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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] Annual Report Under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 1997
[_] Transition Report Under Section 13 or 15(d) of the Securities Exchange
Act of 1934
Commission File Number: 1-14116
CONSUMER PORTFOLIO SERVICES, INC.
(Exact name of registrant as specified in its charter)
California 33-0459135
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2 Ada, Irvine, California 92618
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code: (714) 753-6800
Securities registered pursuant to section 12(b) of the Act:
Title of each class: Rising Interest Subordinated Redeemable Securities
due 2006
10.50% Participating Equity Notes due 2004
Name of each exchange on which registered: New York Stock Exchange
Securities registered pursuant to section 12(g) of the Act: Common stock, no
par value
Indicate by check mark whether the registrant (1) filed all reports required to
be filed by Section 13 or 15(d) of the Exchange Act during the past 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 if there is no disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value on March 4, 1998 (based on the $10.875 closing price
on the Nasdaq Stock Market on that date) of the voting stock beneficially held
by non-affiliates of the registrant was $93,083,236. The number of shares of
the registrant's Common Stock outstanding on March 4, 1998 was 15,210,042.
Documents Incorporated by Reference
The registrant's proxy statement for its 1998 annual meeting of shareholders is
incorporated by reference into Part III of this report.
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PART I
Item 1. BUSINESS
General
Consumer Portfolio Services, Inc., ("CPS", and together with its
subsidiaries, the "Company") is a consumer finance company specializing in the
business of purchasing, selling and servicing retail automobile installment
contracts ("Contracts") originated by dealers ("Dealers") in the sale of new and
used automobiles, light trucks and passenger vans. Through its purchases, the
Company provides indirect financing to borrowers with limited credit histories,
low incomes or past credit problems ("Sub-Prime Borrowers"). The Company serves
as an alternative source of financing for Dealers, allowing sales to customers
who otherwise might not be able to obtain financing from more traditional
sources of automobile financing such as banks, credit unions or finance
companies affiliated with major automobile manufacturers.
History
The Company was incorporated in March 1991 as a wholly owned subsidiary of
CPS Holdings, Inc. ("Holdings") (formerly known as FWB Acceptance Corp.).
Holdings was formed in April 1990 by Charles E. Bradley, Sr., the Chairman of
the Board of the Company, in order to enter into the automobile financing
business. Mr. Bradley believed that the Sub-Prime Borrower segment of this
business had the potential for growth and profit due in part to the withdrawal
from such business by many savings and loan associations and other financial
institutions. In December 1995, Holdings was merged with and into the Company.
The period from March 8, 1991 (the Company's inception) through May 1991 was
devoted to the start-up of the Company's operations. On May 31, 1991, the
Company first acquired certain third-party loan servicing contracts and in June
1991 began earning servicing fee income. The Company thereafter added to its
third-party loan servicing portfolio and, in October 1991, began acquiring
Contracts and selling them to General Electric Capital Corporation ("GECC"). To
date, the Company has sold $42.6 million in Contracts to GECC and an additional
$100.1 million to Sun Life Insurance Company of America ("Sun Life"). Since June
1994, the Company has issued an additional $1.1 billion of "AAA"-rated and $50.9
million of "BB"-rated certificates backed by Contracts to various institutional
investors. Since June 1996, all sales of "AAA"-rated certificates have been made
in public offerings pursuant to registration statements filed with the
Securities and Exchange Commission. See "Servicing of Contracts," "Purchase and
Sale of Contracts" and "Securitization and Sale of Contracts to Institutional
Investors."
Automobile Financing Industry
Automobile financing is a major component of consumer installment debt in the
United States. Most traditional sources of automobile financing, such as
commercial banks, credit unions and captive finance companies affiliated with
major automobile manufacturers, generally provide automobile financing for the
most creditworthy, or so-called "prime" borrowers. The Company believes that
the strong credit performance and large size of the market have led to intense
price competition in the financing market for prime borrowers, and, in turn, low
profit margins, effectively limiting this market to only the largest
participants. In addition, special low-rate financing programs offered by
automobile manufacturers' captive finance companies to promote the sale of
specific automobiles have added to the competition within the prime borrower
market.
Although prime borrowers represent the largest segment of the automobile
financing market, there are many potential purchasers of automobiles who do not
qualify as prime borrowers. Purchasers considered by the Company to be Sub-
Prime Borrowers have limited credit histories, low incomes or past credit
problems and, therefore, are unable to obtain credit from traditional sources of
automobile financing, such as commercial banks, credit unions or captive finance
companies affiliated with major automobile manufacturers. (The terms "prime"
and "sub-prime" reflect the Company's categorization of borrowers and bear no
relationship to the prime rate of interest or persons who are able to borrow at
that rate.) The Company believes that, because these potential purchasers
represent a substantial market, there is a demand by automobile dealers for Sub-
Prime Borrower financing that has not been effectively served by traditional
automobile financing sources.
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
Business Strategy
The Company's primary objective is to increase revenue and earnings through
the expansion of its sales and servicing of Contracts purchased from Dealers.
The Company's strategy is to:
- Maintain consistent underwriting standards and portfolio performance.
- Increase the number of Contracts it purchases from its existing Dealers.
- Expand its Dealer network, in part by entry into other geographic areas
(see "Purchase and Sale of Contracts--Dealer Contract Purchase Program").
- Control and/or reduce its cost of funds by proper structuring of its
securitization offerings and by obtaining the necessary ratings from
nationally recognized credit rating agencies.
- Evaluate opportunities to provide additional products and services, such
as automobile insurance, credit cards and extended maintenance contracts.
Expansion And Diversification
In March 1996, CPS formed Samco Acceptance Corp. ("Samco"), an 80 percent-
owned subsidiary based in Dallas, Texas. Samco's business plan is to provide
the Company's sub-prime auto finance products to rural areas through
independently owned finance companies. The Company believes that many rural
areas are not adequately served by other industry participants due to their
distance from large metropolitan areas where a Dealer marketing representative
is most likely to be based.
Samco employees call on independent finance companies ("IFCs"), primarily in
the southeastern United States, and present them with financing programs that
are essentially identical to those which CPS markets directly to Dealers through
its marketing representatives. The Company believes that a typical rural IFC has
relationships with many local automobile purchasers as well as Dealers who,
because of their financial resources or capital structure, are generally unable
to provide 36, 48 or 60 month financing for an automobile. IFCs may offer
Samco's financing programs to borrowers directly or to local Dealers. Upon
submission of applications to Samco, credit personnel who have been trained by
CPS use CPS's proprietary systems to evaluate the borrower and the proposed
Contract terms. Samco purchases Contracts from the IFCs after its credit
personnel have performed all of the underwriting and verification procedures
that CPS performs for Contracts it purchases from Dealers. Servicing and
collection procedures on Samco Contracts are performed by CPS at its
headquarters in Irvine, California. However, Samco may solicit aid from the IFC
in collecting accounts that are seriously past due. For the year ended December
31, 1997, Samco purchased 2,306 Contracts with original balances aggregating
$26.2 million.
In May 1996, CPS formed LINC Acceptance Corp. ("LINC"), an 80 percent-owned
subsidiary based in Norwalk, Connecticut. LINC provides the Company's sub-prime
auto finance products to credit unions, banks and savings and loans ("Deposit
Institutions"). The Company believes that Deposit Institutions do not generally
make loans to Sub-Prime Borrowers, even though they may have relationships with
Dealers and have Sub-Prime Borrowers as deposit customers.
LINC calls on various Deposit Institutions and presents them with a financing
program that is similar to those which CPS markets directly to Dealers through
its marketing representatives. The LINC program is intended to result in a
slightly more creditworthy borrower than the Company's regular programs by
requiring slightly higher income and lower debt-to-income ratios. LINC's
customers may offer its financing program to borrowers directly or to local
Dealers. Unlike Samco, which has employees who evaluate applications and make
decisions to purchase Contracts, LINC applications are submitted by the Deposit
Institution directly to CPS, where the approval, underwriting and purchase
procedures are performed by CPS staff who work with LINC as well as with CPS
Dealers. Servicing and collection procedures on LINC Contracts are performed
entirely by CPS using its personnel. For the year ended December 31, 1997, LINC
purchased 678 Contracts with original balances aggregating $8.9 million.
Purchase And Sale Of Contracts
Dealer Contract Purchase Program. As of December 31, 1997, the Company was a
party to its standard form dealer agreements ("Dealer Agreements") with 3,193
Dealers. Approximately 97.9% of these Dealers are franchised new car dealers
that sell both new and used cars and the remainder are independent used car
dealers. For the year
2
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
ended December 31, 1997, approximately 91.5% of the
Contracts purchased by the Company consisted of financing for used cars and the
remaining 8.5% for new cars. Most of these Dealers regularly submit Contracts
to the Company for purchase, although such Dealers are under no obligation to
submit any Contracts to the Company, nor is the Company obligated to purchase
any Contracts. During the year ended December 31, 1997, no Dealer accounted for
more than 1.0% of the total number of Contracts purchased by the Company. In
addition, the Company continues to diversify geographically, and has reduced its
concentration of Contract purchases in California from 25.8% for the year ended
December 31, 1996, to 18.1% for the year ended December 31, 1997. The following
table sets forth the geographical sources of the Contracts purchased by the
Company (based on the addresses of the borrowers as stated on the Company's
records) during the years ended December 31, 1997 and December 31, 1996:
Contracts Purchased During Year Ended
---------------------------------------------------------------------------
December 31, 1997 December 31, 1996
----------------------------------- ----------------------------------
Number Percent Number Percent
---------------- -------------- -------------- ---------------
California 9,035 18.1% 7,296 25.8%
Texas 3,649 7.3% 2,073 7.3%
Pennsylvania 3,622 7.2% 2,730 9.6%
Florida 3,404 6.8% 2,638 9.3%
Louisiana 3,142 6.3% 1,184 4.2%
New York 2,941 5.9% 1,201 4.2%
Illinois 2,413 4.8% 1,385 4.9%
Alabama 2,070 4.1% 906 3.2%
Tennessee 2,012 4.0% 1,225 4.3%
Michigan 1,954 3.9% 788 2.8%
North Carolina 1,613 3.2% 155 0.6%
Maryland 1,586 3.2% 920 3.3%
Georgia 1,503 3.0% 181 0.6%
Nevada 1,271 2.5% 1,060 3.7%
New Jersey 1,188 2.4% 625 2.2%
Other States 8,660 17.3% 3,938 13.9%
---------------- -------------- -------------- ---------------
Total 50,063 28,305
================ ==============
When a retail automobile buyer elects to obtain financing from a Dealer, an
application is taken for submission by the Dealer to its financing sources.
Typically, a Dealer will submit the buyer's application to more than one
financing source for review. The Company believes the Dealer's decision to
finance the automobile purchase with the Company, rather than other financing
sources, is based primarily upon an analysis of the discounted purchase price
offered for the Contract, the timeliness, consistency and predictability of
response, the cash resources of the financing source, and any conditions to
purchase.
Upon receipt of an application from a Dealer, the Company's administrative
personnel order a report containing information from the three major national
credit bureaus on the applicant to document the buyer's credit history. If,
upon review by a Company loan officer, it is determined that the application
meets the Company's underwriting criteria, or would meet such criteria with
modification, the Company requests and reviews further information and
supporting documentation and, ultimately, decides whether to purchase the
Contract. When presented with an application, the Company attempts to notify
the Dealer within four hours as to whether it intends to purchase such Contract.
The Company buys Contracts directly from Dealers and does not make loans
directly to purchasers of automobiles.
3
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
Through December 1996, the Company had purchased Contracts from Dealers at
percentage discounts ranging from 0% to 10% of the total amount financed under
the Contracts, depending on the perceived credit risk of the Contract, plus a
flat acquisition fee, generally $200, for each Contract purchased. Percentage
discounts averaged 4.1% and 2.8% for the years ended December 31, 1995 and 1996,
respectively. The Company believes that the level of discounts and fees are a
significant factor in the Dealer's decision to submit a Contract to the Company
for purchase, and will continue to play such a role in the future. Effective
January 10, 1997, the Company began purchasing Contracts in general without a
percentage discount, charging Dealers only an acquisition fee ranging from zero
to $1,195 for each Contract purchased. The fees vary based on the perceived
credit risk and, in some cases, the interest rate on the Contract. The
acquisition fees instituted in January 1997 are larger, on average, than the
acquisition fees previously charged in conjunction with percentage discounts, so
as to result in a similar net purchase price on a typical Contract. For the
year ended December 31, 1997, the average amount charged per Contract purchased
was $438 or 3.5% of the amount financed.
The Company attempts to control Dealer misrepresentation by carefully
screening the Contracts it purchases, by establishing and maintaining
professional business relationships with Dealers, and by including certain
representations and warranties by the Dealer in the Dealer Agreement. Pursuant
to the Dealer Agreement, the Company may require the Dealer to repurchase any
Contract in the event that the Dealer breaches its representations or warranties
or if a borrower fails, for any reason, to make timely payment of the first
installment due under a Contract. There can be no assurance, however, that any
Dealer will have the financial resources to satisfy its repurchase obligations
to the Company.
Contract Purchase Criteria. To be eligible for purchase by the Company, a
Contract must have been originated by a Dealer that has entered into a Dealer
Agreement to sell Contracts to the Company. The Contracts must be secured by a
first priority lien on a new or used automobile, light truck or passenger van
and must meet the Company's underwriting criteria. In addition, each Contract
requires the borrower to maintain physical damage insurance covering the
financed vehicle and naming the Company as a loss payee. The Company or any
purchaser of the Contract from the Company may, nonetheless, suffer a loss upon
theft or physical damage of any financed vehicle if the borrower fails to
maintain insurance as required by the Contract and is unable to pay for repairs
to or replacement of the vehicle or is otherwise unable to fulfill its
obligations under the Contract.
The Company believes that its objective underwriting criteria enable it to
evaluate effectively the creditworthiness of Sub-Prime Borrowers and the
adequacy of the financed vehicle as security for a Contract. These criteria
include standards for price; term; amount of down payment, installment payment
and add-on interest rate; mileage, age and type of vehicle; principal amount of
the Contract in relation to the value of the vehicle; borrower's income level,
job and residence stability, credit history and debt serviceability; and other
factors. Specifically, the Company's guidelines limit the maximum principal
amount of a purchased Contract to 115% of wholesale book value in the case of
used vehicles or to 110% of the manufacturer's invoice in the case of new
vehicles, plus, in each case, sales tax, licensing and, when the customer
purchases such additional items, a service contract or a credit life or
disability policy. The Company does not finance vehicles that are more than
eight model years old or have in excess of 85,000 miles. The maximum term of a
purchased Contract is 60 months; a shorter maximum term may be applied based on
the year and mileage of the vehicle. These criteria are subject to change from
time to time as circumstances may warrant. Upon receiving this information with
the borrower's application, the Company's underwriters verify the borrower's
employment, residency, insurance and credit information provided by the borrower
by contacting various parties noted on the borrower's application, credit
information bureaus and other sources.
Credit Scoring. From inception through December 31, 1997, the Company has
purchased $1.4 billion in Contracts and, as of December 31, 1997, had an
outstanding servicing portfolio of $902.7 million. The Company's management
information systems are structured to include a variety of credit and
demographic data for each Contract as well as maintaining data which indicate
each Contract's past or current performance characteristics. Furthermore, the
Company's technical staff have the ability to interrogate the database to
compare performing and non-performing Contracts and to ascertain which
demographic and credit related data elements may be predictors of credit
performance.
In November 1996, the Company implemented a scoring model that assigns each
Contract a numeric value (a "credit score") at the time the application is
received from the Dealer and the borrower's credit information is retrieved from
the credit reporting agencies. The credit score is based on a variety of
parameters such as the
4
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
borrower's job and residence stability, the amount of the down payment, and the
age and mileage of the vehicle. The Company has developed the credit score as a
means of identifying Contracts where a review by a supervisor or manager, prior
to approval, is warranted. Regardless of the credit score a Contract originally
receives, the Company's underwriters perform the same extensive review and
verification procedures on all Contracts. The credit score is also used to
identify Contracts for which review by a supervisor or manager prior to approval
and purchase may be appropriate.
The actual agreement for purchase of the vehicle ("Contract") is prepared by
the Dealer. The Dealer also arranges for recording the Company's lien on the
vehicle. After the appropriate documents are signed by the Dealer and the
borrower, the Dealer sells the Contract to the Company. The borrower then
receives monthly billing statements.
All of the Contracts purchased by the Company are fully amortizing and
provide for level payments over the term of the Contract. The average original
principal amount financed under Contracts purchased in the year ended December
31, 1997 was approximately $12,625, with an average original term of
approximately 55.0 months and an average down payment of 15.5%. Based on
information contained in borrower applications, for this twelve-month period,
the retail purchase price of the related automobiles averaged $13,020 (which
excludes tax and license fees, and any additional costs such as a maintenance
contract), the average age of the vehicle at the time the Contract was purchased
was 3 years, and the Company's average borrower at the time of purchase was
approximately 36.0 years old, with approximately $34,973 in average household
income and an average of 4 years' history with his or her current employer.
All Contracts may be prepaid at any time without penalty. In the event a
borrower elects to prepay a Contract in full, the payoff amount is calculated by
deducting the unearned interest from the Contract balance, in the case of a pre-
computed Contract, or by adding accrued interest to the Contract balance, in the
case of a simple interest Contract.
Each Contract purchased by the Company prohibits the sale or transfer of the
financed vehicle without the Company's consent and allows for the acceleration
of the maturity of a Contract upon a sale or transfer without such consent. In
most circumstances, the Company will not consent to a sale or transfer of a
financed vehicle unless the related Contract is prepaid in full.
The Company believes that the most important requirements to succeed in the
sub-prime automobile financing market are the ability to control borrower and
Dealer misrepresentation at the point of origination; the development and
consistent implementation of objective underwriting criteria specifically
designed to evaluate the creditworthiness of Sub-Prime Borrowers; and the
maintenance of an active program to monitor performance and collect payments.
Securitization and Sale of Contracts to Institutional Investors
The Company purchases Contracts with the primary intention of reselling them
to investors as asset-backed securities through securitizations. The
securitizations are generally structured as follows: First, the Company sells a
portfolio of Contracts to a wholly owned subsidiary ("SPS") which has been
established for the limited purpose of buying and reselling the Company's
Contracts. The SPS then transfers the same Contracts to either a Grantor or
Owner Trust (the "Trust"), and the Trust in turn issues interest-bearing asset-
backed securities (the "Certificates"), generally in an amount equal to the
aggregate principal balance of the Contracts. One or more investors purchase
these Certificates; the proceeds from the sale of the certificates are then used
to purchase the Contracts from the Company. In addition, the Company provides a
credit enhancement for the benefit of the investors in the form of an initial
cash deposit to a specific account ("Spread Account") held by the Trust. The
Spread Account is required by the Servicing Agreement (as defined below) to
be maintained at specified levels.
5
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
In connection with the sale of the Contracts, the Company is required to make
certain normal representations and warranties, which generally duplicate the
substance of the representations and warranties made by Dealers in connection
with the Company's purchase of the Contracts. If the Company breaches any of
its representations or warranties to a purchaser of the Contracts, the Company
will be obligated to repurchase the Contract from such purchaser at a price
equal to such purchaser's purchase price less the related cash securitization
reserve and any payments received by such purchaser on the Contract. In most
cases, the Company would then be entitled under the terms of its Dealer
Agreement to require the selling Dealer to repurchase the Contract at a price
equal to the Company's purchase price, less any payments made by the borrower.
Subject to any recourse against Dealers, the Company will bear the risk of loss
on repossession and resale of vehicles under Contracts repurchased by it.
Terms of Servicing Agreements. The Company currently services all Contracts
sold and expects to service all Contracts that it purchases and sells in the
future. Pursuant to the Company's usual form of servicing agreement (the
Company's servicing agreements are collectively referred to as the "Servicing
Agreements"), the Company is obligated to service all Contracts sold to the
investors or Trusts in accordance with the Company's standard procedures. The
Servicing Agreements generally provide that the Company will bear all costs and
expenses incurred in connection with the management, administration and
collection of the Contracts serviced. The Servicing Agreements also provide
that the Company will take all actions necessary or reasonably requested by the
investor to maintain perfection and priority of the investor's or the Trust's
security interest in the financed vehicles.
Upon the sale of a portfolio of Contracts to an investor or a trust, the
Company mails to borrowers monthly billing statements directing them to mail
payments on the Contracts to a lock-box account. The Company engages an
independent lock-box processing agent to retrieve and process payments received
in the lock-box account. This results in a daily deposit to the investor's or
the Trust's bank account of the entire amount of each day's lock-box receipts
and the simultaneous electronic data transfer to the Company of borrower payment
data records. Pursuant to the Servicing Agreements, the Company is required to
deliver monthly reports to the investor or the Trust reflecting all transaction
activity with respect to the Contracts. The reports contain, among other
information, a reconciliation of the change in the aggregate principal balance
of the Contracts in the portfolio to the amounts deposited into the investor's
or the Trust's bank account as reflected in the daily reports of the lock-box
processing agent.
The Company is entitled under most of the Servicing Agreements to receive a
base monthly servicing fee of 2.0% per annum computed as a percentage of the
declining outstanding principal balance of the non-defaulted Contracts in the
portfolio. Each month, after payment of the Company's base monthly servicing
fee and certain other fees, the investor receives the paid principal reduction
of the Contracts in its portfolios and interest thereon at the pass-through
rate. If, in any month, collections on the Contracts are insufficient to pay
such amounts and any principal reduction due to charge-offs, the shortfall is
satisfied from the Spread Account established in connection with the sale of the
portfolio. (If the Spread Account is not sufficient to satisfy a shortfall,
then the investor or Trust may suffer a loss to the extent that the shortfall
exceeds the Spread Account.) If collections on the Contracts exceed such
amounts, the excess is utilized, first, to build up or replenish the Spread
Account to the extent required, next, to cover deficiencies in Spread Accounts
for other portfolios, and the balance, if any, constitutes excess cash flows,
which are distributed to the Company. The Servicing Agreements also provide
that the Company is entitled to receive certain late fees collected from
borrowers.
Pursuant to the Servicing Agreements, the Company is generally required to
charge off the balance of any Contract by the earlier of the end of the month in
which the Contract becomes five scheduled installments past due or, in the case
of repossessions, the month that the proceeds from the liquidation of the
financed vehicle are received by the Company. In the case of a repossession,
the amount of the charge-off is the difference between the outstanding principal
balance of the defaulted Contract and the repossession sale proceeds. In the
event collections on the Contracts are not sufficient to pay to the investor the
entire principal balance of any Contracts charged off during the month, the
Spread Account established in connection with the sale of the Contracts is
reduced by the unpaid principal amount of such Contracts. Such amount would
then have to be restored to the Spread Account from future collections on the
Contracts remaining in the portfolio before the Company would again be entitled
to receive excess cash. In addition, the Company would not be entitled to
receive any further monthly servicing fees with respect to the defaulted
Contracts. Subject to any recourse against the Company in the event of a breach
of the Company's representations and warranties with respect to any Contracts
and after any recourse to any insurer guarantees backing the Certificates, the
investor bears the risk of all charge-offs on the Contracts in excess of the
Spread
6
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
Account. However, the Company would experience a reduction in cash
distributions in the event of greater than anticipated charge-offs or
prepayments on Contracts sold and serviced by the Company.
The Servicing Agreements are terminable by the investor in the event of
certain defaults by the Company and under certain other circumstances. None of
the Servicing Agreements are in default or otherwise terminable as of December
31, 1997.
Servicing of Contracts
General. The Company's servicing activities consist of collecting,
accounting for and posting of all payments received; responding to borrower
inquiries; taking all necessary action to maintain the security interest granted
in the financed vehicle or other collateral; investigating delinquencies;
communicating with the borrower to obtain timely payments; repossessing and
reselling the collateral when necessary; and generally monitoring each Contract
and any related collateral.
Collection Procedures. The Company believes that its ability to monitor
performance and collect payments owed from Sub-Prime Borrowers is primarily a
function of its collection approach and support systems. The Company believes
that if payment problems are identified early and the Company's collection staff
works closely with borrowers to address these problems, it is possible to
correct many of them before they deteriorate further. To this end, the Company
utilizes pro-active collection procedures, which include making early and
frequent contact with delinquent borrowers; educating borrowers as to the
importance of maintaining good credit; and employing a consultative and customer
service approach to assist the borrower in meeting his or her obligations, which
includes attempting to identify the underlying causes of delinquency and cure
them whenever possible. In support of its collection activities, the Company
maintains a computerized collection system specifically designed to service
automobile installment sale contracts with Sub-Prime Borrowers and similar
consumer loan contracts. See "Management Information Systems."
With the aid of its high penetration auto dialer, the Company typically
attempts to make telephonic contact with delinquent borrowers on the sixth day
after their monthly payment due date. Using coded instructions from a
collection supervisor, the automatic dialer will attempt to contact borrowers
based on their physical location, state of delinquency, size of balance or other
parameters. If the automatic dialer obtains a "no-answer" or a busy signal, it
records the attempt on the borrower's record and moves on to the next call. If
a live voice answers the automatic dialer's call, the call is transferred to a
waiting collector at the same time that the borrower's pertinent information is
simultaneously displayed on the collector's workstation. The collector then
inquires of the borrower the reason for the delinquency and when the Company can
expect to receive the payment. The collector will attempt to get the borrower
to make a promise for the delinquent payment for a time generally not to exceed
one week from the date of the call. If the borrower makes such a promise, the
account is routed to a pending queue and is not contacted until the outcome of
the promise is known. If the payment is made by the promise date and the
account is no longer delinquent, the account is routed out of the collection
system. If the payment is not made, or if the payment is made, but the account
remains delinquent, the account is returned to the automatic dialing queue for
subsequent contacts.
If a borrower fails to make or keep promises for payments, or if the borrower
is uncooperative or attempts to evade contact or hide the vehicle, a supervisor
will review the collection activity relating to the account to determine if
repossession of the vehicle is warranted. Generally, such a decision will occur
between the 45th and 90th day past the borrower's payment due date, but could
occur sooner or later, depending on the specific circumstances.
If a decision to repossess is made by a supervisor, such assignment is given
to one of many licensed, bonded repossession agents used by the Company. When
the vehicle is recovered, the repossession agent delivers it to a wholesale auto
auction where it is kept until it is liquidated, usually within 30 days of the
repossession. Liquidation proceeds are applied to the borrower's outstanding
obligation under the Contract and the borrower is advised of his obligation to
pay any deficiency balance that remains. The Company uses all practical means
available to collect deficiency balances, including filing for judgments against
borrowers where applicable.
7
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
The Company's financial results are affected by the performance of the of
Contracts it has purchased. The tables below document the delinquency,
repossession and net credit loss experience of all Contracts purchased by the
Company since its inception:
Delinquency Experience (1)
December 31, 1997 December 31, 1996 December 31, 1995
-------------------------- ------------------------ ----------------------
Number Number Number
of Contracts Amount of Contracts Amount of Contracts Amount
------------ ---------- ------------ -------- ------------ -------
(Dollars in thousands)
Gross servicing portfolio.......... 83,414 $1,031,573 47,187 $604,092 27,129 $356,114
Period of delinquency (2)
31-60 days......................... 3,092 36,609 1,801 22,099 910 11,525
61-90 days......................... 1,243 15,303 724 9,068 203 2,654
91+ days........................... 1,393 17,869 768 9,906 273 3,912
------ ---------- ------ -------- ------ --------
Total delinquencies(2)............. 5,728 69,781 3,293 41,073 1,386 18,091
Amount in repossession (3)......... 1,977 24,463 1,168 14,563 836 10,179
------ ---------- ------ -------- ------ --------
Total delinquencies and amount in
repossession (2)................... 7,705 $ 94,244 4,461 $ 55,636 2,222 $ 28,270
====== ========== ====== ======== ====== ========
Delinquencies as a percent
of gross servicing portfolio....... 6.9% 6.8% 7.0% 6.8% 5.1% 5.1%
Total delinquencies and amount in
repossession as a percent of gross
servicing portfolio................ 9.2% 9.1% 9.5% 9.2% 8.2% 7.9%
(1) All amounts and percentages are based on the full amount remaining to be
repaid on each Contract, including, for Rule of 78s Contracts, any unearned
finance charges. The information in the table represents the principal
amount of all Contracts purchased by the Company, including Contracts
subsequently sold by the Company which it continues to service.
(2) The Company considers a 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. Contracts less than 31 days
delinquent are not included.
(3) Amount in repossession represents financed vehicles which have been
repossessed but not yet liquidated.
8
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
Net Charge-Off Experience(1)
Nine Months
Ended
Year Ended December 31, December 31,
--------------------------- ------------
(Dollars in thousands)
1997 1996 1995 (2)
---------- ----------- ------------
Average servicing portfolio outstanding......... $703,100 $397,430 $240,864
Net charge-offs as a percent of average
servicing portfolio (3)........................ 5.9% 5.1% 4.9%
(1) All amounts and percentages are based on the principal amount scheduled to
be paid on each Contract. The information in the table represents all
Contracts purchased by the Company including Contracts subsequently sold by
the Company that it continues to service.
(2) The percentages set forth for the nine-month period ended December 31,
1995, are computed using annualized operating data which do not necessarily
represent comparable data for a full twelve-month period.
(3) 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). For periods prior to the year
ended December 31, 1996, post liquidation amounts received on previously
charged off Contracts were applied to the period in which the related
Contract was originally charged off. These prior period allocations were
made only for the purpose of calculating this ratio. For financial
statement purposes, post liquidation amounts are recognized in the period
received. Effective January 1, 1996, post liquidation amounts received on
previously charged off Contracts are applied in the period in which they
are received, both for this ratio and financial statement purposes.
Management Information Systems
The Company maintains sophisticated data processing support and management
information systems. To support its collection efforts, the Company utilizes
Digital Systems International's Intelligent Dialing System, a high-penetration
automatic dialer, in conjunction with the American Management Systems' Computer
Assisted Collection System software, which has been customized by the Company,
and other accounting software programs. All systems are operated at the
Company's offices on an Advance System IBM AS/400 computer.
The Company's high-penetration automatic dialer controls multiple telephone
lines and automatically dials numbers from file records in accordance with
programmed instructions established by management. If the dialer receives a
busy signal or no answer, it will generally route the number for a subsequent
re-call. The dialer has the ability to distinguish a pre-recorded voice and
will leave the appropriate digitized human voice message on the borrower's
answering machine. Generally, the dialer transfers the call to a collector only
after it has determined that there is a live voice on the line. In most
instances, this is accomplished so rapidly that the individual receiving the
call is unaware that an automatic dialer has been used. The efficiency of the
auto dialer allows the Company to place as many as 5,000 telephone calls per
day.
The high-penetration automatic dialer also monitors telephone activity and
activates more telephone lines when connect rates are low or shuts down lines
when connect rates are high. Once a live call is passed to a collector, all
relevant account information, including one of 99 account status codes,
automatically appears on the collector's video screen. The Company believes the
capabilities of the automatic dialer reduce the likelihood that an account will
remain delinquent for a prolonged period without appropriate follow-up.
9
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
The Company's automation allows it to electronically sort and prioritize each
collector's workload as well as to implement specific collection strategies.
Moreover, the Company has adopted certain procedural controls designed to ensure
that certain important decisions, such as ordering a repossession, initiating
legal action or materially modifying an account, are automatically routed to a
supervisor for review and approval.
Competition
The automobile financing business is highly competitive. The Company
competes with a number of national, local and regional finance companies with
operations similar to those of the Company. In addition, competitors or
potential competitors include other types of financial services companies, such
as commercial banks, savings and loan associations, leasing companies, credit
unions providing retail loan financing and lease financing for new and used
vehicles, and captive finance companies affiliated with major automobile
manufacturers such as General Motors Acceptance Corporation, Ford Motor Credit
Corporation, Chrysler Credit Corporation and Nissan Motors Acceptance
Corporation. Many of the Company's competitors and potential competitors
possess substantially greater financial, marketing, technical, personnel and
other resources than the Company. Moreover, the Company's future profitability
will be directly related to the availability and cost of its capital in relation
to the availability and cost of capital to its competitors. The Company's
competitors and potential competitors include far larger, more established
companies that have access to capital markets for unsecured commercial paper and
investment grade-rated debt instruments and to other funding sources which may
be unavailable to the Company. Many of these companies also have long-standing
relationships with Dealers and may provide other financing to Dealers, including
floor plan financing for the Dealers' purchase of automobiles from
manufacturers, which is not offered by the Company.
The Company believes that the principal competitive factors affecting a
Dealer's decision to offer Contracts for sale to a particular financing source
are the purchase price offered for the Contracts, the reasonableness of the
financing source's underwriting guidelines and documentation requests, the
predictability and timeliness of purchases and the financial stability of the
funding source. The Company believes that it can obtain from Dealers sufficient
Contracts for purchase at attractive prices by consistently applying reasonable
underwriting criteria and making timely purchases of qualifying Contracts.
The Company believes that it can compete effectively for the interest of
institutional investors in purchasing Contracts acquired by the Company, based
upon (i) the historical performance of portfolios of Contracts sold and serviced
by it, (ii) its willingness to establish substantial credit enhancements for the
benefit of investors, and (iii) its willingness to derive a portion of its
revenues from excess cash flow distributed on a monthly basis, rather than up-
front fees paid at the time of sale of the Contracts.
Marketing
The Company establishes relationships with Dealers through Company
representatives who contact a prospective Dealer to explain the Company's
Contract purchases and thereafter provide Dealer training and support services.
As of December 31, 1997, the Company had 80 representatives, 43 of whom are
employees and 37 of whom are independent. The independent representatives are
contractually obligated to represent the Company's financing program
exclusively. The Company's representatives present the Dealer with a marketing
package, which includes the Company's promotional material containing the terms
offered by the Company for the purchase of Contracts, a
10
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
copy of the Company's standard-form Dealer Agreement, examples of monthly
reports and required documentation relating to Contracts, but they have no
authority relating to the decision to purchase Contracts from Dealers. The
Company's acceptance of a Dealer is subject to its analysis of, among other
things, the Dealer's operating history.
The Company has not actively advertised its automobile financing or third-
party loan servicing businesses, although it may do so selectively in the
future.
Government Regulation
The Company intends to obtain and maintain all licenses necessary to the
lawful conduct of its business and operations. The Company is not licensed to
make loans directly to borrowers.
Several federal and state consumer protection laws, including the Federal
Truth-In-Lending Act, the Federal Equal Credit Opportunity Act, the Federal Fair
Debt Collection Practices Act and the Federal Trade Commission Act, regulate the
extension of credit in consumer credit transactions. These laws mandate certain
disclosures with respect to finance charges on Contracts and impose certain
other restrictions on Dealers. In addition, laws in a number of states impose
limitations on the amount of finance charges that may be charged by Dealers on
credit sales. The so-called Lemon Laws enacted by the Federal government and
various states provide certain rights to purchasers with respect to motor
vehicles that fail to satisfy express warranties. The application of Lemon Laws
or violation of such other Federal and state laws may give rise to a claim or
defense of a borrower against a Dealer and its assignees, including the Company
and purchasers of Contracts from the Company. The Dealer Agreement contains
representations by the Dealer that, as of the date of assignment of Contracts,
no such claims or defenses have been asserted or threatened with respect to the
Contracts and that all requirements of such Federal and state laws have been
complied with in all material respects. Although a Dealer would be obligated to
repurchase Contracts that involve a breach of such warranty, there can be no
assurance that the Dealer will have the financial resources to satisfy its
repurchase obligations to the Company. Certain of these laws also regulate the
Company's servicing activities, including its methods of collection.
Although the Company believes that it is currently in compliance with
applicable statutes and regulations, there can be no assurance that the Company
will be able to maintain such compliance. The failure to comply with such
statutes and regulations could have a material adverse effect upon the Company.
Furthermore, the adoption of additional statutes and regulations, changes in the
interpretation and enforcement of current statutes and regulations or the
expansion of the Company's business into jurisdictions that have adopted more
stringent regulatory requirements than those in which the Company currently
conducts business could have a material adverse effect upon the Company. In
addition, due to the consumer-oriented nature of the industry in which the
Company operates and the application of certain laws and regulations, industry
participants are regularly named as defendants in litigation involving alleged
violations of Federal and state laws and regulations and consumer law torts,
including fraud. Many of these actions involve alleged violations of consumer
protection laws. A significant judgment against the Company or within the
industry in connection with any such litigation could have a material adverse
effect on the Company's financial condition, results of operations or liquidity.
See "Legal Proceedings."
Upon the purchase of Contracts by the Company, the original Contracts and
related title documents for the financed vehicles are delivered by the selling
Dealers to the Company. Upon the sale of each portfolio of Contracts by the
Company, a financing statement is filed under the Uniform Commercial Code as
adopted in the applicable state (the "UCC") to perfect and give notice of the
purchaser's security interest in the Contracts.
The Dealer Agreement and related assignment contain representations and
warranties by the Dealer that an application for state registration of each
financed vehicle, naming the Company as secured party with respect to the
vehicle, was effected at the time of sale of the related Contract to the
Company, and that all necessary steps have been taken to obtain a perfected
first priority security interest in each financed vehicle in favor of the
Company under the laws of the state in which the financed vehicle is registered.
If a Dealer or the Company, because of clerical error or otherwise, has failed
to take such action in a timely manner, or to maintain such interest with
respect to a financed vehicle, neither the Company nor any purchaser of the
related Contract from the Company would have a perfected security interest in
the financed vehicle and its security interest may be subordinate to the
interest of, among others, subsequent purchasers of the financed vehicle,
holders of perfected security interests and a trustee in bankruptcy of
11
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
the borrower. The security interest of the Company or the purchaser of a
Contract may also be subordinate to the interests of third parties if the
interest is not perfected due to administrative error by state recording
officials. Moreover, fraud or forgery by the borrower could render a Contract
unenforceable against third parties. In such events, the Company could be
required by the purchaser to repurchase the Contract. In the event the Company
is required to repurchase a Contract, it will generally have recourse against
the Dealer from which it purchased the Contract. This recourse will be unsecured
except for a lien on the vehicle covered by the Contract, and there can be no
assurance that any Dealer will have the financial resources to satisfy its
repurchase obligations to the Company. Subject to any recourse against Dealers,
the Company will bear any loss on repossession and resale of vehicles financed
under Contracts repurchased by it from investors.
Under the laws of many states, liens for storage and repairs performed on a
vehicle and for unpaid taxes take priority over a perfected security interest in
the vehicle. Pursuant to its securitization purchase commitments, the Company
generally warrants that, to the best of the Company's knowledge, no such liens
or claims are pending or threatened with respect to a financed vehicle, which
may be or become prior to or equal with the lien of the related Contracts. In
the event that any of the Company's representations or warranties proves to be
incorrect, the Trust or the investor would be entitled to require the Company to
repurchase the Contract relating to such financed vehicle.
The Company, on behalf of purchasers of Contracts, may take action to enforce
the security interest in financed vehicles with respect to any related Contracts
in default by repossession and resale of the financed vehicles. The UCC and
other state laws regulate repossession sales by requiring that the secured party
provide the borrower with reasonable notice of the date, time and place of any
public sale of the collateral, the date after which any private sale of the
collateral may be held and of the borrower's right to redeem the financed
vehicle prior to any such sale and by providing that any such sale be conducted
in a commercially reasonable manner. Financed vehicles repossessed generally
are resold by the Company through unaffiliated wholesale automobile networks or
auctions, which are attended principally by used car dealers.
In the event of a repossession and resale of a financed vehicle, after
payment of outstanding liens for storage, repairs and unpaid taxes, to the
extent those liens take priority over the Company's security interest, and after
payment of the reasonable costs of retaking, holding and selling the vehicle,
the secured party would be entitled to be paid the full outstanding balance of
the Contract out of the sale proceeds before payments are made to the holders of
junior security interests in the financed vehicles, to unsecured creditors of
the borrower, or, thereafter, to the borrower. Under the UCC and other laws
applicable in most states (including California), a creditor is entitled to
obtain a deficiency judgment from a borrower for any deficiency on repossession
and resale of the motor vehicle securing the unpaid balance of such borrower's
Contract. However, some states impose prohibitions or limitations on deficiency
judgments. If a deficiency judgment were granted, the judgment would be a
personal judgment against the borrower for the shortfall, and a defaulting
borrower may often have very little capital or few sources of income available
following repossession. Therefore, in many cases, it may not be useful to seek
a deficiency judgment against a borrower or, if one is obtained, it may be
settled at a significant discount.
Employees
As of December 31, 1997, the Company had 570 full-time and 4 part-time
employees, of whom 10 are management personnel, 229 are collections personnel,
194 are Contract origination personnel, 57 are marketing personnel (43 of whom
are marketing representatives), 71 are operations personnel, and 13 are
accounting personnel. The Company believes that its relations with its
employees are good. The Company is not a party to any collective bargaining
agreement.
Item 2. PROPERTY
The Company's headquarters are located in Irvine, California, where it leases
approximately 51,400 square feet of general office space from an unaffiliated
lessor. The annual rent is $524,596 through the year 2000, the final year of
the lease. The Company has an option to extend the lease for an additional five
years upon terms substantially similar to those of the existing lease.
The Company in March 1997 and September 1997 established branch collection
facilities in Chesapeake, Virginia and Irvine, California, respectively. The
Company leases approximately 22,719 square feet of general office
12
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
space in Chesapeake at a base rent that is currently $318,066 per year,
increasing to $501,545 over a ten-year term. The Company leases approximately
26,251 square feet of general office space for its Irvine collections branch, at
a base rent of $588,000 per year. The Company's lease on the Irvine branch will
expire in August 1998. In addition to base rent, the Company pays its share of
property taxes, maintenance and other common area expenses of all three
premises, currently at the approximate aggregate rate of $164,000 per year.
In addition, the Company has agreed to lease a new headquarters building,
currently under construction, in Irvine, California. The new building is
scheduled for completion in September 1998, and will have approximately 115,000
square feet of rentable space, all of which the Company intends to occupy
itself. The Company has agreed to pay base rent at the rate of $1,904,400 per
year for the first five years of the lease term, and at the rate of $2,097,600
per year for years six through ten. The Company's lease is to run for a ten-
year term commencing with completion of construction. The Company will have the
option to cancel the lease after five years without penalty. In addition to the
foregoing base rent, the Company has agreed to pay the property taxes,
maintenance and other expenses of the premises.
Item 3. LEGAL PROCEEDINGS
The Company is party to litigation in the ordinary course of business,
generally involving actions against automobile purchasers to collect amounts due
on purchased Contracts or to recover vehicles. In one such case, relating to
the Chapter 13 bankruptcy of obligors Madeline and Darryl Brownlee, of Chicago,
Illinois, the obligors counterclaimed against the Company on June 30, 1997 in
the bankruptcy court for the Northern District of Illinois. The obligors seek
class-action treatment of their allegation that the cost of an extended service
contract on the automobile they purchased was inadequately disclosed by the
automobile dealer, Joe Cotton Ford of Carol Stream, Illinois. The disclosure is
alleged to violate the Federal Truth In Lending Act and Illinois consumer
protection statutes. The obligors' claim is directed against both the dealer for
making the allegedly improper disclosures and against the Company as holder of
the purchase contract. The relief sought is damages in an unspecified amount,
plus costs of suit and attorney's fees. The court has not ruled on the obligors'
request for class-action treatment, nor on the merits of the claims.
In another proceeding, arising out of efforts to collect a deficiency balance
from Joseph Barrios of Chicago, Illinois, the debtor has brought suit against
the Company alleging defects in the notice given upon repossession of the
vehicle. This lawsuit was filed on February 18, 1998 in the circuit court of
Cook County, Illinois. Barrios, represented by the same law firm as the
Brownlee obligors, seeks class-action treatment of his allegation that notice of
a fifteen day period to reinstate his Contract was misleading, in that it did
not refer to an alleged right to redeem collateral up to the date of sale. The
relief sought is damages in an unspecified amount, plus costs of suit and
attorney's fees. As of the date of this filing, the Company has not been
required to respond to this litigation and has not yet done so.
The Company intends to dispute both of these matters vigorously, and believes
that it has meritorious defenses to each claim made. Nevertheless, the outcome
of any litigation is uncertain, and there is the possibility that damages could
be assessed against the Company in amounts that could be material. It is
management's opinion that all litigation of which it is aware, including the
matters discussed above, will no have a material adverse effect on the Company's
consolidated financial position, results of operations or liquidity.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
13
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the Company's executive officers follows:
Charles E. Bradley, Jr., 38, has been the President and a director of the
Company since its formation in March 1991. In January 1992, Mr. Bradley was
appointed Chief Executive Officer of the Company. From March 1991 until December
1995 he served as Vice President and a director of CPS Holdings, Inc. From
April 1989 to November 1990, he served as Chief Operating Officer of Barnard and
Company, a private investment firm. From September 1987 to March 1989, Mr.
Bradley, Jr. was an associate of The Harding Group, a private investment banking
firm. Mr. Bradley, Jr. is currently serving as a director of NAB Asset
Corporation, Chatwins Group, Inc., Texon Energy Corporation, and Thomas Nix
Distributor, Inc. Charles E. Bradley, Sr., Chairman of the board of directors
of the Company, is his father.
Jeffrey P. Fritz, 38, has been Senior Vice President - Chief Financial
Officer and Secretary of the Company since March 1991. From December 1988 to
March 1991, Mr. Fritz was Vice President and Chief Financial Officer of Far
Western Bank. From 1985 to December 1988, Mr. Fritz was a management consultant
for Price Waterhouse in St. Louis, Missouri.
William L. Brummund, Jr., 45, has been Senior Vice President - Systems
Administration since March 1991. From 1986 to March 1991, Mr. Brummund was Vice
President and Systems Administrator for Far Western Bank.
Nicholas P. Brockman, 53, has been Senior Vice President - Asset Recovery &
Liquidation since January 1996. He was Senior Vice President of Contract
Originations from April 1991 to January 1996. From 1986 to March 1991, Mr.
Brockman served as a Vice President and Branch Manager of Far Western Bank.
Richard P. Trotter, 54, has been Senior Vice President-Contract Origination
since January 1996. He was Senior Vice President of Administration from April
1995 to December 1995. From January 1994 to April 1995 he was Senior Vice
President-Marketing of the Company. From December 1992 to January 1994, Mr.
Trotter was Executive Vice President of Lange Financial Corporation, Newport
Beach, California. From May 1992 to December 1992, he was Executive Director of
Fabozzi, Prenovost & Normandin, Santa Ana, California. From December 1990 to
May 1992 he was Executive Vice President/Chief Operating Officer of R. Thomas
Ashley, Newport Beach, California. From April 1984 to December 1990, he was
President/Chief Executive Officer of Far Western Bank, Tustin, California.
Curtis K. Powell, 41, has been Senior Vice President - Marketing of the
Company since April 1995. He joined the Company in January 1993 as an
independent marketing representative until being appointed Regional Vice
President of Marketing for Southern California in November 1994. From June 1985
through January 1993, Mr. Powell was in the retail automobile sales and leasing
business.
Mark A. Creatura, 38, has been Senior Vice President - General Counsel since
October 1996. From October 1993 through October 1996, he was Vice President and
General Counsel at Urethane Technologies, Inc., a polyurethane chemicals
formulator. Mr. Creatura was previously engaged in the private practice of law
with the Los Angeles law firm of Troy & Gould Professional Corporation, from
October 1985 through October 1993.
Thurman Blizzard, 55, has been Senior Vice President - Collections since
January 1998. The Company had previously engaged Mr. Blizzard as a consultant
from October 1997 to December 1997 to provide recommendations to the Company
concerning its collections operation. Prior thereto, Mr. Blizzard served as
Chief Operations Officer of Monaco Finance from May 1994 to March 1997. Mr.
Blizzard was previously an Asset Liquidation Manager with the Resolution Trust
Corporation, from November 1991 to May 1994.
Michael J. Campbell, 38, has been Senior Vice President - Corporate
Development since January 1998. The Company had engaged Mr. Campbell as a
consultant from April 1997 to December 1997 to pursue corporate development
objectives on the Company's behalf. Prior thereto, Mr. Campbell was chief
financial officer of National IPF Company from February 1996 to March 1997, and
had served as an investment officer with SunAmerica Corporate Finance from
February 1990 to January 1995.
14
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
PART II
Item 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market System,
under the symbol "CPSS." The following table sets forth the high and low closing
prices reported for the Common Stock for the periods indicated (retroactively
adjusted for the two-for-one stock split that occured on March 14, 1996). Such
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission.
High Low
January 1 - March 31, 1996................................................ $10.438 $ 7.375
April 1 - June 30, 1996................................................... 10.250 8.250
July 1 - September 30, 1996............................................... 12.750 7.500
October 1 - December 31, 1996............................................. 14.375 10.625
January 1 - March 31, 1997................................................ 13.875 7.375
April 1 - June 30, 1997................................................... 12.375 7.000
July 1 - September 30, 1997............................................... 18.250 10.500
October 1 - December 31, 1997............................................. 17.750 7.500
As of March 4, 1998, there were 74 holders of record of the Company's
Common Stock.
To date, the Company has not declared or paid any dividends on its Common
Stock. The payment of future dividends, if any, on the Company's Common Stock
is within the discretion of the Board of Directors and will depend upon the
Company's earnings, its capital requirements and financial condition, and other
relevant factors. The instruments governing the Company's outstanding debt
place certain restrictions on the payment of dividends. The Company does not
intend to declare any dividends on its Common Stock in the foreseeable future,
but instead intends to retain any earnings for use in the Company's operations.
15
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
Item 6. SELECTED FINANCIAL DATA
Nine-Month
Period Ended
Year ended December 31, December 31, Fiscal Year Ended March 31,
-----------------------------------------------------------------------------
1997 1996 1995 1995 1994(1)
----------- ---------- ------------ ----------- ----------
(In Thousands, except per share data)
Statement of Earnings Data:
Gain on sale of Contracts, net............ $ 39,133 $ 23,321 $ 11,549 $ 9,455 $ 5,425
Interest income........................... 23,526 19,980 9,220 10,561 3,955
Servicing fees............................ 14,487 7,893 3,485 2,489 1,044
Total revenue............................. 79,340 51,194 24,254 22,505 10,424
Operating expenses (1).................... 47,381 27,502 11,597 11,358 11,712
Net earnings (loss)....................... 18,532 14,097 7,575 6,666 (1,778)
Basic earnings (loss) per share (2)....... $ 1.29 $ 1.05 $ 0.65 $ 0.75 $ (0.21)
Diluted earnings (loss) per share (2)..... $ 1.17 $ 0.93 $ 0.52 $ 0.61 $ (0.21)
December 31, March 31,
--------------------------------------------------------
1997 1996 1995 1995 1994 1993
------- ------- ------ ------ ------ -----
(In Thousands)
Balance Sheet Data:
Contracts held for sale...................... 68,271 21,657 19,549 21,896 647 5,054
Residual interests in securitization......... 124,616 67,252 41,586 28,355 12,791 503
Total assets................................. 225,895 101,946 77,878 57,975 16,538 6,922
Warehouse lines of credit.................... 61,666 13,265 7,500 19,730 - -
Subordinated debt............................ 55,000 23,000 23,000 5,000 5,000 2,000
Total liabilities............................ 143,288 44,989 36,397 30,981 6,337 2,833
Total shareholders' equity................... 82,607 56,957 41,481 26,994 10,201 4,089
(1) In October 1992, as a condition to the initial public offering of Common
Stock of the Company, the then majority shareholder of the Company
deposited 1,200,000 shares of Common Stock (the "Escrow Shares") in escrow.
The escrow agreement provided that part or all of the Escrow Shares would
be released if the Company's net earnings after taxes (as defined in the
escrow agreement) or the average market price of the Common Stock for
specified periods exceeded specified levels. The Company's net earnings
(as defined in the escrow agreement) for fiscal 1994 (prior to the
accounting effect of the release of the Escrow Shares) exceeded the
specified level and, accordingly, all 1,200,000 Escrow Shares were
released. The release of the Escrow Shares was deemed compensatory for
accounting purposes, resulting in a one-time, non-cash charge of $6,450,000
against earnings for fiscal 1994. Without that charge, net earnings, basic
earnings per share and diluted net earnings per share for fiscal 1994 would
have been $4,672,000, $.54 and $.48, respectively.
(2) All prior periods have been restated in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings per Share."
16
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following analysis of the financial condition of the Company should be
read in conjunction with "Selected Financial Data" and the Company's
Consolidated Financial Statements and the Notes thereto and the other financial
data included elsewhere in this report.
Overview
The Company specializes in the business of purchasing, selling and servicing
retail automobile installment sales Contracts originated by Dealers in the sale
of new and used automobiles, light trucks and passenger vans and has done so
since its inception on March 8, 1991. Through its purchases, the Company
provides indirect financing to borrowers with limited credit histories, low
incomes or past credit problems.
The Company generates earnings primarily from the gains recognized on the
sale or securitization of its Contracts, servicing fees earned on Contracts
sold, and interest earned on Contracts held for sale. Earnings from gains on
sale, interest and servicing fees for the year ended December 31, 1997, were
$39.1 million, $23.5 million, and $14.5 million, respectively. Such earnings
for the year ended December 31, 1996, were $23.3 million, $20.0 million, and
$7.9 million, respectively. For the nine-month period ended December 31, 1995,
such earnings were $11.5 million, $9.2 million and $3.5 million, respectively.
The Company's income is affected by losses incurred on Contracts, whether such
Contracts are held for sale or have been sold in securitizations. The Company's
cash requirements have been and will continue to be significant. Net cash used
in operating activities for the year, ended December 31, 1997 and 1996, and the
nine-month period ended December 31, 1995 were $26.1 million, $8.4 million and
$18.5 million, respectively.
The Company purchases Contracts with the primary intention of reselling them
to Investors as asset-backed securities through securitizations. The
securitizations are generally structured as follows: First, the Company sells a
portfolio of Contracts to a wholly owned subsidiary ("SPS") which has been
established for the limited purpose of buying and reselling the Company's
Contracts. The SPS then transfers the same Contracts to either a Grantor Trust
or an Owner Trust (the "Trust"), and the Trust in turn issues interest-bearing
asset-backed securities (the "Certificates") generally in an amount equal to the
aggregate principal balance of the Contracts. The Company typically sells these
Contracts at face value and without recourse except that the normal
representations and warranties provided by the Dealer to the Company are
similarly provided by the Company to the Trust. One or more investors purchase
these Certificates; the proceeds from the sale of the certificates are then used
to purchase the Contracts from the Company. In addition, the Company provides a
credit enhancement for the benefit of the investors in the form of an initial
cash deposit to a specific account ("Spread Account") held by the Trust. The
Spread Account is required by the Servicing Agreement to be maintained at
specified levels.
At the closing of each securitization, the Company removes from its
consolidated balance sheet the Contracts held for sale and adds to its
consolidated balance sheet (i) the cash received and (ii) the estimated fair
value of the portion of the Contracts retained from the securitizations
("Residuals"), which consist of (a) the cash held in the Spread Account and (b)
the net interest receivables ("NIRs"). NIRs represent the discounted cash flows
to be received by the Trust in the future. The excess of the cash received and
the assets retained by the Company over the carrying value of the Contracts
sold, less transaction costs, equals the net gain on sale of Contracts recorded
by the Company.
The Company is not aware of an active market for the purchase or sale of
residuals, and accordingly, the Company determines the estimated fair value of
the Residuals by discounting the expected excess cash flows released from the
Spread Account (the cash out method) using a discount rate which the Company
believes is commensurate with the risks involved. The Company has utilized an
effective discount rate of approximately 14% on the estimated cash flows
released from the Spread Account to value the Residuals.
The Company receives periodic base servicing fees for the servicing and
collection of the Contracts. In addition, the Company is entitled to the cash
flows from the Trusts that represent collections on the Contracts in excess of
the amounts required to pay the Certificate principal and interest, the base
servicing fees and certain other
17
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
fees such as trustee and custodial fees. At the end of each collection period,
the aggregate cash collections from the Contracts are allocated first to the
base servicing fees and certain other fees such as trustee and custodial fees
for the period, then to the certificateholders for interest at the pass-through
rate on the certificates plus principal as defined in the Servicing Agreements.
If the amount of cash required for the above allocations exceeds the amount
collected during the collection period, the shortfall is drawn from the Spread
Account. If the cash collected during the period exceeds the amount necessary
for the above allocations, and there is no shortfall in the related Spread
Account, the excess is released to the Company. If the Spread Account balance is
not at the required credit enhancement level the excess cash collected is
retained in the Spread Account until the specified level is achieved. Cash held
in the various Spread Accounts is invested in either high quality liquid
investment securities, as specified in the securitization agreements or,
pursuant to certain securitization agreements, is used to make accelerated
principal paydowns on the Certificates to create excess collateral (over-
collateralization or OC account), which is held by the Trusts on behalf of the
Company as the Residual holder. The specified credit enhancement levels are
defined in the Servicing Agreements as the Spread Account balance, expressed
generally as a percentage of the current collateral principal balance. The
Spread Account includes both the cash and OC accounts.
The annual percentage rate ("APR") on the Contracts is relatively high in
comparison to the pass through rate on the Certificates; accordingly, the
Residuals described above can be a significant asset of the Company. In
determining the value of the Residuals described above, the Company must
estimate the future rates of prepayments, delinquencies, defaults and default
loss severity as they impact the amount and timing of the estimated cash flows.
The Company estimates prepayments by evaluating historical prepayment
performance of comparable Contracts and the impact of trends in the industry.
The Company has used a constant prepayment estimate of 15%. The Company
estimates defaults and default losses using available historical loss data for
comparable Contracts and the specific characteristics of the Contracts purchased
by the Company. In addition, the Company has used default losses of 11.5% to
13.5% as a percentage of the original principal balance over the life of the
Contracts.
In future periods, the Company will recognize additional revenue from the
Residuals if the actual performance of the Contracts is higher than the original
estimate or the Company may increase the estimated fair value of the Residuals.
If the actual performance of the Contracts is lower than the original estimate,
then an adjustment to the carrying value of the Residuals may be required if the
estimated fair value of the Residuals is less than its carrying value.
For the year ended December 31, 1997 the Trusts received $31.7 million in
cash flows which was $255,000 in excess of the cash flows estimated to be
received by the Trusts during this period. As of December 31, 1997 the Trusts
had received cumulatively $4.2 million of cash flows in excess of the amounts
estimated for all the Company's securitizations.
For the year ended December 31, 1997, initial deposits to Spread Accounts,
cash deposited to Spread Accounts and cash released from Spread Accounts was
$20.1 million, $31.7 million, and $15.8 million, respectively. For the year
ended December 31, 1996, initial deposits to Spread Accounts, cash deposited to
Spread Accounts and cash released from Spread Accounts was $12.3 million, $18.8
million, and $17.9 million, respectively. For the nine-month period ended
December 31, 1995, initial deposits to Spread Accounts, cash deposited to Spread
Accounts and cash released from Spread Accounts was $4.9 million, $7.6 million,
and $7.7 million, respectively.
During 1997 eight of the 21 Trusts incurred cumulative net losses as a
percentage of the original contract balance in excess of the predetermined
levels specified in the respective Securitization Agreements. Accordingly,
pursuant to the Securitization Agreements, the specified credit enhancement
levels were increased. As a result of this and certain cross collateralization
arrangements excess cash flows that would otherwise have been released to the
18
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
Company were retained by the Spread Accounts to bring the balance of those
Spread Accounts up to the higher level. Approximately $7.0 million of cash
flows were delayed and retained in the Spread Accounts as of December 31, 1997.
The Year Ended December 31, 1997 Compared to the Year Ended December 31, 1996
Results Of Operations
Revenue. During the year ended December 31, 1997, revenue increased $28.1
million, or 55.0%, compared to the year ended December 31, 1996. Gain on sale of
Contracts, net, increased by $15.8 million, or 67.8%, and represented 49.3% of
total revenue for the year ended December 31, 1997. The increase in gain on sale
is largely due to the volume of Contracts which were sold in the period. During
the year ended December 31, 1997, the Company sold $573.3 million in Contracts,
compared to $341.0 million in the year ended December 31, 1996.
Interest income increased by $3.5 million, or 17.7%, representing 29.7% of
total revenues for the year ended December 31, 1997. The increase is due to the
increase in the volume of contracts purchased and held for sale. During the
year ended December 31, 1997, the Company purchased $632.1 million in Contracts
from Dealers, compared to $351.4 million in the year ended December 31, 1996.
Servicing fees increased by $6.6 million, or 83.5%, and represented 18.3% of
total revenue. The increase in servicing fees is due to the Company's continued
expansion of its Contract purchase, sale and servicing activities. As of
December 31, 1997, the Company was earning servicing fees on 77,731 Contracts
approximating $830.9 million compared to 45,363 Contracts approximating $483.1
million as of December 31, 1996. In addition to the $830.9 million in sold
Contracts on which servicing fees were earned, the Company was holding for sale
and servicing an additional $71.8 million in Contracts for an aggregate
servicing portfolio of $902.7 million. Amortization of NIRs increased by $7.2
million and represented 59.0% of residual interest income for the year ended
December 31, 1997 versus 38.0% for year ended December 31, 1996. The increase
is primarily due to the increase in the average age of the Contracts making up
the Company's servicing portfolio and consequently the increase in charge-offs
and corresponding reduction of residual interest income. The Company expects
these increases in the ratio of amortization of NIRs to Residual interest income
to continue until the size and average age of the servicing portfolio
stabilizes.
Expenses. During the year ended December 31, 1997, operating expenses
increased $19.9 million, or 72.3%, compared to the year ended December 31, 1996.
Employee costs increased by $7.0 million, or 78.0%, and represented 33.5% of
total operating expenses. The increase is due to the addition of staff
necessary to accommodate the Company's growth and certain increases in salaries
of existing staff. General and administrative expenses increased by $6.9
million, or 95.2% and represented 29.9% of total operating expenses. Increases
in general and administrative expenses included increases in telecommunications,
stationery, credit reports and other related items as a result of increases in
the volume of purchasing and servicing of Contracts.
Interest expense increased $3.4 million, or 58.9%, and represented 19.4% of
total operating expenses. The increase is due in part to the interest paid on
an additional $35 million in subordinated debt securities issued by the Company
during 1997. Interest expense was also impacted by the volume of Contracts held
for sale as well as by the Company's cost of borrowed funds.
During the year ended December 31, 1997, the provision for losses on
Contracts held for sale increased by $1.3 million, or 48.4%, and represented
8.6% of total operating expenses. The increase in the provision reflects
somewhat higher charge-off rates and a larger volume of Contracts held prior to
sale when compared to the year ended December 31, 1996.
Marketing expenses increased by $170,789 or 10.2%, and represented 3.9% of
total expenses. The increase is primarily due to the increase in printing,
travel, promotion and convention expenses. Fees paid to marketing
representatives for their role in the submission of Contracts ultimately
purchased by the Company are included as a component in gain on sale of
Contracts, net.
Occupancy expenses increased by $635,506 or 82.7%, and represented 3.0% of
total expenses. Depreciation and amortization expenses increased by $481,548 or
174.9%, and represented 1.6% of total expenses. During 1997, the Company
established a satellite collection branch in Chesapeake, Virginia and leased
additional office space near
19
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
its headquarters in Irvine, California. This resulted in an increase in base
rent expense of $906,066 for the year ended December 31, 1997. The increase in
occupancy, depreciation and amortization is due primarily to the establishment
of this additional office space and the related furniture, fixtures and
equipment. The Company has agreed to lease a new headquarters facility, which
is currently under construction. The lease will be for a ten-year term, with
base rent of $1,904,400 for the first five years, and $2,097,600 for years six
through ten. In addition to base rent, the Company has agreed to pay property
taxes, maintenance, and other expenses of the property. Occupancy of the new
building can be expected to increase the Company's overall occupancy expenses in
the future beginning with commencement of the lease, which will commence upon
completion of the building, currently scheduled for September 1998.
The results for the year ended December 31, 1997 include net earnings of $1.2
million from the Company's subsidiary Samco. For the year ended December 31,
1996, Samco incurred a net operating loss of $491,000.
The results for the year ended December 31, 1997 also include net operating
losses of $11,000 from the Company's subsidiary LINC. For the year ended
December 31, 1996, LINC incurred a net operating loss of $324,000.
In addition, the Company's results for the year ended December 31, 1997,
include $88,000 in net operating losses from the Company's subsidiary, CPS
Leasing, Inc., which was acquired in January 1997, and $849,000 in net earnings
from the Company's investment in 38% of NAB Asset Corp.
The Company's effective tax rate was 42.0% for the year ended December 31,
1997 and 40.5% for the year ended December 31, 1996. See note 11 to the Notes
to Consolidated Financial Statements.
The Year Ended December 31, 1996 Compared to the Nine-Month Transition Period
Ended December 31, 1995
The Company changed its fiscal year-end from March 31 to December 31,
effective with the nine-month period ended December 31, 1995. Accordingly,
readers should take into account that the following discussion compares figures
for a full twelve month year to a nine-month period. The discussion below does
not attempt to explain, for each item discussed, the extent to which the
differing length of these periods has affected the figures.
Revenue. During the year ended December 31, 1996, revenue increased $26.9
million, or 111.1%, compared to the nine-month transition period ended December
31, 1995. Gain on sale of Contracts, net, increased by $11.8 million, or
101.9%, and represented 45.6% of total revenue for the year ended December 31,
1996. The increase in gain on sale is largely due to the volume of Contracts
which were sold in the period. During the year ended December 31, 1996, the
Company sold $341.0 million in Contracts, compared to $155.7 million in the
nine-month transition period ended December 31, 1995.
Servicing fees increased by $4.4 million, or 126.5%, and represented 15.4% of
total revenue. The increase in servicing fees is due to the Company's continued
expansion of its Contract purchase, sale and servicing activities. As of
December 31, 1996, the Company was earning servicing fees on 45,363 Contracts
approximating $483.1 million compared to 25,398 Contracts approximating $268.2
million as of December 31, 1995. In addition to the $483.1 million in sold
Contracts on which servicing fees were earned, the Company was holding for sale
and servicing an additional $22.8 million in Contracts for an aggregate
servicing portfolio of $505.9 million.
Interest income increased by $10.8 million, or 116.7%, representing 39.0% of
total revenues for the year ended December 31, 1996. The increase is due to the
increase in the volume of contracts held for sale, and the increase in the
amount of sold contracts. During the year ended December 31, 1996, the Company
purchased $351.4 million in Contracts from Dealers, compared to $160.1 million
in the nine-month transition period ended December 31, 1995.
Expenses. During the year ended December 31, 1996, operating expenses
increased $15.9 million, or 137.1%, compared to the nine-month transition period
ended December 31, 1995. Employee costs increased by $5.6 million, or 169.6%,
and represented 32.4% of total operating expenses. The increase is due to the
addition of staff necessary to accommodate the Company's growth and certain
increases in salaries of existing staff. General and administrative expenses
increased by $4.4 million, or 158.9% and represented 26.4% of total operating
expenses. Increases in general and administrative expenses included increases
in telecommunications, stationery, credit reports and other related items as a
result of increases in the volume of purchasing and servicing of Contracts.
Additionally, general and administrative expenses increased by $595,000 as a
result of including the company's share of losses incurred by NAB Asset
Corporation, in which the Company made a 38% equity investment on June 6, 1996.
20
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
Marketing expenses increased by $447,564, or 36.4%, and represented 6.1% of
total expenses. The increase is primarily due to the increase in the volume of
contracts purchased as marketing representatives are compensated directly in
proportion to the number of Contracts the Company purchases from Dealers
serviced by the marketing representative. Additional increases in marketing
expense relate to other marketing expenses such as travel, promotion and
convention expenses.
Interest expense increased $3.1 million, or 112.2%, and represented 21.0% of
total operating expenses. The increase is primarily due to the interest paid on
the $20.0 million in subordinated debt securities issued on December 20, 1995.
Interest expense was also impacted by the volume of Contracts held for sale as
well as by the Company's cost of borrowed funds.
During the year ended December 31, 1996, the provision for losses on
Contracts held for sale increased by $1.9 million, or 232.6%, and represented
10.0% of total operating expenses. The increase in the provision reflects
somewhat higher charge-off rates and a larger volume of Contracts held prior to
sale when compared to the nine-month transition period ended December 31, 1995.
The results for the year ended December 31, 1996 include net operating losses
of $491,000 from the Company's subsidiary Samco. The results for the year ended
December 31, 1996 also include net operating losses of $324,000 from the
Company's subsidiary LINC.
The Company's effective tax rate was 40.5% for the year ended December 31,
1996 and 40.2% for the nine months ended December 31, 1995. See Note 11 to
Notes to Consolidated Financial Statements.
21
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
Change Of Fiscal Year
In 1995, the Company changed its fiscal year-end from March 31 to December
31. For that reason, the information contained herein compares the fiscal year
ended December 31, 1996 to the nine-month transition period ended December 31,
1995. The table below presents summary financial information for fiscal 1997 and
1996 and the twelve months ended December 31, 1995.
12 Months Ended December 31,
------------------------------------------
1997 1996 1995
------------------------------------------
(In thousands, except per share data)
Revenues:
Gain on sale of contracts, net................. $ 39,133 $ 23,321 $ 13,719
Interest income................................ 23,526 19,980 12,537
Servicing fees................................. 14,487 7,893 4,351
Other.......................................... 2,194 -- --
---------- --------- ---------
79,340 51,194 30,607
Expenses:
Marketing, general and administrative and
other expenses ............................ 17,476 9,769 5,626
Employee costs................................. 15,875 8,921 3,888
Interest....................................... 9,184 5,781 3,842
Provision for losses........................... 4,089 2,756 1,008
Depreciation and amortization.................. 757 275 209
---------- --------- ---------
47,381 27,502 14,573
---------- --------- ---------
Earnings before income taxes................... 31,959 23,692 16,034
Income taxes................................... 13,427 9,595 6,440
Net earnings................................... $ 18,532 $ 14,097 $ 9,594
========== ========= =========
Basic earnings per share....................... $ 1.29 $ 1.05 $ 0.86
Diluted earnings per share..................... $ 1.17 $ 0.93 $ 0.68
Liquidity And Capital Resources
The Company's primary sources of cash from operating activities include
servicing fees on portfolios of Contracts it has previously sold, cash flows
released from Spread Accounts, proceeds on the sales of Contracts in excess of
its recorded investment of the Contracts, borrower payments on Contracts held
for sale, and interest earned on Contracts held for sale. The Company's primary
uses of cash include its normal operating expenses, the establishment and build-
up of Spread Accounts used for credit enhancement to their specified levels, and
income taxes.
Net cash used in operating activities was $26.1 million during the year ended
December 31, 1997 compared to net cash used of $8.4 million during the year
ended December 31, 1996. Cash used for purchasing Contracts was $632.1 million,
an increase of $280.7 million, or 79.9%, over cash used for purchasing Contracts
in the year ended December 31, 1996. Cash provided from the liquidation of
Contracts was $581.4 million, an increase of $234.9 million, or 67.8%, over cash
provided from liquidation of Contracts in the year ended December 31, 1996.
The Company's cash requirements have been and will continue to be
significant. The Securitization Agreements require the Company to make a
significant initial cash deposit, for purposes of credit enhancement, to the
Spread Accounts. Excess cash flows from the securitized Contracts are also
deposited into the Spread Accounts until such time as the Spread Account balance
reaches its requisite level, which is computed as a specified percent of the
outstanding balance of the related asset-backed securities or collateral.
22
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
During the year ended December 31, 1997, cash used for initial deposits to
Spread Accounts was $20.1 million, an increase of $7.8 million, or 63.5%, from
the amount of cash used for initial deposits to Spread Accounts in the year
ended December 31, 1996. Cash deposited to Spread Accounts for the year ended
December 31, 1997, was $31.7 million, an increase of $12.9 million, or 68.6%,
over cash deposited to Spread Accounts in the year ended December 31, 1996. The
cash deposited in Spread Accounts in 1997 includes $9.6 million of cash used to
pay down the senior certificates to create excess collateral in an over-
collateralization account. Cash released from Spread Accounts for the year
ended December 31, 1997, was $15.8 million, a decrease of $2.1 million, or
11.7%, of cash released from Spread Accounts in the year ended December 31,
1996. Changes in deposits to and releases from Spread Accounts are affected by
the relative size, seasoning and performance of the various pools of sold
Contracts that make up the Company's Servicing Portfolio.
The Securitization Agreements call for the requisite levels of the various
Spread Accounts to increase if the related receivables experience delinquencies,
repossessions or net losses in excess of certain predetermined levels. During
the Company's history, the predetermined levels have frequently been reached,
causing the requisite levels of certain Spread Accounts to be raised. The
requisite levels of the Spread Accounts may be returned to the original lower
levels if the related receivables delinquency, repossession and net loss
performance of the related receivables is reduced below the pre-determined
levels. In addition, on two occasions, the parties to the pertinent agreements
have made modifications that effectively raised the permissible delinquency,
repossession and net loss levels, thus resulting in Spread Accounts reverting to
their original requisite levels. As of December 31, 1997, the Spread Accounts
for eight of the Company's 21 securitized pools were at higher than original
requisite levels due to delinquency, repossession or net loss performance. Such
Spread Account balances therefore included approximately $7.0 million more than
would have been required at the original requisite levels.
23
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
The table below documents the Company's history of Contract
securitizations, comprising sales to 21 securitization trusts.
Structured Contract Securitizations
Securitized
Period Funded Dollar Amount Ratings(1) Rating Agency Pool Name
- ------------- ------------- ----------- ------------- --------------------------------
(In Thousands)
April 1993 $ 4,990 A Duff & Phelps Alton Grantor Trust 1993-1
May 1993 3,933 A Duff & Phelps Alton Grantor Trust 1993-1
June 1993 3,467 A Duff & Phelps Alton Grantor Trust 1993-1
July 1993 5,575 A Duff & Phelps Alton Grantor Trust 1993-2
August 1993 3,336 A Duff & Phelps Alton Grantor Trust 1993-2
September 1993 3,578 A Duff & Phelps Alton Grantor Trust 1993-2
October 1993 1,921 A Duff & Phelps Alton Grantor Trust 1993-2
November 1993 1,816 A Duff & Phelps Alton Grantor Trust 1993-3
December 1993 6,694 A Duff & Phelps Alton Grantor Trust 1993-3
January 1994 1,998 A Duff & Phelps Alton Grantor Trust 1993-3
March 1994 20,787 A Duff & Phelps Alton Grantor Trust 1993-4
June 1994 24,592 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-1
September 1994 28,916 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-2
October 1994 13,136 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-3
December 1994 28,893 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1994-4
February 1995 20,084 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-1
June 1995 49,290 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-2
September 1995 45,009 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-3
September 1995 2,369 BB S&P CPS Auto Grantor Trust 1995-3
December 1995 53,634 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1995-4
December 1995 2,823 BB S&P CPS Auto Grantor Trust 1995-4
March 1996 63,747 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1996-1
March 1996 3,355 BB S&P CPS Auto Grantor Trust 1996-1
June 1996 (2) 84,456 Aaa/AAA Moody's/S&P Fasco Auto Grantor Trust 1996-1
June 1996 4,445 BB S&P Fasco Auto Grantor Trust 1996-1
September 1996 87,523 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1996-2
September 1996 4,606 BB S&P CPS Auto Grantor Trust 1996-2
December 1996 88,215 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1996-3
December 1996 4,643 BB S&P CPS Auto Grantor Trust 1996-3
March 1997 97,211 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1997-1
March 1997 5,116 BB S&P CPS Auto Grantor Trust 1997-1
May 1997 113,394 Aaa/AAA Moody's/S&P CPS Auto Grantor Trust 1997-2
May 1997 5,968 BB S&P CPS Auto Grantor Trust 1997-2
August 1997(3) 142,500 Aaa/AAA Moody's/S&P CPS Auto Receivables Trust 1997-3
August 1997 7,499 BB S&P CPS Auto Receivables Trust 1997-3
October 1997 100,568 Aaa/AAA Moody's/S&P CPS Auto Receivables Trust 1997-4
October 1997 5,293 BB S&P CPS Auto Receivables Trust 1997-4
December 1997 90,925 Aaa/AAA Moody's/S&P CPS Auto Receivables Trust 1997-5
December 1997 4,781 BB S&P CPS Auto Receivables Trust 1997-5
-----------
$ 1,241,086
===========
24
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
(1) Commencing with the securitization completed on June 28, 1994, the
principal and interest due on the asset-backed securities issued by the
various grantor trusts have been guaranteed by Financial Security Assurance
Inc. ("FSA"), enabling the issuer to obtain Aaa/AAA ratings for the asset-
backed securities issued in such transactions. See "Business -- Purchase
and Sale of Contracts -- Securitization and Sale of Contracts to
Institutional Investors."
(2) Commencing with the securitization completed on June 27, 1996, asset-backed
securities with Aaa/AAA ratings have been sold through public offerings
pursuant to registration statements filed with the Securities and Exchange
Commission.
(3) Commencing with the securitization completed on August 15, 1997, the
Company began using an "owner trust" structure rather than the "grantor
trust" structure that had been used on all previous securitizations.
The Company funds its daily purchases of Contracts by use of two warehouse
lines of credit. Borrowings under those lines of credit rise as the Company
purchases Contracts and then are substantially repaid when the Company completes
a Contract securitization. Such securitizations and substantial repayments have
occurred at least once each quarter during the past three fiscal years.
Under one of the two warehouse lines of credit, the Company borrows from
Redwood Receivables Corporation ("Redwood"), with the loans funded by commercial
paper issued by Redwood and secured by Contracts pledged periodically by the
Company. A standby line of credit with General Electric Capital Corporation
("GECC") is available if, but only if, Redwood does not provide funding as
described above. It has never been necessary to draw on the standby line, which
is secured by Contracts and substantially all the other assets of the Company.
The Redwood/GECC line has an aggregate maximum lending amount of $100.0 million.
The maximum amount outstanding under the Redwood/GECC line in 1997 was $100.0
million and the average was $51.3 million. The Company's other warehouse line
of credit was opened in December 1997. Under this second line of credit, an
affiliate of First Union Capital Markets lends to the Company, with the loans
funded by commercial paper issued by that affiliate, and secured by Contracts
pledged periodically by the Company. The First Union line has a maximum lending
amount of $150.0 million. Interest under each line is at a variable rate,
indexed to prevailing rates for commercial paper. The two lines together had an
outstanding balance of $61.7 million at December 31, 1997, as compared to $13.3
million under the Redwood/GECC line alone at December 31, 1996. The Company
uses the warehouse lines of credit in tandem, pledging specific Contracts to
each lender alternatively.
In August 1997, to supplement its working capital resources the Company
entered into a line of credit agreement (the "Stanwich Line"), with Stanwich
Financial Services Corp. ("SFSC"). SFSC is a financial services company that was
owned by Stanwich Holdings, Inc. ("Stanwich Holdings") at the time. Charles E.
Bradley, Sr., Charles E. Bradley, Jr., and John G. Poole, who are officers and
directors of the Company, collectively owned 92.5% of the common stock of
Stanwich Holdings at the time of the transaction, and Mr. Bradley, Sr., was the
president and a director of Stanwich Holdings. Under the Stanwich Line, SFSC
agreed to lend up to $25 million to the Company from time to time upon request,
through December 19, 1997. Any amount outstanding at December 31, 1997, would be
due at that time. Borrowings under the Stanwich Line bore interest at the rate
of 10% per annum, and the Company paid a $250,000 (one percent) commitment fee
to SFSC in connection with opening the line of credit. The Company drew the full
amount of the line at its inception, none of which remained outstanding at
December 31, 1997. NAB Asset Corp. purchased all outstanding stock of Stanwich
Holdings on March 2, 1998.
The Company funds the increase in its servicing portfolio through off balance
sheet securitization transactions, as discussed above, and funds its other
capital needs with cash from operations and with the proceeds from the issuance
of long-term debt. During the year ended December 31, 1997, the Company
completed five securitization transactions, issued $20 million of 10.50%
Participating Equity Notes due 2004 ("PENs") and borrowed $15 million in an
unsecured related party loan due 2004 ("RPL").
The PENs are long-term subordinated debt instruments issued in a registered
public offering in April 1997. After deduction of underwriting commissions, the
proceeds of that offering were $18.8 million. The PENs have a 10.5% fixed coupon
rate of interest per annum, payable monthly beginning May 15, 1997. The fixed
interest rate payable on the PENs may be considered comparable to the rising
interest rate payable on the $20 million of debt securities (Rising Interest
Subordinated Redeemable Securities or "RISRS") that the Company issued in
December 1995: the RISRS interest rate was 10.25% per annum throughout 1997 and
will rise by .25% per annum in each
25
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
calendar year through 2004, and then by an additional .50% per annum for the
final year prior to maturity on December 31, 2005. The RISRS may be redeemed
without premium at any time after January 1, 2000, and the PENs may be redeemed
without premium at any time after April 15, 2000. The PENs are also partially
convertible into equity. At maturity or earlier redemption of the PENs, the
holders thereof will have the option to convert 25% of the principal amount into
common stock of the Company, at a conversion rate of $10.15 per share.
The RPL is long-term subordinated debt representing $15 million borrowed in
June 1997 from SFSC. The RPL has a fixed rate of interest of 9% per annum,
payable monthly beginning July 1997. The Company may pre-pay the RPL without
penalty at any time on or after June 12, 2000. At maturity or early repayment
of the RPL, the holder thereof will have the option to convert 20% of the
principal amount into common stock of the Company, at a conversion rate of
$11.86 per share. In conjunction with the RPL, in May 1997, the Company entered
into two additional transactions; (i) the Company purchased $14.5 million of
preferred stock of Stanwich Holdings, with dividends cumulative at the rate of
9% per annum and redeemable at an aggregate price of $14.6 million, plus accrued
dividends, and (ii) the Company borrowed $14.5 million with interest at 8% per
annum under a 60-day related party loan from SFSC. In August 1997, the Company
received $14.9 million in redemption of the preferred stock of Stanwich Holdings
and repaid the 60-day related party loan in its entirety.
The Company anticipates that the proceeds from the PENs, the RPL, funds
available under the two warehouse lines, proceeds from the sale of Contracts and
cash from operations will be sufficient to satisfy the Company's estimated cash
requirements for the next twelve months, assuming that the Company continues to
have a means by which to sell its warehoused Contracts. If for any reason the
Company is unable to sell its Contracts, or if the Company's available cash
otherwise proves to be insufficient to fund operations (because of future
changes in the industry, general economic conditions, unanticipated increases in
expenses, or other factors), the Company may be required to seek additional
funding.
In addition to capital required for the Company's existing business and its
growth, the Company may require additional capital resources if it should choose
to expand its operations by acquisition of other businesses. Although the
Company has no commitments to make any acquisition, it does regularly review
proposals to make acquisitions in the financial services field.
There can be no assurance that such additional financing, if required, will
be available to the Company, nor can there be any assurance as to the cost of
any such financing that may be available. The Company is exploring the
possibility of issuing additional debt to provide additional capital, but has no
commitment to do so.
In January 1997, the Company acquired a company engaged in the equipment
leasing business. Any material growth in that subsidiary's business will
require significant capital resources, to allow that subsidiary to purchase
equipment for lease. In March 1997, the leasing company obtained a $5 million
line of credit to purchase equipment for lease.
26
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
Forward-Looking Statements
The descriptions of the Company's business and activities set forth in this
report and in other past and future reports and announcements by the Company may
contain forward-looking statements and assumptions regarding the future
activities and results of operations of the Company. Actual results may be
adversely affected by various factors including the following: increases in
unemployment or other changes in domestic economic conditions which adversely
affect the sales of new and used automobiles and may result in increased
delinquencies, foreclosures and losses on Contracts; adverse economic conditions
in geographic areas in which the Company's business is concentrated; changes in
interest rates, adverse changes in the market for securitized receivables pools,
or a substantial lengthening of the Company's warehousing period, each of which
could restrict the Company's ability to obtain cash for new Contract
originations and purchases; increases in the amounts required to be set aside in
Spread Accounts or to be expended for other forms of credit enhancement to
support future securitizations; the reduction or unavailability of warehouse
lines of credit which the Company uses to accumulate Contracts for
securitization transactions; increased competition from other automobile finance
sources; reduction in the number and amount of acceptable Contracts submitted to
the Company by its automobile Dealer network; changes in government regulations
affecting consumer credit; and other economic, financial and regulatory factors
beyond the Company's control. A further discussion of factors that may cause
actual results to differ, or may otherwise have an adverse effect on the
Company's financial condition or results of operations, is contained in the
exhibit to this report titled "risk factors," incorporated herein by this
reference.
New Accounting Pronouncements
The Company has adopted in 1997 and will adopt in future periods new
accounting pronouncements. For information on how adoption has and will affect
the Financial Statements, see Note 1 of Notes to Consolidated Financial
Statements.
Year 2000
The Company has performed an examination of its major software applications
to ensure that each system is prepared to accommodate the year 2000. This
examination included a review of program code which is maintained by the Company
as well as obtaining confirmation from outside software vendors that their
products are year 2000 compliant. In addition, the Company has communicated with
firms with whom it does significant business to determine their readiness for
the year 2000. The Company believes that based on their current examination that
the year 2000 will not have a material adverse impact on the Company's
operations. However, there can be no assurance that software incompatibility
with the year 2000 on the part of the Company or any of its significant
suppliers will not have a material adverse effect on the Company.
27
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
This report includes Consolidated Financial Statements, Notes thereto and an
Independent Auditors' Report, at the pages indicated below. Certain unaudited
quarterly financial information is included in the Notes to Consolidated
Financial Statements, as Note 15.
INDEX TO FINANCIAL STATEMENTS
Page
Reference
Independent Auditors' Report............................................................ F-1
Consolidated Balance Sheets as of December 31, 1997 and 1996............................ F-2
Consolidated Statements of Earnings for the years ended December 31, 1997
and 1996, and the nine-month period ended December 31, 1995............................ F-3
Consolidated Statements of Shareholders' Equity for the years ended December 31,
1997 and 1996, and the nine-month period ended December 31, 1995....................... F-4
Consolidated Statements of Cash Flows for the years ended December 31, 1997 and
1996, and the nine-month period ended December 31, 1995................................ F-5
Notes to Consolidated Financial Statements for the years ended December 31, 1997 and
1996, and the nine-month period ended December 31, 1995................................ F-6
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS
Information regarding directors of the registrant is incorporated by reference
to the registrant's definitive proxy statement for its annual meeting of
shareholders to be held in 1998 (the "1998 Proxy Statement"). The 1998 Proxy
Statement will be filed not later than April 30, 1997. Information regarding
executive officers of the registrant appears in Part I of this report, and is
incorporated herein by reference.
Item 11. EXECUTIVE COMPENSATION
Incorporated by reference to the 1998 Proxy Statement.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference to the 1998 Proxy Statement.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference to the 1998 Proxy Statement.
28
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The financial statements listed above under the caption "Index to Financial
Statements" are filed as a part of this report. No financial statement
schedules are filed as the required information is inapplicable or the
information is presented in the consolidated financial statements or the
related notes. Separate financial statements of the Company have been
omitted as the Company is primarily an operating company and its
subsidiaries are wholly owned and do not have minority equity interests
and/or indebtedness to any person other than the Company in amounts which
together exceed 5% of the total consolidated assets as shown by the most
recent year-end consolidated balance sheet.
The following exhibits are filed as part of this report:
3.1 Restated Articles of Incorporation (incorporated by reference to exhibit
filed with registrant's report on Form 10-KSB dated December 31, 1995)
3.2 Amended and Restated Bylaws. (filed herewith)
4.1 Indenture re Rising Interest Subordinated Redeemable Securities ("RISRs")
(incorporated by reference to exhibit filed with registrant's report on Form 8-K
filed December 26, 1995)
4.2 First Supplemental Indenture re RISRs (incorporated by reference to
exhibit filed with registrant's report on Form 8-K filed December 26, 1995)
4.3 Form of Indenture re 10.50% Participating Equity Notes ("PENs")
(incorporated by reference to exhibit filed with registrant's registration
statement on Form S-3, no. 333-21289)
4.4 Form of First Supplemental Indenture re PENs (incorporated by reference
to exhibit filed with registrant's registration statement on Form S-3, no.333-
21289)
10.1 1991 Stock Option Plan & forms of Option Agreements thereunder
(incorporated by reference to exhibit filed with registrant's report on Form 10-
KSB dated March 31, 1994)
10.2 1997 Long-Term Incentive Stock Plan (filed herewith)
10.3 Purchase Agreement relating to PENs. (incorporated by reference to
exhibit filed with registrant's registration statement on Form S-3 no. 333-
21289)
10.4 Lease Agreement, First Amendment to Lease, Assignment and Assumption of
Lease (incorporated by reference to exhibit filed with registrant's registration
statement on Form S-1, no. 33-49770)
10.5 Amendment #2 to Lease Agreement, First Amendment to Lease and Assignment
and Assumption of Lease. (incorporated by reference to exhibit filed with
registrant's report on Form 10-KSB, dated March 31, 1995.
10.6 Lease Agreement re Chesapeake Collection Facility. (incorporated by
reference to exhibit filed with registrant's report on Form 10-K dated December
31, 1996)
10.7 Consulting Agreement. (incorporated by reference to exhibit filed with
registrant's report on Form 10-KSB dated December 31, 1995)
10.8 Agreement to Build and Lease Headquarters Building. (incorporated by
reference to exhibit filed with registrant's report on Form 10-Q dated September
30, 1997)
10.9 Lease of Headquarters Building. (incorporated by reference to exhibit
filed with registrant's report on Form 10-Q dated September 30, 1997)
10.10 Amended and Restated Motor Vehicle Installment Contract Loan and
Security Agreement re Redwood Warehouse Line. (incorporated by reference to
exhibit filed with registrant's report on Form 10-KSB dated December 31, 1995)
29
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
10.11 The Receivables Funding and Servicing Agreement re Redwood Warehouse
Line. (incorporated by reference to exhibit filed with registrant's report on
Form 10-KSB dated December 31, 1995)
10.12 Partially Convertible Subordinated Note. (incorporated by reference to
exhibit filed with registrant's report on Form 10-Q dated September 30, 1997)
10.13 Registration Rights Agreement. (incorporated by reference to exhibit
filed with registrant's report on Form 10-Q dated September 30, 1997)
10.14 Receivables Funding and Servicing Agreement relating to First Union
Warehouse Line (filed herewith)
10.15 Receivables Transfer Agreement relating to First Union Warehouse Line
(filed herewith)
10.16 Line of Credit Note Issued to Stanwich Financial Services Corp. (filed
herewith)
21.1 Subsidiaries of the Company. (filed herewith)
23.1 Consent of independent auditors. (filed herewith)
27 Financial Data Schedule. (filed herewith)
99.1 Cautionary Statement. (filed herewith)
(b) REPORTS ON FORM 8-K
During the last quarter of the fiscal year ended December 1997, three reports on
Form 8-K were filed by the Company. Each such Form 8-K reports (i) related to
one of the Company's securitization transactions, (ii) reported under Item 5
thereof that certain exhibits were filed, and (iii) included such exhibits
pursuant to Item 7 thereof. No financial statements were filed with any of such
reports on Form 8-K. The first of the three reports, dated October 14, 1997 and
filed October 17, 1997 related to the Company's October 1997 securitization
transaction. The second report, dated August 19, 1997 and filed November 12,
1997, related to the Company's August 1997 securitization transaction. The
third report, filed December 4, 1997 and dated December 2, 1997, related to the
Company's December 1997 securitization transaction.
30
Consumer Portfolio Services, Inc.
Form 10-K December 31, 1997
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
CONSUMER PORTFOLIO SERVICES, INC.
(Registrant)
By: /s/ Charles E. Bradley, Jr. Date: March 9, 1998
----------------------------------
Charles E. Bradley, Jr., President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By: /s/ Charles E. Bradley, Sr. Date: March 9, 1998
------------------------------------------------------
Charles E. Bradley, Sr.
Chairman of the Board
By: /s/ Charles E. Bradley, Jr. Date: March 9, 1998
------------------------------------------------------
Charles E. Bradley, Jr., Director, President and
Chief Executive Officer (Principal Executive Officer)
By: /s/ William B. Roberts Date: March 9, 1998
------------------------------------------------------
William B. Roberts, Director
By: /s/ John G. Poole Date: March 9, 1998
------------------------------------------------------
John G. Poole, Director
By: /s/ Thomas L. Chrystie Date: March 9, 1998
------------------------------------------------------
Thomas L. Chrystie, Director
By: /s/ Robert A. Simms Date: March 9, 1998
------------------------------------------------------
Robert A. Simms, Director
By: /s/ Jeffrey P. Fritz Date: March 9, 1998
------------------------------------------------------
Jeffrey P. Fritz, Chief Financial Officer
(Principal Financial Officer)
By: /s/ James L. Stock Date: March 9, 1998
------------------------------------------------------
James L. Stock, Controller
(Principal Accounting Officer)
31
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Consumer Portfolio Services, Inc.:
We have audited the accompanying consolidated balance sheets of Consumer
Portfolio Services, Inc. and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of earnings, shareholders' equity and cash
flows for the years ended December 31, 1997 and 1996, and for the nine-month
period ended December 31, 1995. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Consumer
Portfolio Services, Inc. and subsidiaries as of December 31, 1997 and 1996, and
the results of their operations and their cash flows for the years ended
December 31, 1997 and 1996, and for the nine-month period ended December 31,
1995, in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Orange County, California
February 18, 1998
F-1
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, December 31,
------------ ------------
1997 1996
------------ ------------
ASSETS (note 12)
Cash $ 1,745,200 $ 153,958
Contracts held for sale (note 2) 68,271,200 21,656,773
Servicing fees receivable 5,424,645 3,086,194
Residual interest in securitizations (note 3) 124,615,504 67,251,933
Furniture and equipment, net (note 7) 3,128,085 629,774
Taxes receivable (note 11) 1,527,861 610,913
Deferred financing costs (note 12) 1,840,018 943,222
Investment in unconsolidated affiliates (note 8) 3,892,224 2,263,768
Related party receivables (note 8) 7,295,400 1,308,194
Other assets (note 8) 8,155,107 4,041,691
------------ ------------
$225,895,244 $101,946,420
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Accounts payable & accrued expenses $ 10,426,880 $ 1,697,051
Warehouse lines of credit (note 12) 61,665,583 13,264,585
Deferred tax liability (note 11) 13,142,843 7,027,251
Capital lease obligation (note 10) 1,492,122 --
Notes payable (note 12) 1,505,593 --
Subordinated debt (note 12) 40,000,000 23,000,000
Related party debt (note 8) 15,055,431 --
------------ ------------
143,288,452 44,988,887
Shareholders' Equity (notes 9 and 12)
Preferred stock, $1 par value; authorized
5,000,000 shares; none issued -- --
Series A preferred stock, $1 par value;
authorized 5,000,000 shares; 3,415,000
shares issued; none outstanding -- --
Common stock, no par value; authorized
30,000,000 shares; 15,210,042 and 13,779,242
shares issued and outstanding at December 31, 1997
and December 31, 1996, respectively 42,261,410 34,644,314
Note receivable from exercise of options (500,000) --
Retained earnings 40,845,382 22,313,219
------------ -------------
82,606,792 56,957,533
Commitments and contingencies (notes 2, 3, 5, 10, 11, 12 and 13)
------------ ------------
$225,895,244 $101,946,420
============ ============
See accompanying notes to consolidated financial statements
F-2
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Earnings
Nine Months Ended
Year Ended December 31, December 31,
------------------------------ ------------------
1997 1996 1995
------------ ------------ ------------------
Revenues:
Gain on sale of contracts,
net (notes 3 and 4) $39,133,475 $23,321,015 $11,549,413
Interest income (note 5) 23,525,579 19,979,775 9,220,397
Servicing fees 14,487,429 7,893,013 3,484,903
Other (note 8) 2,193,106 -- --
------------ ------------ ------------
79,339,589 51,193,803 24,254,713
------------ ------------ ------------
Expenses:
Employee costs 15,875,404 8,920,521 3,309,139
General and administrative (note 8) 14,146,982 7,247,011 2,799,599
Interest 9,184,463 5,780,529 2,724,403
Provision for credit losses (note 2) 4,088,504 2,755,803 828,458
Marketing 1,849,463 1,678,674 1,231,110
Occupancy 1,404,027 768,521 267,641
Depreciation and amortization 756,896 275,348 174,555
Related party consulting fees
(note 8) 75,000 75,000 262,500
------------ ------------ ------------
47,380,739 27,501,407 11,597,405
------------ ------------ ------------
Earnings before income taxes 31,958,850 23,692,396 12,657,308
Income taxes (note 11) 13,426,687 9,595,020 5,082,186
------------ ------------ ------------
Net earnings $18,532,163 $14,097,376 $ 7,575,122
============ ============ ============
Earnings per share (note 1):
Basic $ 1.29 $ 1.05 $ 0.65
Diluted $ 1.17 $ 0.93 $ 0.52
Number of shares used in computing
earnings per share (note 1):
Basic 14,332,008 13,489,241 11,582,625
Diluted 16,052,703 15,329,582 14,803,592
See accompanying notes to consolidated financial statements.
F-3
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
Series A Note Receivable
Preferred Stock Common Stock from Exercise Retained
Shares Amount Shares Amount of Options Earnings Total
--------- ---------- --------- ------------- ---------------- ----------- ------------
Balance at March 31, 1995 -- $ -- 10,820,800 $26,353,637 $ -- $ 640,721 $26,994,358
Common stock issued upon exercise
of warrants (note 9) -- -- 100,534 301,602 -- -- 301,602
Common stock issued upon exercise
of options (note 9) -- -- 1,843,974 4,610,000 -- -- 4,610,000
Common stock issued upon conversion
of debt (note 12) -- -- 533,334 2,000,000 -- -- 2,000,000
Net earnings -- -- -- -- -- 7,575,122 7,575,122
---------- ---------- ---------- ----------- ---------- ----------- -----------
Balance at December 31, 1995 -- -- 13,298,642 33,265,239 -- 8,215,843 41,481,082
Common stock issued upon exercise
of warrants (note 9) -- -- 86,000 258,000 -- -- 258,000
Common stock issued upon exercise
of options (note 9) -- -- 394,600 1,121,075 -- -- 1,121,075
Net earnings -- -- -- -- -- 14,097,376 14,097,376
---------- ---------- ---------- ----------- ---------- ----------- -----------
Balance at December 31, 1996 13,779,242 34,644,314 -- 22,313,219 56,957,533
Common stock issued upon exercise
of warrants (note 9) -- -- 14,000 42,000 -- -- 42,000
Common stock issued upon exercise
of options (note 9) -- -- 936,800 2,464,300 (500,000) -- 1,964,300
Common stock issued upon conversion
of debt (note 12) -- -- 480,000 3,000,000 -- -- 3,000,000
Income tax benefit from exercise of
options (note 11) -- -- -- 2,110,796 -- -- 2,110,796
Net earnings -- -- -- -- -- 18,532,163 18,532,163
---------- ---------- ---------- ----------- ---------- ------------ -----------
Balance at December 31, 1997 -- $ -- 15,210,042 $42,261,410 $(500,000) $40,845,382 $82,606,792
========== ========== ========== =========== ========== =========== ===========
See accompanying notes to consolidated financial statements
F-4
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Nine-Month
Period Ended
Year Ended December 31, December 31,
------------------------------ -------------
1997 1996 1995
------------- ------------- -------------
Cash flows from operating activities:
Net earnings $ 18,532,163 $ 14,097,376 $ 7,575,122
Adjustments to reconcile net earnings to net cash
used in operating activities:
Depreciation and amortization 756,896 275,348 174,555
Amortization of net interest receivables 13,309,995 6,119,219 2,023,938
Amortization of deferred financing costs 268,155 157,208 5,265
Provision for credit losses 4,088,504 2,755,803 828,458
NIR gains recognized (34,767,175) (18,665,429) (7,977,828)
Loss on sale of fixed asset 13,449 -- --
(Gain) loss on investment in unconsolidated affiliates (912,000) 595,352 --
Gain on redemption of related party preferred stock (145,000) -- --
Changes in operating assets and liabilities:
Purchases of contracts held for sale (632,096,553) (351,350,070) (160,150,781)
Liquidation of contracts held for sale 581,393,622 346,486,336 156,890,700
Servicing fees receivable (2,338,451) (1,631,487) (658,385)
Initial deposits to spread accounts (20,064,059) (12,270,168) (4,931,325)
Deposits to spread accounts and
overcollateralization accounts (31,688,820) (18,790,430) (7,553,086)
Release of cash from spread accounts 15,846,488 17,940,919 7,693,839
Deferred taxes 6,115,592 5,383,997 2,199,068
Other assets (2,146,431) (2,053,460) (425,695)
Accounts payable and accrued expenses 8,268,594 355,146 (131,382)
Warehouse line of credit 48,400,998 5,764,585 (12,230,389)
Taxes payable/receivable 1,032,196 (3,522,997) (1,865,464)
------------- ------------- -------------
Net cash used in operating activities (26,131,837) (8,352,752) (18,533,390)
Cash flows from investing activities:
Proceeds from sale of subordinated certificates -- 2,022,220 --
Related party receivables (9,987,206) (1,308,194) --
Repayment of related party receivables 4,000,000 -- --
Purchase of related party preferred stock (14,500,000) -- --
Proceeds from sale of related party preferred stock 14,645,000 -- --
Investment in unconsolidated affiliate (716,456) (4,277,407) --
Purchases of furniture and equipment (1,031,561) (356,587) (263,496)
Payments received on subordinated certificates -- 152,446 118,764
Purchase of subsidiary, net of cash acquired 92,336 -- --
------------- ------------- -------------
Net cash used in investing activities (7,497,887) (3,767,522) (144,732)
Cash flows from financing activities:
Issuance of promissory notes -- -- 2,000,000
Issuance of notes to related party 54,500,000 -- 2,000,000
Issuance of subordinated debt 20,000,000 -- 20,000,000
Repayment of capital lease obligations (165,955) -- --
Repayment of notes payable (9,859) -- (2,000,000)
Repayment of related party debt (39,944,569) -- (2,000,000)
Payment of financing costs (1,164,951) -- (1,105,695)
Exercise of options and warrants 2,006,300 1,379,075 4,911,602
------------- ------------- -------------
Net cash provided by financing activities 35,220,966 1,379,075 23,805,907
------------- ------------- -------------
Increase (decrease) in cash 1,591,242 (10,741,199) 5,127,785
Cash at beginning of period 153,958 10,895,157 5,767,372
------------- ------------- -------------
Cash at end of period $ 1,745,200 $ 153,958 $ 10,895,157
============= ============= =============
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 8,475,925 $ 5,213,912 $ 2,542,718
Income taxes $ 6,203,740 $ 6,679,000 $ 4,759,050
Supplemental disclosure of non-cash investing and
financing activities:
Issuance of common stock upon conversion of debt $ 3,000,000 $ -- $ 2,000,000
Investment in subordinated certificates $ -- $ -- $ 4,779,166
Note receivable from exercise of options $ 500,000 $ -- $ --
Income tax benefit from exercise of options $ 2,110,796 $ -- $ --
Furniture and equipment acquired through
capital leases $ 1,658,077 $ -- $ --
Purchase of CPS Leasing, Inc.
Assets acquired $ 2,718,338 $ -- $ --
Liabilities assumed (2,638,338) -- --
------------- ------------- -------------
Cash paid to acquire business 80,000 -- --
Less: cash acquired (172,336)
------------- ------------- -------------
Net cash received upon acquisition $ (92,336) $ -- $ --
============= ============= =============
See accompanying notes to consolidated financial statements
F-5
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 1997 and 1996, and
nine-month period ended December 31, 1995
(1) Summary of Significant Accounting Policies
Description of Business
Consumer Portfolio Services, Inc. ("CPS") was incorporated in California on
March 8, 1991. CPS and its subsidiaries (collectively, the "Company") engage
primarily in the business of purchasing, selling and servicing retail automobile
installment sale contracts ("Contracts") originated by dealers located
throughout the United States. The Company specializes in Contracts with
borrowers who generally would not be expected to qualify for traditional
financing such as that provided by commercial banks or automobile manufacturers'
captive finance companies. The Company's headquarters and principal collection
facilities are located in Irvine, California and a satellite collection facility
is located in Chesapeake, Virginia. The Company has purchased Contracts from
dealers in California since its inception. During the year ended December 31,
1997, Contract purchases relating to borrowers who resided in California totaled
18.1% of all Contract purchases. Moreover, at December 31, 1997, borrowers who
resided in California made up 23.9% of the servicing portfolio of Contracts
serviced by the Company. A significant adverse change in the economic climate
in California or other states could result in fewer Contracts available for sale
and potentially less revenue.
Principles of Consolidation
The consolidated financial statements include the accounts of Consumer
Portfolio Services, Inc. and its wholly-owned subsidiaries, CPS Marketing Corp.,
Alton Receivables Corp. ("Alton"), CPS Receivables Corp. ("CPSRC"), CPS Funding
Corp. ("CPSFC") and CPS Warehouse Corp. ("CPSWC"). Alton, CPSRC, CPSFC and CPSWC
are limited purpose corporations formed to accommodate the structures under
which the Company purchases and sells its Contracts. CPS Marketing Corp.
employs marketing representatives who solicit business from dealers. The
consolidated financial statements also include the accounts of SAMCO Acceptance
Corp., LINC Acceptance Company, LLC, and CPS Leasing Inc., each of which are 80%
owned subsidiaries. All significant intercompany balances and transactions have
been eliminated in consolidation. Investments in unconsolidated affiliates
which are not majority owned are reported using the equity method. The excess
of the cost of the stock over the Company's share of the net assets at the
acquisition date ("goodwill") is being amortized over a period of up to fifteen
years.
Prior to December 11, 1995, the Company was a majority-owned subsidiary of
CPS Holdings, Inc., a Delaware corporation ("Holdings"). In September 1995,
the shareholders of the Company approved the merger of Holdings into the
Company. The merger was completed on December 11, 1995, and had no effect on
the Company's consolidated financial statements. Prior to the merger, Charles
E. Bradley, Sr., the Company's Chairman of the Board, was the principal
shareholder of Holdings.
Contracts Held for Sale
Contracts held for sale include automobile installment sales contracts on
which interest is precomputed and added to the face of the loan. The interest
on precomputed contracts is included in unearned financed charges. Unearned
financed charges are amortized using the interest method over the remaining
period to contractual maturity. Contracts held for sale are stated at the lower
of cost or market value. Market value is determined by purchase commitments
from investors and prevailing market prices. Gains and losses are recorded as
appropriate when Contracts are sold. The Company considers a transfer of
Contracts where the Company surrenders control over the Contracts a sale to the
extent that consideration other than beneficial interests in the transferred
Contracts is received in exchange for the Contracts.
On January 1, 1997, the Company adopted Financial Accounting Standards
Board's Statement of Financial Accounting Standards No. 125 ("SFAS No. 125"),
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities. As a result of adopting SFAS No. 125 the Company reclassified
"Investment in Credit Enhancement" (Spread Account) and "Excess Servicing Fee
Receivable" (NIR Receivable) to Residual Interests in Securitizations. The
adoption of SFAS No. 125 did not have a material effect on the operations of the
Company.
Allowance for Credit Losses
The Company provides an allowance for credit losses which management
believes provides adequately for known and inherent losses that may develop in
the Contracts held for sale. Management evaluates the
F-6
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 1997 and 1996, and
nine-month period ended December 31, 1995
adequacy of the allowance by examining current delinquencies, the
characteristics of the portfolio, the value of underlying collateral, and
general economic conditions and trends.
F-7
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Contract Acquisition Fees and Discounts
Upon purchase of a Contract from a Dealer, the Company generally charges the
dealer an acquisition fee or purchases the Contract at a discount from its face
value. The acquisition fees and discounts associated with Contract purchases
are deferred until the Contracts are sold at which time the deferred acquisition
fees or discounts are recognized as a component of the gain on sale.
Investments
The Company determines the appropriate classification of its investments in
debt securities at the time of purchase or creation. Debt securities for which
the Company does not have the intent or ability to hold to maturity are
classified as available for sale. Securities available for sale are carried at
fair value, with unrealized gains and losses, net of tax, reported in a separate
component of shareholders' equity.
The amortized cost of debt securities classified as available for sale is
adjusted for amortization of premiums and accretion of discounts, over the
estimated life of the security. Such amortization and interest earned on the
debt securities are included in interest income.
Residual Interests in Securitizations and Gain on Sale of Contracts
The Company purchases Contracts with the primary intention of reselling them
to Investors as asset-backed securities through securitizations. The
securitizations are generally structured as follows: First, the Company sells a
portfolio of Contracts to a wholly owned subsidiary ("SPS") which has been
established for the limited purpose of buying and reselling the Company's
Contracts. The SPS then transfers the same Contracts to either a Grantor or
Owners Trust (the "Trust"), and the Trust in turn issues interest-bearing asset-
backed securities (the "Certificates") generally in an amount equal to the
aggregate principal balance of the Contracts. The Company typically sells these
Contracts at face value and without recourse except that the normal
representations and warranties provided by the dealer to the Company are
similarly provided by the Company to the Trust. One or more investors purchase
these Certificates; the proceeds from the sale of the certificates are then used
to purchase the Contracts from the Company. In addition, the Company provides a
credit enhancement for the benefit of the investors in the form of an initial
cash deposit to a specific account ("Spread Account") held by the Trust. The
Spread Account is required by the servicing agreement (the Company's servicing
agreements are collectively referred to as the "Servicing Agreements") to be
maintained at specified levels.
At the closing of each securitization, the Company removes from its
consolidated balance sheet the Contracts held for sale and adds to its
consolidated balance sheet (i) the cash received and (ii) the estimated fair
value of the portion of the Contracts retained from the securitizations
("Residuals"), which consist of (a) the cash held in the Spread Account and (b)
the net interest receivables ("NIRs"). NIRs represent the discounted cash flows
to be received by the Trust in the future. The excess of the cash received and
the assets retained by the Company over the carrying value of the Contracts
sold, less transaction costs, equals the net gain on sale of Contracts recorded
by the Company.
The Company allocates its basis in the Contracts between the portion of the
Contracts sold through the certificates and the portion retained (the Residuals)
based on the relative fair values of those portions on the date of the sale.
The Company may recognize gains or losses attributable to the change in the fair
value of the Residuals, which are recorded at estimated fair value and accounted
for as "held-for-trading" securities. The Company is not aware of an active
market for the purchase or sale of residuals, and accordingly, the Company
determines the estimated fair value of the Residuals by discounting the expected
cash flows released from the Spread Account (the cash out method) using a
discount rate which the Company believes is commensurate with the risks
involved. The Company has utilized an effective discount rate of approximately
14% on the estimated cash flows released from the Spread Account to value the
Residuals.
F-8
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Company receives periodic base servicing fees for the servicing and
collection of the Contracts. In addition, the Company is entitled to the cash
flows from the Residuals that represent collections on the Contracts in excess
of the amounts required to pay the Certificate principal and interest, the base
servicing fees and certain other fees such as trustee and custodial fees. At
the end of each collection period, the aggregate cash collections from the
Contracts are allocated first to the base servicing fees and certain other fees
such as trustee and custodial fees for the period, then to the
Certificateholders for interest at the pass-through rate on the certificates
plus principal as defined in the Servicing Agreements. If the amount of cash
required for the above allocations exceeds the amount collected during the
collection period, the shortfall is drawn from the Spread Account. If the cash
collected during the period exceeds the amount necessary for the above
allocations, and there is no shortfall in the related Spread Account, the excess
is released to the Company. If the Spread Account balance is not at the required
credit enhancement level the excess cash collected is retained in the Spread
Account until the specified level is achieved. The cash in the Spread Accounts
and OC accounts is restricted from use by the Company. Cash held in the various
Spread Accounts is invested in either high quality liquid investment securities,
as specified in the Servicing Agreements or pursuant to certain Servicing
Agreements used to make accelerated principal paydowns on the certificates to
create excess collateral (over-collateralization or OC Account) which is held by
the Trusts on behalf of the Company as the Residual holder. The specified credit
enhancement levels are defined in the Servicing Agreements as the Spread Account
balance expressed generally as a percentage of the current collateral principal
balance. The Spread Account includes both qualified investment and OC accounts
(see note 3).
The Annual Percentage Rate ("APR") on the Contracts is relatively high in
comparison to the pass through rate on the certificates, accordingly, the
Residuals described above are a significant asset of the Company. In
determining the value of the Residuals described above, the Company must
estimate the future rates of prepayments, delinquencies, defaults and default
loss severity as they impact the amount and timing of the estimated cash flows.
The Company estimates prepayments by evaluating historical prepayment
performance of comparable Contracts and the impact of trends in the industry.
The Company has used a constant prepayment estimate of 15%. The Company
estimates defaults and default loss severity using available historical loss
data for comparable Contracts and the specific characteristics of the Contracts
purchased by the Company. The Company used default losses of 11.5% to 13.5% as a
percentage of the original principal balance over the life of the Contracts.
In future periods, the Company will recognize additional revenue from the
Residuals if the actual performance of the Contracts is higher than the original
estimate or the Company may increase the estimated fair value of the Residuals.
If the actual performance of the Contracts is lower than the original estimate,
then an adjustment to the carrying value of the Residuals may be required if the
estimated fair value of the Residuals is less than its carrying value.
Servicing
Servicing fees are reported as income when earned. Servicing costs are
charged to expense as incurred. Servicing fee receivables represent fees earned
but not yet remitted to the Company by the trustee.
Furniture and Equipment
Furniture and equipment are stated at cost net of accumulated depreciation
which is calculated using the straight-line method over the estimated useful
lives of the assets. Assets held under capital leases and leasehold
improvements are amortized over the lesser of the estimated useful lives of the
assets or the related lease terms.
F-9
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Earnings per Share
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings per Share" ("SFAS No. 128"). This
statement replaces the previously reported primary and fully diluted earnings
per share with basic and diluted earnings per share. Unlike primary earnings
per share, basic earnings per share excludes any diluted effects of options.
Diluted earnings per share is very similar to the previously reported fully
diluted earnings per share. All earnings per share amounts have been restated
to conform to the SFAS No. 128 requirements.
The following table illustrates the computation of basic and diluted earnings
per share:
Nine months
ended
Year ended December 31, December 31,
------------------------------------------------
1997 1996 1995
------------------------------------------------
Numerator:
Numerator for basic earnings per share --
net earnings......................................... $18,532,163 $14,097,376 $ 7,575,122
Interest on borrowings, net of tax effect on conversion of
convertible subordinated debt........................ 313,055 169,575 127,823
----------- ----------- -----------
Numerator for diluted earnings per share.................. $18,845,218 $14,266,951 $ 7,702,945
================================================
Denominator:
Denominator for basic earnings per share -- weighted
average number of common shares outstanding during
the period........................................... 14,332,008 13,489,241 11,582,625
Incremental common shares attributable to exercise of
outstanding options and warrants..................... 1,211,498 1,360,341 2,740,967
Incremental common shares attributable to conversion of
subordinated debt.................................... 509,197 480,000 480,000
----------- ---------- ----------
Denominator for diluted earnings per share................ 16,052,703 15,329,582 14,803,592
================================================
Basic earnings per share.................................. $ 1.29 $ 1.05 $ .65
================================================
Diluted earnings per share................................ $ 1.17 $ .93 $ .52
================================================
Income Taxes
The Company and its subsidiaries file a consolidated Federal income and
combined state franchise tax return. The Company utilizes the asset and
liability method of accounting for income taxes under which deferred income
taxes are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts 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. The Company has
accounted for income taxes in this manner since its inception.
Stock Split
On February 16, 1996, the Board of Directors authorized a two-for-one stock
split to be distributed on or about March 14, 1996, to shareholders of record on
March 7, 1996. All references in the consolidated financial statements to
number of shares, per share amounts and market prices of the Company's common
stock have been retroactively restated to reflect the increased number of common
shares outstanding.
Stock Option Plan
As permitted by Statement of Financial Accounting Standards No. 123
"Accounting for Stock-Based Compensation" ("SFAS No. 123"), the Company accounts
for stock-based employee compensation plans in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
F-10
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
and related interpretations. The Company provides the pro forma net earnings,
pro forma earnings per share, and stock based compensation plan disclosure
requirements set forth in SFAS No. 123.
F-11
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," the Company reviews identifiable intangibles, goodwill and
other long-lived assets for impairment whenever events or circumstances indicate
the carrying amounts may not be recoverable. If the sum of the expected future
cash flows (undiscounted and without interest charges) is less than the carrying
amount of an asset, an impairment loss is recognized.
New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards Nos. 130 and 131, "Reporting Comprehensive
Income" ("SFAS No. 130") and "Disclosures about Segments of an Enterprise and
Related Information" ("SFAS No. 131"), respectively (collectively, the
"Statements"). The Statements are effective for fiscal years beginning after
December 15, 1997. SFAS No. 130 established standards for reporting of
comprehensive income and its components in annual financial statements. SFAS
No. 131 establishes standards for reporting financial and descriptive
information about an enterprise's operating segments in its annual financial
statements and selected segment information in interim financial reports.
Reclassification or restatement of comparative financial statements or financial
information for earlier periods is required upon adoption of SFAS No. 130 and
SFAS No. 131, respectively. Application of the Statements' requirements is not
expected to have a material impact on the Company's consolidated financial
position, results of operations or liquidity.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management 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. Specifically, a number of estimates were made in
connection with the recording of the allowance for credit losses and Residuals
and the related gain. Actual results could differ from those estimates.
Reclassification
Certain amounts for the prior periods have been reclassified to conform to
the current presentation.
(2) Contracts Held for Sale
The following table presents the components of Contracts held for sale:
December 31, December 31,
1997 1996
--------------- --------------
Gross receivable balance................................................. $ 81,905,819 $ 28,095,461
Unearned finance charges................................................. (10,077,417) (5,268,107)
Deferred acquisition fees and discounts.................................. (1,091,761) (447,492)
Allowance for credit losses.............................................. (2,465,441) (723,089)
--------------- --------------
Net contracts held for sale........................................... $ 68,271,200 $ 21,656,773
=============== ==============
F-12
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table presents the activity in the allowance for credit losses:
Nine months
ended
Year ended December 31, December 31,
--------------------------------------------------------
1997 1996 1995
--------------------------------------------------------
Balance, beginning of period.................... $ 723,089 $ 330,156 $ 323,631
Provisions...................................... 4,088,504 2,755,803 828,458
Charge-offs..................................... (2,935,010) (2,755,303) (1,076,982)
Recoveries...................................... 588,858 392,433 255,049
Balance, end of period....................... $ 2,465,441 $ 723,089 $ 330,156
=======================================================
The Company is required to represent and warrant certain matters with respect
to the Contracts sold to investors, which generally duplicate the substance of
the representations and warranties made by the dealers in connection with the
Company's purchase of the Contracts. In the event of a breach by the Company of
any representation or warranty, the Company is obligated to repurchase the
Contracts from the investors at a price equal to the investors' purchase price
less the related credit enhancement and any principal payments received from the
borrower. In most cases, the Company would then be entitled under the terms of
its agreements with dealers to require the selling dealer to repurchase the
Contracts at the Company's purchase price less any principal payments received
from the borrower.
As of December 31, 1997, the Company had commitments to purchase $3,773,738
of Contracts from Dealers in the ordinary course of business.
(3) Residual Interests in Securitizations
The following table presents the components of the residual interest in
securitizations:
December 31, December 31,
1997 1996
-----------------------------------
Funds held by investor................................................... $ 578,710 $ 1,263,660
Investment in subordinated certificates.................................. 790,516 1,530,950
Cash, commercial paper, US government securities and other qualifying
investments (Spread Account)............................................. 68,513,454 40,802,862
OC accounts.............................................................. 9,621,183 --
NIRs..................................................................... 45,111,641 23,654,461
-----------------------------------
$ 124,615,504 $ 67,251,933
===================================
The following table presents the activity of the NIRs :
Nine months
ended
Year ended December 31, December 31,
---------------------------------------------------------
1997 1996 1995
---------------------------------------------------------
Balance, beginning of period...................... $ 23,654,461 $ 11,108,251 $ 5,154,361
NIR gains recognized (note 4)..................... 34,767,175 18,665,429 7,977,828
Amortization of NIRs (note 5)..................... (13,309,995) (6,119,219) (2,023,938)
---------------------------------------------------------
Balance, end of period............................ $ 45,111,641 $ 23,654,461 $ 11,108,251
=========================================================
F-13
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table presents the estimated credit losses as a percentage of
the Company's servicing portfolio subject to recourse provisions:
December 31,
----------------------------------------------
1997 1996 1995
------------ ------------ ------------
Estimated credit losses....................... $ 90,814,217 $ 45,880,979 $ 25,363,061
Servicing subject to recourse provisions...... $830,918,120 $483,106,256 $268,163,150
============ ============ ============
Estimated credit losses as percentage of
servicing subject to recourse provisions... 10.93% 9.50% 9.46%
============ ============ ============
(4) Gain on Sale of Contracts
The following table presents the components of the net gain on sale of
Contracts:
Nine months
ended
Year ended December 31, December 31,
--------------------------- ------------
1997 1996 1995
---------- ------------ ------------
NIR gains recognized............ $34,767,175 $18,665,429 $ 7,977,828
Deferred acquisition fees and 8,924,719 6,890,341 5,044,501
discounts......................
Expenses related to sales....... (4,558,419) (2,234,755) (1,472,916)
----------- ----------- -----------
$39,133,475 $23,321,015 $11,549,413
=========== =========== ===========
(5) Interest Income
The following table presents the components of interest income:
Nine months
ended
Year ended December 31, December 31,
------------------------- ------------
1997 1996 1995
---------- ----------- ------------
Interest on Contracts held for sale... $ 14,279,120 $ 9,980,518 $ 4,856,591
Residual interest income.............. 22,556,454 16,118,476 6,387,744
Amortization of NIRs (13,309,995) (6,119,219) (2,023,938)
------------ ---------- -----------
Net interest income................ $ 23,525,579 $19,979,775 $ 9,220,397
============ =========== ===========
(6) Servicing
The following table presents the components of the Company's servicing
portfolio:
December 31,
------------------------------------------
1997 1996 1995
------------ ------------ ------------
Contracts held for sale....................... $ 71,828,402 $ 22,827,354 $ 20,764,205
Servicing subject to recourse provisions:
Whole loan portfolios................... 4,838,858 11,212,010 21,213,050
Alton Receivables Corp.................. 3,073,254 10,240,973 22,732,021
CPS Receivables Corp.................... 823,006,008 461,653,273 224,218,079
------------ ------------ ------------
$902,746,522 $505,933,610 $288,927,355
============ ============ ============
F-14
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(7) Furniture and Equipment
The following table presents the component of furniture and equipment:
December 31, December 31,
1997 1996
------------- -------------
Furniture and fixtures......................................................... $ 1,869,308 $ 759,783
Computer equipment............................................................. 1,894,807 875,870
Leasing assets................................................................. 916,188 --
Leasehold improvements......................................................... 126,781 91,700
Other Fixed assets............................................................. 54,530 --
------------- -------------
4,861,614 1,727,353
Less accumulated depreciation and amortization................................. (1,733,529) (1,097,579)
------------- -------------
$ 3,128,085 $ 629,774
============= =============
(8) Related Party Transactions
Investment in Unconsolidated Affiliates
Investment in unconsolidated affiliates primarily consists of a 38% interest
in NAB Asset Corporation ("NAB") that was acquired by the Company on June 6,
1996, for approximately $4.3 million. At the time of the acquisition, NAB had
approximately $3.5 million in cash and no significant operations. The Company's
investment in NAB exceeded the Company's share of the net assets of NAB at the
acquisition date by approximately $1.4 million. This amount, which is included
in other assets in the accompanying balance sheet, has been recorded by the
Company as goodwill. Based on the closing price on the Nasdaq, the market value
of the investment in NAB was approximately $4.0 million and $7.5 million at
December 31, 1997 and 1996, respectively. Charles E. Bradley, Sr., Chairman of
the Company's Board of Directors and principal shareholder and Charles E.
Bradley, Jr., President, Chief Executive Officer and a member of the Company's
Board of Directors are both on the Board of Directors of NAB.
Subsequent to the Company's investment in NAB, NAB purchased Mortgage
Portfolio Services, Inc. ("MPS") from the Company for $300,000. MPS, formed by
the Company in April, 1996, is a mortgage broker-dealer based in Texas. In July
1996, NAB formed CARSUSA, Inc. ("CARSUSA"), which purchased, and now owns and
operates, a Mitsubishi automobile dealership in Southern California. On June
27, 1997, NAB sold CARSUSA to Charles E. Bradley, Sr. and Charles E. Bradley,
Jr., for $1.5 million. Included in other income for the year ended December 31,
1997, is $848,920, which represents the Company's share of NAB's income for the
year then ended. Included in general and administrative expenses for the year
ended December 31, 1996, is $595,352, which represents the Company's share of
NAB's loss from June 6, through December 31, 1996.
F-15
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Related Party Receivables
The following table presents the components of related party receivables:
December 31,
--------------------------------
Related Party 1997 1996
------------- -------------
NAB Asset Corporation $ 5,601,750 $ 101,750
CARSUSA, Inc. 1,350,954 991,231
Service and Management Cooperative, Inc. 128,421 115,213
Global Equipment Leasing, LLC 114,275 --
Stanwich Partners, Inc. 100,000 100,000
------------ ------------
$ 7,295,400 $ 1,308,194
============ ============
Included in the receivable from CARSUSA at December 31, 1997 and 1996, is
$790,000 and $800,000, respectively, related to a flooring line of credit
provided to CARSUSA and the remainder relates to amounts owed by CARSUSA for
other borrowings.
During fiscal 1997 and 1996, respectively, the Company sold 107 and 69
automobiles to CARSUSA and received proceeds of $749,800 and $458,650,
respectively. Additionally, the Company purchased 183 and 39 Contracts from
CARSUSA, with an aggregate principal balance of $2,405,100 and $517,264,
respectively.
Included in the receivable from NAB is $5.5 million arising from the
issuance of two promissory notes totaling $9.5 million, bearing interest at 13%
annually. On December 31, 1997, one of the promissory notes for $4.0 million
was sold to Stanwich Financial Services Corp. ("SFSC") for $4.0 million, the
proceeds of which were received on December 31, 1997. Charles E. Bradley, Sr.,
Charles E. Bradley, Jr., and John G. Poole, who are officers and directors of
the Company, collectively own 92.5% of the common stock of Stanwich Holdings,
Inc. ("Stanwich Holdings"), and Mr. Bradley, Sr., is the president and a
director of Stanwich Holdings. SFSC is a wholly-owned subsidiary of Stanwich
Holdings.
On March 2, 1998, NAB acquired Stanwich Holdings. At that time the Company
received a note from NAB for $530,835 in exchange for an option it had held to
acquire 100% of the outstanding common stock of Stanwich Holdings. The March 2,
1998 transaction and related note are unaudited.
At December 31, 1997 and 1996, respectively, $128,421 and $115,213 is
due from Service and Management Cooperative, Inc. These amounts
represent liabilities incurred by Service and Management Cooperative, Inc.,
which were paid for by the Company. Certain officers of the Company's
subsidiary Samco are officers of Service and Management Cooperative, Inc.
At December 31, 1997, $114,275 is due from Global Equipment Leasing, LLC.
These amounts represent payments by the Company's subsidiary CPS Leasing, Inc.,
of certain debt obligations of Global Equipment Leasing, LLC., which is 50%
owned by CPS Leasing, Inc.
The amount due from Stanwich Partners, Inc. ("SPI") at December 31, 1997 and
1996, is related to investment banking services performed by the Company in
connection with the Company's January 2, 1997 acquisition of CPS Leasing, Inc.
The Chairman of the Board of Directors of the Company is a principal shareholder
of SPI.
The Company is a party to a consulting agreement with SPI that calls for
monthly payments of $6,250 through December 31, 1998. Included in the
accompanying consolidated statements of earnings for the year ended December 31,
1997 and 1996, and for the nine-month period ended December 31, 1995, is
$75,000, $75,000 and $262,500, respectively, of consulting expense related to
this consulting agreement.
F-16
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Related Party Debt
In May 1997, the Company entered into two transactions with a related party:
(i) the Company purchased $14.5 million of preferred stock of Stanwich Holdings
with dividends cumulative at the rate of 9% per annum and redeemable at an
aggregate price of $14.6 million, plus accrued dividends, and (ii) the Company
borrowed $14.5 million with an interest rate of 8% per annum under a 60-day
related party loan from SFSC. In August 1997, the Company received $14.9
million in redemption of its preferred stock of Stanwich Holdings and repaid the
60-day related party loan in its entirety. In August 1997, the Company entered
into a line of credit agreement with SFSC ("Stanwich Line"), to supplement its
working capital resources. Under the Stanwich Line, SFSC agreed to lend up to
$25 million to the Company from time to time upon request, through December 19,
1997. Any amount outstanding at December 31, 1997 would be due at that time.
Borrowings under the Stanwich Line bear interest at the rate of 10% per annum,
and the Company paid a $250,000 (one percent) commitment fee to SFSC in
connection with opening the line of credit. The Company drew the full amount of
the line at its inception, none of which remained outstanding at December 31,
1997.
The Company has also received long-term financing from SFSC. In June 1997
the Company borrowed $15 million on an unsecured and subordinated basis from
SFSC. This loan ("RPL") is due 2004, and has a fixed rate of interest of 9% per
annum, payable monthly beginning July 1997. The Company may pre-pay the RPL
without penalty at any time after three years. At maturity or repayment of the
RPL, the holder thereof will have an option to convert 20% of the principal
amount into common stock of the Company, at a conversion rate of $11.86 per
share.
(9) Shareholders' Equity
Common Stock
Holders of the common stock are entitled to such dividends as the Company's
Board of Directors, in its discretion, may declare out of funds available,
subject to the terms of any outstanding shares of preferred stock and other
restrictions. In the event of liquidation of the Company, holders of common
stock are entitled to receive, pro rata, all of the assets of the Company
available for distribution, after payment of any liquidation preference to the
holders of outstanding shares of preferred stock. Holders of the shares of
common stock have no conversion or preemptive or other subscription rights and
there are no redemption or sinking fund provisions applicable to the common
stock.
The Company is required to comply with various operating and financial
covenants defined in the agreements governing the warehouse lines and the
subordinated debt. The covenants restrict the payment of certain distributions,
including dividends.
Options and Warrants
In 1991, the Company adopted and gained sole shareholder approval of the 1991
Stock Option Plan (the "1991 Plan") pursuant to which the Company's Board of
Directors may grant stock options to officers and key employees. The Plan, as
amended, authorizes grants of options to purchase up to 2,700,000 shares of
authorized but unissued common stock. Stock options are granted with an
exercise price equal to the stock's fair market value at the date of grant.
Stock options have terms that range from 7 to 10 years and vest over a range of
0 to 7 years. In addition to the 1991 Plan, in fiscal 1995, the Company granted
60,000 options to certain directors of the Company that vest over three years
and expire nine years from the grant date.
In July, 1997 the Company adopted and gained shareholder approval of the 1997
Long-Term Incentive Plan (the "1997 Plan") pursuant to which the Company's Board
of Directors may grant stock options, restricted stock and stock appreciation
rights to employees, Directors or employees of entities in
F-17
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
which the Company has a controlling or significant equity interest. Options that
have been granted under the 1997 Plan have in all cases been granted at an
exercise price equal to the stock's fair market value at the date of the grant,
with terms of 10 years and vesting over 4 years. The 1997 Plan provides that an
aggregate maximum of 1,500,000 shares of the Company's common shares may be
subject to awards under the 1997 Plan. As of December 31, 1997, the shares
reserved under the 1997 Plan were not registered with the Securities and
Exchange Commission.
At December 31, 1997, there were 1,443,400 additional shares available for
grant under the 1991 Plan and 1997 Plan. Of the options outstanding at December
31, 1997, 1996 and 1995, 584,920, 1,319,420 and 1,296,786, respectively, were
exercisable with weighted-average exercise prices of $6.77, $4.02 and $2.71,
respectively. The per share weighted-average fair value of stock options granted
during the years ended December 31, 1997 and 1996, and the nine-month period
ended December 31, 1995, was $5.79, $4.99, and $4.17, respectively, at the date
of grant using the Black-Scholes option-pricing model with the following
weighted average assumptions:
Nine months ended
Year ended December 31, December 31,
------------------------- -----------------
1997 1996 1995
------------------------- -----------------
Expected life (years)............................ 6.50 5.86 6.33
Risk-free interest rate.......................... 6.48% 6.23% 6.80%
Volatility....................................... 52.04% 46.20% 46.20%
Expected dividend yield.......................... -- -- --
The Company applies APB Opinion No. 25 in accounting for its plans and,
accordingly, no compensation cost has been recognized for its stock options in
the consolidated financial statements. Had the Company determined compensation
cost based on the fair value at the grant date for its stock options under
Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation", the Company's net earnings and net earnings per share would have
been reduced to the pro forma amounts indicated below.
Year ended December 31,
-----------------------------------------------------
1997 1996 1995
-------------- -------------- ---------------
Net earnings
As reported.................................... $ 18,532,163 $ 14,097,376 $ 7,575,122
Pro forma...................................... $ 18,182,000 $ 13,550,000 $ 7,505,000
Net earnings per share - basic
As reported.................................... $ 1.29 $ 1.05 $ 0.65
Pro forma...................................... $ 1.27 $ 1.00 $ 0.65
Net earnings per share - diluted
As reported.................................... $ 1.17 $ 0.93 $ 0.52
Pro forma...................................... $ 1.17 $ 0.90 $ 0.52
Pro forma net earnings and net earnings per share reflects only options
granted in the year ended December 31, 1997, 1996, and the nine-month period
ended December 31, 1995. Therefore, the full impact of calculating compensation
cost for stock options under SFAS No. 123 is not reflected in the pro forma net
earnings amounts presented above because compensation cost is reflected over the
options' vesting period and compensation cost for options granted prior to Apri1
1, 1995 is not considered.
F-18
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Stock options activity during the periods indicated is as follows:
Number of Weighted-Average
Shares Exercise Price
--------- -----------------
Balance at March 31, 1995................ 2,045,040 $ 3.23
Granted............................. 159,360 7.61
Exercised........................... 44,000 2.50
Canceled............................ -- --
--------- -----------------
Balance at December 31, 1995............. 2,160,400 3.56
Granted............................. 513,400 9.60
Exercised........................... 394,600 2.82
Canceled............................ 124,800 5.23
--------- -----------------
Balance at December 31, 1996............. 2,154,400 5.04
Granted............................. 321,000 9.76
Exercised........................... 936,800 2.64
Canceled............................ 145,400 11.69
--------- -----------------
Balance at December 31, 1997............. 1,393,200 $ 7.05
========= =================
On August 21, 1992, the Board of Directors approved the grant to Holdings of
a non-qualified option to purchase 1,800,000 shares of common stock at an
exercise price of $2.50 per share, the estimated fair market value at the date
of grant. This option is in addition to and is not part of the 1991 Plan or
1997 Plan. This ten year option vested in full on the date of grant. On December
6, 1995, Holdings exercised its option in full.
At December 31, 1997, the range of exercise prices, the number, weighted-
average exercise price and weighted-average remaining term of options
outstanding and the number and weighted-average price of options currently
exercisable are as follows:
Weighted- Weighted
Average Average Weighted-Average
Number Remaining Exercise Number Exercise
Range of Exercise Prices Outstanding Term Price Exercisable Price
- ------------------------ ----------- --------- -------- ----------- ----------------
$ 2.50 - $2.69 192,040 4.04 $ 2.62 123,500 $ 2.58
$ 4.38 - $4.38 70,000 6.01 $ 4.38 52,000 $ 4.38
$ 5.38 - $5.38 281,200 6.29 $ 5.38 45,800 $ 5.38
$ 5.56 - $7.25 164,360 6.65 $ 6.97 69,350 $ 7.25
$ 7.38 - $8.50 217,200 9.21 $ 8.29 43,650 $ 8.37
$ 8.63 - $8.63 15,000 8.53 $ 8.63 6,500 $ 8.63
$ 8.88 - $8.88 326,400 8.25 $ 8.88 221,520 $ 8.88
$ 9.63 - $13.50 116,000 9.29 $11.56 20,400 $11.66
$16.75 - $16.75 10,000 9.73 $16.75 2,000 $16.75
$17.63 - $17.63 1,000 9.67 $17.63 200 $17.63
In connection with the Company's initial public offering, the Company sold to
the underwriter of the offering, for an aggregate price of $120, warrants to
purchase up to 240,000 shares of the Company's common stock at an exercise price
of $3.00 per share. The warrants were exercisable during the four year period
commencing one year from the date of the offering. The shares represented by
the warrants have been registered for public sale. During the year ended
December 31, 1997, 1996, and the nine month period ended December 31, 1995, the
underwriter exercised 14,000, 86,000, and 100,534 warrants, respectively. At
December 31, 1997 all warrants had been exercised.
F-19
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(10) Commitments and Contingencies
Leases
The Company leases its facilities and certain computer equipment under non-
cancelable operating and capital leases which expire through 2007. Future
minimum lease payments at December 31, 1997, under these leases are as follows:
Capital Operating
---------- ----------
1998.............................................. $ 512,775 $1,699,346
1999.............................................. 502,285 1,158,278
2000.............................................. 350,762 1,037,613
2001.............................................. 270,550 481,449
2002.............................................. 176,413 331,084
Thereafter........................................ -- 1,351,780
---------- ----------
Total minimum lease payments 1,812,785 $6,059,550
==========
Less: amount representing interest................ 320,663
---------
Present value of net minimum lease payments....... $1,492,122
==========
On October 27, 1997, the Company entered into agreements to have built and to
lease a new headquarters building in Irvine, California. The lease is for a
ten-year term and calls for total minimum lease payments of $20.0 million over
that term.
Included in furniture and equipment in the accompanying consolidated balance
sheets are the following assets held under capital leases at December 31, 1997:
Data processing equipment............. $ 663,101
Furniture and fixtures................ 994,976
----------
1,658,077
Less: accumulated depreciation........ (129,205)
$1,528,872
==========
Rent expense for the years ended December 31, 1997 and 1996, and the nine-
month period ended December 31, 1995, was $1,036,677, $463,592 and $186,483,
respectively. The Company's facility lease contains certain rental concessions
and escalating rental payments which are recognized as adjustments to rental
expense and are amortized on a straight-line basis over the term of the lease.
Litigation
The Company is party to litigation in the ordinary course of business,
generally involving actions against automobile purchasers to collect amounts due
on purchased Contracts or to recover vehicles. In one such case, relating to the
Chapter 13 bankruptcy of obligors Madeline and Darryl Brownlee, of Chicago,
Illinois, the obligors counterclaimed against the Company on June 30, 1997 in
the bankruptcy court for the Northern District of Illinois. The obligors seek
class-action treatment of their allegation that the cost of an extended service
contract on the automobile they purchased was inadequately disclosed by the
automobile dealer, Joe Cotton Ford of Carol Stream, Illinois. The disclosure is
alleged to violate the Federal Truth In Lending Act and Illinois consumer
protection statutes. The obligors' claim is directed against both the dealer for
making the allegedly improper disclosures and against the Company as holder of
the purchase contract. The relief sought is damages in an unspecified amount,
plus costs of suit and attorney's fees. The court has not ruled on the obligors'
request for class-action treatment, nor on the merits of the claims.
F-20
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In another proceeding, arising out of efforts to collect a deficiency balance
from Joseph Barrios of Chicago, Illinois, the debtor has brought suit against
the Company alleging defects in the notice given upon repossession of the
vehicle. This lawsuit was filed on February 18, 1998 in the circuit court of
Cook County, Illinois. Barrios, represented by the same law firm as the
Brownlee obligors, seeks class-action treatment of his allegation that notice of
a fifteen day period to reinstate his installment purchase contract was
misleading, in that it did not refer to an alleged right to redeem collateral up
to the date of sale. The relief sought is damages in an unspecified amount,
plus costs of suit and attorney's fees. As of the date of this filing, the
Company has not been required to respond to this litigation and has not yet done
so.
The Company intends to dispute both of these matters vigorously, and believes
that it has meritorious defenses to each claim made. Nevertheless, the outcome
of any litigation is uncertain, and there is the possibility that damages could
be assessed against the Company in amounts that could be material. It is
management's opinion that all litigation of which it is aware, including the
matters discussed above, will no have a material adverse effect on the Company's
consolidated financial position, results of operations or liquidity.
(11) Income Taxes
Income taxes are comprised of the following:
Nine months
ended
Year ended December 31, December 31,
------------------------- -----------
1997 1996 1995
----------- ---------- ----------
Current
Federal..................................... $ 4,277,787 $3,060,164 $2,156,799
State....................................... 922,512 1,150,859 726,319
----------- ---------- ----------
5,200,299 4,211,023 2,883,118
Deferred
Federal..................................... 4,504,636 4,565,383 1,683,960
State....................................... 1,610,956 818,614 515,108
----------- ---------- ----------
6,115,592 5,383,997 2,199,068
Income tax benefit from exercise of options
credited to shareholders' equity.............. 2,110,796 -- --
----------- ---------- ----------
Income taxes............................ $13,426,687 $9,595,020 $5,082,186
=========== ========== ==========
The Company's effective tax expense differs from the amount determined by
applying the statutory Federal rate of 35% for the years ended December 31, 1997
and 1996, and for the nine-month period ended December 31, 1995, to earnings
before income taxes as follows:
Nine months
ended
Year ended December 31, December 31,
-------------------------- -----------
1997 1996 1995
----------- ---------- ----------
Expense at Federal tax rate............................ $11,185,598 $8,292,338 $4,430,058
California franchise tax, net of federal income tax
benefit............................................... 1,672,089 1,280,157 737,192
State tax benefit from exercise of options, net of
federal income tax benefit, credited to shareholders'
equity................................................ 585,608 -- --
Other.................................................. (16,608) 22,525 (85,064)
----------- ---------- ----------
$13,426,687 $9,595,020 $5,082,186
=========== ========== ==========
F-21
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The tax effected cumulative temporary differences that give rise to deferred
tax assets and liabilities as of December 31, 1997 and 1996, are as follows:
December 31,
---------------------------------
1997 1996
-------------- -------------
Deferred Tax Assets:
Accrued liabilities....................... $ 558,881 $ 13,670
Furniture and equipment................... 27,295 23,095
Provision for credit losses............... 1,105,849 301,357
State taxes............................... 1,850,507 508,219
Other..................................... 289,419 --
-------------- -------------
3,831,951 846,341
Deferred Tax Liabilities:
Excess servicing receivables.............. 16,408,622 7,873,592
Equity investments........................ 566,172 --
-------------- -------------
16,974,794 7,873,592
Net deferred tax liability................ $ 13,142,843 $ 7,027,251
============== =============
In determining the possible future realization of deferred tax assets, future
taxable income from the following sources are taken into account: (a) the
reversal of taxable temporary differences, and (b) future operations exclusive
of reversing temporary differences.
The Company believes that the deferred tax asset will more likely than not be
realized due to the reversal of the deferred tax liability and expected future
taxable income.
The Company is in the process of an audit by the Internal Revenue Service of
the Company's Federal income tax return for the tax year ended March 31, 1995.
Management does not believe this examination will have a material adverse
effect on the Company's consolidated financial position, results of operations
or liquidity.
(12) Debt
In June 1995, the Company entered into two warehouse line of credit
agreements (collectively the "Line"). The Line provides the Company with an
interim financing facility to hold Contracts for sale in greater numbers and for
longer periods of time prior to their sale to other institutional investors.
The primary agreement provides for loans by Redwood Receivables Corporation
("Redwood") to the Company, to be funded by commercial paper issued by Redwood
and secured by Contracts pledged periodically by the Company. The Redwood
facility provides for a maximum of $100.0 million of advances to the Company,
with interest at a variable rate (7.35% at December 31, 1997) indexed to
prevailing commercial paper rates.
The second agreement is a standby line of credit with General Electric
Capital Corporation ("GECC"), also with a $100.0 million maximum, which the
Company may use only if and to the extent that Redwood does not provide funding
as described above. The GECC line is secured by Contracts and substantially all
the other assets of the Company. Both agreements expire November 30, 1998.
The two agreements are viewed as a single short-term warehouse line of
credit, with advances varying according to the amount of pledged Contracts. The
Company is charged a non-utilization fee of .25% per annum on the unused portion
of the Line. The balance outstanding at December 31, 1997 and 1996 under the
Line was $30.8 million and $13.3 million, respectively.
F-22
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In November 1997, the Company entered into a third warehouse line of credit
agreement with First Union Capital Markets ("First Union Line"). The First
Union Line provides for a maximum of $150 million of advances to the Company,
with interest at a variable rate (7.14% at December 31, 1997) indexed to
prevailing commercial paper rates. The agreement expires November 30, 1998 and
is renewable for one year with the mutual consent of the Company and First Union
Capital Markets. The balance outstanding under the First Union Line at December
31, 1997 was $30,892,013.
When the Company wishes to securitize Contracts, a substantial part of the
proceeds received from investors is paid to the providers of the warehouse
lines, simultaneously with their release of the pledged Contracts for transfer
to a pass-through securitization trust.
In December 1996, the Company entered into an overdraft financing facility,
with a bank, that provides for maximum borrowings of $2.0 million. Interest is
charged on the outstanding balance at the bank's reference rate (8.50% at
December 31, 1997) plus 1.75%. During 1997, the overdraft facility was
increased to $4.0 million. There were no borrowings outstanding under this
facility at December 31, 1997. The facility expires on June 1, 1998. The Line,
First Union Line and the overdraft financing facility contain various
restrictive and financial covenants with which the Company was in compliance at
December 31, 1997.
On April 15, 1997, the Company issued $20.0 million in subordinated
participating equity notes ("PENs") due April 15, 2004. The PENs are unsecured
general obligations of the Company. Interest on the PENs is payable on the
fifteenth of each month, commencing May 15, 1997, at an interest rate of 10.5%
per annum. In connection with the issuance of the PENs, the Company incurred
and capitalized issuance costs of $1.2 million. The Company recognizes interest
and amortization expense related to the PENs using the effective interest method
over the expected redemption period. The PENs are subordinated to certain
existing and future indebtedness of the Company as defined in the indenture
agreement. The Company may at its option elect to redeem the PENs from the
registered holders, in whole but not in part, at any time on or after April 15,
2000, at 100% of their principal amount, subject to limited conversion rights,
plus accrued interest to and including the date of redemption. At maturity,
upon the exercise by the Company of an optional redemption, or upon the
occurrence of a "Special Redemption Event," each holder will have the right to
convert into common stock of the Company ("Common Stock"), 25% of the aggregate
principal amount of the PENs held by such holder at the conversion price of
$10.15 per share of Common Stock. "Special Redemption Events" are certain
events related to a change in control of the Company.
On December 20, 1995, the Company issued $20.0 million in rising interest
subordinated redeemable securities due January 1, 2006 (the "Notes"). The Notes
are unsecured general obligations of the Company. Interest on the Notes is
payable on the first day of each month, commencing February 1, 1996, at an
interest rate of 10.0% per annum. The interest rate increases 0.25% on each
January 1 for the first nine years and 0.50% in the last year. In connection
with the issuance of the Notes, the Company incurred and capitalized issuance
costs of $1.1 million. The Company recognizes interest and amortization expense
related to the Notes using the effective interest method over the expected
redemption period. The Notes are subordinated to certain existing and future
indebtedness of the Company as defined in the indenture agreement. The Company
is required to redeem, subject to certain adjustments, $1.0 million of the
aggregate principal amount of the Notes through the operation of a sinking fund
on each of January 1, 2000, 2001, 2002, 2003, 2004 and 2005. The Notes are not
redeemable at the option of the Company prior to January 1, 1998. The Company
may at its option elect to redeem the Notes from the registered holders of the
Notes, in whole or in part, at any time, on or after January 1, 1998, and prior
to January 1, 1999, at 102% of their principal amount, on or after January 1,
1999, and prior to January 1, 2000, at 101% of their principal amount, and on or
after January 1, 2000, at 100% of their principal amount, in each case plus
accrued interest to and including the date of redemption.
During the year ended December 31, 1997 the Company acquired CPS Leasing,
Inc. At December 31, 1997, CPS Leasing, Inc. had borrowings to banks of
$1.5 million.
F-23
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
On March 12, 1993, the Company issued a $2 million five year convertible
subordinated note ("Note 1") to an institutional investor in conjunction with an
agreement by that investor to commit to purchase up to $50 million of the
Company's Contracts. Interest accrued at 11% and was payable semi-annually. On
July 5, 1995, the holder converted Note 1 to 533,334 shares of the Company's
common stock. On November 16, 1993, the Company issued a $3 million five year
convertible subordinated note ("Note 2") to the same institutional investor in
conjunction with an agreement by that investor to commit to purchase an
additional $50 million of the Company's Contracts. Interest accrued at 9.5% and
was payable semi-annually. On January 17, 1997, the holder converted Note 2
into 480,000 shares of the Company's common stock.
On July 6, 1995, the Company issued a promissory note in the amount of $2.0
million to the same institutional investor who held Notes 1 and 2. The note
bore interest at 200 basis points over the Citibank Base Rate and matured on
December 31, 1995. On December 6, 1995, this note was repaid in full.
(13) Employee Benefits
The Company sponsors a pretax savings and profit sharing plan (the "401(K)
Plan") under section 401(K) of the Internal Revenue Code. Under the 401(K)
Plan, eligible employees are able to contribute up to 15% of their compensation
(subject to stricter limitation in the case of highly compensated employees).
The Company matches 40% of employees' contributions up to $500 per employee per
calendar year. The Company's contribution to the 401(K) Plan was $115,684,
$63,801, and $13,811 for the years ended December 31, 1997 and 1996, and for the
nine month period ended December 31, 1995, respectively.
(14) Fair Value of Financial Instruments
The following summary presents a description of the methodologies and
assumptions used to estimate the fair value of the Company's 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 the Company's financial
instruments, active market values do not exist. Therefore, considerable
judgments 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 December
31, 1997 and 1996, the amounts that will actually be realized or paid at
settlement or maturity of the instruments could be significantly different. The
estimated fair values of financial assets and liabilities at December 31, 1997
and 1996, were as follows:
December 31,
-------------------------------------------------------------------------------
1997 1996
--------------------------------------- ----------------------------------
Carrying Fair Carrying Fair
Financial Instrument Value Value Value Value
- -------------------- ------------------ --------------- -------------- --------------
Cash........................................ $ 1,745,200 $ 1,745,200 $ 153,958 $ 153,958
Contracts held for sale..................... 68,271,200 70,900,000 21,656,773 22,800,000
Residual interest in securitizations........ 124,615,504 124,615,504 67,251,933 67,251,933
Warehouse lines of credit................... 61,665,583 61,665,583 13,264,585 13,264,585
Notes payable............................... 1,505,593 1,505,593 -- --
Subordinated debt........................... 40,000,000 40,000,000 23,000,000 23,000,000
Related party debt.......................... $ 15,055,431 $ 15,055,431 $ -- $ --
Cash
The carrying value equals fair value.
F-24
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The fair value of the Company's contracts held for sale is determined by
purchase commitments from investors and prevailing market rates.
F-25
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Residual Interest in Securitizations
The fair value is estimated by discounting future cash flows using credit and
discount rates that the Company believes reflect the estimated credit, interest
rate and prepayment risks associated with similar types of instruments.
Warehouse Line of Credit
The carrying value approximates fair value because the warehouse line of
credit is short-term in nature and the related interest rates are estimated to
reflect current market conditions for similar types of instruments.
Notes Payable, Subordinated and Related Party Debt
The carrying value approximates fair value because the related interest rates
are estimated to reflect current market conditions for similar types of
instruments.
(15) Selected Quarterly Data (unaudited)
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
March 31, June 30, September 30, December 31,
------------- ------------- ------------- -------------
1997
Revenues.......................... $ 16,257,664 $ 18,110,679 $ 21,283,927 $ 23,687,319
Earnings before income taxes...... 7,143,361 7,548,532 8,309,076 8,957,881
Net earnings...................... 4,144,754 4,385,632 4,816,135 5,185,642
Earnings per share:
Basic............................ $ 0.29 $ 0.31 $ 0.34 $ 0.36
Diluted.......................... $ 0.27 $ 0.28 $ 0.30 $ 0.32
1996
Revenues.......................... $ 9,907,581 $ 12,485,185 $ 13,758,526 $ 15,042,511
Earnings before income taxes...... 5,101,297 5,517,249 6,451,297 6,622,553
Net earnings...................... 3,051,297 3,271,229 3,834,297 3,940,553
Earnings per share:
Basic............................ $ 0.23 $ 0.24 $ 0.28 $ 0.29
Diluted.......................... $ 0.20 $ 0.22 $ 0.25 $ 0.26
F-26