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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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, 2002
[ ] 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.)
16355 LAGUNA CANYON ROAD, IRVINE, CALIFORNIA 92618
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (949) 753-6800
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Title of each class: Name of each exchange on which
registered:
10.50% Participating Equity Notes due 2004 New York Stock Exchange
Rising Interest Subordinated Redeemable
Securities due 2006 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 disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not 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. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [ x ]
The aggregate market value on March 25, 2003 (based on the $1.62 per share
closing price on the Nasdaq Stock Market on that date) of the voting stock
beneficially held by non-affiliates of the registrant was approximately
$20,563,000. The number of shares of the registrant's Common Stock outstanding
on March 25, 2003, was 20,239,176.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant's proxy statement for its 2003 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 purchase
contracts ("Contracts") originated by licensed motor vehicle dealers ("Dealers")
in the sale of new and used automobiles, light trucks and passenger vans.
Through its purchases, the Company provides indirect financing to Dealer
customers with limited credit histories, low incomes or past credit problems
("Sub-Prime Customers"). The Company serves as an alternative source of
financing for Dealers, allowing sales to customers who otherwise might not be
able to obtain financing. The Company does not lend money directly to consumers.
Rather, it purchases installment Contracts from Dealers.
CPS was incorporated and began its operations in 1991. From inception through
December 31, 2002, the Company has purchased approximately $4.6 billion of
Contracts. The Company also obtained in March 2002, an additional $381.8 million
of Contracts when the Company acquired MFN Financial Corporation and its
subsidiaries in a merger (the "MFN Merger"). MFN Financial Corporation and its
subsidiaries (collectively, the "MFN Companies") were engaged in business
similar to that of the Company: buying Contracts from Dealers, pooling and
selling those Contracts in securitization transactions, and servicing those
Contracts.
The Company makes the decision to purchase Contracts exclusively from its
headquarters location. Prior to the MFN Merger, the Company had primarily
serviced Contracts from two regional centers, one in its California
headquarters, and the other in Virginia, as well as a small satellite office in
Dallas, Texas. Following the MFN Merger the Company also services Contracts
obtained in the MFN Merger from multiple other locations acquired in that
transaction. As of December 31, 2002, the Company had an outstanding servicing
portfolio, net of unearned income on pre-computed Contracts, of approximately
$595.2 million, including the remaining outstanding balance of Contracts
acquired in the MFN Merger.
CREDIT RISK RETAINED
The Company purchases Contracts with the intention of reselling them in
securitizations. In a securitization, the Company sells Contracts to a special
purpose subsidiary, which funds the purchase by sale of asset-backed,
interest-bearing securities. At the closing of each securitization, the Company
removes the sold Contracts from its Consolidated Balance Sheet. The Company
remains responsible for collecting payments due under the Contracts, and retains
a residual interest in the sold Contracts. The residual interest represents the
discounted value of what the Company expects will be the excess of future
collections on the Contracts over principal and interest due on the asset-backed
securities. That residual interest appears on the Company's Consolidated Balance
Sheet as "residual interest in securitizations," and its value is dependent on
estimates of the future performance of the sold Contracts. Further, the special
purpose subsidiary may be prohibited from releasing the excess cash to the
Company if the credit performance of the sold Contracts falls short of
pre-determined standards. Such releases represent a material portion of the cash
that the Company uses to fund its operations. An unexpected deterioration in the
performance of sold Contracts could therefore have a material adverse effect on
both the Company's liquidity and its results of operations. See "--
Securitization and Sale of Contracts," "-- The Servicing Agreements," and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
THE MARKET WE SERVE
The Company's automobile financing programs are designed to serve customers who
generally would not qualify for automobile financing from traditional sources,
such as commercial banks, credit unions and the captive finance companies
affiliated with major automobile manufacturers. Such customers generally have
limited credit histories, low incomes or past credit problems, and are therefore
often unable to obtain credit from traditional sources of automobile financing.
(The terms "prime" and "sub-prime" reflect the Company's categorization of
customers and bear no relationship to the prime rate of interest or persons who
are able to borrow at that rate.) Because the Company serves customers who are
unable to meet the credit standards imposed by most traditional automobile
financing sources, the Company generally receives interest at rates higher than
those charged by traditional automobile financing sources. The Company also
sustains a higher level of credit losses than traditional automobile financing
sources since the Company provides financing in a relatively high risk market.
MARKETING
The Company directs its marketing efforts to Dealers, rather than to consumers.
As of December 31, 2002, the Company was a party to its standard form dealer
agreements ("Dealer Agreements") with over 3,000 Dealers. Approximately 95% 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 ended December
31, 2002, approximately 88% of the Contracts purchased by the Company consisted
of financing for used cars and the remaining 12% for new cars, as compared to
87% used and 13% new in the year ended December 31, 2001.
The Company establishes relationships with Dealers through Company
representatives who contact a prospective Dealer to explain the Company's
Contract purchase programs, and who thereafter provide Dealer training and
support services. As of December 31, 2002, the Company had 40 representatives,
39 of whom were employees and one of whom was independent. The 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 copy of the Company's
standard-form Dealer Agreement, examples of monthly reports, and required
documentation relating to Contracts. Marketing representatives have no authority
relating to the decision to purchase Contracts from Dealers.
Most of the Dealers under contract with CPS regularly submit Contracts to the
Company for purchase, although they 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, 2002, no Dealer accounted for more
than 1% of the total number of Contracts purchased by the Company. The following
table sets forth the geographical sources of the Contracts purchased by the
Company (based on the addresses of the customers as stated on the Company's
records) during the years ended December 31, 2002 and 2001. Contracts purchased
by the MFN Companies are not included in the table as MFN Contract purchases
were terminated shortly after the MFN Merger. All Contracts are acquired from
Dealers located within the United States.
2
CONTRACTS PURCHASED DURING THE YEAR ENDED
-----------------------------------------
DECEMBER 31, 2002 DECEMBER 31, 2001
----------------- -----------------
NUMBER PERCENT (1) NUMBER PERCENT (1)
------ ----------- ------ -----------
Texas................................ 3,313 10.3% 5,811 12.7%
Illinois............................. 2,274 7.1 2,529 5.5
California........................... 2,111 6.5 3,229 7.0
North Carolina....................... 1,979 6.1 3,128 6.8
Georgia.............................. 1,831 5.7 2,933 6.4
Michigan............................. 1,776 5.5 2,338 5.1
Ohio................................. 1,733 5.4 1,801 3.9
Louisiana............................ 1,680 5.2 3,288 7.2
Pennsylvania......................... 1,539 4.8 1,752 3.8
Florida.............................. 1,453 4.5 2,426 5.3
Kentucky............................. 1,449 4.5 1,282 2.8
Alabama.............................. 1,288 4.0 2,118 4.6
New York............................. 1,215 3.8 1,657 3.6
Other States......................... 8,614 26.7 11,579 25.2
-------- ----- -------- -----
Total................................ 32,255 100.0% 45,871 100.0%
======== ======= ======== =======
------------
(1) Amounts may not total 100% due to rounding.
ORIGINATION OF CONTRACTS
DEALER ORIGINATION
When a retail automobile buyer elects to obtain financing from a Dealer, the
Dealer takes a credit application to submit 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 on the monthly payment that will be offered to the automobile buyer,
the 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 information from a Dealer, the Company's administrative
personnel order a credit report to document the buyer's credit history. If, upon
review by a Company credit analyst, it is determined that the Contract 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
two hours as to whether it would purchase the related Contract.
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
customer, the Dealer sells the Contract to the Company. During 2001 and the
first quarter of 2002 the Company immediately sold most of the Contracts that it
purchased, and held the remainder for its own account. See "--Flow Purchase
Program." The customer thereafter receives monthly billing statements.
The Company purchases Contracts from Dealers at a price generally equal to the
total amount financed under the Contracts, adjusted for an acquisition fee,
which varies based on the perceived credit risk and, in some cases, the interest
rate on the Contract. For the years ended December 31, 2002, 2001 and 2000, the
average fee charged per Contract purchased was $313, $355 and $469,
3
respectively, or 2.2%, 2.4% and 3.2%, respectively, of the amount financed. The
Company also purchases certain Contracts for a premium over the amount financed.
The Company is willing to pay a premium when it estimates the credit risk to be
low, compared to that of other Contracts that it purchases. During 2002, 2001
and 2000, respectively, the Company purchased 9,971, 9,962 and 2,104 of these
Contracts, representing approximately 30.9%, 21.7% and 5.1% of all Contracts
purchased. The average premium paid to Dealers on these Contracts was $435, $172
and $595, respectively.
The Company attempts to control misrepresentation regarding the customer's
credit worthiness 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. There can be no assurance, however, that any
Dealer will have the willingness or the financial resources to satisfy its
repurchase obligations to the Company.
OBJECTIVE 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 customer 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 customer 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 his or her obligations under the Contract.
The Company believes that its objective underwriting criteria enable it to
evaluate effectively the creditworthiness of Sub-Prime Customers 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 interest rate; mileage, age and type of vehicle; principal amount of the
Contract in relation to the value of the vehicle; customer income level,
employment and residence stability, credit history and debt service ability; 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 115% 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
seven model years old or have in excess of 85,000 miles. Under most CPS
programs, the maximum term of a purchased Contract is 72 months; a shorter
maximum term may be applied based on the year and mileage of the vehicle, and
Contracts with the maximum term of 72 months may be purchased if the customer is
among the more creditworthy of CPS's obligors and the vehicle is not more than
two model years old and has less than 25,000 miles. Contract purchase criteria
are subject to change from time to time as circumstances may warrant. Upon
receiving this information with the customer's application, the Company's
underwriters verify the customer's employment, residency, insurance and credit
information provided by the customer by contacting various parties noted on the
customer's application, credit information bureaus and other sources. In
addition, prior to purchasing a Contract, CPS contacts each customer by
telephone to confirm that the Customer understands and agrees to the terms of
the related Contract.
CREDIT SCORING. The Company uses a proprietary scoring model to assign to each
Contract a "credit score" at the time the application is received from the
Dealer and the customer's credit information is retrieved from the credit
4
reporting agencies. The credit score is based on a variety of parameters, such
as the customer's employment 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 improving its allocation of credit evaluation
resources, and managing the risk inherent in the sub-prime market.
CHARACTERISTICS OF CONTRACTS. 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, 2002 was approximately $14,362, with an average original
term of approximately 60.2 months and an average down payment amount of 12.5%.
Based on information contained in customer applications, for this twelve-month
period, the retail purchase price of the related automobiles averaged $14,585
(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 2 years, and the Company's customers averaged approximately 37
years of age, with approximately $36,036 in average annual household income and
an average of 4.8 years' history with his or her current employer.
All Contracts may be prepaid at any time without penalty. In the event a
customer elects to prepay a Contract in full, the payoff amount is calculated by
deducting the unearned income 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. The
Company generally does not consent to a sale or transfer of a financed vehicle
unless the related Contract is prepaid in full.
DEALER COMPLIANCE. 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 the
customer. 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 could render a Contract unenforceable. In such events, the
Company could suffer a loss with respect to the related Contract. In the event
the Company suffers such a loss, it will generally have recourse against the
Dealer from which it purchased the Contract. This recourse will be unsecured,
and there can be no assurance that any particular Dealer will satisfy any such
repurchase obligations to the Company.
SERVICING OF CONTRACTS
GENERAL. The Company's servicing activities consist of collecting, accounting
for and posting of all payments received; responding to customer inquiries;
taking all necessary action to maintain the security interest granted in the
financed vehicle or other collateral; investigating delinquencies; communicating
with the customer to obtain timely payments; repossessing and liquidating the
collateral when necessary; and generally monitoring each Contract and the
related collateral.
5
COLLECTION PROCEDURES. The Company believes that its ability to monitor
performance and collect payments owed from Sub-Prime Customers 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 customers 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 customers; educating customers as to the
importance of maintaining good credit; and employing a consultative and customer
service approach to assist the customer 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 Customers and similar
consumer obligations.
With the aid of its high-penetration automatic dialer, as well as manual efforts
made by collection staff, the Company typically attempts to make telephonic
contact with delinquent customers on the sixth day after their monthly payment
due date. Using coded instructions from a collection supervisor, the automatic
dialer will attempt to contact customers 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 customer'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 customer's pertinent information is simultaneously displayed on the
collector's workstation. The collector then inquires of the customer the reason
for the delinquency and when the Company can expect to receive the payment. The
collector will attempt to get the customer 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 customer makes such a promise, the account is routed to a promise 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 queue for subsequent contacts.
If a customer fails to make or keep promises for payments, or if the customer 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 customer's payment due date, but could
occur sooner or later, depending on the specific circumstances.
If CPS elects to repossess the vehicle, it assigns the task to an independent
local repossession service. Such services are licensed and/or bonded as required
by law. When the vehicle is recovered, the repossessor delivers it to a
wholesale auto auction, where it is kept until sold. The Uniform Commercial Code
("UCC") and other state laws regulate repossession sales by requiring that the
secured party provide the customer 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 customer'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 that have been
repossessed are generally resold by the Company through unaffiliated automobile
auctions, which are attended principally by car dealers. Net liquidation
proceeds are applied to the customer's outstanding obligation under the
Contract. Such proceeds usually are insufficient to pay the customer's
obligation in full, resulting in a deficiency.
Under the UCC and other laws applicable in most states, a creditor is entitled
to obtain a judgment against a customer for such a deficiency. However, some
states impose prohibitions or limitations on deficiency judgments. When
obtained, deficiency judgments are entered against defaulting individuals who
may have little capital or income. Therefore, in many cases, it may not be
useful to seek a deficiency judgment against a customer or, if one is obtained,
it may be settled at a significant discount.
6
CREDIT EXPERIENCE
The Company's financial results are dependent on the performance of the
Contracts in which it retains an ownership interest. The tables below document
the delinquency, repossession and net credit loss experience of all Contracts
that the Company was servicing as of the respective dates shown. Credit
experience for CPS and MFN (since the Merger Date) is shown on both a combined
and individual basis in the tables below.
DELINQUENCY EXPERIENCE (1)
CPS AND MFN COMBINED
DECEMBER 31, 2002 DECEMBER 31, 2001 DECEMBER 31, 2000
------------------------- ------------------------- ----------------------
NUMBER OF NUMBER OF NUMBER OF
CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT
--------- ------ --------- ------ --------- ------
(DOLLARS IN THOUSANDS)
Gross servicing portfolio (1)... 86,940 $616,519 44,080 $288,756 60,178 $427,734
Period of delinquency (2)
31-60 days...................... 3,658 18,388 2,149 12,409 2,319 16,778
61-90 days...................... 1,541 6,595 721 4,018 683 4,983
91+ days........................ 825 3,422 552 3,488 418 3,148
------- --------- ------- --------- ------- ---------
Total delinquencies (2)......... 6,024 28,405 3,422 19,915 3,420 24,909
Amount in repossession (3)...... 1,402 10,835 787 5,757 1,106 8,302
------- --------- ------- --------- ------- ---------
Total delinquencies and amount in
repossession (2)................ 7,426 $ 39,240 4,209 $ 25,672 4,526 $ 33,211
======= ========= ======= ========= ======= =========
Delinquencies as a percentage of
gross servicing portfolio....... 6.9% 4.6% 7.8% 6.9% 5.7% 5.8%
Total delinquencies and amount in
repossession as a percentage of
gross servicing portfolio....... 8.5% 6.4% 9.6% 8.9% 7.5% 7.8%
CPS
DECEMBER 31, 2002 DECEMBER 31, 2001 DECEMBER 31, 2000
------------------------- ------------------------- -----------------------
NUMBER OF NUMBER OF NUMBER OF
CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT
--------- ------ --------- ------ --------- ------
(DOLLARS IN THOUSANDS)
Gross servicing portfolio (1)... 43,244 $394,845 44,080 $288,756 60,178 $427,734
Period of delinquency (2)
31-60 days...................... 1,734 10,738 2,149 12,409 2,319 16,778
61-90 days...................... 643 3,619 721 4,018 683 4,983
91+ days........................ 282 1,508 552 3,488 418 3,148
------- --------- ------- --------- ------- ---------
Total delinquencies (2)......... 2,659 15,865 3,422 19,915 3,420 24,909
Amount in repossession (3)...... 654 6,305 787 5,757 1,106 8,302
------- --------- ------- --------- ------- ---------
Total delinquencies and amount in
repossession (2)................ 3,313 $ 22,170 4,209 $ 25,672 4,526 $ 33,211
======= ========= ======= ========= ======= =========
Delinquencies as a percentage of
gross servicing portfolio....... 6.2% 4.0% 7.8% 6.9% 5.7% 5.8%
Total delinquencies and amount in
repossession as a percentage of
gross servicing portfolio....... 7.7% 5.6% 9.6% 8.9% 7.5% 7.8%
7
MFN
DECEMBER 31, 2002
-----------------
NUMBER OF
CONTRACTS AMOUNT
--------- ------
(DOLLARS IN THOUSANDS)
Gross servicing portfolio (1)............... 43,696 $221,674
Period of delinquency (2)
31-60 days ................................. 1,924 7,650
61-90 days ................................. 898 2,976
91+ days ................................... 543 1,914
--------- ---------
Total delinquencies (2)..................... 3,365 12,540
Amount in repossession (3).................. 748 4,530
--------- ---------
Total delinquencies and amount in
repossession (2)............................ 4,113 $ 17,070
========= =========
Delinquencies as a percentage of
gross servicing portfolio .................. 7.7% 5.7%
Total delinquencies and amount in
repossession as a percentage of
gross servicing portfolio .................. 9.4% 7.7%
- ------------
(1) All amounts and percentages are based on the amount remaining to be repaid
on each Contract, including, for pre-computed Contracts, any unearned interest.
The information in the table represents the gross principal amount of all
Contracts purchased by the Company on an other than flow basis, including
Contracts subsequently sold by the Company in securitization transactions that
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 that have been
repossessed but not yet liquidated.
NET CHARGE-OFF EXPERIENCE (1)
CPS AND MFN COMBINED
YEAR ENDED DECEMBER 31,
------------------------------------------
2002 2001 2000
------------ ------------ ------------
(DOLLARS IN THOUSANDS)
Average servicing portfolio outstanding............................ $ 524,286 $ 341,498 $ 578,200
Net charge-offs as a percentage of average servicing
portfolio (2) (3) (4).............................................. 8.6% 6.2% 11.2%
8
CPS
YEAR ENDED DECEMBER 31,
------------------------------------------
2002 2001 2000
------------ ------------ ------------
(DOLLARS IN THOUSANDS)
Average servicing portfolio outstanding................... $ 291,863 $ 341,498 $ 578,200
Net charge-offs as a percentage of average servicing
portfolio (2) (4)......................................... 5.0% 6.2% 11.2%
MFN
YEAR ENDED DECEMBER 31, 2002
----------------------------
(DOLLARS IN THOUSANDS)
Average servicing portfolio outstanding.................. $ 278,908
Net charge-offs as a percentage of average servicing
portfolio (2)............................................ 11.0%
- ------------
(1) All amounts and percentages are based on the principal amount scheduled to
be paid on each Contract, net of unearned income on pre-computed Contracts. The
information in the table represents all Contracts serviced by the Company.
(2) Net charge-offs include the remaining principal balance, after the
application of the net proceeds from the liquidation of the vehicle (excluding
accrued and unpaid interest).
(3) The fluctuation in net charge-offs as a percentage of the average servicing
portfolio between 2002 and 2001 is primarily due to the addition of MFN
Contracts, which are anticipated to charge off at rates greater than CPS
Contracts.
(4) The fluctuation in net charge-offs between 2001 and 2000 is primarily due to
the addition of Contracts held for the Company's own account, i.e., Contracts
purchased on an other than flow basis, in 2001, compared to the year over year
decrease in the Company's average servicing portfolio. During 2001, the Company
added new Contracts to its servicing portfolio. Newer Contracts would be
expected to have a lower percentage of charge-offs than more seasoned Contracts,
which would be approaching their peak losses and related charge-offs.
Additionally, the Company believes that the CPS Contracts originated during 2001
are of a higher credit quality than those originated in previous years.
FLOW PURCHASE PROGRAM
From May 1999 through the first quarter of 2002, the Company purchased Contracts
primarily for immediate and outright resale to non-affiliated third parties. The
Company sold such Contracts for a mark-up above what the Company paid the
Dealer. In such sales, the Company made certain representations and warranties
to the purchasers, normal in the industry, which related primarily to the
legality of the sale of the underlying motor vehicle and to the validity of the
security interest that conveyed to the purchaser. These representations and
warranties were generally similar to the representations and warranties given by
the originating Dealer to the Company. In the event of a breach of such
representations or warranties, the Company might incur liabilities in favor of
the purchaser(s) of the Contracts and there can be no assurance that the Company
would be able to recover, in turn, against the originating Dealer(s).
One of the two flow purchasers ceased to purchase Contracts in December 2001,
and the other ceased to purchase in May 2002. The flow purchase program
accordingly ended at that time.
9
SECURITIZATION AND SALE OF CONTRACTS
The Company purchases Contracts resale in securitization transactions. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and Note 1 of Notes to
Consolidated Financial Statements. The Company funds such purchases mostly with
proceeds from two warehouse lines of credit. These warehouse lines of credit
include a $125 million floating rate variable funding note facility, and a $75
million floating rate variable funding note facility. These facilities are
independent of each other, and are funded and insured by different institutions.
Approximately 73.0% and 72.5%, respectively, of the principal balance of
Contracts may be advanced to the Company under these facilities, subject to
collateral tests and certain other conditions and covenants.
Sales of Contracts to the facility-related special purpose subsidiaries are
treated as ongoing securitization sales. The lenders under those facilities have
the option to require a term securitization of the Contracts sold into the
warehouse facilities. Such options were exercised three times in 2002, resulting
in sales of Contracts in term securitization transactions conducted in March,
August and December 2002.
In a securitization sale, the Company is required to make certain
representations and warranties, which are generally similar to 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. The Company may 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 principal payments made by the customer. 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.
Upon the sale of a portfolio of Contracts in a securitization transaction,
generally to a trust that is specifically created for such purpose ("Trust"),
the Company retains the obligation to service the Contracts, and receives a
monthly fee for doing so. Among other services performed, the Company mails to
obligors monthly billing statements directing them to mail payments on the
Contracts to a lockbox account. The Company engages an independent lockbox
processing agent to retrieve and process payments received in the lockbox
account. This results in a daily deposit to the Trust's bank account of the
entire amount of each day's lockbox receipts and the simultaneous electronic
data transfer to the Company of customer payment data records. Pursuant to the
Servicing Agreements, as defined below, the Company is required to deliver
monthly reports to 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 Trust's bank account as reflected in the daily
reports of the lockbox processing agent.
In its securitization transactions, 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, that 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 would
be entitled to require the Company to repurchase the Contract relating to such
financed vehicle.
THE SERVICING AGREEMENTS
The Company currently services all Contracts that it owns, as well as those
Contracts included in portfolios that it has sold to securitization Trusts. The
Company does not service Contracts that were sold in its flow purchase program.
Pursuant to the Company's usual form of servicing agreement (the Company's
servicing agreements with purchasers of portfolios of Contracts are collectively
referred to as the "Servicing Agreements"), CPS is obligated to service all
10
Contracts sold to the 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
Trust's security interest in the financed vehicles.
The Company is entitled under most of the Servicing Agreements to receive a base
monthly servicing fee of 2.5% per annum (5.0% per annum pursuant to the MFN
Securitization Agreements) 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 Trust receives the paid principal reduction of the Contracts in its
portfolios and interest thereon at the fixed rate that was agreed when the
Contracts were sold to the Trust. 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. The "Spread Account" is an account
established at the time the Company sells a portfolio of Contracts, to provide
security to the Note Insurers, as defined below. 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.
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 four 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 or if the vehicle has been in
repossession inventory for more than 90 days. 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 net repossession sale proceeds. In the
event collections on the Contracts are not sufficient to pay to the holders
("Investors") of interests in the Trust the entire principal balance of
Contracts charged off during the month, the trustee draws on the related Spread
Account to pay the Investors. The amount drawn 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 Notes, as defined below, the Investors bear the
risk of all charge-offs on the Contracts in excess of the Spread Account. The
Investors' rights with respect to distributions from the Trusts are senior to
the Company's rights. Accordingly, variation in performance of pools of
Contracts affects the Company's ultimate realization of value derived from such
Contracts.
The Servicing Agreements are terminable by the insurers of certain of the
Trust's obligations in the event of certain defaults by the Company and under
certain other circumstances. Were either of the Note Insurers in the future to
exercise its option to terminate the Servicing Agreements, such a termination
would have a material adverse effect on the Company's liquidity and results of
operations. The Company continues to receive Servicer extensions on a monthly
and/or quarterly basis, pursuant to the Servicing Agreements.
COMPETITION
The automobile financing business is highly competitive. The Company competes
with a number of national, regional and local 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
11
vehicles, and captive finance companies affiliated with major automobile
manufacturers such as General Motors Acceptance Corporation, Ford Motor Credit
Corporation, Chrysler Financial 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 that 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.
GOVERNMENT REGULATION
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 many states, a license is required to engage
in the business of purchasing Contracts from 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 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
customer 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 material compliance with
applicable statutes and regulations, there can be no assurance that the Company
will be able to maintain such compliance. The past or future 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."
12
EMPLOYEES
As of December 31, 2002, the Company had 638 full-time and 5 part-time
employees, of whom 8 are senior management personnel, 388 are collections
personnel, 103 are Contract origination personnel, 50 are marketing personnel
(39 of whom are marketing representatives), 69 are operations and systems
personnel, and 25 are administrative 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 115,000 square feet of general office space from an unaffiliated
lessor. The annual rent is approximately $1.9 million through October 2003, and
increases to $2.1 million for the following five years. The Company has the
option to cancel the lease without penalty in October 2003. In addition to the
foregoing base rent, the Company pays the property taxes, maintenance and other
expenses of the premises.
In March 1997, the Company established a branch collection facility in
Chesapeake, Virginia. The Company leases approximately 28,000 square feet of
general office space in Chesapeake, Virginia, at a base rent that is currently
$419,470 per year, increasing to $504,545 over a ten-year term.
The remaining four regional servicing centers occupy a total of approximately
49,000 square feet of leased space in Orlando, Florida; Atlanta, Georgia;
Hinsdale, Illinois and Cleveland, Ohio. The termination dates of such leases
range from 2007 to 2008.
See Notes 2 and 14 of Notes to Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
On May 12, 2000, Jon L. Kunert and Penny Kunert commenced a lawsuit against an
automobile dealer, the Company and in excess of 20 other defendants in the
Superior Court of California, Los Angeles County. The defendants other than the
automobile dealer appear to be various entities ("finance defendants") that may
have purchased retail installment contracts from that dealer. The lawsuit
alleges that the various finance defendants conspired with the automobile dealer
defendant to conceal from motor vehicle purchasers the full cost of credit
applicable to their purchases, and seeks a refund of the concealed excess cost.
The court subsequently ordered the plaintiffs to file separate lawsuits against
each finance defendant. Such a substitute lawsuit was filed against the Company
by Angela Hicks, on March 8, 2001. The lawsuits were dismissed with prejudice in
September 2001. The dismissal is currently on appeal.
On November 15, 2000, Denice and Gary Lang commenced a lawsuit against the
Company in South Carolina Common Pleas Court, Beaufort County, alleging that
they, and a purported nationwide class, were harmed by an alleged failure to
refer, in the notice given after repossession of their vehicle, of the right to
purchase the vehicle by tender of the full amount owed under the retail
installment contract. They seek damages in an unspecified amount.
On July 23, 1997, Elaine McLean commenced a lawsuit in the 134th District Court,
Dallas County, Texas against a subsidiary of MFN in the state of Texas alleging
deceptive practices related to various loans and the related purchase and sale
of insurance. The lawsuit seeks damages in an unspecified amount.
13
In 2001, the district court denied McLean's motion for class certification.
Later that same year, the appellate court denied McLean's appeal of the district
court ruling. The appellate court's denial is itself currently on appeal.
STANWICH LITIGATION. The Company is currently a defendant in a class action (the
"Stanwich Case") pending in the California Superior Court, Los Angeles County.
The plaintiffs in that case are persons entitled to receive regular payments
(the "Settlement Payments") under out-of-court settlements reached with third
party defendants. Stanwich Financial Services Corp. ("Stanwich"), an affiliate
of the former Chairman of the Board of Directors of the Company, is the entity
that is obligated to pay the Settlement Payments. Stanwich has defaulted on its
payment obligations to the plaintiffs and in June 2001 filed for reorganization
under the Bankruptcy Code, in the federal Bankruptcy Court of Connecticut. The
Company is also a defendant in certain cross-claims brought by other defendants
in the case, which assert claims of equitable and/or contractual indemnity
against the Company.
In November 2001, one of the defendants in the Stanwich Case, Jonathan Pardee,
asserted claims for indemnity against the Company in a separate action, which is
now pending in federal district court in Rhode Island. The Company has filed
counterclaims in the Rhode Island federal court against Mr. Pardee. The Company
plans to defend this matter and pursue its counterclaims vigorously.
In February 2002, the Company entered into a Term Sheet with Stanwich, the
plaintiffs in the Stanwich Case and others, which provides for the Company's
release upon its repayment of the amounts concededly owed to Stanwich, all of
which amounts have been recorded in the Company's financial statements as
indebtedness.
In February 2003, a court-sponsored mediation resulted in an agreement in
principle to settle the Stanwich Case (other than with respect to defendant
Pardee). The Company believes that the plaintiff's allegations and the
cross-claims brought by other defendants referenced above will be dismissed upon
final execution of such settlement.
MISSISSIPPI LITIGATION. On September 26, 2001, Maggie Chandler, Bobbie Mike and
Mary Ann Benford each commenced a lawsuit against subsidiaries of MFN in the
state of Mississippi. Chandler filed in Mississippi state court, county of
Leflore. Mike filed in Mississippi state court, county of Humphreys. Benford
filed in Mississippi state court, county of Holmes. Plaintiffs in all three
cases allege deceptive practices related to various loans and the related
purchase and sale of insurance, and seek unspecified damages. The Company
believes that there are substantive legal defenses to such claims, and intends
to defend them vigorously.
The outcome of any litigation is uncertain, and there is the possibility that
damages could be awarded against the Company in amounts that could be material.
It is management's opinion, based on the advice of counsel, that all litigation
of which it is aware, including the matters discussed above, will not have a
material adverse effect on the Company's consolidated financial position,
results of operations or liquidity, beyond reserves already taken.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the Company's executive officers follows:
14
CHARLES E. BRADLEY, JR., 43, 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.
WILLIAM L. BRUMMUND, JR., 50, has been Senior Vice President - Operations since
March 1991. From 1986 to March 1991, Mr. Brummund was Vice President and Systems
Administrator for Far Western Bank, Tustin, California.
NICHOLAS P. BROCKMAN, 58, 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.
CURTIS K. POWELL, 46, has been Senior Vice President - Contract Origination
since June 2001. Previously, he was the Company's Senior Vice President -
Marketing, from 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, 43, 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.
DAVID N. KENNEALLY, 40, has been Senior Vice President - Finance since July
2001. Previously, he was Chief Financial Officer of LoanGenie.com, Inc. from May
2000 to July 2001, and prior to that he served as Vice President - Financial
Reporting of Fidelity National Financial, Inc., from January 1994 through May
2000. From August 1992 through January 1994, Mr. Kenneally was Assistant Vice
President and Controller of Pacific States Casualty Company. Mr. Kenneally began
his professional career with KPMG LLP, leaving as a Senior Manager in July 1992.
ROD RIFAI, 36, has been Senior Vice President - Marketing since July 2001.
Previously, Mr. Rifai had served as the Company's Regional Vice President of
Marketing for the Southeast region, since December 1998, and as a marketing
representative from June 1997 to December 1998. Previous to that time Mr. Rifai
had been in the retail automobile sales and leasing business in various
management capacities for over ten years.
ROBERT E. RIEDL, 39, has been Senior Vice President - Risk Management since
January 2003. Mr. Riedl was a Principal at Northwest Capital Appreciation, a
middle market private equity firm, from 1999 to 2002. Mr. Riedl was an
investment banker for ContiFinancial Services Corporation from 1995 until
joining Northwest Capital Appreciation.
15
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 sales prices
reported by Nasdaq for the Common Stock for the periods shown.
HIGH LOW
---- ---
January 1 - March 31, 2001.................................... $1.969 $1.438
April 1 - June 30, 2001....................................... 1.950 1.375
July 1 - September 30, 2001................................... 1.840 1.220
October 1 - December 31, 2001................................. 2.138 1.150
January 1 - March 31, 2002.................................... 2.000 1.110
April 1 - June 30, 2002....................................... 3.250 1.750
July 1 - September 30, 2002................................... 2.650 1.410
October 1 - December 31, 2002................................. 2.290 1.550
As of March 25, 2003, there were 84 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 income, 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 income for use in the Company's operations.
The table below presents information regarding outstanding options to purchase
the Company's Common Stock.
Number of securities
remaining available for
Number of securities to Weighted-average exercise future issuance under equity
be issued upon exercise price of outstanding compensation plans (excluding
of outstanding options, options, warrants and securities reflected in
Plan category warrants and rights rights column (a))
- ------------------------------- --------------------------- --------------------------- -------------------------------
DECEMBER 31, 2002
- ------------------------------- --------------------------- --------------------------- -------------------------------
(a) (b) (c)
- ------------------------------- --------------------------- --------------------------- -------------------------------
Equity compensation plans
approved by security holders 4,027,599 $1.64 -0-
- ------------------------------- --------------------------- --------------------------- -------------------------------
Equity compensation plans not
approved by security holders None N/A N/A
- ------------------------------- --------------------------- --------------------------- -------------------------------
Total 4,027,599 $1.64 -0-
- ------------------------------- --------------------------- --------------------------- -------------------------------
Included in the table above as being pursuant to equity compensation plans
approved by security holders are 1,589,200 options the Company has conditionally
granted, subject to shareholder approval of an increase in the number of shares
available for grant under its 1997 Long-Term Incentive Plan. All of such options
have an exercise price of $1.50 per share. Until and unless such shareholder
approval is gained, these options are not outstanding or exercisable. Excluding
such options, there would be 2,438,399 shares to be issued upon exercise of
outstanding options, the weighted average exercise price per share would be
$1.56, and there would be 620,851 options available for future issuance.
16
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
2002 2001 2000 (1) 1999 (1) 1998
----------- ----------- ----------- ----------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Gain (loss) on sale of Contracts, net............. $ 16,444 $ 32,765 $ 16,234 $ (14,844) $ 58,306
Interest income................................... 48,644 17,205 3,480 3,032 41,841
Servicing fees.................................... 14,621 10,666 15,848 27,761 25,156
Total revenue..................................... 91,952 62,005 35,951 14,805 126,280
Operating expenses................................ 91,890 61,685 68,354 86,968 81,960
Income (loss) before extraordinary item........... 2,996 320 (22,147) (44,532) 25,703
Extraordinary item (2) ........................... 17,412 -- -- -- --
Net income (loss) ................................ 20,408 320 (22,147) (44,532) 25,703
Basic income (loss) per share before ex. item..... 0.15 0.02 (1.10) (2.38) 1.67
Diluted income (loss) per share before ex. item... 0.14 0.02 (1.10) (2.38) 1.50
Basic income (loss) per share..................... 1.03 0.02 (1.10) (2.38) 1.67
Diluted income (loss) per share................... 0.97 0.02 (1.10) (2.38) 1.50
DECEMBER 31,
---------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- ----------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and restricted cash.......................... $ 51,859 $ 13,924 $ 24,315 $ 3,324 $ 3,559
Finance receivables, net.......................... 84,592 -- 18,830 2,421 165,582
Residual interest in securitizations.............. 127,170 106,103 99,199 172,530 217,848
Total assets...................................... 285,448 151,204 175,694 220,314 431,962
Term debt......................................... 175,942 82,555 102,614 119,173 274,546
Total liabilities................................. 202,874 89,518 113,572 135,877 312,881
Total shareholders' equity........................ 82,574 61,686 62,122 84,437 119,081
- ------------
(1) Beginning with the year ended December 31, 1999 and through December 31,
2000, the Company did not sell any Contracts in securitization transactions due
to then existing market conditions.
(2) On March 8, 2002, CPS acquired 100% of MFN Financial Corporation and
subsidiaries, resulting in the recognition of $17.4 million of negative goodwill
as an extraordinary gain, which is reflected in the Company's 2002 Consolidated
Statement of Operations.
17
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. The Company's Consolidated Balance Sheet and
Consolidated Statement of Operations as of and for the year ended December 31,
2002 include the results of operations of MFN Financial Corporation for the
period subsequent to March 8, 2002, the Merger date, through December 31, 2002.
See Note 2 of Notes to Consolidated Financial Statements.
OVERVIEW
Consumer Portfolio Services, Inc. and its subsidiaries (collectively, the
"Company") primarily engage in the business of purchasing, selling and servicing
retail automobile installment sale contracts ("Contracts") originated by
automobile dealers ("Dealers") located throughout the United States. Through its
purchase of Contracts, the Company provides indirect financing to Dealer
customers with limited credit histories, low incomes or past credit problems,
who generally would not be expected to qualify for financing provided by banks
or by automobile manufacturers' captive finance companies.
On March 8, 2002, the Company acquired 100% of MFN Financial Corporation, a
Delaware corporation ("MFN") and its subsidiaries, by the merger (the "Merger")
of CPS Mergersub, Inc., a Delaware corporation ("Mergersub") and a direct wholly
owned subsidiary of CPS, with and into MFN. In the Merger, MFN became a wholly
owned subsidiary of CPS. The Company thus acquired the assets of MFN, consisting
principally of interests in automobile installment sales finance Contracts and
the facilities for originating and servicing such Contracts. The Merger was
accounted for as a purchase. MFN, through its primary operating subsidiary,
Mercury Finance Company LLC, was engaged in business substantially similar to
that of the Company: purchasing automobile installment sales finance Contracts
from Dealers, and securitizing and servicing such Contracts.
The Company historically has generated revenue primarily from the gains
recognized on the sale or securitization of its Contracts, servicing fees earned
on Contracts sold, and interest earned on Residuals, as defined below, and on
finance receivables. In the years ended December 31, 1999 and 2000, the Company
did not sell any Contracts in securitization transactions, and therefore
recognized no gains on sale from securitization transactions. All sales of
Contracts during 1999 were on a servicing released basis, either in the form of
bulk sales of Contracts being held by the Company for sale, or as part of a flow
through agreement with a third party for which the Company earned fees on a per
Contract basis, also known as "the flow purchase program" or "purchases made on
a flow basis." During the year ended December 31, 2000, the Company entered into
another flow through agreement and proceeded to sell nearly all of the Contracts
purchased during the year to one or the other third party, for a mark-up above
what the Company paid the Dealer. The Company recorded a loss of $22.7 million
related to bulk sales in 1999. There were no bulk sales during 2000 or 2001. As
a result of the Company's flow through sales during the years ended December 31,
2002, 2001 and 2000, the Company recognized gain on sale of Contracts of $5.7
million, $16.6 million and $18.4 million, respectively. One of the two flow
purchasers ceased to purchase Contracts in December 2001, and the other has in
May 2002. The flow purchase program accordingly ended at that time.
18
The Company's securitization structure has generally been as follows:
The Company sells a portfolio of Contracts to a wholly owned Special Purpose
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 an owner trust ("Trust"). The Trust is a qualifying special purpose entity as
defined in Statement of Financial Accounting Standards No. 140 ("SFAS 140"), and
is therefore not consolidated in the Company's Consolidated Financial
Statements. The Trust issues interest-bearing asset-backed securities (the
"Notes"), generally in a principal amount equal to the aggregate principal
balance of the Contracts. The Company typically sells these Contracts to the
Trust at face value and without recourse, except that representations and
warranties similar to those provided by the Dealer to the Company are provided
by the Company to the Trust. One or more investors purchase the Notes issued by
the Trust; the proceeds from the sale of the Notes are then used to purchase the
Contracts from the Company. The Company may retain subordinated Notes issued by
the Trust. The Company purchases a financial guaranty insurance policy,
guaranteeing timely payment of principal and interest on the senior Notes, from
an insurance company (the "Note Insurers"). In addition, the Company provides a
credit enhancement for the benefit of the Note Insurers and the investors in the
form of an initial cash deposit to an account ("Spread Account") held by the
Trust or in the form of subordinated Notes, or both. The agreements governing
the securitization transactions (collectively referred to as the "Securitization
Agreements") require that the initial deposits to the Spread Accounts be
supplemented by a portion of collections from the Contracts until the Spread
Accounts reach specified levels, and then maintained at those levels. The
specified levels are generally computed as a percentage of the principal amount
remaining unpaid under the related Notes. The specified levels at which the
Spread Accounts are to be maintained will vary depending on the performance of
the portfolios of Contracts held by the Trusts and on other conditions, and may
also be varied by agreement among the Company, the SPS, the Note Insurers and
the trustee. Such levels have increased and decreased from time to time based on
performance of the portfolios, and have also varied by Securitization Agreement.
The Securitization Agreements generally grant the Company the option to
repurchase the sold Contracts from the Trust when the aggregate outstanding
balance has amortized to 10% or less of the initial aggregate balance.
The Company's continuous securitization structure is similar to the above,
except that (i) the SPS that purchases the Contracts pledges the Contracts to
secure promissory notes issued directly by the SPS, (ii) the initial purchaser
of such notes has the right, but not the obligation, to require that the Company
repurchase the Contracts, (iii) the promissory notes are in an aggregate
principal amount of not more than 72.5% to 73% of the aggregate principal
balance of the Contracts (that is, up to 27.5% over-collateralization), and (iv)
no Spread Account is involved. The SPS is a qualifying special purpose entity
and is therefore not consolidated in the Company's Consolidated Financial
Statements.
Upon each sale of Contracts in a securitization, whether a term securitization
or a continuous 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 ownership
interest that the Company retains in Contracts sold in the securitization. That
retained interest (the "Residual") consists of (a) the cash held in the Spread
Account, if any, (b) over collateralization, if any, (c) subordinated Notes
retained, if any, and (d) receivables from Trust, which include the net interest
receivables ("NIRs"). NIRs represent the estimated discounted cash flows to be
received from the Trust in the future, net of principal and interest payable
with respect to the Notes, and certain expenses. 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 Notes and the
Residuals sold and retained based on the relative fair values of those portions
on the date of the sale. The Company recognizes gains or losses attributable to
the change in the fair value of the Residuals, which are recorded at estimated
fair value. The Company is not aware of an active market for the purchase or
sale of interests such as the Residuals; accordingly, the Company determines the
estimated fair value of the Residuals by discounting the amount and timing of
anticipated cash flows that it estimates will be released to the Company in the
future (the cash out method), using a discount rate that the Company believes is
appropriate for the risks involved. The Company estimates the value of its
19
optional right to repurchase receivables pursuant to the terms of the
Securitization Agreements primarily based on its estimate of the amount and
timing of cash flows that it anticipates will be received from the repurchased
receivables following exercise of the optional right. The anticipated cash flows
include collections from both current and charged off receivables. The Company
has used an effective discount rate of approximately 14% per annum, which it
believes is appropriate for the risks involved.
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 principal and interest on the Notes, the base
servicing fees, and certain other fees (such as trustee and custodial fees).
Required principal payments are in most cases defined as the payments sufficient
to keep the principal balance of the Notes equal to the aggregate principal
balance of the related Contracts (excluding those Contracts that have been
charged off). Some of the Securitization Agreements require accelerated payment
of principal until the principal balance of the Notes is reduced to a specified
percentage of the aggregate principal balance of the related Contracts. Such
accelerated principal payment is said to create "over-collateralization" of the
Notes.
If the amount of cash required for payment of fees, interest and principal
exceeds the amount collected during the collection period, the shortfall is
drawn from the Spread Account, if any. 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,
or in certain cases is transferred to other Spread Accounts that may be below
their required levels. If the Spread Account balance is not at the required
credit enhancement level, then the excess cash collected is retained in the
Spread Account until the specified level is achieved. Although Spread Account
balances are held by the Trusts on behalf of the Company's SPS as the owner of
the Residuals, the cash in the Spread Accounts is restricted from use by the
Company. Cash held in the various Spread Accounts is invested in high quality,
liquid investment securities, as specified in the Securitization Agreements. The
interest rate payable on the Contracts is significantly greater than the
interest rate on the Notes. As a result, the Residuals described above are a
significant asset of the Company. In determining the value of the Residuals, the
Company must estimate the future rates of prepayments, delinquencies, defaults
and default loss severity, and the value of the Company's optional right to
repurchase receivables pursuant to the terms of the Securitization Agreements,
as all of these factors affect the amount and timing of the estimated cash
flows. The Company estimates prepayments by evaluating historical prepayment
performance of comparable Contracts. The Company has used prepayment estimates
of approximately 20% to 23% cumulatively over the lives of the related
Contracts. 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 estimates
recovery rates of previously charged off receivables using available historical
recovery data and projected future recovery levels. In valuing the Residuals,
the Company estimates that gross losses as a percentage of the original
principal balance will approximate 13% to 18% cumulatively over the lives of the
related Contracts, with recovery rates approximating 2% to 5% of the original
principal balance.
In future periods, the Company will recognize additional revenue from the
Residuals if the actual performance of the Contracts is better than the original
estimate, or the Company would increase the estimated fair value of the
Residuals. If the actual performance of the Contracts were worse than the
original estimate, then a downward adjustment to the carrying value of the
Residuals would be required.
The Noteholders and the related securitization Trusts have no recourse to the
Company for failure of the Contract obligors to make payments on a timely basis.
The Company's Residuals, however, are subordinate to the Notes until the
Noteholders are fully paid, and the Company is therefore at risk to that extent.
See "Critical Accounting Policies."
20
CRITICAL ACCOUNTING POLICIES
The Company believes that its accounting policies related to (a) Allowance for
Finance Credit Losses, (b) Residual Interest in Securitizations and Gain on Sale
of Contracts and (c) Income Taxes could be considered critical. Such policies
are described below.
(a) ALLOWANCE FOR FINANCE CREDIT LOSSES
In order to estimate an appropriate allowance for losses to be incurred on
finance receivables, the Company uses a loss reserving methodology commonly
referred to as "static pooling," which stratifies its finance receivable
portfolio into separately identified pools. Using analytical and formula driven
techniques, the Company estimates an allowance for finance credit losses, which
management believes is adequate for known and inherent losses in the finance
receivable Contract portfolio. Provision for loss is charged to the Company's
Consolidated Statement of Operations. Charge offs are charged to the allowance.
Management evaluates the adequacy of the allowance by examining current
delinquencies, the characteristics of the portfolio and the value of the
underlying collateral. As conditions change, the Company's level of provisioning
and/or allowance may change as well.
(b) RESIDUAL INTEREST IN SECURITIZATIONS AND GAIN ON SALE OF CONTRACTS
Gain on sale may be recognized on the disposition of Contracts either outright
or in securitization transactions. In its securitization transactions, a wholly
owned subsidiary of the Company retains a residual interest in the Contracts
that are sold. The Company's securitization transactions include "term"
securitizations (purchaser holds the Contracts for substantially their entire
term) and "continuous" securitizations (the Contracts sold may be put back to
the Company, and subsequently replaced with other Contracts).
The residual interest in term securitizations and the residual interest in the
Contracts sold continuously are reflected in the line item "residual interest in
securitizations" on the Company's Consolidated Balance Sheet. In either case,
the residual interest represents the discounted sum of expected future releases
from securitization trusts. Accordingly, the valuation of the residual is
heavily dependent on estimates of future performance.
The key economic assumptions used in measuring all retained interests remaining
as of December 31, 2002 and 2001 are included in the table below. The discount
rate remained constant at 14%.
2002 2001
-------------- --------------
Prepayment speed (Cumulative)................ 19.8% - 22.9% 22.0% - 27.2%
Credit losses (Cumulative)................... 10.0% - 15.4% 12.0% - 17.5%
21
Key economic assumptions and the sensitivity of the current fair value of
residual cash flows to immediate 10% and 20% adverse changes in those
assumptions are as follows:
DECEMBER 31, 2002
-----------------
(DOLLARS IN
THOUSANDS)
Carrying amount/fair value of residual interest in securitizations $127,170
Weighted average life in years ................................... 3.90
Prepayment Speed Assumption (Cumulative) ......................... 19.8% - 22.9%
Estimated fair value assuming 10% adverse change ................. $126,647
Estimated fair value assuming 20% adverse change ................. 126,144
Expected Credit Losses (Cumulative) .............................. 10.0% - 15.4%
Estimated fair value assuming 10% adverse change ................. $120,302
Estimated fair value assuming 20% adverse change ................. 113,424
Residual Cash Flows Discount Rate (Annual) ....................... 14.0%
Estimated fair value assuming 10% adverse change ................. $124,723
Estimated fair value assuming 20% adverse change ................. 122,351
These sensitivities are hypothetical and should be used with caution. As the
figures indicate, changes in fair value based on 10% and 20% percent variation
in assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
this table, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another
(for example, increases in market rates may result in lower prepayments and
increased credit losses), which could magnify or counteract the sensitivities.
(c) INCOME TAXES
The Company and its subsidiaries file a consolidated federal income and combined
state franchise tax returns. 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 the differences between the
financial statement values of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred taxes of a change in tax rates is recognized in income in the period
that includes the enactment date. The Company has estimated a valuation
allowance against that portion of the deferred tax asset whose utilization in
future periods is not more than likely.
22
In determining the possible realization of deferred tax assets, future taxable
income from the following sources are considered: (a) the reversal of taxable
temporary differences, (b) future operations exclusive of reversing temporary
differences, and (c) tax planning strategies that, if necessary, would be
implemented to accelerate taxable income into periods in which net operating
losses might otherwise expire.
See "Liquidity and Capital Resources" and Note 1 of Notes to Consolidated
Financial Statements.
MFN FINANCIAL CORPORATION ACQUISITION
MFN, through its primary operating subsidiary, Mercury Finance Company LLC, was
in the business of purchasing Contracts from Dealers, and securitizing and
servicing such Contracts. CPS intends to continue to use the assets acquired in
the Merger in the automobile finance business, but a portion of such assets have
been disposed of. CPS has ceased to use the acquired assets for the purchase of
Contracts, and does not anticipate recommencing such use. In connection with the
termination of MFN origination activities and the integration and consolidation
of other activities, the Company recognized as a liability its estimate of the
costs to exit these activities and terminate the affected employees of MFN. The
terminated activities include service departments such as accounting, finance,
human resources, information technology, administration, payroll and executive
management. The estimated costs include the following:
MARCH 8, DECEMBER 31,
2002 ACTIVITY 2002 (2)
---- -------- --------
(IN THOUSANDS)
Severance payments and consulting contracts........... $ 3,215 $ (2,644) $ 571
Facilities closures (1)............................... 2,152 (157) 1,995
Termination of contracts, leases, services
and other obligations.......................... 597 (274) 323
Acquisition expenses accrued but unpaid............... 250 (199) 51
----------- ----------- -----------
Total liabilities assumed............. $ 6,214 $ (3,274) $ 2,940
=========== =========== ===========
- ------------
(1) Activity resulting in a net charge $157,000 includes charges against
liability of $1.4 million, and the "reclassification" of an existing accrual for
offices closed prior to the Merger Date of approximately $1.2 million.
(2) Approximately $2.9 million of remaining accrual is recorded in the
Consolidated Balance Sheet of the Company at December 31, 2002. The Company
believes that this amount provides adequately for anticipated remaining costs
related to exiting certain activities of MFN, and that amounts indicated above
are reasonably allocated.
Upon effectiveness of the Merger, each outstanding share of common stock of MFN
converted into the right to receive $10.00 per share in cash. The total Merger
consideration payable to stockholders of MFN was approximately $99.9 million.
The amount of such consideration was agreed to as the result of arms'-length
negotiations between CPS and MFN. The aggregate purchase price, including
expenses related to the transaction, was approximately $123.2 million.
Acquisition financing was provided to CPS by Westdeutsche Landesbank
Girozentrale, New York Branch ("WestLB") and Levine Leichtman Capital Partners
II, L.P ("LLCP"). CPS obtained acquisition financing from LLCP through its
issuance and sale of certain senior secured notes to LLCP in the aggregate
principal amount of $35 million.
The Company's Consolidated Balance Sheet and Consolidated Statement of
Operations as of and for the year ended December 31, 2002 include the results of
operations of MFN for the period subsequent to March 8, 2002, the Merger date.
23
The Company has recorded certain purchase accounting adjustments recorded on its
Consolidated Balance Sheet, which are estimates based on available information.
In addition, the Company's Consolidated Statement of Operations for the year
ended December 31, 2002 includes an extraordinary gain related to the excess of
net assets acquired over purchase price ("negative goodwill") totaling $17.4
million.
RESULTS OF OPERATIONS
THE YEAR ENDED DECEMBER 31, 2002 COMPARED TO THE YEAR ENDED DECEMBER 31, 2001
REVENUE. During the year ended December 31, 2002, revenues increased $29.9
million, or 48.3%, compared to the year ended December 31, 2001. Net gain on
sale of Contracts decreased by $16.3 million, from $32.8 million for the year
ended December 31, 2001, to $16.4 million for the year ended December 31, 2002.
The primary reason for the decrease in the gain on sale component of revenue is
the termination of the Company's flow purchase program in May 2002, offset in
part by an increase in the amount of Contracts securitized by the Company in
2002 compared to 2001. The Company securitized $281.2 million of Contracts
during the year ended December 31, 2002, compared to $141.7 million during the
year ended December 31, 2001. During the year ended December 31, 2002, the
Company sold $181.1 million of Contracts on a flow basis compared to $537.9
million of Contracts in the year ended December 31, 2001.
Gain on sale of Contracts also includes the effect of fluctuations in the
Company's estimate of the required provision for losses on certain CPS Contracts
and recovery of losses on such Contracts. During 2001, recoveries exceeded the
provision for losses; in 2002 the provision for losses was greater than
recoveries. During 2002, the amount of Contracts for which the Company recorded
a provision for Contract losses has increased, requiring the Company to provide
for losses on such Contracts in an amount exceeding related recoveries. For the
year ended December 31, 2002 the Company recorded a $2.6 million provision for
Contract losses, compared to a reduction of the provision for Contract losses of
$5.7 million for the year ended December 31, 2001. Also during 2002, as a result
of revised Company estimates resulting from analyses of the current and
historical performance of certain of the Company's securitized pools, the
Company recorded a reduction to gain on sale of approximately $2.0 million.
Interest income increased $31.4 million to $48.6 million in the year ended
December 31, 2002, from $17.2 million in the prior year. The increase in
interest income is primarily due to the expansion of the Company's servicing
portfolio, primarily as a result of the MFN Merger, as well as the addition of
Contracts to the CPS portfolio and the related increase in the Company's
residual interest in securitizations as a result of the increased level of
securitizations. As of December 31, 2002, the servicing portfolio, net of
unearned income on pre-computed Contracts, was $595.2 million, compared to
$285.5 million as of December 31, 2001.
Servicing fees increased by $4.0 million, or 37.1%, to $14.6 million for the
year ended December 31, 2002, from $10.7 million for the year ended December 31,
2001. Servicing fees are composed of base fees, which are payable at the rate of
2.5% per annum on the principal balance of the outstanding CPS Contracts (5.0%
on MFN Contracts) in the related Trusts, plus any other fees collected by the
Company, such as late fees and returned check fees. The increase in servicing
fees is primarily due to the increase in the Company's servicing portfolio.
EXPENSES. During the year ended December 31, 2002, operating expenses increased
by $30.2 million, or 49.0%, to $91.9 million, compared to the year ended
December 31, 2001 operating expenses of $61.7 million. The Company's operating
expenses consist primarily of personnel costs and other operating expenses,
which are incurred as applications and Contracts are received, processed and
24
serviced. Factors that affect margins and net income include changes in the
automobile and automobile finance market environments, macroeconomic factors
such as interest rates, and mix of business between Contracts purchased on a
flow basis and Contracts purchased on an other than flow basis. The overall
increase in expenses is primarily attributable to the MFN Merger. Personnel
costs increased $13.8 million, or 57.4%, to $37.8 million in 2002 from $24.0
million in 2001. Personnel costs include base salaries, commissions and bonuses
paid to employees, and certain expenses related to the accounting treatment of
outstanding warrants and stock options, and are the Company's most significant
operating expenses, representing approximately 41.1% of 2002 operating expenses.
These costs generally fluctuate with the level of applications and Contracts
processed and serviced, with the mix of revenue and with overall portfolio
performance. Other material operating expenses include facilities expenses,
telephone and other communication services, credit services, computer services
(including personnel costs associated with information technology support),
professional services, marketing and advertising expenses, and depreciation and
amortization.
In connection with the termination of MFN origination activities and the
integration and consolidation of certain activities (see above), the Company has
recognized certain liabilities related to the costs to exit these activities and
terminate the affected employees of MFN. These activities include service
departments such as accounting, finance, human resources, information
technology, administration, payroll and executive management. Such exit and
termination costs have been charged against these liabilities and are not
reflected in the Company's Consolidated Statement of Operations.
General and administrative expenses increased by $7.5 million, or 59.2%, and
represented 21.9% of total operating expenses. The increase in general and
administrative expenses is primarily due to the MFN Merger and an increase in
costs associated with servicing the Company's expanded portfolio. Also included
in 2002 general and administrative expenses is $669,000 related to the write off
a related party receivable from CARSUSA, Inc. See Note 13 of Notes to
Consolidated Financial Statements.
Interest expense increased by $9.6 million, or 66.9%, and represented 26.0% of
total operating expenses. The increase is due to the interest expense resulting
from the MFN acquisition, including interest expense related to acquisition debt
and the interest expense related to the Notes Payable to Securitization Trust.
See "Liquidity and Capital Resources."
Marketing expenses decreased by $1.6 million, or 25.0%, and represented 5.3% of
total operating expenses. The decrease is primarily due to the decrease in
Contracts purchased during the year ended December 31, 2002.
Occupancy expenses increased by $860,000, or 27.2%, and represented 4.4% of
total operating expenses. The increase is primarily due to the addition of
facilities acquired in the MFN Merger.
Depreciation and amortization expenses increased by $119,000, or 11.7%, and
represented 1.2% of total operating expenses.
The results for the years ended December 31, 2002 and 2001, include net income
of $116,732 and $161,710, respectively, from the Company's subsidiary CPS
Leasing, Inc.
Income tax benefit of $2.9 million, including the elimination of the valuation
allowance of $3.2 million, was recorded in the 2002 period pursuant to relevant
tax statutes and regulations. The Company's provision for income taxes was zero
for the year ended December 31, 2001.
25
THE YEAR ENDED DECEMBER 31, 2001 COMPARED TO THE YEAR ENDED DECEMBER 31, 2000
REVENUE. During the year ended December 31, 2001, revenues increased $26.1
million, or 72.5%, compared to the year ended December 31, 2000. Net gain on
sale of Contracts increased by $16.5 million, from $16.2 million for the year
ended December 31, 2000, to $32.8 million for the year ended December 31, 2001.
The primary reason for the increase in the gain on sale component of revenue is
the Company's securitization of approximately $141.7 million of Contracts in the
2001 period, resulting in a gain on sale of Contracts of $9.2 million. The
availability and structure of the Company's note purchase facility enabled it to
execute securitization sales during 2001; no such sales occurred in the prior
year. In addition, the Company completed a term securitization in September
2001. Substantially all of the proceeds from the September 2001 transaction were
used to reduce amounts outstanding under the Company's floating rate variable
note purchase facility. Additionally, gain on sale of Contracts includes the
effect of fluctuations in the Company's estimate of the required provision for
losses on Contracts and in recoveries of losses on Contracts. During 2001,
recoveries exceeded the provision for losses; in 2000 the provision for losses
was greater than recoveries. The Company makes recoveries on Contracts
previously held on balance sheet or from pools for which the Company has
exercised its optional right to repurchase receivables pursuant to the
Securitization Agreements. The amount of Contracts for which the Company
requires a provision for Contract losses has contracted, while the amount
recovered increased. As such the Company is able to recover its provision for
Contract losses. For the year ended December 31, 2001 the Company recorded a
reduction of the provision for Contract losses of $5.7 million, compared to a
charge of $1.8 million for the year ended December 31, 2000.
During the year ended December 31, 2001, the Company sold $537.9 million of
Contracts on a flow basis compared to $600.4 million of Contracts in the year
ended December 31, 2000. The Company's flow purchase program ended in May 2002.
Interest income increased $13.7 million to $17.2 million in the year ended
December 31, 2001, from $3.5 million in the prior year. The increase in interest
income is primarily due to the increase in residual interest income resulting
from a change in the method residual interest income was calculated beginning in
the second quarter of 2000. The increase in residual interest income is due to
the Company refining its methodology of calculation of such interest income
beginning with the three-month period ended June 30, 2000. The refined method is
designed to accrete residual interest income on a level yield basis. The Company
now uses an accretion rate that approximates the discount rate used to value the
residual interest in securitizations, approximately 14% per annum. Prior to such
period, the Company recognized residual interest income as the excess cash flows
generated by the Trusts over the related obligations of the Trusts, net of any
amortization of the related NIRs. This prior method of residual interest income
recognition had approximated a level yield rate of residual interest income due
to the continued addition of new securitizations. Since the Company had not
securitized any Contracts since December 1998, this prior method would not have
reflected the appropriate level yield and thus was refined during the second
quarter of 2000. The effect of this refinement has been offset, in part, by the
contraction of the Company's servicing portfolio.
Servicing fees decreased by $5.2 million, or 32.7%, to $10.7 million for the
year ended December 31, 2001, from $15.8 million for the year ended December 31,
2000. Servicing fees are composed of base fees, which are payable at the rate of
2% to 2.5% per annum on the principal balance of the outstanding Contracts in
the related Trusts, plus any other fees collected by the Company, such as late
fees and returned check fees. The decrease in servicing fees is primarily due to
the decrease in the Company's servicing portfolio. As of December 31, 2001, the
servicing portfolio, net of unearned income on pre-computed Contracts, was
$285.5 million, compared to $411.9 million as of December 31, 2000.
26
EXPENSES. During the year ended December 31, 2001, operating expenses decreased
by $6.7 million, or 9.8%, compared to the year ended December 31, 2000.
Personnel costs were effectively flat year over year, decreasing $640,000, or
2.6%, to $24.0 million in 2001 from $24.6 million in 2000. Personnel costs
include base salaries, commissions and bonuses paid to employees, and certain
expenses related to the accounting treatment of outstanding warrants and stock
options, and are the Company's most significant operating expenses, representing
approximately 38.9% of total operating expenses. These costs generally fluctuate
with the level of applications and Contracts processed and serviced, with the
mix of revenue and with overall portfolio performance. Other material operating
expenses include facilities expenses, telephone and other communication
services, credit services, computer services (including personnel costs
associated with information technology support), professional services,
marketing and advertising expenses, and depreciation and amortization. General
and administrative expenses decreased by $3.1 million, or 19.8%, and represented
20.5% of total operating expenses. The decrease in general and administrative
expenses is primarily due to the decrease in costs associated with servicing the
Company's diminished portfolio.
Interest expense decreased by $2.9 million, or 16.9%, and represented 23.2% of
total operating expenses. The decrease in interest expense is primarily due to
the reductions in non-warehouse indebtedness from the prior year. See "Liquidity
and Capital Resources."
Marketing expenses increased by $399,000, or 6.5%, and represented 10.6% of
total operating expenses. The increase is primarily due to the increase in
Contracts purchased during the year ended December 31, 2001.
Occupancy expenses decreased by $241,000, or 7.1%, and represented 5.1% of total
operating expenses. The decrease is primarily due to additional property taxes
paid during 2000, not due in 2001. In November 1998, the Company moved its
headquarters to a new 115,000 square foot facility. Depreciation and
amortization expenses decreased by $142,000, or 12.2%, and represented 1.7% of
total operating expenses.
The results for the years ended December 31, 2001 and 2000, include net earnings
of $161,710 and $19,816, respectively, from the Company's subsidiary CPS
Leasing, Inc. The increase in net income of CPS Leasing, Inc. is primarily
attributable to the decision to cease lease receivable origination and to simply
service the existing receivables, resulting in significant expense reductions.
The results for the year ended December 31, 2000, include net operating losses
of $755,000 from the Company's investment in 38% of NAB Asset Corp.
The Company's effective tax rate was zero and 31.7%, for the years ended
December 31, 2001 and 2000, respectively.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
The Company's business requires substantial cash to support its purchases of
Contracts and other operating activities. The Company's primary sources of cash
have been cash flows from operating activities, including proceeds from sales of
Contracts, amounts borrowed under various revolving credit facilities (also
sometimes known as warehouse credit facilities), servicing fees on portfolios of
Contracts previously sold, customer payments of principal and interest on
Contracts held for sale, fees for origination of Contracts, and releases of cash
27
from credit enhancements provided by the Company for the financial guaranty
insurers (Note Insurers) and Investors, initially made in the form of a cash
deposit to an account (Spread Account), and releases of cash from securitized
pools of Contracts in which the Company has retained a residual ownership
interest. The Company's primary uses of cash have been the purchases of
Contracts, repayment of amounts borrowed under lines of credit and otherwise,
operating expenses such as employee, interest, occupancy expenses and other
general and administrative expenses, the establishment of and further
contributions to "Spread Accounts" (cash posted to enhance credit of securitized
pools), and income taxes. There can be no assurance that internally generated
cash will be sufficient to meet the Company's cash demands. The sufficiency of
internally generated cash will depend on the performance of securitized pools
(which determines the level of releases from Spread Accounts), the rate of
expansion or contraction in the Company's servicing portfolio, and the terms
upon which the Company is able to acquire, sell, and borrow against Contracts.
Net cash provided by operating activities for the years ended December 31, 2002,
2001 and 2000, was $146.9 million, $3.7 million and $38.7 million, respectively.
Cash from operating activities is generally provided by the net releases from
the Company's securitization Trusts and from the amortization and liquidation of
Contracts. Such amortization and liquidation of Contracts increased in 2002
compared to prior years as a result of the MFN Merger and the addition of
Contracts to the CPS servicing portfolio and related increase in securitization
transactions. On March 8, 2002, the Company completed the MFN Merger (See Note 2
of Notes to Consolidated Financial Statements.). The acquisition cost was
approximately $123.2 million, and was substantially funded by existing cash and
borrowings. Cash flows from the underlying purchased assets are expected to
provide adequate liquidity to fund the acquisition borrowings, as well as
generate positive cash flows from which to fund the Company's operating
activities.
Net cash used in investing activities for the years ended December 31, 2002,
2001 and 2000, was $29.8 million, $536,000 and $623,000, respectively. Cash used
in the acquisition of MFN Financial Corporation, net of the cash acquired in the
transaction, totaled $29.5 million.
Net cash used in financing activities for the years ended December 31, 2002,
2001 and 2000, was $86.8 million, $19.7 million and $20.4 million, respectively.
In connection with the acquisition of MFN Financial Corporation the Company
incurred debt related to the MFN 2001-A Securitization Trust (See Note 7 of
Notes to Consolidated Financial Statements.) and additional senior secured debt
(See Note 8 of Notes to Consolidated Financial Statements.). Cash used in
financing activities is primarily attributable to the repayment of outstanding
debt. In connection with the MFN Merger the amount of outstanding debt,
securitization trust debt and senior secured debt, and the required repayment
thereof, increased compared to prior years.
The Company believes that cash flows generated as a result of the acquisition of
MFN Financial Corporation will be sufficient to meet the obligations incurred as
a result of the Merger. There can be no assurance that internally generated cash
will be sufficient to meet such cash demands. The sufficiency of internally
generated cash will depend on the performance of the securitized pools. At the
time of the Merger, MFN had outstanding $22.5 million in principal amount of
senior subordinated debt, which was due and repaid in full on March 23, 2002.
Such debt bore interest at the rate of 11.00% per annum, payable quarterly in
arrears.
Contracts are purchased from Dealers for a cash price approximating their
principal amount, and generate cash flow over a period of years. As a result,
the Company has been dependent on warehouse credit facilities to purchase
Contracts, and on the availability of cash from outside sources in order to
finance its continuing operations, as well as to fund the portion of Contract
purchase prices not financed under warehouse credit facilities. During 2001 and
through May 2002, the Company's Contract purchasing program consisted of both
(i) purchases for the Company's own account made on other than a flow basis,
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funded primarily by advances under a revolving warehouse credit facility, and
(ii) flow purchases for immediate resale to non-affiliates. Flow purchases
allowed the Company to purchase Contracts with minimal demands on liquidity. The
Company's revenues from the resale of flow purchase Contracts, however, were
materially less than those that may be received by holding Contracts to maturity
or by selling Contracts in securitization transactions. During the year ended
December 31, 2002, the Company purchased $181.1 million of Contracts on a flow
basis, and $282.2 million on an other than flow basis for its own account,
compared to $537.9 million and $134.4 million, respectively, of Contracts
purchased in 2001. For the year ended December 31, 2000, the Company purchased
$600.4 million of Contracts on a flow basis and $31.1 million on an other than
flow basis. The Company's flow purchase program ended in May 2002.
During the years ended December 31, 2002 and 2001, the Company purchased
Contracts to for resale into securitization transactions. The Company did not
sell Contracts in a securitization transaction during 2000 or 1999; however,
since November 2000, the Company has been able to purchase Contracts for its own
account, which are generally resold into a term securitization transaction,
using proceeds from two warehouse lines of credit.