CPSS

Business Context and Reporting Period

Company: Consumer Portfolio Services, Inc. (CPS)
Filing Type: Form 10-Q (Unaudited)
Period Ended: September 30, 2006
Business Model: CPS specializes in purchasing and servicing retail automobile installment sale contracts from licensed dealers, primarily serving sub-prime customers. The company does not lend directly to consumers but purchases contracts from dealers. Since the third quarter of 2003, the company has structured securitization transactions as secured financings rather than sales, resulting in the consolidation of finance receivables and related debt on its balance sheet.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 49.3% ($24.3 million) for the three months ended September 30, 2006, compared to the same period in 2005. This was driven primarily by a 55.8% increase in interest income due to a larger portfolio of finance receivables held by consolidated subsidiaries.
• Expense Increases: Total operating expenses rose 44.8% to $69.5 million for the quarter. The increase was led by a 52.0% rise in the provision for credit losses ($8.2 million increase) and an 85.6% increase in interest expense ($11.6 million increase), both correlated with portfolio growth.
• Profitability: Net income for the quarter increased to $4.3 million from $1.4 million in the prior year period. For the nine-month period, net income rose to $8.7 million from $1.7 million.
• Portfolio Expansion: The managed portfolio owned by consolidated subsidiaries grew to $1,424.2 million as of September 30, 2006, from $900.7 million in the prior year. The company purchased 16,541 contracts aggregating $254.4 million in the quarter.
• Decline in Servicing Fees: Servicing fees decreased 55.8% to $633,000 for the quarter, attributed to the shift in securitization structure (from sales to secured financings) and the decline in the managed portfolio held by non-consolidated subsidiaries.

Guidance, Outlook, Risks, and Unusual Items

• Liquidity and Capital: The company relies on warehouse credit facilities ($350 million total capacity) and term securitizations to fund operations. As of September 30, 2006, $64.8 million was outstanding on warehouse lines, with $285.2 million in available capacity. Management plans to match contract purchases to cash availability.
• Credit Risk: Annualized net charge-offs for the nine months ended September 30, 2006, were 4.0% of the average servicing portfolio, an improvement from 4.9% in the prior year period. Total delinquencies (31+ days) were 4.3% of the gross servicing portfolio.
• Legal Proceedings:
  • Stanwich Litigation: A cross-claim was settled for $3.24 million in 2005. Other related indemnity claims remain pending but are stayed.
  • Class Actions: Several class actions regarding repossession notices and credit information access are pending. The company has reached agreements in principle to settle two Illinois cases and believes it has defenses for others.
• Accounting Changes: The company adopted SFAS 123(R) for stock-based compensation effective January 1, 2006. No stock-based compensation costs were recorded in the current period as all outstanding options were fully vested. The company also began deferring direct employee costs associated with contract purchases under SFAS 91.
• Forward-Looking Statements: Management estimates cumulative prepayments of 22.3% to 34.7% and net credit losses of 11.4% to 14.7% over the lives of related automobile contracts.

Investor Verification Checklist

• Debt Covenants: Verify continued compliance with financial covenants regarding delinquency, credit loss criteria, liquidity, and leverage levels required by securitization and warehouse agreements.
• Credit Performance: Monitor the trend of net charge-offs and delinquency rates, as deterioration could restrict cash releases from securitization trusts and impact liquidity.
• Securitization Capacity: Assess the company's ability to complete term securitizations on favorable terms to repay warehouse debt and fund new purchases.
• Legal Exposure: Review the status of pending class action lawsuits to ensure recorded liabilities are sufficient to cover potential adverse judgments.
• Stock Repurchases: Note the company's ongoing share repurchase program; $2.5 million was spent on repurchases in the nine-month period, with approximately $2.5 million remaining under the plan as of September 30, 2006.