Consumer Portfolio Services, Inc. — Q2 2017 Form 10-Q
Business context and reporting period
Unaudited results cover the three and six months ended June 30, 2017, compared with the same 2016 periods. CPS purchases and services U.S. automobile installment contracts, primarily for subprime borrowers, and relies on securitizations and warehouse facilities to fund portfolio growth. Unless otherwise noted, dollar amounts below are in millions.
Financial and operating results
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $110.1 | $104.9 | $217.7 | $205.6 |
| Interest income | $107.5 | $101.7 | $212.1 | $198.4 |
| Operating expenses | $102.1 | $92.6 | $201.9 | $181.0 |
| Provision for credit losses | $48.6 | $44.4 | $95.7 | $88.6 |
| Interest expense | $23.2 | $19.7 | $45.3 | $37.5 |
| Income before tax | $8.0 | $12.3 | $15.7 | $24.6 |
| Net income | $4.6 | $7.3 | $9.1 | $14.5 |
| Diluted EPS | $0.17 | $0.25 | $0.32 | $0.49 |
- Net margin was approximately 4.2% for both Q2 and the first half of 2017, down from approximately 6.9% and 7.0%, respectively, a year earlier.
- Net interest income was $84.2 million in Q2 and $166.7 million in the first half. Annualized net interest yield declined to 14.5% from 15.0% in Q2 and to 14.5% from 15.2% for the first half. Management attributed the lower receivables yield to offering dealers lower acquisition fees and requiring slightly lower contract rates on some purchases.
- Six-month operating cash flow was $114.7 million, versus $113.3 million. Investing cash use was $133.9 million, compared with $312.7 million; financing cash provided was $21.1 million, compared with $195.8 million. Cash and equivalents ended at $15.8 million, up from $13.9 million at year-end 2016. Restricted cash was $118.3 million.
- At June 30, total debt was approximately $2.229 billion: $2.082 billion of securitization trust debt, $131.3 million of warehouse lines, and $16.1 million of subordinated renewable notes. Shareholders’ equity was $193.3 million. Reported net finance receivables were $2.207 billion.
- Unrestricted cash was $15.8 million, and available warehouse borrowing capacity was reported at $167 million, subject to sufficient eligible collateral; CPS reported approximately $19.2 million of eligible collateral. The April 2017 renewal extended one $100 million warehouse facility’s revolving period to April 2019.
Material changes versus prior periods
- Q2 revenue rose 4.9% year over year, but operating expenses increased 10.3%; net income fell 37.1%. For the first half, revenue increased 5.9%, expenses rose 11.5%, and net income declined 37.5%.
- Portfolio growth supported higher interest income: average owned receivables were $2.340 billion in Q2, up from $2.217 billion. However, securitization debt interest costs rose; Q2 average securitization debt cost was 3.8% versus 3.3%, and first-half cost was 3.7% versus 3.2%.
- First-half contract purchases fell to $463.5 million from $631.4 million, while the managed portfolio reached $2.343 billion, compared with $2.254 billion at June 2016. First-half share repurchases totaled approximately 1.1 million shares for $5.379 million.
- Annualized net charge-offs increased to 7.8% from 7.2% for the comparable first-half period. At June 30, total delinquencies were 8.4% of the servicing portfolio, versus 7.5% a year earlier; receivables more than 90 days delinquent were $23.9 million, down from $31.2 million.
- Extensions increased: average monthly extensions were 5.6% of average outstanding accounts in the first half, versus 3.3% in first-half 2016. Management considers extensions a loss-mitigation tool.
Outlook, risks, contingencies and other matters
- The filing gives no specific numerical earnings or revenue guidance. Management plans to align contract purchases with available capital and, as appropriate, control operating costs. Its ability to grow depends on securitization access, warehouse funding, cash releases from securitized pools, dealer supply and contract performance.
- Management cites economic conditions, unemployment, interest rates, used-vehicle values, competition, regulation, credit losses and funding availability as factors that could affect results. It warns that poor securitized-pool performance can restrict excess-cash releases and harm liquidity.
- CPS reported compliance with all financial covenants at June 30, 2017. It nevertheless cautioned that substantial debt could constrain flexibility and that sufficient cash flow to service debt is not assured.
- The company continued responding to a 2015 U.S. Department of Justice subpoena concerning subprime contract origination and securitization; it produced documents in July 2017. CPS said it knew of no material developments since the investigation began. Potential damages, fines or claims cannot be ruled out. Management estimated reasonably possible losses for legal proceedings and contingencies at no more than $1 million, while noting the investigation’s eventual impact remains uncertain.
- The 2014 FTC consent decree required servicing-practice changes that management believes contributed to higher delinquencies and extensions. The filing also notes that recognized deferred tax assets of $45.2 million depend on forecast future earnings.
- Disclosure controls were assessed as effective, with no reported material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether credit-loss trends, charge-offs and extension volumes stabilize, and how they affect future provisions and recoveries.
- Whether securitization markets and warehouse facilities remain available on workable terms, and whether eligible collateral supports stated borrowing capacity.
- Whether securitized pools continue releasing cash under their performance tests, given the company’s limited unrestricted cash and high leverage.
- Any material developments in the DOJ investigation or other litigation, and whether legal exposure or reserves change.
- Whether forecast earnings support realization of the $45.2 million deferred tax asset.