CPSS

Business Context and Reporting Period

Company: Consumer Portfolio Services, Inc. (CPS)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Three months ended March 31, 2007
Business Overview: CPS is a specialty finance company that purchases and services retail automobile installment sale contracts from licensed dealers, primarily serving sub-prime customers. The company does not currently lend directly to consumers but plans to begin direct lending in 2007. Since the third quarter of 2003, the company has structured securitization transactions as secured financings rather than sales, resulting in the consolidation of assets and liabilities on its balance sheet.

Key Financial Metrics

Liquidity: As of March 31, 2007, the company held $10.4 million in unrestricted cash and had $271.8 million in available capacity under warehouse credit facilities. Total managed portfolio outstanding was $1.727 billion.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 49.1% to $86.5 million, driven primarily by a 47.6% increase in interest income ($80.5 million) due to portfolio expansion. Servicing fees declined 71.9% to $282,000 as the company shifted toward consolidated securitization structures.
• Expense Increases: Total operating expenses rose 44.2% to $81.1 million. The provision for credit losses increased 54.4% to $29.5 million, and interest expense increased 63.6% to $29.5 million, reflecting the larger portfolio of consolidated receivables.
• Profitability: Net income increased 80.5% to $3.2 million, despite higher expenses, due to significant revenue growth and a $2.5 million gain recognized on residual interest in securitizations included in "Other Income."
• Cash Flow: Net cash used in operating activities was $6.0 million, a reversal from the $33.5 million provided in the prior year. This was largely due to an increase in restricted cash holdings related to pre-funding structures for securitizations.

Outlook, Risks, and Management Commentary

• Portfolio Strategy: Management anticipates continuing to structure future securitizations as secured financings, which will further reduce servicing fee revenue from non-consolidated subsidiaries. The company plans to begin direct lending to consumers in 2007.
• Credit Performance: Annualized net charge-offs were 5.1% of the average servicing portfolio for the quarter ended March 31, 2007, compared to 4.8% in the prior year. Total delinquencies (31+ days) represented 2.4% of the gross servicing portfolio.
• Liquidity Management: The company relies on warehouse facilities and term securitizations to fund operations. It currently has two $200 million warehouse facilities. Management notes that cash availability depends on the performance of securitized pools and the ability to complete new securitizations.
• Legal Contingencies:
  • Stanwich Litigation: A proposed settlement agreement to resolve an adversary action in the Stanwich bankruptcy is pending a court hearing scheduled for May 16, 2007. CPS expects to pay $625,000 to the estate. An adverse judgment in excess of recorded liabilities could have a material adverse effect.
  • Other Litigation: Various class actions regarding repossession notices and credit information access are pending or settled. Management believes it has substantive defenses and has recorded sufficient allowances for legal contingencies.
• Accounting Changes: The company adopted FIN 48 (Accounting for Uncertainty in Income Taxes) on January 1, 2007, resulting in a $1.1 million charge to retained earnings.

Investor Verification Checklist

• Credit Loss Trends: Verify the sustainability of the 5.1% annualized net charge-off rate and monitor delinquency trends in the sub-prime portfolio.
• Liquidity Constraints: Confirm the availability of warehouse credit facilities and the ability to execute term securitizations to fund receivable purchases.
• Legal Exposure: Monitor the outcome of the Stanwich bankruptcy settlement hearing and any potential objections to settled class action lawsuits.
• Direct Lending Execution: Assess the company's ability to successfully launch and underwrite direct consumer loans as planned for 2007.
• Restricted Cash Utilization: Review the impact of increasing restricted cash balances ($236.2 million) on overall liquidity and cash flow from operations.