses, telephone and other communication services, credit services, computer services, marketing and advertising expenses, and depreciation and amortization.

 

During the nine months ended September 30, 2013, we recognized $9.7 million in contingent liability expenses to either record or increase the amounts we believe we may incur related to various pending litigation. The amount was allocated in part to a long running case we refer to as the Stanwich litigation, and also to more recent matters including two California class action suits where we are the defendant, and a governmental inquiry, in which the United States Federal Trade Commission (“FTC”) has informally proposed that the we refrain from certain allegedly unfair trade practices, and make restitutionary payments into a consumer relief fund.

 

The following comparison of our expenses for the nine months ended September 30, 2013 and 2012 excludes the impact of the $9.7 million contingent liability expense incurred in the nine months ended September 30, 2013.

 

Total operating expenses, excluding the $9.7 million in contingent liability expense, were $153.9 million for the nine months ended September 30, 2013, compared to $132.0 million for the prior year, an increase of $21.8 million, or 16.6%. The increase is primarily due to the increase in the amount of new contracts we purchased, the resulting increase in our consolidated portfolio and associated servicing costs, and the related increase in our provision for credit losses. Increases in provision for credit losses and core operating expenses were partially offset by decreases in interest expense.

 

Employee costs increased by $5.8 million or 22.4%, to $31.7 million for the nine months ended September 30, 2013, representing 20.6% of total operating expenses, from $25.9 million for the prior year, or 19.6% of total operating expenses. Since 2010, we have added employees in our Originations and Marketing departments to accommodate the increase in contract purchases. More recently, we have also added Servicing staff to accommodate the increase in the number of accounts in our managed portfolio. The table below summarizes our employees by category as well as contract purchases and units in our managed portfolio as of, and for the nine-month periods, ended September 30, 2013 and 2012:

 

   September 30, 2013   September 30,
2012
 
   Amount   Amount 
   ($ in millions) 
Contracts purchased (dollars)  $592.3   $400.9 
Contracts purchased (units)   38,339    26,180 
Managed portfolio outstanding (dollars)  $1,166.9   $844.9 
Managed portfolio outstanding (units)   96,989    92,908 
           
Number of Originations staff   160    118 
Number of Marketing staff   121    71 
Number of Servicing staff   295    281 
Number of other staff   65    60 
Total number of employees   641    530 

 

 

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General and administrative expenses include costs associated with purchasing and servicing our portfolio of finance receivables, including expenses for facilities, credit services, and telecommunications. General and administrative expenses were $12.3 million, an increase of $581,000, or 4.9%, compared to the previous year and represented 8.0% of total operating expenses.

 

Interest expense for the nine months ended September 30, 2013 decreased by $16.9 million to $44.8 million, or 27.4%, compared to $61.7 million in the previous year.

 

Interest expense on the Fireside portfolio credit facility decreased by $9.9 million compared to the prior year period as the Fireside portfolio and the related debt have paid down to significantly lower levels over the last year.

 

Interest on securitization trust debt decreased by $2.8 million in the nine months ended September 30, 2013 compared to the prior year. Although the outstanding amount of securitization trust debt increased to $1,094.6 million at September 30, 2013 compared to $792.5 million at September 30, 2012, the blended interest rates on term securitizations completed since 2012 are significantly less than the blended interest rates on securitization trust debt incurred prior to 2012.

 

Interest expense on senior secured debt and subordinated debt decreased by $3.5 million. This is due primarily to the April 2013 repayment of $15.0 million of senior secured debt and to the reduction in the interest rate on the remaining senior secured debt from 16.0% to 13.0%. Interest expense on residual interest financing increased $541,000 in the nine months ended September 30, 2013 compared to the prior year. The increase is due to the establishment in April 2013 of a new $20 million residual interest financing. This was partially offset by the September 2013 repayment of the $13.8 million of indebtedness outstanding under the residual facility originally established in 2007.

 

Interest expense on warehouse debt decreased by $1.2 million for the nine months ended September 30, 2013 compared to the prior year. Although we increased our contract purchases to $592.3 million for the nine months ended September 30, 2013 compared to $400.9 million in the prior period, recently we have relied less on warehouse credit facilities and more on unrestricted cash balances to fund receivables prior to securitization.

 

34
 

 

The following table presents the components of interest income and interest expense and a net interest yield analysis for the nine-month periods ended September 30, 2013 and 2012:

 

   Nine Months Ended September 30, 
   2013   2012 
  (Dollars In thousands) 
   Average Balance(1)   Interest   Annualized Average
Yield/Rate
   Average
Balance(1)
   Interest   Annualized Average
Yield
/Rate
 
Interest Earning Assets                              
Finance receivables gross (2)  $966,881   $162,100    22.4%   $625,942   $108,628    23.1% 
Finance receivables measured at fair value   36,110    5,326    19.7%    115,856    18,582    21.4% 
   $1,002,991    167,426    22.3%   $741,798   127,210    22.9% 
                               
Interest Bearing Liabilities                              
Warehouse lines of credit  $44,246    4,026    12.1%   $36,092    5,243    19.4% 
Residual interest financing   25,576    2,666    13.9%    16,363    2,125    17.3% 
Debt secured by receivables measured at fair value   31,802    3,435    14.4%    113,958    13,362    15.6% 
Securitization trust debt   892,307    25,725    3.8%    599,097    28,557    6.4% 
Senior secured debt, related party   40,755    6,474    21.2%    54,899    9,873    24.0% 
Subordinated renewable notes   22,551    2,474    14.6%    21,038    2,536    16.1% 
   $1,057,237    44,800    5.6%   $841,447    61,696    9.8% 
                               
Net interest income/spread       $122,626             $65,514      
Net interest yield (3)             16.3%              11.8% 
Ratio of average interest earning assets to average interest bearing liabilities   95%              88%           

____________

(1) Average balances are based on month end balances except for warehouse lines of credit, which are based on daily balances.

(2) Net of deferred fees and direct costs.

(3) Annualized net interest income divided by average interest earning assets.

 

   Nine Months Ended September 30, 2013 
   Compared to September 30, 2012 
   Total   Change Due   Change Due 
   Change   to Volume   to Rate 
  (In thousands) 
Interest Earning Assets               
Finance receivables gross  $53,472  $59,168   $(5,696)
Finance receivables measured at fair value   (13,256)   (12,790)   (466)
    40,216    46,378    (6,162)
Interest Bearing Liabilities               
Warehouse lines of credit   (1,217)   1,185    (2,402)
Residual interest financing   541    1,196    (655)
Debt secured by receivables measured at fair value   (9,927)   (9,633)   (294)
Securitization trust debt   (2,832)   13,976    (16,808)
Senior secured debt, related party   (3,399)   (2,544)   (855)
Subordinated renewable notes   (62)   182    (244)
    (16,896)   4,362    (21,258)
                
Net interest income/spread  $57,112  $42,016   $15,096 

 

35
 

 

Provision for credit losses was $52.7 million for the nine months ended September 30, 2013, an increase of $30.7 million, or 139.6%, compared to the prior year and represented 34.3% of total operating expenses. The provision for credit losses maintains the allowance for finance credit losses at levels that we feel are adequate for probable incurred credit losses that can be reasonably estimated. Our approach for establishing the allowance requires greater amounts of provision for credit losses early in the terms of our finance receivables. Consequently, the increase in provision expense is the result of the increase in contract purchases during the last year and the larger portfolio owned by our consolidated subsidiaries compared to the prior year.

 

Marketing expenses consist primarily of commission-based compensation paid to our employee marketing representatives. Our marketing representatives earn a salary plus commissions based on volume of contract purchases and sales of ancillary products and services that we offer our dealers, such as training programs, internet lead sales, and direct mail products. Marketing expenses increased by $1.9 million, or 24.1%, to $10.0 million during the nine months ended September 30, 2013, compared to $8.1 million in the prior year period, and represented 6.5% of total operating expenses. For the nine months ended September 30, 2013, we purchased 38,339 contracts representing $592.3 million in receivables in the current period compared to 26,180 contracts representing $400.9 million in receivables in the prior year.

 

Occupancy expenses decreased by $249,000 or 11.5%, to $1.9 million compared to $2.2 million in the previous year and represented 1.2% of total operating expenses.

 

Depreciation and amortization expenses decreased by $56,000, or 14.0%, to $345,000 compared to $401,000 in the previous year and represented 0.2% of total operating expenses.

 

For the nine months ended September 30, 2013, we recorded income tax expense of $11.2 million, representing a 43.5% effective income tax rate. In the prior year period, we recorded no income tax expense but we reduced our valuation allowance for our deferred tax assets by $1.8 million.

 

36
 

 

Credit Experience

 

Our financial results are dependent on the performance of the automobile contracts in which we retain an ownership interest. Broad economic factors such as recession and significant changes in unemployment levels influence the credit performance of our portfolio, as does the weighted average age of the receivables at any given time. The tables below document the delinquency, repossession and net credit loss experience of all such automobile contracts that we originated or own an interest in as of the respective dates shown. The tables do not include the experience of third party originated and owned portfolios.

 

Delinquency Experience (1)

Total Originated Portfolio Excluding Fireside

 

   September 30, 2013   September 30, 2012   December 31, 2012 
   Number of       Number of       Number of     
   Contracts   Amount   Contracts   Amount   Contracts   Amount 
  (Dollars in thousands) 
Delinquency Experience                              
Gross servicing portfolio (1)   89,461   $1,141,029    71,462   $749,131    74,124   $825,186 
Period of delinquency (2)                              
31-60 days   3,065   $27,030    2,234   $14,694    2,545   $18,034 
61-90 days   1,745    16,437    969    6,718    1,179    9,360 
91+ days   967    8,428    491    2,957    773    5,297 
Total delinquencies (2)   5,777    51,895    3,694    24,369    4,497    32,691 
Amount in repossession (3)   2,249    20,828    1,633    9,997    1,932    12,506 
Total delinquencies and amount in repossession (2)   8,026   $72,723    5,327   $34,366    6,429   $45,197 
                               
Delinquencies as a percentage of gross servicing portfolio   6.5%    4.5%    5.2%    3.3%    6.1%    4.0% 
                               
Total delinquencies and amount in repossession as a percentage of gross servicing portfolio   9.0%    6.4%    7.5%    4.6%    8.7%    5.5% 
                               
Extension Experience                              
Contracts with one extension, accruing   11,356   $135,575    9,263   $63,338    9,094   $73,632 
Contracts with two or more extensions, accruing   5,403    34,143    8,891    44,754    7,795    37,761 
    16,759    169,718    18,154    108,092    16,889    111,393 
                               
Contracts with one extension, non-accrual   740    6,822    563    3,340    632    4,401 
Contracts with two or more extensions, non-accrual   554    2,770    862    3,931    1,044    4,344 
    1,294    9,592    1,425    7,271    1,676    8,745 
                               
Total contracts with extensions   18,053   $179,310    19,579   $115,363    18,565   $120,138 

 

 

37
 

 

Delinquency Experience (1)

Fireside Portfolio

 

   September 30, 2013   September 30, 2012   December 31, 2012 
   Number of Contracts   Amount   Number of Contracts   Amount   Number of Contracts   Amount 
   (Dollars in thousands) 
Delinquency Experience                              
Gross servicing portfolio (1)   6,513   $21,701    18,529   $80,314    15,039   $60,804 
Period of delinquency (2)                              
31-60 days   410   $1,218    566   $2,047    621   $2,206 
61-90 days   181    436    221    758    204    710 
91+ days   102    252    140    430    114    331 
Total delinquencies (2)   693    1,906    927    3,235    939    3,247 
Amount in repossession (3)   48    253    181    866    175    703 
Total delinquencies and amount in repossession (2)   741   $2,159    1,108   $4,101    1,114   $3,950 
                               
Delinquencies as a percentage of gross servicing portfolio   10.6    8.8%    5.0%    4.0    6.2%    5.3% 
                               
Total delinquencies and amount in repossession as a percentage of gross servicing portfolio   11.4    9.9%    6.0%    5.1    7.4%    6.5% 
                               
Extension Experience                              
Contracts with one extension, accruing   1,651   $6,069    3,062   $16,189    3,117   $15,262 
Contracts with two or more extensions, accruing   656    2,991    53    279    134    717 
    2,307    9,060    3,115    16,468    3,251    15,979 
                               
Contracts with one extension, non-accrual   60    197    142    750    160    726 
Contracts with two or more extensions, non-accrual   33    149    2    11    6    20 
    93    346    144    761    166    746 
                               
Total contracts with extensions   2,400   $9,406    3,259   $17,229    3,417   $16,725 

 

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Delinquency Experience (1)

Total Originated and Fireside Portfolio

 

   September 30, 2013   September 30, 2012   December 31, 2012 
   Number of       Number of       Number of     
   Contracts   Amount   Contracts   Amount   Contracts   Amount 
  (Dollars in thousands) 
Delinquency Experience                              
Gross servicing portfolio (1)   95,974   $1,162,730    89,991   $829,445    89,163   $885,993 
Period of delinquency (2)                              
31-60 days   3,475   $28,248    2,800   $16,741    3,166   $20,240 
61-90 days   1,926    16,873    1,190    7,476    1,383    10,070 
91+ days   1,069    8,681    631    3,387    887    5,629 
Total delinquencies (2)   6,470    53,802    4,621    27,604    5,436    35,939 
Amount in repossession (3)   2,297    21,081    1,817    10,863    2,107    13,209 
Total delinquencies and amount in repossession (2)   8,767   $74,883    6,438   $38,467    7,543   $49,148 
                               
Delinquencies as a percentage of gross servicing portfolio   6.7    4.6    5.1%    3.3%    6.1%    4.1% 
                               
Total delinquencies and amount in repossession as a percentage of gross servicing portfolio   9.1    6.4    7.2%    4.6%    8.5%    5.5% 
                               
                               
Extension Experience                              
Contracts with one extension, accruing   13,007   $141,644    12,325   $79,527    12,211   $88,894 
Contracts with two or more extensions, accruing   6,059    37,133    8,944    45,033    7,929    38,478 
    19,066    178,777    21,269    124,560    20,140    127,372 
                               
Contracts with one extension, non-accrual   800    7,019    705    4,090    792    5,127 
Contracts with two or more extensions, non-accrual   587    2,919    864    3,941    1,050    4,364 
    1,387    9,938    1,569    8,031    1,842    9,491 
                               
    20,453   $188,715    22,838   $132,591    21,982   $136,863 

_______________

(1) All amounts and percentages are based on the amount remaining to be repaid on each automobile contract, including, for pre-computed automobile contracts, any unearned interest. The information in the table represents the gross principal amount of all automobile contracts we have purchased, including automobile contracts subsequently sold to or financed in securitization transactions that we continue to service.

 

(2) We consider an automobile contract delinquent when an obligor fails to make at least 90% of a contractually due payment by the following due date, which date may have been extended within limits specified in the Servicing Agreements. The period of delinquency is based on the number of days payments are contractually past due, as extended where applicable. Automobile contracts less than 31 days delinquent are not included.

 

(3) Amount in repossession represents financed vehicles that have been repossessed but not yet liquidated.

 

39
 

 

Net Charge-Off Experience (1)

Total Owned Portfolio Excluding Fireside

 

   September 30,   September 30,   December 31, 
   2013   2012   2012 
   (Dollars in thousands) 
Average servicing portfolio outstanding  $1,049,282   $665,043   $699,030 
Annualized net charge-offs as a percentage of
average servicing portfolio (2)
  $4.2%    3.3%    3.5% 

 

Net Charge-Off Experience (1)

Fireside Portfolio

 

   September 30,   September 30,   December 31, 
   2013   2012   2012 
   (Dollars in thousands) 
Average servicing portfolio outstanding  $29,664    115,826   $103,548 
Annualized net charge-offs as a percentage of
average servicing portfolio (2)
  $5.9%    4.2%    4.5% 

 

Net Charge-Off Experience (1)

Total Owned Portfolio Including Fireside

 

   September 30,   September 30,   December 31, 
   2013   2012   2012 
   (Dollars in thousands) 
Average servicing portfolio outstanding  $1,078,946   $780,869   $802,579 
Annualized net charge-offs as a percentage of
average servicing portfolio (2)
  $4.2%    3.5%    3.6% 

_______________

(1) All amounts and percentages are based on the principal amount scheduled to be paid on each automobile contract, net of unearned income on pre-computed automobile contracts.

 

(2) Net charge-offs include the remaining principal balance, after the application of the net proceeds from the liquidation of the vehicle (excluding accrued and unpaid interest) and amounts collected subsequent to the date of charge-off, including some recoveries which have been classified as other income in the accompanying interim financial statements. September 30, 2013 and September 30, 2012 percentage represents nine months ended September 30, 2013 and September 30, 2012 annualized. December 31, 2012 represents 12 months ended December 31, 2012.

 

Extensions

 

In certain circumstances we will grant obligors one-month payment extensions to assist them with temporary cash flow problems. In general, an obligor would not be entitled to more than two such extensions in any 12-month period and no more than six over the life of the contract. The only modification of terms is to advance the obligor’s next due date by one month and extend the maturity date of the receivable by one month. In some cases, a two-month extension may be granted. There are no other concessions such as a reduction in interest rate, forgiveness of principal or of accrued interest. Accordingly, we consider such extensions to be insignificant delays in payments rather than troubled debt restructurings.

 

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The basic question in deciding to grant an extension is whether or not we will (a) be delaying the inevitable repossession and liquidation or (b) risk losing the vehicle as a result of not being able to locate the obligor and vehicle. In both of those situations, the loss would likely be higher than if the vehicle had been repossessed without the extension. The benefits of granting an extension include minimizing current losses and delinquencies, minimizing lifetime losses, getting the obligor’s account current (or close to it) and building goodwill with the obligor so that he might prioritize us over other creditors on future payments. Our servicing staff are trained to identify when a past due obligor is facing a temporary problem that may be resolved with an extension. In most cases, the extension will be granted in conjunction with our receiving a past due payment (and where allowed by law, a nominal fee) from the obligor, thereby indicating an additional monetary and psychological commitment to the contract on the obligor’s part.

 

The credit assessment for granting an extension is initially made by our collector, who bases the recommendation on the collector’s discussions with the obligor. In such assessments the collector will consider, among other things, the following factors: (1) the reason the obligor has fallen behind in payment; (2) whether or not the reason for the delinquency is temporary, and if it is, have conditions changed such that the obligor can begin making regular monthly payments again after the extension; (3) the obligor's past payment history, including past extensions if applicable; and (4) the obligor’s willingness to communicate and cooperate on resolving the delinquency. If the collector believes the obligor is a good candidate for an extension, he must obtain approval from his supervisor, who will review the same factors stated above prior to offering the extension to the obligor. After receiving an extension, an account remains subject to our normal policies and procedures for interest accrual, reporting delinquency and recognizing charge-offs.

 

We believe that a prudent extension program is an integral component to mitigating losses in our portfolio of sub-prime automobile receivables. The table below summarizes the status, as of September 30, 2013, for accounts that received extensions from 2008 through 2012 (2013 data are not included at this time due to insufficient passage of time for meaningful evaluation of results):

 

Period of Extension  # Extensions Granted   Active or Paid Off at September 30, 2013   % Active or Paid Off at September 30, 2013   Charged Off > 6 Months After Extension   % Charged Off > 6 Months After Extension   Charged Off <= 6 Months After Extension   % Charged Off <= 6 Months After Extension   Avg Months to Charge Off Post Extension
                                
2008   35,588    11,428    32.1%    19,234    54.0%    4,819    13.5%   18
                                       
2009   32,004    11,362    35.5%    15,081    47.1%    5,783    18.1%   15
                                       
2010   22,593    13,621    60.3%    10,547    46.7%    1,999    8.8%   16
                                       
2011   17,001    12,703    74.7%    5,151    30.3%    932    5.5%   14
                                       
2012   18,783    15,072    80.2%    2,915    15.5%    796    4.2%   9

 

Table excludes extensions on portfolios serviced for third parties.

 

We view these results as a confirmation of the effectiveness of our extension program. For the accounts receiving extensions in 2008, 2009, 2010, 2011 and 2012, 32.1%, 35.5%, 60.3%, 74.7% and 80.2%, respectively, were either paid in full or active and performing at September 30, 2013. Each of these successful accounts represent continued payments of interest and principal (including payment in full in many cases), where without the extension we likely would have incurred a substantial loss and no interest revenue subsequent to the extension.

 

For the extension accounts that ultimately charge off, we consider any that charged off more than six months after the extension to be at least partially successful. For the 2008, 2009, 2010, 2011 and 2012 extensions, of the accounts that charged off, the charge off was incurred, on average, 18, 15, 16, 14 and 9 months, respectively, after the extension, indicating that even in the cases of an ultimate loss, the obligor serviced the account with additional payments of principal and interest.

 

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Additional information about our extensions is provided in the tables below:

 

   Nine Months Ended
September 30,
   Year Ended December 31, 
   2013   2012   2012 
             
Average number of extensions granted per month   1,701    1,557    1,565 
                
Average number of outstanding accounts   91,567    94,248    93,022 
                
Average monthly extensions as % of average outstandings   1.9%    1.7%    1.7% 

 

Table excludes portfolios originated and owned by third parties.

 

   September 30, 2013   September 30, 2012   December 31, 2012 
   Number of Contracts   Amount   Number of Contracts   Amount   Number of Contracts   Amount 
           (Dollars in thousands)         
                         
Contracts with one extension   13,807   $148,663    13,030   $83,618    13,003   $94,021 
Contracts with two extensions   4,041    28,979    5,376    26,538    4,801    23,213 
Contracts with three extensions   1,636    7,147    3,074    15,472    2,822    13,095 
Contracts with four extensions   716    2,875    1,181    6,004    1,134    5,371 
Contracts with five extensions   217    875    155    842    196    1,038 
Contracts with six extensions   36    176    22    117    26    125 
    20,453   $188,715    22,838   $132,591    21,982   $136,863 
                               
Managed portfolio (excluding originated and owned by 3rd parties)   95,974   $1,162,730    89,991   $829,445    89,163   $885,993 

 

Table excludes portfolios originated and owned by third parties.

 

Non-Accrual Receivables

 

It is not uncommon for our obligors to fall behind in their payments. However, with the diligent efforts of our Servicing staff and systems for managing our collection efforts, we regularly work with our customers to resolve delinquencies. Our staff is trained to employ a counseling approach to assist our customers with their cash flow management skills and help them to prioritize their payment obligations in order to avoid losing their vehicle to repossession. Through our experience, we have learned that once a customer becomes greater than 90 days past due, it is not likely that the delinquency will be resolved and will ultimately result in a charge-off. As a result, we do not recognize any interest income or retain on our balance sheet any accrued interest for contracts that are greater than 90 days past due.

 

If a contract exceeds the 90 days past due threshold at the end of one period, and then makes the necessary payments such that it becomes less than or equal to 90 days delinquent at the end of a subsequent period, it would be restored to full accrual status for our financial reporting purposes. At the time a contract is restored to full accrual in this manner, there can be no assurance that full repayment of interest and principal will ultimately be made. However, we monitor each obligor’s payment performance and are aware of the severity of his delinquency at any time. The fact that the delinquency has been reduced below the 90-day threshold is a positive indicator. Should the contract again exceed the 90-day delinquency level at the end of any reporting period, it would again be reflected as a non-accrual account.

 

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Our policy for placing a contract on non-accrual status is independent of our policy to grant an extension. In practice, it would be an uncommon circumstance where an extension was granted and the account remained in a non-accrual status, since the goal of the extension is to bring the contract current (or nearly current).

 

Liquidity and Capital Resources

 

Our business requires substantial cash to support our purchases of automobile contracts and other operating activities. Our primary sources of cash have been cash flows from operating activities, including proceeds from term securitization transactions and other sales of automobile contracts, amounts borrowed under various revolving credit facilities (also sometimes known as warehouse credit facilities), servicing fees on portfolios of automobile contracts previously sold in securitization transactions or serviced for third parties, customer payments of principal and interest on finance receivables, fees for origination of automobile contracts, and releases of cash from securitization transactions and their related spread accounts. Our primary uses of cash have been the purchases of automobile contracts, repayment of amounts borrowed under lines of credit and otherwise, operating expenses such as employee, interest, occupancy expenses and other general and administrative expenses, the establishment of spread accounts and initial overcollateralization, if any, the increase of credit enhancement to required levels in securitization transactions, and income taxes. There can be no assurance that internally generated cash will be sufficient to meet our cash demands. The sufficiency of internally generated cash will depend on the performance of securitized pools (which determines the level of releases from those pools and their related spread accounts), the rate of expansion or contraction in our managed portfolio, and the terms upon which we are able to acquire and borrow against automobile contracts.

 

Net cash provided by operating activities for the nine-month period ended September 30, 2013 was $71.2 million compared to net cash provided by operating activities for the nine-month period ended September 30, 2012 of $16.4 million. Cash provided by operating activities is significantly affected by our net income, or loss, before provisions for credit losses. The increase is due primarily to the increase in net income of $9.9 million, the increase in provision for credit losses of $30.7 million, and the increase in provision for contingent liabilities of $9.7 million.

 

Net cash used in investing activities for the nine-month period ended September 30, 2013 was $325.0 million compared to net cash used by investing activities of $31.2 million in the prior year period. Cash provided by investing activities primarily results from principal payments and other proceeds received on finance receivables held for investment and reductions in restricted cash. Cash used in investing activities generally relates to purchases of automobile contracts. Purchases of finance receivables held for investment were $592.3 million and $400.9 million during the first nine months of 2013 and 2012, respectively. The significant change from the prior year is largely attributable to the increase in our purchases of finance receivables, net of principal payments received. For the nine-month period ended September 30, 2013, purchases of finance receivables net of principal payments resulted in net cash used of $339.2 million, compared to the prior year when purchases of finance receivables net of payments resulted in net cash used of $174.5 million.

 

Net cash provided by financing activities for the nine months ended September 30, 2013 was $265.0 million compared to net cash provided by financing activities of $15.2 million in the prior year period. Cash provided by financing activities is primarily related to the issuance of securitization trust debt, reduced by the amount of repayment of securitization trust debt and net proceeds or repayments on our warehouse lines of credit. In the first nine months of 2013, we issued $595.0 million in new securitization trust debt compared to $443.5 million in the same period of 2012. In addition, we repaid $282.0 million in securitization trust debt and $41.4 million in debt associated with the Fireside portfolio in the nine months ended September 30, 2013 compared to repayments of securitization trust debt of $306.5 million and repayment of $97.7 million in debt associated with the Fireside portfolio in the prior year period. In the nine months ended September 30, 2013, we received net proceeds on warehouse lines of credit of $5.2 million, compared to net repayments of $5.0 million in the prior year’s period. In addition, in the nine months ended September 30, 2013, we received net proceeds of $6.2 million in residual debt, which consisted of proceeds on new residual interest debt of $20.0 million and repayments under previously issued residual interest debt of $13.8 million. In the prior year period repayments of residual interest debt were $8.1 million. Senior secured related party debt decreased by $12.9 million as a result of our repayment of a $15 million note and the issuance of a new note that had a balance owing of $2.1 million at September 30, 2013.

 

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We purchase automobile contracts from dealers for a cash price approximately equal to their principal amount, adjusted for an acquisition fee which may either increase or decrease the automobile contract purchase price. Those automobile contracts generate cash flow, however, over a period of years. As a result, we have been dependent on warehouse credit facilities to purchase automobile contracts, and on the availability of cash from outside sources in order to finance our continuing operations, as well as to fund the portion of automobile contract purchase prices not financed under revolving warehouse credit facilities.

 

The acquisition of automobile contracts for subsequent financing 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 our automobile contract purchases, 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 us or capture cash from collections on securitized automobile contracts. Of those, the factor most subject to our control is the rate at which we purchase automobile contracts.

 

We are and may in the future be limited in our ability to purchase automobile contracts due to limits on our capital. As of September 30, 2013, we had unrestricted cash of $24.1 million, $84.0 million available under one warehouse credit facility and $89.0 million available under another warehouse credit facility (such figures assume the availability of sufficient eligible collateral). During the nine-month period ended September 30, 2013, we completed three securitizations aggregating $595.0 million of receivables. We intend to complete one more securitization during 2013, although there can be no assurance that we will be able to so. Our plans to manage our liquidity include maintaining our rate of automobile contract purchases at a level that matches our available capital, and, as appropriate, minimizing our operating costs. If we are unable to complete such securitizations, we may be unable to increase our rate of automobile contract purchases, in which case our interest income and other portfolio related income could decrease.

 

Our liquidity will also be affected by releases of cash from the trusts established with our securitizations. While the specific terms and mechanics of each spread account vary among transactions, our securitization agreements generally provide that we will receive excess cash flows, if any, only if the amount of credit enhancement has reached specified levels and the delinquency or net losses related to the automobile contracts in the pool are below certain predetermined levels. In the event delinquencies or net losses on the automobile contracts exceed such levels, the terms of the securitization may require increased credit enhancement to be accumulated for the particular pool. There can be no assurance that collections from the related trusts will continue to generate sufficient cash. Moreover, most of our retained interests in securitization transactions and their related spread accounts are pledged as collateral to our residual interest financings and, under certain circumstances, cash releases from these transactions will be used to repay the financings.

 

One of our securitization transactions, our warehouse credit facilities, our residual interest financing and our financing for the Fireside portfolio 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. As of September 30, 2013, we were in compliance with all such financial covenants. In addition, some agreements contain cross-default provisions that would allow certain creditors to declare a default if a default occurred under a different facility.

 

We have and will continue to have a substantial amount of indebtedness. At September 30, 2013, we had approximately $1,218.0 million of debt outstanding. Such debt consisted primarily of $1,094.6 million of securitization trust debt, and also included $16.9 million in debt for the acquisition of the Fireside portfolio, $27.0 million of warehouse lines of credit, $20.0 million of residual interest financing, $39.0 million of senior secured related party debt and $20.6 million in subordinated renewable notes. We are also currently offering the subordinated notes to the public on a continuous basis, and such notes have maturities that range from three months to 10 years.

 

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Our recent operating results include pre-tax earnings of $25.6 million for the nine months ended September 30, 2013 and $9.2 million for the year ended December 31, 2012. Those periods were preceded by pre-tax losses of $14.5 million and $16.2 million in 2011 and 2010, respectively. We believe that our 2011 and 2010 results were materially and adversely affected by the disruption in the capital markets that began in the fourth quarter of 2007, by the recession that began in December 2007, and by related high levels of unemployment.

 

Although we believe we are able to service and repay our debt, there is no assurance that we will be able to do so. If our plans for future operations do not generate sufficient cash flows and earnings, our ability to make required payments on our debt would be impaired. If we fail to pay our indebtedness when due, it could have a material adverse effect on us and may require us to issue additional debt or equity securities.

 

Critical Accounting Policies

 

We believe that our accounting policies related to (a) Allowance for Finance Credit Losses, (b) Amortization of Deferred Originations Costs and Acquisition Fees, (c) Term Securitizations, (d) Finance Receivables and Related Debt Measured at Fair Value, and (e) Income Taxes are the most critical to understanding and evaluating our reported financial results. Such policies are described below.

 

Allowance for Finance Credit Losses

 

In order to estimate an appropriate allowance for losses to be incurred on finance receivables, we use a loss allowance methodology commonly referred to as "static pooling," which stratifies our finance receivable portfolio into separately identified pools based on the period of origination. Using analytical and formula driven techniques, we estimate an allowance for finance credit losses, which we believe is adequate for probable incurred credit losses that can be reasonably estimated in our portfolio of automobile contracts. The estimate for probable incurred credit losses is reduced by our estimate for future recoveries on previously incurred losses. Provision for losses is charged to our consolidated statement of operations. Net losses incurred on finance receivables are charged to the allowance. We evaluate the adequacy of the allowance by examining current delinquencies, the characteristics of the portfolio, prospective liquidation values of the underlying collateral and general economic and market conditions. As circumstances change, our level of provisioning and/or allowance may change as well. While our allowance as a percentage of finance receivables has increased recently, previously it had decreased for several years due primarily to the continued seasoning of our portfolio. Our historical static loss data shows that, in general, incremental monthly losses as a percentage of the balance outstanding increase to a peak between months 36 and 42 of the life of a static portfolio, after which such monthly incremental losses tend to decrease. As of September 30, 2013 the weighted average age of our portfolio of finance receivables was 14 months. In addition, receivables originated after the second quarter of 2008 have exhibited significantly better credit performance metrics than 2006 and 2007 vintage portfolios at similar aging stages.

 

Amortization of Deferred Originations Costs and Acquisition Fees

 

Upon purchase of a contract from a dealer, we generally either charge or advance the dealer an acquisition fee. In addition, we incur certain direct costs associated with originations of our contracts. All such acquisition fees and direct costs are applied to the carrying value of finance receivables and are accreted into earnings as an adjustment to the yield over the estimated life of the contract using the interest method.

 

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Term Securitizations

 

Our term securitization structure has generally been as follows:

 

We sell automobile contracts we acquire to a wholly-owned special purpose subsidiary, which has been established for the limited purpose of buying and reselling our automobile contracts. The special-purpose subsidiary then transfers the same automobile contracts to another entity, typically a statutory trust. The trust issues interest-bearing asset-backed securities, in a principal amount equal to or less than the aggregate principal balance of the automobile contracts. We typically sell these automobile contracts to the trust at face value and without recourse, except that representations and warranties similar to those provided by the dealer to us are provided by us to the trust. One or more investors purchase the asset-backed securities issued by the trust; the proceeds from the sale of the asset-backed securities are then used to purchase the automobile contracts from us. We may retain or sell subordinated asset-backed securities issued by the trust or by a related entity. We structure our securitizations to include internal credit enhancement for the benefit of the investors (i) in the form of an initial cash deposit to an account ("spread account") held by the trust, (ii) in the form of overcollateralization of the senior asset-backed securities, where the principal balance of the senior asset-backed securities issued is less than the principal balance of the automobile contracts, (iii) in the form of subordinated asset-backed securities, or (iv) some combination of such internal credit enhancements. The agreements governing the securitization transactions require that the initial level of internal credit enhancement be supplemented by a portion of collections from the automobile contracts until the level of internal credit enhancement reaches a specified level, which is then maintained. This specified level is generally computed as a percentage of the principal amount of the related automobile contracts and will vary depending on the performance of the specific portfolio. Such levels have increased and decreased from time to time based on performance of the various portfolios, and have also varied from one transaction to another. The agreements governing the securitizations generally grant us the option to repurchase the automobile contracts from the trust when the aggregate outstanding balance of the automobile contracts has amortized to a specified percentage of the initial aggregate balance.

 

Upon each transfer of automobile contracts in a transaction structured as a secured financing for financial accounting purposes, we retain on our consolidated balance sheet the related automobile contracts as assets and record the asset-backed notes issued in the transaction as indebtedness.

 

We receive periodic base servicing fees for the servicing and collection of the automobile contracts. Under our securitization structures treated as secured financings for financial accounting purposes, such servicing fees are included in interest income from the automobile contracts. In addition, we are entitled to the cash flows from the trusts that represent collections on the automobile contracts in excess of the amounts required to pay principal and interest on the asset-backed securities, base servicing fees, and certain other fees and expenses (such as trustee and custodial fees).

 

If the amount of cash required for payment of fees, expenses, interest and principal on the senior asset-backed notes exceeds the amount collected during the collection period, the shortfall is withdrawn from the spread account, if any. If the cash collected during the period exceeds the amount necessary for the above allocations plus required principal payments on the subordinated asset-backed notes, and there is no shortfall in the related spread account or the required overcollateralization level, the excess is released to us. If the spread account and overcollateralization are not at the required levels, then the excess cash collected is retained in the trust until the specified levels are achieved. Although spread account balances are held by the trusts on behalf of our special-purpose subsidiaries as the owner of the residual interests or the trusts, we are restricted in use of the cash in the spread accounts. Cash held in the various spread accounts is invested in high quality, liquid investment securities, as specified in the securitization agreements.

 

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Finance Receivables and Related Debt Measured at Fair Value

 

In September 2011 we purchased finance receivables from Fireside Bank. These receivables are secured by debt that was structured specifically for the acquisition of this portfolio. Since the Fireside receivables were originated by another entity with its own underwriting guidelines and procedures, we have elected to account for the Fireside receivables and the related debt secured by those receivables at their estimated fair values so that changes in fair value will be reflected in our results of operations as they occur. There are limited observable inputs available to us for measurement of such receivables, or for the related debt. We use our own assumptions about the factors that we believe market participants would use in pricing similar receivables and debt, and are based on the best information available in the circumstances. The valuation method used to estimate fair value may produce a fair value measurement that may not be indicative of ultimate realizable value. Furthermore, while we believe our valuation methods are appropriate and consistent with those used by other market participants, the use of different methods or assumptions to estimate the fair value of certain financial instruments could result in different estimates of fair value. Those estimated values may differ significantly from the values that would have been used had a readily available market for such receivables or debt existed, or had such receivables or debt been liquidated, and those differences could be material to the financial statements.

 

Income Taxes

 

We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

 

Deferred tax assets are recognized subject to management’s judgment that realization is more likely than not. A valuation allowance is recognized for a deferred tax asset if, based on the weight of the available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized. In making such judgments, significant weight is given to evidence that can be objectively verified. As a result of the unprecedented adverse changes in the market for securitizations, the recession and the resulting high levels of unemployment that occurred in 2008 and 2009, we incurred substantial operating losses from 2009 through 2011 which led us to establish a valuation allowance against a substantial portion of our deferred tax assets. However, from the fourth quarter of 2011 through September 2013, we reported eight consecutive quarters of increasing profitability, observed improvement in credit metrics, and produced reliable internal financial projections. Furthermore, we demonstrated an ability to increase our volumes of contract purchases, grow our managed portfolio and obtain cost effective short- and long-term financing for our finance receivables. As a result of these and other factors, we determined at December 31, 2012 that, based on the weight of the available objective evidence, it was more likely than not that we would generate sufficient future taxable income to utilize our net deferred tax assets. Accordingly, we reversed the related valuation allowance of $62.8 million in the fourth quarter of 2012.

 

In determining the possible future realization of deferred tax assets, we have considered future taxable income from the following sources: (a) reversal of taxable temporary differences; and (b) forecasted future net earnings from operations. Based upon those considerations, we have concluded that it is more likely than not that the U.S. and state net operating loss carryforward periods provide enough time to utilize the deferred tax assets pertaining to the existing net operating loss carryforwards and any net operating loss that would be created by the reversal of the future net deductions which have not yet been taken on a tax return. Our estimates of taxable income are forward-looking statements, and there can be no assurance that our estimates of such taxable income will be correct.

 

We recognize interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying consolidated statement of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheet.

 

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Forward Looking Statements

 

This report on Form 10-Q includes certain “forward-looking statements.” Forward-looking statements may be identified by the use of words such as “anticipates,” “expects,” “plans,” “estimates,” or words of like meaning. Our provision for credit losses is a forward-looking statement, as it is dependent on our estimates as to future chargeoffs and recovery rates. Factors that could affect charge-offs and recovery rates include changes in the general economic climate, which could affect the willingness or ability of obligors to pay pursuant to the terms of automobile contracts, changes in laws respecting consumer finance, which could affect our ability to enforce rights under automobile contracts, and changes in the market for used vehicles, which could affect the levels of recoveries upon sale of repossessed vehicles. Factors that could affect our revenues in the current year include the levels of cash releases from existing pools of automobile contracts, which would affect our ability to purchase automobile contracts, the terms on which we are able to finance such purchases, the willingness of dealers to sell automobile contracts to us on the terms that we offer, and the terms on which and whether we are able to complete term securitizations once automobile contracts are acquired. Factors that could affect our expenses in the current year include competitive conditions in the market for qualified personnel and interest rates (which affect the rates that we pay on notes issued in our securitizations).

 

Item 4. Controls and Procedures

 

We maintain a system of internal controls and procedures designed to provide reasonable assurance as to the reliability of our published financial statements and other disclosures included in this report. As of the end of the period covered by this report, we evaluated the effectiveness of the design and operation of such disclosure controls and procedures. Based upon that evaluation, the principal executive officer (Charles E. Bradley, Jr.) and the principal financial officer (Jeffrey P. Fritz) concluded that the disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, material information relating to us that is required to be included in our reports filed under the Securities Exchange Act of 1934. There has been no change in our internal controls over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 

 

 

 

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PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

 

The information provided under the caption “Legal Proceedings,” Note 9 to the Unaudited Condensed Consolidated Financial Statements, included in Part I of this report, is incorporated herein by reference.

 

Item 1A. Risk Factors

 

We remind the reader that risk factors are set forth in Item 1A of our report on Form 10-K, filed with the U.S. Securities and Exchange Commission on February 15, 2013. Where we are aware of material changes to such risk factors as previously disclosed, we set forth below an updated discussion of such risks. The reader should note that the other risks identified in our report on Form 10-K remain applicable.

 

We have substantial indebtedness.

 

We have and will continue to have a substantial amount of indebtedness. At September 30, 2013 and December 31, 2012, we had approximately $1,218.0 million and $958.5 million, respectively, of debt outstanding. Such debt consisted, as of September 30, 2013, primarily of $1,094.6 million of securitization trust debt, and also included $16.9 million in debt for the acquisition of the Fireside portfolio, $27.0 million of warehouse lines of credit indebtedness, $20.0 million of residual interest financing, $38.9 million of senior secured related party debt and $20.6 million in subordinated renewable notes. At December 31, 2012, such debt consisted primarily of $792.5 million of securitization trust debt, and also included $57.1 million in debt for the acquisition of the Fireside portfolio, $21.7 million of warehouse indebtedness, $13.8 million of residual interest financing, $50.1 million of senior secured related party debt, and $23.3 million in subordinated renewable notes. We are also currently offering the subordinated notes to the public on a continuous basis, and such notes have maturities that range from three months to 10 years.

 

Our substantial indebtedness could adversely affect our financial condition by, among other things:

 

·increasing our vulnerability to general adverse economic and industry conditions;

 

·requiring us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing amounts available for working capital, capital expenditures and other general corporate purposes;

 

·limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

 

·placing us at a competitive disadvantage compared to our competitors that have less debt; and

 

·limiting our ability to borrow additional funds.

 

Although we believe we are able to service and repay such debt, there is no assurance that we will be able to do so. If we do not generate sufficient operating profits, our ability to make required payments on our debt would be impaired. Failure to pay our indebtedness when due could have a material adverse effect.

 

If an increase in interest rates results in a decrease in our cash flow from excess spread, our results of operations may be impaired.

 

Our profitability is largely determined by the difference, or "spread," between the effective interest rate on the automobile contracts that we acquire and the interest rates payable under warehouse credit facilities and on the asset-backed securities issued in our securitizations. In the past, disruptions in the market for asset-backed securities resulted in an increase in the interest rates we paid on asset-backed securities. Should similar disruptions take place in the future, we may pay higher interest rates on asset-backed securities issued in the future. Although we have the ability partially to offset increases in our cost of funds by increasing fees we charge to dealers when purchasing contracts, or by demanding higher interest rates on contracts we purchase, there can be no assurance that such actions would offset the entire increase in interest that we might pay to finance our managed portfolio.

 

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Several factors affect our ability to manage interest rate risk. Specifically, we are subject to interest rate risk during the period after we purchase automobile contracts from dealers and before we finance such contracts in a term securitization. Interest rates on warehouse credit facilities are typically adjustable, while the interest rates on the automobile contracts are fixed. If interest rates increase, the interest we must pay to the lenders under warehouse credit facilities is likely to increase, while the interest we collect from those warehoused automobile contracts remains the same. Therefore, during the warehousing period, excess spread cash flow would likely decrease. Additionally, contracts warehoused and then securitized during a rising interest rate environment may result in less excess spread cash flow as our securitizations typically have paid interest rates set at prevailing interest rates at the time of the closing of the securitization, which may not take place until several months after we purchased those contracts. Our customers, on the other hand, pay fixed rates of interest on the contracts, which are agreed to at the time they purchase the underlying vehicles. A decrease in excess spread cash flow could adversely affect our earnings and cash flow.

 

To mitigate, but not eliminate, the short-term risk relating to floating interest rates payable under the warehouse facilities, we have historically held automobile contracts in the warehouse credit facilities for less than four months. To mitigate, but not eliminate, the long-term risk relating to interest rates payable in securitizations, we have in the past, and intend to continue to, structure some of our securitization transactions to include pre-funding structures, whereby the amount of securities issued exceeds the amount of contracts initially sold into the securitization. In pre-funding, the proceeds from the pre-funded portion are held in an escrow account until we sell the additional contracts into the securitization. In pre-funded securitizations, we effectively lock in our borrowing costs with respect to the contracts we subsequently sell into the securitization. However, we incur an expense in pre-funded securitizations equal to the difference between the money market yields earned on the proceeds held in escrow prior to subsequent delivery of contracts and the interest rate paid on the securities issued in the securitization. The amount of such expense may vary. Despite these mitigation strategies, an increase in prevailing interest rates would cause us to receive less excess spread cash flow on automobile contracts, and thus could adversely affect our earnings and cash flow.

 

Forward-Looking Statements

 

Discussions of certain matters contained in this report may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Exchange Act, and as such, may involve risks and uncertainties. These forward-looking statements relate to, among other things, expectations of the business environment in which we operate, projections of future performance, perceived opportunities in the market and statements regarding our mission and vision. You can generally identify forward-looking statements as statements containing the words "will," "would," "believe," "may," "could," "expect," "anticipate," "intend," "estimate," "assume" or other similar expressions. Our actual results, performance and achievements may differ materially from the results, performance and achievements expressed or implied in such forward-looking statements. The discussion under "Risk Factors" identifies some of the factors that might cause such a difference, including the following:

 

  changes in general economic conditions;
     
  our ability or inability to obtain necessary financing
     
  in interest rates;
     
  our ability to generate sufficient operating and financing cash flows;
     
  competition;
     
  level of future provisioning for receivables losses; and
     
  regulatory requirements.

 

 

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Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Actual results may differ from expectations due to many factors beyond our ability to control or predict, including those described herein, and in documents incorporated by reference in this report. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

 

We undertake no obligation to publicly update any forward-looking information. You are advised to consult any additional disclosure we make in our periodic reports filed with the SEC. See "Where You Can Find More Information" and "Documents Incorporated by Reference."

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

During the three months ended September 30, 2013, we re-purchased 205,130 shares of our common stock, in a net exercise of outstanding warrants. In that transaction, the holder of warrants to purchase 272,000 shares of our common stock paid the aggregate $1,346,400 warrant exercise price by surrender to us of 205,130 of such 272,000 shares.

 

Issuer Purchases of Equity Securities

 

   Total Number of Shares   Average Price Paid  
Total Number of Shares Purchased as Part of Publicly Announced Plans or
   Approximate Dollar Value of Shares that May Yet be Purchased Under the Plans or 
Period(1)  Purchased   per Share   Programs   Programs (2) 
July 2013      $       $986,193 
August 2013   205,130    6.56       $986,193 
September 2013              $986,193 
Total   205,130   $6.56          

_________________

(1)Each monthly period is the calendar month.
(2)Through September 30, 2013, our board of directors had authorized the purchase of up to $34.5 million of our outstanding securities, which program was first announced in our 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.

 

 

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Item 6. Exhibits

 

The Exhibits listed below are filed with this report.

 

4.14 Instruments defining the rights of holders of long-term debt of certain consolidated subsidiaries of the registrant are omitted pursuant to the exclusion set forth in subdivisions (b)(iv)(iii)(A) and (b)(v) of Item 601 of Regulation S-K (17 CFR 229.601).  The registrant agrees to provide copies of such instruments to the United States Securities and Exchange Commission upon request.
   
4.47 Indenture dated September 1, 2013 re Notes issued by CPS Auto Receivables Trust 2013-C. Incorporated by reference to the exhibit filed with the registrant's Form 8-K/A on October 30, 2013.
   
4.48 Sale and Servicing Agreement dated as of September 1, 2013. Incorporated by reference to the exhibit filed with the registrant's Form 8-K/A on October 30, 2013.
   
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.*

 

101.INS XBRL Instance Document
   
101.SCH XBRL Schema Document
   
101.CAL XBRL Calculation Linkbase Document
   
101.DEF XBRL Definition Linkbase Document
   
101.LAB XBRL Label Linkbase Document
   
101.PRE XBRL Presentation Linkbase Document

 

* 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.

 

 

 

 

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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: October 30, 2013        
         
    By: /s/ JEFFREY P. FRITZ  
      Charles E. Bradley, Jr.  
     

President and Chief Executive Officer

(Principal Executive Officer)

 

 

         
Date: October 30, 2013        
         
    By: /s/ CHARLES E. BRADLEY, JR  
      Jeffrey P. Fritz  
     

Senior Vice President and Chief Financial Officer

(Principal Financial Officer)

 

 

 

 

 

 

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