CONSUMER PORTFOLIO SERVICES, INC. annual report, FY2014

Consumer Portfolio Services, Inc. — FY 2014 Form 10-K

Reporting period: Fiscal year ended December 31, 2014. The filing also reports fourth-quarter results. CPS is a specialty finance company that purchases and services subprime retail auto contracts, funding purchases principally through asset-backed securitizations and warehouse credit facilities.

Financial and operating highlights

Metric20142013
Total revenue$300.3 million$255.8 million, including a $10.9 million debt-cancellation gain; $244.8 million excluding that gain
Interest income$286.7 million$231.3 million
Pre-tax income$52.2 million$37.2 million
Net income$29.5 million$21.0 million
Diluted EPS$0.92$0.67
Net interest margin17.0%16.5%
Net cash from operating activities$135.8 million$99.4 million
Net cash used in investing activities$541.2 million$409.6 million
Net cash from financing activities$401.1 million$319.3 million
  • Fourth-quarter 2014 revenue was $83.5 million, pre-tax income $14.3 million, net income $8.0 million, and diluted EPS $0.25.
  • Contract purchases grew 23.7% to $944.9 million; the managed portfolio rose to $1.644 billion from $1.231 billion. Four 2014 securitizations funded $923.0 million of receivables.
  • Provision for credit losses increased to $108.2 million from $76.9 million. Net charge-offs were 5.8% of average servicing portfolio, up from 4.7%; total delinquencies were 5.5% versus 4.8%, and delinquencies plus repossessions were 7.2% versus 6.8%.
  • At year-end, total debt was approximately $1.684 billion, including $1.598 billion of securitization trust debt. Shareholders’ equity was $127.3 million. Unrestricted cash was $17.9 million; restricted cash was $175.4 million and was not freely available for general use.
  • Warehouse capacity totaled $200 million. Reported undrawn availability was $76.4 million and $66.7 million under the two facilities, subject to eligible collateral. The company was in compliance with its financial covenants at year-end.

Material changes and management commentary

  • Higher portfolio balances drove interest income and revenue growth. Net interest margin improved despite the average yield on interest-earning assets declining to 20.6% from 22.1%; lower funding costs helped, including a decline in the average securitization debt rate to 3.0% from 3.7%.
  • Credit costs rose alongside portfolio expansion. The allowance for finance credit losses increased to $61.5 million from $39.6 million, or 3.7% of contracts held by consolidated subsidiaries versus 3.3%.
  • Employee and general and administrative costs increased as CPS expanded origination, marketing and servicing capacity. Headcount rose to 869 from 705.
  • Cash and cash equivalents decreased by $4.3 million during 2014. Year-end restricted cash included $85.3 million of securitization pre-funding proceeds; the remaining receivables were delivered in January 2015, and most of the released cash was used to repay warehouse borrowings.
  • Management expected quarterly profits during 2015 and planned to continue regular securitizations and align contract purchases with available capital. These are expectations, not guaranteed results; the filing provides no numerical 2015 earnings or purchase-volume guidance.
  • The 2012 net income of $69.4 million included a $60.2 million income-tax benefit from reversing a deferred-tax valuation allowance; this benefit was not recurring. The 2014 net deferred tax asset was $42.8 million, dependent on future taxable income, and state NOLs began expiring in 2015.

Risks, contingencies and unusual items

  • Funding and liquidity: CPS depends on warehouse credit and recurring securitizations. Adverse capital-market conditions, weaker collateral performance or restricted releases of trust cash could constrain purchases, liquidity and earnings. Much of its reported cash is restricted.
  • Credit performance: The subprime portfolio is exposed to borrower defaults, repossession losses, economic weakness and used-vehicle values. Delinquencies, charge-offs and provisions increased in 2014; deterioration can also trap cash in securitization structures.
  • Regulatory and legal matters: The FTC consent decree required approximately $1.9 million in restitution, $1.6 million in customer account adjustments, a $2.0 million federal penalty and procedural changes. In January 2015, the Department of Justice subpoenaed documents concerning origination and securitization practices since 2005; CPS said it was cooperating. The outcome is uncertain.
  • Other legal exposure: CPS was defending two purported class actions, one settled subject to court approval. It estimated additional reasonably possible legal losses above recorded reserves at $0–$1.5 million, while cautioning that actual outcomes could exceed reserves.
  • Regulatory change: New securitization risk-retention requirements were scheduled to take effect in October 2015; whether CPS qualifies for the auto-loan underwriting exception could affect future securitizations. CFPB oversight and potential rule changes may increase costs.
  • Capital structure and shareholder returns: Debt agreements impose financial and operating restrictions, including limits relevant to dividends. CPS had never paid common-stock dividends and did not expect to do so in the foreseeable future.

Important facts for investors to verify

  • Whether rising delinquencies, charge-offs and credit-loss provisions reflect portfolio seasoning, underwriting changes or worsening borrower performance—and how subsequent vintages perform.
  • Whether 2015 securitizations and warehouse renewals proceed on acceptable terms, including the status of the facility whose revolving period was scheduled to end in March 2015.
  • How much cash is unrestricted and available after collateral, covenant and securitization requirements, and whether trust cash releases remain adequate to support growth.
  • The status and potential financial or operational consequences of the DOJ investigation, class actions and FTC consent-decree compliance.
  • The assumptions supporting the $42.8 million deferred tax asset and the company’s forecast of future profitability.
  • Share dilution and equity compensation: year-end options and warrants included 10.8 million potential shares, and 2014 weighted-average diluted shares were 32.0 million versus 25.0 million basic shares.