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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________
FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
COMMISSION FILE NUMBER: 0-51027
CONSUMER PORTFOLIO SERVICES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 33-0459135
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
16355 LAGUNA CANYON ROAD, IRVINE, CALIFORNIA 92618
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (949) 753-6800
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Title of Each Class Name of Each Exchange on Which Registered
------------------- -----------------------------------------
Common Stock, no par value The Nasdaq Stock Market LLC (Global Market)
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such shorter period that the registrant was required to file such
reports) and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The aggregate market value of the 13,522,700 shares of the registrant's common
stock held by non-affiliates, based upon the closing price of the registrant's
common stock of $6.71 per share reported by Nasdaq as of June 30, 2006, was
approximately $90,737,317. For purposes of this computation, a registrant
sponsored pension plan and all directors, executive officers, and beneficial
owners of 10 percent or more of the registrant's common stock are deemed to be
affiliates. Such determination is not an admission that such plan, directors,
executive officers, and beneficial owners are, in fact, affiliates of the
registrant. The number of shares of the registrant's Common Stock outstanding on
February 27, 2007, was 21,530,054.
DOCUMENTS INCORPORATED BY REFERENCE
The proxy statement for registrant's 2007 annual shareholders meeting is
incorporated by reference into Part III hereof.
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PART I
ITEM 1. BUSINESS
OVERVIEW
We are a specialty finance company engaged in purchasing and servicing
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 the
customers of dealers, who have limited credit histories, low incomes or past
credit problems, who we refer to as sub-prime customers. 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. We generally do not lend money directly to
consumers. Rather, we purchase automobile contracts from dealers under several
different financing programs. We are headquartered in Irvine, California, where
all credit and underwriting functions are centralized. We service our automobile
contracts from our California headquarters and from three servicing branches in
Virginia, Florida and Illinois.
We direct our marketing efforts to dealers, rather than to consumers.
We establish relationships with dealers through our employee marketing
representatives who contact a prospective dealer to explain our automobile
contract purchase programs, and thereafter provide dealer training and support
services. The marketing representatives are obligated to represent our financing
program exclusively. Our marketing representatives present the dealer with a
marketing package, which includes our promotional material containing the terms
offered by us for the purchase of automobile contracts, a copy of our
standard-form dealer agreement, and required documentation relating to
automobile contracts. As of December 31, 2006, we had 94 marketing
representatives and we were a party to dealer agreements with over 8,600 dealers
in 48 states. Approximately 90% of these dealers are franchised new car dealers
that sell both new and used cars and the remainder are independent used car
dealers. For the year ended December 31, 2006, approximately 87% of the
automobile contracts purchased under our programs consisted of financing for
used cars and 13% consisted of financing for new cars, as compared to 81%
financing for used cars and 19% for new cars in the year ended December 31,
2005.
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. Depending on the structure of the securitization, the
transaction may, for financial accounting purposes, be treated as a sale of the
contracts or as a secured financing. From inception through the third quarter of
2003, we generated revenue primarily from the gains recognized on the sale or
securitization of automobile contracts, servicing fees earned on automobile
contracts sold, interest earned on residual interests and interest on finance
receivables. However, since the third quarter of 2003, we have structured our
securitizations to be treated as secured financings rather than as sales of
automobile contracts for financial accounting purposes. By accounting for these
securitizations as secured financings, the contracts and asset-backed notes
issued remain on our balance sheet with the interest income of the contracts in
the trust and the related financing costs reflected over the life of the
underlying pool of contracts.
We were incorporated and began our operations in March 1991. From
inception through December 31, 2006, we have purchased a total of approximately
$7.1 billion of automobile contracts from dealers. In addition, we obtained a
total of approximately $605.0 million of automobile contracts in our 2002, 2003
and 2004 acquisitions, as described below. Our total managed portfolio, net of
unearned interest on pre-computed automobile contracts, grew to approximately
$1,565.9 million at December 31, 2006 from $1,122.0 million at December 31,
2005, $906.9 million as of December 31, 2004 and $743.5 million as of December
31, 2003.
HISTORICAL ACQUISITIONS
In March 2002, we acquired MFN Financial Corporation and its
subsidiaries, or MFN, in a merger, which we refer to as the MFN merger. In May
2003, we acquired TFC Enterprises, Inc. and its subsidiaries, or TFC, in a
second merger, which we refer to as the TFC merger. We acquired $381.8 million
of automobile contracts in the MFN merger, and $152.1 million in the TFC merger.
MFN and TFC were engaged in businesses similar to that of ours. MFN ceased
acquiring automobile contracts in March 2002, while TFC continues to acquire
automobile contracts under its TFC programs. Automobile contracts purchased by
TFC during the year ended December 31, 2006 accounted for less than 4% of our
total purchases during the year. In April 2004, we acquired $74.9 million in
automobile contracts from SeaWest Financial Corporation and its subsidiaries. In
addition, we were named servicer of approximately $111.8 million of automobile
contracts that SeaWest had previously securitized, and which we do not own. We
sometimes refer to those non-owned contracts as the SeaWest third-party
portfolio.
SUB-PRIME AUTO FINANCE INDUSTRY
Automobile financing is the second largest consumer finance market in
the United States. The automobile finance industry can be divided into two
principal segments: a prime credit market and a sub-prime credit market.
Traditional automobile finance companies, such as commercial banks, savings
institutions, credit unions and captive finance companies of automobile
manufacturers, generally lend to the most creditworthy, or so-called prime,
borrowers. The sub-prime automobile credit market, in which we operate, provides
financing to less creditworthy borrowers, at higher interest rates.
Historically, traditional lenders have not serviced the sub-prime
market or have done so through programs that were not consistently available.
Independent companies specializing in sub-prime automobile financing and
subsidiaries of larger financial services companies currently compete in this
segment of the automobile finance market, which we believe remains highly
fragmented, with no single company having a dominant position in the market.
OUR OPERATIONS
Our automobile financing programs are designed to serve sub-prime
customers, who generally have limited credit histories, low incomes or past
credit problems. Because we serve customers who are unable to meet certain
credit standards, we incur greater risks, and generally receive interest rates
higher than those charged in the prime credit market. We also sustain a higher
level of credit losses because we provide financing in a relatively high risk
market.
ORIGINATIONS
When a retail automobile buyer elects to obtain financing from a
dealer, the dealer takes a credit application to submit to its financing
sources. Typically, a dealer will submit the buyer's application to more than
one financing source for review. We believe the dealer's decision to choose a
financing source is based primarily on: (i) the monthly payment; (ii) the
purchase price offered for the contract; (iii) timeliness, consistency and
predictability of response; (iv) funding turnaround time; and (v) any conditions
to purchase. Dealers can send credit applications to us via the Internet or fax.
For the year ended December 31, 2006, we received approximately 81% of all
applications through DealerTrack (the industry leading dealership application
aggregator), 9% via our website and 10% via fax. Our automated application
decisioning system produced our response within minutes to about 88% of those
applications.
Upon receipt of information from a dealer, our proprietary automated
decisioning system orders a credit report to document the buyer's credit
history. If, upon review by the automated decisioning systems, or in some cases,
one of our credit analysts, it is determined that the automobile contract meets
our underwriting criteria, or would meet such criteria with modification, we
request and review further information and supporting documentation and,
ultimately, decide whether to approve the automobile contract for purchase. When
presented with an application, we attempt to notify the dealer within one hour
as to whether we would purchase the related automobile contract.
Dealers with which we do business are under no obligation to submit any
automobile contracts to us, nor are we obligated to purchase any automobile
contracts from them. During the year ended December 31, 2006, no dealer
accounted for more than 1% of the total number of automobile contracts we
purchased. Automobile contracts purchased by TFC after the TFC merger under the
TFC programs are purchased with a dealer marketing strategy that is similar to
that of ours as described above, except that the marketing efforts are directed
at independent used car dealers and the vehicle purchasers we are looking for
are enlisted personnel of the U.S. Armed Forces. The following table sets forth
the geographical sources of the automobile contracts purchased by us (based on
the addresses of the customers as stated on our records) during the years ended
December 31, 2006 and 2005.
2
Contracts Purchased During the Year Ended (1)
----------------------------------------------------
December 31, 2006 December 31, 2005
-------------------------- -------------------------
Number Percent (2) Number Percent (2)
------------ ------------- ------------ ------------
Texas 7,004 10.9% 4,734 10.7%
California 5,887 9.2% 3,981 9.0%
Florida 5,100 7.9% 3,151 7.1%
Ohio 4,758 7.4% 3,311 7.5%
Pennsylvania 3,642 5.7% 2,732 6.2%
Illinois 2,950 4.6% 2,188 4.9%
North Carolina 2,864 4.5% 2,003 4.5%
Michigan 2,791 4.3% 1,883 4.2%
Louisiana 2,755 4.3% 2,268 5.1%
New York 2,732 4.3% 1,617 3.6%
Kentucky 2,180 3.4% 1,851 4.2%
Maryland 2,107 3.3% 1,933 4.4%
Virginia 1,678 2.6% 1,379 3.1%
New Jersey 1,543 2.4% 667 1.5%
Other States 16,210 25.2% 10,678 24.1%
------------ ------------- ------------ ------------
Total 64,201 100.0% 44,376 100.0%
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(1) AUTOMOBILE CONTRACTS PURCHASED BY TFC AFTER THE TFC MERGER ARE NOT INCLUDED
BECAUSE SUCH PURCHASES ACCOUNTED FOR LESS THAN 10% OF THE TOTAL PURCHASES
DURING THE YEAR.
(2) PERCENTAGES MAY NOT TOTAL TO 100.0% DUE TO ROUNDING.
We purchase automobile contracts under our programs from dealers at a
price generally equal to the total amount financed under the automobile
contracts, adjusted for an acquisition fee, which may either increase or
decrease the automobile contract purchase price paid by us. The amount of the
acquisition fee, and whether it results in an increase or decrease to the
automobile contract purchase price, is based on the perceived credit risk of
and, in some cases, the interest rate on the automobile contract. For the years
ended December 31, 2006, 2005 and 2004, the average acquisition fee charged per
automobile contract purchased under our programs was $241, $150 and $226,
respectively, or 1.6%, 1.0% and 1.6%, respectively, of the amount financed.
We offer seven different financing programs to our dealership
customers, and price each program according to the relative credit risk. We
offer programs covering a wide band of the credit spectrum. Our upper credit
tier products, which are our Preferred, Super Alpha, Alpha Plus and Alpha
programs accounted for approximately 78% and 82% of our new contract
originations in 2006 and 2005, respectively, in each case measured by aggregate
amount financed.
The following table identifies the credit program, sorted from highest
to lowest credit quality, under which we purchased automobile contracts during
the years ended December 31, 2006, 2005 and 2004.
Contracts Purchased (1) During the Year Ended
December 31, 2006 December 31, 2005 December 31, 2004
---------------------------- ----------------------------- -----------------------------
AMOUNT AMOUNT AMOUNT
FINANCED PERCENT (2) FINANCED PERCENT (2) FINANCED PERCENT (2)
------------- ----------- ------------- ----------- ------------- -----------
(dollars in thousands)
Preferred $ 30,700 3.1% $ 13,735 2.1% $ 6,273 1.5%
Super Alpha 120,118 12.2% 78,030 11.8% 34,134 8.3%
Alpha Plus 178,371 18.1% 135,926 20.6% 70,786 17.3%
Alpha 444,775 45.0% 314,444 47.6% 233,521 57.1%
Standard 85,190 8.6% 67,293 10.2% 36,561 8.9%
Mercury / Delta 77,481 7.8% 20,346 3.1% 9,988 2.4%
First Time Buyer 50,893 5.2% 30,329 4.6% 17,655 4.3%
------------- ----------- ------------- ----------- ------------- -----------
$ 987,528 100.0% $ 660,103 100.0% $ 408,918 100.0%
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(1) AUTOMOBILE CONTRACTS PURCHASED BY TFC AFTER THE TFC MERGER ARE NOT INCLUDED
BECAUSE SUCH PURCHASES ACCOUNTED FOR LESS THAN 10% OF THE TOTAL PURCHASES
DURING THE YEAR.
(2) PERCENTAGES MAY NOT TOTAL TO 100.0% DUE TO ROUNDING.
3
We attempt to control misrepresentation regarding the customer's credit
worthiness by carefully screening the automobile contracts we purchase, by
establishing and maintaining professional business relationships with dealers,
and by including certain representations and warranties by the dealer in the
dealer agreement. Pursuant to the dealer agreement, we may require the dealer to
repurchase any automobile contract in the event that the dealer breaches our
representations or warranties. There can be no assurance, however, that any
dealer will have the willingness or the financial resources to satisfy our
repurchase obligations to us.
In addition to our purchases of installment contracts from dealers, we
purchased in 2006 an immaterial number of vehicle purchase money loans,
evidenced by promissory notes and security agreements. A non-affiliated lender
originated all such loans directly to vehicle purchasers, and sold the loans to
us. We plan to begin financing vehicle purchases by direct loans to consumers in
2007, on terms similar to those that we offer through dealers, though without a
down payment requirement. There can be no assurance as to the extent to which we
will in fact make any such loans, nor as to their future performance.
UNDERWRITING
To be eligible for purchase by us, an automobile contract must have
been originated by a dealer that has entered into a dealer agreement to sell
automobile contracts to us. The automobile contract must be secured by a first
priority lien on a new or used automobile, light truck or passenger van and must
meet our underwriting criteria. In addition, each automobile contract requires
the customer to maintain physical damage insurance covering the financed vehicle
and naming us as a loss payee. We may, nonetheless, suffer a loss upon theft or
physical damage of any financed vehicle if the customer fails to maintain
insurance as required by the automobile contract and is unable to pay for
repairs to or replacement of the vehicle or is otherwise unable to fulfill his
or her obligations under the automobile contract.
We believe that our underwriting criteria enable us to evaluate
effectively the creditworthiness of sub-prime customers and the adequacy of the
financed vehicle as security for an automobile contract. The underwriting
criteria include standards for price, term, amount of down payment, installment
payment and interest rate; mileage, age and type of vehicle; principal amount of
the automobile contract in relation to the value of the vehicle; customer income
level, employment and residence stability, credit history and debt service
ability, as well as other factors. Specifically, the underwriting guidelines for
our CPS programs generally limit the maximum principal amount of a purchased
automobile contract to 115% of wholesale book value in the case of used vehicles
or to 115% of the manufacturer's invoice in the case of new vehicles, plus, in
each case, sales tax, licensing and, when the customer purchases such additional
items, a service contract or a credit life or disability policy. We generally do
not finance vehicles that are more than eight model years old or have in excess
of 85,000 miles. Under most of our programs, the maximum term of a purchased
contract is 72 months; a shorter maximum term may be applicable based on the
mileage and age of the vehicle. Automobile contracts with the maximum term of 72
months may be purchased if the customer is among the more creditworthy of our
obligors and the vehicle is generally not more than two model years old and has
less than 45,000 miles. Automobile contract purchase criteria are subject to
change from time to time as circumstances may warrant. Upon receiving the
vehicle and customer information with the customer's application, our
underwriters verify the customer's employment, residency, and credit information
by contacting various parties noted on the customer's application, credit
information bureaus and other sources. In addition, prior to purchasing an
automobile contract, we contact each customer by telephone to confirm that the
customer understands and agrees to the terms of the related automobile contract.
During this "welcome call," we also ask the customer a series of open ended
questions about his application and the contract to uncover any potential
misrepresentations.
CREDIT SCORING. We use a proprietary scoring model to assign each
automobile contract a "credit score" at the time the application is received
from the dealer and the customer's credit information is retrieved from the
credit reporting agencies. The credit score is based on a variety of parameters
including the customer's credit history, employment and residence stability,
income, and monthly payment amount,. Our score also considers the loan-to-value
ratio and the age and mileage of the vehicle. We have developed the credit score
utilizing statistical risk management techniques and historical performance data
from our managed portfolio. We believe this improves our allocation of credit
evaluation resources, and more effectively manages the risk inherent in the
sub-prime market.
CHARACTERISTICS OF CONTRACTS. All of the automobile contracts purchased
by us are fully amortizing and provide for level payments over the term of the
automobile contract. All automobile contracts may be prepaid at any time without
penalty. The average original principal amount financed, under the CPS programs
and in the year ended December 31, 2006, was $15,382, with an average original
term of 63 months and an average down payment amount of 12.3%. Based on
information contained in customer applications for this 12-month period, the
retail purchase price of the related automobiles averaged $15,667 (which
4
excludes tax, license fees and any additional costs such as a maintenance
contract), the average age of the vehicle at the time the automobile contract
was purchased was 3 years, and our customers averaged approximately 38 years of
age, with approximately $40,440 in average annual household income and an
average of 5 years history with his or her current employer. Because our TFC
programs are directed towards enlisted military personnel, contracts purchased
under the TFC programs tend to have smaller balances and the purchasers are
generally younger and have lower incomes.
DEALER COMPLIANCE. The dealer agreement and related assignment contain
representations and warranties by the dealer that an application for state
registration of each financed vehicle, naming us as secured party with respect
to the vehicle, was effected at the time of sale of the related automobile
contract to us, and that all necessary steps have been taken to obtain a
perfected first priority security interest in each financed vehicle in favor of
us under the laws of the state in which the financed vehicle is registered.
SERVICING AND COLLECTION
We currently service all automobile contracts that we own as well as
those automobile contracts that are included in portfolios that we have sold to
off balance sheet securitization trusts or in the SeaWest third party portfolio.
We organize our servicing activities based on the tasks performed by our
personnel. Our servicing activities consist of mailing monthly billing
statements; collecting, accounting for and posting of all payments received;
responding to customer inquiries; taking all necessary action to maintain the
security interest granted in the financed vehicle or other collateral;
investigating delinquencies; communicating with the customer to obtain timely
payments; repossessing and liquidating the collateral when necessary; collecting
deficiency balances; and generally monitoring each automobile contract and the
related collateral. We are typically entitled to receive a base monthly
servicing fee between 2.5% and 3.5% per annum computed as a percentage of the
declining outstanding principal balance of the non-charged-off automobile
contracts in the securitization pools. The servicing fee is included in interest
income for on balance sheet financings.
COLLECTION PROCEDURES. We believe that our ability to monitor
performance and collect payments owed from sub-prime customers is primarily a
function of our collection approach and support systems. We believe that if
payment problems are identified early and our collection staff works closely
with customers to address these problems, it is possible to correct many of
problems before they deteriorate further. To this end, we utilize pro-active
collection procedures, which include making early and frequent contact with
delinquent customers; educating customers as to the importance of maintaining
good credit; and employing a consultative and customer service approach to
assist the customer in meeting his or her obligations, which includes attempting
to identify the underlying causes of delinquency and cure them whenever
possible. In support of our collection activities, we maintain a computerized
collection system specifically designed to service automobile contracts with
sub-prime customers and similar consumer obligations.
With the aid of our automatic dialer, as well as manual efforts made by
collection staff, we attempt to make telephonic contact with delinquent
customers from one to 15 days after their monthly payment due date, depending on
our proprietary behavioral assessment of the customer's likelihood of payment
during early stages of delinquency. Using coded instructions from a collection
supervisor, the automatic dialer will attempt to contact customers based on
their physical location, stage of delinquency, size of balance or other
parameters. If the automatic dialer obtains a "no answer" or a busy signal, it
records the attempt on the customer's record and moves on to the next call. If a
live voice answers the automatic dialer's call, the call is transferred to a
waiting collector as the customer's pertinent information is simultaneously
displayed on the collector's workstation. The collector then inquires of the
customer the reason for the delinquency and when we can expect to receive the
payment. The collector will attempt to get the customer to make a promise for
the delinquent payment for a time generally not to exceed one week from the date
of the call. If the customer makes such a promise, the account is routed to a
promise queue and is not contacted until the outcome of the promise is known. If
the payment is made by the promise date and the account is no longer delinquent,
the account is routed out of the collection system. If the payment is not made,
or if the payment is made, but the account remains delinquent, the account is
returned to the queue for subsequent contacts.
If a customer fails to make or keep promises for payments, or if the
customer is uncooperative or attempts to evade contact or hide the vehicle, a
supervisor will review the collection activity relating to the account to
determine if repossession of the vehicle is warranted. Generally, such a
decision will occur between the 45th and 90th day past the customer's payment
due date, but could occur sooner or later, depending on the specific
circumstances. At the time the vehicle is repossessed we will stop accruing
interest in this automobile contract, and reclassify the remaining automobile
contract balance to other assets. In addition we will apply a specific reserve
to this automobile contract so that the net balance represents the estimated
fair value less costs to sell.
5
If we elect to repossess the vehicle, we assign the task to an
independent local repossession service. Such services are licensed and/or bonded
as required by law. When the vehicle is recovered, the repossessor delivers it
to a wholesale automobile auction, where it is kept until sold. Financed
vehicles that have been repossessed are generally resold by us through
unaffiliated automobile auctions, which are attended principally by car dealers.
Net liquidation proceeds are applied to the customer's outstanding obligation
under the automobile contract. Such proceeds usually are insufficient to pay the
customer's obligation in full, resulting in a deficiency. In many cases we will
continue to contact our customers to recover all or a portion of this deficiency
for up to several years after charge-off.
Once an automobile contract becomes greater than 90 days delinquent, we
do not recognize additional interest income until the borrower under the
automobile contract makes sufficient payments to be less than 90 days
delinquent. Any payments received by a borrower that are greater than 90 days
delinquent are first applied to accrued interest and then to principal
reduction.
We generally charge off the balance of any contract by the earlier of
the end of the month in which the automobile contract becomes five scheduled
installments past due or, in the case of repossessions, the month that the
proceeds from the liquidation of the financed vehicle are received by us or if
the vehicle has been in repossession inventory for more than three months. In
the case of repossession, the amount of the charge-off is the difference between
the outstanding principal balance of the defaulted automobile contract and the
net repossession sale proceeds.
CREDIT EXPERIENCE
Our financial results are dependent on the performance of the
automobile contracts in which we retain an ownership interest. The tables below
document the delinquency, repossession and net credit loss experience of all
automobile contracts that we are servicing (excluding contracts from the SeaWest
third party portfolio) as of the respective dates shown. Credit experience for
us, MFN (since the date of the MFN merger), TFC (since the date of the TFC
merger) and SeaWest (since the date of the SeaWest asset acquisition) is shown
on a combined basis in the table below.
6
DELINQUENCY EXPERIENCE (1)
CPS, MFN, TFC AND SEAWEST COMBINED
DECEMBER 31, 2006 DECEMBER 31, 2004 DECEMBER 31, 2005
----------------------- ----------------------- -----------------------
NUMBER OF NUMBER OF NUMBER OF
CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT
---------- ---------- ---------- ---------- ---------- ----------
DELINQUENCY EXPERIENCE (DOLLARS IN THOUSANDS)
Gross servicing portfolio (1) ........ 126,574 $1,568,329 95,689 $1,116,534 83,018 $ 873,880
Period of delinquency (2)
31-60 days ........................... 3,275 37,328 2,367 24,047 2,106 19,010
61-90 days ........................... 1,367 14,903 1,057 10,156 1,069 8,051
91+ days ............................. 1,035 10,301 1,031 7,946 1,176 7,758
---------- ---------- ---------- ---------- ---------- ----------
Total delinquencies (2) .............. 5,677 62,532 4,455 42,149 4,351 34,819
Amount in repossession (3) ........... 2,148 24,135 1,335 13,531 1,408 14,090
---------- ---------- ---------- ---------- ---------- ----------
Total delinquencies and
amount in repossession (2) ........ 7,825 $ 86,667 5,790 $ 55,680 5,759 $ 48,909
========== ========== ========== ========== ========== ==========
Delinquencies as a percentage
of gross servicing portfolio ...... 4.5 % 4.0 % 4.7 % 3.8 % 5.2 % 4.0 % %
Total delinquencies and
amount in repossession as a
percentage of gross servicing
portfolio ......................... 6.2 % 5.5 % 6.1 % 5.0 % 6.9 % 5.6 % %
EXTENSION EXPERIENCE
Contracts with One Extension (4) ..... 12,318 $ 128,386 10,602 $ 95,412 9,661 $ 86,138
Contracts with Two or More
Extensions (4) .................... 3,183 24,978 4,575 29,428 4,383 23,659
---------- ---------- ---------- ---------- ---------- ----------
Total Contracts with Extensions ...... 15,501 $ 153,364 15,177 $ 124,840 14,044 $ 109,797
========== ========== ========== ========== ========== ==========
(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 PURCHASED,
INCLUDING AUTOMOBILE CONTRACTS WE SUBSEQUENTLY SOLD IN SECURITIZATION
TRANSACTIONS THAT WE CONTINUE TO SERVICE. THE TABLE DOES NOT INCLUDE THE
SEAWEST THIRD PARTY PORTFOLIO (AUTOMOBILE CONTRACTS THAT WE SERVICE ON
BEHALF OF SEAWEST SECURITIZATIONS, BUT DO NOT OWN).
(2) WE CONSIDER AN AUTOMOBILE CONTRACT DELINQUENT WHEN AN OBLIGOR FAILS TO MAKE
AT LEAST 90% OF A CONTRACTUALLY DUE PAYMENT BY THE FOLLOWING DUE DATE,
WHICH DATE MAY HAVE BEEN EXTENDED WITHIN LIMITS SPECIFIED IN THE SERVICING
AGREEMENTS. THE PERIOD OF DELINQUENCY IS BASED ON THE NUMBER OF DAYS
PAYMENTS ARE CONTRACTUALLY PAST DUE. AUTOMOBILE CONTRACTS LESS THAN 31 DAYS
DELINQUENT ARE NOT INCLUDED.
(3) AMOUNT IN REPOSSESSION REPRESENTS THE CONTRACT BALANCE ON FINANCED VEHICLES
THAT HAVE BEEN REPOSSESSED BUT NOT YET LIQUIDATED. THIS AMOUNT IS NOT
NETTED WITH THE SPECIFIC RESERVE TO ARRIVE AT THE ESTIMATED ASSET VALUE
LESS COSTS TO SELL.
(4) THE AGING CATEGORIES SHOWN IN THE TABLES REFLECT THE EFFECT OF EXTENSIONS.
EXTENSIONS
We may offer a customer an extension, under which the customer agrees
with us to move past due payments to the end of the automobile contract term. In
such cases the customer must sign an agreement for the extension, and may pay a
fee representing partial payment of accrued interest. Our policies, and
contractual arrangements for our warehouse and securitization transactions,
limit the number of extensions that may be granted. In general, a customer may
arrange for an extension no more than once every 12 months, not to exceed four
extensions over the life of the contract.
If a customer is granted such an extension, the date next due is
advanced. Subsequent delinquency aging classifications would be based on the
future payment performance of the automobile contract.
7
YEAR ENDED DECEMBER 31,
-------------------------------------------
2006 2005 2004
-------------------------------------------
(DOLLARS IN THOUSANDS)
CPS, MFN, TFC and SeaWest Combined
Average servicing portfolio outstanding............ $ 1,367,935 $ 966,295 $ 796,436
Net charge-offs as a percentage of average
servicing portfolio (2)............................ 4.5 % 5.3 % 7.8 %
(1) ALL AMOUNTS AND PERCENTAGES ARE BASED ON THE PRINCIPAL AMOUNT SCHEDULED TO
BE PAID ON EACH AUTOMOBILE CONTRACT, NET OF UNEARNED INCOME ON PRE-COMPUTED
AUTOMOBILE CONTRACTS. THE INFORMATION IN THE TABLE REPRESENTS ALL
AUTOMOBILE CONTRACTS SERVICED BY US, EXCLUDING THE SEAWEST THIRD PARTY
PORTFOLIO (AUTOMOBILE CONTRACTS ORIGINATED BY SEAWEST FOR WHICH WE ARE THE
SERVICER BUT HAVE NO EQUITY INTEREST).
(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 FINANCIAL STATEMENTS.
SECURITIZATION OF AUTOMOBILE CONTRACTS
We purchase automobile contracts with the intention of financing them
on a long-term basis through securitizations. All such securitizations have
involved identification of specific automobile contracts, sale of those
automobile contracts (and associated rights) to a special purpose subsidiary,
and issuance of asset-backed securities to fund the transactions. Upon the
securitization of a portfolio of automobile contracts, we retain the obligation
to service the contracts, and receive a monthly fee for doing so. We have been a
regular issuer of asset-backed securities since 1994, completing 43
securitizations totaling over $5.0 billion through December 31, 2006. Depending
on the structure of the securitization, the transaction may be treated as a sale
of the automobile contracts or as a secured financing for financial accounting
purposes. Since the third quarter of 2003, we have structured our
securitizations as secured financings rather than as sales of contracts.
When structured to be treated as a secured financing, the subsidiary is
consolidated and, accordingly, the automobile contracts and the related
securitization trust debt appear as assets and liabilities, respectively, on our
consolidated balance sheet. We then recognize interest income on the contracts
and interest expense on the securities issued in the securitization and record
as expense a provision for probable credit losses on the contracts.
When structured to be treated as a sale, the subsidiary is not
consolidated. Accordingly, the securitization removes the sold automobile
contracts from our consolidated balance sheet, the related debt does not appear
as our debt, and our consolidated balance sheet shows, as an asset, a retained
residual interest in the sold automobile contracts. The residual interest
represents the discounted value of what we expect will be the excess of future
collections on the automobile contracts over principal and interest due on the
asset-backed securities. That residual interest appears on our consolidated
balance sheet as "residual interest in securitizations," and the determination
of its value is dependent on our estimates of the future performance of the sold
automobile contracts.
Prior to a securitization transaction, we fund our automobile contract
purchases primarily with proceeds from warehouse credit facilities. As of
December 31, 2006, we had $400 million in warehouse credit capacity, in the form
of two $200 million facilities. Both warehouse credit facilities provide funding
for automobile contracts purchased under the CPS programs, while one facility
also provides funding for automobile contracts purchased under the TFC programs.
Up to 83% of the principal balance of the automobile contracts may be advanced
to us under these facilities, subject to collateral tests and certain other
conditions and covenants. Subsequent to year-end, we amended our warehouse
facilities to permit issuance of subordinated debt to additional lenders. The
result is to increase the effective advance rate to as high as 93%. Long-term
financing for the automobile contract purchases is achieved through
securitization transactions and the proceeds from such securitization
transactions are used primarily to repay the warehouse credit facilities.
In a securitization and in our warehouse credit facilities, we are
required to make certain representations and warranties, which are generally
similar to the representations and warranties made by dealers in connection with
our purchase of the automobile contracts. If we breach any of our
representations or warranties, we will be obligated to repurchase the automobile
contract at a price equal to the principal balance plus accrued and unpaid
interest. We may then be entitled under the terms of our dealer agreement to
require the selling dealer to repurchase the contract at a price equal to our
purchase price, less any principal payments made by the customer. Subject to any
recourse against dealers, we will bear the risk of loss on repossession and
resale of vehicles under automobile contracts that we repurchase.
8
Whether a securitization is treated as a secured financing or as a sale
for financial accounting purposes, the related special purpose subsidiary may be
unable to release excess cash to us if the credit performance of the securitized
automobile contracts falls short of pre-determined standards. Such releases
represent a material portion of the cash that we use to fund our operations. An
unexpected deterioration in the performance of securitized automobile contracts
could therefore have a material adverse effect on both our liquidity and results
of operations, regardless of whether such automobile contracts are treated as
having been sold or as having been financed. For estimation of the magnitude of
such risk, it may be appropriate to look to the size of our "managed portfolio,"
which represents both financed and sold automobile contracts as to which such
credit risk is retained. Our managed portfolio as of December 31, 2006 was
approximately $1.6 billion (this amount includes $3.8 million related to the
SeaWest third party portfolio, on which we earn only servicing fees and have no
credit risk).
COMPETITION
The automobile financing business is highly competitive. We compete
with a number of national, regional and local finance companies with operations
similar to ours. In addition, competitors or potential competitors include other
types of financial services companies, such as commercial banks, savings and
loan associations, leasing companies, credit unions providing retail loan
financing and lease financing for new and used vehicles, and captive finance
companies affiliated with major automobile manufacturers such as General Motors
Acceptance Corporation, Ford Motor Credit Corporation, Chrysler Finance
Corporation and Nissan Motors Acceptance Corporation. Many of our competitors
and potential competitors possess substantially greater financial, marketing,
technical, personnel and other resources than we do. Moreover, our future
profitability will be directly related to the availability and cost of our
capital in relation to the availability and cost of capital to our competitors.
Our competitors and potential competitors include far larger, more established
companies that have access to capital markets for unsecured commercial paper and
investment grade-rated debt instruments and to other funding sources that may be
unavailable to us. Many of these companies also have long-standing relationships
with dealers and may provide other financing to dealers, including floor plan
financing for the dealers' purchase of automobiles from manufacturers, which we
do not offer.
We believe that the principal competitive factors affecting a dealer's
decision to offer automobile contracts for sale to a particular financing source
are the purchase price offered for the automobile contracts, the reasonableness
of the financing source's underwriting guidelines and documentation requests,
the predictability and timeliness of purchases and the financial stability of
the funding source. While we believe that we can obtain from dealers sufficient
automobile contracts for purchase at attractive prices by consistently applying
reasonable underwriting criteria and making timely purchases of qualifying
automobile contracts, there can be no assurance that we will do so.
REGULATION
Several federal and state consumer protection laws, including the
federal Truth-In-Lending Act, the federal Equal Credit Opportunity Act, the
federal Fair Debt Collection Practices Act and the Federal Trade Commission Act,
regulate the extension of credit in consumer credit transactions. These laws
mandate certain disclosures with respect to finance charges on automobile
contracts and impose certain other restrictions on dealers. In many states, a
license is required to engage in the business of purchasing automobile contracts
from dealers. In addition, laws in a number of states impose limitations on the
amount of finance charges that may be charged by dealers on credit sales. The
so-called Lemon Laws enacted by various states provide certain rights to
purchasers with respect to automobiles that fail to satisfy express warranties.
The application of Lemon Laws or violation of such other federal and state laws
may give rise to a claim or defense of a customer against a dealer and its
assignees, including us and purchasers of automobile contracts from us. The
dealer agreement contains representations by the dealer that, as of the date of
assignment of automobile contracts, no such claims or defenses have been
asserted or threatened with respect to the automobile contracts and that all
requirements of such federal and state laws have been complied with in all
material respects. Although a dealer would be obligated to repurchase automobile
contracts that involve a breach of such warranty, there can be no assurance that
the dealer will have the financial resources to satisfy our repurchase
obligations. Certain of these laws also regulate our servicing activities,
including our methods of collection.
Although we believe that we are currently in material compliance with
applicable statutes and regulations, there can be no assurance that we will be
able to maintain such compliance. The past or future failure to comply with such
statutes and regulations could have a material adverse effect upon us.
Furthermore, the adoption of additional statutes and regulations, changes in the
interpretation and enforcement of current statutes and regulations or the
expansion of our business into jurisdictions that have adopted more stringent
regulatory requirements than those in which we currently conduct business could
have a material adverse effect upon us. In addition, due to the
consumer-oriented nature of the industry in which we operate and the application
9
of certain laws and regulations, industry participants are regularly named as
defendants in litigation involving alleged violations of federal and state laws
and regulations and consumer law torts, including fraud. Many of these actions
involve alleged violations of consumer protection laws. A significant judgment
against us or within the industry in connection with any such litigation could
have a material adverse effect on our financial condition, results of operations
or liquidity.
EMPLOYEES
As of December 31, 2006, we had 789 employees. The breakdown of the
employees is as follows: 6 are senior management personnel, 420 are collections
personnel, 168 are automobile contract origination personnel, 113 are marketing
personnel (94 of whom are marketing representatives), 56 are operations and
systems personnel, and 26 are administrative personnel. We believe that our
relations with our employees are good. We are not a party to any collective
bargaining agreement.
ITEM 1A. RISK FACTORS
Our business, operating results and financial condition could be
adversely affected by any of the following specific risks. The trading price of
our common stock could decline due to any of these risks and other industry
risks, and you could lose all or part of your investment. In addition to the
risks described below, we may encounter risks that are not currently known to us
or that we currently deem immaterial, which may also impair our business
operations and your investment in our common stock.
RISKS RELATED TO OUR BUSINESS
WE REQUIRE A SUBSTANTIAL AMOUNT OF CASH TO SERVICE OUR SUBSTANTIAL DEBT.
To service our existing substantial indebtedness, we require a
significant amount of cash. Our ability to generate cash depends on many
factors, including our successful financial and operating performance. Our
financial and operational performance depends upon a number of factors, many of
which are beyond our control. These factors include, without limitation:
o the economic and competitive conditions in the asset-backed
securities market;
o the performance of our current and future automobile contracts;
o the performance of our residual interests from our securitizations
and warehouse credit facilities;
o any operating difficulties or pricing pressures we may experience;
o our ability to obtain credit enhancement for our securitizations;
o our ability to establish and maintain dealer relationships;
o the passage of laws or regulations that affect us adversely;
o our ability to compete with our competitors; and
o our ability to acquire and finance automobile contracts.
Depending upon the outcome of one or more of these factors, we may not
be able to generate sufficient cash flow from operations or obtain sufficient
funding to satisfy all of our obligations. If we were unable to pay our debts,
we would be required to pursue one or more alternative strategies, such as
selling assets, refinancing or restructuring our indebtedness or selling
additional equity capital. These alternative strategies might not be feasible at
the time, might prove inadequate or could require the prior consent of our
secured and unsecured lenders.
WE NEED SUBSTANTIAL LIQUIDITY TO OPERATE OUR BUSINESS.
We have historically funded our operations principally through
internally generated cash flows, sales of debt and equity securities, including
through securitizations and warehouse credit facilities, borrowings under senior
subordinated debt agreements and sales of subordinated notes. However, we may
not be able to obtain sufficient funding for our future operations from such
sources. If we were unable to access the capital markets or obtain other
acceptable financing, our results of operations, financial condition and cash
flows would be materially and adversely affected. We require a substantial
amount of cash liquidity to operate our business. Among other things, we use
such cash liquidity to:
o acquire automobile contracts;
o fund overcollateralization in warehouse credit facilities and
securitizations;
o pay securitization fees and expenses;
o fund spread accounts in connection with securitizations;
o satisfy working capital requirements and pay operating expenses; and
o pay interest expense.
10
OUR RESULTS OF OPERATIONS WILL DEPEND ON OUR ABILITY TO SECURE AND MAINTAIN
ADEQUATE CREDIT AND WAREHOUSE FINANCING ON FAVORABLE TERMS.
We depend on warehouse credit facilities to finance our purchases of
automobile contracts. Our business strategy requires that these warehouse credit
facilities continue to be available to us from the time of purchase or
origination of an automobile contract until it is financed through a
securitization.
Our primary sources of day-to-day liquidity are our warehouse credit
facilities, in which we sell and contribute automobile contracts, as often as
twice a week, to affiliated special-purpose entities, where they are
"warehoused" until they are securitized, at which time funds advanced under one
or more warehouse credit facilities are repaid from the proceeds of the
securitizations. The special-purpose entities obtain the funds to purchase these
contracts by pledging the contracts to a trustee for the benefit of warehouse
lenders, who advance funds to our affiliated special-purpose entities based on
the dollar amount of the contracts pledged. We depend substantially on two
warehouse credit facilities: (i) a $200 million warehouse credit facility, which
we established in November 2005 and, unless earlier renewed or terminated upon
the occurrence of certain events, which will expire in November 2007; and (ii) a
$200 million warehouse credit facility, which we established in June 2004 and
which, unless renewed or earlier terminated upon the occurrence of certain
events, will expire in June 2007. Each of these facilities may be renewed by
mutual agreement between the lender and us. These warehouse credit facilities
will remain available to us only if, among other things, we comply with certain
financial covenants contained in the documents governing these facilities. These
warehouse credit facilities may not be available to us in the future and we may
not be able to obtain other credit facilities on favorable terms to fund our
operations.
If we were unable to arrange new warehousing or other credit facilities
or renew our existing warehouse credit facilities when they come due, our
results of operations, financial condition and cash flows would be materially
and adversely affected.
OUR RESULTS OF OPERATIONS WILL DEPEND ON OUR ABILITY TO SECURITIZE OUR PORTFOLIO
OF AUTOMOBILE CONTRACTS.
We are dependent upon our ability to continue to finance pools of
automobile contracts in securitizations in order to generate cash proceeds for
new purchases of automobile contracts. We have historically depended on
securitizations of automobile contracts to provide permanent financing of those
contracts. By "permanent financing" we mean financing that extends to cover the
full term during which the underlying contracts are outstanding. By contrast,
our warehouse credit facilities permit us to borrow against the value of such
receivables only for limited periods of time. Our past practice and future plan
has been and is to repay loans made to us under our warehouse credit facilities
with the proceeds of securitizations. There can be no assurance that any
securitization transaction will be available on terms acceptable to us, or at
all. The timing of any securitization transaction is affected by a number of
factors beyond our control, any of which could cause substantial delays,
including, without limitation:
o market conditions;
o the approval by all parties of the terms of the securitization;
o the availability of credit enhancement on acceptable terms; and
o our ability to acquire a sufficient number of automobile contracts for
securitization.
Adverse changes in the market for securitized pools of automobile
contracts may result in our inability to securitize automobile contracts and may
result in a substantial extension of the period during which our automobile
contracts are financed through our warehouse credit facilities, which would
burden our financing capabilities, could require us to curtail our purchase of,
or find an alternative source of financing for, such automobile contracts and
would have a material adverse effect on our results of operations.
OUR RESULTS OF OPERATIONS WILL DEPEND ON CASH FLOWS FROM OUR RESIDUAL INTERESTS
IN OUR SECURITIZATION PROGRAM AND OUR WAREHOUSE CREDIT FACILITIES.
When we finance our automobile contracts through securitizations and
warehouse credit facilities, we receive cash and a residual interest in the
assets financed. Those financed assets are owned by the special-purpose
subsidiary that is formed for the related securitization. This residual interest
represents the right to receive the future cash flows to be generated by the
automobile contracts in excess of (i) the interest and principal paid to
investors on the indebtedness issued in connection with the financing (ii) the
costs of servicing the contracts and (iii) certain other costs incurred in
connection with completing and maintaining the securitization or warehouse
credit facility. We sometimes refer to these future cash flows as "excess spread
cash flows."
11
Under the financial structures we have used to date in our
securitizations and warehouse credit facilities, excess spread cash flows that
would otherwise be paid to the holder of the residual interest are first used to
increase overcollateralization or are retained in a spread account within the
securitization trusts or the warehouse facility to provide liquidity and credit
enhancement for the related securities.
While the specific terms and mechanics vary among transactions, our
securitization and warehousing agreements generally provide that we will receive
excess spread cash flows only if the amount of overcollateralization and spread
account balances have reached specified levels and/or the delinquency, defaults
or net losses related to the contracts in the automobile contract pools are
below certain predetermined levels. In the event delinquencies, defaults or net
losses on contracts exceed these levels, the terms of the securitization or
warehouse credit facility:
o may require increased credit enhancement, including an increase in the
amount required to be on deposit in the spread account, to be accumulated
for the particular pool;
o may restrict the distribution to us of excess spread cash flows associated
with other securitized or warehoused pools; and
o in certain circumstances, may permit affected parties to require the
transfer of servicing on some or all of the securitized or warehoused
contracts from us to an unaffiliated servicer.
We typically retain or sell residual interests or use them as
collateral to borrow cash. In any case, the future excess spread cash flow
received in respect of the residual interests is integral to the financing of
our operations. The amount of cash received from residual interests depends in
large part on how well our portfolio of securitized and warehoused automobile
contracts performs. If our portfolio of securitized and warehoused automobile
contracts has higher delinquency and loss ratios than expected, then the amount
of money realized from our retained residual interests, or the amount of money
we could obtain from the sale or other financing of our residual interests,
would be reduced, which could have an adverse effect on our operations,
financial condition and cash flows.
IF WE ARE UNABLE TO OBTAIN CREDIT ENHANCEMENT FOR OUR SECURITIZATIONS OR OUR
WAREHOUSE CREDIT FACILITIES UPON FAVORABLE TERMS, OUR RESULTS OF OPERATIONS
WOULD BE IMPAIRED.
In our securitizations, we typically utilize credit enhancement in the
form of one or more financial guaranty insurance policies issued by financial
guaranty insurance companies. Each of these policies unconditionally and
irrevocably guarantees certain interest and principal payments on the senior
classes of the securities issued in our securitizations. These guarantees enable
these securities to achieve the highest credit rating available. This form of
credit enhancement reduces the costs of our securitizations relative to
alternative forms of credit enhancement currently available to us. None of such
financial guaranty insurance companies is required to insure future
securitizations. As we pursue future securitizations, we may not be able to
obtain:
o credit enhancement in any form from financial guaranty insurance companies
or any other provider of credit enhancement on terms acceptable to us, or
at all; or
o similar ratings for senior classes of securities to be issued in future
securitizations.
If We Were Unable to Obtain Such Enhancements or Such Ratings, We Would
Expect To Incur Increased Interest Expense, Which Would adversely Affect Our
Results of Operations.
IF WE ARE UNABLE TO SUCCESSFULLY COMPETE WITH OUR COMPETITORS, OUR RESULTS OF
OPERATIONS MAY BE IMPAIRED.
The automobile financing business is highly competitive. We compete
with a number of national, regional and local finance companies. In addition,
competitors or potential competitors include other types of financial services
companies, such as commercial banks, savings and loan associations, leasing
companies, credit unions providing retail loan financing and lease financing for
new and used vehicles and captive finance companies affiliated with major
automobile manufacturers such as General Motors Acceptance Corporation and Ford
Motor Credit Corporation. Many of our competitors and potential competitors
possess substantially greater financial, marketing, technical, personnel and
other resources than we do, including greater access to capital markets for
unsecured commercial paper and investment grade rated debt instruments, and to
other funding sources which may be unavailable to us. Moreover, our future
profitability will be directly related to the availability and cost of our
capital relative to that of our competitors. Many of these companies also have
long-standing relationships with automobile dealers and may provide other
financing to dealers, including floor plan financing for the dealers' purchases
of automobiles from manufacturers, which we do not offer. There can be no
assurance that we will be able to continue to compete successfully and, as a
result, we may not be able to purchase contracts from dealers at a price
acceptable to us, which could result in reductions in our revenues or the cash
flows available to us.
12
IF OUR DEALERS DO NOT SUBMIT A SUFFICIENT NUMBER OF SUITABLE AUTOMOBILE
CONTRACTS TO US FOR PURCHASE, OUR RESULTS OF OPERATIONS MAY BE IMPAIRED.
We are dependent upon establishing and maintaining relationships with a
large number of unaffiliated automobile dealers to supply us with automobile
contracts. During the year ended December 31, 2006, no dealer accounted for more
than 1.0% of the contracts we purchased. The agreements we have with dealers to
purchase contracts do not require dealers to submit a minimum number of
contracts for purchase. The failure of dealers to submit contracts that meet our
underwriting criteria could result in reductions in our revenues or the cash
flows available to us, and, therefore, could have an adverse effect on our
results of operations.
IF A SIGNIFICANT NUMBER OF OUR AUTOMOBILE CONTRACTS PREPAY OR EXPERIENCE
DEFAULTS, OUR RESULTS OF OPERATIONS MAY BE IMPAIRED.
We specialize in the purchase and servicing of contracts to finance
automobile purchases by sub-prime customers, those who have limited credit
history, low income, or past credit problems. Such contracts entail a higher
risk of non-performance, higher delinquencies and higher losses than contracts
with more creditworthy customers. While we believe that our pricing of the
automobile contracts and the underwriting criteria and collection methods we
employ enable us to control, to a degree, the higher risks inherent in contracts
with sub-prime customers, no assurance can be given that such pricing, criteria
and methods will afford adequate protection against such risks. We have in the
past experienced fluctuations in the delinquency and charge-off performance of
our contracts.
If automobile contracts that we purchase or service are prepaid or
experience defaults to a greater extent than we have anticipated, this could
materially and adversely affect our results of operations, financial condition,
cash flows and liquidity. Our results of operations, financial condition, cash
flows and liquidity, depend, to a material extent, on the performance of
automobile contracts that we purchase, warehouse and securitize. A portion of
the automobile contracts acquired by us will default or prepay. In the event of
payment default, the collateral value of the vehicle securing an automobile
contract realized by us in a repossession will most likely not cover the
outstanding principal balance on that contract and the related costs of
recovery. We maintain an allowance for credit losses on automobile contracts
held on our balance sheet, which reflects our estimates of probable credit
losses that can be reasonably estimated for securitizations that are accounted
for as financings and warehoused contracts. If the allowance is inadequate, then
we would recognize the losses in excess of the allowance as an expense and our
results of operations could be adversely affected. In addition, under the terms
of our warehouse credit facilities, we are not able to borrow against defaulted
automobile contracts, including contracts that are, at the time of default,
funded under our warehouse credit facilities, which will reduce the
overcollateralization of those warehouse credit facilities and possibly reduce
the amount of cash flows available to us.
Our servicing income can also be adversely affected by prepayment of,
or defaults under, automobile contracts in our non-consolidated servicing
portfolio. Our contractual servicing revenue is based on a percentage of the
outstanding principal balance of the automobile contracts in our servicing
portfolio. If automobile contracts are prepaid or charged off, then our
servicing revenue will decline, while our servicing costs may not decline
proportionately. In addition unexpected levels of defaults or losses may trigger
changes in the terms applicable to our securitizations and warehouse credit
facilities, which could adversely affect our cash flows, our revenues, or both.
The value of our residual interest in the securitized assets in each
securitization treated as a sale for financial accounting purposes
(securitizations entered into prior to the beginning of the third quarter of
2003) reflects our estimate of expected future credit losses and prepayments for
the automobile contracts included in that securitization. If actual rates of
credit loss or prepayments, or both, on such automobile contracts exceed our
estimates, the value of our residual interest and the related cash flow would be
impaired, and we would be required to record an impairment charge, which would
reduce our earnings. We periodically review our credit loss and prepayment
assumptions relative to the performance of the securitized automobile contracts
and to market conditions. Our results of operations and liquidity could be
adversely affected if actual credit loss or prepayment levels on securitized
automobile contracts substantially exceed anticipated levels.
Higher credit losses than anticipated could also result in adverse
changes in the structure of future securitization transactions, such as a
requirement of increased cash collateral or other credit enhancement in such
transactions.
IF WE LOSE SERVICING RIGHTS ON OUR PORTFOLIO OF AUTOMOBILE CONTRACTS, OUR
RESULTS OF OPERATIONS WILL BE IMPAIRED.
We are entitled to receive servicing fees only while we act as servicer
under the applicable sale and servicing agreements governing our warehouse
facilities and securitizations. Under such agreements, we may be terminated as
servicer upon the occurrence of certain events, including:
13
o our failure generally to observe and perform covenants and agreements
applicable to us;
o certain bankruptcy events involving us; or
o the occurrence of certain events of default under the documents governing
the facilities.
The loss of our servicing rights could materially and adversely affect
our results of operations, financial condition and cash flows. Our results of
operations, financial condition and cash flows, would be materially and
adversely affected if we were to be terminated as servicer with respect to a
material portion of the automobile contracts for which we are receiving
servicing fees.
IF WE LOSE KEY PERSONNEL, OUR RESULTS OF OPERATIONS MAY BE IMPAIRED.
Our management team averages eleven years of service with us. Charles
E. Bradley, Jr., our President and CEO, has been our President since our
formation in 1991. Our future operating results depend in significant part upon
the continued service of our key senior management personnel, none of whom is
bound by an employment agreement. Our future operating results also depend in
part upon our ability to attract and retain qualified management, technical,
sales and support personnel for our operations. Competition for such personnel
is intense. We cannot assure you that we will be successful in attracting or
retaining such personnel. The loss of any key employee, the failure of any key
employee to perform in his or her current position or our inability to attract
and retain skilled employees, as needed, could materially and adversely affect
our results of operations, financial condition and cash flows.
IF WE FAIL TO COMPLY WITH REGULATIONS, OUR RESULTS OF OPERATIONS MAY BE
IMPAIRED.
Failure to materially comply with all laws and regulations applicable
to us could materially and adversely affect our ability to operate our business.
Our business is subject to numerous federal and state consumer protection laws
and regulations, which, among other things:
o require us to obtain and maintain certain licenses and qualifications;
o limit the interest rates, fees and other charges we are allowed to charge;
o limit or prescribe certain other terms of our automobile contracts;
o require specific disclosures to our customers;
o define our rights to repossess and sell collateral; and
o maintain safeguards designed to protect the security and confidentiality of
customer information.
We believe that we are in compliance in all material respects with all
such laws and regulations, and that such laws and regulations have had no
material adverse effect on our ability to operate our business. However, we may
be materially and adversely affected if we fail to comply with:
o applicable laws and regulations;
o changes in existing laws or regulations;
o changes in the interpretation of existing laws or regulations; or
o any additional laws or regulations that may be enacted in the future.
IF WE EXPERIENCE UNFAVORABLE LITIGATION RESULTS, OUR RESULTS OF OPERATIONS MAY
BE IMPAIRED.
Unfavorable outcomes in any of our current or future litigation
proceedings could materially and adversely affect our results of operations,
financial conditions and cash flows. As a consumer finance company, we are
subject to various consumer claims and litigation seeking damages and statutory
penalties based upon, among other things, disclosure inaccuracies and wrongful
repossession, which could take the form of a plaintiff's class action complaint.
We, as the assignee of finance contracts originated by dealers, may also be
named as a co-defendant in lawsuits filed by consumers principally against
dealers. We are also subject to other litigation common to the automobile
industry and businesses in general. The damages and penalties claimed by
consumers and others in these types of matters can be substantial. The relief
requested by the plaintiffs varies but includes requests for compensatory,
statutory and punitive damages.
While we intend to vigorously defend ourselves against such
proceedings, there is a chance that our results of operations, financial
condition and cash flows could be materially and adversely affected by
unfavorable outcomes.
14
IF WE EXPERIENCE PROBLEMS WITH OUR ORIGINATIONS, ACCOUNTING OR COLLECTION
SYSTEMS, OUR RESULTS OF OPERATIONS MAY BE IMPAIRED.
We are dependent on our receivables originations, accounting and
collection systems to service our portfolio of automobile contracts. Such
systems are vulnerable to damage or interruption from natural disasters, power
loss, telecommunication failures, terrorist attacks, computer viruses and other
events. A significant number of our systems are not redundant, and our disaster
recovery planning is not sufficient for every eventuality. Our systems are also
subject to break-ins, sabotage and intentional acts of vandalism by internal
employees and contractors as well as third parties. Despite any precautions we
may take, such problems could result in interruptions in our services, which
could harm our reputation and financial condition. We do not carry business
interruption insurance sufficient to compensate us for losses that may result
from interruptions in our service as a result of system failures. Such systems
problems could materially and adversely affect our results of operations,
financial conditions and cash flows.
WE HAVE SUBSTANTIAL INDEBTEDNESS.
We have and will continue to have a substantial amount of indebtedness.
At December 31, 2006, we had approximately $1,586.0 million of debt outstanding.
Such debt consisted primarily of $1,443.0 million of securitization trust debt,
and also included $73.0 million of warehouse indebtedness, $31.4 million of
residual interest financing, $25.0 million owed to a related party, and $13.6
million owed under a subordinated notes program. 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 ten years.
Our substantial indebtedness could adversely affect our financial
condition by, among other things:
o increasing our vulnerability to general adverse economic and industry
conditions;
o requiring us to dedicate a substantial portion of our cash flow from
operations payments on our indebtedness, thereby reducing amounts available
for working capital, capital expenditures and other general corporate
purposes;
o limiting our flexibility in planning for, or reacting to, changes in our
business and the industry in which we operate;
o placing us at a competitive disadvantage compared to our competitors that
have less debt; and
o 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. Further, our ability to repay when due the $25.0 million owed to a
related party is dependent on our ability to obtain replacement financing prior
to its May 2007 maturity, or to extend the maturity date. Failure to pay that
debt when due could have a material adverse effect.
BECAUSE WE ARE SUBJECT TO MANY RESTRICTIONS IN OUR EXISTING CREDIT FACILITIES
AND SECURITIZATION TRANSACTIONS, OUR ABILITY TO PAY DIVIDENDS OR ENGAGE IN
SPECIFIED TRANSACTIONS MAY BE IMPAIRED.
The terms of our existing credit facilities and our outstanding debt
impose significant operating and financial restrictions on us and our
subsidiaries and require us to meet certain financial tests. These restrictions
may have an adverse effect on our business activities, results of operations and
financial condition. These restrictions may also significantly limit or prohibit
us from engaging in certain transactions, including the following:
o incurring or guaranteeing additional indebtedness;
o making capital expenditures in excess of agreed upon amounts;
o paying dividends or other distributions to our stockholders or redeeming,
repurchasing or retiring our capital stock or subordinated obligations;
o making investments;
o creating or permitting liens on our assets or the assets of our
subsidiaries;
o issuing or selling capital stock of our subsidiaries;
o transferring or selling our assets;
o engaging in mergers or consolidations;
o permitting a change of control of our company;
o liquidating, winding up or dissolving our company;
o changing our name or the nature of our business, or the names or nature of
the business of our subsidiaries; and
o engaging in transactions with our affiliates outside the normal course of
business.
15
These restrictions may limit our ability to obtain additional sources
of capital, which may limit our ability to generate earnings. In addition, the
failure to comply with any of the covenants of our existing credit facilities or
to maintain certain indebtedness ratios would cause a default under one or more
of our credit facilities or our other debt agreements that may be outstanding
from time to time. A default, if not waived, could result in acceleration of the
related indebtedness, in which case such debt would become immediately due and
payable. A continuing default or acceleration of one or more of our credit
facilities or any other debt agreement, would likely cause a default under other
debt agreements that otherwise would not be in default, in which case all such
related indebtedness could be accelerated. If this occurs, we may not be able to
repay our debt or borrow sufficient funds to refinance our indebtedness. Even if
any new financing is available, it may not be on terms that are acceptable to us
or it may not be sufficient to refinance all of our indebtedness as it becomes
due.
In addition, the transaction documents for our securitizations restrict
our securitization subsidiaries from declaring or making payment to us of (i)
any divided or other distribution on or in respect of any shares of their
capital stock, or (ii) any payment on account of the purchase, redemption,
retirement or acquisition of any option, warrant or other right to acquire
shares of their capital stock unless (in each case) at the time of such
declaration or payment (and after giving effect thereto) no amount payable under
any transaction document with respect to the related securitization is then due
and owing, but unpaid. These restrictions may limit our ability to receive
distributions in respect of the residual interests from our securitization
facilities, which may limit our ability to generate earnings.
RISKS RELATED TO GENERAL FACTORS
IF THE ECONOMY OF ALL OR CERTAIN REGIONS OF THE UNITED STATES SLOWS OR ENTERS
INTO A RECESSION, OUR RESULTS OF OPERATIONS MAY BE IMPAIRED.
Our business is directly related to sales of new and used automobiles,
which are sensitive to employment rates, prevailing interest rates and other
domestic economic conditions. Delinquencies, repossessions and losses generally
increase during economic slowdowns or recessions. Because of our focus on
sub-prime customers, the actual rates of delinquencies, repossessions and losses
on our automobile contracts could be higher under adverse economic conditions
than those experienced in the automobile finance industry in general,
particularly in the states of Texas, California, Ohio, Florida, Pennsylvania and
Louisiana, states in which our automobile contracts are geographically
concentrated. Any sustained period of economic slowdown or recession could
adversely affect our ability to acquire suitable contracts, or to securitize
pools of such contracts. The timing of any economic changes is uncertain, and
weakness in the economy could have an adverse effect on our business and that of
the dealers from which we purchase contracts and result in reductions in our
revenues or the cash flows available to us.
OUR RESULTS OF OPERATIONS MAY BE IMPAIRED AS A RESULT OF NATURAL DISASTERS.
Our automobile contracts are geographically concentrated in the states
of Texas, California, Ohio, Florida, Pennsylvania, and Louisiana. Several of
such states are particularly susceptible to natural disasters: earthquake in the
case of California, and hurricanes and flooding in the states of Florida, Texas
and Louisiana. Natural disasters, in those states or others, could cause a
material number of our vehicle purchasers to lose their jobs, or could damage or
destroy vehicles that secure our automobile contracts. In either case, such
events could result in our receiving reduced collections on our automobile
contracts, and could thus result in reductions in our revenues or the cash flows
available to us.
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 received by us on the automobile contracts
that we acquire and the interest rates payable under our warehouse credit
facilities and on the asset-backed securities issued in our securitizations.
Several factors affect our ability to manage interest rate risk.
Specifically, we are subject to interest rate risk during the period between
when automobile contracts are purchased from dealers and when such contracts are
sold and financed in a securitization. Interest rates on our warehouse credit
facilities are adjustable while the interest rates on the automobile contracts
are fixed. Therefore, if interest rates increase, the interest we must pay to
the lenders under our warehouse credit facilities is likely to increase while
the interest realized by us from those warehoused automobile contracts remains
the same, and thus, during the warehousing period, the excess spread cash flow
received by us would likely decrease. Additionally, contracts warehoused and
then securitized during a rising interest rate environment may result in less
excess spread cash flow realized by us under those securitizations as,
16
historically, our securitization facilities pay interest to security holders on
a fixed rate basis set at prevailing interest rates at the time of the closing
of the securitization, which may be several months after the securitized
contracts were originated and entered the warehouse, while our customers pay
fixed rates of interest on the contracts, set 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
interest rates payable by us under the warehouse facilities, we generally hold
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 by us 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 amounts up to the balance of
the pre-funded escrow account. 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
flows on automobile contracts, and thus could adversely affect our earnings and
cash flows.
THE EFFECTS OF TERRORISM AND MILITARY ACTION MAY IMPAIR OUR RESULTS OF
OPERATIONS.
The long-term economic impact of the events of September 11, 2001,
possible future terrorist attacks or other incidents and related military
action, or current or future military action by United States forces in Iraq and
other regions, could have a material adverse effect on general economic
conditions, consumer confidence, and market liquidity in the United States. No
assurance can be given as to the effect of these events on the performance of
our automobile contracts. Any adverse impact resulting from these events could
materially affect our results of operations, financial condition and cash flows.
In addition, activation of a substantial number of U.S. military reservists or
members of the National Guard may significantly increase the proportion of
contracts whose interest rates are reduced by the application of the
Servicemembers' Civil Relief Act, which provides, generally, that an obligor who
is covered by that act may not be charged interest on the related contract in
excess of 6% annually during the period of the obligor's active duty.
RISKS RELATED TO OUR COMMON STOCK
OUR COMMON STOCK IS THINLY-TRADED.
Our stock is thinly-traded, which means investors will have limited
opportunities to sell their shares of common stock in the open market. Limited
trading of our common stock also contributes to more volatile price
fluctuations. Because there historically has been low trading volume in our
common stock, there can be no assurance that our stock price will not decline as
additional shares are sold in the public market. As of December 31, 2006, all of
our directors and executive officers and a related party beneficially owned
8,449,114 shares of our common stock, or approximately 28%.
WE DO NOT INTEND TO PAY DIVIDENDS ON OUR COMMON STOCK.
We have never declared or paid any cash dividends on our common stock.
We currently intend to retain any future earnings and do not expect to pay any
dividends in the foreseeable future. Even if we were to change our intention,
the terms of our secured debt prohibit us from paying any dividends to our
shareholders without the consent of the holder of such secured debt, which may
be withheld in its sole discretion. See "Dividend Policy. "
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:
17
o changes in general economic conditions;
o changes in interest rates;
o our ability to generate sufficient operating and financing cash flows;
o competition;
o level of future provisioning for receivables losses; and
o regulatory requirements.
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 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTY
The Company's headquarters are located in Irvine, California, where it
leases approximately 115,000 square feet of general office space from an
unaffiliated lessor. The annual base rent was approximately $1.9 million through
October 2003, and increased to $2.1 million for the following five years. In
addition to base rent, the Company pays the property taxes, maintenance and
other expenses of the premises.
In March 1997, the Company established a branch collection facility in
Chesapeake, Virginia. The Company leases approximately 28,000 square feet of
general office space in Chesapeake, Virginia, at a base rent that is currently
$489,228 per year, increasing to $501,542 over a 10-year term.
The remaining two regional servicing centers occupy a total of
approximately 51,000 square feet of leased space in Maitland, Florida; and
Hinsdale, Illinois. The termination dates of such leases range from 2008 to
2010.
ITEM 3. LEGAL PROCEEDINGS
STANWICH LITIGATION. CPS was for some time a defendant in a class
action (the "Stanwich Case") brought in the California Superior Court, Los
Angeles County. The original plaintiffs in that case were persons entitled to
receive regular payments (the "Settlement Payments") under out-of-court
settlements reached with third party defendants. Stanwich Financial Services
Corp. ("Stanwich"), an affiliate of the former chairman of the board of
directors of CPS, 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. At December 31, 2004, CPS was a defendant only
in a cross-claim brought by one of the other defendants in the case, Bankers
Trust Company, which asserted a claim of contractual indemnity against CPS.
CPS subsequently settled the cross-claim of Bankers Trust by payment of
$3.24 million, in February 2005. Pursuant to that settlement, the court has
dismissed the cross-claim, with prejudice.
In November 2001, one of the defendants in the Stanwich Case, Jonathan
Pardee, asserted claims for indemnity against the Company in a separate action,
which is now pending in federal district court in Rhode Island. The Company has
filed counterclaims in the Rhode Island federal court against Mr. Pardee, and
has filed a separate action against Mr. Pardee's Rhode Island attorneys, in the
same court. The litigation between Mr. Pardee and CPS is stayed, awaiting
resolution of an adversary action brought against Mr. Pardee in the bankruptcy
court, which is hearing the bankruptcy of Stanwich.
CPS has reached an agreement in principle with the representative of
creditors in the Stanwich bankruptcy to resolve the adversary action. Under the
agreement in principle, CPS would pay the bankruptcy estate $625,000 and abandon
its claims against the estate, while the estate would abandon its adversary
action against Mr. Pardee. A hearing to consider that agreement is scheduled for
18
March 2007. If approved, CPS expects that the agreement will result in (i)
limitation of its exposure to Mr. Pardee to no more than some portion of his
attorneys fees incurred and (ii) stays in Rhode Island being lifted, causing
those cases to become active again. There can be no assurance as to these
expectations nor as to whether the court will approve the proposed agreement.
The reader should consider that an adverse judgment against CPS in the
Rhode Island case for indemnification, if in an amount materially in excess of
any liability already recorded in respect thereof, could have a material adverse
effect on our financial condition.
OTHER LITIGATION. On June 2, 2004, Delmar Coleman filed a lawsuit in
the circuit court of Tuscaloosa, Alabama, alleging that plaintiff Coleman was
harmed by an alleged failure to refer, in the notice given after repossession of
her vehicle, to the right to purchase the vehicle by tender of the full amount
owed under the retail installment contract. Plaintiff seeks damages in an
unspecified amount, on behalf of a purported nationwide class. CPS removed the
case to federal bankruptcy court, and filed a motion for summary judgment as
part of its adversary proceeding against the plaintiff in the bankruptcy court.
The federal bankruptcy court granted the plaintiff's motion to send the matter
back to Alabama state court. CPS appealed that ruling to the federal district
court. That court ordered the bankruptcy court to decide whether the plaintiff
has standing to pursue her claims, and, if standing is found, to reconsider its
remand decision. The matter is currently pending before the bankruptcy court.
Although we believe that we have one or more defenses to each of the claims made
in this lawsuit, no discovery has yet been conducted and the case is still in
its earliest stages. Accordingly, there can be no assurance as to its outcome.
In June 2004, Plaintiff Jeremy Henry filed a lawsuit against the
Company in the California Superior Court, San Diego County, alleging improper
practices related to the notice given after repossession of a vehicle that he
purchased. Plaintiff's motion for a certification of a class has been denied,
and is the subject of an appeal now before the California Court of Appeal.
Irrespective of the outcome of that appeal, as to which there can be no
assurance, the Company has a number of defenses that may dispose of the claims
of plaintiff Henry.
In August and September 2005, two plaintiffs represented by the same
law firm filed substantially identical lawsuits in the federal district court
for the northern district of Illinois, each of which purports to be a class
action, and each of which alleges that CPS improperly accessed consumer credit
information. CPS has reached agreements in principle to settle these cases. One
of the settlements has received final approval from the court and the other has
received preliminary approval. Notice of the settlements has been sent to the
class.
The Company has recorded a liability as of December 31, 2006 that it
believes represents a sufficient allowance for legal contingencies. Any adverse
judgment against the Company, if in an amount materially in excess of the
recorded liability, could have a material adverse effect on the financial
position of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to our shareholders during the fourth quarter
of 2006.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
CHARLES E. BRADLEY, JR., 47, has been our President and a director
since our formation in March 1991, and was elected Chairman of the Board of
Directors in July 2001. In January 1992, Mr. Bradley was appointed Chief
Executive Officer. From April 1989 to November 1990, he served as Chief
Operating Officer of Barnard and Company, a private investment firm. From
September 1987 to March 1989, Mr. Bradley, Jr. was an associate of The Harding
Group, a private investment banking firm. Mr. Bradley does not currently serve
on the board of directors of any other publicly-traded companies.
MARK A. CREATURA, 47, has been Senior Vice President - General Counsel
since October 1996. From October 1993 through October 1996, he was Vice
President and General Counsel at Urethane Technologies, Inc., a polyurethane
chemicals formulator. Mr. Creatura was previously engaged in the private
practice of law with the Los Angeles law firm of Troy & Gould Professional
Corporation, from October 1985 through October 1993.
JEFFREY P. FRITZ, 47, has been Senior Vice President - Chief Financial
Officer since April 2006. He was Senior Vice President - Accounting from August
2004 through March 2006. He served as a consultant to us from May 2004 to August
2004. Previously, he was the Chief Financial Officer of SeaWest Financial Corp.
from February 2003 to May 2004, and the Chief Financial Officer of AFCO Auto
Finance from April 2002 to February 2003. He practiced public accounting with
Glenn M. Gelman & Associates from March 2001 to April 2002 and was Chief
Financial Officer of Credit Services Group, Inc. from May 1999 to November 2000.
He previously served as our Chief Financial Officer from our inception through
May 1999.
19
CURTIS K. POWELL, 50, has been Senior Vice President - Contract
Origination since June 2001. Previously, he was our Senior Vice President -
Marketing, from April 1995. He joined us in January 1993 as an independent
marketing representative until being appointed Regional Vice President of
Marketing for Southern California in November 1994. From June 1985 through
January 1993, Mr. Powell was in the retail automobile sales and leasing
business.
ROBERT E. RIEDL, 43, has been Senior Vice President - Chief Investment
Officer since April 2006. Mr. Riedl was Senior Vice President - Chief Financial
Officer from August 2003 until assuming his current position. Mr. Riedl joined
the Company as Senior Vice President - Risk Management in January 2003.
Previously, Mr. Riedl was a Principal at Northwest Capital Appreciation ("NCA"),
a middle market private equity firm, from 2000 to 2002. For a year prior to
joining Northwest Capital, Mr. Riedl served as Senior Vice President for one of
NCA's portfolio companies, SLP Capital. Mr. Riedl was an investment banker for
ContiFinancial Services Corporation from 1995 until joining SLP Capital in 1999.
CHRISTOPHER TERRY, 39, has been Senior Vice President - Servicing since
May 2005, and prior to that was Senior Vice President - Asset Recovery since
January 2003. He joined us in January 1995 as a loan officer, held a series of
successively more responsible positions, and was promoted to Vice President -
Asset Recovery in June 1999. Mr. Terry was previously a branch manager with
Norwest Financial from 1990 to October 1994.
20
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND
ISSUER PURCHASES OF EQUITY SECURITIES
The Company's Common Stock is traded on the Nasdaq Global Market, under
the symbol "CPSS." The following table sets forth the high and low sale prices
as reported by Nasdaq for the Company's Common Stock for the periods shown.
HIGH LOW
-------- --------
January 1 - March 31, 2005 ........................... 5.50 4.26
April 1 - June 30, 2005 .............................. 5.38 3.50
July 1 - September 30, 2005 .......................... 5.45 4.14
October 1 - December 31, 2005 ........................ 6.50 4.82
January 1 - March 31, 2006 ........................... 8.50 5.30
April 1 - June 30, 2006 .............................. 8.84 6.04
July 1 - September 30, 2006 .......................... 7.53 5.08
October 1 - December 31, 2006 ........................ 7.46 5.30
As of February 5, 2007, there were 77 holders of record of the
Company's Common Stock. To date, the Company has not declared or paid any
dividends on its Common Stock. The payment of future dividends, if any, on the
Company's Common Stock is within the discretion of the Board of Directors and
will depend upon the Company's income, its capital requirements and financial
condition, and other relevant factors. The instruments governing the Company's
outstanding debt place certain restrictions on the payment of dividends. The
Company does not intend to declare any dividends on its Common Stock in the
foreseeable future, but instead intends to retain any cash flow for use in the
Company's operations.
The table below presents information regarding outstanding options to
purchase the Company's Common Stock as of December 31, 2006:
Number of securities Weighted average Number of
to be issued upon exercise price of securities remaining
exercise of outstanding outstanding available for future
options, warrants options, warrants issuance under equity
Plan category and rights and rights compensation plans
------------------------------------------ --------------- -------------- ---------------
Equity compensation plans
approved by security holders ............. 5,352,199 $ 4.11 624,261
Equity compensation plans not
approved by security holders ............. -- -- --
--------------- -------------- ---------------
Total .................................... 5,352,199 $ 4.11 624,261
=============== ============== ===============
21
ISSUER PURCHASES OF EQUITY SECURITIES IN THE FOURTH QUARTER
Total number of Approximate dollar
Total Shares Purchased as Value of Shares that
Number of Average Part of Publicly May Yet be Purchased
Shares Price Paid Announced Plans or Under the Plans or
Period(1) Purchased per Share Programs(2) Programs
------------------------------ ---------------- ----------- ---------------- -------------------
October 2006 ................ 113,667 $ 6.15 113,667 $ 1,807,692
November 2006 ............... 152,028 7.12 152,028 713,481
December 2006 ............... 74,300 6.64 74,300 213,277
---------------- ----------- ----------------
Total ....................... 339,995 $ 6.69 339,995
================ =========== ================
(1) EACH MONTHLY PERIOD IS THE CALENDAR MONTH.
(2) OUR BOARD OF DIRECTORS HAS AUTHORIZED THE PURCHASE OF UP TO $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. ON FEBRUARY 8, 2007, THE BOARD OF DIRECTOR'S
AUTHORIZED THE PURCHASE OF AN ADDITIONAL $5 MILLION OF OUR SECURITIES,
CONTINGENT UPON CONSENT FROM THE RELATED PARTY SENIOR SECURED LENDER.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents our selected consolidated financial data
and operating data as of and for the dates indicated. The data under the
captions "Statement of Operations Data" and "Balance Sheet Data" have been
derived from our audited and unaudited consolidated financial statements. The
remainder is derived from other records of ours.
You should read the selected consolidated financial data together with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our audited and unaudited financial statements and notes thereto
that are included in this report.
22
As of and
For the Year Ended December 31,
(dollars in thousands, except per share data) 2006 2005 2004 2003 2002
----------- ----------- ----------- ----------- -----------
Statement of Operations Data
Revenues:
Interest income ................................... $ 263,566 $ 171,834 $ 105,818 $ 58,164 $ 48,644
Servicing fees .................................... 2,894 6,647 12,480 17,058 14,621
Net gain on sale of contracts ..................... -- -- -- 10,421 21,518
Other income ...................................... 12,403 15,216 14,394 19,343 13,605
----------- ----------- ----------- ----------- -----------
Total revenues ............................... 278,863 193,697 132,692 104,986 98,388
----------- ----------- ----------- ----------- -----------
Expenses:
Employee costs .................................... 38,483 40,384 38,173 37,141 37,778
General and administrative ........................ 42,011 39,285 33,936 31,581 31,549
Interest expense .................................. 93,112 51,669 32,147 23,861 23,925
Provision for credit losses ....................... 92,057 58,987 32,574 11,390 --
Impairment loss on residual assets (1) ............ -- -- 11,750 4,052 5,074
----------- ----------- ----------- ----------- -----------
Total expenses ............................... 265,663 190,325 148,580 108,025 98,326
----------- ----------- ----------- ----------- -----------
Income (loss) before income tax benefit ................ 13,200 3,372 (15,888) (3,039) 62
Income tax benefit ..................................... (26,355) -- -- (3,434) (2,934)
Extraordinary item, unallocated negative goodwill ...... -- -- -- -- 17,412
----------- ----------- ----------- ----------- -----------
Net income (loss) ...................................... $ 39,555 $ 3,372 $ (15,888) $ 395 $ 20,408
=========== =========== =========== =========== ===========
Earnings (loss) per share before
extraordinary item-basic .......................... $ 1.82 $ 0.16 $ (0.75) $ 0.02 $ 0.15
Earnings (loss) per share before
extraordinary item-diluted ........................ $ 1.64 $ 0.14 $ (0.75) $ 0.02 $ 0.14
Earnings (loss) per share-basic ........................ $ 1.82 $ 0.16 $ (0.75) $ 0.02 $ 1.03
Earnings (loss) per share-diluted ...................... $ 1.64 $ 0.14 $ (0.75) $ 0.02 $ 0.97
Pre-tax income (loss) per share-basic (2) .............. $ 0.61 $ 0.16 $ (0.75) $ (0.15) $ 0.00
Pre-tax income (loss) per share-diluted (3) ............ $ 0.55 $ 0.14 $ (0.75) $ (0.14) $ 0.00
Weighted average shares outstanding-basic .............. 21,759 21,627 21,111 20,263 19,902
Weighted average shares outstanding-diluted ............ 24,052 23,513 21,111 21,578 20,987
BALANCE SHEET DATA
Total assets ........................................... $ 1,728,341 $ 1,155,144 $ 766,599 $ 492,470 $ 285,448
Cash and cash equivalents .............................. 14,215 17,789 14,366 33,209 32,942
Restricted cash and equivalents ........................ 193,001 157,662 125,113 67,277 18,912
Finance receivables, net ............................... 1,401,414 913,576 550,191 266,189 84,592
Residual interest in securitizations ................... 13,795 25,220 50,430 111,702 127,170
Warehouse lines of credit .............................. 72,950 35,350 34,279 33,709 --
Residual interest financing ............................ 31,378 43,745 22,204 -- --
Securitization trust debt .............................. 1,442,995 924,026 542,815 245,118 71,630
Long-term debt ......................................... 38,574 58,655 74,829 102,465 103,572
Shareholders' equity ................................... 111,512 73,589 69,920 82,160 82,574
23
As of and
For the Year Ended December 31,
(dollars in thousands, except per share data) 2006 2005 2004 2003 2002
----------- ----------- ----------- ----------- -----------
CONTRACT PURCHASES/SECURITIZATIONS
Automobile contract purchases .......................... $ 1,019,018 $ 691,252 $ 447,232 $ 357,320 $ 463,253
Automobile contract acquisitions (4) ................... -- -- 74,901 152,143 380,000
Automobile contracts securitized - structured
as sales .......................................... -- -- -- 254,436 418,059
Automobile contracts securitized - structured
as secured financings ............................. 957,681 674,421 479,369 140,288 --
MANAGED PORTFOLIO DATA
Contracts held by consolidated subsidiaries ............ $ 1,527,285 $ 1,000,597 $ 619,794 $ 315,598 $ 117,075
Contracts held by non-consolidated subsidiaries ........ 34,850 103,130 233,621 425,534 478,136
SeaWest third party portfolio (5) ...................... 3,770 18,018 53,463 --
----------- ----------- ----------- ----------- -----------
Total managed portfolio ................................ $ 1,565,905 $ 1,121,745 $ 906,878 $ 741,132 $ 595,211
Average managed portfolio .............................. 1,376,781 997,697 861,262 662,382 524,286
Weighted average fixed effective interest rate
(total managed portfolio) (6) ..................... 18.5% 18.6% 19.2% 19.7% 20.4%
Core operating expense
(% of average managed portfolio) (7) .............. 5.8% 8.0% 8.4% 10.4% 13.2%
Allowance for loan losses .............................. $ 79,380 $ 57,728 $ 42,615 $ 35,889 $ 25,828
Allowance for loan losses (% of total contracts
held by consolidated subsidiaries) ................ 5.2% 5.8% 6.9% 11.4% 22.1%
Total delinquencies (6) (8) ............................ 4.0% 3.8% 4.0% 4.7% 4.6%
Total delinquencies and repossessions (6) (8) .......... 5.5% 5.0% 5.6% 6.2% 6.4%
Net charge-offs (6) (9) ................................ 4.5% 5.3% 7.8% 6.8% 8.6%
(1) THE IMPAIRMENT LOSS WAS RELATED TO OUR ANALYSIS AND ESTIMATE OF THE
EXPECTED ULTIMATE PERFORMANCE OF OUR PREVIOUSLY SECURITIZED POOLS THAT WERE
HELD BY OUR NON-CONSOLIDATED SUBSIDIARIES AND THE RESIDUAL INTEREST IN
SECURITIZATIONS. THE IMPAIRMENT LOSS WAS A RESULT OF THE ACTUAL NET LOSS
AND PREPAYMENT RATES EXCEEDING OUR PREVIOUS ESTIMATES FOR THE AUTOMOBILE
CONTRACTS HELD BY OUR NON-CONSOLIDATED SUBSIDIARIES.
(2) INCOME (LOSS) BEFORE INCOME TAX BENEFIT DIVIDED BY WEIGHTED AVERAGE SHARES
OUTSTANDING-BASIC. INCLUDED FOR ILLUSTRATIVE PURPOSES BECAUSE SOME OF THE
PERIODS PRESENTED INCLUDE SIGNIFICANT INCOME TAX BENEFITS WHILE OTHER
PERIODS HAVE NEITHER INCOME TAX BENEFIT NOR EXPENSE.
(3) INCOME (LOSS) BEFORE INCOME TAX BENEFIT DIVIDED BY WEIGHTED AVERAGE SHARES
OUTSTANDING-DILUTED. INCLUDED FOR ILLUSTRATIVE PURPOSES BECAUSE SOME OF THE
PERIODS PRESENTED INCLUDE SIGNIFICANT INCOME TAX BENEFITS WHILE OTHER
PERIODS HAVE NEITHER INCOME TAX BENEFIT NOR EXPENSE.
(4) REPRESENTS AUTOMOBILE CONTRACTS NOT PURCHASED DIRECTLY FROM DEALERS, BUT
ACQUIRED AS A RESULT OF OUR ACQUISITIONS OF MFN IN 2002, TFC IN 2003 AND OF
CERTAIN ASSETS OF SEAWEST IN 2004.
(5) RECEIVABLES RELATED TO THE SEAWEST THIRD PARTY PORTFOLIO, ON WHICH WE EARN
ONLY A SERVICING FEE.
(6) EXCLUDES RECEIVABLES RELATED TO THE SEAWEST THIRD PARTY PORTFOLIO.
(7) TOTAL EXPENSES EXCLUDING PROVISION FOR CREDIT LOSSES, INTEREST EXPENSE AND
IMPAIRMENT LOSS ON RESIDUAL ASSETS.
(8) FOR FURTHER INFORMATION REGARDING DELINQUENCIES AND THE MANAGED PORTFOLIO,
SEE THE TABLE CAPTIONED "DELINQUENCY EXPERIENCE," IN ITEM 1, PART I OF THIS
REPORT AND THE NOTES TO THAT TABLE.
(9) 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 THE CHARGE-OFF, INCLUDING SOME RECOVERIES WHICH HAVE BEEN
CLASSIFIED AS OTHER INCOME IN THE ACCOMPANYING FINANCIAL STATEMENTS. FOR
FURTHER INFORMATION REGARDING CHARGE-OFFS, SEE THE TABLE CAPTIONED "NET
CHARGE-OFF EXPERIENCE," IN ITEM I, PART I OF THIS REPORT AND THE NOTES TO
THAT TABLE.
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with our consolidated financial statements and notes thereto and other
information included or incorporated by reference herein.
OVERVIEW
We are a specialty finance company engaged in purchasing and servicing
new and used retail automobile contracts originated primarily by franchised
automobile dealerships and to a lesser extent by select independent dealers of
used automobiles in the United States. We serve as an alternative source of
financing for dealers, facilitating sales to sub-prime customers, who have
limited credit history, low income or past credit problems and who otherwise
might not be able to obtain financing from traditional sources. We are
headquartered in Irvine, California and have three additional servicing branches
in Virginia, Florida and Illinois.
On March 8, 2002, we acquired MFN Financial Corporation and its
subsidiaries in a merger. On May 20, 2003, we acquired TFC Enterprises, Inc. and
its subsidiaries in a second merger. Each merger was accounted for as a
purchase. MFN Financial Corporation and its subsidiaries and TFC Enterprises,
Inc. and its subsidiaries were engaged in businesses similar to ours: buying
automobile contracts from dealers and servicing those automobile contracts. MFN
Financial Corporation and its subsidiaries ceased acquiring automobile contracts
in May 2002; TFC continues to acquire automobile contracts under its "TFC
Programs," which provide financing exclusively for vehicle purchases by members
of the United States Armed Forces.
On April 2, 2004, we purchased a portfolio of automobile contracts and
certain other assets from SeaWest Financial Corporation and its subsidiaries. In
addition, we were named the successor servicer of three term securitization
transactions originally sponsored by SeaWest. We do not offer financing programs
similar to those previously offered by SeaWest.
From inception through June 2003, we generated revenue primarily from
the gains recognized on the sale or securitization of automobile contracts,
servicing fees earned on automobile contracts sold, interest earned on residuals
interests retained in securitizations, and interest earned on finance
receivables. Since July 2003, we have not recognized any gains from the sale of
automobile contracts. Instead, since July 2003 our revenues have been derived
from interest on finance receivables and, to a lesser extent, servicing fees and
interest earned on residual interests in securitizations.
SECURITIZATION AND WAREHOUSE CREDIT FACILITIES
GENERALLY
Throughout the periods for which information is presented in this
report, we have purchased automobile contracts with the intention of financing
them on a long-term basis through securitizations, and on an interim basis
through our warehouse credit facilities. All such financings have involved
identification of specific automobile contracts, sale of those automobile
contracts (and associated rights) to one of our special-purpose subsidiaries,
and issuance of asset-backed securities to fund the transactions. Depending on
the structure, these transactions may 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.
When structured to be treated as a sale for accounting purposes, the
assets and liabilities of the special-purpose subsidiary are not consolidated
with us. Accordingly, the transaction removes the sold automobile contracts from
our consolidated balance sheet, the related debt does not appear as our debt,
and our consolidated balance sheet shows, as an asset, a retained residual
interest in the sold automobile contracts. The residual interest represents the
discounted value of what we expect will be the excess of future collections on
the automobile contracts over principal and interest due on the asset-backed
securities. That residual interest appears on our consolidated balance sheet as
"residual interest in securitizations," and the determination of its value is
dependent on our estimates of the future performance of the sold automobile
contracts.
25
CHANGE IN POLICY
Beginning in the third quarter of 2003, we began to structure our
securitization transactions so that they would be treated for financial
accounting purposes as secured financings, rather than as sales. All subsequent
securitizations of automobile contracts have been so structured. Prior to the
third quarter of 2003, we had structured our securitization transactions to be
treated as sales of automobile contracts for financial accounting purposes. In
our acquisitions of MFN and TFC, we acquired automobile contracts that these
companies had previously securitized in securitization transactions that were
treated as secured financings for financial accounting purposes. As of December
31, 2006, our consolidated balance sheet included net finance receivables of
$1.9 million related to automobile contracts acquired in the two mergers, out of
totals of net finance receivables of $1,401.4 million.
CREDIT RISK RETAINED
Whether a sale of automobile contracts in connection with a
securitization or warehouse credit facility is treated as a secured financing or
as a sale for financial accounting purposes, the related special-purpose
subsidiary may be unable to release excess cash to us if the credit performance
of the related automobile contracts falls short of pre-determined standards.
Such releases represent a material portion of the cash that we use to fund our
operations. An unexpected deterioration in the performance of such automobile
contracts could therefore have a material adverse effect on both our liquidity
and our results of operations, regardless of whether such automobile contracts
are treated for financial accounting purposes as having been sold or as having
been financed. For estimation of the magnitude of such risk, it may be
appropriate to look to the size of our "managed portfolio," which represents
both financed and sold automobile contracts as to which such credit risk is
retained. Our managed portfolio as of December 31, 2006 was approximately
$1,565.9 million (this amount includes $3.8 million of automobile contracts
securitized by SeaWest, on which we earn only servicing fees and have no credit
risk).
CRITICAL ACCOUNTING POLICIES
We believe that our accounting policies related to (a) Allowance for
Finance Credit Losses, (b) Residual Interest in Securitizations and Gain on Sale
of Automobile Contracts and (c) 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 credit losses that can be
reasonably estimated in our portfolio of automobile contracts. 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.
RESIDUAL INTEREST IN SECURITIZATIONS AND GAIN ON SALE OF AUTOMOBILE CONTRACTS
In transactions prior to the third quarter of 2003, we recognized gain
on sale on the disposition of automobile contracts either outright, in
securitization transactions, and in certain of our warehouse credit facilities.
In those securitization transactions and in the warehousing transactions that
were treated as sales for financial accounting purposes, we, or one of our
wholly-owned, consolidated subsidiaries, retain a residual interest in the
automobile contracts that were sold to a wholly-owned, unconsolidated special
purpose subsidiary.
The line item "residual interest in securitizations" on our
consolidated balance sheet represents the residual interests in securitizations
completed prior to the third quarter of 2003. This line represents the
discounted sum of expected future cash flows from these securitization trusts.
Accordingly, the valuation of the residual interest is heavily dependent on
estimates of future performance of the automobile contracts included in the
securitizations.
We structured all subsequent securitizations and warehouse credit
facilities as secured financings. The warehouse credit facilities are
accordingly reflected in the line items "Finance receivables" and "Warehouse
lines of credit" on our consolidated balance sheet, and the securitizations are
reflected in the line items "Finance receivables" and "Securitization trust
debt."
26
The key economic assumptions used in measuring all residual interests
as of December 31, 2006 and December 31, 2005 are included in the table below.
We have used an effective pre-tax discount rate of 14% per annum except for
certain collections from charged off receivables related to our securitizations
executed from 2001 through the second quarter of 2003. With respect to
collections from such charged off receivables, we have used a discount rate of
25% per annum.
12/31/2006 12/31/2005
---------------------------------------- -------------- --------------
Prepayment Speed (Cumulative)........... 22.7% - 32.5% 22.2% - 35.8%
Net Credit Losses (Cumulative).......... 11.8% - 15.4% 11.9% - 20.2%
Key economic assumptions and the sensitivity of the fair value of
residual cash flows to immediate 10% and 20% adverse changes in those
assumptions as of December 2006 are as follows:
DECEMBER 31,
---------------------
2006
(DOLLARS IN THOUSANDS)
Carrying amount/fair value of residual interest in securitizations... $ 13,795
Weighted average life in years....................................... 1.49
Prepayment Speed Assumption (Cumulative)............................. 22.7% - 32.5%
Estimated Fair value assuming 10% adverse change..................... $ 13,774
Estimated Fair value assuming 20% adverse change..................... 13,754
Expected Net Credit Losses (Cumulative).............................. 11.8% - 15.4%
Estimated Fair value assuming 10% adverse change..................... $ 13,661
Estimated Fair value assuming 20% adverse change..................... 13,539
Residual Cash Flows Discount Rate (Annual)........................... 14.0% - 25.0%
Estimated Fair value assuming 10% adverse change..................... $ 13,648
Estimated Fair value assuming 20% adverse change..................... 13,505
These sensitivities are hypothetical and should be used with caution.
As the figures indicate, changes in fair value based on 10% and 20% variation in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
this table, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another
(for example, increases in market rates may result in lower prepayments and
increased credit losses), which could magnify or counteract the sensitivities.
Our residual interest is attributable to receivables originated and
securitized prior to the third quarter of 2003. Consequently, these receivables
are nearing the end of their contractual terms and, we believe, have already
incurred a substantial portion of the losses that they will likely incur in
total. Moreover, the terms of the securitizations provide us the option to
repurchase the underlying receivables from the trust and retire the related
bonds. Such repurchases are referred to as "clean-ups". When a clean-up takes
place, we purchase the underlying receivables and record them on our balance
sheet and remove that portion of the residual interest that is attributable to
the trust that is terminated when the related bonds are retired. We often
conduct such clean-ups as the terms of the securitizations permit including two
each in 2005 and 2006, and one since December 31, 2006. A portion of our
residual interest represents future cash flows from recoveries on charges offs
from clean-up securitizations and will remain on our balance sheet for some time
even after the clean-up of the final transaction until those particular cash
flows are realized.
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
27
asset-backed securities issued by the trust or by a related entity. We purchase
external credit enhancement in the form of a financial guaranty insurance
policy, guaranteeing timely payment of interest and ultimate payment of
principal on the senior asset-backed securities, from an insurance company. In
addition, we structure our securitizations to include internal credit
enhancement for the benefit of the insurance company and 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 specified levels, which are then
maintained. The specified levels are generally computed as a percentage of the
principal amount remaining unpaid under the related automobile contracts. The
specified levels at which the internal credit enhancement is to be maintained
will vary depending on the performance of the portfolios of automobile contracts
held by the trusts and on other conditions, and may also be varied by agreement
among us, our special purpose subsidiary, the insurance company and the trustee.
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 sold 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.
The prior securitizations that were treated as sales for financial
accounting purposes differ from those treated as secured financings in that the
trust to which our special-purpose subsidiaries sold the automobile contracts
met the definition of a "qualified special-purpose entity" under Statement of
Financial Accounting Standards No. 140 ("SFAS 140"). As a result, assets and
liabilities of those trusts are not consolidated into our consolidated balance
sheet.
Our warehouse credit facility structures are similar to the above,
except that (i) our special-purpose subsidiaries that purchase the automobile
contracts pledge the automobile contracts to secure promissory notes that they
issue, (ii) no increase in the required amount of internal credit enhancement is
contemplated, and (iii) we do not purchase financial guaranty insurance. During
2006 the maximum advance under our warehouse lines increased from 80% to 83% of
the aggregate principal balance of eligible automobile contracts. In January
2007, one of our warehouse lines was further amended to provide for an advance
of up to 93% of the aggregate principal balance of eligible automobile
contracts. The other warehouse line was similarly amended in February 2007.
Upon each sale of automobile contracts in a transaction structured as a
secured financing for financial accounting purposes, whether a term
securitization or a warehouse financing, 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.
Under the prior securitizations and warehouse credit facilities
structured as sales for financial accounting purposes, we removed from our
consolidated balance sheet the automobile contracts sold and added to our
consolidated balance sheet (i) the cash received, if any, and (ii) the estimated
fair value of the ownership interest that we retained in the automobile
contracts sold in the transaction. That retained or residual interest consisted
of (a) the cash held in the spread account, if any, (b) overcollateralization,
if any, (c) subordinated asset-backed securities retained, if any, and (d)
receivables from the trust, which include the net interest receivables. Net
interest receivables represent the estimated discounted cash flows to be
received from the trust in the future, net of principal and interest payable
with respect to the asset-backed notes, the premium paid to the insurance
company, and certain other expenses. The excess of the cash received and the
assets we retained over the carrying value of the automobile contracts sold,
less transaction costs, equaled the net gain on sale of automobile contracts we
recorded. Until the maturity of these transactions, our consolidated balance
sheet will reflect both securitization transactions structured as sales and
others structured as secured financings.
With respect to transactions structured as sales for financial
accounting purposes, we allocate our basis in the automobile contracts between
the asset-backed securities sold and the residual interests retained based on
the relative fair values of those portions on the date of the sale. We recognize
gains or losses attributable to the change in the fair value of the residual
interests, which are recorded at estimated fair value. We are not aware of an
active market for the purchase or sale of interests such as the residual
interests; accordingly, we determine the estimated fair value of the residual
interests by discounting the amount of anticipated cash flows that we estimate
will be released to us in the future (the cash out method), using a discount
rate that we believe is appropriate for the risks involved. The anticipated cash
flows include collections from both current and charged off receivables. We have
used an effective pre-tax discount rate of 14% per annum, except for certain
collections from charged off receivables related to our securitizations executed
from 2001 through the second quarter of 2003. With respect to collections from
such charged off receivables, we have used a discount rate of 25% per annum.
28
We receive periodic base servicing fees for the servicing and
collection of the automobile contracts. (Under our current securitization
structure, 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). Required principal payments on the notes are generally defined
as the payments sufficient to keep the principal balance of such notes equal to
the aggregate principal balance of the related automobile contracts (excluding
those automobile contracts that have been charged off), or a pre-determined
percentage of such balance. Where that percentage is less than 100%, the related
securitization agreements require accelerated payment of principal until the
principal balance of the asset-backed securities is reduced to the specified
percentage. Such accelerated principal payment is said to create
overcollateralization of the asset-backed notes.
If the amount of cash required for payment of fees, expenses, interest
and principal 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, 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 is not at the required level, then the excess cash
collected is retained in the trust until the specified level is achieved.
Although spread account balances are held by the trusts on behalf of our
special-purpose subsidiaries as the owner of the residual interests (in the case
of securitization transactions structured as sales for financial accounting
purposes) or the trusts (in the case of securitization transactions structured
as secured financings for financial accounting purposes), 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. The interest rate payable on the automobile contracts
is significantly greater than the interest rate on the asset-backed notes. As a
result, the residual interests described above historically have been a
significant asset of ours. In determining the value of the residual interests,
we must estimate the future rates of prepayments, delinquencies, defaults,
default loss severity, and recovery rates, as all of these factors affect the
amount and timing of the estimated cash flows. We estimate prepayments by
evaluating historical prepayment performance of comparable automobile contracts.
We estimate recovery rates of previously charged off receivables using available
historical recovery data. We estimate defaults and default loss severity using
available historical loss data for comparable automobile contracts and the
specific characteristics of the automobile contracts we purchased. In valuing
the residuals as of December 31, 2006, we estimate that charge-offs as a
percentage of the original principal balance will approximate 15.5% to 19.4%
cumulatively over the lives of the related automobile contracts, with recovery
rates approximating 3.6% to 4.2% of the original principal balance and
prepayment estimates of approximately 22.7% to 32.5% cumulatively over the lives
of the related automobile contracts.
For securitizations that were structured as a sale for financial
accounting purposes, we recognize interest income on the balance of the residual
interests. In addition, we would recognize as gain additional revenue from the
residual interests if the actual performance of the automobile contracts were
better than our estimate of the value of the residual interest. If the actual
performance of the automobile contracts were worse than our estimate, then a
downward adjustment to the carrying value of the residuals and a related
impairment charge would be required. In a securitization structured as a secured
financing for financial accounting purposes, interest income is recognized when
accrued under the terms of the related automobile contracts and, therefore,
presents less potential for fluctuations in performance when compared to the
approach used in a transaction structured as a sale for financial accounting
purposes.
In all of our term securitizations and warehouse credit facilities,
whether treated as secured financings or as sales, we have sold the automobile
contracts (through a subsidiary) to the securitization entity. The difference
between the two structures is that in securitizations that are treated as
secured financings we report the assets and liabilities of the securitization
trust on our consolidated balance sheet. Under both structures, recourse to us
by holders of the asset-backed securities and by the trust, for failure of the
automobile contract obligors to make payments on a timely basis, is limited to
the automobile contracts included in the securitizations or warehouse credit
facilities, the spread accounts and our retained interests in the respective
trusts.
29
INCOME TAXES
We and our 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. We measure
deferred tax assets and liabilities 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.
As part of the both the MFN Merger and the TFC Merger, we acquired
certain net operating losses and built-in loss assets. During each period since
the MFN Merger through the third quarter of 2006, we have identified the types
and amounts of temporary differences and the nature and amount of each type of
operating loss and tax credit carryforward as well as the length of the
carryforward period. Moreover, we considered various positive and negative
evidence to ascertain, based on the weight of that evidence, if a valuation
allowance against the certain components of deferred tax assets was appropriate.
Through the third quarter of 2006, based on our analysis of both positive and
negative evidence pertaining to the realization of deferred tax assets, we had
determined that it was not more than likely that a significant amount of the
deferred tax assets would be realized in the future. As a result, we maintained
a significant valuation allowance against those available deferred tax assets.
However, as of December 31, 2006 our review of both positive and
negative evidence pertaining to the realization of deferred tax assets suggests
to us that it is now more than likely that we will realize a substantial portion
of deferred tax assets. A significant portion of the deferred tax assets is
attributable to the mergers and is limited as to the annual amount and the
number of future periods that it can be realized. Consequently, we considered
our history of cumulative taxable income since our inception in the evaluation
of positive and negative evidence. Other significant components of our deferred
tax asset are not limited as to their annual amount and timeframe for
realization as they have resulted from our recent history of taxable income
substantially in excess of our net income. As a result, we have released that
portion of the valuation allowance that represents the portion of deferred tax
assets that we believe are more likely than not to be realized. We continue to
maintain a valuation allowance against that portion of the deferred tax asset
whose utilization in future periods is not more than likely.
In determining the possible realization of deferred tax assets, we
consider future taxable income from future operations exclusive of reversing
temporary differences and tax planning strategies that, if necessary, would be
implemented to accelerate taxable income into periods in which net operating
losses might otherwise expire.
RESULTS OF OPERATIONS
EFFECTS OF CHANGE IN SECURITIZATION STRUCTURE
Our decision in the third quarter of 2003 to structure securitization
transactions as secured financings for financial accounting purposes, rather
than as sales, has affected and will affect the way in which the transactions
are reported. The major effects are these: (i) the automobile contracts are
shown as assets on our balance sheet; (ii) the debt issued in the transactions
is shown as indebtedness; (iii) cash deposited in the spread accounts to enhance
the credit of the securitization transactions is shown as "Restricted cash" on
our balance sheet; (iv) cash collected from automobile purchasers and other
sources related to the automobile contracts prior to making the required
payments under the securitization agreements is also shown as "Restricted cash"
on our balance sheet; (v) the servicing fee that we receive in connection with
such contracts is recorded as a portion of the interest earned on such contracts
in our statements of operations; (vi) we have initially and periodically
recorded as expense a provision for estimated credit losses on the contracts in
our statements of operations; and (vii) portions of scheduled payments on the
contracts and on the debt issued in the transactions representing interest are
recorded as interest income and expense, respectively, in our statements of
operations.
These changes collectively represent a deferral of revenue and
acceleration of expenses, and thus a more conservative approach to accounting
for our operations compared to the previous securitization transactions, which
were accounted for as sales at the consummation of the transaction. As a result
of the changes, we initially reported lower earnings than we would have reported
if we had continued to structure our transactions to require recognition of gain
on sale. It should also be noted that growth in our portfolio of receivables
resulted in an increase in expenses in the form of provision for credit losses,
and initially had a negative effect on net earnings. Our cash availability and
cash requirements should be unaffected by the change in structure.
30
Since the third quarter of 2003, we have conducted 18 term
securitizations. Of these 18, 14 were quarterly securitizations of automobile
contracts that we purchased from automobile dealers under our regular programs.
In addition, in March 2004 and November 2005, we completed securitizations of
our retained interests in other securitizations that we and our affiliates
previously sponsored. The debt from the March 2004 transaction was repaid in
August 2005. Also, in June 2004, we completed a securitization of automobile
contracts purchased in the SeaWest asset acquisition and under our TFC programs.
Further, in December 2005, we completed a securitization 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 of our MFN and TFC subsidiaries. All such
securitizations since the third quarter of 2003 have been structured as secured
financings.
COMPARISON OF OPERATING RESULTS FOR THE YEAR ENDED DECEMBER 31, 2006 WITH THE
YEAR ENDED DECEMBER 31, 2005
REVENUES. During the year ended December 31, 2006, revenues were $278.9
million, an increase of $85.2 million, or 44.0%, from the prior year revenue of
$193.7 million. The primary reason for the increase in revenues is an increase
in interest income. Interest income for the year ended December 31, 2006
increased $91.7 million, or 53.4%, to $263.6 million from $171.8 million in the
prior year. The primary reason for the increase in interest income is the
increase in finance receivables held by consolidated subsidiaries (resulting in
an increase of $102.4 million in interest income). This increase was partially
offset by the decline in the balance of the portfolios of automobile contracts
we acquired in the MFN, TFC and SeaWest transactions (in the aggregate,
resulting in a decrease of $10.9 million in interest income). In addition,
interest income on our residual asset increased by $318,000.
Servicing fees totaling $2.9 million in the year ended December 31,
2006 decreased $3.8 million, or 56.5%, from $6.6 million in the prior year. The
decrease in servicing fees is the result of the change in securitization
structure and the consequent decline in our managed portfolio held by
non-consolidated subsidiaries. As a result of the decision to structure future
securitizations as secured financings, our managed portfolio held by
non-consolidated subsidiaries will continue to decline in future periods, and
servicing fee revenue is anticipated to decline proportionately. As of December
31, 2006 and 2005, our managed portfolio owned by consolidated vs.
non-consolidated subsidiaries and other third parties was as follows:
December 31, 2006 December 31, 2005
------------------- -------------------
Amount % Amount %
---------- ------ ---------- ------
Total Managed Portfolio ($ in millions)
Owned by Consolidated Subsidiaries .......... $ 1,527.3 97.5% $ 1,000.6 89.2%
Owned by Non-Consolidated Subsidiaries ...... 34.8 2.2% 103.1 9.2%
SeaWest Third Party Portfolio ............... 3.8 0.2% 18.0 1.6%
---------- ------ ---------- ------
Total ....................................... $ 1,565.9 100.0% $ 1,121.7 100.0%
========== ====== ========== ======
At December 31, 2006, we were generating income and fees on a managed
portfolio with an outstanding principal balance of $1,565.9 million (this amount
includes $3.8 million of automobile contracts securitized by SeaWest, on which
we earn only servicing fees), compared to a managed portfolio with an
outstanding principal balance of $1,121.7 million as of December 31, 2005. As
the portfolios of automobile contracts acquired in the MFN Merger, TFC Merger,
and SeaWest transaction decrease, the portfolio of automobile contracts that we
purchased directly from automobile dealers continues to expand. At December 31,
2006 and 2005, the managed portfolio composition was as follows:
December 31, 2006 December 31, 2005
------------------- -------------------
Amount % Amount %
---------- ------ ---------- ------
Originating Entity ($ in millions)
CPS ......................................... $ 1,496.5 95.6% $ 1,017.3 90.7%
TFC ......................................... 60.9 3.9% 68.6 6.1%
MFN ......................................... 0.2 0.0% 2.5 0.2%
SeaWest ..................................... 4.5 0.3% 15.3 1.4%
SeaWest Third Party Portfolio ............... 3.8 0.2% 18.0 1.6%
---------- ------ ---------- ------
Total ....................................... $ 1,565.9 100.0% $ 1,121.7 100.0%
========== ====== ========== ======
31
Other income decreased $2.8 million, or 18.5%, to $12.4 million in the
year ended December 31, 2006 from $15.2 million during the prior year. The year
over year decrease is the result of a variety of factors. Current year other
income includes $1.2 million resulting from an increase in the carrying value of
our residual interest in securitizations. The carrying value was increased
primarily as a result of the underlying receivables having incurred fewer losses
than we had previously estimated. The prior year period included proceeds of
$2.4 million from the sale of certain charged off receivables acquired in the
MFN, TFC and SeaWest acquisitions. In addition, we experienced decreases in
recoveries on MFN and certain other automobile contracts (a decrease of
$638,000) compared to the same prior year and decreased revenue on our direct
mail services (a decrease of $752,000). These direct mail services are provided
to our dealers and consist of customized solicitations targeted to prospective
vehicle purchasers, in proximity to the dealer, who appear to meet our credit
criteria. We also experienced increases in convenience fees charged to obligors
for certain transaction types (an increase of $690,000).
EXPENSES. Our operating expenses consist primarily of provisions for
credit losses, interest expense, employee costs and general and administrative
expenses. Provisions for credit losses and interest expense are significantly
affected by the volume of automobile contracts we purchased during a period and
by the outstanding balance of finance receivables held by consolidated
subsidiaries. Employee costs and general and administrative expenses are
incurred as applications and automobile contracts are received, processed and
serviced. Factors that affect margins and net income include changes in the
automobile and automobile finance market environments, and macroeconomic factors
such as interest rates and the unemployment level.
Employee costs include base salaries, commissions and bonuses paid to
employees, and certain expenses related to the accounting treatment of
outstanding warrants and 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 primarily of facilities expenses,
telephone and other communication services, credit services, computer services,
marketing and advertising expenses, and depreciation and amortization.
Total operating expenses were $265.7 million for the year ended
December 31, 2006, compared to $190.3 million for the prior year, an increase of
$75.3 million, or 39.6%. The increase is primarily due to increases in provision
for credit losses and interest expense, which increased by $33.1 million and
$41.4 million, or 56.1% and 80.2%, respectively. Both interest expense and
provision for credit losses are directly affected by the growth in our portfolio
of automobile contracts held by consolidated affiliates.
Employee costs decreased slightly to $38.5 million during the year
ended December 31, 2006, representing 14.5% of total operating expenses, from
$40.4 million for the prior year, or 21.2% of total operating expenses. During
the year ended December 31, 2006, we deferred $2.9 million of direct employee
costs associated with the purchase of automobile contracts in the period, in
accordance with Statement of Financial Accounting Standard No. 91, Accounting
for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans
and Initial Direct Costs of Leases (SFAS 91). Prior to 2006, we have not
deferred and amortized such costs as our analyses indicated that the effect of
such deferral and amortization would not have been material. However, due to
continued increases in volumes of automobile contract purchases and refinements
in our methodology to measure direct costs associated with automobile contract
purchases, our estimate of direct costs has increased, resulting in the need to
defer such costs and amortize them over the lives of the related automobile
contracts as an adjustment to the yield in accordance with SFAS 91. The decrease
as a percentage of total operating expenses reflects the higher total of
operating expenses, primarily a result of the increased provision for credit
losses and interest expense.
General and administrative expenses increased slightly to $23.2 million
and represented 8.7% of total operating expenses in the year ending December 31,
2006, as compared to the prior year when general and administrative expenses
represented 12.1% of total operating expenses. The decrease as a percentage of
total operating expenses reflects the higher operating expenses primarily a
result of the provision for credit losses and interest expense.
Interest expense for the year ended December 31, 2006 increased $41.4
million, or 80.2%, to $93.1 million, compared to $51.7 million in the previous
year. The increase is primarily the result of changes in the amount and
composition of securitization trust debt carried on our consolidated balance
sheet. Interest on securitization trust debt increased by $40.5 million in 2006
compared to the prior year. We also experienced increases in warehouse interest
expense and residual interest financing interest expenses of $2.7 million and
$2.7 million, respectively. A portion of the increase in interest expense can
also be attributed to a gradual increase in market interest rates during 2006.
Increases in interest expense for securitization trust debt, warehouse and
residual interest financing were somewhat offset by a decrease of $4.5 million
in interest expense for subordinated debt.
32
Marketing expenses consist primarily of commission-based compensation
paid to our employee marketing representatives and increased by $2.0 million, or
16.9%, to $14.0 million, compared to $12.0 million in the previous year and
represented 5.3% of total operating expenses. The increase is primarily due to
the increase in automobile contracts we purchased during the year ended December
31, 2006 as compared to the prior year. During the year ended December 31, 2006,
we purchased 66,504 automobile contracts aggregating $1,019.0 million, compared
to 46,666 automobile contracts aggregating $691.3 million in the prior year.
Occupancy expenses increased by $583,000 or 17.1%, to $4.0 million
compared to $3.4 million in the previous year and represented 1.5% of total
operating expenses.
Depreciation and amortization expenses increased by $10,000, or 1.3%,
to $800,000 from $790,000 in the previous year.
During the year ended December 31, 2006, we recorded an income tax
benefit of $41.8 million related to the reversal of a portion of the valuation
allowance against deferred tax assets, offset by current income tax paid or
currently payable of $20.2 million, less $4.8 million in deferred tax benefit.
As of December 31, 2006, we had remaining deferred tax assets of $64.1 million,
partially offset by a valuation allowance of $9.4 million related to federal and
state net operating losses and other timing differences, leaving a net deferred
tax asset of $54.7 million.
COMPARISON OF OPERATING RESULTS FOR THE YEAR ENDED DECEMBER 31, 2005 WITH THE
YEAR ENDED DECEMBER 31, 2004
REVENUES. During the year ended December 31, 2005, revenues were $193.7
million, an increase of $61.0 million, or 46.0%, from the prior year revenue of
$132.7 million. The primary reason for the increase in revenues is an increase
in interest income. Interest income for the year ended December 31, 2005
increased $66.0 million, or 62.4%, to $171.8 million in 2005 from $105.8 million
in 2004. The primary reason for the increase in interest income is the growth of
the finance receivables held by consolidated subsidiaries on our balance sheet.
During 2005, we purchased $691.3 million of automobile contracts and increased
our balance of receivables held by consolidated subsidiaries to $1,000.6 million
at December 31, 2005 from $619.8 million at December 31, 2004, an increase of
61.4%. Offsetting the increase in interest income were decreases in the balance
of receivables acquired in the MFN, TFC and SeaWest transactions, which resulted
in decreases in interest income of $1.8 million, $2.0 million and $2.6 million,
respectively.
Servicing fees totaling $6.6 million in the year ended December 31,
2005 decreased $5.8 million, or 46.7%, from $12.5 million in the same period a
year earlier. The decrease in servicing fees is the result of the change in
securitization structure and the consequent decline in our managed portfolio
held by non-consolidated subsidiaries, and the decrease in the balance of
automobile contracts originated by SeaWest for which we receive only servicing
fees. As a result of the decision to structure future securitizations as secured
financings, our managed portfolio held by non-consolidated subsidiaries will
continue to decline in future periods, and servicing fee revenue is anticipated
to decline proportionately. As of December 31, 2005 and 2004, our managed
portfolio owned by consolidated vs. non-consolidated subsidiaries and other
third parties was as follows:
December 31, 2005 December 31, 2004
------------------ ----------------
Amount % Amount %
-------- ----- -------- -----
Total Managed Portfolio ($ in millions)
Owned by Consolidated Subsidiaries .......... $ 1,000.6 89.2% $ 619.8 68.3%
Owned by Non-Consolidated Subsidiaries ...... 103.1 9.2% 233.6 25.8%
SeaWest Third Party Portfolio ............... 18.0 1.6% 53.5 5.9%
---------- ----- -------- -----
Total ....................................... $ 1,121.7 100.0% $ 906.9 100.0%
========== ===== ======== =====
33
At December 31, 2005, we were generating income and fees on a managed
portfolio with an outstanding principal balance of $1,121.7 million (this amount
includes $18.0 million of automobile contracts securitized by SeaWest, on which
we earn only servicing fees), compared to a managed portfolio with an
outstanding principal balance of $906.9 million as of December 31, 2004. As the
portfolios of automobile contracts acquired in the MFN, TFC and SeaWest
transactions decrease, the portfolio of automobile contracts that we purchased
directly from automobile dealers continues to expand. At December 31, 2005 and
2004, the managed portfolio composition was as follows:
December 31, 2005 December 31, 2004
------------------ ----------------
Amount % Amount %
---------- ----- -------- -----
Originating Entity ($ in millions)
CPS ......................................... $ 1,017.3 90.7% $ 706.8 77.9%
TFC ......................................... 68.6 6.1% 89.4 9.9%
MFN ......................................... 2.5 0.2% 17.8 2.0%
SeaWest ..................................... 15.3 1.4% 39.4 4.3%
SeaWest Third Party Portfolio ............... 18.0 1.6% 53.5 5.9%
---------- ----- -------- -----
Total ....................................... $ 1,121.7 100.0% $ 906.9 100.0%
========== ===== ======== =====
Other income increased $822,000, or 5.7%, to $15.2 million during 2005
from $14.4 million in 2004. During 2005, other income included $2.4 million from
the sale of charged off receivables acquired in the MFN, TFC, and SeaWest
transactions, compared to no such proceeds in 2004. Recoveries on MFN
receivables decreased by $3.1 million to $4.9 million in 2005, compared to $8.0
million in 2004. Other income associated with direct mail services increased by
$765,000 to $4.5 million in 2005, compared to $3.8 million in 2004. These direct
mail services are provided to our dealers and represent direct mail products
which consist of customized solicitations targeted to prospective vehicle
purchasers, in proximity to the dealer, who are likely to meet our credit
criteria.
EXPENSES. Total operating expenses were $190.3 million for 2005,
compared to $148.6 million for 2004. The increase is primarily due to a $26.4
million increase, or 81.1% in the provision for credit losses to $59.0 million
during the 2005 period as compared to $32.6 million in the 2004 period. Interest
expense increased by $19.5 million to $51.7 million from $32.1 million in 2004,
an increase of 60.7%. The increase is primarily the result of the amount of
securitization trust debt carried on our consolidated balance sheet, which
increased along with the growth of our portfolio of finance receivables. The
increase was somewhat offset by the decrease in securitization trust debt
acquired in the MFN and TFC transactions. For 2005, the provision for credit
losses and interest expense represented 31.0% and 27.1%, respectively, of total
operating expenses, compared to 21.9% and 21.6% in 2004.
Employee costs increased to $40.4 million, or 5.8% during 2005,
representing 21.2% of total operating expenses, from $38.2 million for 2004, or
25.7% of total operating expenses. The decrease as a percentage of total
operating expenses reflects the higher total of operating expenses, primarily a
result of the increased provision for credit losses and interest expense.
General and administrative expenses increased slightly to $23.1
million, or 12.1% of total operating expenses, in 2005, as compared to $21.3
million, or 14.3% of total operating expenses, in 2004. The decrease as a
percentage of total operating expenses reflects the higher operating expenses
primarily a result of the increased provision for credit losses and interest
expense. During the year ended December 31, 2005, we recognized what we believe
will be a one-time, non-cash impairment charge of $1.9 million against certain
assets other than finance receivables.
In December 2005, the Compensation Committee of the Board of Directors
approved accelerated vesting of all the outstanding stock options we issued.
Options to purchase 2,113,998 shares of our common stock, which would otherwise
have vested from time to time through 2010, became immediately exercisable as a
result of the acceleration of vesting. The decision to accelerate the vesting of
the options was made primarily to reduce non-cash compensation expenses that
would have been recorded in our income statement in future periods upon the
adoption of Financial Accounting Standards Board Statement No. 123R, Share-Based
Payment, in January 2006. We estimate that approximately $3.5 million of future
non-cash compensation expense was eliminated as a result of the acceleration of
vesting.
At the time of the acceleration of vesting, we accounted for our stock
options in accordance with Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees. Consequently, the acceleration of
vesting resulted in non-cash compensation charge of $427,000 for the year ended
December 31, 2005.
34
For 2005, we recognized no impairment loss on our residual interest in
securitizations compared to $11.8 million in 2004. In 2004, such impairment loss
related to our analysis and estimate of the expected ultimate performance of our
previously securitized pools that are held by non-consolidated subsidiaries and
the residual interest in securitizations. The impairment loss was a result of
the actual net loss and prepayment rates exceeding our previous estimates for
the automobile contracts held by non-consolidated subsidiaries.
Marketing expenses increased by $3.7 million, or 43.9%, to $12.0
million, compared to $8.3 million in the same period of the previous year and
represented 6.3% of total operating expenses. The increase is primarily due to
the increase in automobile contracts we purchased during the year ended December
31, 2005.
Occupancy expenses decreased by $120,000, or 3.4%, to $3.4 million,
compared to $3.5 million in the same period of the previous year and represented
1.8% of total operating expenses. The decrease is primarily due to the closure
and sub-leasing during 2005 of certain facilities acquired in the MFN and TFC
transactions.
Depreciation and amortization expenses remained essentially unchanged
at $790,000 for 2005, compared to $785,000 for 2004, and represented 0.4% of
total operating expenses.
We would have recorded income tax expense of $1.4 million for the year
ended December 31, 2005, but the income tax expense was offset primarily by a
$1.4 million decrease in the valuation allowance that we had established to
offset our deferred tax assets.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
Our business requires substantial cash to support purchases of
automobile contracts and other operating activities. Our primary sources of cash
have been cash flows from operating activities, including proceeds from sales of
automobile contracts, amounts borrowed under our 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 securitized portfolios of
automobile contracts in which we have retained a residual ownership interest and
from the spread accounts associated with such pools. Our primary uses of cash
have been the purchases of automobile contracts, repayment of amounts borrowed
under warehouse credit facilities and otherwise, operating expenses such as
employee, interest, occupancy expenses and other general and administrative
expenses, the establishment of spread accounts and initial
overcollateralization, if any, and the increase of credit enhancement to
required levels in securitization transactions, and income taxes. There can be
no assurance that internally generated cash will be sufficient to meet 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 portfolios and their related spread accounts), the rate of expansion or
contraction in our managed portfolio, and the terms upon which we are able to
purchase, sell, and borrow against automobile contracts.
Net cash provided by operating activities for the years ended December
31, 2006, 2005 and 2004 was $57.1 million, $36.7 million and $10.0 million,
respectively. Cash from operating activities is generally provided by net income
from our operations. The increase in 2006 vs. 2005, and 2005 vs. 2004, is due in
part to our increased net earnings before the significant increase in the
provision for credit losses.
Net cash used in investing activities for the years ended December 31,
2006, 2005 and 2004, was $568.4 million, $411.7 million, and $314.1 million,
respectively. Cash used in investing activities generally relates to purchases
of automobile contracts. Purchases of finance receivables held for investment
were $1,019.0 million, $691.3 million and $506.0 million in 2006, 2005 and 2004,
respectively.
Net cash provided by financing activities for the year ended December
31, 2006, was $507.7 million compared with $378.4 million for the year ended
December 31, 2005 and $285.3 million for the year ended December 31, 2004. Cash
used or provided by financing activities is primarily attributable to the
issuance or repayment of debt. We issued $1,003.6 million of securitization
trust debt in 2006 as compared to $662.4 million in 2005 and $474.7 million in
2004.
We purchase automobile contracts from dealers for a cash price
approximating 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
35
automobile contract purchase prices not financed under revolving warehouse
credit facilities. As of December 31, 2006, we had $400 million in warehouse
credit capacity, in the form of two $200 million facilities. One $200 million
facility provides funding for automobile contracts purchased under the TFC
Programs while both warehouse facilities provide funding for automobile
contracts purchased under the CPS Programs. On June 29, 2005, we terminated a
third facility in the amount of $125 million, which we had utilized to fund
automobile contracts under the CPS and TFC Programs.
The first of two warehouse facilities mentioned above is structured to
allow us to fund a portion of the purchase price of automobile contracts by
drawing against a floating rate variable funding note issued by our consolidated
subsidiary Page Three Funding, LLC. This facility was established on November
15, 2005, and expires on November 14, 2007, although it is renewable with the
mutual agreement of the parties. On November 8, 2006 the facility was increased
from $150 million to $200 million and the advance was increased to 83% from 80%
of eligible contracts, subject to collateral tests and certain other conditions
and covenants. Notes under this facility accrue interest at a rate of one-month
LIBOR plus 2.00% per annum. At December 31, 2006, $45.2 million was outstanding
under this facility.
The second of two warehouse facilities is similarly structured to allow
us to fund a portion of the purchase price of automobile contracts by drawing
against a floating rate variable funding note issued by our consolidated
subsidiary Page Funding LLC. This facility was entered into on June 30, 2004. On
June 29, 2005 the facility was increased from $100 million to $125 million and
further amended to provide for funding for automobile contracts purchased under
the TFC programs, in addition to our CPS programs. The available credit under
the facility was increased again to $200 million on August 31, 2005. In April
2006, the terms of this facility were amended to allow advances to us of up to
80% of the principal balance of automobile contracts that we purchase under our
CPS programs, and of up to 70% of the principal balance of automobile contracts
that we purchase under our TFC programs, in all events subject to collateral
tests and certain other conditions and covenants. On June 30, 2006, the terms of
this facility were amended to allow advances to us of up to 83% of the principal
balance of automobile contracts that we purchase under our CPS programs, in all
events subject to collateral tests and certain other conditions and covenants.
Notes under this facility accrue interest at a rate of one-month LIBOR plus
2.00% per annum. The lender has annual termination options at its sole
discretion on each June 30 through 2007, at which time the agreement expires. At
December 31, 2006, $27.8 million was outstanding under this facility.
The balance outstanding under these warehouse facilities generally will
increase as we purchase additional automobile contracts, until we effect a
securitization utilizing automobile contracts warehoused in the facilities, at
which time the balance outstanding will decrease.
We securitized $957.7 million of automobile contracts in four private
placement transactions during the year ended December 31, 2006, as compared to
$674.4 million of automobile contracts in five private placement transactions
during the year ended December 31, 2005. All of these transactions were
structured as secured financings and, therefore, resulted in no gain on sale. In
March 2004, one of our wholly-owned bankruptcy remote consolidated subsidiaries
issued $44.0 million of asset-backed notes secured by its retained interest in
eight term securitization transactions. The notes had an interest rate of 10.0%
per annum and a final maturity in October 2009 and were required to be repaid
from the distributions on the underlying retained interests. In connection with
the issuance of the notes, we incurred and capitalized issuance costs of $1.3
million. We repaid the notes in full in August 2005. In November 2005, we
completed a similar securitization whereby a wholly-owned bankruptcy remote
consolidated subsidiary of ours issued $45.8 million of asset-backed notes
secured by its retained interest in 10 term securitization transactions. These
notes, which bear interest at a blended interest rate of 8.70% per annum and
have a final maturity in July 2011, are required to be repaid from the
distributions on the underlying residual interests. In connection with the
issuance of the notes, we incurred and capitalized issuance costs of $915,000.
In December 2006 we entered into a $35 million residual credit facility
that is secured by our retained interests in more recent term securitizations.
This facility, which bears interest at LIBOR plus 6.125%, allows for new
borrowings over a two-year period and then amortizes over a five-year period. At
December 31, 2006, there was $12.2 million outstanding under this facility and
was secured by our retained interests in six term securitization transactions.
Cash released from trusts and their related spread accounts to us
related to the portfolio owned by consolidated subsidiaries for the years ended
December 31, 2006, 2005 and 2004 was $16.5 million, $23.1 million and $21.4
million, respectively. Changes in the amount of credit enhancement required for
term securitization transactions and releases from trusts and their related
spread accounts are affected by the structure of the credit enhancement and the
relative size, seasoning and performance of the various pools of automobile
contracts securitized that make up our managed portfolio to which the respective
spread accounts are related. The trend in our recent securitizations has been
towards credit enhancements that require a lower proportion of spread account
cash and a greater proportion of over-collateralization. This trend has led to
somewhat lower levels of restricted cash and releases from trusts relative to
the size of our managed portfolio.
36
The acquisition of automobile contracts for subsequent sale in
securitization transactions, and the need to fund spread accounts and initial
overcollateralization, if any, and increase credit enhancement levels when those
transactions take place, results in a continuing need for capital. The amount of
capital required is most heavily dependent on the rate of 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. We may be limited in our
ability to purchase automobile contracts due to limits on our capital. As of
December 31, 2006, we had unrestricted cash on hand of $14.2 million and
available capacity from our warehouse credit facilities of $327.0 million.
Warehouse capacity is subject to the availability of suitable automobile
contracts to serve as collateral and of sufficient cash to fund the portion of
such automobile contracts purchase price not advanced under the warehouse
facilities. Our plans to manage the need for liquidity include the completion of
additional securitizations that would provide additional credit availability
from the warehouse credit facilities, and matching our levels of automobile
contract purchases to our availability of cash. There can be no assurance that
we will be able to complete securitizations on favorable economic terms or that
we will be able to complete securitizations at all. If we are unable to complete
such securitizations, we may be unable to purchase automobile contracts and
interest income and other portfolio related income would decrease.
Our primary means of ensuring that our cash demands do not exceed our
cash resources is to match our levels of automobile contract purchases to our
availability of cash. Our ability to adjust the quantity of automobile contracts
that we purchase and securitize will be subject to general competitive
conditions and the continued availability of warehouse credit facilities. There
can be no assurance that the desired level of automobile contract purchases can
be maintained or increased. 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 only if the amount of credit
enhancement has reached specified levels and/or the delinquency, defaults or net
losses related to the automobile contracts in the pool are below certain
predetermined levels. In the event delinquencies, defaults or net losses on the
automobile contracts exceed such levels, the terms of the securitization: (i)
may require increased credit enhancement to be accumulated for the particular
pool; (ii) may restrict the distribution to us of excess cash flows associated
with other pools; or (iii) in certain circumstances, may permit the insurers to
require the transfer of servicing on some or all of the automobile contracts to
another servicer. There can be no assurance that collections from the related
trusts will continue to generate sufficient cash.
Certain of our securitization transactions and the warehouse credit
facilities contain various financial covenants requiring certain minimum
financial ratios and results. Such covenants include maintaining minimum levels
of liquidity and net worth and not exceeding maximum leverage levels and maximum
financial losses. 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.
The agreements under which we receive periodic fees for servicing
automobile contracts in securitizations are terminable by the respective
insurance companies upon defined events of default, and, in some cases, at the
will of the insurance company. Were an insurance company in the future to
exercise its option to terminate such agreements, such a termination could have
a material adverse effect on our liquidity and results of operations, depending
on the number and value of the terminated agreements. Our note insurers continue
to extend our term as servicer on a monthly and/or quarterly basis, pursuant to
the servicing agreements. CONTRACTUAL OBLIGATIONS
The following table summarizes our material contractual obligations as
of December 31, 2006 (dollars in thousands):
PAYMENT DUE BY PERIOD (1)
------------------------------------------------
LESS THAN 1 TO 3 3 TO 5 MORE THAN
TOTAL 1 YEAR YEARS YEARS 5 YEARS
------- ------- ------- ------- -------
Long Term Debt (2) ........... $38,619 $30,887 $ 6,309 $ 1,318 $ 105
Operating Leases ............. $ 7,066 $ 3,892 $ 2,970 $ 204 $ --
(1) SECURITIZATION TRUST DEBT, IN THE AGGREGATE AMOUNT OF $1,443.0 MILLION AS
OF DECEMBER 31, 2006, IS OMITTED FROM THIS TABLE BECAUSE IT BECOMES DUE AS
AND WHEN THE RELATED RECEIVABLES BALANCE IS REDUCED. EXPECTED PAYMENTS,
WHICH WILL DEPEND ON THE PERFORMANCE OF SUCH RECEIVABLES, AS TO WHICH THERE
CAN BE NO ASSURANCE, ARE $472.3 MILLION IN 2007, $342.2 MILLION IN 2008,
$261.3 MILLION IN 2009, $191.4 MILLION IN 2010, $128.3 MILLION IN 2011, AND
37
$47.5 MILLION IN 2012. RESIDUAL INTEREST FINANCING, OF $31.4 MILLION AS OF
DECEMBER 31, 2006, IS ALSO OMITTED FROM THIS TABLE BECAUSE IT BECOMES DUE
AS AND WHEN THE RELATED RESIDUAL INTEREST AND SPREAD ACCOUNT BALANCES ARE
REDUCED. EXPECTED PAYMENTS, WHICH WILL DEPEND ON THE PERFORMANCE OF THE
RELATED RECEIVABLES, AS TO WHICH THERE CAN BE NO ASSURANCE, ARE $11.0
MILLION IN 2007, $7.6 MILLION IN 2008 AND $12.8MILLION IN 2009.
(2) LONG-TERM DEBT INCLUDES SENIOR SECURED DEBT, SUBORDINATED DEBT,
SUBORDINATED RENEWABLE NOTES AND NOTES PAYABLE.
WAREHOUSE CREDIT FACILITIES
The terms on which credit has been available to us for purchase of
automobile contracts have varied over the three years 2004-2006 and through
December 31, 2006, as shown in the following summary of our warehouse credit
facilities:
FACILITY IN USE FROM NOVEMBER 2000 TO FEBRUARY 2004. In November 2000,
we (through our subsidiary CPS Funding LLC) entered into a floating rate
variable note purchase facility under which up to $75.8 million of notes could
be outstanding at any time subject to collateral tests and other conditions. We
used funds derived from this facility to purchase automobile contracts under the
CPS programs, which were pledged to secure the notes. The collateral tests and
other conditions generally allowed us to borrow up to approximately 72.5% of the
principal balance of the automobile contracts. Notes issued under this facility
bore interest at one-month LIBOR plus 0.75% per annum, plus a premium to an
insurance company. This facility expired on February 21, 2004.
FACILITY IN USE FROM MARCH 2002 TO JUNE 2005. In March 2002, we
(through our subsidiary CPS Warehouse Trust) entered into a second floating rate
variable note purchase facility, under which up to $125.0 million of notes could
be outstanding at any time, subject to collateral tests and other conditions. We
used funds derived from this facility to purchase automobile contracts under the
CPS programs and the TFC programs, which were pledged to secure the notes. The
collateral tests and other conditions generally allowed us to borrow up to
approximately 73% of the principal balance of the automobile contracts purchased
under the CPS programs. Notes issued under this facility bore interest at
commercial paper plus 1.18% per annum, plus a premium to a financial guarantor.
During November 2004, this facility was amended to allow us to borrow up to
approximately 70% of the principal balance of automobile contracts purchased
under the TFC programs. This facility was due to expire on April 11, 2006, but
we elected to terminate it on June 29, 2005.
FACILITY IN USE FROM MAY 2003 TO JUNE 2004. In connection with the TFC
merger in May 2003, we (through our subsidiary TFC Warehouse I LLC) entered into
a third floating rate variable note purchase facility, under which up to $25.0
million of notes could be outstanding at any time, subject to collateral tests
and other conditions. We used funds derived from this facility to purchase
automobile contracts under the TFC programs, which were pledged to secure the
notes. The collateral tests and other conditions generally allowed us to borrow
up to approximately 71% of the principal balance of the automobile contracts.
Notes issued under this facility bore interest at LIBOR plus 1.75% per annum,
plus a premium to a financial guarantor. This facility expired on June 24, 2004.
FACILITY IN USE FROM JUNE 2004 TO PRESENT. In June 2004, we (through
our subsidiary Page Funding LLC) entered into a floating rate variable note
purchase facility. Up to $200.0 million of notes may be outstanding under this
facility at any time subject to certain collateral tests and other conditions.
We use funds derived from this facility to purchase automobile contracts under
the CPS programs and TFC programs, which are pledged to secure the notes. The
collateral tests and other conditions generally allow us to borrow up to
approximately 93% of the principal balance of automobile contracts that we
purchase under our CPS programs, and of up to 70% of the principal balance of
automobile contracts that we purchase under our TFC programs. Notes issued under
this facility bear interest at one-month LIBOR plus 2.00% per annum. The balance
of notes outstanding related to this facility at December 31, 2006 was $27.8
million.
FACILITY IN USE FROM NOVEMBER 2005 TO PRESENT. In November 2005, we
(through our subsidiary Page Three Funding LLC) entered into a floating rate
variable note purchase facility. Up to $200 million of notes may be outstanding
under this facility at any time subject to certain collateral tests and other
conditions. We use funds derived from this facility to purchase automobile
contracts under the CPS programs, which are pledged to secure the notes. The
collateral tests and other conditions generally allow us to borrow up to
approximately 93.0% of the principal balance of the automobile contracts. Notes
issued under this facility bear interest at one-month LIBOR plus 2.00% per
annum. The balance of notes outstanding related to this facility at December 31,
2006 was $45.2 million.
38
CAPITAL RESOURCES
Approximately $25.0 million of long-term debt matures in May 2007. We
plan to repay our long-term debt from a combination of the following: (i)
additional proceeds from the offering of subordinated renewable notes; (ii) a
possible transaction similar to the financings that we undertook in March 2004
and November 2005, where we issued notes secured by our residual interests in
securitizations; and (iii) possible senior secured financing similar to our
existing outstanding senior secured financing. There can be no assurance that we
will be able to complete these transactions. Securitization trust debt is repaid
from collections on the related receivables, and becomes due in accordance with
its terms as the principal amount of the related receivables is reduced.
Although the securitization trust debt also has alternative maximum maturity
dates, those dates are significantly later than the dates at which repayment of
the related receivables is anticipated, and at no time in our history have any
of our sponsored asset-backed securities reached those alternative maximum
maturities.
The acquisition of automobile contracts for subsequent transfer in
securitization transactions, and the need to fund spread accounts and initial
overcollateralization, if any, 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
trusts and related spread accounts either release cash to us or capture cash
from collections on securitized automobile contracts. We plan to adjust our
levels of automobile contract purchases so as to match anticipated releases of
cash from the trusts and related spread accounts with our capital requirements.
CAPITALIZATION
Over the period from January 1, 2004 through December 31, 2006 we have
managed our capitalization by issuing and restructuring debt as summarized in
the following table:
39
YEAR ENDED DECEMBER 31,
-----------------------------------------
2006 2005 2004
----------- ----------- -----------
(Dollars in thousands)
RESIDUAL INTEREST FINANCING:
Beginning balance ................. $ 43,745 $ 22,204 $ --
Issuances .................... 13,667 45,800 44,000
Payments ..................... (26,034) (24,259) (21,796)
----------- ----------- -----------
Ending balance .................... $ 31,378 $ 43,745 $ 22,204
=========== =========== ===========
SECURITIZATION TRUST DEBT:
Beginning balance ................. $ 924,026 $ 542,815 $ 245,118
Issuances .................... 1,003,645 662,350 474,720
Payments ..................... (484,676) (281,139) (177,023)
----------- ----------- -----------
Ending balance .................... $ 1,442,995 $ 924,026 $ 542,815
=========== =========== ===========
SENIOR SECURED DEBT, RELATED PARTY:
Beginning balance ................. $ 40,000 $ 59,829 $ 49,965
Issuances .................... -- -- 25,000
Payments ..................... (15,000) (19,829) (15,136)
----------- ----------- -----------
Ending balance .................... $ 25,000 $ 40,000 $ 59,829
=========== =========== ===========
SUBORDINATED DEBT:
Beginning balance ................. $ 14,000 $ 15,000 $ 35,000
Payments ..................... (14,000) (1,000) (20,000)
----------- ----------- -----------
Ending balance .................... $ -- $ 14,000 $ 15,000
=========== =========== ===========
SUBORDINATED RENEWABLE NOTES:
Beginning balance ................. $ 4,655 $ -- $ --
Issuances .................... 9,985 4,685 --
Payments ..................... (1,068) (30) --
----------- ----------- -----------
Ending balance .................... $ 13,572 $ 4,655 $ --
=========== =========== ===========
RELATED PARTY DEBT:
Beginning balance ................. $ -- $ -- $ 17,500
Non-cash conversion .......... -- -- (1,000)
Payments ..................... -- -- (16,500)
----------- ----------- -----------
Ending balance .................... $ -- $ -- $ --
=========== =========== ===========
RESIDUAL INTEREST FINANCING. In March 2004, one of our wholly-owned
bankruptcy remote consolidated subsidiaries issued $44.0 million of asset-backed
notes secured by our retained interests in eight term securitization
transactions. We repaid the notes in full in August 2005. In November 2005, we
completed a similar securitization in which a wholly-owned bankruptcy remote
consolidated subsidiary of ours issued $45.8 million of asset-backed notes
secured by our retained interests in 10 term securitization transactions. These
notes have a final maturity in July 2011, and are required to be repaid from the
distributions on the underlying retained interests. In December 2006, we entered
into a $35 million residual credit facility that is secured by our retained
interests in more recent term securitizations. This facility, which bears
interest at LIBOR plus 6.125%, allows for new borrowings over a two-year period
and then amortizes over a five-year period.
SECURITIZATION TRUST DEBT. Since the third quarter of 2003, we have for
financial accounting purposes, treated securitizations of automobile contracts
as secured financings, and the asset-backed securities issued in such
securitizations remain on our balance sheet as securitization trust debt.
SENIOR SECURED DEBT. Since 1998, we have entered into a series of
financing transactions with Levine Leichtman.
SUBORDINATED DEBT. In April 1997, we issued $20.0 million in
subordinated participating equity notes due April 2004, which we retired in the
second quarter of 2004. In 1995, we issued $20.0 million of Rising Interest
Subordinated Redeemable Securities, or RISRS, due 2006. The RISRS included a
40
sinking fund in their terms, and we repaid in the first quarter of 2006 the
$14.0 million that remained outstanding. In May 2003, in connection with the
acquisition of TFC, we assumed $6.3 million in principal amount of subordinated
debt that TFC had outstanding. We amortized this debt monthly and repaid it in
full in June 2005.
SUBORDINATED RENEWABLE NOTES DEBT. In June 2005, we began issuing
registered subordinated renewable notes in an ongoing offering to the public.
Upon maturity, the notes are automatically renewed for the same term as the
maturing notes, unless we elect not to have the notes renewed or unless the
investor notifies us within 15 days after the maturity date for his notes that
he wants his notes repaid. Renewed notes bear interest at the rate we are
offering at that time to other investors with similar aggregate note portfolios.
Based on the terms of the individual notes, interest payments may be required
monthly, quarterly, annually or upon maturity.
RELATED PARTY DEBT. In June 1997 we borrowed $15.0 million from
Stanwich Financial Services Corp., or Stanwich, which was an affiliated
corporation at that time. This debt was due in 2004 and we repaid it in the
second quarter of 2004. During 1999 we borrowed another $1.5 million from
Stanwich, which we also repaid in the second quarter of 2004. During 1998 we
borrowed $1.0 million from one of our directors. In the second quarter of 2004,
our indebtedness to that director was converted, in accordance with its terms,
into common stock at the rate of $3.00 per share.
We must comply with certain affirmative and negative covenants related
to debt facilities, which require, among other things, that we maintain certain
financial ratios related to liquidity, net worth, capitalization, investments,
acquisitions, restricted payments and certain dividend restrictions. As a result
of waivers and amendments to covenants related to securitization and
non-securitization related debt throughout 2004 and 2005, we were in compliance
with all such covenants as of December 31, 2006. In addition, certain
securitization and non-securitization related debt contain cross-default
provisions that would allow certain creditors to declare default if a default
occurred under a different facility.
FORWARD-LOOKING STATEMENTS
This report on Form 10-K includes certain "forward-looking statements,"
including, without limitation, the statements or implications to the effect that
prepayments as a percentage of original balances will approximate 22.7% to 32.5%
cumulatively over the lives of the related Contracts, that charge-offs as a
percentage of original balances will approximate 15.5% to 19.4% cumulatively
over the lives of the related Contracts, with recovery rates approximating 3.6%
to 4.2% of original principal balances. Other forward-looking statements may be
identified by the use of words such as "anticipates," "expects," "plans,"
"estimates," or words of like meaning. As to the specifically identified
forward-looking statements, factors that could affect charge-offs and recovery
rates include changes in the general economic climate, which could affect the
willingness or ability of obligors to pay pursuant to the terms of Contracts,
changes in laws respecting consumer finance, which could affect the ability of
the Company to enforce rights under Contracts, and changes in the market for
used vehicles, which could affect the levels of recoveries upon sale of
repossessed vehicles. Factors that could affect the Company's revenues in the
current year include the levels of cash releases from existing pools of
Contracts, which would affect the Company's ability to purchase Contracts, the
terms on which the Company is able to finance such purchases, the willingness of
Dealers to sell Contracts to the Company on the terms that it offers, and the
terms on which the Company is able to complete term securitizations once
Contracts are acquired. Factors that could affect the Company's expenses in the
current year include competitive conditions in the market for qualified
personnel, and interest rates (which affect the rates that the Company pays on
Notes issued in its securitizations). The statements concerning the Company
structuring future securitization transactions as secured financings and the
effects of such structures on financial items and on the Company's future
profitability also are forward-looking statements. Any change to the structure
of the Company's securitization transaction could cause such forward-looking
statements not to be accurate. Both the amount of the effect of the change in
structure on the Company's profitability and the duration of the period in which
the Company's profitability would be affected by the change in securitization
structure are estimates. The accuracy of such estimates will be affected by the
rate at which the Company purchases and sells Contracts, any changes in that
rate, the credit performance of such Contracts, the financial terms of future
securitizations, any changes in such terms over time, and other factors that
generally affect the Company's profitability.
NEW ACCOUNTING PRONOUNCEMENTS
In February 2006, the FASB issued FASB Statement No. 155, "Accounting
for Certain Hybrid Instruments". This statement amends the guidance in FASB
Statements No. 133, "Accounting for Derivative Instruments and Hedging
Activities", and No. 140, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities". Statement 155 allows financial
instruments that have embedded derivatives to be accounted for as a whole
(eliminating the need to bifurcate the derivative from its host) if the holder
41
elects to account for the whole instrument on a fair value basis. The Statement
also amends Statement 140 to eliminate the prohibition on a qualifying
special-purpose entity from holding a derivative financial instrument that
pertains to a beneficial interest other than another derivative financial
instrument. Statement 155 is effective for all financial instruments acquired or
issued after January 1, 2007. The Company does not believe the adoption of this
statement will have a material effect on the Company's financial position or
operations.
In March 2006, the FASB issued FASB Statement No. 156, "Accounting for
the Servicing of Financial Assets an Amendment to FASB Statement No. 140" (FAS
156). With respect to the accounting for separately recognized servicing assets
and servicing liabilities, this statement: (1) requires an entity to recognize a
servicing asset or servicing liability each time it undertakes an obligation to
service a financial asset by entering into a specific types of servicing
contracts identified in the statement, (2) requires that all separately
recognized servicing assets and servicing liabilities be initially measured at
fair value, if practicable, (3) permits an entity to choose subsequent
measurement methods for each class of separately recognized servicing assets and
servicing liabilities, (4) permits a one-time reclassification of
available-for-sale securities to trading securities by entities with recognized
servicing rights at the initial adoption of this statement, and (5) requires a
separate presentation of servicing assets and servicing liabilities subsequently
measured at fair value in the statement of financial position and additional
disclosures for all separately recognized servicing assets and servicing
liabilities. FAS 156 will be effective for the Company on January 1, 2007. The
Company is currently in the process of evaluating the effects of this Standard,
but does not believe it will have a significant effect on its financial position
or results of operations.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements" ("SFAS No. 157"). SFAS No. 157 clarifies the principle that fair
value should be based on the assumptions market participants would use when
pricing an asset or liability and establishes a fair value hierarchy that
prioritizes the information used to develop those assumptions. Under the
standard, fair value measurements would be separately disclosed by level within
the fair value hierarchy. SFAS 157 is effective for the Company on January 1,
2008. The Company is in the process of evaluating SFAS No. 157 but does not
believe it will have a significant effect on its financial position or results
of operations.
In February 2007, the FASB issued SFAS 159, THE FAIR VALUE OPTION FOR
FINANCIAL ASSETS AND FINANCIAL LIABILITIES-INCLUDING AN AMENDMENT OF FASB
STATEMENT NO. 115. SFAS 159 permits an entity to choose to measure many
financial instruments and certain other items at fair value. Most of the
provisions of SFAS 159 are elective, however, the amendment to SFAS 115,
ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES, applies to all
entities with available for sale or trading securities. SFAS 159 is elective as
of the beginning of an entity's first fiscal year that begins after November 15,
2007. SFAS 159 was recently issued and we are currently assessing the financial
impact the Statement will have on our financial statements.
In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting
for Uncertainty in Income Taxes" ("FIN 48"). FIN 48 clarifies when tax benefits
should be recorded in financial statements, requires certain disclosures of
uncertain tax matters and indicates how any tax reserves should be classified in
a balance sheet. FIN 48 is effective for the Company in the first quarter of
2007. The Company is currently analyzing the effects of the adoption of FIN 48
but currently does not anticipate that the adoption will have a significant
impact on its financial condition or results of operations.
OFF-BALANCE SHEET ARRANGEMENTS Prior to July 2003, the Company
structured its securitization transactions to meet the accounting criteria for
sales of finance receivables. In this structure the notes issued by the
Company's special purpose subsidiary do not appear as debt on the Company's
consolidated balance sheet. See Critical Accounting Policies for a detailed
discussion of the Company's securitization structure.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
The Company is subject to interest rate risk during the period between
when Contracts are purchased from Dealers and when such Contracts become part of
a term securitization. Specifically, the interest rates on the warehouse
facilities are adjustable while the interest rates on the Contracts are fixed.
Historically, the Company's term securitization facilities have had fixed rates
of interest. To mitigate some of this risk, the Company has in the past, and
intends to continue to, structure certain of its securitization transactions to
42
include pre-funding structures, whereby the amount of Notes issued exceeds the
amount of Contracts initially sold to the Trusts. In pre-funding, the proceeds
from the pre-funded portion are held in an escrow account until the Company
sells the additional Contracts to the Trust in amounts up to the balance of the
pre-funded escrow account. In pre-funded securitizations, the Company locks in
the borrowing costs with respect to the Contracts it subsequently delivers to
the Trust. However, the Company incurs an expense in pre-funded securitizations
equal to the difference between the money market yields earned on the proceeds
held in escrow prior to subsequent delivery of Contracts and the interest rate
paid on the Notes outstanding, the amount as to which there can be no assurance.
The following table provides information on the Company's interest
rate-sensitive financial instruments by expected maturity date as of December
31, 2006:
2007 2008 2009 2010 2011 THEREAFTER FAIR VALUE
----------- ---------- ---------- ----------- ----------- ---------- ----------
(In thousands)
Assets:
Finance receivables(1) ............ $ 482,482 $ 373,299 $ 283,485 $ 210,631 $ 142,636 $ 34,752 $1,527,285
Weighted average fixed
effective interest rate ....... 18.45% 18.46% 18.42% 18.40% 18.40% 18.53%
LIABILITIES:
Warehouse lines
of credit ...................... 72,950 -- -- -- -- -- 72,950
Weighted average variable ......
effective interest rate ....... 7.35% -- -- -- -- -- --
Residual interest
financing ...................... 10,947 7,649 12,782 -- -- -- 31,378
Weighted average fixed
effective interest rate ....... 8.70% -- -- -- -- -- --
Securitization trust debt ......... 472,287 342,185 261,307 191,413 128,308 47,498 1,441,881
Weighted average fixed
effective interest rate ....... 5.18% 5.29% 5.43% 5.60% 5.75% 5.91%
Senior secured debt ............... 25,000 -- -- -- -- -- 25,000
Fixed interest rate ........... 11.75% -- -- -- -- -- --
Subordinated renewable notes ...... 5,843 2,937 3,371 467 851 105 13,574
Weighted average fixed
effective interest rate ....... 8.38% 9.86% 11.06% 10.23% 11.17% 9.71%
(1) BASED ON SCHEDULED PAYMENTS OF FINANCE RECEIVABLES AND EXCLUDING SUCH
COMPONENTS AS DEFERRED ORIGINATIONS COSTS AND DEFERRED ACQUISITION FEES.
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 the Company's financial
instruments, active markets do not exist. Therefore, considerable judgments 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 the dates shown in the table,
the amounts that will actually be realized or paid at settlement or maturity of
the instruments could be significantly different.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
This report includes Consolidated Financial Statements, notes thereto
and an Independent Auditors' Report, at the pages indicated below, in the "Index
to Financial Statements." Certain unaudited quarterly financial information is
included in the Notes to Consolidated Financial Statements, as Note 17.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
43
ITEM 9A. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES. Under the supervision and with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, management of the Company has evaluated the effectiveness of the design
and operation of the Company's disclosure controls and procedures, as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the
"Exchange Act") as of December 31, 2006 (the "Evaluation Date"). Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that, as of the Evaluation Date, the Company's disclosure controls and
procedures are effective (i) to ensure that information required to be disclosed
by us in reports that the Company files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the rules and forms of the Securities and Exchange Commission; and (ii) to
ensure that information required to be disclosed in the reports that the Company
files or submits under the Exchange Act is accumulated and communicated to our
management, including the Company's Chief Executive Officer and Chief Financial
Officer, to allow timely decisions regarding required disclosures.
The certifications of the Company's Chief Executive Officer and Chief
Financial Officer required under Section 302 of the Sarbanes-Oxley Act have been
filed as Exhibits 31.1 and 31.2 to this report.
INTERNAL CONTROL. Management's Report on Internal Control over
Financial Reporting is included in this Annual Report, immediately below. During
the fiscal quarter ended December 31, 2006, there were no changes in the
Company's internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING.
Management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting as defined in Rule 13a-15(f)
under the Securities Exchange Act of 1934. The Company's internal control over
financial reporting is designed to provide reasonable assurance to the Company's
management and Board of Directors regarding the preparation and fair
presentation of published financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Therefore, even those systems
determined to be effective can only provide reasonable assurance with respect to
financial statement preparation and presentation.
Management, with the participation of the Chief Executive and Chief
Financial Officers, assessed the effectiveness of the Company's internal control
over financial reporting as of December 31, 2006. In making this assessment,
management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control --
Integrated Framework. Based on this assessment, management, with the
participation of the Chief Executive and Chief Financial Officers, believes
that, as of December 31, 2006, the Company's internal control over financial
reporting is effective based on those criteria.
Management's assessment of the effectiveness of internal control over
financial reporting as of December 31, 2006, has been audited by McGladrey &
Pullen, LLP, the independent registered public accounting firm that also audited
the Company's consolidated financial statements. McGladrey & Pullen's
attestation report on management's assessment of the Company's internal control
over financial reporting appears below.
44
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Consumer Portfolio Services, Inc.
Irvine, California
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that Consumer
Portfolio Services, Inc. maintained effective internal control over financial
reporting as of December 31, 2006, based on criteria established in INTERNAL
CONTROL--INTEGRATED FRAMEWORK issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Consumer Portfolio Services'
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that Consumer Portfolio
Services, Inc. maintained effective internal control over financial reporting as
of December 31, 2006, is fairly stated, in all material respects, based on
criteria established in INTERNAL CONTROL--INTEGRATED FRAMEWORK issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in
our opinion, Consumer Portfolio Services, Inc. maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2006, based on criteria established in INTERNAL CONTROL--INTEGRATED FRAMEWORK
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the 10-K of Consumer
Portfolio Services, Inc. and our report dated March 8, 2007 expressed an
unqualified opinion.
/s/ McGladrey & Pullen, LLP
McGladrey & Pullen, LLP
Irvine, California
March 8, 2007
45
ITEM 9B. OTHER INFORMATION
Not Applicable
46
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors of the registrant is incorporated by
reference to the registrant's definitive proxy statement for its annual meeting
of shareholders to be held in 2007 (the "2007 Proxy Statement"). The 2007 Proxy
Statement will be filed not later than April 30, 2006. Information regarding
executive officers of the registrant appears in Part I of this report, and is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference to the 2007 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Incorporated by reference to the 2007 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference to the 2007 Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Incorporated by reference to the 2007 Proxy Statement.
47
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
The financial statements listed below under the caption "Index to
Financial Statements" are filed as a part of this report. No financial statement
schedules are filed as the required information is inapplicable or the
information is presented in the Consolidated Financial Statements or the related
notes. Separate financial statements of the Company have been omitted as the
Company is primarily an operating company and its subsidiaries are wholly owned
and do not have minority equity interests held by any person other than the
Company in amounts that together exceed 5% of the total consolidated assets as
shown by the most recent year-end Consolidated Balance Sheet.
The exhibits listed below are filed as part of this report, whether
filed herewith or incorporated by reference to an exhibit filed with the report
identified in the parentheses following the description of such exhibit. Unless
otherwise indicated, each such identified report was filed by or with respect to
the registrant.
Exhibit Description ("**" indicates compensatory plan or agreement.)
Number
2.1 Agreement and Plan of Merger, dated as of November 18, 2001, by and
among the Registrant, CPS Mergersub, Inc. and MFN Financial
Corporation. (Exhibit 2.1 to Form 8-K filed on November 19, 2001 by MFN
Financial Corporation)
3.1 Restated Articles of Incorporation (Exhibit 3.1 to Form S-2, No.
333-121913)
3.2 Amended and Restated Bylaws (Exhibit 3.2 to Form 8-K filed August 8,
2006)
4.1 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.
4.2 Form of Indenture re Renewable Unsecured Subordinated Notes ("RUS
Notes"), (Exhibit 4.1 to Form S-2, no. 333-121913)
4.2.1 Form of RUS Notes (Exhibit 4.2 to Form S-2, no. 333-121913)
4.5 Third Amended and Restated Securities Purchase Agreement ("3rd SPA")
dated as of January 29, 2004, between the registrant and Levine
Leichtman Capital Partners II, L.P. ("LLCP") (Exhibit 99.16 to the
Schedule 13D filed by LLCP with respect to the registrant on February
3, 2004)
4.5.1 Amendment to the 3rd SPA, dated as of March 25, 2004. (Exhibit 99.22 to
the Schedule 13D filed by LLCP with respect to the registrant on June
4, 2004)
4.5.2 Amendment to the 3rd SPA, dated as of April 2, 2004. (Exhibit 99.23 to
the Schedule 13D filed by LLCP with respect to the registrant on June
4, 2004)
4.5.3 Amendment to the 3rd SPA, dated as of May 28, 2004. (Exhibit 99.25 to
the Schedule 13D filed by LLCP with respect to the registrant on June
4, 2004)
4.5.4 Amendment to the 3rd SPA, dated as of June 25, 2004. (Exhibit 99.29 to
the Schedule 13D filed by LLCP with respect to the registrant on June
29, 2004)
4.5.5 Amendment to the 3rd SPA, dated as of May 26, 2006. (Exhibit 4.5.5 to
the to Form 10-Q filed August 11, 2006)
4.6 Amended and Restated Secured Senior Note due December 15, 2005 (Exhibit
99.18 to the Schedule 13D filed by LLCP with respect to the registrant
on February 3, 2004)
4.6.1 Amendment to Amended and Restated Secured Senior Note due December 15,
2005 (Exhibit 4.6.1 to Form 10-Q filed August 11, 2006)
4.7 11.75% Secured Senior Note Due 2006 (Exhibit 99.26 to the Schedule 13D
filed by LLCP with respect to the registrant on June 4, 2004)
4.7.1 Amendment dated May 26, 2006 to the preceding 11.75% Secured Senior
Note Due 2006, extending the maturity thereof. (Exhibit 4.7.1 to the to
Form 10-Q filed August 11, 2006)
48
Exhibit Description ("**" indicates compensatory plan or agreement.)
Number
4.8 11.75% Secured Senior Note Due 2006 (Exhibit 99.30 to the Schedule 13D
filed by LLCP with respect to the registrant on June 29, 2004)
4.8.1 Amendment dated May 26, 2006 to the preceding 11.75% Secured Senior
Note Due 2006, extending the maturity thereof. (Exhibit 4.8.1 to the to
Form 10-Q filed August 11, 2006)
4.16 Form of Indenture, dated as of September 1, 2006, respecting notes
issued by CPS Auto Receivables Trust 2006-C (exhibit 4 to Form 8-K
filed by the registrant on September 29, 2006)
4.17 Indenture dated as of December 1, 2006, respecting notes issued by CPS
Auto Receivables Trust 2006-D (exhibit 4.17 to Form 8-K filed by the
registrant on September 29, 2006)
4.18 Sale and Servicing Agreement dated as of December 1, 2006, related to
notes issued by CPS Auto Receivables Trust 2006-D (exhibit 4.18 to Form
8-K filed by the registrant on September 29, 2006.)
10.1 1991 Stock Option Plan & forms of Option Agreements thereunder (Exhibit
10.19 to Form S-2, no. 333-121913) **
10.2 1997 Long-Term Incentive Stock Plan ("1997 Plan") (Exhibit 10.20 to
Form S-2, no. 333-121913) **
10.2.1 Form of Option Agreement under 1997 Plan (Exhibit 10.2.1 to Form 10-K
filed March 13, 2006) **
10.3 Lease Agreement re Chesapeake Collection Facility (Exhibit 10.11 to
registrant's Form 10-K filed March 31, 1997)
10.4 Lease of Headquarters Building (Exhibit 10.22 to registrant's Form 10-Q
filed Nov. 14, 1997)
10.5 Third Amended & Restated Sale and Servicing Agreement dated February
14, 2007 by and among Page Funding LLC ("PFLLC"), the registrant and
Wells Fargo Bank, N.A. ("WFBNA") (filed herewith)
10.6 Second Amended & Restated Indenture dated as of February 14, 2007 by
and between PFLLC and WFBNA (filed herewith)
10.8 Second Amended & Restated Note Purchase Agreement dated as of February
14, 2007 by and among PFLLC, UBS Real Estate Securities Inc. and WFBNA
(filed herewith)
10.10 Amended & Restated Sale and Servicing Agreement dated as of January 12,
2007, among Page Three Funding LLC ("P3FLLC"), the registrant and WFBNA
(filed herewith)
10.11 Amended & Restated Indenture dated as of January 12, 2007 between
P3FLLC and WFBNA (filed herewith)
10.12 Amended & Restated Note Purchase Agreement dated as of January 12, 2007
among P3FLLC, the registrant and Bear, Stearns International Limited
(filed herewith)
10.14 2006 Long-Term Equity Incentive Plan (Appendix A to the registrant's
proxy statement for its 2006 annual meeting of shareholder's, filed on
Schedule 14A on May 19, 2006)**
10.14.1 Form of Option Agreement under the 2006 Long-Term Equity Incentive Plan
(filed herewith)**
14 Registrant's Code of Ethics for Senior Financial Officers (Exhibit 14
to Form 10-K filed March 13, 2006)
21 List of subsidiaries of the registrant (filed herewith)
23.1 Consent of McGladrey & Pullen, LLP (filed herewith)
31.1 Rule 13a-14(a) certification by chief executive officer (filed
herewith)
31.2 Rule 13a-14(a) certification by chief financial officer (filed
herewith)
32 Section 1350 certification (filed herewith)
49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
CONSUMER PORTFOLIO SERVICES, INC. (REGISTRANT)
March 9, 2007 By: /s/ CHARLES E. BRADLEY, JR.
--------------------------------------
Charles E. Bradley, Jr., PRESIDENT
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
March 9, 2007 /s/ CHARLES E. BRADLEY, JR.
--------------------------------------
Charles E. Bradley, Jr., DIRECTOR,
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
March 9, 2007 /s/ E. BRUCE FREDRIKSON
--------------------------------------
E. Bruce Fredrikson, DIRECTOR
March 9, 2007 /s/ JOHN E. MCCONNAUGHY, JR.
--------------------------------------
John E. McConnaughy, Jr., DIRECTOR
March 9, 2007 /s/ JOHN G. POOLE
--------------------------------------
John G. Poole, DIRECTOR
March 9, 2007 /s/ BRIAN J. RAYHILL
--------------------------------------
Brian J. Rayhill, DIRECTOR
March 9, 2007 /s/ WILLIAM B. ROBERTS
--------------------------------------
William B. Roberts, DIRECTOR
March 9, 2007 /s/ JOHN C. WARNER
--------------------------------------
John C. Warner, DIRECTOR
March 9, 2007 /s/ DANIEL S. WOOD
--------------------------------------
Daniel S. Wood, DIRECTOR
March 9, 2007 /s/ JEFFREY P. FRITZ
--------------------------------------
Jeffrey P. Fritz, SR. VICE PRESIDENT
AND CHIEF FINANCIAL OFFICER
(PRINCIPAL ACCOUNTING OFFICER)
50
INDEX TO FINANCIAL STATEMENTS
PAGE
REFERENCE
---------
Report of Independent Registered Public Accounting Firm .............. F-2
Consolidated Balance Sheets as of December 31, 2006 and 2005.......... F-3
Consolidated Statements of Operations for the years ended
December 31, 2006, 2005, and 2004................................. F-4
Consolidated Statements of Comprehensive Income (Loss) for
the years ended December 31, 2006, 2005, and 2004................. F-5
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 2006, 2005, and 2004........................... F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 2006, 2005, and 2004................................. F-7
Notes to Consolidated Financial Statements ........................... F-9
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Consumer Portfolio Services, Inc.
Irvine, California
We have audited the consolidated balance sheets of Consumer Portfolio
Services, Inc. and subsidiaries as of December 31, 2006 and 2005, and the
related consolidated statements of operations, comprehensive income (loss),
retained earnings and cash flows for each of the three years in the period ended
December 31, 2006. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Consumer
Portfolio Services, Inc. and subsidiaries as of December 31, 2006 and 2005, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2006, in conformity with U.S. generally
accepted accounting principles.
As described in Note 9 to the consolidated financial statements, the Company
adopted Financial Accounting Standards Board Statement No. 123(R), "SHARE-BASED
PAYMENT" in 2006.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Consumer
Portfolio Services, Inc. and subsidiaries' internal control over financial
reporting as of December 31, 2006, based on criteria established in INTERNAL
CONTROL--INTEGRATED FRAMEWORK ISSUED BY THE COMMITTEE OF SPONSORING
ORGANIZATIONS OF THE TREADWAY COMMISSION (COSO) and our report dated March 8,
2007 expressed an unqualified opinion on management's assessment of the
effectiveness of Consumer Portfolio Services, Inc.'s internal control over
financial reporting and an unqualified opinion on the effectiveness of Consumer
Portfolio Services Inc.'s internal control over financial reporting.
/s/ McGladrey & Pullen, LLP
McGladrey & Pullen, LLP
Irvine, California
March 8, 2007
F-2
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
DECEMBER 31, DECEMBER 31,
2006 2005
------------- -------------
ASSETS
Cash and cash equivalents $ 14,215 $ 17,789
Restricted cash and equivalents 193,001 157,662
Finance receivables 1,480,794 971,304
Less: Allowance for finance credit losses (79,380) (57,728)
------------- -------------
Finance receivables, net 1,401,414 913,576
Residual interest in securitizations 13,795 25,220
Furniture and equipment, net 824 1,079
Deferred financing costs 12,702 8,596
Deferred tax assets, net 54,669 7,532
Accrued interest receivable 17,043 10,930
Other assets 20,678 12,760
------------- -------------
$ 1,728,341 $ 1,155,144
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Accounts payable and accrued expenses $ 20,590 $ 19,568
Warehouse lines of credit 72,950 35,350
Income taxes payable 10,297 --
Notes payable 45 211
Residual interest financing 31,378 43,745
Securitization trust debt 1,442,995 924,026
Senior secured debt, related party 25,000 40,000
Subordinated renewable notes 13,574 4,655
Subordinated debt -- 14,000
------------- -------------
1,616,829 1,081,555
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value;
authorized 5,000,000 shares; none issued -- --
Series A preferred stock, $1 par value;
authorized 5,000,000 shares; none issued -- --
Common stock, no par value; authorized
30,000,000 shares; 21,504,688 and 21,687,584
shares issued and outstanding at December 31, 2006 and
December 31, 2005, respectively 64,438 66,748
Additional paid in capital, warrants 794 794
Retained earnings 48,031 8,476
Accumulated other comprehensive loss (1,751) (2,429)
------------- -------------
111,512 73,589
------------- -------------
$ 1,728,341 $ 1,155,144
============= =============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-3
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
--------------------------------------------------
2006 2005 2004
------------- ------------- -------------
REVENUES:
Interest income $ 263,566 $ 171,834 $ 105,818
Servicing fees 2,894 6,647 12,480
Other income 12,403 15,216 14,394
------------- ------------- -------------
278,863 193,697 132,692
------------- ------------- -------------
EXPENSES:
Employee costs 38,483 40,384 38,173
General and administrative 23,197 23,095 21,293
Interest 87,510 44,148 25,876
Interest, related party 5,602 7,521 6,271
Provision for credit losses 92,057 58,987 32,574
Impairment loss on residual asset -- -- 11,750
Marketing 14,031 12,000 8,338
Occupancy 3,983 3,400 3,520
Depreciation and amortization 800 790 785
------------- ------------- -------------
265,663 190,325 148,580
------------- ------------- -------------
Income (loss) before income tax benefit 13,200 3,372 (15,888)
Income tax (benefit) (26,355) -- --
------------- ------------- -------------
Net income (loss) $ 39,555 $ 3,372 $ (15,888)
============= ============= =============
Earnings (loss) per share:
Basic $ 1.82 $ 0.16 $ (0.75)
Diluted 1.64 0.14 (0.75)
Number of shares used in computing earnings (loss) per share:
Basic 21,759 21,627 21,111
Diluted 24,052 23,513 21,111
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-4
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
---------------------------------------------
2006 2005 2004
----------- ----------- -----------
Net income (loss) $ 39,555 $ 3,372 $ (15,888)
Other comprehensive income (loss):
Minimum pension liability, net of tax 678 (1,412) 1,409
----------- ----------- -----------
Comprehensive income (loss) $ 40,233 $ 1,960 $ (14,479)
=========== =========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-5
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
Additional Accumulated
Paid-in Other
Common Stock Capital, Retained Comprehensive Deferred
Shares Amount Warrants Earnings Loss Compensation Total
--------- --------- --------- --------- --------- --------- ---------
Balance at December 31,2003 20,589 $ 64,397 $ -- $ 20,992 $ (2,426) $ (803) $ 82,160
Common stock issued upon exercise
of options, including tax benefit 575 1,079 -- -- -- -- 1,079
Common stock issued upon
conversion of debt 333 1,000 -- -- -- -- 1,000
Purchase of common stock (26) (111) -- -- -- -- (111)
Pension benefit obligation -- -- -- -- 1,409 -- 1,409
Deferred compensation on
stock options -- (82) -- -- -- 82 --
Amortization of stock compensation -- -- -- -- -- 271 271
Net loss -- -- -- (15,888) -- -- (15,888)
--------- --------- --------- --------- --------- --------- ---------
Balance at December 31, 2004 21,471 66,283 -- 5,104 (1,017) (450) 69,920
Common stock issued upon exercise
of options, including tax benefit 415 1,311 -- -- -- -- 1,311
Purchase of common stock (199) (1,040) -- -- -- -- (1,040)
Pension benefit obligation -- -- -- -- (1,412) -- (1,412)
Valuation of warrants issued -- -- 794 -- -- -- 794
Deferred compensation on
stock options -- 194 -- -- -- (194) --
Amortization of stock compensation -- -- -- -- -- 644 644
Net income -- -- -- 3,372 -- -- 3,372
--------- --------- --------- --------- --------- --------- ---------
Balance at December 31, 2005 21,687 66,748 794 8,476 (2,429) -- 73,589
Common stock issued upon exercise
of options, including tax benefit 553 2,254 -- -- -- -- 2,254
Purchase of common stock (735) (4,808) -- -- -- -- (4,808)
Pension benefit obligation -- -- -- -- 678 -- 678
Stock-based compensation -- 244 -- -- -- -- 244
Net income -- -- -- 39,555 -- -- 39,555
--------- --------- --------- --------- --------- --------- ---------
Balance at December 31, 2006 21,505 $ 64,438 $ 794 $ 48,031 $ (1,751) $ -- $ 111,512
========= ========= ========= ========= ========= ========= =========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-6
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
---------------------------------------------
2006 2005 2004
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 39,555 $ 3,372 $ (15,888)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Reversal of restructuring accrual -- -- (1,287)
Impairment loss (gain) on residual asset (1,200) -- 11,750
Amortization of deferred acquisition fees (11,912) (10,851) (6,725)
Amortization of discount on Class B Notes 3,005 1,486 588
Depreciation and amortization 800 790 785
Amortization of deferred financing costs 6,580 3,296 3,479
Provision for credit losses 92,057 58,987 32,574
Share based compensation 244 644 271
Releases of cash from Trusts to Company 16,530 23,074 21,357
Net deposits to Trusts to increase Credit Enhancement -- -- (2,858)
Interest income on residual assets (5,656) (5,338) (4,633)
Cash received from residual interest in securitizations 18,282 30,548 54,154
Impairment charge against non-auto finanace receivable assets -- 1,882 --
Changes in assets and liabilities:
Payments on restructuring accrual (633) (1,425) (1,969)
Restricted cash and equivalents (51,868) (55,623) (76,336)
Accrued interest receivable (6,113) (4,519) (3,510)
Other assets (8,051) (1,059) (1,905)
Deferred tax assets, net (47,138) (7,532) --
Accounts payable and accrued expenses 12,629 (1,050) 109
----------- ----------- -----------
Net cash provided by operating activities 57,111 36,682 9,956
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of finance receivables held for investment (1,019,018) (691,252) (505,977)
Purchases of note receivable -- -- (2,799)
Proceeds received on finance receivables held for investment 451,037 279,730 196,126
Purchase of furniture and equipment (412) (166) (1,408)
----------- ----------- -----------
Net cash used in investing activities (568,393) (411,688) (314,058)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of securitization trust debt 1,003,645 662,350 474,720
Proceeds from issuance of senior secured debt, related party -- -- 25,000
Proceeds from issuance of other debt 23,652 50,485 44,000
Net proceeds from warehouse lines of credit 37,599 1,071 570
Repayment of securitization trust debt (487,681) (282,625) (177,611)
Repayment of senior secured debt, related party (15,000) (19,829) (15,137)
Repayment of related party debt -- -- (16,500)
Repayment of other debt (41,266) (26,498) (43,705)
Payment of financing costs (10,687) (6,796) (7,046)
Repurchase of common stock (4,808) (1,040) (111)
Exercise of options and warrants 1,555 1,311 1,079
Excess tax benefit related to option exercises 699 -- --
----------- ----------- -----------
Net cash provided by financing activities 507,708 378,429 285,259
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents (3,574) 3,423 (18,843)
Cash and cash equivalents at beginning of period 17,789 14,366 33,209
----------- ----------- -----------
Cash and cash equivalents at end of period $ 14,215 $ 17,789 $ 14,366
=========== =========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-7
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2006 2005 2004
------------ ------------ ------------
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 81,628 $ 45,929 $ 28,228
Income taxes 10,219 9,377 420
Supplemental disclosure of non-cash investing and financing activities:
Conversion of related party debt to common stock -- -- (1,000)
Pension benefit obligation, net (678) 1,412 (1,409)
Value of warrants issued -- 794 --
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-8
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Consumer Portfolio Services, Inc. ("CPS") was incorporated in
California on March 8, 1991. CPS and its subsidiaries (collectively, the
"Company") specialize in purchasing, selling and servicing retail automobile
installment sale contracts ("Contracts") originated by licensed motor vehicle
dealers ("Dealers") located throughout the United States. Dealers located in
Texas, California, Florida and Ohio represented 10.9%, 9.2%, 7.9% and 7.4%,
respectively of Contracts purchased during 2006 compared with 10.7%, 9.0%, 7.1%
and 7.5%, respectively in 2005. No other state had a concentration in excess of
7.0%. The Company specializes in Contracts with obligors who generally would not
be expected to qualify for traditional financing, such as that provided by
commercial banks or automobile manufacturers' captive finance companies.
The Company is subject to various regulations and laws as they relate
to the extension of credit in consumer credit transactions. Although the Company
believes it is currently in material compliance with these regulation and laws,
there can be no assurance that the Company will be able to maintain such
compliance. Failure to comply with such laws and regulations could have a
material adverse effect on the Company.
ACQUISITIONS
On March 8, 2002, the Company acquired MFN Financial Corporation and
its subsidiaries in a merger (the "MFN Merger"). On May 20, 2003, the Company
acquired TFC Enterprises, Inc. and its subsidiaries in a second merger (the "TFC
Merger"). Each merger was accounted for as a purchase. MFN Financial Corporation
and its subsidiaries ("MFN") and TFC Enterprises, Inc. and its subsidiaries
("TFC") were engaged in businesses similar to that of the Company: buying
Contracts from Dealers, financing those Contracts through securitization
transactions, and servicing those Contracts. MFN ceased acquiring Contracts in
March 2002; TFC continues to acquire Contracts under its "TFC Programs."
On April 2, 2004, the Company purchased a portfolio of Contracts and
certain other assets (the "SeaWest Asset Acquisition") from SeaWest Financial
Corporation ("SeaWest"). In addition, the Company was named the successor
servicer for three term securitization transactions originally sponsored by
SeaWest (the "SeaWest Third Party Portfolio"). The Company does not offer
financing programs similar to those previously offered by SeaWest.
PRINCIPLES OF CONSOLIDATION
The Consolidated Financial Statements include the accounts of Consumer
Portfolio Services, Inc. and its wholly-owned subsidiaries, certain of which are
Special Purpose Subsidiaries ("SPS"), formed to accommodate the structures under
which the Company purchases and securitizes its Contracts. The Consolidated
Financial Statements also include the accounts of CPS Leasing, Inc., an 80%
owned subsidiary. All significant intercompany balances and transactions have
been eliminated in consolidation.
CASH AND CASH EQUIVALENTS
For purposes of the statements of cash flows, the Company considers all
highly liquid debt instruments with original maturities of three months or less
to be cash equivalents. Cash equivalents consist of cash on hand and due from
banks and money market accounts. The Company's cash is primarily deposited at
three financial institutions. The Company maintains cash due from banks in
excess of the bank's insured deposit limits. The Company does not believe it is
exposed to any significant credit risk on these deposits. As part of certain
financial covenants related to debt facilities, the Company is required to
maintain a minimum unrestricted cash balance.
FINANCE RECEIVABLES, NET OF UNEARNED INCOME
Finance receivables are presented at cost. All Finance receivable
Contracts are held for investment and include automobile installment sales
contracts on which interest is pre-computed and added to the amount financed.
The interest on such Contracts is included in unearned finance charges. Unearned
finance charges are amortized using the interest method over the contractual
term of the receivables. Generally, payments received on finance receivables are
restricted to certain securitized pools, and the related Contracts cannot be
resold. Finance receivables are charged off pursuant to the controlling
documents of certain securitized pools, generally before they become
contractually delinquent five payments. Contracts that are deemed uncollectible
prior to the maximum delinquency period are charged off immediately. Management
may authorize an extension of payment terms if collection appears likely during
the next calendar month.
F-9
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company's portfolio of finance receivables consists of
smaller-balance homogeneous Contracts that are collectively evaluated for
impairment on a portfolio basis. The Company reports delinquency on a
contractual basis. Once a Contract becomes greater than 90 days delinquent, the
Company does not recognize additional interest income until the borrower under
the Contract makes sufficient payments to be less than 90 days delinquent. Any
payments received by a borrower that is greater than 90 days delinquent is first
applied to accrued interest and then to principal reduction.
ALLOWANCE FOR FINANCE CREDIT LOSSES
In order to estimate an appropriate allowance for losses to be incurred
on finance receivables, the Company uses a loss allowance methodology commonly
referred to as "static pooling," which stratifies its finance receivable
portfolio into separately identified pools based on their period of origination.
Using analytical and formula driven techniques, the Company estimates an
allowance for finance credit losses, which management believes is adequate for
probable credit losses that can be reasonably estimated in its portfolio of
finance receivable Contracts. Provision for loss is charged to the Company's
Consolidated Statement of Operations. Net losses incurred on finance receivables
are charged to the allowance. Management evaluates the adequacy of the allowance
by examining current delinquencies, the characteristics of the portfolio, the
value of the underlying collateral and historical loss trends. As conditions
change, the Company's level of provisioning and/or allowance may change as well.
CHARGE OFF POLICY
Delinquent Contracts for which the related financed vehicle has been
repossessed are generally charged off at the earliest of the month in which the
proceeds from the sale of the financed vehicle were received, the month in which
90 days have passed from the date of repossession or the month in which the
Contract becomes 210 days past due (see Repossessed and Other Assets below). The
amount charged off is the remaining principal balance of the Contract, after the
application of the net proceeds from the liquidation of the financed vehicle.
With respect to delinquent Contracts for which the related financed vehicle has
not been repossessed, the remaining principal balance thereof is generally
charged off no later than the end of the month that the Contract becomes 120
days past due for CPS Program receivables, and no later than the end of the
month that the Contract becomes 180 days past due for other receivables.
CONTRACT ACQUISITION FEES AND ORIGINATIONS COSTS
Upon purchase of a Contract from a Dealer, the Company generally
charges or advances the Dealer an acquisition fee. For Contracts securitized in
pools which were structured as sales for financial accounting purposes, the
acquisition fees associated with Contract purchases were deferred until the
Contracts were securitized, at which time the deferred acquisition fees were
recognized as a component of the gain on sale.
For Contracts purchased and securitized in pools which are structured
as secured financings for financial accounting purposes, dealer acquisition fees
and deferred originations costs are reduced against the carrying value of
finance receivables and are accreted into earnings as an adjustment to the yield
over the life of the Contract using the interest method.
REPOSSESSED AND OTHER ASSETS
If a customer fails to make or keep promises for payments, or if the
customer is uncooperative or attempts to evade contact or hide the vehicle, a
supervisor will review the collection activity relating to the account to
determine if repossession of the vehicle is warranted. Generally, such a
decision will occur between the 45th and 90th day past the customer's payment
due date, but could occur sooner or later, depending on the specific
circumstances. At the time the vehicle is repossessed the Company will stop
accruing interest on this Contract, and reclassify the remaining Contract
balance to other assets at its estimated fair value less costs to sell. Included
in other assets in the accompanying balance sheets are repossessed vehicles
pending sale of $10.1 million and $4.2 million at December 31, 2006 and 2005,
respectively.
Included in Other Assets are non-finance receivable assets totaling
$1.8 million as of December 31, 2006, net of a valuation allowance of $1.9
million. The valuation allowance was established in 2005 and is included in
general and administrative expenses in the Company's Consolidated Statement of
Operations. Included in the $1.9 million valuation allowance is $900,000
associated with related party receivables.
F-10
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
TREATMENT OF SECURITIZATIONS
Prior to July 2003, dispositions of Contracts in securitization
transactions were structured as sales for financial accounting purposes,
therefore, gain on sale was recognized on those securitization transactions in
which the Company, or a wholly-owned, consolidated subsidiary of the Company,
retained a residual interest in the Contracts that were sold to a wholly-owned,
unconsolidated special purpose subsidiary. These securitization transactions
included "term" securitizations (the purchaser held the Contracts for
substantially their entire term) and "warehouse" securitizations (which financed
the acquisition of the Contracts for future sale into term securitizations).
The line item "Residual interest in securitizations" on the Company's
Consolidated Balance Sheet represents the residual interests in term
securitizations completed prior to July 2003. This line represents the
discounted sum of expected future cash flows from these securitization trusts.
Since the residual interest is attributable to receivables originated and
securitized prior to the third quarter of 2003, these receivables are nearing
the end of their contractual terms. Moreover, the terms of the securitizations
provide the Company the option to repurchase the underlying receivables from the
trust and retire the related bonds. Such repurchases are referred to as
"clean-ups". When a clean-up takes place, the Company purchases the underlying
receivables and records them on the balance sheet and removes that portion of
the residual interest that is attributable to the trust that is terminated when
the related bonds are retired. The Company conducts such clean-ups as the terms
of the securitizations permit including two each in 2005 and 2006, and one since
December 31, 2006. A portion of the residual interest represents future cash
flows from recoveries on charge offs from clean-up securitizations and will
remain on the balance sheet for some time, even after the clean-up of the final
transaction, until those particular cash flows are realized.
All subsequent securitizations were structured as secured financings.
The warehouse securitizations are accordingly reflected in the line items
"Finance receivables" and "Warehouse lines of credit" on the Company's
Consolidated Balance Sheet, and the term securitizations are reflected in the
line items "Finance receivables" and "Securitization trust debt."
The Company's term securitization structure has generally been as
follows:
The Company sells Contracts it acquires to a wholly-owned Special
Purpose Subsidiary ("SPS"), which has been established for the limited purpose
of buying and reselling the Company's Contracts. The SPS then transfers the same
Contracts to another entity, typically a statutory trust ("Trust"). The Trust
issues interest-bearing asset-backed securities ("Notes"), in a principal amount
equal to or less than the aggregate principal balance of the Contracts. The
Company typically sells these Contracts to the Trust at face value and without
recourse, except that representations and warranties similar to those provided
by the Dealer to the Company are provided by the Company to the Trust. One or
more investors purchase the Notes issued by the Trust (the "Noteholders"); the
proceeds from the sale of the Notes are then used to purchase the Contracts from
the Company. The Company may retain or sell subordinated Notes issued by the
Trust. The Company purchases a financial guaranty insurance policy, guaranteeing
timely payment of interest and ultimate payment of principal on the senior
Notes, from an insurance company (a "Note Insurer"). In addition, the Company
provides "Credit Enhancement" for the benefit of the Note Insurer and the
Noteholders in three forms: (1) an initial cash deposit to a bank account (a
"Spread Account") held by the Trust, (2) overcollateralization of the Notes,
where the principal balance of the Notes issued is less than the principal
balance of the Contracts, and (3) in the form of subordinated Notes. The
agreements governing the securitization transactions (collectively referred to
as the "Securitization Agreements") require that the initial level of Credit
Enhancement be supplemented by a portion of collections from the Contracts until
the level of Credit Enhancement reaches specified, levels which are then
maintained. The specified levels are generally computed as a percentage of the
principal amount remaining unpaid under the related Contracts. The specified
levels at which the Credit Enhancement is to be maintained will vary depending
on the performance of the portfolios of Contracts held by the Trusts and on
other conditions, and may also be varied by agreement among the Company, the
SPS, the Note Insurers and the trustee. Such levels have increased and decreased
from time to time based on performance of the various portfolios, and have also
varied by Securitization Agreement. The Securitization Agreements generally
grant the Company the option to repurchase the sold Contracts from the Trust
(i.e., a "clean-up call") when the aggregate outstanding balance of the
Contracts has amortized to a specified percentage of the initial aggregate
balance.
The Company's warehouse securitization structures are similar to the
above, except that (i) the SPS that purchases the Contracts pledges the
Contracts to secure promissory notes that it issues, (ii) no increase in the
required amount of Credit Enhancement is contemplated, and (iii) the Company
does not purchase financial guaranty insurance. Upon each sale of Contracts in a
securitization structured as a secured financing, the Company retains on its
Consolidated Balance Sheet the Contracts securitized as assets and records the
Notes issued in the transaction as indebtedness of the Company.
F-11
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Under the prior securitizations structured as sales for financial
accounting purposes, the Company removed from its Consolidated Balance Sheet the
Contracts sold and added to its Consolidated Balance Sheet (i) the cash
received, if any, and (ii) the estimated fair value of the ownership interest
that the Company retains in Contracts sold in the securitization. That retained
or residual interest (the "Residual") consists of (a) the cash held in the
Spread Account, if any, (b) overcollateralization, if any, (c) subordinated
Notes retained, if any, and (d) receivables from the Trust, which include the
net interest receivables ("NIRs"). NIRs represent the estimated discounted cash
flows to be received from the Trust in the future, net of principal and interest
payable with respect to the Notes, the premium paid to the Note Insurer, and
certain other expenses. Until the maturity of these transactions, the Company's
Consolidated Balance Sheet will reflect securitization transactions structured
both as sales and as secured financings.
The Company recognizes gains or losses attributable to the change in
the estimated fair value of the Residuals. Gains in fair value are recognized in
the income statement with losses being recorded as an impairment loss in the
income statement. The Company is not aware of an active market for the purchase
or sale of interests such as the Residuals; accordingly, the Company determines
the estimated fair value of the Residuals by discounting the amount of
anticipated cash flows that it estimates will be released to the Company in the
future (the cash out method), using a discount rate that the Company believes is
appropriate for the risks involved. The anticipated cash flows include
collections from both current and charged off receivables. The Company has used
an effective pre-tax discount rate of 14% per annum, except for certain
collections from charged off receivables related to the Company's
securitizations in 2001 and later, for which the Company has used a discount
rate of 25%.
The Company receives periodic base servicing fees for the servicing and
collection of the Contracts. In addition, the Company is entitled to the cash
flows from the Trusts that represent collections on the Contracts in excess of
the amounts required to pay principal and interest on the Notes, the base
servicing fees, and the premium paid to the Note Insurer, and certain other fees
(such as trustee and custodial fees). Required principal payments on the Notes
are generally defined as the payments sufficient to keep the principal balance
of the Notes equal to the aggregate principal balance of the related Contracts
(excluding those Contracts that have been charged off), or a pre-determined
percentage of such balance. Where that percentage is less than 100%, the related
Securitization Agreements require accelerated payment of principal until the
principal balance of the Notes is reduced to the specified percentage. Such
accelerated principal payment is said to create "overcollateralization" of the
Notes.
If the amount of cash required for payment of fees, interest and
principal 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, and
there is no shortfall in the related Spread Account or other form of Credit
Enhancement, the excess is released to the Company. If the total Credit
Enhancement amount is not at the required level, then the excess cash collected
is retained in the Trust until the specified level is achieved. Cash in the
Spread Accounts is restricted from use by the Company. Cash held in the various
Spread Accounts is invested in high quality, liquid investment securities, as
specified in the Securitization Agreements. In determining the value of the
Residuals, the Company must estimate the future rates of prepayments,
delinquencies, defaults, default loss severity, and recovery rates, as all of
these factors affect the amount and timing of the estimated cash flows. The
Company's estimates are based on historical performance of comparable Contracts.
Following a securitization that is structured as a sale for financial
accounting purposes, interest income is recognized on the balance of the
Residuals. In addition, the Company will recognize as a gain additional revenue
from the Residuals if the actual performance of the Contracts is better than the
Company's estimate of the value of the residual. If the actual performance of
the Contracts were worse than the Company's estimate, then a downward adjustment
to the carrying value of the Residuals and a related impairment charge would be
required. In a securitization structured as a secured financing for financial
accounting purposes, interest income is recognized when accrued under the terms
of the related Contracts and, therefore, presents less potential for
fluctuations in performance when compared to the approach used in a transaction
structured as a sale for financial accounting purposes.
In all the Company's term securitizations, whether treated as secured
financings or as sales, the Company has transferred the receivables (through a
subsidiary) to the securitization trust. The difference between the two
structures is that in securitizations that are treated as secured financings the
Company reports the assets and liabilities of the securitization trust on its
consolidated balance sheet. Under both structures the noteholders' and the
related securitization trusts' recourse to the Company for failure of the
contract obligors to make payments on a timely basis is limited to the Company's
finance receivables, spread accounts and residuals.
F-12
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SERVICING
The Company considers the contractual servicing fee received on its
managed portfolio held by non-consolidated subsidiaries to be equal to adequate
compensation. As a result, no servicing asset or liability has been recognized.
Servicing fees received on its managed portfolio held by non-consolidated
subsidiaries are reported as income when earned. Servicing fees received on its
managed portfolio held by consolidated subsidiaries are included in interest
income when earned. Servicing costs are charged to expense as incurred.
Servicing fees receivable, which are included in Other Assets in the
accompanying balance sheets, represent fees earned but not yet remitted to the
Company by the trustee.
FURNITURE AND EQUIPMENT
Furniture and equipment are stated at cost net of accumulated
depreciation. The Company calculates depreciation using the straight-line method
over the estimated useful lives of the assets, which range from three to five
years. Assets held under capital leases and leasehold improvements are amortized
over the lesser of the estimated useful lives of the assets or the related lease
terms. Amortization expense on assets acquired under capital lease is included
with depreciation expense on Company owned assets.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
Long-lived assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to future net cash flows expected to be generated by the asset. If such assets
are considered to be impaired, the impairment to be recognized is measured by
the amount by which the carrying amount of the assets exceeds the fair value of
the assets. Assets to be disposed of are reported at the lower of carrying
amount or fair value less costs to sell.
OTHER INCOME
Other Income consists primarily of recoveries on previously charged off
MFN Contracts, fees paid to the Company by Dealers for certain direct mail
services the Company provides, refunds of sales taxes paid by obligors under the
Contracts, and, in 2005, $2.7 million in proceeds from sales of previously
charged off Contracts to independent third parties. The recoveries on previously
charged off MFN Contracts relate to Contracts that were acquired in the MFN
acquisition. These recoveries totaled $4.3 million, $4.9 million and $8.0
million for the years ended December 31, 2006, 2005 and 2004, respectively.
Included in Other Income for the year ended December 31, 2006 is a gain
recognized on the Residual interest in securitizations in the amount of $1.2
million.
F-13
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
EARNINGS PER SHARE
The following table illustrates the computation of basic and diluted
earnings (loss) per share:
-------------------------------------------------
2006 2005 2004
------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Numerator:
Numerator for basic and diluted earnings (loss) per share .... $ 39,555 $ 3,372 $ (15,888)
============= ============= =============
Denominator:
Denominator for basic earnings (loss) per share
- weighted average number of common shares
outstanding during the year ............................... 21,760 21,627 21,111
Incremental common shares attributable to exercise
of outstanding options and warrants ....................... 2,292 1,886 --
------------- ------------- -------------
Denominator for diluted earnings (loss) per share ............ 24,052 23,513 21,111
============= ============= =============
Basic earnings (loss) per share .............................. $ 1.82 $ 0.16 $ (0.75)
============= ============= =============
Diluted earnings (loss) per share ............................ $ 1.64 $ 0.14 $ (0.75)
============= ============= =============
Incremental shares of 950,000, 639,000 and 1.8 million related to stock
options have been excluded from the diluted earnings (loss) per share
calculation for the year ended December 31, 2006, 2005 and 2004, respectively,
because the impact is anti-dilutive.
DEFERRAL AND AMORTIZATION OF DEBT ISSUANCE COSTS
Costs related to the issuance of debt are deferred and amortized using
the interest method over the contractual or expected term of the related debt.
INCOME TAXES
The Company and its subsidiaries file a consolidated federal income tax
return and combined or stand-alone state franchise tax returns for certain
states. The Company utilizes the asset and liability method of accounting for
income taxes, under which deferred income taxes are recognized for the future
tax consequences attributable to the differences between the financial statement
values of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred
taxes of a change in tax rates is recognized in income in the period that
includes the enactment date. The Company has estimated a valuation allowance
against that portion of the deferred tax asset whose utilization in future
periods is not more than likely.
PURCHASES OF COMPANY STOCK
The Company records purchases of its own common stock at cost and
treats the shares as retired.
STOCK OPTION PLAN
Effective January 1, 2006, the Company adopted SFAS No. 123 (revised),
"Share-Based Payment" (SFAS 123(R)) utilizing the modified prospective approach.
Under the modified prospective approach, Employee Costs include all share based
payments granted subsequent to January 1, 2006, based on the grant date fair
value estimated in accordance with the provisions of SFAS 123(R). Prior periods
were not restated to reflect the impact of adopting the new standard.
Prior to the adoption of SFAS 123(R) we accounted for stock-based
employee compensation plans in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations, whereby stock options are recorded at intrinsic value equal to
the excess of the share price over the exercise price at the date of grant. For
the periods prior to the adoption of SFAS 123(R) we have provided the pro forma
net income (loss), pro forma earnings (loss) per share, and stock based
compensation plan disclosure requirements set forth in SFAS No. 123.
F-14
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In December 2005, the Compensation Committee of the Board of Directors
approved accelerated vesting of all the outstanding stock options issued by the
Company. Options to purchase 2,113,998 shares of the Company's common stock,
which would otherwise have vested from time to time through 2010, became
immediately exercisable as a result of the acceleration of vesting. The decision
to accelerate the vesting of the options was made primarily to reduce non-cash
compensation expenses that would have been recorded in the Company's income
statement upon the adoption of SFAS 123(R) in January 2006. The Company
estimates that approximately $3.5 million of future non-cash compensation
expense was eliminated as a result of the acceleration of vesting.
At the time of the acceleration of vesting, the Company accounted for
its stock options in accordance with Accounting Principals Board Opinion No. 25,
Accounting for Stock Issued to Employees. Consequently, the acceleration of
vesting resulted in non-cash compensation charge of $427,000 for the year ended
December 31, 2005.
The per share weighted-average fair value of stock options granted
during the years ended December 31, 2006, 2005 and 2004, was $3.39, $3.07, and
$2.30, respectively. That fair value was estimated using the Black-Scholes
option-pricing model using the weighted average assumptions noted in the
following table. The Company estimates the expected life of each option as the
average of the vesting period and the contractual life of the option. The
volatility estimate is based on the historical volatility of the Company's stock
over the period that equals the expected life of the option. Volatility
assumptions ranged from 34% to 50% for 2006, 51% to 63% for 2005 and 47% to 64%
for 2004. The risk-free interest rate is based on the yield on a US Treasury
bond with a maturity comparable to the expected life of the option. The dividend
yield is estimated to be zero based on the Company's intention not to issue
dividends for the foreseeable future.
YEAR ENDED DECEMBER 31,
---------------------------------------
2006 2005 2004
------------ ------------ -------------
Expected life (years)........ 5.69 6.50 6.50
Risk-free interest rate...... 4.80% 4.32% 4.48%
Volatility................... 47% 57% 55%
Expected dividend yield...... - - -
Prior to the adoption of SFAS 123(R) on January 1, 2006, compensation
cost had been recognized for certain stock options in the Consolidated Financial
Statements in accordance with APB Opinion No. 25. Had the Company determined
compensation cost based on the fair value at the grant date for its stock
options under Statement of Financial Accounting Standards No. 123 ("SFAS 123"),
"Accounting for Stock Based Compensation," the Company's net income (loss) and
earnings (loss) per share would have been adjusted to the pro forma amounts
indicated below.
YEAR ENDED DECEMBER 31,
-----------------------------
2005 2004
------------ ------------
(IN THOUSANDS,
EXCEPT
PER SHARE DATA)
Net income (loss)
As reported ......................... $ 3,372 $ (15,888)
Pro forma ........................... (648) (16,808)
Earnings (loss) per share - basic
As reported ......................... $ 0.16 $ (0.75)
Pro forma ........................... (0.03) (0.80)
Earnings (loss) per share - diluted
As reported ......................... $ 0.14 $ (0.75)
Pro forma ........................... (0.03) (0.80)
F-15
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEW ACCOUNTING PRONOUNCEMENTS
In February 2006, the FASB issued FASB Statement No. 155, "Accounting
for Certain Hybrid Instruments". This statement amends the guidance in FASB
Statements No. 133, "Accounting for Derivative Instruments and Hedging
Activities", and No. 140, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities". Statement 155 allows financial
instruments that have embedded derivatives to be accounted for as a whole
(eliminating the need to bifurcate the derivative from its host) if the holder
elects to account for the whole instrument on a fair value basis. The Statement
also amends Statement 140 to eliminate the prohibition on a qualifying
special-purpose entity from holding a derivative financial instrument that
pertains to a beneficial interest other than another derivative financial
instrument. Statement 155 is effective for all financial instruments acquired or
issued after January 1, 2007. The Company does not believe the adoption of this
statement will have a material effect on the Company's financial position or
operations.
In March 2006, the FASB issued FASB Statement No. 156, "Accounting for
the Servicing of Financial Assets an Amendment to FASB Statement No. 140" (FAS
156). With respect to the accounting for separately recognized servicing assets
and servicing liabilities, this statement: (1) requires an entity to recognize a
servicing asset or servicing liability each time it undertakes an obligation to
service a financial asset by entering into a specific types of servicing
contracts identified in the statement, (2) requires that all separately
recognized servicing assets and servicing liabilities be initially measured at
fair value, if practicable, (3) permits an entity to choose subsequent
measurement methods for each class of separately recognized servicing assets and
servicing liabilities, (4) permits a one-time reclassification of
available-for-sale securities to trading securities by entities with recognized
servicing rights at the initial adoption of this statement, and (5) requires a
separate presentation of servicing assets and servicing liabilities subsequently
measured at fair value in the statement of financial position and additional
disclosures for all separately recognized servicing assets and servicing
liabilities. FAS 156 will be effective for the Company on January 1, 2007. The
Company is currently in the process of evaluating the effects of this Standard,
but does not believe it will have a significant effect on its financial position
or results of operations.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements" ("SFAS No. 157"). SFAS No. 157 clarifies the principle that fair
value should be based on the assumptions market participants would use when
pricing an asset or liability and establishes a fair value hierarchy that
prioritizes the information used to develop those assumptions. Under the
standard, fair value measurements would be separately disclosed by level within
the fair value hierarchy. SFAS 157 is effective for the Company on January 1,
2008, with early adoption permitted. The Company is in the process of evaluating
SFAS No. 157 but does not believe it will have a significant effect on its
financial position or results of operations.
In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting
for Uncertainty in Income Taxes" ("FIN 48"). FIN 48 clarifies when tax benefits
should be recorded in financial statements, requires certain disclosures of
uncertain tax matters and indicates how any tax reserves should be classified in
a balance sheet. FIN 48 is effective for the Company in the first quarter of
2007. The Company is currently analyzing the effects of the adoption of FIN 48
but currently does not anticipate that the adoption will have a significant
impact on its financial condition or results of operations.
In February 2007, the FASB issued SFAS 159, "The Fair Value Option for
Financial Assets and Financial Liabilities-Including an Amendment of FASB
Statement No. 115". SFAS 159 permits an entity to choose to measure many
financial instruments and certain other items at fair value. Most of the
provisions of SFAS 159 are elective, however, the amendment to SFAS 115,
"Accounting for Certain Investments in Debt and Equity Securities", applies to
all entities with available for sale or trading securities. SFAS 159 is elective
as of the beginning of an entity's first fiscal year that begins after November
15, 2007. SFAS 159 was recently issued and we are currently assessing the
financial impact the Statement will have on our financial statements.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management 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 the Residuals,
accreting discounts and acquisition fees, amortizing deferred costs and the
recording of deferred tax assets. These are material estimates that could be
susceptible to changes in the near term and, accordingly, actual results could
differ from those estimates.
F-16
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
RECLASSIFICATION
Certain amounts for the prior years have been reclassified to conform
to the current year's presentation with no impact on previously reported
earnings or shareholders' equity.
(2) RESTRICTED CASH
Restricted cash comprised the following components:
DECEMBER 31,
-----------------------------
2006 2005
------------ ------------
(IN THOUSANDS)
Securitization trust accounts ..... $ 192,851 $ 157,492
Note purchase facility reserve .... -- 20
Other ............................. 150 150
------------ ------------
Total restricted cash ............. $ 193,001 $ 157,662
============ ============
Certain of the Company's operating agreements require that the Company
establish cash reserves for the benefit of the other parties to the agreements,
in case those parties are subject to any claims or exposure.
(3) FINANCE RECEIVABLES
The following table presents the components of Finance Receivables, net of
unearned interest:
DECEMBER 31, DECEMBER 31,
2006 2005
----------- -----------
Finance Receivables (IN THOUSANDS)
Automobile
Simple Interest .................................. $ 1,474,126 $ 933,510
Pre-compute, net of unearned interest ............ 29,251 54,693
----------- -----------
Finance Receivables, net of unearned interest .... 1,503,377 988,203
Less: Unearned acquisition fees and discounts .... (22,583) (16,899)
----------- -----------
Finance Receivables .............................. $ 1,480,794 $ 971,304
=========== ===========
Finance receivables totaling $12.2 million and $5.1 million at December
31, 2006 and 2005, respectively, have been placed on non-accrual status as a
result of their delinquency status.
The following table presents a summary of the activity for the
allowance for credit losses, for the years ended December 31, 2006, 2005 and
2004:
DECEMBER 31,
------------------------------------
2006 2005 2004
-------- -------- --------
(IN THOUSANDS)
Balance at beginning of year .... $ 57,728 $ 42,615 $ 35,889
Provision for credit losses ..... 92,057 58,987 32,574
Charge-offs ..................... (88,335) (55,978) (34,636)
Recoveries ...................... 17,930 12,104 8,788
-------- -------- --------
Balance at end of year .......... $ 79,380 $ 57,728 $ 42,615
======== ======== ========
F-17
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) RESIDUAL INTEREST IN SECURITIZATIONS
The following table presents the components of the residual interest in
securitizations and shown at their discounted amounts:
DECEMBER 31,
---------------------------
2006 2005
----------- -----------
(IN THOUSANDS)
Cash, commercial paper, United States government securities
and other qualifying investments (Spread Accounts) .......... $ 9,987 $ 12,748
Receivables from Trusts (NIRs) and recoveries of previously
charged-off receivables ..................................... 808 5,798
Overcollateralization .......................................... 3,000 6,674
----------- -----------
Residual interest in securitizations ........................... $ 13,795 $ 25,220
=========== ===========
The following table presents the estimated remaining undiscounted
credit losses included in the fair value estimate of the Residuals as a
percentage of the Company's managed portfolio held by non-consolidated
subsidiaries subject to recourse provisions:
DECEMBER 31,
---------------------------------------------
2006 2005 2004
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Undiscounted estimated credit losses ............................... $ 1,759 $ 5,724 $ 23,588
Managed portfolio held by non-consolidated subsidiaries ............ 34,850 103,130 233,621
Undiscounted estimated credit losses as a percentage of managed
portfolio held by non-consolidated subsidiary ...................... 5.05% 5.55% 10.10%
The key economic assumptions used in measuring all residual interest in
securitizations as of December 31, 2006 and 2005 are included in the table
below. The pre-tax discount rate remained constant at 14%, except for certain
cash flows from charged off receivables related to the Company's securitizations
from 2001 to 2003 where the Company has used a discount rate of 25%. The Company
assumes that it will exercise it's clean-up option to repurchase the underlying
receivables and retire the related bonds prior to the contractual maturity of
the bonds.
2006 2005
--------------- ---------------
Prepayment speed (Cumulative) ................ 22.7% - 32.5% 22.2% - 35.8%
Net credit losses (Cumulative) ............... 11.8% - 15.4% 11.9% - 20.2%
Static pool losses are calculated by summing the actual and projected
future credit losses and dividing them by the original balance of each pool of
assets.
F-18
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Key economic assumptions and the sensitivity of the current fair value
of residual cash flows to immediate 10% and 20% adverse changes in those
assumptions are as follows:
Carrying amount/fair value of residual interest in securitizations .... $13,795
Weighted average life in years ........................................ 1.49
Prepayment Speed Assumption (Cumulative) .............................. 22.7% - 32.5%
Estimated fair value assuming 10% adverse change ...................... $13,774
Estimated fair value assuming 20% adverse change ...................... 13,754
Expected Net Credit Losses (Cumulative) ............................... 11.8% - 15.4%
Estimated fair value assuming 10% adverse change ...................... $13,661
Estimated fair value assuming 20% adverse change ...................... 13,539
Residual Cash Flows Discount Rate (Annual) ........................... 14.0% - 25.0%
Estimated fair value assuming 10% adverse change ...................... $13,648
Estimated fair value assuming 20% adverse change ...................... 13,505
These sensitivities are hypothetical and should be used with caution.
As the figures indicate, changes in fair value based on 10% and 20% percent
variation in assumptions generally cannot be extrapolated because the
relationship of the change in assumption to the change in fair value may not be
linear. Also, in this table, the effect of a variation in a particular
assumption on the fair value of the retained interest is calculated without
changing any other assumption; in reality, changes in one factor may result in
changes in another (for example, increases in market rates may result in lower
prepayments and increased credit losses), which could magnify or counteract the
sensitivities.
The following table summarizes the cash flows received from (paid to)
the Company's unconsolidated securitization Trusts:
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------
2006 2005 2004
------------ ------------ ------------
(IN THOUSANDS)
Releases of cash from Spread Accounts .......... $ 5,565 $ 7,420 $ 17,175
Servicing Fees received ........................ 2,435 4,490 13,631
Net deposits to increase Credit Enhancement .... -- -- (2,106)
Purchase of delinquent or foreclosed assets .... (9,068) (22,682) (44,473)
Repurchase of trust assets ..................... (8,064) (9,658) --
(5) FURNITURE AND EQUIPMENT
The following table presents the components of furniture and equipment:
DECEMBER 31,
----------------------------
2006 2005
----------- -----------
(IN THOUSANDS)
Furniture and fixtures ............................. $ 3,846 $ 3,780
Computer equipment ................................. 5,107 4,815
Leasing assets ..................................... 673 673
Leasehold improvements ............................. 666 666
Other fixed assets ................................. 71 17
----------- -----------
10,363 9,951
Less: accumulated depreciation and amortization .... (9,539) (8,872)
----------- -----------
$ 824 $ 1,079
=========== ===========
Depreciation expense totaled $667,000, $654,000 and $660,000 for the
years ended December 31, 2006, 2005 and 2004, respectively.
F-19
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) RESTRUCTURING ACCRUALS
MFN MERGER
In connection with the MFN Merger, the Company subsequently terminated
the MFN origination activities and consolidated certain activities of MFN. In
connection therewith, the Company recognized certain liabilities related to the
costs to exit these activities and terminate the affected employees of MFN.
These activities include service departments such as accounting, finance, human
resources, information technology, administration, payroll and executive
management. Of these liabilities recognized at the merger date in the amount of
$6.2 million, only the accrual related to facility closures remained outstanding
as of December 31, 2006 and 2005 in the amounts of $366,000 and $545,000,
respectively.
TFC MERGER
In connection with the TFC Merger, the Company consolidated certain
activities of CPS and TFC. As a result of this consolidation, the Company
recognized certain liabilities related to the costs to integrate and terminate
affected employees of TFC. These activities include service departments such as
accounting, finance, human resources, information technology, administration,
payroll and executive management. The total liabilities recognized by the
Company at the time of the merger were $4.5 million. As of December 31, 2006,
none of these liabilities remain outstanding compared with $454,000 outstanding
as of December 31, 2005.
(7) SECURITIZATION TRUST DEBT
The Company has completed a number of securitization transactions that
are structured as secured borrowings for financial accounting purposes. The debt
issued in these transactions is shown on the Company's consolidated balance
sheets as "Securitization trust debt," and the components of such debt are
summarized in the following table:
WEIGHTED
FINAL RECEIVABLES OUTSTANDING OUTSTANDING AVERAGE
SCHEDULED PLEDGED AT PRINCIPAL AT PRINCIPAL AT INTEREST RATE
PAYMENT DECEMBER 31, INITIAL DECEMBER 31, DECEMBER 31, AT DECEMBER 31,
SERIES DATE (1) 2006 PRINCIPAL 2006 2005 2006
-------------------- ---------------- -------------- -------------- ------------- ------------- ---------------
(DOLLARS IN THOUSANDS)
TFC 2003-1 January 2009 $ - $ 52,365 $ - $ 6,557 -
CPS 2003-C March 2010 15,473 87,500 14,815 30,550 3.57%
CPS 2003-D October 2010 15,829 75,000 15,191 29,688 3.91%
CPS 2004-A October 2010 21,519 82,094 21,608 40,225 4.32%
PCR 2004-1 March 2010 9,727 76,257 8,097 22,873 4.00%
CPS 2004-B February 2011 29,338 96,369 29,437 52,704 4.17%
CPS 2004-C April 2011 35,565 100,000 35,480 61,779 4.24%
CPS 2004-D December 2011 48,239 120,000 47,384 82,801 4.44%
CPS 2005-A October 2011 66,157 137,500 62,610 110,021 5.19%
CPS 2005-B February 2012 75,747 130,625 70,933 113,194 4.80%
CPS 2005-C May 2012 122,947 183,300 117,434 173,509 5.19%
CPS 2005-TFC July 2012 48,481 72,525 45,444 72,525 5.75%
CPS 2005-D July 2012 102,915 145,000 100,615 127,600 5.63%
CPS 2006-A November 2012 197,493 245,000 195,822 N/A 5.27%
CPS 2006-B January 2013 227,149 257,500 224,478 N/A 6.31%
CPS 2006-C July 2013 236,834 247,500 236,139 N/A 5.65%
CPS 2006-D (2) August 2013 148,506 220,000 217,508 N/A 5.61%
------------- -------------- ------------- -------------
$ 1,401,919 $ 2,328,535 $ 1,442,995 $ 924,026
============= ============== ============= =============
-----------------
(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 $472.3 MILLION IN 2007,
$342.2 MILLION IN 2008, $261.3 MILLION IN 2009, $191.4 MILLION IN 2010, $128.3 MILLION IN 2011, AND $47.5
MILLION IN 2012.
(2) RECEIVABLES PLEDGED AT DECEMBER 31, 2006 EXCLUDES APPROXIMATELY $70.3 MILLION IN CONTRACTS DELIVERED TO
THE TRUST IN JANUARY 2007 PURSUANT TO A PRE-FUNDING STRUCTURE.
F-20
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All of the securitization trust debt was issued in private placement
transactions to qualified institutional investors. The debt was issued through
wholly-owned, bankruptcy remote subsidiaries of CPS, TFC or MFN, and is secured
by the assets of such subsidiaries, but not by other assets of the Company.
Principal and interest payments are guaranteed by financial guaranty insurance
policies.
The terms of the various Securitization Agreements related to the
issuance of the securitization trust debt require that certain delinquency and
credit loss criteria be met with respect to the collateral pool, and require
that the Company maintain minimum levels of liquidity and net worth and not
exceed maximum leverage levels and maximum financial losses. The Company was in
compliance with all such covenants as of December 31, 2006.
The Company is responsible for the administration and collection of the
Contracts. The Securitization Agreements also require certain funds be held in
restricted cash accounts to provide additional collateral for the borrowings or
to be applied to make payments on the securitization trust debt. As of December
31, 2006, restricted cash under the various agreements totaled approximately
$192.9 million. Interest expense on the securitization trust debt is composed of
the stated rate of interest plus amortization of additional costs of borrowing.
Additional costs of borrowing include facility fees, insurance premiums, and
amortization of transaction costs. Deferred financing costs related to the
securitization trust debt are amortized using the interest method. Accordingly,
the effective cost of borrowing of the securitization trust debt is greater than
the stated rate of interest.
The wholly-owned, bankruptcy remote subsidiaries of CPS, MFN and TFC
were formed to facilitate the above asset-backed financing transactions. Similar
bankruptcy remote subsidiaries issue the debt outstanding under the Company's
warehouse lines of credit. Bankruptcy remote refers to a legal structure in
which it is expected that the applicable entity would not be included in any
bankruptcy filing by its parent or affiliates. All of the assets of these
subsidiaries have been pledged as collateral for the related debt. All such
transactions, treated as secured financings for accounting and tax purposes, are
treated as sales for all other purposes, including legal and bankruptcy
purposes. None of the assets of these subsidiaries are available to pay other
creditors of the Company or its affiliates.
(8) DEBT
The terms of the Company's significant debt outstanding at December 31,
2006 and 2005 are summarized below:
December 31,
----------------------
2006 2005
---- ----
(IN THOUSANDS)
RESIDUAL INTEREST FINANCING
Notes secured by the Company's residual interests in securitizations. The
notes outstanding at December 31, 2005, with a remaining balance of $19.2
million at December 31, 2006, were issued in November 2005 with issuance
costs of $915,000. They are secured by 10 securitizations, bear interest at
a blended rate of 8.70% per annum and have a final maturity of July 2011. Of
the notes outstanding at December 31, 2006, $12.2 million are secured by
retained interests in six more recent securitizations. These notes were
issued in December 2006 with issuance costs of $437,500, bear interest at
6.125% over LIBOR
and have a final maturity of December 2013. $31,378 $43,745
F-21
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31,
----------------------
2006 2005
---- ----
(IN THOUSANDS)
SENIOR SECURED DEBT, RELATED PARTY
Notes payable to Levine Leichtman Capital Partners II, L.P. ("LLCP"). The
notes consists of separate term notes that each bear interest at 11.75% per
annum, require monthly interest payments and are due in May 2007, after
having been amended from higher rates and earlier maturities. The Company
incurred issuance and amendment fees aggregating $1.3 million in relation to
these notes. The notes are secured by all assets of the Company that are not
pledged to securitization debt or residual interest debt and are the last in
a series of borrowings from LLCP that have taken place since November 1998,
which have also included the issuances to LLCP of warrants to purchase the
Company's common stock. As of December 31, 2006 and 2005, a warrant to
purchase 1,000 shares of common stock at $.01 per share remained outstanding
and will expire in April 2009.
$25,000 $40,000
SUBORDINATED DEBT
Notes bearing interest at 12.50% per annum at December 31, 2005. The Company
incurred issuance costs of $1.1 million when the notes were issued in
December 1995 and repaid at their
maturity date in January 2006. -- $14,000
SUBORDINATED RENEWABLE NOTES
Notes bearing interest ranging from 6.15% to 13.85%, with a weighted average
rate of 9.84%, and with maturities from January 2007 to December 2016 with a
weighted average maturity of September 2008. The Company began issuing the
notes in June 2005 and incurred issuance costs of $250,000. Payments are
made monthly, quarterly, annually or upon maturity based on the terms
of the individual notes. $13,574 $4,655
------------ -------------
$69,952 $102,400
============ =============
The costs incurred in conjunction with the above debt are recorded as
deferred financing costs on the accompanying balance sheets and is more fully
described in Note 1.
The Company must comply with certain affirmative and negative covenants
related to debt facilities, which require, among other things, that the Company
maintain certain financial ratios related to liquidity, net worth,
capitalization and maximum financial losses. Further covenants include matters
relating to investments, acquisitions, restricted payments and certain dividend
restrictions.
F-22
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the contractual and expected maturity
amounts of debt as of December 31, 2006:
CONTRACTUAL RESIDUAL RENEWABLE
MATURITY INTEREST SENIOR SUBORDINATED
DATE FINANCING (1) SECURED DEBT NOTES TOTAL
------------------------------------------------------------------------------------------
(IN THOUSANDS)
2007 $ 10,947 $ 25,000 $ 5,842 $ 41,789
2008 7,649 - 2,938 10,587
2009 12,782 - 3,371 16,153
2010 - - 467 467
2011 - - 851 851
Thereafter - - 105 105
---------------------------------------------------------------------
$ 31,378 $ 25,000 $ 13,574 $ 69,952
=====================================================================
-----------------
(1) THE CONTRACTUAL MATURITY DATE FOR THE RESIDUAL INTEREST FINANCING IS JULY
2011. THE NOTES ARE EXPECTED TO BE PAID PRIOR TO THAT DATE, BASED ON THE
AMORTIZATION OF THE RELATED SECURITIZATIONS. SINCE THE AMORTIZATION OF THE
RELATED SECURITIZATIONS IS BASED ON THE PERFORMANCE OF THE UNDERLYING
FINANCE RECEIVABLES, THERE CAN BE NO ASSURANCE AS TO THE EXACT TIMING OF
PAYMENTS.
(9) SHAREHOLDERS' EQUITY
COMMON STOCK
Holders of common stock are entitled to such dividends as the Company's
Board of Directors, in its discretion, may declare out of funds available,
subject to the terms of any outstanding shares of preferred stock and other
restrictions. In the event of liquidation of the Company, holders of common
stock are entitled to receive, pro rata, all of the assets of the Company
available for distribution, after payment of any liquidation preference to the
holders of outstanding shares of preferred stock. Holders of the shares of
common stock have no conversion or preemptive or other subscription rights and
there are no redemption or sinking fund provisions applicable to the common
stock.
The Company is required to comply with various operating and financial
covenants defined in the agreements governing the warehouse lines of credit,
senior debt, and subordinated debt. The covenants restrict the payment of
certain distributions, including dividends (See Note 8.).
Included in compensation expense for the years ended December 31, 2006,
2005, and 2004, is $244,000, $644,000, and $271,000 related to the amortization
of deferred compensation expense and valuation of stock options.
STOCK PURCHASES
During 2000, the Company's Board of Directors authorized the Company to
purchase up to $5 million of Company securities. In October 2002, the Board of
Directors authorized the purchase of an additional $5 million of outstanding
debt or equity securities. In October 2004, the Board of Directors authorized
the purchase of an additional $5.0 million of outstanding debt or equity
securities. As of December 31, 2006, the Company had purchased $5.0 million in
principal amount of the debt securities, and $9.8 million of its common stock,
representing 3,101,046 shares.
OPTIONS AND WARRANTS
In July 1997, the Company adopted and its shareholders approved the
1997 Long-Term Incentive Plan (the "1997 Plan") pursuant to which the Company's
Board of Directors may grant stock options, restricted stock and stock
appreciation rights to employees, directors or employees of entities in which
the Company has a controlling or significant equity interest. Options that have
been granted under the 1997 Plan have been granted at an exercise price equal to
(or greater than) the stock's fair market value at the date of the grant, with
terms of 10 years and vesting generally over five years. Subsequent amendments
to the 1997 Plan have increased the aggregate maximum 6,900,000 shares.
F-23
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In 2006, the Company adopted and its shareholders approved the CPS 2006
Long-Term Equity Incentive Plan (the "2006 Plan") pursuant to which the
Company's Board of Directors, or a duly-authorized committee thereof, may grant
stock options, restricted stock, restricted stock units and stock appreciation
rights to employees of the Company or its subsidiaries, to directors of the
Company, and to individuals acting as consultants to the Company or its
subsidiaries. The maximum number of shares that may be subject to awards under
the 2006 Plan is 1,500,000. Options that have been granted under the 2006 Plan
have been granted at an exercise price equal to (or greater than) the stock's
fair market value at the date of the grant, with terms of 10 years and vesting
generally over five years.
Effective January 1, 2006, the Company adopted Statement of Financial
Accounting Standards No. 123(R), "Share-Based Payment, revised 2004" ("SFAS
123R"), prospectively for all option awards granted, modified or settled after
January 1, 2006, using the modified prospective method. Under this method, the
Company recognizes compensation costs in the financial statements for all
share-based payments granted subsequent to January 1, 2006 based on the grant
date fair value estimated in accordance with the provisions of SFAS 123(R).
Results for prior periods have not been restated.
For the year ended December 31, 2006, the Company recorded stock-based
compensation costs in the amount of $244,000. As of December 31, 2006,
unrecognized stock-based compensation costs to be recognized over future periods
equaled $3.2 million. This amount will be recognized as expense over a
weighted-average period of 4.6 years.
At December 31, 2006, the aggregate intrinsic value of options
outstanding and exercisable was $12.8 million and $13.2 million, respectively.
The total intrinsic value of options exercised was $2.2 million, $1.3 million,
and $1.6 million for the years ended December 31, 2006, 2005, and 2004,
respectively. New shares were issued for all options exercised during the years
ended December 31, 2006 and 2005. At December 31, 2006, there were a total of
582,131 additional shares available for grant under the 2006 Plan and the 1997
Plan.
Stock option activity for the year ended December 31, 2006 are as
follows:
WEIGHTED
NUMBER OF WEIGHTED AVERAGE
SHARES AVERAGE REMAINING
(IN THOUSANDS) EXERCISE PRICE CONTRACTUAL TERM
----------------- ------------------ -------------------
Options outstanding at the beginning of period 4,864 $ 3.38 N/A
Granted 1,055 6.82 N/A
Exercised (553) 2.77 N/A
Forefeited (14) 5.22 N/A
----------------- ------------------ -------------------
Options outstanding at the end of period 5,352 $ 4.11 7.22 years
================= ================== ===================
Options exercisable at the end of period 4,297 $ 3.45 6.58 years
================= ================== ===================
The per share weighted average fair value of stock options granted
whose exercise price was equal to the market price of the stock on the grant
date during the years ended December 31, 2006, 2005 and 2004, was $3.39, $2.77,
and $2.30, respectively.
The per share weighted average fair value and exercise price of stock
options granted whose exercise price was above the market price of the stock on
the grant date during the year ended December 31, 2005 was $3.61 and $6.00,
respectively. The Company did not issue any stock options above the market price
of the stock during the years ended December 31, 2006 and 2004.
The Company did not issue any stock options with an exercise price
below the market price of the stock on the grant date.
F-24
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On November 17, 1998, in conjunction with the issuance of a $25.0
million subordinated promissory note to an affiliate of LLCP, the Company issued
warrants to purchase up to 3,450,000 shares of common stock at $3.00 per share,
exercisable through November 30, 2005. In April 1999, in conjunction with the
issuance of $5.0 million of an additional subordinated promissory note to an
affiliate of LLCP, the Company issued additional warrants to purchase 1,335,000
shares of the Company's common stock at $0.01 per share to LLCP. As part of the
purchase agreement, the existing warrants to purchase 3,450,000 shares at $3.00
per share were exchanged for warrants to purchase 3,115,000 shares at a price of
$0.01 per share. The aggregate value of the warrants, $12.9 million, which is
comprised of $3.0 million from the original warrants issued in November 1998 and
$9.9 million from the repricing and additional warrants issued in April 1999, is
reported as deferred interest expense to be amortized over the expected life of
the related debt, five years. As of December 31, 2006 and 2005, 1,000 warrants
remained unexercised which expire in April 2009. Such warrants and the 4,449,000
shares of common stock issued, upon the exercise of such warrants, have not been
registered for public sale. However, the holder has the right to require the
Company register the warrants and common stock for public sale in the future.
The Company on August 4, 2005, issued six-year warrants with respect to
272,000 shares of its common stock, in a transaction exempted from the
registration requirements of the Securities Act of 1933 as a transaction not
involving a public offering. The warrants are exercisable at $4.85 per share,
and were issued to the lender's nominee in settlement of a claim against the
Company that arose out of a loan of $500,000 made in September 1998. The Company
and the claimant dispute whether the loan was to the Company or to Stanwich
Financial Services Corp. ("Stanwich"). The Company received in exchange for the
warrants an assignment of the lender's claim in bankruptcy against Stanwich, as
well as a release of all claims against the Company. The Company estimated the
value of the warrants to be $794,000 using a Black-Scholes model, assuming a
risk-free interest rate of 3.41%, a six year life and stock price volatility of
63%. The Company included the value of the warrant, net of a previously recorded
accrual of $500,000, in general & administrative expense for the year ended
December 31, 2005.
F-25
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(10) INTEREST INCOME
The following table presents the components of interest income:
YEAR ENDED DECEMBER 31,
----------------------------------
2006 2005 2004
-------- -------- --------
(IN THOUSANDS)
Interest on Finance Receivables .... $251,609 $163,552 $ 99,701
Residual interest income ........... 5,656 5,338 4,634
Other interest income .............. 6,301 2,944 1,483
-------- -------- --------
Net interest income ................ $263,566 $171,834 $105,818
======== ======== ========
As a result of the uncertainty of collection of the residual assets,
the Company ceased accruing interest on the residual assets from May 2004
through December 2004. In January 2005, the Company resumed accretion of
interest on the residual assets after it determined that there was no longer any
significant uncertainty as to the collection of the assets.
(11) INCOME TAXES
Income taxes consist of the following:
YEAR ENDED DECEMBER 31,
-------------------------------------------------
2006 2005 2004
------------ ------------ ------------
(IN THOUSANDS)
Current:
Federal .......................... $ 19,036 $ 5,340 $ 712
State ............................ 1,193 1,687 862
------------ ------------ ------------
20,229 7,027 1,574
Deferred:
Federal .......................... (9,660) (3,537) (5,859)
State ............................ 4,877 (2,114) (2,282)
Change in valuation allowance .... (41,801) (1,376) 6,567
------------ ------------ ------------
(46,584) (7,027) (1,574)
------------ ------------ ------------
Income tax benefit ........ $ (26,355) $ -- $ --
============ ============ ============
The Company's effective tax expense/(benefit) for the years ended
December 31, 2006, 2005 and 2004, differs from the amount determined by applying
the statutory federal rate of 35% to income (loss) before income taxes as
follows:
YEAR ENDED DECEMBER 31,
----------------------------------------------
2006 2005 2004
----------- ----------- -----------
(IN THOUSANDS)
Expense (benefit) at federal tax rate ............. $ 4,620 $ 1,180 $ (5,561)
State taxes, net of federal income tax benefit .... 5,585 (277) (1,015)
Other adjustments to tax reserve .................. 5,136 -- --
Effect of change in state tax rate ................ 486 -- --
Valuation allowance ............................... (41,801) (1,376) 6,567
Other ............................................. (381) 473 9
----------- ----------- -----------
$ (26,355) $ -- $ --
=========== =========== ===========
F-26
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The tax effected cumulative temporary differences that give rise to
deferred tax assets and liabilities as of December 31, 2006 and 2005 are as
follows:
DECEMBER 31,
------------------------------
2006 2005
------------ ------------
(IN THOUSANDS)
DEFERRED TAX ASSETS:
Finance receivables .................. $ 30,777 $ 20,303
Accrued liabilities .................. 1,297 2,415
Furniture and equipment .............. 524 359
NOL carryforwards and BILs ........... 30,682 34,863
Pension Accrual ...................... -- 1,632
Other ................................ 846 (21)
------------ ------------
Total deferred tax assets ......... 64,126 59,551
Valuation allowance .................. (9,361) (51,162)
------------ ------------
54,765 8,389
------------ ------------
DEFERRED TAX LIABILITIES:
NIRs ................................. -- (857)
Pension Accrual ...................... (96) --
------------ ------------
Total deferred tax liabilities .... (96) (857)
------------ ------------
Net deferred tax asset ............ $ 54,669 $ 7,532
============ ============
As part of the MFN and TFC Mergers, CPS acquired certain net operating
losses and built-in loss assets. Moreover, both MFN and TFC have undergone an
ownership change for purposes of Internal Revenue Code ("IRC") Section 382. In
general, IRC Section 382 imposes an annual limitation on the ability of a loss
corporation (that is, a corporation with a net operating loss ("NOL")
carryforward, credit carryforward, or certain built-in losses ("BILs")) to
utilize its pre-change NOL carryforwards or BILs to offset taxable income
arising after an ownership change. The Company has a valuation allowance of $9.4
million against MFN's deferred tax assets, as it is not more than likely that
these amounts will be realized in the future. The Company has no valuation
allowance against the TFC deferred tax assets, as it is more than likely that
these amounts will be realized in the future.
In determining the possible future realization of deferred tax assets,
the Company considers the taxes paid in the current and prior years that may be
available to recapture as well as future taxable income from the following
sources: (a) reversal of taxable temporary differences; (b) future operations
exclusive of reversing temporary differences; and (c) tax planning strategies
that, if necessary, would be implemented to accelerate taxable income into years
in which net operating losses might otherwise expire. As a result of the
Company's analysis of all available evidence, both positive and negative as of
the end of the fourth quarter of 2006, it was considered more likely than not
that a full valuation allowance for deferred tax assets was not required,
resulting in the reversal of a portion of the valuation allowance previous
recorded against deferred tax assets and generating a $41.8 million tax benefit
recorded in the statement of operations. As of December 31, 2006, we believe it
is more likely than not that the amount of the deferred tax assets recorded on
our balance sheet as a result of the partial release of the valuation allowance
will ultimately be recovered. As of December 31, 2006, a valuation allowance of
approximately $9.4 million remained recorded against the deferred tax assets.
However, should there be a change in our ability to recover our deferred tax
assets, our tax provision would increase in the period in which we determine
that recovery is not more than likely.
As of December 31, 2006, the Company has net operating loss
carryforwards for federal and state income tax purposes of $17.4 million (all of
which is subject to annual IRC 382 limitations) and $20.3 million, respectively,
which are available to offset future taxable income, if any, subject to annual
IRC Section 382 limitations, through 2021 and 2012-2013, respectively.
The statute of limitations on certain of the Company's tax returns are
open and the returns could be audited by the various tax authorities. From time
to time, there may be differences in opinions with respect to the tax treatment
accorded to certain transactions. When, and if, such differences occur and
become probable and estimable, such amounts will be recognized.
F-27
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company's tax returns for the years 2003 and 2004 are currently
under examination by the California Franchise Tax Board. The Company does not
expect that the results of this examination will have a material effect on its
financial condition or results of operations.
(12) RELATED PARTY TRANSACTIONS
LOANS TO OFFICERS TO EXERCISE CERTAIN STOCK OPTIONS
During 2002, the Company's Board of Directors approved a program under
which officers of the Company would be advanced amounts sufficient to enable
them to exercise certain of their outstanding options. Such loans were available
for a limited period of time, and available only to exercise previously repriced
options. The loans bear interest at a rate of 5.50% per annum, and are due in
2007. At December 31, 2006 and 2005, there was $407,000 and $434,000,
respectively outstanding related to these loans. Such amounts have been recorded
as contra-equity within common stock in the Shareholders' Equity section of the
Company's Consolidated Balance Sheet.
(13) COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases its facilities and certain computer equipment under
non-cancelable operating leases, which expire through 2010. Future minimum lease
payments at December 31, 2006, under these leases are due during the years ended
December 31 as follows:
AMOUNT
----------
(IN THOUSANDS)
2007 ............................ $ 3,892
2008 ............................ 2,518
2009 ............................ 452
2010 ............................ 204
----------
Total minimum lease payments .... $ 7,066
==========
Rent expense for the years ended December 31, 2006, 2005 and 2004, was
$3.9 million, $3.4 million, and $3.5 million, respectively.
The Company's facility leases contain certain rental concessions and
escalating rental payments, which are recognized as adjustments to rental
expense and are amortized on a straight-line basis over the terms of the leases.
During 2006, 2005 and 2004, the Company received $194,000, $482,000 and
$385,000, respectively, of sublease income, which is included in occupancy
expense. Future minimum sublease payments totaled $31,000 at December 31, 2006.
LITIGATION
STANWICH LITIGATION. CPS was for some time a defendant in a class
action (the "Stanwich Case") brought in the California Superior Court, Los
Angeles County. The original plaintiffs in that case were persons entitled to
receive regular payments (the "Settlement Payments") under out-of-court
settlements reached with third party defendants. Stanwich Financial Services
Corp. ("Stanwich"), an affiliate of the former chairman of the board of
directors of CPS, 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. At December 31, 2004, CPS was a defendant only
in a cross-claim brought by one of the other defendants in the case, Bankers
Trust Company, which asserted a claim of contractual indemnity against CPS.
CPS subsequently settled the cross-claim of Bankers Trust by payment of
$3.24 million, in February 2005. Pursuant to that settlement, the court has
dismissed the cross-claim, with prejudice.
In November 2001, one of the defendants in the Stanwich Case, Jonathan
Pardee, asserted claims for indemnity against the Company in a separate action,
which is now pending in federal district court in Rhode Island. The Company has
filed counterclaims in the Rhode Island federal court against Mr. Pardee, and
has filed a separate action against Mr. Pardee's Rhode Island attorneys, in the
same court. The litigation between Mr. Pardee and CPS is stayed, awaiting
resolution of an adversary action brought against Mr. Pardee in the bankruptcy
court, which is hearing the bankruptcy of Stanwich.
F-28
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CPS has reached an agreement in principle with the representative of
creditors in the Stanwich bankruptcy to resolve the adversary action. Under the
agreement in principle, CPS would pay the bankruptcy estate $625,000 and abandon
its claims against the estate, while the estate would abandon its adversary
action against Mr. Pardee. A hearing to consider that agreement is scheduled for
March 2007. If approved, CPS expects that the agreement will result in (i)
limitation of its exposure to Mr. Pardee to no more than some portion of his
attorneys fees incurred and (ii) stays in Rhode Island being lifted, causing
those cases to become active again. There can be no assurance as to these
expectations nor as to whether the court will approve the proposed agreement.
The reader should consider that an adverse judgment against CPS in the
Rhode Island case for indemnification, if in an amount materially in excess of
any liability already recorded in respect thereof, could have a material adverse
effect.
OTHER LITIGATION. On June 2, 2004, Delmar Coleman filed a lawsuit in
the circuit court of Tuscaloosa, Alabama, alleging that plaintiff Coleman was
harmed by an alleged failure to refer, in the notice given after repossession of
her vehicle, to the right to purchase the vehicle by tender of the full amount
owed under the retail installment contract. Plaintiff seeks damages in an
unspecified amount, on behalf of a purported nationwide class. CPS removed the
case to federal bankruptcy court, and filed a motion for summary judgment as
part of its adversary proceeding against the plaintiff in the bankruptcy court.
The federal bankruptcy court granted the plaintiff's motion to send the matter
back to Alabama state court. CPS appealed that ruling to the federal district
court. That court ordered the bankruptcy court to decide whether the plaintiff
has standing to pursue her claims and, if standing is found, to reconsider its
remand decision. The matter is currently pending before the bankruptcy court.
Although we believe that we have one or more defenses to each of the claims made
in this lawsuit, no discovery has yet been conducted and the case is still in
its earliest stages. Accordingly, there can be no assurance as to its outcome.
In June 2004, Plaintiff Jeremy Henry filed a lawsuit against the
Company in the California Superior Court, San Diego County, alleging improper
practices related to the notice given after repossession of a vehicle that he
purchased. Plaintiff's motion for a certification of a class has been denied,
and is the subject of an appeal now before the California Court of Appeal.
Irrespective of the outcome of that appeal, as to which there can be no
assurance, the Company has a number of defenses that may dispose of the claims
of plaintiff Henry.
In August and September 2005, two plaintiffs represented by the same
law firm filed substantially identical lawsuits in the federal district court
for the northern district of Illinois, each of which purports to be a class
action, and each of which alleges that CPS improperly accessed consumer credit
information. CPS has reached agreements in principle to settle these cases. One
of the settlements has received final approval from the court and the other has
received preliminary approval. Notice of the settlements has been sent to the
class.
The Company has recorded a liability as of December 31, 2006 that it
believes represents a sufficient allowance for legal contingencies. Any adverse
judgment against the Company, if in an amount materially in excess of the
recorded liability, could have a material adverse effect on the financial
position of the Company. The Company is involved in various other legal matters
arising in the normal course of business. Management believes that any liability
as a result of those matters would not have a material effect on the Company's
financial position.
(14) EMPLOYEE BENEFITS
The Company sponsors a pretax savings and profit sharing plan (the
"401(k) Plan") qualified under Section 401(k) of the Internal Revenue Code.
Under the 401(k) Plan, eligible employees are able to contribute up to 15% of
their compensation (subject to stricter limitation in the case of highly
compensated employees). The Company may, at its discretion, match 100% of
employees' contributions up to $1,500 per employee per calendar year. The
Company's contributions to the 401(k) Plan were $520,000, $439,000 and $409,000
for the year ended December 31, 2006, 2005 and 2004, respectively.
The Company also sponsors the MFN Financial Corporation Pension Plan
("the Plan"). The Plan benefits were frozen June 30, 2001.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting
for Defined Benefit Pension and Other Postretirement Plans - an amendment of
FASB Statements No. 87, 88, 106 and 132(R)" ("SFAS No. 158"). SFAS No. 158
requires an employer that sponsors one or more single-employer defined benefit
plans to (a) recognize the overfunded or underfunded status of a benefit plan in
its statement of financial position, (b) recognize as a component of other
F-29
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
comprehensive income, net of tax, the gains or losses and prior service costs or
credits that arise during the period but are not recognized as components of net
periodic benefit cost pursuant to SFAS No. 87, "Employers' Accounting for
Pensions", or SFAS No. 106, "Employers' Accounting for Postretirement Benefits
Other Than Pensions", (c) measure defined benefit plan assets and obligations as
of the date of the employer's fiscal year-end, and (d) disclose in the notes to
financial statements additional information about certain effects on net
periodic benefit cost for the next fiscal year that arise from delayed
recognition of the gains or losses, prior service costs or credits, and
transition asset or obligation. SFAS No. 158 was adopted by the Company in the
fourth quarter of 2006. The adoption did not have a significant impact on the
Company's financial position or results of operations. The disclosure
requirements of this standard are included herein.
The following tables set forth the plan's benefit obligations, fair
value of plan assets, and amounts recognized at December 31, 2006 and 2005:
DECEMBER 31,
------------------------------
2006 2005
------------ ------------
(IN THOUSANDS)
CHANGE IN PROJECTED BENEFIT OBLIGATION
Projected benefit obligation, beginning of year .... $ 15,799 $ 13,683
Service cost ....................................... -- --
Interest cost ...................................... 876 845
Actuarial (gain) loss .............................. (494) 1,867
Benefits paid ...................................... (725) (596)
------------ ------------
Projected benefit obligation, end of year ....... $ 15,456 $ 15,799
============ ============
The accumulated benefit obligation for the plan was $15.5 million and
$15.8 million at December 31, 2006 and 2005, respectively.
CHANGE IN PLAN ASSETS
Fair value of plan assets, beginning of year .... $ 13,812 $ 13,287
Return on assets ................................ 1,770 973
Employer contribution ........................... 900 207
Expenses ........................................ (61) (59)
Benefits paid ................................... (725) (596)
------------ ------------
Fair value of plan assets, end of year ....... $ 15,696 $ 13,812
============ ============
DECEMBER 31,
--------------------------
2006 2005
---------- ----------
(IN THOUSANDS)
BENEFIT OBLIGATION RECOGNIZED IN OTHER COMPREHENSIVE INCOME
Net loss (gain) ................................................ $ (1,223) $ 2,044
Prior service cost (credit) .................................... -- --
Amortization of prior service cost ............................. -- --
---------- ----------
Net amount recognized in other comprehensive income ......... $ (1,223) $ 2,044
========== ==========
F-30
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ADDITIONAL INFORMATION
Weighted average assumptions used to determine benefit obligations and
cost at December 31, 2006 and 2005 were as follows:
WEIGHTED AVERAGE ASSUMPTIONS USED TO DETERMINE BENEFIT OBLIGATIONS
Discount rate ............................................................... 5.88% 5.50%
WEIGHTED AVERAGE ASSUMPTIONS USED TO DETERMINE NET PERIODIC BENEFIT COST
Discount rate ............................................................... 5.50% 5.50%
Expected return on plan assets .............................................. 8.50% 8.50%
The Company's overall expected long-term rate of return on assets is
8.50% per annum as of December 31, 2006. The expected long-term rate of return
is based on the weighted average of historical returns on individual asset
categories, which are described in more detail below.
DECEMBER 31,
-------------------------
2006 2005
--------- ---------
(IN THOUSANDS)
AMOUNTS RECOGNIZED ON CONSOLIDATED BALANCE SHEET
Other assets ............................................................ $ 240 $ --
Other liabilities ....................................................... -- (1,987)
--------- ---------
Net amount recognized ................................................ $ 240 $ (1,987)
========= =========
AMOUNTS RECOGNIZED IN ACCUMULATED OTHER COMPREHENSIVE INCOME CONSISTS OF:
Net loss (gain) ......................................................... $ 2,838 $ 4,071
Unrecognized transition asset ........................................... -- (10)
--------- ---------
Net amount recognized ................................................ $ 2,838 $ 4,061
========= =========
COMPONENTS OF NET PERIODIC BENEFIT COST
Interest Cost ........................................................... $ 876 $ 845
Expected return on assets ............................................... (1,149) (1,104)
Amortization of transition asset ........................................ (10) (35)
Amortization of net loss ............................................... 179 48
--------- ---------
Net periodic benefit cost ............................................ $ (104) $ (246)
========= =========
UNFUNDED ACCUMULATED BENEFIT OBLIGATION AT YEAR-END
Projected Benefit Obligation ............................................ $ N/A $ 15,799
Accumulated Benefit Obligation .......................................... N/A 15,799
Fair Value of Plan Assets ............................................... N/A 13,812
The weighted average asset allocation of the Company's pension benefits
at December 31, 2006 and 2005 were as follows:
WEIGHTED AVERAGE ASSET ALLOCATION AT YEAR-END
ASSET CATEGORY
Equity securities ........................... 79% 75%
Debt securities ............................. 21% 25%
------ ------
Total .................................... 100% 100%
====== ======
F-31
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CASH FLOWS
EXPECTED BENEFIT PAYOUTS
2007 .............................................. $ 552
2008 .............................................. 604
2009 .............................................. 608
2010 .............................................. 625
2011 .............................................. 699
Years 2012 - 2016 ................................. 4,281
Anticipated Contributions in 2007 ................. $ -
The Company's investment policies and strategies for the pension
benefits plan utilize a target allocation of 70% equity securities and 30% fixed
income securities. The Company's investment goals are to maximize returns
subject to specific risk management policies. The Company addresses risk
management and diversification by the use of a professional investment advisor
and several sub-advisors which invest in domestic and international equity
securities and domestic fixed income securities. Each sub-advisor focuses its
investments within a specific sector of the equity or fixed income market. For
the sub-advisors focused on the equity markets, the sectors are differentiated
by the market capitalization and the relative valuation of the underlying
issuer. For the sub-advisors focused on the fixed income markets, the sectors
are differentiated by the credit quality and the maturity of the underlying
fixed income investment. The investments made by the sub-advisors are readily
marketable and can be sold to fund benefit payment obligations as they become
payable.
(15) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following summary presents a description of the methodologies and
assumptions used to estimate the fair value of the Company's 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 the Company's financial
instruments, active markets do not exist. Therefore, considerable judgments 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 December 31, 2006 and 2005, the
amounts that will actually be realized or paid at settlement or maturity of the
instruments could be significantly different. The estimated fair values of
financial assets and liabilities at December 31, 2006 and 2005, were as follows:
DECEMBER 31,
-------------------------------------------------------
2006 2005
------------------------- -------------------------
CARRYING FAIR CARRYING FAIR
FINANCIAL INSTRUMENT VALUE VALUE VALUE VALUE
----------------------------------------- ---------- ---------- ---------- ----------
(IN THOUSANDS)
Cash and cash equivalents ............... $ 14,215 $ 14,215 $ 17,789 $ 17,789
Restricted cash and equivalents ......... 193,001 193,001 157,662 157,662
Finance receivables, net ................ 1,401,414 1,401,414 913,576 913,576
Residual interest in securitizations .... 13,795 13,795 25,220 25,220
Accrued interest receivable ............. 17,043 17,043 10,930 10,930
Note receivable and accrued interest ... 2,371 2,371 2,178 2,178
Warehouse lines of credit ............... 72,950 72,950 35,350 35,350
Notes payable ........................... 45 45 211 211
Accrued interest payable ................ 3,870 3,870 1,971 1,971
Residual interest financing ............. 31,378 31,378 43,745 43,745
Securitization trust debt ............... 1,442,995 1,441,881 924,026 914,901
Senior secured debt ..................... 25,000 25,000 40,000 40,000
Subordinated renewable notes ............ 13,574 13,574 4,655 4,655
Subordinated debt ....................... -- -- 14,000 14,000
F-32
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CASH, CASH EQUIVALENTS AND RESTRICTED CASH
The carrying value equals fair value.
FINANCE RECEIVABLES, NET
The carrying value approximates fair value because the related interest
rates are estimated to reflect current market conditions for similar types of
instruments.
RESIDUAL INTEREST IN SECURITIZATIONS
The fair value is estimated by discounting future cash flows using
credit and discount rates that the Company believes 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.
NOTE RECEIVABLE
The fair value is estimated by discounting future cash flows using
credit and discount rates that the Company believes reflect the estimated credit
and interest rate risks associated with similar types of instruments.
WAREHOUSE LINES OF CREDIT, NOTES PAYABLE, RESIDUAL INTEREST FINANCING, AND
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 the Company believes reflect the current market rates.
SUBORDINATED DEBT
The fair value is based on a market quote.
(16) LIQUIDITY
Our business requires substantial cash to support purchases of
automobile contracts and other operating activities. Our primary sources of cash
have been cash flows from operating activities, including proceeds from sales of
automobile contracts, amounts borrowed under various revolving credit facilities
(also sometimes known as warehouse credit facilities), servicing fees on
portfolios of automobile contracts previously sold in securitization
transactions or serviced for third parties, customer payments of principal and
interest on finance receivables, fees for origination of automobile contracts,
and releases of cash from securitized portfolios of automobile contracts in
which we have retained a residual ownership interest and from the spread
accounts associated with such pools. Our primary uses of cash have been the
purchases of automobile contracts, repayment of amounts borrowed under lines of
credit and otherwise, operating expenses such as employee, interest, occupancy
expenses and other general and administrative expenses, the establishment of
spread accounts and initial overcollateralization, if any, and the increase of
credit enhancement to required levels in securitization transactions, and income
taxes. There can be no assurance that internally generated cash will be
sufficient to meet 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 portfolios and their related spread accounts), the
rate of expansion or contraction in our managed portfolio, and the terms upon
which we are able to purchase, sell, and borrow against automobile contracts.
Net cash provided by operating activities for the years ended December
31, 2006, 2005 and 2004 was $57.1 million, $36.7 million and $10.0 million,
respectively. Cash from operating activities is generally provided by net income
from our operations. The increase in 2006 vs. 2005, and 2005 vs. 2004, is due in
part to our increased net earnings before the significant increase in the
provision for credit losses.
Net cash used in investing activities for the years ended December 31,
2006, 2005 and 2004, was $568.4 million, $411.7 million, and $314.1 million,
respectively. Cash used in investing activities generally relates to purchases
of automobile contracts. Purchases of finance receivables held for investment
were $1,019.0 million, $691.3 million and $506.0 million in 2006, 2005 and 2004,
respectively.
F-33
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Net cash provided by financing activities for the year ended December
31, 2006, was $507.7 million compared with $378.4 million for the year ended
December 31, 2005 and $285.3 million for the year ended December 31, 2004. Cash
used or provided by financing activities is primarily attributable to the
issuance or repayment of debt. We issued $1,003.6 million of securitization
trust debt in 2006 as compared to $662.4 million in 2005 and $474.7 million in
2004.
We purchase automobile contracts from dealers for a cash price
approximating 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. As of December 31, 2006, we had $400 million in warehouse
credit capacity, in the form of two $200 million facilities. One $200 million
facility provides funding for automobile contracts purchased under the TFC
Programs while both warehouse facilities provide funding for automobile
contracts purchased under the CPS Programs. On June 29, 2005, we terminated a
third facility in the amount of $125 million, which we had utilized to fund
automobile contracts under the CPS and TFC Programs.
The first of two warehouse facilities mentioned above is structured to
allow us to fund a portion of the purchase price of automobile contracts by
drawing against a floating rate variable funding note issued by our consolidated
subsidiary Page Three Funding, LLC. This facility was established on November
15, 2005, and expires on November 14, 2007, although it is renewable with the
mutual agreement of the parties. On November 8, 2006 the facility was increased
from $150 million to $200 million and the advance was increased to 83% from 80%
of eligible contracts, subject to collateral tests and certain other conditions
and covenants. Notes under this facility accrue interest at a rate of one-month
LIBOR plus 2.00% per annum. At December 31, 2006, $45.2 million was outstanding
under this facility.
The second of two warehouse facilities is similarly structured to allow
us to fund a portion of the purchase price of automobile contracts by drawing
against a floating rate variable funding note issued by our consolidated
subsidiary Page Funding LLC. This facility was entered into on June 30, 2004. On
June 29, 2005 the facility was increased from $100 million to $125 million and
further amended to provide for funding for automobile contracts purchased under
the TFC programs, in addition to our CPS programs. The available credit under
the facility was increased again to $200 million on August 31, 2005. In April
2006, the terms of this facility were amended to allow advances to us of up to
80% of the principal balance of automobile contracts that we purchase under our
CPS programs, and of up to 70% of the principal balance of automobile contracts
that we purchase under our TFC programs, in all events subject to collateral
tests and certain other conditions and covenants. On June 30, 2006, the terms of
this facility were amended to allow advances to us of up to 83% of the principal
balance of automobile contracts that we purchase under our CPS programs, in all
events subject to collateral tests and certain other conditions and covenants.
Notes under this facility accrue interest at a rate of one-month LIBOR plus
2.00% per annum. The lender has annual termination options at its sole
discretion on each June 30 through 2007, at which time the agreement expires. At
December 31, 2006, $27.8 million was outstanding under this facility.
The balance outstanding under these warehouse facilities generally will
increase as we purchase additional automobile contracts, until we effect a
securitization utilizing automobile contracts warehoused in the facilities, at
which time the balance outstanding will decrease.
We securitized $957.7 million of automobile contracts in four private
placement transactions during the year ended December 31, 2006, as compared to
$674.4 million of automobile contracts in five private placement transactions
during the year ended December 31, 2005. All of these transactions were
structured as secured financings and, therefore, resulted in no gain on sale. In
March 2004, one of our wholly-owned bankruptcy remote consolidated subsidiaries
issued $44.0 million of asset-backed notes secured by its retained interest in
eight term securitization transactions. The notes had an interest rate of 10.0%
per annum and a final maturity in October 2009 and were required to be repaid
from the distributions on the underlying retained interests. In connection with
the issuance of the notes, we incurred and capitalized issuance costs of $1.3
million. We repaid the notes in full in August 2005. In November 2005, we
completed a similar securitization whereby a wholly-owned bankruptcy remote
consolidated subsidiary of ours issued $45.8 million of asset-backed notes
secured by its retained interest in 10 term securitization transactions. These
notes, which bear interest at a blended interest rate of 8.70% per annum and
have a final maturity in July 2011, are required to be repaid from the
distributions on the underlying residual interests. In connection with the
issuance of the notes, we incurred and capitalized issuance costs of $915,000.
F-34
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In December 2006 we entered into a $35 million residual credit facility
that is secured by our retained interests in more recent term securitizations.
This facility, which bears interest at LIBOR plus 6.125%, allows for new
borrowings over a two-year period and then amortizes over a five-year period. At
December 31, 2006, there was $12.2 million outstanding under this facility and
was secured by our retained interests in six term securitization transactions.
Cash released from trusts and their related spread accounts to us
related to the portfolio owned by consolidated subsidiaries for the years ended
December 31, 2006, 2005 and 2004 was $16.5 million, $23.1 million and $21.4
million, respectively. Changes in the amount of credit enhancement required for
term securitization transactions and releases from trusts and their related
spread accounts are affected by the structure of the credit enhancement and the
relative size, seasoning and performance of the various pools of automobile
contracts securitized that make up our managed portfolio to which the respective
spread accounts are related. The trend in our recent securitizations has been
towards credit enhancements that require a lower proportion of spread account
cash and a greater proportion of over-collateralization. This trend has led to
somewhat lower levels of restricted cash and releases from trusts relative to
the size of our managed portfolio.
The acquisition of automobile contracts for subsequent sale in
securitization transactions, and the need to fund spread accounts and initial
overcollateralization, if any, and increase credit enhancement levels when those
transactions take place, results in a continuing need for capital. The amount of
capital required is most heavily dependent on the rate of 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. We may be limited in our
ability to purchase automobile contracts due to limits on our capital. As of
December 31, 2006, we had unrestricted cash on hand of $14.2 million and
available capacity from our warehouse credit facilities of $327.0 million.
Warehouse capacity is subject to the availability of suitable automobile
contracts to serve as collateral and of sufficient cash to fund the portion of
such automobile contracts purchase price not advanced under the warehouse
facilities. Our plans to manage the need for liquidity include the completion of
additional securitizations that would provide additional credit availability
from the warehouse credit facilities, and matching our levels of automobile
contract purchases to our availability of cash. There can be no assurance that
we will be able to complete securitizations on favorable economic terms or that
we will be able to complete securitizations at all. If we are unable to complete
such securitizations, we may be unable to purchase automobile contracts and
interest income and other portfolio related income would decrease.
Our primary means of ensuring that our cash demands do not exceed our
cash resources is to match our levels of automobile contract purchases to our
availability of cash. Our ability to adjust the quantity of automobile contracts
that we purchase and securitize will be subject to general competitive
conditions and the continued availability of warehouse credit facilities. There
can be no assurance that the desired level of automobile contract purchases can
be maintained or increased. 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 only if the amount of credit
enhancement has reached specified levels and/or the delinquency, defaults or net
losses related to the automobile contracts in the pool are below certain
predetermined levels. In the event delinquencies, defaults or net losses on the
automobile contracts exceed such levels, the terms of the securitization: (i)
may require increased credit enhancement to be accumulated for the particular
pool; (ii) may restrict the distribution to us of excess cash flows associated
with other pools; or (iii) in certain circumstances, may permit the insurers to
require the transfer of servicing on some or all of the automobile contracts to
another servicer. There can be no assurance that collections from the related
trusts will continue to generate sufficient cash.
Certain of our securitization transactions and the warehouse credit
facilities contain various financial covenants requiring certain minimum
financial ratios and results. Such covenants include maintaining minimum levels
of liquidity and net worth and not exceeding maximum leverage levels and maximum
financial losses. 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.
The agreements under which we receive periodic fees for servicing
automobile contracts in securitizations are terminable by the respective
insurance companies upon defined events of default, and, in some cases, at the
will of the insurance company. Were an insurance company in the future to
exercise its option to terminate such agreements, such a termination could have
a material adverse effect on our liquidity and results of operations, depending
on the number and value of the terminated agreements. Our note insurers continue
to extend our term as servicer on a monthly and/or quarterly basis, pursuant to
the servicing agreements.
F-35
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(17) SELECTED QUARTERLY DATA (UNAUDITED)
QUARTER QUARTER QUARTER QUARTER
ENDED ENDED ENDED ENDED
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
----------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
2006
Revenues ............................. $ 58,024 $ 67,233 $ 73,713 $ 79,893
Income before income taxes ........... 1,790 2,627 4,265 4,518
Net income ........................... 1,790 2,627 4,265 30,873
Income per share:
Basic ............................. $ 0.08 $ 0.12 $ 0.20 $ 1.43
Diluted ........................... 0.07 0.11 0.18 1.30
2005
Revenues ............................. $ 41,833 $ 47,776 $ 49,374 $ 54,714
Income (loss) before income taxes .... (239) 545 1,398 1,668
Net income (loss) .................... (239) 545 1,398 1,668
Income (loss) per share:
Basic ............................. $ (0.01) $ 0.03 $ 0.06 $ 0.08
Diluted ........................... (0.01) 0.02 0.06 0.07
F-36