CPSS

Business Context and Reporting Period

Company: Consumer Portfolio Services, Inc. (CPS)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2010
Business Overview: CPS is a specialty finance company that purchases and services retail automobile installment sale contracts ("finance receivables") originated by licensed motor vehicle dealers. The company focuses on providing indirect financing to sub-prime customers (those with limited credit histories, low incomes, or past credit problems). Since January 2008, the company has been reducing its managed portfolio to conserve liquidity due to adverse capital market conditions, though it began gradually increasing contract purchases in late 2009.

Key Financial Metrics

Note: Total debt includes $632.8 million in securitization trust debt, $39.7 million in warehouse lines of credit, $44.3 million in residual interest financing, $27.0 million in senior secured debt, and $21.3 million in subordinated notes.

Material Changes vs. Prior Period

• Revenue Decline: Total revenues for the nine months ended September 30, 2010, decreased by $57.3 million (32.3%) to $119.9 million compared to $177.2 million in the prior year. This was primarily driven by a $58.4 million decrease in interest income due to a smaller portfolio of finance receivables held by consolidated subsidiaries.
• Net Loss Increase: Net loss for the nine months ended September 30, 2010, was $19.3 million, compared to a net loss of $10.8 million in the same period in 2009. The increase in loss is attributed to higher tax valuation allowances and continued operating losses despite expense reductions.
• Expense Reduction: Total operating expenses decreased by $53.4 million (28.4%) to $134.6 million for the nine-month period. This reduction aligns with the shrinking managed portfolio and staff reductions (435 employees in 2010 vs. 489 in 2009).
• Portfolio Size: The total managed portfolio decreased to $843.0 million as of September 30, 2010, from $1,197.3 million as of September 30, 2009.
• Provision for Credit Losses: The provision for credit losses decreased by $24.1 million (48.3%) to $25.7 million for the nine-month period, reflecting the smaller portfolio size, though annualized net charge-offs as a percentage of the average servicing portfolio remained relatively constant.

Guidance, Outlook, Risks, and Contingencies

• Capital Markets and Liquidity: The company faces significant uncertainty regarding access to capital markets. While it successfully completed a re-securitization in September 2010 (its first rated term securitization since 1993 without a financial guaranty), it has no immediate plans for further term securitizations. Liquidity is managed through two credit facilities: a $50 million revolving credit facility with Fortress Credit Corp. and a $50 million term funding facility.
• Covenant Waivers: CPS is currently in violation of certain financial covenants (minimum net worth, maximum leverage, warehouse capacity) for four of its 12 outstanding securitization transactions. The company has obtained temporary waivers from note insurers. Without these waivers, the company would face default premiums and potential diversion of cash flows to spread accounts. There is no assurance these waivers will be extended.
• Rescission Liability: The company discovered it may no longer be permitted to sell renewable unsecured subordinated notes under a 2005 registration statement. Purchasers of notes sold between October 1, 2009, and September 30, 2010 (totaling $4.3 million) may have a statutory right to rescind their purchases, potentially requiring the company to repurchase the notes.
• Legal Proceedings: The company is involved in the "Stanwich Litigation," a class action and related indemnity claims. While a settlement was reached in principle, the bankruptcy court rejected it, and the appeal was denied. The outcome remains uncertain.
• Outlook: Management plans to gradually increase contract purchases to return to profitability, aiming to access lower-cost funding. However, future operations depend heavily on the ability to obtain financing and the performance of the existing portfolio in a weak economic environment.

Key Facts for Investor Verification

• Covenant Compliance: Verify the status of the temporary waivers for financial covenants and the risk of default premiums or servicer termination if waivers are not extended.
• Rescission Liability Exposure: Assess the potential financial impact of the $4.3 million in subordinated notes sold under the potentially invalid registration statement and the likelihood of repurchase demands.
• Liquidity Position: Monitor the utilization of the $50 million Fortress revolving facility and the $50 million term funding facility, as well as the company's ability to generate sufficient cash flow from operations to service its ~$765 million debt load.
• Portfolio Performance: Track delinquency rates and net charge-offs, which have remained elevated (annualized net charge-offs at 9.7% for the nine months ended Sep 30, 2010) despite the shrinking portfolio size.
• Securitization Access: Confirm the company's ability to execute future securitizations without financial guaranty insurance, which has historically been a key component of its financing structure.