Table of Contents

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

[X]          QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2018

 

Commission file number: 1-11416

 

CONSUMER PORTFOLIO SERVICES, INC.

(Exact name of registrant as specified in its charter)

 

California	33-0459135
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)
3800 Howard Hughes Parkway, Suite 1400, Las Vegas, Nevada	89169
(Address of principal executive offices)	(Zip Code)

 

Registrant’s telephone number, including Area Code: (949) 753-6800

 

Former name, former address and former fiscal year, if changed since last report: N/A

 

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [_]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one)

 

Large accelerated filer [_]	Accelerated filer  [X]
Non-accelerated filer  [_] (Do not check if a smaller reporting company)	Smaller reporting company  [_]
	Emerging growth company [_]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to section 13(a) of the Exchange Act. [_]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [_] No [X]

 

As of July 31, 2018 the registrant had 22,948,687 common shares outstanding.

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

INDEX TO FORM 10-Q

For the Quarterly Period Ended June 30, 2018

 

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Unaudited Condensed Consolidated Balance Sheets as of June 30, 2018 and December 31, 2017	3
	Unaudited Condensed Consolidated Statements of Operations for the three-month and six-month periods ended June 30, 2018 and 2017	4
	Unaudited Condensed Consolidated Statements of Comprehensive Income for the three-month and six-month periods ended June 30, 2018 and 2017	5
	Unaudited Condensed Consolidated Statements of Cash Flows for the six-month periods ended June 30, 2018 and 2017	6
	Notes to Unaudited Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
Item 4.	Controls and Procedures	40

PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	41
Item 1A.	Risk Factors	41

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	42
Item 6.	Exhibits	42
	Signatures	43

 

 

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

		June 30,				December 31,
		2018				2017
ASSETS
Cash and cash equivalents		$	17,435			$	12,731
Restricted cash and equivalents			119,940				111,965
Finance receivables			1,887,530				2,304,984
Less: Allowance for finance credit losses			(94,376	)			(109,187	)
Finance receivables, net			1,793,154				2,195,797
Finance receivables measured at fair value			412,895				–
Furniture and equipment, net			1,899				1,752
Deferred tax assets, net			31,430				32,446
Accrued interest receivable			37,517				46,753
Other assets			26,400				23,397
		$	2,440,670			$	2,424,841
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Accounts payable and accrued expenses		$	27,313			$	28,715
Warehouse lines of credit			137,930				112,408
Residual interest financing			39,269				–
Securitization trust debt			2,030,705				2,083,215
Subordinated renewable notes			15,831				16,566
			2,251,048				2,240,904
COMMITMENTS AND CONTINGENCIES
Shareholders' Equity
Preferred stock, $1 par value; authorized 4,998,130 shares; none issued			–				–
Series A preferred stock, $1 par value; authorized 5,000,000 shares; none issued			–				–
Series B preferred stock, $1 par value; authorized 1,870 shares; none issued			–				–
Common stock, no par value; authorized 75,000,000 shares; 20,962,592 and 21,488,589 shares issued and outstanding at June 30, 2018 and December 31, 2017, respectively			70,955				71,582
Retained earnings			125,849				119,537
Accumulated other comprehensive loss			(7,182	)			(7,182	)
			189,622				183,937
		$	2,440,670			$	2,424,841

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2018				2017				2018				2017
Revenues:
Interest income		$	97,012			$	107,485			$	197,918			$	212,060
Other income			2,350				2,587				5,008				5,610
			99,362				110,072				202,926				217,670
Expenses:
Employee costs			19,842				17,572				40,483				35,352
General and administrative			7,450				6,819				14,946				13,741
Interest			25,187				23,236				49,249				45,324
Provision for credit losses			35,531				48,550				76,038				95,717
Marketing			4,588				3,990				8,798				7,950
Occupancy			1,860				1,733				3,709				3,394
Depreciation and amortization			250				220				490				448
			94,708				102,120				193,713				201,926
Income before income tax expense			4,654				7,952				9,213				15,744
Income tax expense			1,489				3,380				2,901				6,692
Net income		$	3,165			$	4,572			$	6,312			$	9,052
Earnings per share:
Basic		$	0.15			$	0.20			$	0.30			$	0.39
Diluted			0.13				0.17				0.25				0.32
Number of shares used in computing earnings per share:
Basic			21,178				23,076				21,375				23,296
Diluted			25,123				27,602				25,393				28,024

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2018				2017				2018				2017
Net income		$	3,165			$	4,572			$	6,312			$	9,052
Other comprehensive income/(loss); change in funded status of pension plan			–				–				–				–
Comprehensive income		$	3,165			$	4,572			$	6,312			$	9,052

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

 

 

 

 

 

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

		Six Months Ended
		June 30,
		2018				2017
Cash flows from operating activities:
Net income		$	6,312			$	9,052
Adjustments to reconcile net income to net cash provided by operating activities:
Accretion of deferred acquisition fees and origination costs			1,444				152
Net interest income accretion on fair value receivables			4,743				–
Depreciation and amortization			490				448
Amortization of deferred financing costs			4,313				4,367
Provision for credit losses			76,038				95,717
Stock-based compensation expense			2,153				2,622
Changes in assets and liabilities:
Accrued interest receivable			9,236				(719	)
Deferred tax assets, net			1,016				(2,353	)
Other assets			(3,048	)			5,172
Accounts payable and accrued expenses			(1,402	)			227
Net cash provided by operating activities			101,295				114,685
Cash flows from investing activities:
Purchases of finance receivables held for investment			–				(463,546	)
Payments received on finance receivables held for investment			325,161				332,835
Purchases of finance receivables measured at fair value			(430,611	)			–
Payments received on finance receivables at fair value			12,973				4
Change in repossessions held in inventory			45				2,839
Change in restricted cash and cash equivalents, net			(7,975	)			(5,544	)
Purchase of furniture and equipment			(637	)			(525	)
Net cash used in investing activities			(101,044	)			(133,937	)
Cash flows from financing activities:
Proceeds from issuance of securitization trust debt			391,823				431,490
Proceeds from issuance of subordinated renewable notes			407				2,340
Payments on subordinated renewable notes			(1,142	)			(1,209	)
Net advances of warehouse lines of credit			24,766				28,029
Net advances of residual interest financing debt			40,000				–
Repayment of securitization trust debt			(444,818	)			(430,750	)
Payment of financing costs			(3,803	)			(4,133	)
Purchase of common stock			(3,260	)			(5,379	)
Exercise of options and warrants			480				738
Net cash provided by financing activities			4,453				21,126
Increase (decrease) in cash and cash equivalents			4,704				1,874
Cash and cash equivalents at beginning of period			12,731				13,936
Cash and cash equivalents at end of period		$	17,435			$	15,810
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest		$	44,534			$	40,579
Income taxes		$	7,258			$	3,302

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(1) Summary of Significant Accounting Policies

 

Description of Business

 

We were formed in California on March 8, 1991. We specialize in purchasing and servicing retail automobile installment sale contracts (“automobile contracts” or “finance receivables”) originated by licensed motor vehicle dealers located throughout the United States (“dealers”) in the sale of new and used automobiles, light trucks and passenger vans. Through our purchases, we provide indirect financing to dealer customers for borrowers with limited credit histories or past credit problems (“sub-prime customers”). We serve as an alternative source of financing for dealers, allowing sales to customers who otherwise might not be able to obtain financing. In addition to purchasing installment purchase contracts directly from dealers, we have also (i) acquired installment purchase contracts in four merger and acquisition transactions, (ii) purchased immaterial amounts of vehicle purchase money loans from non-affiliated lenders, and (iii) lent money directly to consumers for an immaterial amount of loans secured by vehicles. In this report, we refer to all of such contracts and loans as "automobile contracts."

 

Basis of Presentation

 

Our Unaudited Condensed Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America, with the instructions to Form 10-Q and with Article 10 of Regulation S-X of the Securities and Exchange Commission, and include all adjustments that are, in management’s opinion, necessary for a fair presentation of the results for the interim periods presented. All such adjustments are, in the opinion of management, of a normal recurring nature. Results for the six month period ended June 30, 2018 are not necessarily indicative of the operating results to be expected for the full year.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted from these Unaudited Condensed Consolidated Financial Statements. These Unaudited Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of income and expenses during the reported periods.

 

Finance Receivables Measured at Fair Value

 

Effective January 1, 2018, we adopted the fair value method of accounting for finance receivables acquired on or after that date. For each finance receivable acquired after 2017, we consider the price paid on the purchase date as the fair value for such receivable.  We estimate the cash to be received in the future with respect to such receivables, based on our experience with similar receivables acquired in the past.  We then compute the internal rate of return that results in the present value of those estimated cash receipts being equal to the purchase date fair value. Thereafter, we recognize interest income on such receivables on a level yield basis using that internal rate of return as the applicable interest rate. Cash received with respect to such receivables is applied first against such interest income, and then to reduce the carrying value of the receivables.

 

We re-evaluate the fair value of such receivables at the close of each measurement period. If the reevaluation were to yield a value materially different from the carrying value, an adjustment would be required.

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Anticipated credit losses are included in our estimation of cash to be received with respect to receivables.  Because such credit losses are included in our computation of the appropriate level yield, we do not make continuing provision for credit losses, as our best estimate of the lifetime aggregate of credit losses is included in that initial computation. Also as a result of including anticipated credit losses in our computation of the level yield, that level yield is materially lower than the average contractual rate applicable to the receivables. Because our initial carrying value is fixed as the price we pay for the receivable, rather than as the contractual principal balance, we do not record acquisition fees as an amortizing asset related to the receivables, nor do we capitalize costs of acquiring the receivables. Rather we recognize the costs of acquisition as expenses in the period incurred.

 

Other Income

 

The following table presents the primary components of Other Income for the three-month and six-month periods ending June 30, 2018 and 2017:

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
			2018				2017				2018				2017
			(In thousands)								(In thousands)
Direct mail revenues		$	1,708			$	1,634			$	3,504			$	3,633
Convenience fee revenue			390				510				840				1,080
Recoveries on previously charged-off contracts			36				138				154				324
Sales tax refunds			204				215				438				412
Other			12				90				72				161
Other income for the period		$	2,350			$	2,587			$	5,008			$	5,610

 

On January 1, 2018, the Company adopted Accounting Standards Codification (“ASC”) Topic 606, “Revenue from Contracts with Customers”. The majority of the Company’s revenues come from interest income which is outside the scope of ASC 606. The Company’s services that fall within the scope of ASC 606 are presented within Other Income and are recognized as revenue as the Company satisfies its obligation to the customer. Services within the scope of ASC 606 include revenue associated with direct mail and other related products and services that we offer to our dealers.

 

Warrants

 

In connection with the amendment to and partial repayment of our residual interest financing in July 2008, we issued warrants exercisable for 2,500,000 common shares for $4,071,429. The warrants represent the right to purchase 2,500,000 CPS common shares at a nominal exercise price. In March 2010 we repurchased warrants for 500,000 of these shares for $1.0 million. Warrants to purchase 2,000,000 shares were outstanding as of June 30, 2018. The warrants were exercised on July 10, 2018 and 1,999,995 net shares were issued to the holder.

 

Stock-based Compensation

 

We recognize compensation costs in the financial statements for all share-based payments based on the grant date fair value estimated in accordance with the provisions of ASC 718 “Stock Compensation”.

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

For the three and six months ended June 30, 2018, we recorded stock-based compensation costs in the amount of $1.2 million and $2.2 million, respectively. These stock-based compensation costs were $1.3 million and $2.6 million for the three and six months ended June 30, 2017. As of June 30, 2018, unrecognized stock-based compensation costs to be recognized over future periods equaled $4.8 million. This amount will be recognized as expense over a weighted-average period of 2.2 years.

 

The following represents stock option activity for the six months ended June 30, 2018:

 

										Weighted
		Number of				Weighted				Average
		Shares				Average				Remaining
		(in thousands)				Exercise Price				Contractual Term
Options outstanding at the beginning of period			13,135			$	4.66			N/A
Granted			1,700				3.49			N/A
Exercised			(312	)			1.54			N/A
Forfeited			(119	)			7.20			N/A
Options outstanding at the end of period			14,404			$	4.57			4.30 years
Options exercisable at the end of period			9,982			$	4.71			3.89 years

 

 

At June 30, 2018, the aggregate intrinsic value of options outstanding and exercisable was $10.2 million and $8.7 million, respectively. There were 312,500 options exercised for the six months ended June 30, 2018 compared to 429,300 for the comparable period in 2017. The total intrinsic value of options exercised was $860,000 and $1.3 million for the six-month periods ended June 30, 2018 and 2017. There were 893,000 shares available for future stock option grants under existing plans as of June 30, 2018.

 

Purchases of Company Stock

 

The table below describes the purchase of our common stock for the six-month ended June 30, 2018 and 2017:

 

		Six Months Ended
		June 30, 2018								June 30, 2017
			Shares				Avg. Price				Shares				Avg. Price
Open market purchases			714,898			$	3.81				1,102,410			$	4.74
Shares redeemed upon net exercise of stock options			33,599				4.37				30,149				4.86
Other			90,000				4.13				–				–
Total stock purchases			838,497			$	3.87				1,132,559			$	4.75

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Reclassifications

 

Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications had no effect on prior year net income or total shareholders’ equity.

 

Financial Covenants

 

Certain of our securitization transactions, our warehouse credit facilities and our residual interest financing contain various financial covenants requiring minimum financial ratios and results. Such covenants include maintaining minimum levels of liquidity and net worth and not exceeding maximum leverage levels. As of June 30, 2018, we were in compliance with all such covenants. In addition, certain of our debt agreements other than our term securitizations contain cross-default provisions. Such cross-default provisions would allow the respective creditors to declare a default if an event of default occurred with respect to other indebtedness of ours, but only if such other event of default were to be accompanied by acceleration of such other indebtedness.

 

Provision for Contingent Liabilities

 

We are routinely involved in various legal proceedings resulting from our consumer finance activities and practices, both continuing and discontinued. Our legal counsel has advised us on such matters where, based on information available at the time of this report, there is an indication that it is both probable that a liability has been incurred and the amount of the loss can be reasonably determined.

 

We record at each measurement date, most recently as of June 30, 2018, our best estimate of probable incurred losses for legal contingencies. The amount of losses that may ultimately be incurred cannot be estimated with certainty.

 

Adoption of New Accounting Standards

 

On January 1, 2018, the Company adopted Accounting Standards Codification (“ASC”) Topic 606, “Revenue from Contracts with Customers”, which (i) creates a single framework for recognizing revenue from contracts with customers that fall within its scope and (ii) revises when it is appropriate to recognize a gain (loss) from the transfer of nonfinancial assets. The majority of the Company’s revenues come from interest income which is outside the scope of ASC 606. The Company’s services that fall within the scope of ASC 606 are presented within Other Income and are recognized as revenue as the Company satisfies its obligation to the customer. Services within the scope of ASC 606 include revenue associated with direct mail and other related products and services that we offer to our dealers. The Company adopted ASC 606 in the first quarter of 2018 with no material effect on our financial statements.

 

The Company adopted ASC Topic 825 "Financial Instruments." Authoritative accounting guidance under ASC Topic 825, "Financial Instruments" amended prior guidance to require equity investments (except those accounted for under the equity method of accounting) to be measured at fair value with changes in fair value recognized in net income. An entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investment of the same issuer. The guidance simplifies the impairment assessment of equity investments without readily determinable fair values, requires public entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from changes in the instrument-specific credit risk when the entity has selected the fair value option for financial instruments and requires separate presentation of financial assets and liabilities by measurement category and form of financial asset. The Company adopted ASC 825 on January 1, 2018 with no material effect on our financial statements, however, the disclosures were added.

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(2) Finance Receivables

 

Our portfolio of finance receivables consists of small-balance homogeneous contracts comprising a single segment and class that is collectively evaluated for impairment on a portfolio basis according to delinquency status. Our contract purchase guidelines are designed to produce a homogenous portfolio. For key terms such as interest rate, length of contract, monthly payment and amount financed, there is relatively little variation from the average for the portfolio. We report delinquency on a contractual basis. Once a contract becomes greater than 90 days delinquent, we do not recognize additional interest income until the obligor under the contract makes sufficient payments to be less than 90 days delinquent. Any payments received on a contract that is greater than 90 days delinquent are first applied to accrued interest and then to principal reduction.

 

In January 2018 the Company adopted the fair value method of accounting for finance receivables acquired after 2017. Finance receivables measured at fair value are recorded separately on the Company’s Balance Sheet and are excluded from all tables in this footnote.

 

The following table presents the components of Finance Receivables, net of unearned interest:

 

		June 30,				December 31,
		2018				2017
Finance receivables		(In thousands)
Automobile finance receivables, net of unearned interest		$	1,882,599			$	2,298,608
Unearned acquisition fees and originations costs			4,931				6,376
Finance receivables		$	1,887,530			$	2,304,984

 

We consider an automobile contract delinquent when an obligor fails to make at least 90% of a contractually due payment by the following due date, which date may have been extended within limits specified in the servicing agreements. The period of delinquency is based on the number of days payments are contractually past due, as extended where applicable. Automobile contracts less than 31 days delinquent are not included. In certain circumstances we will grant obligors one-month payment extensions to assist them with temporary cash flow problems. The only modification of terms is to advance the obligor’s next due date by one month and extend the maturity date of the receivable by one month. In certain limited cases, a two-month extension may be granted. There are no other concessions such as a reduction in interest rate, forgiveness of principal or of accrued interest. Accordingly, we consider such extensions to be insignificant delays in payments rather than troubled debt restructurings. The following table summarizes the delinquency status of finance receivables as of June 30, 2018 and December 31, 2017:

 

		June 30,				December 31,
		2018				2017
		(In thousands)
Delinquency Status
Current		$	1,689,353			$	2,069,617
31 - 60 days			120,042				138,395
61 - 90 days			50,866				63,081
91 + days			22,338				27,515
		$	1,882,599			$	2,298,608

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Finance receivables totaling $22.3 million and $27.5 million at June 30, 2018 and December 31, 2017, respectively, including all receivables greater than 90 days delinquent, have been placed on non-accrual status as a result of their delinquency status.

 

We use a loss allowance methodology commonly referred to as "static pooling," which stratifies our finance receivable portfolio into separately identified pools based on the period of origination. Using analytical and formula driven techniques, we estimate an allowance for finance credit losses, which we believe is adequate for probable incurred credit losses that can be reasonably estimated in our portfolio of automobile contracts. The estimate for probable incurred credit losses is reduced by our estimate for future recoveries on previously incurred losses. Provision for credit losses is charged to our consolidated statement of operations. Net losses incurred on finance receivables are charged to the allowance. We establish the allowance for new receivables over the 12-month period following their acquisition.

 

The following table presents a summary of the activity for the allowance for finance credit losses for the three-month and six-month periods ended June 30, 2018 and 2017:

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2018				2017				2018				2017
		(In thousands)								(In thousands)
Balance at beginning of period		$	100,844			$	99,255			$	109,187			$	95,578
Provision for credit losses on finance receivables			35,531				48,550				76,038				95,717
Charge-offs			(53,493	)			(48,474	)			(109,595	)			(98,773	)
Recoveries			11,494				7,984				18,746				14,793
Balance at end of period		$	94,376			$	107,315			$	94,376			$	107,315

 

Excluded from finance receivables are contracts that were previously classified as finance receivables but were reclassified as other assets because we have repossessed the vehicle securing the Contract. The following table presents a summary of such repossessed inventory together with the allowance for losses in repossessed inventory that is not included in the allowance for finance credit losses:

 

		June 30,				December 31,
		2018				2017
		(In thousands)
Gross balance of repossessions in inventory		$	33,673			$	33,679
Allowance for losses on repossessed inventory			(24,063	)			(24,024	)
Net repossessed inventory included in other assets		$	9,610			$	9,655

 

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(3) Securitization Trust Debt

 

We have completed many securitization transactions that are structured as secured borrowings for financial accounting purposes. The debt issued in these transactions is shown on our Unaudited Condensed Consolidated Balance Sheets as “Securitization trust debt,” and the components of such debt are summarized in the following table:

 

																						Weighted
																						Average
				Final		Receivables								Outstanding				Outstanding				Contractual
				Scheduled		Pledged at								Principal at				Principal at				Interest Rate
				Payment		June 30,				Initial				June 30,				December 31,				at June 30,
Series				Date (1)		2018 (2)				Principal				2018				2017				2018
				(Dollars in thousands)
	CPS 2013-B			September 2020			–				205,000				–				18,407				–
	CPS 2013-C			December 2020			–				205,000				–				25,559				–
	CPS 2013-D			March 2021			19,366				183,000				17,737				24,917				5.57%
	CPS 2014-A			June 2021			24,224				180,000				21,894				30,521				4.74%
	CPS 2014-B			September 2021			35,335				202,500				33,419				44,516				4.09%
	CPS 2014-C			December 2021			56,842				273,000				55,081				71,174				4.22%
	CPS 2014-D			March 2022			63,322				267,500				61,433				79,099				4.52%
	CPS 2015-A			June 2022			70,365				245,000				68,531				87,194				4.09%
	CPS 2015-B			September 2022			83,535				250,000				82,450				102,873				4.11%
	CPS 2015-C			December 2022			115,839				300,000				114,701				141,362				4.52%
	CPS 2016-A			March 2023			150,370				329,460				148,789				180,761				4.82%
	CPS 2016-B			June 2023			170,132				332,690				166,163				201,199				4.99%
	CPS 2016-C			September 2023			172,255				318,500				168,262				203,504				4.57%
	CPS 2016-D			April 2024			128,194				206,325				125,394				149,671				3.46%
	CPS 2017-A			April 2024			139,256				206,320				135,994				161,892				3.62%
	CPS 2017-B			December 2023			167,524				225,170				155,525				186,594				3.13%
	CPS 2017-C			September 2024			172,642				224,825				163,372				197,155				3.05%
	CPS 2017-D			June 2024			169,697				196,300				160,527				189,277				2.90%
	CPS 2018-A			March 2025			176,804				190,000				168,757				–				2.98%
	CPS 2018-B			December 2024			198,546				201,823				194,653				–				3.46%
						$	2,114,248			$	4,742,413			$	2,042,682			$	2,095,675

 

_________________

(1)

The Final Scheduled Payment Date represents final legal maturity of the securitization trust debt. Securitization trust debt is expected to become due and to be paid prior to those dates, based on amortization of the finance receivables pledged to the trusts. Expected payments, which will depend on the performance of such receivables, as to which there can be no assurance, are $468.4 million in 2018, $760.0 million in 2019, $458.5 million in 2020, $234.5 million in 2021, $90.4 million in 2022, $18.9 million in 2023.

 

(2)

Includes repossessed assets that are included in Other assets on our Unaudited Condensed Consolidated Balance Sheet.

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Debt issuance costs of $12.0 million and $12.5 million as of June 30, 2018 and December 31, 2017, respectively, have been excluded from the table above. These debt issuance costs are presented as a direct deduction to the carrying amount of the securitization trust debt on our Unaudited Condensed Consolidated Balance Sheets.

 

All of the securitization trust debt was sold in private placement transactions to qualified institutional buyers. The debt was issued through our wholly-owned bankruptcy remote subsidiaries and is secured by the assets of such subsidiaries, but not by our other assets.

 

The terms of the securitization agreements related to the issuance of the securitization trust debt and the warehouse credit facilities require that we meet certain delinquency and credit loss criteria with respect to the pool of receivables, and certain of the agreements require that we maintain minimum levels of liquidity and not exceed maximum leverage levels. As of June 30, 2018, we were in compliance with all such covenants.

 

We are responsible for the administration and collection of the automobile contracts. The securitization agreements also require certain funds be held in restricted cash accounts to provide additional collateral for the borrowings, to be applied to make payments on the securitization trust debt or as pre-funding proceeds from a term securitization prior to the purchase of additional collateral. As of June 30, 2018, restricted cash under the various agreements totaled approximately $119.9 million. Interest expense on the securitization trust debt consists of the stated rate of interest plus amortization of additional costs of borrowing. Additional costs of borrowing include facility fees, amortization of deferred financing costs and discounts on notes sold. Deferred financing costs and discounts on notes sold related to the securitization trust debt are amortized using a level yield method. Accordingly, the effective cost of the securitization trust debt is greater than the contractual rate of interest disclosed above.

 

Our wholly-owned bankruptcy remote subsidiaries were formed to facilitate the above asset-backed financing transactions. Similar bankruptcy remote subsidiaries issue the debt outstanding under our credit facilities. Bankruptcy remote refers to a legal structure in which it is expected that the applicable entity would not be included in any bankruptcy filing by its parent or affiliates. All of the assets of these subsidiaries have been pledged as collateral for the related debt. All such transactions, treated as secured financings for accounting and tax purposes, are treated as sales for all other purposes, including legal and bankruptcy purposes. None of the assets of these subsidiaries are available to pay other creditors.

 

On July 17, 2018 we completed our third securitization transaction of 2018. In the transaction, qualified institutional buyers purchased $230.3 million of asset-backed notes secured by $239.9 million in automobile receivables purchased by us. The sold notes, issued by CPS Auto Receivables Trust 2018-C, consist of five classes. Ratings of the notes were provided by Standard & Poor’s and DBRS and were based on the structure of the transaction, the historical performance of similar receivables and our experience as a servicer. The weighted average yield on the notes is approximately 4.18%.

 

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(4) Debt

 

The terms and amounts of our other debt outstanding at June 30, 2018 and December 31, 2017 are summarized below:

 

								Amount Outstanding at
								June 30,				December 31,
								2018				2017
								(In thousands)
Description		Interest Rate		Maturity
Warehouse lines of credit		5.50% over one month Libor (Minimum 6.50%)			April 2019			$	71,823			$	25,629
		5.50% over one month Libor (Minimum 6.25%)			August 2018				54,913				77,546
		6.75% over a commercial paper rate (Minimum 7.75%)			November 2019				12,304				11,100
Residual interest financing		8.60%			January 2026				40,000				–
Subordinated renewable notes		Weighted average rate of 8.19% and 7.99% at June 30, 2018 and December 31, 2017, respectively			Weighted average maturity of June 2020 and March 2020 at June 30, 2018 and December 31, 2017, respectively				15,831				16,566
								$	194,871			$	130,841

 

On May 16, 2018, we completed a $40 million securitization of residual interests from previously issued securitizations. In this residual interest financing transaction, qualified institutional buyers purchased $40.0 million of asset-backed notes secured by residual interests in thirteen CPS securitizations consecutively issued from September 2013 through December 2016, and an 80% interest in a CPS affiliate that owns the residual interests in four CPS securitizations issued in 2017. The sold notes, issued by CPS Auto Securitization Trust 2018-1, consist of a single class with a coupon of 8.595%.

 

Collateral for the notes includes amounts on deposit in the underlying spread accounts for each related securitization and the over-collateralization of each related securitization, which is the difference between the outstanding principal balance of the related receivables less the outstanding principal balance of the notes associated with the securitization. With respect to the securitizations issued by CPS in 2017, only 80% of such amounts are included in the collateral. On each monthly payment date, the notes will be paid interest at the coupon rate and, if necessary, a principal payment necessary to maintain a specified minimum collateral ratio.

 

Debt issuance costs of $731,000 have been excluded from the amount reported above for residual interest financing. Similarly, debt issuance costs of $1.1 million and $1.9 million as of June 30, 2018 and December 31, 2017, respectively, have been excluded from the Warehouse lines of credit amounts in the table above. These debt issuance costs are presented as a direct deduction to the carrying amount of the debt on our Unaudited Condensed Consolidated Balance Sheets.

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(5) Interest Income and Interest Expense

 

The following table presents the components of interest income:

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
			2018				2017				2018				2017
			(In thousands)								(In thousands)
Interest on finance receivables		$	87,784			$	107,344			$	184,972			$	211,840
Interest on finance receivables at fair value			8,832				–				12,340				–
Other interest income			396				141				606				220
Interest income		$	97,012			$	107,485			$	197,918			$	212,060

 

The following table presents the components of interest expense:

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2018				2017				2018				2017
		(In thousands)								(In thousands)
Securitization trust debt		$	22,255			$	20,537			$	44,084			$	40,617
Warehouse lines of credit			2,135				2,379				4,023				4,087
Residual interest financing			452				–				452				–
Subordinated renewable notes			345				320				690				620
Interest expense		$	25,187			$	23,236			$	49,249			$	45,324

 

(6) Earnings Per Share

 

Earnings per share for the three-month and six-month periods ended June 30, 2018 and 2017 were calculated using the weighted average number of shares outstanding for the related period. The following table reconciles the number of shares used in the computations of basic and diluted earnings per share for the three-month and six-month periods ended June 30, 2018 and 2017:

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2018				2017				2018				2017
		(In thousands)								(In thousands)
Weighted average number of common shares outstanding during the period used to compute basic earnings per share			21,178				23,076				21,375				23,296
Incremental common shares attributable to exercise of outstanding options and warrants			3,945				4,526				4,018				4,728
Weighted average number of common shares used to compute diluted earnings per share			25,123				27,602				25,393				28,024

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

If the anti-dilutive effects of common stock equivalents were considered, shares included in the diluted earnings per share calculation for the three-month and six-month periods ended June 30, 2018 would have included an additional 10.2 million and 9.7 million shares, respectively, attributable to the exercise of outstanding options and warrants. For the three-month and six-month periods ended June 30, 2017, an additional 8.7 million and 7.0 million shares, respectively, would be included in the diluted earnings per share calculation.

 

(7) Income Taxes

 

We file numerous consolidated and separate income tax returns with the United States and with many states. With few exceptions, we are no longer subject to U.S. federal, state, or local examinations by tax authorities for years before 2013.

 

As of June 30, 2018 and December 31, 2017, we had no unrecognized tax benefits for uncertain tax positions. We do not anticipate that total unrecognized tax benefits will significantly change due to any settlements of audits or expirations of statutes of limitations over the next 12 months.

 

The Company and its subsidiaries file a consolidated federal income tax return and combined or stand-alone state franchise tax returns for certain states. We utilize the asset and liability method of accounting for income taxes, under which deferred income taxes are recognized for the future tax consequences attributable to the differences between the financial statement values of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.

 

Deferred tax assets are recognized subject to management’s judgment that realization is more likely than not. A valuation allowance is recognized for a deferred tax asset if, based on the weight of the available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized. In making such judgments, significant weight is given to evidence that can be objectively verified. Although realization is not assured, we believe that the realization of the recognized net deferred tax asset of $31.4 million as of June 30, 2018 is more likely than not based on forecasted future net earnings. Our net deferred tax asset of $31.4 million consists of approximately $22.0 million of net U.S. federal deferred tax assets and $9.4 million of net state deferred tax assets.

 

Income tax expense was $1.5 million and $2.9 million for the three months and six months ended June 30, 2018 and represents an effective income tax rate of 32%, compared to income tax expense of $3.4 million and $6.7 million for the three and six months ended June 30, 2017, and represents an effective income tax rate of and 43%.

 

(8) Legal Proceedings

 

Consumer Litigation. We are routinely involved in various legal proceedings resulting from our consumer finance activities and practices, both continuing and discontinued. Consumers can and do initiate lawsuits against us alleging violations of law applicable to collection of receivables, and such lawsuits sometimes allege that resolution as a class action is appropriate.

 

For the most part, we have legal and factual defenses to consumer claims, which we routinely contest or settle (for immaterial amounts) depending on the particular circumstances of each case.

 

Department of Justice Industry Inquiry. In January 2015, we were served with a subpoena by the U.S. Department of Justice (the “DOJ”) directing us to produce certain documents relating to our and our subsidiaries’ and affiliates’ origination and securitization of sub-prime automobile contracts since 2005, in connection with an investigation by the DOJ in contemplation of a civil proceeding for potential violations of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989. The DOJ in its investigation requested information relating, among other matters, to the underwriting criteria used to originate these automobile contracts and to the representations and warranties relating to those underwriting criteria that were made in connection with the securitization of the automobile contracts. We are among several other securitizers of sub-prime automobile receivables who received such subpoenas in 2014, 2015 and 2016. We have provided the required information, and we were advised by the DOJ in February 2018 that no further information is required of us and that no enforcement action is recommended.

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Although the inquiry commenced January 2015 is thus completed as to us, no assurance can be given as to whether some other government agency may commence inquiries into or actions against us, nor as to whether the DOJ may recommence its investigation, any of which hypothetical proceedings might materially and adversely affect us.

 

In General. There can be no assurance as to the outcomes of the matters described or referenced above. We record at each measurement date, most recently as of June 30, 2018, our best estimate of probable incurred losses for legal contingencies, including each of the matters described or referenced above. The amount of losses that may ultimately be incurred cannot be estimated with certainty. However, based on such information as is available to us, we believe that the total of probable incurred losses for legal contingencies as of June 30, 2018 is immaterial, and that the range of reasonably possible losses for the legal proceedings and contingencies we face, including those described or referenced above, as of June 30, 2018 does not exceed $1 million.

 

Accordingly, we believe that the ultimate resolution of such legal proceedings and contingencies should not have a material adverse effect on our consolidated financial condition. We note, however, that in light of the uncertainties inherent in contested proceedings, the wide discretion vested in the DOJ and other government agencies, and the deference that courts may give to assertions made by government litigants, there can be no assurance that the ultimate resolution of these matters will not be material to our operating results for a particular period, depending on, among other factors, the size of the loss or liability imposed and the level of our income for that period.

 

(9) Employee Benefits

 

On March 8, 2002 we acquired MFN Financial Corporation and its subsidiaries in a merger. We sponsor the MFN Financial Corporation Benefit Plan (the “Plan”). Plan benefits were frozen June 30, 2001. The table below sets forth the Plan’s net periodic benefit cost for the three-month and six-month periods ended June 30, 2018 and 2017.

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2018				2017				2018				2017
		(In thousands)								(In thousands)
Components of net periodic cost (benefit)
Service cost		$	–			$	–			$	–			$	–
Interest cost			194				214				388				428
Expected return on assets			(291	)			(287	)			(582	)			(574	)
Amortization of transition (asset)/obligation			–				–				–				–
Amortization of net (gain) / loss			111				101				222				202
Net periodic cost (benefit)		$	14			$	28			$	28			$	56

 

We did not make any contributions to the Plan during the three-month periods ended June 30, 2018 and 2017. We do not anticipate making any contributions for the remainder of 2018.

 

(10) Fair Value Measurements

 

ASC 820, "Fair Value Measurements" clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy.

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

ASC 820 defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The three levels are defined as follows: level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets; level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument; and level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

Effective January 2018 we have elected to use the fair value method to value our portfolio of finance receivables acquired in January 2018 and thereafter. Our level 3, unobservable inputs reflect our own assumptions about the factors that market participants use in pricing similar receivables, and are based on the best information available in the circumstances. They include such inputs as estimated net charge-offs and timing of the amortization of the portfolio of finance receivables. The table below presents a reconciliation of the finance receivables measured at fair value on a recurring basis using significant unobservable inputs:

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2018				2017				2018				2017
		(In thousands)								(In thousands)
Balance at beginning of period		$	209,847			$	–			$	–			$	–
Finance receivables at fair value acquired during period			218,001				–				430,611				–
Payments received on finance receivables at fair value			(10,331	)			–				(12,973	)			–
Net interest income accretion on fair value receivables			(4,622	)			–				(4,743	)			–
Mark to fair value			–				–				–				–
Balance at end of period		$	412,895			$	–			$	412,895			$	–

 

The table below compares the fair values of these finance receivables to their contractual balances for the periods shown:

 

June 30, 2018

December 31, 2017

Contractual

Fair

Contractual

Fair

Balance

Value

Balance

Value

(In thousands)

Finance receivables measured at fair value

$

412,001

$

412,895

$

–

$

–

 

The following table provides certain qualitative information about our level 3 fair value measurements:

 

Financial Instrument

Fair Values as of

Inputs as of

June 30,

December 31,

Unobservable

June 30,

December 31,

2018

2017

Inputs

2018

2017

(In thousands)

Assets:

Finance receivables measured at fair value

$

412,895

$

–

Discount rate Cumulative net losses

9.2% - 10.7% 16.0%

n/a n/a

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The following table summarizes the delinquency status of these finance receivables measured at fair value as of June 30, 2018 and December 31, 2017:

 

		June 30,				December 31,
		2018				2017
		(In thousands)
Delinquency Status
Current		$	404,908			$	–
31 - 60 days			4,621				–
61 - 90 days			1,945				–
91 + days			527				–
		$	412,001			$	–

 

Repossessed vehicle inventory, which is included in Other assets on our unaudited condensed consolidated balance sheet, is measured at fair value using level 2 assumptions based on our actual loss experience on sale of repossessed vehicles. At June 30, 2018 the finance receivables related to the repossessed vehicles in inventory totaled $33.7 million. We have applied a valuation adjustment, or loss allowance, of $24.1 million, which is based on a recovery rate of approximately 29%, resulting in an estimated fair value and carrying amount of $9.6 million. The fair value and carrying amount of the repossessed inventory at December 31, 2017 was $9.7 million after applying a valuation adjustment of $24.0 million.

 

There were no transfers in or out of level 1 or level 2 assets and liabilities for the three months ended June 30, 2018 and 2017. We have no material level 3 assets that are measured at fair value on a non-recurring basis.

 

The estimated fair values of financial assets and liabilities at June 30, 2018 and December 31, 2017, were as follows:

 

		As of June 30, 2018
Financial Instrument		(In thousands)
		Carrying				Fair Value Measurements Using:
		Value				Level 1				Level 2				Level 3				Total
Assets:
Cash and cash equivalents		$	17,435			$	17,435			$	–			$	–			$	17,435
Restricted cash and equivalents			119,940				119,940				–				–				119,940
Finance receivables, net			1,793,154				–				–				1,800,111				1,800,111
Finance receivables measured at fair value			412,895				–				–				412,895				412,895
Accrued interest receivable			37,517				–				–				37,517				37,517
Liabilities:
Warehouse lines of credit		$	137,930			$	–			$	–			$	137,930			$	137,930
Accrued interest payable			4,614				–				–				4,614				4,614
Securitization trust debt			2,030,705				–				–				2,031,704				2,031,704
Subordinated renewable notes			15,831				–				–				15,831				15,831

 

		As of December 31, 2017
Financial Instrument		(In thousands)
		Carrying				Fair Value Measurements Using:
		Value				Level 1				Level 2				Level 3				Total
Assets:
Cash and cash equivalents		$	12,731			$	12,731			$	–			$	–			$	12,731
Restricted cash and equivalents			111,965				111,965				–				–				111,965
Finance receivables, net			2,195,797				–				–				2,171,846				2,171,846
Accrued interest receivable			46,753				–				–				46,753				46,753
Liabilities:
Warehouse lines of credit		$	112,408			$	–			$	–			$	112,408			$	112,408
Accrued interest payable			4,212				–				–				4,212				4,212
Securitization trust debt			2,083,215				–				–				2,089,678				2,089,678
Subordinated renewable notes			16,566				–				–				16,566				16,566

 

 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The following summary presents a description of the methodologies and assumptions used to estimate the fair value of our financial instruments. Much of the information used to determine fair value is highly subjective. When applicable, readily available market information has been utilized. However, for a significant portion of our financial instruments, active markets do not exist. Therefore, significant elements of judgment were required in estimating fair value for certain items. The subjective factors include, among other things, the estimated timing and amount of cash flows, risk characteristics, credit quality and interest rates, all of which are subject to change. Since the fair value is estimated as of June 30, 2018 and December 31, 2017, the amounts that will actually be realized or paid at settlement or maturity of the instruments could be significantly different.

 

Cash, Cash Equivalents and Restricted Cash and Equivalents

 

The carrying value equals fair value.

 

Finance Receivables, net

 

The fair value of finance receivables is estimated by discounting future cash flows expected to be collected using discount rates at which similar receivables could be sold.

 

Finance Receivables Measured at Fair Value

 

The carrying value equals fair value.

 

Accrued Interest Receivable and Payable

 

The carrying value approximates fair value.

 

Warehouse Lines of Credit and Subordinated Renewable Notes

 

The carrying value approximates fair value because the related interest rates are estimated to reflect current market conditions for similar types of secured instruments.

 

Securitization Trust Debt

 

The fair value is estimated by discounting future cash flows using interest rates that we believe reflect the current market rates.

 

 

 

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

We are a specialty finance company. Our business is to purchase and service retail automobile contracts originated primarily by franchised automobile dealers and, to a lesser extent, by select independent dealers in the United States in the sale of new and used automobiles, light trucks and passenger vans. Through our automobile contract purchases, we provide indirect financing to the customers of dealers who have limited credit histories, low incomes or past credit problems, who we refer to as sub-prime customers. We serve as an alternative source of financing for dealers, facilitating sales to customers who otherwise might not be able to obtain financing from traditional sources, such as commercial banks, credit unions and the captive finance companies affiliated with major automobile manufacturers. In addition to purchasing installment purchase contracts directly from dealers, we have also (i) acquired installment purchase contracts in four merger and acquisition transactions, (ii) purchased immaterial amounts of vehicle purchase money loans from non-affiliated lenders, and (iii) directly originated an immaterial amount of vehicle purchase money loans by lending money directly to consumers. In this report, we refer to all of such contracts and loans as "automobile contracts."

 

We were incorporated and began our operations in March 1991. From inception through June 30, 2018, we have originated a total of approximately $14.8 billion of automobile contracts, primarily by purchasing retail installment sales contracts from dealers, and to a lesser degree, by originating loans secured by automobiles directly with consumers. In addition, we acquired a total of approximately $822.3 million of automobile contracts in mergers and acquisitions in 2002, 2003, 2004 and, most recently, in September 2011. The September 2011 acquisition consisted of approximately $217.8 million of automobile contracts that we purchased from Fireside Bank of Pleasanton, California. In 2004 and 2009, we were appointed as a third-party servicer for certain portfolios of automobile contracts originated and owned by non-affiliated entities. Recent contract purchase volumes and managed portfolio levels are shown in the table below:

 

Contract Purchases and Outstanding Managed Portfolio
				$ in thousands
Period				Contracts Purchased in Period				Managed Portfolio at Period End
	2012			$	551,742			$	897,575
	2013				764,087				1,231,422
	2014				944,944				1,643,920
	2015				1,060,538				2,031,136
	2016				1,088,785				2,308,070
	2017				859,069				2,333,530
	Six months ended June 30, 2018				425,339				2,329,181

 

Our principal executive offices are in Las Vegas, Nevada. Most of our operational and administrative functions take place in Irvine, California. Credit and underwriting functions are performed primarily in that California branch with certain of these functions also performed in our Florida and Nevada branches. We service our automobile contracts from our California, Nevada, Virginia, Florida and Illinois branches.

 

The programs we offer to dealers and consumers are intended to serve a wide range of sub-prime customers, primarily through franchised new car dealers. We originate automobile contracts with the intention of financing them on a long-term basis through securitizations. Securitizations are transactions in which we sell a specified pool of contracts to a special purpose subsidiary of ours, which in turn issues asset-backed securities to fund the purchase of the pool of contracts from us.

 

Securitization and Warehouse Credit Facilities

 

Throughout the period for which information is presented in this report, we have purchased automobile contracts with the intention of financing them on a long-term basis through securitizations, and on an interim basis through warehouse credit facilities. All such financings have involved identification of specific automobile contracts, sale of those automobile contracts (and associated rights) to one of our special-purpose subsidiaries, and issuance of asset-backed securities to be purchased by institutional investors. Depending on the structure, these transactions may be accounted for under generally accepted accounting principles as sales of the automobile contracts or as secured financings.

 

 

 

 

When structured to be treated as a secured financing for accounting purposes, the subsidiary is consolidated with us. Accordingly, the sold automobile contracts and the related debt appear as assets and liabilities, respectively, on our consolidated balance sheet. We then periodically (i) recognize interest and fee income on the contracts, (ii) recognize interest expense on the securities issued in the transaction and (iii) record as expense a provision for credit losses on the contracts.

 

Since 1994 we have conducted 78 term securitizations of automobile contracts that we originated. As of June 30, 2018, 18 of those securitizations are active and all are structured as secured financings. From 1994 through April 2008 we generally utilized financial guarantees for the senior asset-backed notes issued in the securitization. Since September 2010 we have utilized senior subordinated structures without any financial guarantees. We have generally conducted our securitizations on a quarterly basis, near the end of each calendar quarter, resulting in four securitizations per calendar year. However, in 2015, we elected to defer what would have been our December securitization in favor of a securitization in January 2016, and since that time have generally conducted our securitizations near the beginning of each calendar quarter.

 

Our recent history of term securitizations is summarized in the table below:

 

Recent Asset-Backed Term Securitizations
				$ in thousands
Period				Number of Term Securitizations				Receivables Pledged in Term Securitizations
	2012				4			$	603,500
	2013				4				778,000
	2014				4				923,000
	2015				3				795,000
	2016				4				1,214,997
	2017				4				870,000
	Six months ended June 30, 2018				2				398,581

 

Generally, prior to a securitization transaction we fund our automobile contract purchases primarily with proceeds from warehouse credit facilities. Our current short-term funding capacity is $300 million, comprising three credit facilities. The first $100 million credit facility was established in May 2012. This facility was renewed in August 2016, extending the revolving period to August 2018, and adding an amortization period through August 2019. In April 2015, we entered into a second $100 million facility. This facility was renewed in April 2017, extending the revolving period to April 2019, followed by an amortization period to April 2021. In November 2015, we entered into a third $100 million facility. This facility was renewed in November 2017, extending the revolving period to November 2019, followed by an amortization period to November 2021.

 

In a securitization and in our warehouse credit facilities, we are required to make certain representations and warranties, which are generally similar to the representations and warranties made by dealers in connection with our purchase of the automobile contracts. If we breach any of our representations or warranties, we will be obligated to repurchase the automobile contract at a price equal to the principal balance plus accrued and unpaid interest. We may then be entitled under the terms of our dealer agreement to require the selling dealer to repurchase the contract at a price equal to our purchase price, less any principal payments made by the customer. Subject to any recourse against dealers, we will bear the risk of loss on repossession and resale of vehicles under automobile contracts that we repurchase.

 

In a securitization, the related special purpose subsidiary may be unable to release excess cash to us if the credit performance of the securitized automobile contracts falls short of pre-determined standards. Such releases represent a material portion of the cash that we use to fund our operations. An unexpected deterioration in the performance of securitized automobile contracts could therefore have a material adverse effect on both our liquidity and results of operations.

 

 

 

 

Financial Covenants

 

Certain of our securitization transactions and our warehouse credit facilities contain various financial covenants requiring certain minimum financial ratios and results. Such covenants include maintaining minimum levels of liquidity and net worth and not exceeding maximum leverage levels. In addition, certain of our debt agreements other than our term securitizations contain cross-default provisions. Such cross-default provisions would allow the respective creditors to declare a default if an event of default occurred with respect to other indebtedness of ours, but only if such other event of default were to be accompanied by acceleration of such other indebtedness. As of June 30, 2018, we were in compliance with all such covenants.

 

Results of Operations

 

Comparison of Operating Results for the three months ended June 30, 2018 with the three months ended June 30, 2017

 

Revenues.  During the three months ended June 30, 2018, our revenues were $99.4 million, a decrease of $10.7 million, or 9.7%, from the prior year revenue of $110.1 million. The primary reason for the decrease in revenues is a decrease in interest income. Interest income for the three months ended June 30, 2018 decreased $10.5 million, or 9.7%, to $97.0 million from $107.5 million in the prior year. The primary reason for the decrease in interest income is the lower interest yield on the receivables measured at fair value. The interest yield on receivables measured at fair value is reduced for the impact of expected losses and is therefore less than the yield on other finance receivables. The table below shows the average balances and interest yields of our loan portfolio for the three months ended June 30, 2018 and 2017:

 

		Three Months Ended June 30,
		2018												2017
		(Dollars in thousands)
		Average								Interest				Average								Interest
		Balance				Interest				Yield				Balance				Interest				Yield
Interest Earning Assets
Finance receivables		$	1,985,404			$	88,180				17.8%			$	2,340,226			$	107,485				18.4%
Finance receivables measured at fair value			344,891				8,832				10.2%				–				–				–
Total		$	2,330,295			$	97,012				16.7%			$	2,340,226			$	107,485				18.4%

 

In the three months ended June 30, 2018, other income of $2.4 million decreased by $237,000, or 9.2% compared to the prior year. The three-month period ended June 30, 2018 includes a decrease of $120,000 in payments from third-party providers of convenience fees paid by our customers for web based and other electronic payments, and a decrease of $102,000 on payments to us for our interest in certain sold charge offs and acquired third-party portfolios.

 

Expenses.  Our operating expenses consist largely of provision for credit losses, interest expense, employee costs, marketing and general and administrative expenses. Provision for credit losses is affected by the balance and credit performance of our portfolio of finance receivables excluding finance receivables measured at fair value. Interest expense is significantly affected by the volume of automobile contracts we purchased during the trailing 12-month period and the use of our warehouse facilities and asset-backed securitizations to finance those contracts. Employee costs and general and administrative expenses are incurred as applications and automobile contracts are received, processed and serviced. Factors that affect margins and net income include changes in the automobile and automobile finance market environments, and macroeconomic factors such as interest rates and changes in the unemployment level.

 

Employee costs include base salaries, commissions and bonuses paid to employees, and certain expenses related to the accounting treatment of outstanding stock options, and are one of our most significant operating expenses. These costs (other than those relating to stock options) generally fluctuate with the level of applications and automobile contracts processed and serviced.

 

 

 

 

Other operating expenses consist largely of facilities expenses, telephone and other communication services, credit services, computer services, marketing and advertising expenses, and depreciation and amortization.

 

Total operating expenses were $94.7 million for the three months ended June 30, 2018, compared to $102.1 million for the prior period, a decrease of $7.4 million, or 7.3%. The decrease is primarily due to a decrease in provision for credit losses, offsetting increases in employee costs, interest expense and general and administrative expenses.

 

Employee costs increased by $2.3 million or 12.9%, to $19.8 million during the three months ended June 30, 2018, representing 21.0% of total operating expenses, from $17.6 million for the prior year, or 17.2% of total operating expenses. Employee costs for the prior year period were net of $1.4 million of direct employee costs associated with the originations of contracts during that period. Such deferred costs are then recognized over the life of the related receivables using the interest method. In the current period, new originations of our finance receivables contracts are measured at fair value and the related direct originations costs are no longer deferred. All direct origination or acquisition costs are now expensed in the acquisition period. The table below summarizes our employees by category as well as contract purchases and units in our managed portfolio as of, and for the three-month periods ended, June 30, 2018 and 2017:

 

		June 30, 2018				June 30, 2017
		Amount				Amount
		($ in millions)
Contracts purchased (dollars)		$	214.7			$	233.9
Contracts purchased (units)			12,829				14,244
Managed portfolio outstanding (dollars)		$	2,329.2			$	2,343.3
Managed portfolio outstanding (units)			174,564				173,598
Number of Originations staff			208				209
Number of Marketing staff			131				117
Number of Servicing staff			575				565
Number of other staff			99				93
Total number of employees			1,013				984

 

General and administrative expenses include costs associated with purchasing and servicing our portfolio of finance receivables, including expenses for facilities, credit services, and telecommunications. General and administrative expenses were $7.5 million, an increase of $631,000, or 9.3% compared to the previous year and represented 7.9% of total operating expenses.

 

Interest expense for the three months ended June 30, 2018 increased by $2.0 million to $25.2 million, or 8.4% and represented 26.6% of total operating expenses, compared to $23.2 million in the previous year, when it was 22.8% of total operating expenses.

 

 

 

 

Interest on securitization trust debt increased by $1.7 million, or 8.4%, for the three months ended June 30, 2018 compared to the prior period. The average balance of securitization trust debt decreased 1.9% to $2,126.3 million for the three months ended June 30, 2018 compared to $2,168.0 million for the three months ended June 30, 2017. However, the blended interest rates on new term securitizations have generally increased since June 2014. As a result, the cost of securitization debt during the three-month period ended June 30, 2018 was 4.2%, compared to 3.8% in the prior year period. For any particular quarterly securitization transaction, the blended cost of funds is ultimately the result of many factors including the market interest rates for benchmark swaps of various maturities against which our bonds are priced and the margin over those benchmarks that investors are willing accept, which in turn, is influenced by investor demand for our bonds at the time of the securitization. These and other factors have resulted in a general trend toward higher securitization trust debt interest costs since June 2014, although that trend has reversed somewhat since July 2016. The blended interest rates of our recent securitizations are summarized in the table below:

 

Blended Cost of Funds on Recent Asset-Backed

Term Securitizations

 

Period			Blended Cost of Funds
June 2014			2.37%
September 2014			2.71%
December 2014			3.07%
March 2015			3.04%
June 2015			3.18%
September 2015			3.78%
January 2016			4.34%
April 2016			4.65%
July 2016			4.48%
October 2016			3.62%
January 2017			3.91%
April 2017			3.45%
July 2017			3.52%
October 2017			3.39%
January 2018			3.46%
April 2018			3.98%

 

 

Interest expense on subordinated renewable notes increased by $25,000, or 7.8%. The average yield of subordinated notes increased to 8.7% in the three-month period ended June 30, 2018 compared to 7.9% in the prior period.

 

Interest expense on warehouse debt decreased by $244,000, or 10.2%, for the three months ended June 30, 2018 compared to the prior period. The average rate on the debt decreased to 11.8% in the three-month period ended June 30, 2018 compared to 13.2% in the prior period.

 

The interest is due to the higher outstanding debt balance in the current period.

 

 

 

 

The following table presents the components of interest income and interest expense and a net interest yield analysis for the three-month periods ended June 30, 2018 and 2017:

 

		Three Months Ended June 30,
		2018												2017
		(Dollars in thousands)
										Annualized													Annualized
		Average								Average				Average									Average
		Balance (1)				Interest				Yield/Rate				Balance (1)				Interest					Yield/Rate
Interest Earning Assets
Finance receivables gross (2)		$	1,950,196			$	88,180				18.1%			$	2,306,632			$	107,485				18.6%
Finance receivables at fair value			344,891				8,832				10.2%				–				–				–
			2,295,087				97,012				16.9%				2,306,632				107,485				18.6%
Interest Bearing Liabilities
Warehouse lines of credit (3)		$	72,638			$	2,135				11.8%			$	72,404			$	2,379				13.2%
Residual interest financing			20,220				452				8.9%				–				–				–
Securitization trust debt			2,126,282				22,255				4.2%				2,167,971				20,537				3.8%
Subordinated renewable notes			15,866				345				8.7%				16,180				320				7.9%
		$	2,235,006				25,187				4.5%			$	2,256,555				23,236				4.1%
Net interest income/spread						$	71,825											$	84,249
Net interest yield (3)											12.5%												14.5%
Ratio of average interest earning assets to average interest bearing liabilities											103%												102%

 

     (1)  Average balances are based on month end balances except for warehouse lines of credit, which are based on daily balances

     (2)  Net of deferred fees and direct costs

     (3)  Annualized net interest income divided by average interest earning assets

 

	Three Months Ended June 30, 2018
		Compared to June 30, 2017
			Total				Change Due				Change Due
			Change				to Volume				to Rate
			(In thousands)
Interest Earning Assets
Finance receivables gross		$	(19,305	)		$	(16,867	)		$	(2,438	)
Finance receivables at fair value			8,832				8,832				–
			(10,473	)			(8,035	)			(2,438	)
Interest Bearing Liabilities
Warehouse lines of credit			(244	)			10				(254	)
Residual interest financing			452				452				–
Securitization trust debt			1,718				(408	)			2,126
Subordinated renewable notes			25				(7	)			32
			1,951				47				1,904
Net interest income/spread		$	(12,424	)		$	(8,082	)		$	(4,342	)

 

 

 

 

The reduction in the annualized yield on our finance receivables for the three months ended June 30, 2018 compared to the prior year period is the result of our decision over the last twelve months to offer dealers slightly lower acquisition fees and to require slightly lower contract interest rates on a portion of the contracts we purchase. Another reason for the decrease in the annualized yield is the lower interest yield on the receivables measured at fair value. The interest yield on receivables measured at fair value is reduced for the impact of expected losses and is therefore less than the yield on other finance receivables.

 

Provision for credit losses was $35.5 million for the three months ended June 30, 2018, a decrease of $13.0 million, or 26.8% compared to the prior year and represented 37.5% of total operating expenses. The provision for credit losses maintains the allowance for finance credit losses at levels that we feel are adequate for probable incurred credit losses that can be reasonably estimated. Our approach for establishing the allowance requires greater amounts of provision for credit losses early in the terms of our finance receivables. In addition, we monitor the delinquency and net charge off rates in our portfolio to consider how such rates may affect the allowance for finance credit losses. Finance receivables that we have originated since January 2018 are accounted for at fair value. Under the fair value method of accounting, we recognize interest income under the interest method on a level yield basis based on forecasted future cash flows net of expected credit losses. Thus, no provision for credit loss expense is recorded for finance receivables measured at fair value.

 

Marketing expenses consist primarily of commission-based compensation paid to our employee marketing representatives. Our marketing representatives earn a salary plus commissions based on volume of contract purchases and sales of ancillary products and services that we offer our dealers, such as training programs, internet lead sales, and direct mail products. Marketing expenses increased by $598,000, or 15.0%, to $4.6 million during the three months ended June 30, 2018, compared to $4.0 million in the prior year period, and represented 4.8% of total operating expenses. Our marketing staff increased to 131 as of June 30, 2018 compared to 117 at June 30, 2017. In addition, in recent months, we have gradually shifted to more field marketing representatives as compared to in-house marketing representatives. Field marketing representatives are somewhat more costly than in-house marketing representatives, but we feel will ultimately be more effective. For the three months ended June 30, 2018, we purchased 12,829 contracts representing $214.7 million in receivables compared to 14,244 contracts representing $233.9 million in receivables in the prior period.

 

Occupancy expenses increased by $127,000 or 7.3%, to $1.9 million compared to $1.7 million in the previous year and represented 2.1% of total operating expenses. In May 2017, we entered into a lease for additional office space in Las Vegas, Nevada.

 

Depreciation and amortization expenses increased by $30,000 or 13.6%, to $250,000 compared to $220,000 in the previous year and represented 0.3% of total operating expenses.

 

For the three months ended June 30, 2018 we recorded income tax expense of $1.5 million, representing a 32.0% effective income tax rate. In the prior year period, we recorded $3.4 million in income tax expense, representing a 42.5% effective income tax rate. In December 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act lowered the federal corporate income tax rate from 35% to 21% beginning in 2018.

 

 

 

 

Comparison of Operating Results for the six months ended June 30, 2018 with the six months ended June 30, 2017

 

Revenues.  During the six months ended June 30, 2018, our revenues were $202.9 million, a decrease of $14.7 million, or 6.8%, from the prior year revenue of $217.7 million. The primary reason for the decrease in revenues is a decrease in interest income. Interest income for the six months ended June 30, 2018 decreased $14.1 million, or 6.7%, to $197.9 million from $212.1 million in the prior year. The primary reason for the decrease in interest income is the lower interest yield on the receivables measured at fair value. The interest yield on receivables measured at fair value is reduced for the impact of expected losses and is therefore less than the yield on other finance receivables. The table below shows the outstanding and average balances of our portfolio held by consolidated subsidiaries for the six months ended June 30, 2018 and 2017:

 

		Six Months Ended June 30,
		2018												2017
		(Dollars in thousands)
		Average								Interest				Average								Interest
		Balance				Interest				Yield				Balance				Interest				Yield
Interest Earning Assets
Finance receivables		$	2,091,724			$	185,578				17.7%			$	2,326,016			$	212,060				18.2%
Finance receivables measured at fair value			239,217				12,340				10.3%				–				–				–
Total		$	2,330,941			$	197,918				17.0%			$	2,326,016			$	212,060				18.2%

 

In the six months ended June 30, 2018, other income of $5.0 million decreased by $602,000, or 10.7% compared to the prior year. The six-month period ended June 30, 2018 includes a decrease of $129,000 in revenue associated with direct mail and other related products and services that we offer to our dealers. We also incurred a decrease of $240,000 in payments from third-party providers of convenience fees paid by our customers for web based and other electronic payments, a decrease of $170,000 on payments to us for our interest in certain sold charge offs and acquired third-party portfolios and an increase of $26,000 on sales tax refunds.

 

Expenses.  Our operating expenses consist largely of provision for credit losses, interest expense, employee costs, marketing and general and administrative expenses. Provision for credit losses and interest expense are significantly affected by the volume of automobile contracts we purchased during the trailing 12-month period and by the outstanding balance of finance receivables held by consolidated subsidiaries not measured at fair value. Employee costs and general and administrative expenses are incurred as applications and automobile contracts are received, processed and serviced. Factors that affect margins and net income include changes in the automobile and automobile finance market environments, and macroeconomic factors such as interest rates and changes in the unemployment level.

 

Employee costs include base salaries, commissions and bonuses paid to employees, and certain expenses related to the accounting treatment of outstanding stock options, and are one of our most significant operating expenses. These costs (other than those relating to stock options) generally fluctuate with the level of applications and automobile contracts processed and serviced.

 

Other operating expenses consist largely of facilities expenses, telephone and other communication services, credit services, computer services, marketing and advertising expenses, and depreciation and amortization.

 

Total operating expenses were $193.7 million for the six months ended June 30, 2018, compared to $201.9 million for the prior period, a decrease of $8.2 million, or 4.1%. The decrease is primarily due to a decrease in provision for credit losses, offsetting increases in employee costs, interest expense and general and administrative expenses.

 

 

 

 

Employee costs increased by $5.1 million or 14.5%, to $40.5 million during the six months ended June 30, 2018, representing 20.9% of total operating expenses, from $35.4 million for the prior year, or 17.0% of total operating expenses. Employee costs for the prior year period were net of $2.8 million of direct employee costs associated with the originations of contracts during that period. Such deferred costs are then recognized over the life of the related receivables using the interest method. The table below summarizes our employees by category as well as contract purchases and units in our managed portfolio as of, and for the six-month periods ended, June 30, 2018 and 2017:

 

		June 30, 2018				June 30, 2017
		Amount				Amount
		($ in millions)
Contracts purchased (dollars)		$	425.3			$	463.5
Contracts purchased (units)			25,896				28,548
Managed portfolio outstanding (dollars)		$	2,329.2			$	2,343.3
Managed portfolio outstanding (units)			174,564				173,598
Number of Originations staff			208				209
Number of Marketing staff			131				117
Number of Servicing staff			575				565
Number of other staff			99				93
Total number of employees			1,013				984

 

General and administrative expenses include costs associated with purchasing and servicing our portfolio of finance receivables, including expenses for facilities, credit services, and telecommunications. General and administrative expenses were $14.9 million, an increase of $1.2 million, or 8.8% compared to the previous year and represented 7.7% of total operating expenses.

 

Interest expense for the six months ended June 30, 2018 increased by $3.9 million to $49.2 million, or 8.7% and represented 25.4% of total operating expenses, compared to $45.3 million in the previous year, when it was 22.4% of total operating expenses.

 

 

 

 

Interest on securitization trust debt increased by $3.5 million, or 8.5%, for the six months ended June 30, 2018 compared to the prior period. The average balance of securitization trust debt increased to $2,172.1 million for the six months ended June 30, 2018 compared to $2,168.0 million for the six months ended June 30, 2017. The blended interest rates on new term securitizations have generally increased since June 2014. As a result, the cost of securitization debt during the six-month period ended June 30, 2018 was 4.1%, compared to 3.7% in the prior year period. For any particular quarterly securitization transaction, the blended cost of funds is ultimately the result of many factors including the market interest rates for benchmark swaps of various maturities against which our bonds are priced and the margin over those benchmarks that investors are willing accept, which in turn, is influenced by investor demand for our bonds at the time of the securitization. These and other factors have resulted in a general trend toward higher securitization trust debt interest costs since June 2014, although that trend has reversed somewhat since July 2016. The blended interest rates of our recent securitizations are summarized in the table below:

 

Blended Cost of Funds on Recent Asset-Backed

Term Securitizations

 

Period			Blended Cost of Funds
June 2014			2.37%
September 2014			2.71%
December 2014			3.07%
March 2015			3.04%
June 2015			3.18%
September 2015			3.78%
January 2016			4.34%
April 2016			4.65%
July 2016			4.48%
October 2016			3.62%
January 2017			3.91%
April 2017			3.45%
July 2017			3.52%
October 2017			3.39%
January 2018			3.46%
April 2018			3.98%

 

Interest expense on subordinated renewable notes increased by $70,000, or 11.3%. The increase is due to an increase in the average yield on our subordinated renewable notes to 8.5% for the six-month period ended June 30, 2018 compared to the prior year when the average yield on our subordinated renewable notes was 7.9%.

 

Interest expense on warehouse debt decreased by $64,000, or 1.6%, for the six months ended June 30, 2018 compared to the prior period. When possible, we hold contracts with our own cash rather than pledging them to one of our warehouse facilities to minimize interest expense.

 

 

 

 

The following table presents the components of interest income and interest expense and a net interest yield analysis for the six-month periods ended June 30, 2018 and 2017:

 

		Six Months Ended June 30,
		2018												2017
		(Dollars in thousands)
										Annualized													Annualized
		Average								Average				Average									Average
		Balance (1)				Interest				Yield/Rate				Balance (1)				Interest					Yield/Rate
Interest Earning Assets
Finance receivables gross (2)		$	2,055,585			$	185,578				18.1%			$	2,289,285			$	212,060				18.5%
Finance receivables at fair value			239,217				12,340				10.3%				–				–				–
			2,294,802				197,918				17.2%				2,289,285				212,060				18.5%
Interest Bearing Liabilities
Warehouse lines of credit (3)		$	67,477				4,023				11.9%			$	62,462				4,087				13.1%
Residual interest financing			10,166				452				8.9%				–				–				–
Securitization trust debt			2,172,145				44,084				4.1%				2,167,966				40,617				3.7%
Subordinated renewable notes			16,205				690				8.5%				15,746				620				7.9%
		$	2,265,993				49,249				4.3%			$	2,246,174				45,324				4.0%
Net interest income/spread						$	148,669											$	166,736
Net interest yield (4)											13.0%												14.6%
Ratio of average interest earning assets to average interest bearing liabilities											101%												102%

 

     (1)  Average balances are based on month end balances except for warehouse lines of credit, which are based on daily balances.

     (2)  Net of deferred fees and direct costs.

     (3)  Annualized net interest income divided by average interest earning assets.

 

	Six Months Ended June 30, 2018
		Compared to June 30, 2017
		Total				Change Due					Change Due
		Change				to Volume					to Rate
		(In thousands)
Interest Earning Assets
Finance receivables gross		$	(26,482	)		$	(21,648	)		$	(4,834	)
Finance receivables at fair value			12,340				12,340				–
			(14,142	)			(9,308	)			(4,834	)
Interest Bearing Liabilities
Warehouse lines of credit			(64	)			328				(392	)
Residual interest financing			452				452				–
Securitization trust debt			3,467				78				3,389
Subordinated renewable notes			70				18				52
			3,925				876				3,049
Net interest income/spread		$	(18,067	)		$	(10,184	)		$	(7,883	)

 

 

 

 

The reduction in the annualized yield on our finance receivables for the six months ended June 30, 2018 compared to the prior year period is the result of our decision over the last twelve months to offer dealers slightly lower acquisition fees and to require slightly lower contract interest rates on a portion of the contracts we purchase. Another reason for the decrease in the annualized yield is the lower interest yield on the receivables measured at fair value. The interest yield on receivables measured at fair value is reduced for the impact of expected losses and is therefore less than the yield on other finance receivables.

 

Provision for credit losses was $76.0 million for the six months ended June 30, 2018, a decrease of $19.7 million, or 20.6% compared to the prior year and represented 39.3% of total operating expenses. The provision for credit losses maintains the allowance for finance credit losses at levels that we feel are adequate for probable incurred credit losses that can be reasonably estimated. Our approach for establishing the allowance requires greater amounts of provision for credit losses early in the terms of our finance receivables. In addition, we monitor the delinquency and net charge off rates in our portfolio to consider how such rates may affect the allowance for finance credit losses. Finance receivables that we have originated since January 2018 are accounted for at fair value. Under the fair value method of accounting, we recognize interest income under the interest method on a level yield basis based on forecasted future cash flows net of expected credit losses. Thus, no provision for credit loss expense is recorded for finance receivables measured at fair value.

 

Marketing expenses consist primarily of commission-based compensation paid to our employee marketing representatives. Our marketing representatives earn a salary plus commissions based on volume of contract purchases and sales of ancillary products and services that we offer our dealers, such as training programs, internet lead sales, and direct mail products. Marketing expenses increased by $848,000, or 10.7%, to $8.8 million during the six months ended June 30, 2018, compared to $8.0 million in the prior year period, and represented 4.5% of total operating expenses. Our marketing staff increased to 131 as of June 30, 2018 compared to 117 at June 30, 2017. In addition, in recent months, we have gradually shifted to more field marketing representatives as compared to in-house marketing representatives. Field marketing representatives are somewhat more costly than in-house marketing representatives, but we feel will ultimately be more effective. For the six months ended June 30, 2018, we purchased 25,896 contracts representing $425.3 million in receivables compared to 28,548 contracts representing $463.5 million in receivables in the prior period.

 

Occupancy expenses increased by $315,000 or 9.3%, to $3.7 million compared to $3.4 million in the previous year and represented 1.9% of total operating expenses. In July 2015, we entered into a lease for additional office space in Irvine, California. We then occupied that space, and incurred incremental occupancy expense, in phases. In May 2017, we acquired additional office space in Las Vegas, Nevada.

 

Depreciation and amortization expenses increased by $42,000 or 9.4%, to $490,000 compared to $448,000 in the previous year and represented 0.2% of total operating expenses.

 

For the six months ended June 30, 2018, we recorded income tax expense of $2.9 million, representing a 31.5% effective income tax rate. In the prior year period, we recorded $6.7 million in income tax expense, representing a 42.5% effective income tax rate. In December 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act lowered the federal corporate income tax rate from 35% to 21% beginning in 2018.

 

Credit Experience

 

Our financial results are dependent on the performance of the automobile contracts in which we retain an ownership interest. Broad economic factors such as recession and significant changes in unemployment levels influence the credit performance of our portfolio, as does the weighted average age of the receivables at any given time. The tables below document the delinquency, repossession and net credit loss experience of all such automobile contracts that we originated or own an interest in as of the respective dates shown. The tables do not include the experience of third party originated and owned portfolios.

 

 

 

 

Delinquency, Repossession and Extension Experience (1)

Total Owned Portfolio

 

		June 30, 2018								June 30, 2017								December 31, 2017
		Number of								Number of								Number of
		Contracts				Amount				Contracts				Amount				Contracts				Amount
		(Dollars in thousands)
Delinquency Experience
Gross servicing portfolio (1)			174,563			$	2,329,179				173,597			$	2,343,297				173,998			$	2,333,524
Period of delinquency (2)
31-60 days			9,175			$	124,663				8,877			$	121,354				10,163			$	138,395
61-90 days			4,031				52,811				3,722				49,094				4,741				63,081
91+ days			1,934				22,865				1,907				23,947				2,295				27,515
Total delinquencies (2)			15,140				200,339				14,506				194,395				17,199				228,991
Amount in repossession (3)			2,679				34,148				2,465				31,383				2,630				33,679
Total delinquencies and amount in repossession (2)			17,819			$	234,487				16,971			$	225,778				19,829			$	262,670
Delinquencies as a percentage of gross servicing portfolio			8.7%				8.6%				8.4%				8.3%				9.9%				9.8%
Total delinquencies and amount in repossession as a percentage of gross servicing portfolio			10.2%				10.1%				9.8%				9.6%				11.4%				11.3%
Extension Experience
Contracts with one extension, accruing			27,927			$	371,549				32,871			$	449,931				31,708			$	430,801
Contracts with two or more extensions, accruing			60,365				819,447				42,732				583,364				55,203				756,561
			88,292				1,190,996				75,603				1,033,295				86,911				1,187,362
Contracts with one extension, non-accrual (4)			700				8,126				1,184				14,863				1,032				12,241
Contracts with two or more extensions, non-accrual (4)			2,921				37,369				1,671				21,896				2,701				35,626
			3,621				45,495				2,855				36,759				3,733				47,867
Total contracts with extensions			91,913			$	1,236,491				78,458			$	1,070,054				90,644			$	1,235,229

 

____________________________________

(1) All amounts and percentages are based on the amount remaining to be repaid on each automobile contract, including, for pre-computed automobile contracts, any unearned interest. The information in the table represents the gross principal amount of all automobile contracts we have purchased, including automobile contracts subsequently sold in securitization transactions that we continue to service. The table does not include certain contracts we have serviced for third parties on which we earn servicing fees only and have no credit risk.

(2) We consider an automobile contract delinquent when an obligor fails to make at least 90% of a contractually due payment by the following due date, which date may have been extended within limits specified in the Servicing Agreements. The period of delinquency is based on the number of days payments are contractually past due. Automobile contracts less than 31 days delinquent are not included. The delinquency aging categories shown in the tables reflect the effect of extensions.

(3) Amount in repossession represents financed vehicles that have been repossessed but not yet liquidated.

(4) Amount in repossession and accounts past due more than 90 days are on non-accrual.

 

 

 

 

Net Charge-Off Experience (1)

Total Owned Portfolio

 

	June 30,						June 30,					December 31,
	2018						2017					2017
	(Dollars in thousands)
Average servicing portfolio outstanding			$	2,330,937			$	2,326,008				$2,334,008
Annualized net charge-offs as a percentage of average servicing portfolio (2)				7.9%				7.8%				7.7%

 _________________________

(1) All amounts and percentages are based on the principal amount scheduled to be paid on each automobile contract, net of unearned income on pre-computed automobile contracts.

(2) Net charge-offs include the remaining principal balance, after the application of the net proceeds from the liquidation of the vehicle (excluding accrued and unpaid interest) and amounts collected subsequent to the date of charge-off, including some recoveries which have been classified as other income in the accompanying interim consolidated financial statements. June 30, 2018 and June 30, 2017 percentages represent six months ended June 30, 2018 and June 30, 2017 annualized. December 31, 2017 represents 12 months ended December 31, 2017.

 

Extensions

 

In certain circumstances we will grant obligors one-month payment extensions to assist them with temporary cash flow problems. In general, an obligor would not be entitled to more than two such extensions in any 12-month period and no more than six over the life of the contract. The only modification of terms is to advance the obligor’s next due date by one month and extend the maturity date of the receivable by one month. In some cases, a two-month extension may be granted. There are no other concessions such as a reduction in interest rate, forgiveness of principal or of accrued interest. Accordingly, we consider such extensions to be insignificant delays in payments rather than troubled debt restructurings.

 

The basic question in deciding to grant an extension is whether or not we will (a) be delaying the inevitable repossession and liquidation or (b) risk losing the vehicle as a result of not being able to locate the obligor and vehicle. In both of those situations, the loss would likely be higher than if the vehicle had been repossessed without the extension. The benefits of granting an extension include minimizing current losses and delinquencies, minimizing lifetime losses, getting the obligor’s account current (or close to it) and building goodwill with the obligor so that he might prioritize us over other creditors on future payments. Our servicing staff are trained to identify when a past due obligor is facing a temporary problem that may be resolved with an extension. In most cases, the extension will be granted in conjunction with our receiving a past due payment (and where allowed by law, a nominal fee, applied to the loan as a partial payment) from the obligor, thereby indicating an additional monetary and psychological commitment to the contract on the obligor’s part.

 

The credit assessment for granting an extension is initially made by our collector, who bases the recommendation on the collector’s discussions with the obligor. In such assessments the collector will consider, among other things, the following factors: (1) the reason the obligor has fallen behind in payment; (2) whether or not the reason for the delinquency is temporary, and if it is, have conditions changed such that the obligor can begin making regular monthly payments again after the extension; (3) the obligor's past payment history, including past extensions if applicable; and (4) the obligor’s willingness to communicate and cooperate on resolving the delinquency. If the collector believes the obligor is a good candidate for an extension, he must obtain approval from his supervisor, who will review the same factors stated above prior to offering the extension to the obligor. After receiving an extension, an account remains subject to our normal policies and procedures for interest accrual, reporting delinquency and recognizing charge-offs.

 

 

 

 

We believe that a prudent extension program is an integral component to mitigating losses in our portfolio of sub-prime automobile receivables. The table below summarizes the status, as of June 30, 2018, for accounts that received extensions from 2008 through 2016 (2017 and 2018 extension data are not included at this time due to insufficient passage of time for meaningful evaluation of results):

 

Period of Extension				# Extensions Granted				Active or Paid Off at June 30, 2018				% Active or Paid Off at June 30, 2018				Charged Off > 6 Months After Extension				% Charged Off > 6 Months After Extension				Charged Off <= 6 Months After Extension				% Charged Off <= 6 Months After Extension				Avg Months to Charge Off Post Extension
	2008				35,588				10,710				30.1%				20,059				56.4%				4,819				13.5%				19
	2009				32,226				10,275				31.9%				16,168				50.2%				5,783				17.9%				17
	2010				26,167				12,167				46.5%				12,001				45.9%				1,999				7.6%				19
	2011				18,786				10,978				58.4%				6,876				36.6%				932				5.0%				19
	2012				18,783				11,377				60.6%				6,610				35.2%				796				4.2%				18
	2013				23,398				11,829				50.6%				10,593				45.3%				976				4.2%				21
	2014				25,773				12,425				48.2%				12,522				48.6%				826				3.2%				20
	2015				53,319				30,708				57.6%				21,529				40.4%				1,082				2.0%				18
	2016				80,897				58,280				72.0%				20,684				25.6%				1,933				2.4%				14

  ______________________

Note: Table excludes extensions on portfolios serviced for third parties

 

We view these results as a confirmation of the effectiveness of our extension program. For example, of the accounts granted extensions in 2012, 60.6% were either paid in full or active and performing at June 30, 2018. Each of these successful accounts represent continued payments of interest and principal (including payment in full in many cases), where without the extension we likely would have incurred a substantial loss and no interest revenue subsequent to the extension.

 

For the extension accounts that ultimately charge off, we consider any that charged off more than six months after the extension to be at least partially successful. For example, of the accounts granted extensions in 2012 that subsequently charged off, such charge offs occurred, on average, 18 months after the extension, indicating that even in the cases of an ultimate loss, the obligor serviced the account with additional payments of principal and interest.

 

 

 

 

Additional information about our extensions is provided in the tables below:

 

				Six Months Ended June 30,								Year Ended December 31,
				2018				2017				2017
	Average number of extensions granted per month				10,298				9,598				11,157
	Average number of outstanding accounts				174,415				172,121				173,137
	Average monthly extensions as % of average outstandings				5.9%				5.6%				6.4%

 

______________________

Note: Table excludes portfolios originated and owned by third parties

 

		June 30, 2018								June 30, 2017								December 31, 2017
		Number of Contracts				Amount				Number of Contracts				Amount				Number of Contracts				Amount
										(Dollars in thousands)
Contracts with one extension			28,627			$	379,675				34,055			$	464,795				32,740			$	443,042
Contracts with two extensions			21,977				297,413				22,108				307,357				24,375				335,643
Contracts with three extensions			17,736				243,588				12,130				165,846				16,378				227,980
Contracts with four extensions			12,255				168,623				6,247				83,349				9,506				129,795
Contracts with five extensions			7,395				98,319				2,846				36,404				5,096				67,703
Contracts with six extensions			3,923				48,873				1,072				12,303				2,549				31,067
			91,913			$	1,236,491				78,458			$	1,070,054				90,644			$	1,235,230
Managed portfolio (excluding originated and owned by 3rd parties)			174,563			$	2,329,179				173,597			$	2,343,297				173,998			$	2,333,524

 ______________________

Note: Table excludes portfolios originated and owned by third parties

 

In recent years, we have experienced an increase in the number of extensions that we grant to our customers. We attribute this to a number of factors. First, In June 2014 we entered into a consent decree with the FTC that required us to make certain procedural changes in our servicing practices, which we believe have contributed to somewhat higher delinquencies and extensions compared to prior periods. Secondly, in recent years we have found it more difficult to communicate with our customers via outbound voice telephone calls, which have historically been our primary means of communicating with our customers. Consequently, we have recently developed text messaging platforms to supplement our outbound voice calling efforts. In addition, in 2016 we added features to the customer portal of our website to facilitate the process whereby the customer may request an extension.

 

 

 

 

Non-Accrual Receivables

 

It is not uncommon for our obligors to fall behind in their payments. However, with the diligent efforts of our Servicing staff and systems for managing our collection efforts, we regularly work with our customers to resolve delinquencies. Our staff are trained to employ a counseling approach to assist our customers with their cash flow management skills and help them to prioritize their payment obligations in order to avoid losing their vehicle to repossession. Through our experience, we have learned that once a customer becomes greater than 90 days past due, it is not likely that the delinquency will be resolved and will ultimately result in a charge-off. As a result, we do not recognize any interest income for contracts that are greater than 90 days past due.

 

If a contract exceeds the 90 days past due threshold at the end of one period, and then makes the necessary payments such that it becomes less than or equal to 90 days delinquent at the end of a subsequent period, it would be restored to full accrual status for our financial reporting purposes. At the time a contract is restored to full accrual in this manner, there can be no assurance that full repayment of interest and principal will ultimately be made. However, we monitor each obligor’s payment performance and are aware of the severity of his delinquency at any time. The fact that the delinquency has been reduced below the 90-day threshold is a positive indicator. Should the contract again exceed the 90-day delinquency level at the end of any reporting period, it would again be reflected as a non-accrual account.

 

Our policy for placing a contract on non-accrual status is independent of our policy to grant an extension. In practice, it would be an uncommon circumstance where an extension was granted and the account remained in a non-accrual status, since the goal of the extension is to bring the contract current (or nearly current).

 

Liquidity and Capital Resources

 

Our business requires substantial cash to support our purchases of automobile contracts and other operating activities. Our primary sources of cash have been cash flows from the proceeds from term securitization transactions and other sales of automobile contracts, amounts borrowed under various revolving credit facilities (also sometimes known as warehouse credit facilities), customer payments of principal and interest on finance receivables, fees for origination of automobile contracts, and releases of cash from securitization transactions and their related spread accounts. Our primary uses of cash have been the purchases of automobile contracts, repayment of amounts borrowed under lines of credit, securitization transactions and otherwise, operating expenses such as employee, interest, occupancy expenses and other general and administrative expenses, the establishment of spread accounts and initial overcollateralization, if any, the increase of credit enhancement to required levels in securitization transactions, and income taxes. There can be no assurance that internally generated cash will be sufficient to meet our cash demands. The sufficiency of internally generated cash will depend on the performance of securitized pools (which determines the level of releases from those pools and their related spread accounts), the rate of expansion or contraction in our managed portfolio, and the terms upon which we are able to acquire and borrow against automobile contracts.

 

Net cash provided by operating activities for the six-month period ended June 30, 2018 was $101.3 million, a decrease of $13.4 million, compared to net cash provided by operating activities for the six-month period ended June 30, 2017 of $114.7 million. Cash provided by operating activities is significantly affected by our net income before provisions for credit losses. For the six months ended June 30, 2018, our net income excluding provisions for credit losses was $82.4 million, or $22.4 million less than our net income excluding provisions for credit losses for the six months ended June 30, 2017.

 

Net cash used in investing activities for the six-month period ended June 30, 2018 was $101.0 million compared to net cash used in investing activities of $133.9 million in the prior year period. Cash provided by investing activities primarily results from principal payments and other proceeds received on finance receivables. Cash used in investing activities generally relates to purchases of automobile contracts. Purchases of finance receivables were $425.3 million and $463.5 million during the first six months of 2018 and 2017, respectively.

 

 

 

 

Net cash provided by financing activities for the six months ended June 30, 2018 was $4.5 million compared to net cash provided by financing activities of $21.1 million in the prior year period. Cash provided by financing activities is primarily related to the issuance of securitization trust debt, reduced by the amount of repayment of securitization trust debt and net proceeds or repayments on our warehouse lines of credit and other debt. In the first six months of 2018, we issued $391.8 million in new securitization trust debt compared to $431.5 million in the same period of 2017. In addition, we repaid $444.8 million in securitization trust debt in the six months ended June 30, 2018 compared to repayments of securitization trust debt of $430.8 million in the prior year period. In the six months ended June 30, 2018, we had net advances on warehouse lines of credit of $24.8 million, compared to net advances of $28.0 million in the prior year’s period.

 

We purchase automobile contracts from dealers for a cash price approximately equal to their principal amount, adjusted for an acquisition fee which may either increase or decrease the automobile contract purchase price. Those automobile contracts generate cash flow, however, over a period of years. As a result, we have been dependent on warehouse credit facilities to purchase automobile contracts, and on the availability of cash from outside sources in order to finance our continuing operations, as well as to fund the portion of automobile contract purchase prices not financed under revolving warehouse credit facilities.

 

The acquisition of automobile contracts for subsequent financing in securitization transactions, and the need to fund spread accounts and initial overcollateralization, if any, and increase credit enhancement levels when those transactions take place, results in a continuing need for capital. The amount of capital required is most heavily dependent on the rate of our automobile contract purchases, the required level of initial credit enhancement in securitizations, and the extent to which the previously established trusts and their related spread accounts either release cash to us or capture cash from collections on securitized automobile contracts. Of those, the factor most subject to our control is the rate at which we purchase automobile contracts.

 

We are and may in the future be limited in our ability to purchase automobile contracts due to limits on our capital. As of June 30, 2018, we had unrestricted cash of $17.4 million and $162.1 million aggregate available borrowings under our three warehouse credit facilities (assuming the availability of sufficient eligible collateral). As of June 30, 2018, we had approximately $18.8 million of such eligible collateral. During the six-month period ended June 30, 2018, we completed two securitization aggregating $391.8 million of notes sold. Our plans to manage our liquidity include maintaining our rate of automobile contract purchases at a level that matches our available capital, and, as appropriate, minimizing our operating costs. If we are unable to complete such securitizations, we may be unable to increase our rate of automobile contract purchases, in which case our interest income and other portfolio related income could decrease.

 

Our liquidity will also be affected by releases of cash from the trusts established with our securitizations. While the specific terms and mechanics of each spread account vary among transactions, our securitization agreements generally provide that we will receive excess cash flows, if any, only if the amount of credit enhancement has reached specified levels and the delinquency or net losses related to the automobile contracts in the pool are below certain predetermined levels. In the event delinquencies or net losses on the automobile contracts exceed such levels, the terms of the securitization may require increased credit enhancement to be accumulated for the particular pool. There can be no assurance that collections from the related trusts will continue to generate sufficient cash.

 

Our warehouse credit facilities contain various financial covenants requiring certain minimum financial ratios and results. Such covenants include maintaining minimum levels of liquidity and net worth and not exceeding maximum leverage levels. In addition, certain of our debt agreements other than our term securitizations contain cross-default provisions. Such cross-default provisions would allow the respective creditors to declare a default if an event of default occurred with respect to other indebtedness of ours, but only if such other event of default were to be accompanied by acceleration of such other indebtedness. As of June 30, 2018, we were in compliance with all such financial covenants.

 

We have and will continue to have a substantial amount of indebtedness. At June 30, 2018, we had approximately $2,223.7 million of debt outstanding. Such debt consisted primarily of $2,030.7 million of securitization trust debt and $137.9 million of warehouse lines of credit. Our securitization trust debt has decreased by $51.3 million while our warehouse lines of credit have increased by $6.6 million since June 30, 2017 (each net of deferred financing costs). Since 2005, we have offered renewable subordinated notes to the public on a continuous basis, and such notes have maturities that range from six months to 10 years. We had $15.8 million and $16.1 million in subordinated renewable notes outstanding at June 30, 2018 and 2017, respectively. On May 16, 2018, we completed a $40.0 million securitization of residual interests from previously issued securitizations. At June 30, 2018, $40.0 million of this residual interest financing debt remains outstanding ($39.3 million net of deferred financing costs).

 

 

 

 

Although we believe we are able to service and repay our debt, there is no assurance that we will be able to do so. If our plans for future operations do not generate sufficient cash flows and earnings, our ability to make required payments on our debt would be impaired. If we fail to pay our indebtedness when due, it could have a material adverse effect on us and may require us to issue additional debt or equity securities.

 

Forward Looking Statements

 

This report on Form 10-Q includes certain “forward-looking statements.” Forward-looking statements may be identified by the use of words such as “anticipates,” “expects,” “plans,” “estimates,” or words of like meaning. Our provision for credit losses is a forward-looking statement, as it is dependent on our estimates as to future chargeoffs and recovery rates. Factors that could affect charge-offs and recovery rates include changes in the general economic climate, which could affect the willingness or ability of obligors to pay pursuant to the terms of automobile contracts, changes in laws respecting consumer finance, which could affect our ability to enforce rights under automobile contracts, and changes in the market for used vehicles, which could affect the levels of recoveries upon sale of repossessed vehicles. Factors that could affect our revenues in the current year include the levels of cash releases from existing pools of automobile contracts, which would affect our ability to purchase automobile contracts, the terms on which we are able to finance such purchases, the willingness of dealers to sell automobile contracts to us on the terms that we offer, and the terms on which and whether we are able to complete term securitizations once automobile contracts are acquired. Factors that could affect our expenses in the current year include competitive conditions in the market for qualified personnel and interest rates (which affect the rates that we pay on notes issued in our securitizations).

 

Item 4. Controls and Procedures

 

We maintain a system of internal controls and procedures designed to provide reasonable assurance as to the reliability of our published financial statements and other disclosures included in this report. As of the end of the period covered by this report, we evaluated the effectiveness of the design and operation of such disclosure controls and procedures. Based upon that evaluation, the principal executive officer (Charles E. Bradley, Jr.) and the principal financial officer (Jeffrey P. Fritz) concluded that the disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, material information relating to us that is required to be included in our reports filed under the Securities Exchange Act of 1934. There has been no change in our internal controls over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 

 

 

PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

 

The information provided under the caption “Legal Proceedings,” Note 8 to the Unaudited Condensed Consolidated Financial Statements, included in Part I of this report, is incorporated herein by reference.

 

Item 1A. Risk Factors

 

We remind the reader that risk factors are set forth in Item 1A of our report on Form 10-K, filed with the U.S. Securities and Exchange Commission on June 7, 2018. Where we are aware of material changes to such risk factors as previously disclosed, we set forth below an updated discussion of such risks. The reader should note that the other risks identified in our report on Form 10-K remain applicable.

 

We have substantial indebtedness.

 

We have and will continue to have a substantial amount of indebtedness. At June 30, 2018, we had approximately $2,223.7 million of debt outstanding. Such debt consisted primarily of $2,030.7 million of securitization trust debt and $137.9 million of warehouse lines of credit. Our securitization trust debt has decreased by $51.3 million while our warehouse lines of credit have increased by $6.6 million since June 30, 2017 (each net of deferred financing costs). Since 2005, we have offered renewable subordinated notes to the public on a continuous basis, and such notes have maturities that range from six months to 10 years. We had $15.8 million and $16.1 million in subordinated renewable notes outstanding at June 30, 2018 and 2017, respectively. On May 16, 2018, we completed a $40.0 million securitization of residual interests from previously issued securitizations. At June 30, 2018, $40.0 million of this residual interest financing debt remains outstanding ($39.3 million net of deferred financing costs). Our substantial indebtedness could adversely affect our financial condition by, among other things:

 

·

increasing our vulnerability to general adverse economic and industry conditions;

 

·

requiring us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing amounts available for working capital, capital expenditures and other general corporate purposes;

 

·

limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

 

·

placing us at a competitive disadvantage compared to our competitors that have less debt; and

 

·

limiting our ability to borrow additional funds.

 

Although we believe we are able to service and repay such debt, there is no assurance that we will be able to do so. If we do not generate sufficient operating profits, our ability to make required payments on our debt would be impaired. Failure to pay our indebtedness when due could have a material adverse effect.

 

Forward-Looking Statements

 

Discussions of certain matters contained in this report may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Exchange Act, and as such, may involve risks and uncertainties. These forward-looking statements relate to, among other things, expectations of the business environment in which we operate, projections of future performance, perceived opportunities in the market and statements regarding our mission and vision. You can generally identify forward-looking statements as statements containing the words "will," "would," "believe," "may," "could," "expect," "anticipate," "intend," "estimate," "assume" or other similar expressions. Our actual results, performance and achievements may differ materially from the results, performance and achievements expressed or implied in such forward-looking statements. The discussion under "Risk Factors" identifies some of the factors that might cause such a difference, including the following:

 

	·	changes in general economic conditions;
	·	our ability or inability to obtain necessary financing, and the terms of any such financing;
	·	changes in interest rates, especially as applicable to securitization trust debt;
	·	our ability to generate sufficient operating and financing cash flows;
	·	competition;
	·	level of future provisioning for receivables losses;
	·	the levels of actual losses on receivables; and
	·	regulatory requirements.

 

 

 

 

Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Actual results may differ from expectations due to many factors beyond our ability to control or predict, including those described herein, and in documents incorporated by reference in this report. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

 

We undertake no obligation to publicly update any forward-looking information. You are advised to consult any additional disclosure we make in our periodic reports filed with the SEC.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

During the three months ended June 30, 2018, we repurchased 491,117 shares from existing shareholders, as reflected in the table below.

 

Issuer Purchases of Equity Securities

 

												Total Number of				Approximate Dollar
				Total								Shares Purchased as				Value of Shares that
				Number of				Average				Part of Publicly				May Yet be Purchased
				Shares				Price Paid				Announced Plans or				Under the Plans or
Period(1)				Purchased				per Share				Programs				Programs (2)
	April 2018				187,518			$	3.67				187,518			$	10,669,741
	May 2018				171,404			$	3.60				171,404			$	10,052,713
	June 2018				132,195			$	4.18				132,195			$	9,499,726
	Total				491,117			$	3.78				491,117

 

____________________

(1)

Each monthly period is the calendar month.

(2)

Through June 30, 2018, our board of directors had authorized the purchase of up to $74.5 million of our outstanding securities, under a program first announced in our annual report for the year 2002, filed on June 26, 2003. All purchases described in the table above were under the program announced in June 2003, which has no fixed expiration date.

 

Item 6. Exhibits

 

The Exhibits listed below are filed with this report.

 

4.14	Instruments defining the rights of holders of long-term debt of certain consolidated subsidiaries of the registrant are omitted pursuant to the exclusion set forth in subdivisions (b)(iv)(iii)(A) and (b)(v) of Item 601 of Regulation S-K (17 CFR 229.601).  The registrant agrees to provide copies of such instruments to the United States Securities and Exchange Commission upon request.
31.1	Rule 13a-14(a) Certification of the Chief Executive Officer of the registrant.
31.2	Rule 13a-14(a) Certification of the Chief Financial Officer of the registrant.
32	Section 1350 Certifications.*

 

* These Certifications shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section. These Certifications shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the registration statement specifically states that such Certifications are incorporated therein.

 

 

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

CONSUMER PORTFOLIO SERVICES, INC.

 

(Registrant)

 

Date: August 8, 2018

 

By: /s/   CHARLES E. BRADLEY, JR.                           

Charles E. Bradley, Jr.

President and Chief Executive Officer

(Principal Executive Officer)

 

Date: August 8, 2018

By: /s/   JEFFREY P. FRITZ                                           

Jeffrey P. Fritz

Executive Vice President and Chief Financial Officer

(Principal Financial Officer)