CPSS

Business Context and Reporting Period

Company: Consumer Portfolio Services, Inc. (CPS)
Filing Type: Form 10-Q (Unaudited)
Period Ended: June 30, 2007
Business Overview: CPS is a specialty finance company that purchases and services retail automobile installment sale contracts from licensed dealers, primarily targeting sub-prime customers. The company funds these purchases through warehouse credit facilities and long-term securitizations. As of June 30, 2007, the company had 21,486,983 common shares outstanding.

Key Financial Metrics

Portfolio Performance: The managed portfolio outstanding was $1,900.3 million as of June 30, 2007, compared to $1,375.3 million in the prior year. Annualized net charge-offs for the six months ended June 30, 2007, were 4.6% of the average servicing portfolio.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 45.5% to $182.3 million, driven primarily by a 44.5% increase in interest income ($169.9 million) due to a larger portfolio of finance receivables held by consolidated subsidiaries.
• Expense Increases: Total operating expenses rose 41.2% to $170.6 million. This was largely due to a 50.6% increase in the provision for credit losses ($62.2 million) and a 56.7% increase in interest expense ($63.2 million), both correlated with portfolio growth.
• Profitability: Net income increased 52.1% to $6.7 million. Income tax expense was $4.9 million in 2007, whereas there was no income tax expense in the comparable 2006 period.
• Cash Flow: Operating cash flow turned positive, providing $13.4 million compared to a use of $10.6 million in the prior year, despite a significant increase in restricted cash holdings ($54.3 million) related to pre-funding structures in securitizations.
• Debt Structure: Securitization trust debt increased to $1.84 billion from $1.44 billion. The company also utilized warehouse lines of credit more heavily to fund contract purchases.

Guidance, Outlook, Risks, and Unusual Items

• Recent Developments: In July 2007, CPS opened a new $120 million residual credit facility (comprising a $60 million revolving note and a $60 million term note) to repay remaining senior secured indebtedness. Management anticipates higher interest expense in the near term due to the rates on this new facility.
• Strategic Shift: The company continues to structure securitizations as secured financings rather than sales, which defers revenue recognition and accelerates expense recognition compared to prior accounting methods.
• Legal Contingencies:
  • Stanwich Litigation: A proposed settlement regarding an adversary action in the Stanwich bankruptcy was under submission by the court as of May 2007. CPS expects to pay $625,000 if approved, which would limit exposure to indemnity claims.
  • Other Litigation: A class action regarding repossession notices (Coleman) was dismissed with prejudice. Two class actions regarding credit information access were settled.
• Risks: Liquidity is dependent on the performance of securitized pools and the ability to complete term securitizations. Deterioration in credit performance could restrict cash releases from trusts. The company is also subject to interest rate risk between purchasing contracts and securitizing them.
• Unusual Items: Other income included a $3.6 million gain on the residual interest in securitizations (due to better-than-expected performance) and $1.7 million from the sale of previously charged-off receivables.

Investor Verification Checklist

• Credit Quality Trends: Verify if the 4.6% annualized net charge-off rate is sustainable or if delinquency rates (currently 3.9% of gross portfolio) are trending upward, which could impact future provisions.
• Liquidity Constraints: Confirm the availability of the $320.3 million in warehouse credit capacity and the company's ability to execute future term securitizations to replenish unrestricted cash.
• Interest Rate Exposure: Assess the impact of the new July 2007 residual credit facility on future interest expense margins, as rates are higher than the debt it replaced.
• Legal Resolution: Monitor the final court approval of the Stanwich bankruptcy settlement to ensure no unexpected indemnity liabilities arise.
• Portfolio Composition: Review the shift in portfolio ownership from non-consolidated subsidiaries (servicing fee revenue) to consolidated subsidiaries (interest income revenue) and its effect on margin stability.