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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________ .
COMMISSION FILE NUMBER: 1-11416
CONSUMER PORTFOLIO SERVICES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 33-0459135
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
16355 LAGUNA CANYON ROAD, IRVINE, CALIFORNIA 92618
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER: (949) 753-6800
FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED
SINCE LAST REPORT: N/A
Indicate by check mark whether the registrant (1) filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
As of August 13, 2002, the registrant had 20,401,320 common shares
outstanding.
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CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2002
and December 31, 2001.......................................... 3
Condensed Consolidated Statements of Operations for the
three-month and six-month periods ended June 30, 2002
and 2001 ...................................................... 4
Condensed Consolidated Statements of Cash Flows for the
six-month period ended June 30, 2002 and 2001.................. 5
Notes to Condensed Consolidated Financial Statements.............. 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................... 18
Item 3. Quantitative and Qualitative Disclosure About Market Risk......... 25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................. 26
Item 4. Submission of Matters to a Vote of Security Holders.............. 26
Item 6. Exhibits and Reports on Form 8-K.................................. 27
Signatures................................................................... 28
Item 1. Financial Statements
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share and per share data)
June 30, December 31,
2002 2001
---------- ----------
ASSETS
Cash ............................................. $ 17,086 $ 2,570
Restricted cash .................................. 24,755 11,354
Finance receivables .............................. 181,784 --
Less: Allowance for finance credit losses ........ (42,831) --
---------- ----------
Finance receivables, net ......................... 138,953 --
Servicing fees receivable ........................ 2,139 3,100
Residual interest in securitizations ............. 124,106 106,103
Furniture and equipment, net ..................... 1,991 2,346
Deferred financing costs ......................... 3,010 1,584
Related party receivables ........................ 680 669
Deferred interest expense ........................ 4,032 5,370
Deferred tax assets, net ......................... 1,947 7,429
Other assets ..................................... 16,537 10,679
---------- ----------
$ 335,236 $ 151,204
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Accounts payable and accrued expenses ............ $ 17,557 $ 6,963
Capital lease obligation ......................... 236 476
Notes payable .................................... 1,058 1,590
Securitization trust debt ........................ 115,767 --
Senior secured debt .............................. 65,256 26,000
Subordinated debt ................................ 36,824 36,989
Related party debt ............................... 17,500 17,500
---------- ----------
254,198 89,518
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value;
authorized 5,000,000 shares; none issued ...... -- --
Series A preferred stock, $1 par value;
authorized 5,000,000 shares;
3,415,000 shares issued; none outstanding ..... -- --
Common stock, no par value; authorized
30,000,000 shares; 20,970,579 and
20,551,449 shares issued, 19,701,820
and 19,282,690 shares outstanding at
June 30, 2002 and December 31, 2001,
respectively .................................. 66,467 63,888
Retained earnings ................................ 17,359 189
Deferred compensation ............................ (774) (377)
Treasury stock, 1,268,759 shares at
June 30, 2002 and December 31, 2001,
respectively, at cost ......................... (2,014) (2,014)
---------- ----------
81,038 61,686
---------- ----------
$ 335,236 $ 151,204
========== ==========
See accompanying Notes to Condensed Consolidated Financial Statements.
3
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ---------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Revenues:
Gain on sale of contracts, net ......................... $ 5,095 $ 9,121 $ 6,867 $ 18,492
Interest income ........................................ 14,746 4,299 22,490 9,313
Servicing fees ......................................... 3,376 2,628 6,766 5,208
Other income ........................................... 3,999 272 4,229 632
--------- --------- --------- ---------
27,216 16,320 40,352 33,645
--------- --------- --------- ---------
Expenses:
Employee costs ......................................... 10,972 5,918 19,434 12,870
General and administrative ............................. 5,121 3,799 9,525 6,666
Interest ............................................... 7,217 3,489 11,648 7,758
Marketing .............................................. 1,203 1,804 2,688 3,724
Occupancy .............................................. 1,138 824 1,979 1,593
Depreciation and amortization .......................... 286 245 574 487
--------- --------- --------- ---------
25,937 16,079 45,848 33,098
--------- --------- --------- ---------
Income (loss) before income taxes and
extraordinary item .................................. 1,279 241 (5,496) 547
Income tax expense (benefit) ........................... 540 -- (5,254) 120
--------- --------- --------- ---------
Income (loss) before extraordinary item ................ 739 241 (242) 427
Extraordinary item, unallocated negative goodwill ...... -- -- 17,412 --
--------- --------- --------- ---------
Net income ............................................. $ 739 $ 241 $ 17,170 $ 427
========= ========= ========= =========
Earnings per share:
Basic earnings (loss) per share before
extraordinary item ................................ $ 0.04 $ 0.01 $ (0.01) $ 0.02
Extraordinary item, unallocated negative goodwill .... -- -- 0.89 --
--------- --------- --------- ---------
Basic earnings per share ............................. $ 0.04 $ 0.01 $ 0.88 $ 0.02
========= ========= ========= =========
Diluted earnings (loss) per share before
extraordinary item ................................ $ 0.04 $ 0.01 $ (0.01) $ 0.02
Extraordinary item, unallocated negative goodwill .... -- -- 0.80 --
--------- --------- --------- ---------
Diluted earnings per share ........................... $ 0.04 $ 0.01 $ 0.79 $ 0.02
========= ========= ========= =========
Number of shares used in computing
earnings (loss) per share:
Basic ................................................ 19,418 19,540 19,405 19,558
Diluted .............................................. 21,064 21,222 21,989 21,297
See accompanying Notes to Condensed Consolidated Financial Statements.
4
CONSUMER PORTFOLIO SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Six Months Ended
June 30,
-----------------------
2002 2001
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .......................................... $ 17,170 $ 427
Adjustments to reconcile net income to net cash
provided by operating activities:
Extraordinary gain, excess of assets
acquired over purchase price ................. (17,412) --
Depreciation and amortization ..................... 574 487
Amortization of deferred financing costs .......... 3,209 534
Provision for (recovery of) credit losses ......... 240 (3,092)
NIR gains recognized .............................. (4,500) (5,096)
Loss on sale of fixed asset ....................... 5 --
Deferred stock compensation ....................... 1,908 729
Releases of cash from Trusts to Company ........... 36,068 21,480
Initial deposits to spread accounts ............... (1,273) --
Net deposits to spread accounts ................... (6,700) (13,321)
Increase in receivables from Trusts and
investment in subordinated certificates ........ (9,113) (15,362)
Changes in assets and liabilities:
Restricted cash ................................. 12,098 (1,533)
Purchases of contracts held for sale ............ (256,479) (371,883)
Liquidation of contracts held for sale .......... 307,387 389,584
Other assets .................................... 923 1,677
Accounts payable and accrued expenses ........... (14,031) (908)
Warehouse line of credit ........................ -- (2,003)
Deferred tax asset/liability .................... 190 108
---------- ----------
Net cash provided by operating activities .... 70,264 1,828
CASH FLOWS FROM INVESTING ACTIVITIES:
Net related party receivables ....................... (11) 33
Purchases of furniture and equipment ................ (170) (346)
Purchase of subsidiary, net of cash acquired ........ (29,467) --
---------- ----------
Net cash used in investing activities ........ (29,648) (313)
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in senior secured debt ..................... 46,242 --
Repayment of senior secured debt .................... (6,986) (12,000)
Repayment of subordinated debt ...................... (22,665) (541)
Repayment of capital lease obligations .............. (241) (249)
Repayment of notes payable .......................... (532) (428)
Repayment of related party debt ..................... -- (4,000)
Repayment of securitization trust debt .............. (41,156) --
Payment of financing costs .......................... (1,037) --
Repurchase of common stock .......................... -- (461)
Exercise of options and warrants .................... 275 95
---------- ----------
Net cash used in financing activities ........ (26,100) (17,584)
---------- ----------
Increase (decrease) in cash ............................ 14,516 (16,069)
Cash at beginning of period ............................ 2,570 19,051
---------- ----------
Cash at end of period .................................. $ 17,086 $ 2,982
========== ==========
Supplemental disclosure of cash flow information:
Cash paid (received) during the period for:
Interest ....................................... $ 9,596 $ 5,863
Income taxes ................................... (5,505) 12
Supplemental disclosure of non-cash investing
and financing activities:
Stock compensation ............................... 1,908 729
See accompanying Notes to Condensed Consolidated Financial Statements.
5
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Consumer Portfolio Services, Inc. ("CPS") and its subsidiaries (collectively,
with CPS, the "Company") primarily engage in the business of purchasing, selling
and servicing automobile installment sales finance contracts ("Contracts")
originated by automobile dealers ("Dealers") located throughout the United
States. As of the date of this report the Company is active in 39 states.
Through its purchase of Contracts, the Company provides indirect financing to
Dealer customers with limited credit histories or past credit problems, who
generally would not be expected to qualify for financing provided by banks or by
automobile manufacturers' captive finance companies.
BASIS OF PRESENTATION
The unaudited Condensed Consolidated Financial Statements of the Company have
been prepared in conformity with accounting principles generally accepted in the
United States of America, with the instructions to Form 10-Q and with Article 10
of Regulation S-X of the Securities and Exchange Commission, and include all
adjustments that are, in the opinion of management, necessary for a fair
presentation of the results for the interim periods presented. All such
adjustments are, in the opinion of management, of a normal recurring nature. In
addition, certain items in prior period financial statements have been
reclassified for comparability to current period presentation. Results for the
three-month and six-month periods ended June 30, 2002 are not necessarily
indicative of the operating results to be expected for the full year.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted. These Condensed
Consolidated Financial Statements should be read in conjunction with the
Consolidated Financial Statements and Notes to Consolidated Financial Statements
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2001.
RECENT DEVELOPMENTS
On March 8, 2002, CPS acquired 100 percent of MFN Financial Corporation, a
Delaware corporation ("MFN") and its subsidiaries, by the merger (the "Merger")
of CPS Mergersub, Inc., a Delaware corporation ("Mergersub") and a direct wholly
owned subsidiary of CPS, with and into MFN. The Merger took place pursuant to an
Agreement and Plan of Merger, dated November 18, 2001 (the "Merger Agreement"),
among CPS, Mergersub and MFN. In the Merger, MFN became a wholly owned
subsidiary of CPS. CPS thus acquired the assets of MFN, consisting principally
of interests in automobile installment sales finance Contracts and the
facilities for originating and servicing such Contracts. The Merger was
accounted for as a purchase.
RESIDUAL INTEREST IN SECURITIZATION AND GAIN ON SALE OF CONTRACTS
Gain on sale may be recognized on the disposition of Contracts either outright
(as in the Company's flow purchase program, which was terminated in May 2002) or
in securitization transactions. In its securitization transactions, a wholly
owned subsidiary of the Company retains a residual interest in the Contracts
that are sold. The Company's securitization transactions include "term"
securitizations (purchaser holds the Contracts for substantially their entire
term) and "continuous" securitizations (the Contracts sold may be put back to
the Company, and replaced with other Contracts).
The residual interest in term securitizations and the residual interest in the
Contracts sold continuously are reflected in the line item "residual interest in
securitizations" on the Company's Condensed Consolidated Balance Sheet.
The Company's securitization structure has generally been as follows:
6
First, the Company sells a portfolio of Contracts 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 either a grantor trust or an owner trust ("Trust"). The Trust is a
qualifying special purpose entity and is therefore not consolidated in the
Company's Condensed Consolidated Financial Statements. The Trust in turn issues
interest-bearing asset-backed securities (the "Certificates"), generally in a
principal amount equal to the aggregate principal balance of the Contracts. The
Company typically sells these Contracts to the Trust at face value and without
recourse, except that representations and warranties similar to those provided
by the Dealer to the Company are provided by the Company to the Trust. One or
more investors purchase the Certificates issued by the Trust; the proceeds from
the sale of the Certificates are then used to purchase the Contracts from the
Company. The Company may retain subordinated Certificates issued by the Trust.
The Company purchases a financial guaranty insurance policy, guaranteeing timely
payment of principal and interest on the senior Certificates, from an insurance
company (the "Certificate Insurer"). In addition, the Company provides a credit
enhancement for the benefit of the Certificate Insurer and the investors in the
form of an initial cash deposit to an account ("Spread Account") held by the
Trust or in the form of subordinated Certificates, or both. The agreements
governing the securitization transactions (collectively referred to as the
"Securitization Agreements") require that the initial deposits to the Spread
Accounts be supplemented by a portion of collections from the Contracts until
the Spread Accounts reach specified levels, and then maintained at those levels.
The specified levels are generally computed as a percentage of the principal
amount remaining unpaid under the related Certificates. The specified levels at
which the Spread Accounts are to be maintained will vary depending on the
performance of the portfolios of Contracts held by the Trusts and on other
conditions, and may also be varied by agreement among the Company, the SPS, the
Certificate Insurer and the trustee. Such levels have increased and decreased
from time to time based on performance of the portfolios, and have also been
varied by Securitization Agreement. The Securitization Agreements generally
grant the Company the option to repurchase the sold Contracts from the Trust
when the aggregate outstanding balance has amortized to 10% or less of the
initial aggregate balance.
The Company's continuous securitization structure is similar to the above,
except that (i) the SPS that purchases the Contracts pledges the Contracts to
secure promissory notes issued directly by the SPS, (ii) the initial purchaser
of such notes has the right, but not the obligation, to require that the Company
repurchase the Contracts, (iii) the promissory notes are in an aggregate
principal amount of not more than 76% of the aggregate principal balance of the
Contracts, and (iv) no Spread Account is involved. The SPS is a qualifying
special purpose entity and is therefore not consolidated in the Company's
Condensed Consolidated Financial Statements.
At the closing of each securitization, whether a term securitization or a
continuous securitization, the Company removes from its Condensed Consolidated
Balance Sheet the Contracts held for sale and adds to its Condensed Consolidated
Balance Sheet (i) the cash received and (ii) the estimated fair value of the
ownership interest that the Company retains in Contracts sold in the
securitization. That retained interest (the "Residual") consists of (a) the cash
held in the Spread Account, if any, (b) over collateralization, if any, (c)
subordinated Certificates retained, and (d) receivables from 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 Certificates, and certain
expenses. The excess of the cash received and the assets retained by the Company
over the carrying value of the Contracts sold, less transaction costs, equals
the net gain on sale of Contracts recorded by the Company.
The Company allocates its basis in the Contracts between the Certificates and
the Residuals sold and retained based on the relative fair values of those
portions on the date of the sale. The Company recognizes gains or losses
attributable to the change in the fair value of the Residuals, which are
recorded at estimated fair value. 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 and timing of anticipated cash flows released to the Company (the cash
out method), using a discount rate that the Company believes is appropriate for
the risks involved and estimating the value of the Company's optional right to
repurchase receivables pursuant to the terms of the Securitization Agreements.
The Company estimates the value of its optional right to repurchase receivables
pursuant to the terms of the Securitization Agreements primarily based on its
estimate of the amount and timing of anticipated cash flows to be released from
existing receivables then outstanding and from previously charged off
receivables repurchased, using a discount rate that the Company believes is
appropriate for the risks involved. The Company has used an effective discount
rate of approximately 14% per annum.
The Company receives periodic base servicing fees for the servicing and
collection of the Contracts. In addition, the Company is entitled to the cash
7
flows from the Residuals that represent collections on the Contracts in excess
of the amounts required to pay principal and interest on the Certificates, the
base servicing fees, and certain other fees (such as trustee and custodial
fees). At the end of each collection period, the aggregate cash collections from
the Contracts are allocated first to the base servicing fees and certain other
fees such as trustee and custodial fees for the period, then to the
Certificateholders for interest at the pass-through rate on the Certificates
plus principal as defined in the Securitization Agreements. If the amount of
cash required for the above allocations exceeds the amount collected during the
collection period, the shortfall is drawn from the Spread Account, if 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, the excess
is released to the Company, or in certain cases is transferred to other Spread
Accounts that may be below their required levels. Pursuant to certain
Securitization Agreements, excess cash collected during the period is used to
make accelerated principal paydowns on certain Certificates to create excess
collateral (over-collateralization). If the Spread Account balance is not at the
required credit enhancement level, then the excess cash collected is retained in
the Spread Account until the specified level is achieved. The cash in the Spread
Accounts is restricted from use by the Company. Cash held in the various Spread
Accounts is invested in high quality, liquid investment securities, as specified
in the Securitization Agreements. Spread Account balances are held by the Trusts
on behalf of the Company's SPS as the owner of the Residuals.
The annual percentage rate payable on the Contracts is significantly greater
than the pass-through rate on the Certificates. Accordingly, the Residuals
described above are a significant asset of the Company. In determining the value
of the Residuals described above, the Company must estimate the future rates of
prepayments, delinquencies, defaults and default loss severity, and the value of
the Company's optional right to repurchase receivables pursuant to the terms of
the Securitization Agreements, as all of these factors affect the amount and
timing of the estimated cash flows. The Company estimates prepayments by
evaluating historical prepayment performance of comparable Contracts. The
Company has used prepayment estimates of approximately 20% to 26% cumulatively
over the lives of the related Contracts. The Company estimates defaults and
default loss severity using available historical loss data for comparable
Contracts and the specific characteristics of the Contracts purchased by the
Company. The Company estimates recovery rates of previously charged off
receivables using available historical recovery data and projected future
recovery levels. In valuing the Residuals, the Company estimates that gross
losses as a percentage of the original principal balance will approximate 12% to
20% cumulatively over the lives of the related Contracts, with recovery rates
approximating 2% to 6%.
In future periods, the Company will recognize additional revenue from the
Residuals if the actual performance of the Contracts is better than the original
estimate, or the Company would increase the estimated fair value of the
Residuals. If the actual performance of the Contracts were worse than the
original estimate, then a downward adjustment to the carrying value of the
Residuals would be required. The authoritative accounting standard setting
bodies are currently deliberating the consolidation of non-qualifying special
purpose entities and the accounting treatment for various off-balance sheet
financing transactions. The effect of such deliberations may require the Company
to treat its securitizations differently. However, the outcome of such
deliberations is currently unknown.
The Certificateholders and the related securitization Trusts have no recourse to
the Company for failure of the Contract obligors to make payments on a timely
basis. The Company's Residuals, however, are subordinate to the Certificates
until the Certificateholders are fully paid.
NEW ACCOUNTING PRONOUNCEMENTS
On April 30, 2002, the Financial Accounting Standards Board ("FASB") issued
Statement on Financial Accounting Standards No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" ("SFAS 145"). This statement updates, clarifies and simplifies
existing accounting pronouncements. SFAS 145 rescinds Statement on Financial
Accounting Standards 4, which required all gains and losses from extinguishment
of debt to be aggregated and, if material, classified as an extraordinary item,
net of related income tax effect. As a result, the criteria in Accounting
Pronouncements Board Opinion 30 will now be used to classify those gains and
losses. Statement on Financial Accounting Standards 64 amended Statement on
Financial Accounting Standards 4, and is no longer necessary because Statement
on Financial Accounting Standards 4 has been rescinded. Statement on Financial
Accounting Standards 44 was issued to establish accounting requirements for the
effects of transition to the provisions of the Motor Carrier Act of 1980.
Because the transition has been completed, Statement on Financial Accounting
Standards 44 is no longer necessary. SFAS 145 amends Statement on Financial
Accounting Standards 13 to require that certain lease modifications that have
economic effects similar to sale-leaseback transactions be accounted for in the
same manner as sale-leaseback transactions. This amendment is consistent with
the FASB's goal of requiring similar accounting treatment for transactions that
have similar economic effects.
8
In July 2002, FASB issued SFAS No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities," addresses financial accounting and reporting for
costs associated with exit or disposal activities. SFAS 146 nullifies Emeging
Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring) ("Issue 94-3")." The principal difference
between SFAS 146 and Issue 94-3 relates to the recognition of a liability for a
cost associated with an exit or disposal activity. SFAS 146 requires that a
liability be recognized for those costs only when the liability is incurred,
that is, when it meets the definition of a liability in the FASB's conceptual
framework. In contrast, under Issue 94-3, a company recognized a liability for
an exit cost when it committed to an exit plan. SFAS 146 also establishes fair
value as the objective for initial measurement of liabilities related to exit or
disposal activities. Thus, the SFAS affirms the FASB view that fair value is the
most relevant and faithful representation of the economics of a transaction. The
Company has not determined what effect the adoption of SFAS No. 146 on January
1, 2003 will have.
(2) MFN FINANCIAL CORPORATION ACQUISITION
MFN, through its primary operating subsidiary, Mercury Finance Company LLC, was
in the business of purchasing automobile installment sales finance Contracts
from Dealers, and securitizing and servicing such Contracts. CPS intends to
continue to use the assets acquired in the Merger in the automobile finance
business, but a portion of such assets will be disposed of.
CPS has ceased to use the acquired assets for the purchase of automobile
installment sales finance Contracts, and may or may not recommence such use. In
connection with the termination of MFN origination activities and the
integration and consolidation of certain activities, which are expected to be
completed by year end, the Company has 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. These costs include the following:
MARCH 8, 2002
-------------
(IN THOUSANDS)
Severance payments and consulting contracts.......................... $ 3,215
Facilities closures.................................................. 2,152
Termination of contracts, leases, services and other obligations..... 597
Acquisition expenses accrued but unpaid.............................. 250
----------
Total liabilities assumed............................ $ 6,214
==========
$4.2 million of these costs remain unpaid at June 30, 2002.
Upon effectiveness of the Merger, each outstanding share of common stock of MFN
converted into the right to receive $10.00 per share in cash. The total Merger
consideration payable to stockholders of MFN was approximately $99.9 million.
The amount of such consideration was agreed to as the result of arms'-length
negotiations between CPS and MFN. The aggregate purchase price, including
expenses related to the transaction, was approximately $123.2 million.
Acquisition financing was provided to CPS by Westdeutsche Landesbank
Girozentrale, New York Branch ("WestLB") and Levine Leichtman Capital Partners
II, L.P ("LLCP"). CPS obtained acquisition financing from LLCP through its
issuance and sale of certain senior secured notes to LLCP in the aggregate
principal amount of $35 million.
The Company's Condensed Consolidated Balance Sheet and Condensed Consolidated
Statement of Operations as of and for the three months and the six months ended
June 30, 2002 include the balance sheet accounts of MFN Financial Corporation as
of June 30, 2002, and the results of operations for the period subsequent to
March 8, 2002, the Merger date, through June 30, 2002.
The Company has recorded certain preliminary purchase accounting adjustments,
which are based on estimates utilizing available information. Such purchase
accounting adjustments may be refined as additional information becomes
available. In addition, the Company's Condensed Consolidated Statement of
Operations for the six-month period ended June 30, 2002 includes the recognition
9
of an extraordinary gain related to the excess of net assets acquired over
purchase price ("negative goodwill") totaling $17.4 million.
The following table summarizes the estimated fair value of the assets acquired
and liabilities assumed at the date of acquisition.
MARCH 8, 2002
-------------
(IN THOUSANDS)
Cash.......................................................... $ 93,782
Restricted cash............................................... 25,499
Finance Contracts, net........................................ 186,554
Residual interest in securitizations.......................... 32,485
Other assets.................................................. 12,006
------------
Total assets acquired................................. 350,326
------------
Securitization trust debt..................................... 156,923
Subordinated debt............................................. 22,500
Accounts payable and other liabilities........................ 30,242
------------
Total liabilities assumed............................. 209,665
------------
Net assets acquired................................... 140,661
Less: purchase price.................................. 123,249
------------
Excess of net assets acquired over purchase price..... $ 17,412
============
The unaudited pro forma combined results of operations presented below do not
reflect future events that may occur after the Merger. The Company believes that
operating expense savings between Consumer Portfolio Services, Inc. and MFN will
be realized after the Merger. However, for purposes of unaudited pro forma
combined results of operations presented below, such savings have not been
reflected because the Company cannot give assurances that they will be realized.
Selected unaudited pro forma combined results of operations for the three-month
and six-month periods ending June 30, 2002 and 2001, assuming the Merger
occurred on January 1, 2002 and 2001, are as follows:
THREE MONTHS
ENDED JUNE 30,
------------------------
2002 2001
----------- -----------
(IN THOUSANDS)
Total revenue........................................................... $ 27,216 $ 46,673
Net earnings before Merger-related expenses and extraordinary item...... 739 2,981
Extraordinary item...................................................... -- --
Net earnings............................................................ 739 2,981
Basic net earnings per share before Merger-related expenses and
extraordinary item................................................... $ 0.04 $ 0.15
Extraordinary item...................................................... -- --
----------- -----------
Basic net earnings per share............................................ 0.04 0.15
=========== ===========
Diluted net earnings per share before Merger-related expenses and
extraordinary item................................................... $ 0.04 $ 0.15
Extraordinary item...................................................... -- --
----------- -----------
Diluted net earnings per share.......................................... 0.04 0.15
=========== ===========
10
SIX MONTHS
ENDED JUNE 30,
--------------
2002 2001
----------- -----------
(IN THOUSANDS)
Total revenue ......................................................................... $ 57,755 $ 97,096
Net earnings before Merger-related expenses and extraordinary item .................... (8,833) 6,113
Extraordinary item .................................................................... 17,412 --
Net earnings .......................................................................... 8,579 6,113
Basic net earnings per share before Merger-related expenses and extraordinary item..... $ (0.46) $ 0.31
Extraordinary item .................................................................... 0.89 --
----------- -----------
Basic net earnings per share .......................................................... $ 0.43 $ 0.31
=========== ===========
Diluted net earnings per share before Merger-related expenses and extraordinary item .. $ (0.39) $ 0.30
Extraordinary item .................................................................... .80 --
----------- -----------
Diluted net earnings per share ........................................................ $ 0.41 $ 0.30
=========== ===========
(3) FINANCE CONTRACTS
The following table presents the components of Finance Contracts, net of
unearned income:
JUNE 30, 2002
-------------
(IN THOUSANDS)
Sales finance Contracts
Automobile
Simple interest ........................................ $ 90,044
Precompute or "Rule of 78's", net of unearned income ... 91,059
----------
Total automobile, net of unearned income ............ 181,103
Non-automobile net of unearned income ..................... 506
----------
Total sales finance contracts, net of unearned income ..... 181,609
Direct loans, net of unearned income ...................... 175
----------
Finance Contracts, net of unearned income ................. $ 181,784
==========
The following table presents the contractual maturities of Finance Contracts,
net of unearned income as of June 30, 2002:
AMOUNT %
---------- -------
(DOLLARS IN THOUSANDS)
Due within one year ..................... $ 32,953 18.1%
Due within two years .................... 69,632 38.3
Due within three years .................. 62,180 34.2
Due after three years ................... 17,019 9.4
---------- -------
Total ............................... $ 181,784 100.0%
========== =======
11
The following table presents a summary of the activity for the allowance for
credit losses, for the six-month period ended June 30, 2002:
JUNE 30, 2002
--------------
(IN THOUSANDS)
Balance at beginning of period.......................................... $ --
Addition to allowance for credit losses due to acquisition of MFN....... 59,261
Net charge offs......................................................... (15,137)
Net amount transferred from reserve for repossessed assets.............. (1,293)
--------------
Balance at end of period................................................ $ 42,831
==============
(4) RESIDUAL INTEREST IN SECURITIZATIONS
The following table presents the components of the residual interest in
securitizations:
JUNE 30, DECEMBER 31,
2002 2001
--------- ---------
(IN THOUSANDS)
Cash, commercial paper, United States government
securities and other qualifying investments
(Spread Account) ............................... $ 15,865 $ 43,960
Receivables from Trusts ........................... 31,022 28,874
Over collateralization ............................ 68,178 21,377
Investment in subordinated certificates ........... 9,041 11,892
--------- ---------
Residual interest in securitizations .............. $124,106 $106,103
========= =========
The following table presents estimated remaining undiscounted credit losses
included in the estimated fair value of the residual interest in securitizations
as a percentage of the Company's servicing portfolio subject to recourse
provisions:
JUNE 30, DECEMBER 31,
2002 2001
---------- ----------
(IN THOUSANDS)
Undiscounted estimated credit losses................. $ 42,613 $ 16,210
========== ==========
Servicing subject to recourse provisions............. $ 372,617 $ 281,493
========== ==========
Undiscounted estimated credit losses as percentage
of servicing subject to recourse provisions....... 11.44% 5.76%
========== ==========
During the three-month and six-month periods ended June 30, 2002, the Company
sold approximately $72.6 million and $75.0 million of Contracts, respectively,
excluding Contracts sold on a flow basis. Such sales resulted in an increase to
receivables from the Company's trusts ("Trusts") and over collateralization of
$23.5 million for the three-month period ended June 30, 2002, of which $4.4
million was net interest receivables ("NIRs"), and an increase to receivables
from Trusts and over collateralization of $24.2 million for the six-month period
ended June 30, 2002, of which $4.5 million was NIRs. Such NIRs are included as a
component of gain on sale of Contracts. See Note 7.
On March 8, 2002, CPS (through a subsidiary) sold automobile installment sales
finance Contracts to CPS Auto Receivables Trust 2002-A in a securitization
transaction, retaining a residual interest therein. In this transaction,
qualified institutional buyers purchased $45.65 million of notes backed by
automotive Contracts that were originated by Consumer Portfolio Services. The
Notes, issued by CPS Auto Receivables Trust 2002-A, consist of two classes:
$26.5 million of 3.741% Class A-1 Notes, and $19.15 million of 4.814% Class A-2
Notes. The value of the residual was $5.1 million at June 30, 2002. The key
assumptions used in determining the value were discount rate of 14%, prepayment
speed of 21.4%, and credit losses of 12%.
12
(5) NOTES PAYABLE TO SECURITIZATION TRUST
On June 28, 2001, MFN issued $301 million of notes secured by automobile sales
finance Contracts (the "Securitized Notes") in a private placement (the "Secured
Financing Agreement"). The issuance was completed through the MFN Auto
Receivables Trust 2001-A of MFN Securitization LLC, a wholly owned subsidiary of
Mercury Finance Company LLC. MFN Securitization LLC is a special purpose company
that holds certain automobile sales finance Contracts of the Company and
borrowed funds under the Secured Financing Agreement. MFN Securitization LLC
paid the borrowed funds to Mercury Finance Company LLC in consideration for the
transfer of certain automobile sales finance Contracts. Both classes of the
Securitized Notes issued under the Secured Financing Agreement bear a fixed rate
of interest until their final distribution. While MFN Securitization LLC is
included in the Company's Condensed Consolidated Financial Statements, it is a
separate legal entity. The automobile sales finance Contracts and other assets
held by MFN Securitization LLC are legally owned by MFN Securitization LLC and
are not available to creditors of the Company or its subsidiaries. Interest
payments on the Securitized Notes are payable monthly, in arrears, based on the
respective notes' interest rates. The following table presents the Company's
Securitized Notes outstanding and their stated interest rates at June 30, 2002
(dollars in thousands):
Outstanding Stated Final Scheduled
Principal Interest Rate Distribution Date (1)
----------- ------------- ---------------------
Class A-1 Notes $ -- 4.05125% July 15, 2002
-----------
Class A-2 Notes 115,767 5.07000% July 15, 2007
-----------
Total principal outstanding $ 115,767
===========
(1) Payment in full of the Securitized Notes could occur earlier than the final
scheduled distribution date.
Interest expense on the Securitized Notes is composed of the stated rate of
interest plus additional costs of borrowing. Additional costs of borrowing
include facility fees, insurance and amortization of deferred financing costs.
Deferred financing costs related to the Securitized Notes are amortized in
proportion to the principal distributed to the noteholders. Accordingly, the
effective cost of borrowing of the Securitized Notes is greater than the stated
rate of interest.
The Securitized Notes contain various covenants requiring certain minimum
financial ratios and results. The Company was in compliance with these
covenants, or such covenants have been waived as of the date of this report. The
Company is working with the lenders involved to amend such covenants in order to
eliminate the need for such waivers. The Securitized Notes 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 Securitized Notes. As of
June 30, 2002, restricted cash under the MFN 2001-A Securitization totaled
approximately $13.7 million.
(6) SENIOR SECURED DEBT
In March 2002, the Company and Levine Leichtman Capital Partners II, L.P.,
entered into a series of agreements under which LLCP provided additional funding
to enable the Company to acquire MFN. Under the March 2002 agreements, the
Company borrowed $35 million from LLCP as a "Bridge Note," bearing interest at
13.50% per annum and due February 2003, and approximately $8.5 million as
"Tranche C Note," bearing interest on a deemed principal amount of approximately
$11.2 million at 12.00% per annum and due in March 2008. The Bridge Note
requires principal payments of $2.0 million a month, which began in June 2002,
with a final balloon payment in the amount of $17.0 million in February 2003.
The Tranche C Note repayment schedule is based on the performance of a certain
securitized pool. As the subordinated Certificate of the pool is repaid from the
Trust, principal payments are due on the Tranche C Note. Interest is due monthly
on the Bridge Note and the Tranche C Note. In connection with the March 2002
agreements and the acquisition of MFN, the Company paid LLCP a structuring fee
of $1.75 million and an investment banking fee of $1.0 million, and paid LLCP's
out-of-pocket expenses of approximately $315,000. In addition, the Company paid
LLCP certain other fees and interest amounting to $426,181. The senior secured
debt contains various covenants requiring certain minimum financial ratios and
results. The Company was in compliance with these covenants, as amended, as of
the date of this report.
13
At the time of the Merger, MFN had outstanding $22.5 million in principal amount
of senior subordinated debt, which was due and repaid in full on March 23, 2002.
Such debt bore interest at the rate of 11.00% per annum, payable quarterly in
arrears.
(7) GAIN ON SALE OF CONTRACTS
The following table presents components of net gain on sale of Contracts:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(IN THOUSANDS)
Gain recognized on sale ...................... $ 5,479 $ 6,633 $ 7,131 $ 14,169
Deferred acquisition fees and discounts ...... 1,220 807 1,220 2,088
Expenses related to sales .................... (837) (747) (1,244) (857)
(Provision for) recovery of credit losses .... (767) 2,428 (240) 3,092
--------- --------- --------- ---------
Net gain on sale of contracts ................ $ 5,095 $ 9,121 $ 6,867 $ 18,492
========= ========= ========= =========
(8) INTEREST INCOME
The following table presents the components of interest income:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(IN THOUSANDS)
Interest on Contracts ........................ $ 11,695 $ 349 $ 15,604 $ 1,894
Residual interest income, net ................ 2,935 3,818 6,756 7,152
Other interest income ........................ 116 132 130 267
--------- --------- --------- ---------
Net interest income .......................... $ 14,746 $ 4,299 $ 22,490 $ 9,313
========= ========= ========= =========
(9) EARNINGS (LOSS) PER SHARE
Diluted earnings (loss) per share for the three-month and six-month periods
ended June 30, 2002 and 2001 were calculated using the weighted average number
of shares outstanding for the related period. The following table reconciles the
number of shares used in the computations of basic and diluted earnings (loss)
per share for the three-month and six-month periods ended June 30, 2002 and
2001:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(IN THOUSANDS)
Weighted average number of common shares
outstanding during the period used to
compute basic earnings (loss) per share ... 19,418 19,540 19,405 19,558
Incremental common shares attributable to
exercise of outstanding options and
warrants .................................. 1,646 1,682 1,505 1,739
Incremental common shares attributable to
convertible debt .......................... -- -- 1,079 --
--------- --------- --------- ---------
Number of common shares used to compute
diluted earnings (loss) per share ......... 21,064 21,222 21,989 21,297
========= ========= ========= =========
14
If the anti-dilutive effects of common stock equivalents were not considered,
additional shares included in the diluted earnings per share calculation for the
three-month period ended June 30, 2002 would have included an additional 1.1
million shares attributable to the conversion of certain subordinated debt, for
an aggregate total of approximately 22.2 million diluted shares. Additional
shares included in the diluted loss per share calculation for the three-month
and six-month periods ended June 30, 2001, would have included 1.1 million
shares, respectively, attributable to the conversion of certain subordinated
debt, for an aggregate total of approximately 22.3 million diluted shares for
the three-month period ended June 30, 2001, and 22.4 million diluted shares for
the six-month period ended June 30, 2001.
The assumed conversion of certain subordinated debt during the six-month period
ended June 30, 2002, resulted in an increase to diluted net income for purposes
of the diluted earnings per share calculation of $268,000, representing interest
attributable to the convertible debt that would not have been incurred if the
convertible debt was converted. Diluted net earnings for purposes of the diluted
earnings per share calculation totaled $17.4 million for the six months ended
June 30, 2002.
(10) LIQUIDITY
The Company's business requires substantial cash to support its purchases of
Contracts and other operating activities. The Company's primary sources of cash
have been cash flows from operating activities, including proceeds from sales
ofContracts, amounts borrowed under various revolving credit facilities (also
sometimes known as warehouse credit facilities), servicing fees on portfolios of
Contracts previously sold, customer payments of principal and interest on
Contracts held for sale, fees for origination of Contracts, and releases of cash
from credit enhancements provided by the Company for the financial guaranty
insurer (Certificate Insurer) and Investors, initially made in the form of a
cash deposit to an account (Spread Account), and releases of cash from
securitized pools of Contracts in which the Company has retained a residual
ownership interest. The Company's primary uses of cash have been the purchases
of Contracts, repayment of amounts borrowed under lines of credit and otherwise,
operating expenses such as employee, interest, occupancy expenses and other
general and administrative expenses, the establishment of and further
contributions to "Spread Accounts" (cash posted to enhance credit of securitized
pools), and income taxes. There can be no assurance that internally generated
cash will be sufficient to meet the Company's cash demands. The sufficiency of
internally generated cash will depend on the performance of securitized pools
(which determines the level of releases from Spread Accounts), the rate of
expansion or contraction in the Company's servicing portfolio, and the terms
upon which the Company is able to acquire, sell, and borrow against Contracts.
Net cash provided by operating activities for the six-month periods ended June
30, 2002 and 2001, was $70.3 million and $1.8 million, respectively. On March 8,
2002, the Company completed the acquisition of MFN Financial Corporation (See
Note 2.). The acquisition cost was approximately $123.2 million, and was
substantially funded by existing cash and borrowings. Cash flow from the
underlying purchased assets are expected to provide adequate liquidity to fund
the acquisition borrowings, as well as generate positive cash flows from which
to fund the Company's operating activities.
Net cash used in investing activities for the six-month periods ended June 30,
2002 and 2001, was $29.6 million and $313,000, respectively. Cash flows used in
the acquisition of MFN Financial Corporation, net of the cash acquired in the
transaction, totaled $29.5 million.
Net cash used in financing activities for the six-month periods ended June 30,
2002 and 2001, was $26.1 million and $17.6, respectively. In connection with the
acquisition of MFN Financial Corporation the Company incurred debt related to
the MFN 2001-A Securitization Trust (See Note 5.) and additional senior secured
debt (See Note 6.).
The Company believes that cash flows generated as a result of the acquisition of
MFN Financial Corporation will be sufficient to meet the obligations incurred as
a result of the Merger. There can be no assurance that MFN internally generated
cash will be sufficient to meet such cash demands. The sufficiency of internally
generated cash will depend on the performance of the MFN securitized pools. At
the time of the Merger, MFN had outstanding $22.5 million in principal amount of
15
senior subordinated debt, which was due and repaid in full on March 23, 2002.
Such debt bore interest at the rate of 11.00% per annum, payable quarterly in
arrears.
Contracts are purchased from Dealers for a cash price approximating their
principal amount, and generate cash flow over a period of years. As a result,
the Company has been dependent on warehouse credit facilities to purchase
Contracts, and on the availability of cash from outside sources in order to
finance its continuing operations, as well as to fund the portion of Contract
purchase prices not financed under warehouse credit facilities. During 2001 and
through May 2002, the Company's Contract purchasing program consisted of both
(i) purchases for the Company's own account made on other than a flow basis,
funded primarily by advances under a revolving warehouse credit facility, and
(ii) flow purchases for immediate resale to non-affiliates. Flow purchases allow
the Company to purchase Contracts with minimal demands on liquidity. The
Company's revenues from the resale of flow purchase Contracts, however, are
materially less than those that may be received by holding Contracts to maturity
or by selling Contracts in securitization transactions. During the six-month
period ended June 30, 2002, the Company purchased $181.1 million of Contracts on
a flow basis, and $75.4 million on an other than flow basis for its own account,
compared to $287.2 million and $84.7 million, respectively, of Contracts
purchased in the 2001 period. The Company's flow purchase program terminated in
May 2002.
On March 7, 2002, CPS entered into a new warehouse credit facility. The new
warehouse facility is structured to allow CPS to fund a portion of the purchase
price of automotive Contracts by drawing against a variable funding note issued
by CPS Warehouse Trust, in the maximum amount of $100.0 million. Approximately
76% of the principal balance of Contracts may be advanced to the Company under
that facility, subject to collateral eligibility tests and certain other
conditions and covenants.
The Company securitized $75.0 million of newly originated Contracts during the
six months ended June 30, 2002, resulting in a gain on sale of $4.5 million.
On March 8, 2002, CPS (through a subsidiary) sold automobile installment sales
finance Contracts to CPS Auto Receivables Trust 2002-A in a securitization
transaction, retaining a residual interest therein. In this transaction,
qualified institutional buyers purchased $45.65 million of notes backed by
automotive Contracts that had been originated by Consumer Portfolio Services.
The Notes, issued by CPS Auto Receivables Trust 2002-A, consist of two classes:
$26.5 million of 3.741% Class A-1 Notes, and $19.15 million of 4.814% Class A-2
Notes.
Cash used for subsequent deposits to Spread Accounts for the six-month periods
ended June 30, 2002 and 2001, was $6.7 million and $13.3 million, respectively.
Cash released from Spread Accounts to the Company for the six-month periods
ended June 30, 2002 and 2001, was $36.1 million and $21.5 million, respectively.
Changes in deposits to and releases from Spread Accounts are affected by the
relative size, seasoning and performance of the various pools of Contracts sold
that make up the Company's servicing portfolio to which the respective Spread
Accounts are related. In the March 2002 term securitization transaction the
Company made initial deposits to the related Spread Accounts of $1.3 million. No
such initial deposits were made in the first quarter of 2001, as there were no
term securitizations during the period.
The acquisition of Contracts for subsequent sale in securitization transactions,
and the need to fund Spread Accounts when those transactions take place, results
in a continuing need for capital. The amount of capital required is most heavily
dependent on the rate of the Company's Contract purchases (other than flow
purchases), the required level of initial credit enhancement in securitizations,
and the extent to which the previously established Spread Accounts either
release cash to the Company or capture cash from collections on sold Contracts.
The Company is currently limited in its ability to purchase Contracts due to
certain liquidity constraints. As of June 30, 2002, the Company had cash on hand
of $17.1 million and available Contract purchase commitments from its warehouse
credit facilities of $90.5 million. The Company's plans to manage the need for
liquidity include the completion of additional term securitizations that would
provide additional credit availability from the warehouse credit facilities, and
matching its levels of Contract purchases to its availability of cash. There can
be no assurance that the Company will be able to complete the term
securitizations on favorable economic terms or that the Company will be able to
complete term securitizations at all. If the Company is unable to complete such
securitizations, servicing fees and other portfolio related income would
decrease.
The Company's ability to adjust the quantity of Contracts that it purchases and
sells will be subject to general competitive conditions and the continued
availability of warehouse credit facilities. There can be no assurance that the
desired level of Contract acquisition can be maintained or increased. Obtaining
16
releases of cash from the Spread Accounts is dependent on collections from the
related Trusts generating sufficient cash to maintain the Spread Accounts in
excess of the amended specified levels. There can be no assurance that
collections from the related Trusts will generate cash in excess of the amended
specified levels.
(11) INCOME TAXES
As of December 31, 2001, the Company had deferred tax assets of $10.6 million
and had provided a valuation allowance against these deferred tax assets of $3.2
million. As a result of tax legislation passed during the first quarter of 2002
the Company was able to carryback certain net operating losses to recapture
previously paid taxes totaling $8.3 million. Through June 30, 2002, the Company
had received $5.9 million in cash as a result of this carryback. As a result, in
the first quarter of 2002, the Company eliminated its valuation allowance of
$3.2 million. The Company believes that the current deferred tax asset will more
likely than not be realized due to the reversal of certain deferred tax
liabilities and expected future taxable income. In determining the possible
future realization of deferred tax assets, future taxable income from the
following sources are taken into account: (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. The realization of the net deferred tax asset is dependent on
material improvements over present levels of consolidated pre-tax income. The
majority of the carryforward begins to expire in 2020. Management anticipates
that the Company will earn taxable income in the current year due to significant
increases in Contract originations held for sale, the continuation of
securitization transactions and the acquisition of MFN. Although realization is
not assured, management believes it is more likely than not that the recognized
net deferred tax assets will be realized. The amount of the deferred tax asset
considered realizable, however, could be reduced in the near term if estimates
of future taxable income during the carryforward period are reduced.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Consumer Portfolio Services, Inc. ("CPS," and together with its subsidiaries,
the "Company") is a consumer finance company specializing in the business of
purchasing, selling and servicing automobile installment purchase contracts
("Contracts") originated by licensed automobile dealers ("Dealers") in the sale
of new and used automobiles, light trucks and passenger vans. Through its
purchases, the Company provides indirect financing to Dealer customers with
limited credit histories, low incomes or past credit problems ("Sub-Prime
Customers"). The Company serves as an alternative source of financing for
Dealers, allowing sales to customers who otherwise might not be able to obtain
financing. The Company does not lend money directly to consumers. Rather, it
purchases installment Contracts from Dealers.
CPS was incorporated and began its operations in 1991. From inception through
June 30, 2002 the Company has purchased approximately $4.4 billion of Contracts,
and as of June 30, 2002, had an outstanding servicing portfolio of approximately
$570.7 million. The Company makes the decision to purchase Contracts exclusively
from its headquarters location. The Company services Contracts from regional
centers across the United States.
CREDIT RISK RETAINED
The Company purchases Contracts with the intention of reselling them in
securitizations. In a securitization, the Company sells Contracts to a special
purpose subsidiary, which funds the purchase by sale of asset-backed
interest-bearing securities. At the closing of each securitization, the Company
removes the sold Contracts from its Consolidated Balance Sheet. The Company
remains responsible for collecting payments due under the Contracts, and retains
a residual interest in the sold Contracts. The residual interest represents the
discounted value of what the Company expects will be the excess of future
collections on the Contracts over principal and interest due on the asset-backed
securities. That residual interest appears on the Company's balance sheet as
"Residual interest in securitizations," and its value is dependent on estimates
of the future performance of the sold Contracts. Further, the special purpose
subsidiary may be prohibited from releasing the excess cash to the Company if
the credit performance of the sold Contracts falls short of pre-determined
standards. Such releases represent a material portion of the cash that the
Company uses to fund its operations. An unexpected deterioration in the
performance of sold Contracts could therefore have a material adverse effect on
both the Company's liquidity and its results of operations.
RESULTS OF OPERATIONS
The Company's Condensed Consolidated Balance Sheet and Condensed Consolidated
Statement of Operations as of and for the three months and the six months ended
June 30, 2002 include the balance sheet accounts of MFN Financial Corporation as
of June 30, 2002, and the results of operations for the period subsequent to
March 8, 2002, the Merger date, through June 30, 2002.
THE THREE-MONTH PERIOD ENDED JUNE 30, 2002 COMPARED TO THE THREE-MONTH PERIOD
ENDED JUNE 30, 2001
REVENUES. During the three months ended June 30, 2002, revenues were $27.2
million, an increase of $10.9 million, or 66.8%, from the prior year period
revenue amount of $16.3 million. The primary reason for the increase in revenues
is an increase in interest income, servicing fees and other income, offset by a
decrease in gain on sale of Contracts, net. Gain on sale of Contracts, net,
decreased $4.0 million, or 44.1%, to $5.1 million in the three-month period
ended June 30, 2002, compared to $9.1 million in the year earlier period,
primarily as the result of the termination of the flow purchase program in early
May 2002, and a decrease in recoveries of previously charged off accounts
included with gain on sale.
Interest income for the three-month period ended June 30, 2002 increased $10.4
million, or 243.0%, to $14.7 million in 2002 from $4.3 million in 2001.
Similarly, servicing fees totaling $3.4 million in the three months ended June
30, 2002 increased $748,000, or 28.5%, from $2.6 million in the same period a
year earlier. The increase in interest income and servicing fees can be
attributed to the expansion of the Company's servicing portfolio, primarily as a
result of the MFN Merger. At June 30, 2002, the Company was generating income
and fees on a portfolio with an outstanding principal balance approximating
$570.7 million, compared to a portfolio with an outstanding principal balance
approximating $354.2 million as of June 30, 2001. The volume of Contracts the
Company is currently acquiring, however, is less than the current amortization
of the existing portfolio.
18
The period over period fluctuation in other income can be attributed to
recoveries on previously charged off MFN Contracts totaling $3.4 million.
EXPENSES. The Company's operating expenses consist primarily of personnel costs
and other operating expenses, which are incurred as applications and Contracts
are received, processed and serviced. Factors that affect margins and net income
include changes in the automobile and automobile finance market environments,
macroeconomic factors such as interest rates, and mix of business between
Contracts purchased on a flow basis and Contracts purchased on an other than
flow basis.
Personnel costs include base salaries, commissions and bonuses paid to
employees, and certain expenses related to the accounting treatment of
outstanding warrants and stock options, and are one of the Company's most
significant operating expenses. These costs generally fluctuate with the level
of applications and Contracts processed and serviced, with the mix of revenue
and with overall portfolio performance.
Other operating expenses consist primarily of facilities expenses, telephone and
other communication services, credit services, computer services (including
personnel costs associated with information technology support), professional
services, marketing and advertising expenses, and depreciation and amortization.
Total operating expenses, excluding interest expense related to the Company's
outstanding notes payable and debt, were $18.7 million, or 68.8%, of total
revenues for the second quarter of 2002, as compared with $12.6 million, or
77.1%, of total revenues for the second quarter of 2001.
In connection with the MFN acquisition, management has identified certain
expense savings, which it believes will be achieved through reductions in staff,
consolidation of general and administrative functions, data processing and
elimination of certain duplicate or excess facilities. It is expected to take
approximately nine months from the date of the Merger to realize fully these
expense savings. There can be no assurance that anticipated expense savings will
be achieved in the amounts or at the times anticipated.
Interest expense for the three-month period ended June 30, 2002, increased $3.7
million, or 106.9%, to $7.2 million in 2002, compared to $3.5 million in 2001.
The increase is due to the interest expense resulting from the MFN acquisition,
including interest expense related to acquisition debt and the interest expense
related to the Notes Payable to Securitization Trust. See "Liquidity and Capital
Resources."
Income tax expense of $540,000 has been provided in the 2002 period pursuant to
relevant tax statutes and legislation. In the 2001 period, no income tax expense
was provided.
THE SIX-MONTH PERIOD ENDED JUNE 30, 2002 COMPARED TO THE SIX-MONTH PERIOD ENDED
JUNE 30, 2001
REVENUES. During the six months ended June 30, 2002, revenues were $40.4
million, an increase of $6.7 million, or 19.9%, from the prior year period
revenue amount of $33.6 million. The primary reason for the increase in revenues
is an increase in interest income, servicing fees and other income, offset by a
decrease in gain on sale of Contracts, net. Gain on sale of Contracts, net,
decreased $11.6 million, or 62.9%, to $6.9 million in the six-month period ended
June 30, 2002, compared to $18.5 million in the year earlier period. During the
first quarter of 2002, to prepare for the MFN Merger and related financing
requirements, the Company chose to originate Contracts almost exclusively on a
flow basis, resulting in a significantly lower gain on sale than had the
Contracts been originated for the Company's own account and securitized. In
addition, as a result of revised Company estimates resulting from analyses of
the current and historical performance of certain of the Company's previously
securitized pools, the Company recorded pre-tax charges of approximately $2.5
million in the first quarter of 2002 related to its residual interest in
securitizations. Certain of the Company's older pools related to 1998 and prior
had not performed as originally projected. The Company also recognized a charge
of approximately $500,000 related to a discount realized upon the sale of a
subordinated certificate from the Company's 2002-A securitization. The Company
sold that subordinated certificate to raise funds for the acquisition of MFN.
Interest income for the six-month period ended June 30, 2002 increased $13.2
million, or 141.5%, to $22.5 million in 2002 from $9.3 million in the comparable
2001 period. Similarly, servicing fees totaling $6.8 million in the six months
19
ended June 30, 2002 increased $1.6 million, or 29.9%, from $5.2 million in the
same period a year earlier. The increase in interest income and servicing fees
can be attributed to the expansion of the Company's servicing portfolio,
primarily as a result of the MFN acquisition. At June 30, 2002, the Company was
generating income and fees on a portfolio with an outstanding principal balance
approximating $570.7 million, compared to a portfolio with an outstanding
principal balance approximating $354.2 million as of June 30, 2001.
The period over period fluctuation in other income can be attributed to
recoveries on previously charged off MFN Contracts totaling $3.4 million.
EXPENSES. The Company's operating expenses consist primarily of personnel costs
and other operating expenses, which are incurred as applications and Contracts
are received, processed and serviced. Factors that affect margins and net income
include changes in the automobile and automobile finance market environments,
macroeconomic factors such as interest rates, and mix of business between
Contracts purchased on a flow basis and Contracts purchased on an other than
flow basis.
Personnel costs include base salaries, commissions and bonuses paid to
employees, and certain expenses related to the accounting treatment of
outstanding warrants and stock options, and are one of the Company's most
significant operating expenses. These costs generally fluctuate with the level
of applications and Contracts processed and serviced, with the mix of revenue
and with overall portfolio performance.
Other operating expenses consist primarily of facilities expenses, telephone and
other communication services, credit services, computer services (including
personnel costs associated with information technology support), professional
services, marketing and advertising expenses, and depreciation and amortization.
Total operating expenses, excluding interest expense related to the Company's
outstanding notes payable and debt, were $34.2 million, or 84.8%, of total
revenues for the six months ended June 30, 2002, as compared with $25.3 million,
or 75.3%, of total revenues for the 2001 period.
Interest expense for the six-month period ended June 30, 2002, increased $3.9
million, or 50.1%, to $11.6 million in 2002, compared to $7.8 million in 2001.
The increase is due to the interest expense resulting from the MFN acquisition,
including interest expense related to acquisition debt and the interest expense
related to the Notes Payable to Securitization Trust. See "Liquidity and Capital
Resources."
Income tax benefit of $5.3 million, including the elimination of the valuation
allowance of $3.2 million, was recorded in the 2002 period pursuant to relevant
tax statutes and regulations. In the 2001 period $120,000 of income tax expense
was provided.
The extraordinary gain of $17.4 million results from the Company's acquisition
of MFN Financial Corporation and represents the excess of net assets acquired
over the purchase price paid. See Note 2 of Notes to Condensed Consolidated
Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
The Company's business requires substantial cash to support its purchases of
Contracts and other operating activities. The Company's primary sources of cash
have been cash flows from operating activities, including proceeds from sales of
Contracts, amounts borrowed under various revolving credit facilities (also
sometimes known as warehouse credit facilities), servicing fees on portfolios of
Contracts previously sold, customer payments of principal and interest
onContracts held for sale, fees for origination of Contracts, and releases of
cash from credit enhancements provided by the Company for the financial guaranty
insurer (Certificate Insurer) and Investors, initially made in the form of a
cash deposit to an account (Spread Account), and releases of cash from
securitized pools of Contracts in which the Company has retained a residual
ownership interest. The Company's primary uses of cash have been the purchases
of Contracts, repayment of amounts borrowed under lines of credit and otherwise,
operating expenses such as employee, interest, occupancy expenses and other
general and administrative expenses, the establishment of and further
contributions to "Spread Accounts" (cash posted to enhance credit of securitized
pools), and income taxes. There can be no assurance that internally generated
cash will be sufficient to meet the Company's cash demands. The sufficiency of
internally generated cash will depend on the performance of securitized pools
20
(which determines the level of releases from Spread Accounts), the rate of
expansion or contraction in the Company's servicing portfolio, and the terms
upon which the Company is able to acquire, sell, and borrow against Contracts.
Net cash provided by operating activities for the six-month periods ended June
30, 2002 and 2001, was $70.3 million and $1.8 million, respectively. On March 8,
2002, the Company completed the acquisition of MFN Financial Corporation (See
Note 2 of Notes to Condensed Consolidated Financial Statements.). The
acquisition cost was approximately $123.2 million, and was substantially funded
by existing cash and borrowings. Cash flow from the underlying purchased assets
are expected to provide adequate liquidity to fund the acquisition borrowings,
as well as generate positive cash flows from which to fund the Company's
operating activities.
Net cash used in investing activities for the six-month periods ended June 30,
2002 and 2001, was $29.6 million and $313,000, respectively. Cash flows used in
the acquisition of MFN Financial Corporation, net of the cash acquired in the
transaction, totaled $29.5 million.
Net cash used in financing activities for the six-month periods ended June 30,
2002 and 2001, was $26.1 million and $17.6, respectively. In connection with the
acquisition of MFN Financial Corporation the Company incurred debt related to
the MFN 2001-A Securitization Trust (See Note 5 of Notes to Condensed
Consolidated Financial Statements.) and additional senior secured debt (See Note
6 of Notes to Condensed Consolidated Financial Statements.).
The Company believes that cash flows generated as a result of the acquisition of
MFN Financial Corporation will be sufficient to meet the obligations incurred as
a result of the Merger. There can be no assurance that MFN internally generated
cash will be sufficient to meet such cash demands. The sufficiency of internally
generated cash will depend on the performance of the MFN securitized pools. At
the time of the Merger, MFN had outstanding $22.5 million in principal amount of
senior subordinated debt, which was due and repaid in full on March 23, 2002.
Such debt bore interest at the rate of 11.00% per annum, payable quarterly in
arrears.
Contracts are purchased from Dealers for a cash price approximating their
principal amount, and generate cash flow over a period of years. As a result,
the Company has been dependent on warehouse credit facilities to purchase
Contracts, and on the availability of cash from outside sources in order to
finance its continuing operations, as well as to fund the portion of Contract
purchase prices not financed under warehouse credit facilities. During 2001 and
through May 2002, the Company's Contract purchasing program consisted of both
(i) purchases for the Company's own account made on other than a flow basis,
funded primarily by advances under a revolving warehouse credit facility, and
(ii) flow purchases for immediate resale to non-affiliates. Flow purchases allow
the Company to purchase Contracts with minimal demands on liquidity. The
Company's revenues from the resale of flow purchase Contracts, however, are
materially less than those that may be received by holding Contracts to maturity
or by selling Contracts in securitization transactions. During the six-month
period ended June 30, 2002, the Company purchased $181.1 million of Contracts on
a flow basis, and $75.4 million on an other than flow basis for its own account,
compared to $287.2 million and $84.7 million, respectively, of Contracts
purchased in the 2001 period. The Company's flow purchase program terminated in
May 2002.
On March 7, 2002, CPS entered into a new warehouse credit facility. The new
warehouse facility is structured to allow CPS to fund a portion of the purchase
price of automotive Contracts by drawing against a variable funding note issued
by CPS Warehouse Trust, in the maximum amount of $100.0 million. Approximately
76% of the principal balance of Contracts may be advanced to the Company under
that facility, subject to collateral eligibility tests and certain other
conditions and covenants.
The Company securitized $75.0 million of newly originated Contracts during the
six months ended June 30, 2002, resulting in a gain on sale of $4.5 million.
On March 8, 2002, CPS (through a subsidiary) sold automobile installment sales
finance Contracts to CPS Auto Receivables Trust 2002-A in a securitization
transaction, retaining a residual interest therein. In this transaction,
qualified institutional buyers purchased $45.65 million of notes backed by
automotive Contracts that have been originated by Consumer Portfolio Services.
The Notes, issued by CPS Auto Receivables Trust 2002-A, consist of two classes:
$26.5 million of 3.741% Class A-1 Notes, and $19.15 million of 4.814% Class A-2
Notes.
Cash used for subsequent deposits to Spread Accounts for the six-month periods
ended June 30, 2002 and 2001, was $6.7 million and $13.3 million, respectively.
21
Cash released from Spread Accounts to the Company for the six-month periods
ended June 30, 2002 and 2001, was $36.1 million and $21.5 million, respectively.
Changes in deposits to and releases from Spread Accounts are affected by the
relative size, seasoning and performance of the various pools of Contracts sold
that make up the Company's servicing portfolio to which the respective Spread
Accounts are related. In the March 2002 term securitization transaction the
Company made initial deposits to the related Spread Accounts of $1.3 million. No
such initial deposits were made in the first quarter of 2001, as there were no
term securitizations during the period.
The acquisition of Contracts for subsequent sale in securitization transactions,
and the need to fund Spread Accounts when those transactions take place, results
in a continuing need for capital. The amount of capital required is most heavily
dependent on the rate of the Company's Contract purchases (other than flow
purchases), the required level of initial credit enhancement in securitizations,
and the extent to which the previously established Spread Accounts either
release cash to the Company or capture cash from collections on sold Contracts.
The Company is currently limited in its ability to purchase Contracts due to
certain liquidity constraints. As of June 30, 2002, the Company had cash on hand
of $17.1 million and available Contract purchase commitments from its warehouse
credit facilities of $90.5 million. The Company's plans to manage the need for
liquidity include the completion of additional term securitizations that would
provide additional credit availability from the warehouse credit facilities, and
matching its levels of Contract purchases to its availability of cash.. There
can be no assurance that the Company will be able to complete the term
securitizations on favorable economic terms or that the Company will be able to
complete term securitizations at all. If the Company is unable to complete such
securitizations, servicing fees and other portfolio related income would
decrease.
The Company's ability to adjust the quantity of Contracts that it purchases and
sells will be subject to general competitive conditions and the continued
availability of warehouse credit facilities. There can be no assurance that the
desired level of Contract acquisition can be maintained or increased. Obtaining
releases of cash from the Spread Accounts is dependent on collections from the
related Trusts generating sufficient cash to maintain the Spread Accounts in
excess of the amended specified levels. There can be no assurance that
collections from the related Trusts will generate cash in excess of the amended
specified levels.
The Company's Securitized Notes contain various covenants requiring certain
minimum financial ratios and results. The Company was in compliance with these
covenants, or such covenants have been waived as of the date of this report. The
Company is working with the parties involved to amend such covenants in order to
eliminate the need for such waivers.
CRITICAL ACCOUNTING POLICIES
(a) RESIDUAL INTEREST IN SECURITIZATION AND GAIN ON SALE OF CONTRACTS
Gain on sale may be recognized on the disposition of Contracts either outright
(as in the Company's flow purchase program, which was terminated in May 2002) or
in securitization transactions. In its securitization transactions, a wholly
owned subsidiary of the Company retains a residual interest in the Contracts
that are sold. The Company's securitization transactions include "term"
securitizations (purchaser holds the Contracts for substantially their entire
term) and "continuous" securitizations (the Contracts sold may be put back to
the Company, and replaced with other Contracts).
The residual interest in term securitizations and the residual interest in the
Contracts sold continuously are reflected in the line item "residual interest in
securitizations" on the Company's Condensed Consolidated Balance Sheet.
The Company's securitization structure has generally been as follows:
First, the Company sells a portfolio of Contracts 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 either a grantor trust or an owner trust ("Trust"). The Trust is a
qualifying special purpose entity and is therefore not consolidated in the
Company's Condensed Consolidated Financial Statements. The Trust in turn issues
interest-bearing asset-backed securities (the "Certificates"), generally in a
principal amount equal to the aggregate principal balance of the Contracts. The
Company typically sells these Contracts to the Trust at face value and without
recourse, except that representations and warranties similar to those provided
by the Dealer to the Company are provided by the Company to the Trust. One or
more investors purchase the Certificates issued by the Trust; the proceeds from
the sale of the Certificates are then used to purchase the Contracts from the
Company. The Company may retain subordinated Certificates issued by the Trust.
The Company purchases a financial guaranty insurance policy, guaranteeing timely
payment of principal and interest on the senior Certificates, from an insurance
company (the "Certificate Insurer"). In addition, the Company provides a credit
22
enhancement for the benefit of the Certificate Insurer and the investors in the
form of an initial cash deposit to an account ("Spread Account") held by the
Trust or in the form of subordinated Certificates, or both. The agreements
governing the securitization transactions (collectively referred to as the
"Securitization Agreements") require that the initial deposits to the Spread
Accounts be supplemented by a portion of collections from the Contracts until
the Spread Accounts reach specified levels, and then maintained at those levels.
The specified levels are generally computed as a percentage of the principal
amount remaining unpaid under the related Certificates. The specified levels at
which the Spread Accounts are to be maintained will vary depending on the
performance of the portfolios of Contracts held by the Trusts and on other
conditions, and may also be varied by agreement among the Company, the SPS, the
Certificate Insurer and the trustee. Such levels have increased and decreased
from time to time based on performance of the portfolios, and have also been
varied by Securitization Agreement. The Securitization Agreements generally
grant the Company the option to repurchase the sold Contracts from the Trust
when the aggregate outstanding balance has amortized to 10% or less of the
initial aggregate balance.
The Company's continuous securitization structure is similar to the above,
except that (i) the SPS that purchases the Contracts pledges the Contracts to
secure promissory notes issued directly by the SPS, (ii) the initial purchaser
of such notes has the right, but not the obligation, to require that the Company
repurchase the Contracts, (iii) the promissory notes are in an aggregate
principal amount of not more than 76% of the aggregate principal balance of the
Contracts, and (iv) no Spread Account is involved. The SPS is a qualifying
special purpose entity and is therefore not consolidated in the Company's
Condensed Consolidated Financial Statements.
At the closing of each securitization, whether a term securitization or a
continuous securitization, the Company removes from its Condensed Consolidated
Balance Sheet the Contracts held for sale and adds to its Condensed Consolidated
Balance Sheet (i) the cash received and (ii) the estimated fair value of the
ownership interest that the Company retains in Contracts sold in the
securitization. That retained interest (the "Residual") consists of (a) the cash
held in the Spread Account, if any, (b) over collateralization, if any, (c)
subordinated Certificates retained, and (d) receivables from 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 Certificates, and certain
expenses. The excess of the cash received and the assets retained by the Company
over the carrying value of the Contracts sold, less transaction costs, equals
the net gain on sale of Contracts recorded by the Company.
The Company allocates its basis in the Contracts between the Certificates and
the Residuals sold and retained based on the relative fair values of those
portions on the date of the sale. The Company recognizes gains or losses
attributable to the change in the fair value of the Residuals, which are
recorded at estimated fair value. 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 and timing of anticipated cash flows released to the Company (the cash
out method), using a discount rate that the Company believes is appropriate for
the risks involved and estimating the value of the Company's optional right to
repurchase receivables pursuant to the terms of the Securitization Agreements.
The Company estimates the value of its optional right to repurchase receivables
pursuant to the terms of the Securitization Agreements primarily based on its
estimate of the amount and timing of anticipated cash flows to be released from
existing receivables then outstanding and from previously charged off
receivables repurchased, using a discount rate that the Company believes is
appropriate for the risks involved. The Company has used an effective discount
rate of approximately 14% per annum.
The Company receives periodic base servicing fees for the servicing and
collection of the Contracts. In addition, the Company is entitled to the cash
flows from the Residuals that represent collections on the Contracts in excess
of the amounts required to pay principal and interest on the Certificates, the
base servicing fees, and certain other fees (such as trustee and custodial
fees). At the end of each collection period, the aggregate cash collections from
the Contracts are allocated first to the base servicing fees and certain other
fees such as trustee and custodial fees for the period, then to the
Certificateholders for interest at the pass-through rate on the Certificates
plus principal as defined in the Securitization Agreements. If the amount of
cash required for the above allocations exceeds the amount collected during the
collection period, the shortfall is drawn from the Spread Account, if 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, the excess
is released to the Company, or in certain cases is transferred to other Spread
Accounts that may be below their required levels. Pursuant to certain
Securitization Agreements, excess cash collected during the period is used to
make accelerated principal paydowns on certain Certificates to create excess
collateral (over-collateralization). If the Spread Account balance is not at the
required credit enhancement level, then the excess cash collected is retained in
23
the Spread Account until the specified level is achieved. The cash in the Spread
Accounts is restricted from use by the Company. Cash held in the various Spread
Accounts is invested in high quality, liquid investment securities, as specified
in the Securitization Agreements. Spread Account balances are held by the Trusts
on behalf of the Company's SPS as the owner of the Residuals.
The annual percentage rate payable on the Contracts is significantly greater
than the pass-through rate on the Certificates. Accordingly, the Residuals
described above are a significant asset of the Company. In determining the value
of the Residuals described above, the Company must estimate the future rates of
prepayments, delinquencies, defaults and default loss severity, and the value of
the Company's optional right to repurchase receivables pursuant to the terms of
the Securitization Agreements, as all of these factors affect the amount and
timing of the estimated cash flows. The Company estimates prepayments by
evaluating historical prepayment performance of comparable Contracts. The
Company has used prepayment estimates of approximately 20% to 26% cumulatively
over the lives of the related Contracts. The Company estimates defaults and
default loss severity using available historical loss data for comparable
Contracts and the specific characteristics of the Contracts purchased by the
Company. The Company estimates recovery rates of previously charged off
receivables using available historical recovery data and projected future
recovery levels. In valuing the Residuals, the Company estimates that gross
losses as a percentage of the original principal balance will approximate 12% to
20% cumulatively over the lives of the related Contracts, with recovery rates
approximating 2% to 6%.
In future periods, the Company will recognize additional revenue from the
Residuals if the actual performance of the Contracts is better than the original
estimate, or the Company would increase the estimated fair value of the
Residuals. If the actual performance of the Contracts were worse than the
original estimate, then a downward adjustment to the carrying value of the
Residuals would be required. The authoritative accounting standard setting
bodies are currently deliberating the consolidation of non-qualifying special
purpose entities and the accounting treatment for various off-balance sheet
financing transactions. The effect of such deliberations may require the Company
to treat its securitizations differently. However, the outcome of such
deliberations is currently unknown.
The Certificateholders and the related securitization Trusts have no recourse to
the Company for failure of the Contract obligors to make payments on a timely
basis. The Company's Residuals, however, are subordinate to the Certificates
until the Certificateholders are fully paid.
(b) INCOME TAXES
The Company and its subsidiaries file a consolidated federal income and combined
state franchise tax returns. The Company utilizes the asset and liability method
of accounting for income taxes, under which deferred income taxes are recognized
for the future tax consequences attributable to the differences between the
financial statement values of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred taxes of a change in tax rates is recognized in income in the period
that includes the enactment date. The Company has estimated a valuation
allowance against that portion of the deferred tax asset whose utilization in
future periods is not more than likely.
In determining the possible realization of deferred tax assets, future taxable
income from the following sources are considered: (a) the reversal of taxable
temporary differences, (b) future operations exclusive of reversing temporary
differences, and (c) tax planning strategies that, if necessary, would be
implemented to accelerate taxable income into periods in which bet operating
losses might otherwise expire.
FORWARD LOOKING STATEMENTS
This report on Form 10-Q includes certain "forward-looking statements,"
including, without limitation, the statements or implications to the effect that
(i) gross losses as a percentage of original balances will approximate 12% to
20% cumulatively over the lives of the related Contracts, with recovery rates
approximating 2% to 6%, (ii) that the Company believes it will achieve operating
expense savings or synergies in connection with the Merger, and (iii) that
management anticipates that the Company will earn taxable income during the
current year. 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 gross losses 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
24
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 operating expense savings include the ability of Company staff to perform
tasks previously performed by others, and the real estate markets in regions in
which the Company may close facilities. 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 sell Contracts once
acquired. Factors that could affect the Company's expenses in the current year
include those that affect its ability to achieve expense savings, identified
above, competitive conditions in the market for qualified personnel, and
interest rates (which affect the rates that the Company pays on Certificates
issued in its securitizations).
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
INTEREST RATE RISK
Although the Company utilized its warehouse line and completed a term
securitization during the six months ended June 30, 2002 the structures did not
lend themselves to some of the strategies the Company has used in the past to
minimize interest rate risk, as described below. Specifically, the rate on the
Certificates issued by the revolving note purchase facility is adjustable and
there is no pre-funding component to the revolving note purchase facility. The
Company does intend to issue fixed rate Certificates and to include pre-funding
structures for future term securitization transactions, whereby the amount of
asset-backed securities 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 asset-backed securities
outstanding, the amount as to which there can be no assurance. In addition, the
Contracts the Company does purchase and securitize have fixed rates of interest,
while the Company's interest expense related to the current note purchase
facility is based on a variable rate. The Company's term securitization
facilities have had fixed rates of interest. Therefore, some of the strategies
the Company has used in the past to minimize interest rate risk do not currently
apply.
The Company is subject to market risks due to fluctuations in interest rates
primarily through its outstanding indebtedness and to a lesser extent its
outstanding interest earning assets, and commitments to enter into new
Contracts. The table below outlines the carrying values and estimated fair
values of such indebtedness:
JUNE 30, DECEMBER 31,
2002 2001
---------------------- ----------------------
CARRYING FAIR CARRYING FAIR
FINANCIAL INSTRUMENT VALUE VALUE VALUE VALUE
-------------------- ---------- ---------- ---------- ----------
(IN THOUSANDS)
Finance Contracts, Net................ $ 181,784 $ 181,784 $ -- $ --
Notes payable......................... 1,058 1,058 1,590 1,590
Securitization trust debt............. 115,767 115,767 -- --
Senior secured debt................... 65,256 65,256 26,000 26,000
Subordinated debt..................... 36,824 30,612 36,989 24,791
Related party debt.................... 17,500 14,787 17,500 11,974
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 and do not reflect amounts of which amounts outstanding could be
25
settled by the Company, the amounts that will actually be realized or paid at
settlement or maturity of the instruments could be significantly different.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The information provided under the caption "Legal Proceedings" in the Company's
annual report on Form 10-K for the year ended December 31, 2001, is incorporated
herein by reference. That description states that the Company is a defendant in
a class action (the "Stanwich Case") now pending in California state court, and
that various defendants in the Stanwich Case have asserted cross claims against
the Company for equitable and contractual indemnity, interference with contract
and attorneys fees, which cross claims have been stayed pursuant to an order
issued by the California court in December 2001. One of the defendants in the
Stanwich Case, Jonathan Pardee, has asserted claims for indemnity against the
Company in a separate action now pending in federal district in Rhode Island.
Pardee's claims are not stayed, and the Company has filed counterclaims in the
Rhode Island federal court against Mr. Pardee.
Other than as described above, no material developments have taken place in the
litigation described therein.
The Company is routinely involved in various legal proceedings resulting from
its consumer finance activities and practices, both continuing and discontinued.
Among such proceedings are three cases brought against subsidiaries of MFN in
the state of Mississippi, which allege deceptive practices related to various
loans and the related purchase and sale of insurance, and seek unspecified
damages. The Company believes that there are substantive legal defenses to such
claims, and intends to defend them vigorously. There can be no assurance,
however, as to the outcome.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of shareholders of the Company was held on June 21, 2002.
At the meeting, each of the six nominees to the Board of Directors was elected
for a one-year term by the shareholders, with votes cast as follows:
NOMINEE VOTES FOR VOTES WITHHELD
------- --------- --------------
Charles E. Bradley, Jr. 18,079,528 19,985
Thomas L. Chrystie 18,079,528 19,985
John E. McConnaughy, Jr. 18,079,528 19,985
John G. Poole 18,079,528 19,985
William B. Roberts 18,079,528 19,985
Daniel S. Wood 18,079,528 19,985
The shareholders also approved each other proposal placed before the annual
meeting. Such proposal was were (i) ratification of the appointment of KPMG LLP
as independent auditors of the Company for the fiscal year ending December 31,
2002. Votes on such proposals were cast as follows:
Ratification of Selection of
Independent Auditors
For 18,024,268
Against 9,850
Abstain 65,395
Broker Non-votes 0
Total 18,099,513
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) There are no exhibits filed with this report.
(b) During the quarter ended June 30, 2002, the Company filed one report on
Form 8-K/A, dated March 8, 2002. That report in Item 2. disclosed the
acquisition of MFN Financial Corporation in the Merger, and in Item 7. filed
historical financial statements of MFN and pro forma financial information
related to the Merger.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
CONSUMER PORTFOLIO SERVICES, INC.
(Registrant)
Date: August 14, 2002
/s/ CHARLES E. BRADLEY, JR.
-----------------------------------------------
Charles E. Bradley, Jr.
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(Principal Executive Officer)
Date: August 14, 2002
/s/ DAVID N. KENNEALLY
-----------------------------------------------
David N. Kenneally
SENIOR VICE PRESIDENT-- CHIEF FINANCIAL OFFICER
(Principal Financial and Accounting Officer)
28