Consumer Portfolio Services, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; filed August 8, 2018. Unless noted otherwise, amounts are in U.S. dollars. The company purchases and services auto installment contracts, primarily for subprime borrowers.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Revenue | $99.4 million | $110.1 million | $202.9 million | $217.7 million |
| Interest income | $97.0 million | $107.5 million | $197.9 million | $212.1 million |
| Operating expenses | $94.7 million | $102.1 million | $193.7 million | $201.9 million |
| Income before tax | $4.7 million | $8.0 million | $9.2 million | $15.7 million |
| Net income | $3.2 million | $4.6 million | $6.3 million | $9.1 million |
| Diluted EPS | $0.13 | $0.17 | $0.25 | $0.32 |
Revenue declined 9.7% in Q2 and 6.8% in the first half. Net income declined 30.8% and 30.3%, respectively. Net margin, calculated from reported figures, was approximately 3.2% in Q2 versus 4.2% a year earlier, and 3.1% for the first half versus 4.2%.
- Credit-loss provision fell to $35.5 million in Q2 (down 26.8%) and $76.0 million in the first half (down 20.6%). It applies to receivables not accounted for at fair value; receivables acquired from January 2018 use fair-value accounting and do not carry a separate continuing provision.
- Interest expense increased 8.4% in Q2 to $25.2 million and 8.7% in the first half to $49.2 million. The reported annualized net interest yield fell to 12.5% in Q2 from 14.5%, and to 13.0% in the first half from 14.6%.
- Operating cash flow was $101.3 million for the first half, down from $114.7 million. Investing cash use was $101.0 million versus $133.9 million; financing provided $4.5 million versus $21.1 million. Cash and cash equivalents increased $4.7 million to $17.4 million; restricted cash was $119.9 million.
- At June 30, total assets were $2.441 billion, liabilities $2.251 billion, and shareholders’ equity $189.6 million. Finance receivables measured at fair value were $412.9 million; other net finance receivables were $1.793 billion.
- Debt was approximately $2.224 billion: $2.031 billion securitization trust debt, $137.9 million warehouse lines, $39.3 million net residual-interest financing, and $15.8 million subordinated renewable notes. The company reported $162.1 million of available warehouse borrowings, subject to sufficient eligible collateral; it reported approximately $18.8 million of eligible collateral.
Material changes and operating trends
- Effective January 1, 2018, the company began fair-value accounting for newly acquired receivables. It reported $412.9 million in this category at quarter-end, with a 10.2% Q2 interest yield versus 17.8% on other receivables. Management attributed lower overall interest income partly to these lower-yielding receivables and to lower contract rates and acquisition fees offered to dealers.
- Contract purchases were $214.7 million in Q2 and $425.3 million in the first half, down from $233.9 million and $463.5 million, respectively. The managed portfolio was $2.329 billion at June 30, broadly flat year over year.
- Employee costs rose 12.9% in Q2 and 14.5% in the first half; management cited, in part, the expensing of direct origination costs on fair-value receivables that had previously been deferred. Marketing costs also rose as the company shifted toward more field representatives.
- Delinquencies were 8.7% of the gross servicing portfolio at June 30, compared with 8.3% a year earlier; annualized net charge-offs were 7.9% versus 7.8%. The allowance for credit losses declined to $94.4 million from $109.2 million at year-end 2017.
Outlook, risks, and unusual items
- The filing provides no specific earnings or purchase-volume guidance. Management said purchases must be matched to available capital and that inability to complete securitizations could constrain purchases and reduce portfolio-related income.
- Liquidity depends on securitization access, warehouse financing, customer collections, and releases of excess cash from securitization trusts. Poorer-than-expected delinquencies or losses can restrict those releases. Management warned that internally generated cash may not meet all cash demands and that substantial debt could impair flexibility and increase refinancing and repayment risk.
- All financial covenants were reported in compliance at June 30, 2018. Debt agreements include minimum liquidity and net-worth requirements, leverage limits, and certain cross-default provisions.
- On May 16, the company completed $40.0 million of residual-interest financing at an 8.595% coupon. On July 17, after quarter-end, it completed a $230.3 million asset-backed securitization, with a reported weighted-average note yield of approximately 4.18%.
- Warrants for approximately 2.0 million shares were exercised on July 10, 2018, and 1,999,995 net shares were issued. The filing reports 22,948,687 common shares outstanding as of July 31, compared with 20,962,592 issued and outstanding at June 30.
- The DOJ advised the company in February 2018 that it required no further information and recommended no enforcement action in its inquiry into subprime auto-contract origination and securitization. The company cautioned that other agencies could investigate or the DOJ could resume its inquiry. It estimated reasonably possible losses for legal proceedings and contingencies did not exceed $1 million; ultimate outcomes remain uncertain.
- The company cited the 2014 FTC consent decree and challenges reaching customers by telephone among factors associated with increased extensions. At June 30, 8.7% of the servicing portfolio was delinquent, and 5.9% of average outstanding accounts received extensions monthly in the first half.
- The company adopted ASC 606 and ASC 825 with no material financial-statement effect. Its $31.4 million net deferred tax asset is supported by management’s forecast of future earnings; realization is not assured.
Important facts for investors to verify
- How fair-value accounting and expected credit-loss assumptions affect reported yield, provisions, and comparability with prior periods; fair-value receivables are Level 3 and use unobservable assumptions.
- Whether delinquencies, extensions, and charge-offs worsen, and whether the $94.4 million allowance adequately reflects losses on receivables subject to the allowance methodology.
- Availability of eligible collateral and warehouse capacity, continued access to securitization markets, and the amount of cash ultimately released from securitization trusts.
- Debt service and refinancing capacity, including interest-rate exposure and the terms and performance of the residual-interest financing.
- Post-quarter share count and potential dilution following the warrant exercise, alongside ongoing stock repurchases.
- Updates on legal and regulatory matters, including the DOJ inquiry, FTC-related servicing practices, and the company’s estimated contingent losses.