CPSS

Business Context and Reporting Period

Company: Consumer Portfolio Services, Inc. (CPS)
Filing Type: Form 10-Q (Unaudited)
Period Ended: June 30, 2006
Business Overview: 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

Note: Total Debt includes Securitization trust debt ($1,248,332), Warehouse lines of credit ($59,346), Senior secured debt ($40,000), Subordinated renewable notes ($8,666), and Notes payable ($145) as of June 30, 2006.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 40.7% for the three months ended June 30, 2006, compared to the prior year period, driven primarily by a 55.6% increase in interest income due to the growth in consolidated finance receivables.
• Profitability: Net income for the six months ended June 30, 2006, was $4.4 million, a significant increase from $306,000 in the same period in 2005. This improvement occurred despite a 49.9% increase in the provision for credit losses.
• Expense Increases: Total operating expenses rose 36.9% year-over-year for the quarter. Interest expense increased 86.7% and the provision for credit losses increased 45.7%, both directly correlated with the expansion of the consolidated portfolio.
• Cash Flow: Net cash used in operating activities was $10.6 million for the six months ended June 30, 2006, compared to $21.1 million provided in the prior year. This shift was largely due to an increase in restricted cash held for pre-funding structures in securitization transactions.
• Portfolio Composition: The managed portfolio grew to $1.375 billion as of June 30, 2006, from $966.2 million in 2005. Consolidated subsidiaries now own 94.5% of the portfolio, up from 80.0% in 2005, reflecting the shift to secured financing structures.

Guidance, Outlook, Risks, and Unusual Items

• Outlook: Management anticipates that servicing fee revenue will continue to decline proportionately as the managed portfolio held by non-consolidated subsidiaries decreases. Future profitability depends on the ability to complete term securitizations on favorable terms and the performance of the automobile contract portfolio.
• Liquidity: The company maintains $350 million in warehouse credit capacity, with $290.7 million available as of June 30, 2006. Liquidity is dependent on cash releases from securitized pools, which are contingent on credit performance metrics.
• Risks:
  • Credit Risk: The company retains credit risk on its managed portfolio. Deterioration in credit performance could restrict cash releases from trusts and increase provisions for losses.
  • Legal Proceedings: Ongoing litigation includes the "Stanwich Case" (settled cross-claim, pending indemnity claims) and class action lawsuits regarding repossession notices and credit information access. While the company believes it has substantive defenses, adverse judgments could have a material adverse effect.
  • Market Risk: Interest rate risk exists between the purchase of fixed-rate contracts and the funding via adjustable-rate warehouse facilities.
• Unusual Items: The prior year period (2005) included a one-time, non-cash impairment charge of $1.9 million against non-auto finance receivable assets and proceeds of $2.4 million from the sale of charged-off receivables, which are not present in the current period.

Investor Verification Checklist

• Credit Performance: Verify the trend in annualized net charge-offs (3.7% for the six months ended June 30, 2006) against the company's historical averages and economic forecasts.
• Liquidity Constraints: Confirm the availability of warehouse credit facilities and the sufficiency of cash releases from securitization trusts to fund ongoing contract purchases.
• Legal Exposure: Monitor the status of the Stanwich litigation and the class action suits regarding repossession notices for potential liability exceeding recorded allowances.
• Securitization Capacity: Assess the company's ability to execute future term securitizations, which are critical for converting warehouse debt into long-term funding and releasing restricted cash.
• Accounting Policy Impact: Review the impact of the "secured financing" accounting structure on reported earnings versus cash flow, noting the deferral of revenue and acceleration of expenses.