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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________
FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
[ ] 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) has 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 of common equity held by non-affiliates of the
registrant as of the last business day of the registrant's most recently
completed second fiscal quarter (June 30, 2003) was $38,463,000, based upon the
$2.74 per share closing price of the Common Stock on that date, as reported by
the Nasdaq Stock Market. The number of shares of the registrant's Common Stock
outstanding on March 16, 2004, was 20,705,324.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant's proxy statement for its 2004 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 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, 2003, the Company has purchased approximately $4.9 billion of
Contracts from Dealers. In addition, the Company obtained a total of
approximately $530 million of Contracts in its 2002 and 2003 acquisitions,
described below. As of December 31, 2003, the Company had a total managed
portfolio, net of unearned interest on pre-computed Contracts, of approximately
$741.1 million, including the remaining outstanding balance of Contracts
acquired in the two acquisitions.
ACQUISITIONS
In March 2002, the Company acquired MFN Financial Corporation and its
subsidiaries in a merger (the "MFN Merger"). In May 2003, the Company acquired
TFC Enterprises, Inc. and its subsidiaries in a second merger (the "TFC
Merger"). MFN Financial Corporation and its subsidiaries ("MFN") and TFC
Enterprises, Inc. and its subsidiaries ("TFC") were engaged in businesses
similar to that of the Company; buying Contracts from Dealers, repackaging those
Contracts in securitization transactions, and servicing those Contracts. The
Company acquired approximately $380 million of Contracts in the MFN Merger, and
approximately $150 million in the TFC Merger. MFN ceased acquiring Contracts in
March 2002; TFC continues to acquire Contracts under its "TFC Programs," on
terms and conditions similar to those it used prior to the TFC Merger. Contracts
purchased by TFC after the TFC Merger accounted for less than 10% of the total
purchases during the year.
SECURITIZATIONS
GENERALLY
Throughout the periods for which information is presented in this report, the
Company has purchased Contracts with the intention of repackaging them in
securitizations. All such securitizations have involved identification of
specific Contracts, sale of those Contracts (and associated rights) to a special
purpose subsidiary of the Company, and issuance of asset-backed securities to
fund the transactions. Depending on the structure of the securitization, the
transaction may be properly accounted for as a sale of the Contracts, or as a
secured financing.
When structured to be treated as a secured financing, the subsidiary is
consolidated with the Company. Accordingly, the sold Contracts and the related
securitization trust debt appear as assets and liabilities, respectively, of the
Company on its Consolidated Balance Sheet. The Company then recognizes interest
and fee income on the receivables and interest expense on the securities issued
in the securitization, and records as expense a provision for probable credit
losses on the receivables.
When structured to be treated as a sale, the subsidiary is not consolidated with
the Company. Accordingly, the securitization removes the sold Contracts from the
Company's Consolidated Balance Sheet, the asset-backed securities (debt of the
non-consolidated subsidiary) do not appear as debt of the Company, and the
Company shows as an asset a retained 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 and other expenses. 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.
CHANGE IN POLICY
During August 2003 the Company announced that it would structure its future
securitization transactions to be reflected as secured financings for financial
accounting purposes. The first two term securitizations so structured occurred
in September and December 2003. The Company had structured all of its prior term
securitization transactions related to the CPS programs to be reflected as sales
for financial accounting purposes. In the MFN Merger and TFC Merger the Company
acquired finance receivables that had been previously securitized in term
securitization transactions that were reflected as secured financings. As of
December 31, 2003, the Company's Consolidated Balance Sheet included net finance
receivables of approximately $119.6 million and securitization trust debt of
$95.9 million related to finance receivables acquired in the two mergers, out of
totals of net finance receivables of approximately $266.2 million and
securitization trust debt of approximately $245.1 million.
CREDIT RISK RETAINED
Whether a securitization is treated as a secured financing or as a sale for
financial accounting purposes, the related special purpose subsidiary may be
unable to release excess cash to the Company if the credit performance of the
securitized 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 securitized
Contracts could therefore have a material adverse effect on both the Company's
liquidity and its results of operations, regardless of whether such Contracts
are treated as having been sold or as having been financed. For estimation of
the magnitude of such risk, it may be appropriate to look to the size of the
Company's "managed portfolio," which represents both financed and sold Contracts
as to which such credit risk is retained. The Company's managed portfolio as of
December 31, 2003 was approximately $741.1 million. See "-- Securitization of
Contracts," "-- The Servicing Agreements," "--Management's Discussion and
Analysis of Financial Condition and Results of Operations," and "--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.
2
MARKETING
The Company directs its marketing efforts to Dealers, rather than to consumers.
As of December 31, 2003, 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 remainders are independent used car dealers. For the year ended December
31, 2003, approximately 85% of the Contracts purchased by CPS (under the "CPS
programs") consisted of financing for used cars and the remaining 15% for new
cars, as compared to 88% used and 12% new in the year ended December 31, 2002.
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, 2003, the Company had 42 representatives.
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, 2003, no Dealer accounted for more
than 1% of the total number of Contracts purchased by the Company under the CPS
programs. The following table sets forth the geographical sources of the
Contracts purchased by the Company under the CPS programs (based on the
addresses of the customers as stated on the Company's records) during the years
ended December 31, 2003 and 2002. Contracts purchased by MFN are not included in
the table as MFN Contract purchases were terminated shortly after the MFN
Merger. Contracts purchased by TFC after the TFC Merger are not included because
such purchases accounted for less than 10% of the total purchases during the
year. All Contracts are acquired from Dealers located within the United States.
3
CONTRACTS PURCHASED DURING THE YEAR ENDED (1)
---------------------------------------------
DECEMBER 31, 2003 DECEMBER 31, 2002
------------------- ------------------
NUMBER PERCENT (2) NUMBER PERCENT (2)
------- ------ ------- ------
Texas .................. 2,333 9.8% 3,313 10.3%
Louisiana .............. 1,637 6.8 1,680 5.2
Pennsylvania ........... 1,567 6.6 1,539 4.8
Illinois ............... 1,466 6.1 2,274 7.1
California ............. 1,461 6.1 2,111 6.5
Ohio ................... 1,398 5.8 1,733 5.4
Florida ................ 1,343 5.6 1,453 4.5
North Carolina ......... 1,281 5.4 1,979 6.1
Michigan ............... 1,258 5.3 1,776 5.5
Maryland ............... 1,070 4.5 945 2.9
Georgia ................ 1,046 4.4 1,831 5.7
Kentucky ............... 948 4.0 1,449 4.5
New York ............... 932 3.9 1,215 3.8
Alabama ................ 814 3.4 1,288 4.0
Other States ........... 5,346 22.4 7,669 23.7
------- ------ ------- ------
Total .................. 23,900 100.0% 32,255 100.0%
======= ====== ======= ======
____________
(1) Excludes purchases under the TFC programs.
(2) 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 Company's
TFC subsidiaries seek to finance only vehicle purchases by members of the United
States armed forces. The Contract purchase decision process for the TFC programs
does not make use of credit reports, but relies on verification of military
status.
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 Company purchases Contracts under the CPS programs 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, 2003,
2002 and 2001, the average acquisition fee charged per Contract purchased under
the CPS programs was $372, $313 and $355, respectively, or 2.7%, 2.2% and 2.4%,
respectively, of the amount financed. The Company also purchases certain
Contracts under the CPS programs for a premium over the amount financed. The
4
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 2003, 2002 and
2001, respectively, the Company purchased 6,618, 9,971 and 9,962 of these
Contracts, representing approximately 27.7%, 30.9% and 21.7% of all Contracts
purchased under the CPS programs. The average premium paid to Dealers on these
Contracts was $447, $435 and $172, 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 for the CPS programs 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 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 30,000 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 under the CPS programs, CPS contacts each customer by
telephone to confirm that the Customer understands and agrees to the terms of
the related Contract.
CREDIT SCORING. Under the CPS programs, 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 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.
5
The average original principal amount financed under Contracts purchased, under
the CPS programs, and in the year ended December 31, 2003, was approximately
$13,738, with an average original term of approximately 60.2 months and an
average down payment amount of 13.5%. Based on information contained in customer
applications, for this 12-month period, the retail purchase price of the related
automobiles averaged $14,104 (which excludes tax, 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 three years, and CPS customers
averaged approximately 38 years of age, with approximately $37,440 in average
annual household income and an average of 5.3 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 interest from the Contract balance, in the case of a
pre-computed Contract, or by adding accrued interest to the Contract balance, in
the case of a simple interest Contract.
Each Contract purchased by the Company prohibits the sale or transfer of the
financed vehicle without the Company's consent and allows for the acceleration
of the maturity of a Contract upon a sale or transfer without such consent. 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 mailing monthly billing
statements; 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.
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.
6
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 as 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 the Company 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.
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, MFN (since the date of the MFN Merger) and TFC (since the
date of the TFC Merger) is shown on both a combined and individual basis in the
tables below.
7
DELINQUENCY EXPERIENCE (1)
CPS, MFN AND TFC COMBINED
DECEMBER 31, 2003 DECEMBER 31, 2002 DECEMBER 31, 2001
--------------------- --------------------- ---------------------
NUMBER OF NUMBER OF NUMBER OF
CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT
--------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Gross servicing portfolio (1)... 84,860 $773,220 86,940 $616,519 44,080 $288,756
Period of delinquency (2)
31-60 days ..................... 2,506 17,982 3,658 18,388 2,149 12,409
61-90 days ..................... 1,340 8,942 1,541 6,595 721 4,018
91+ days ....................... 1,522 9,452 825 3,422 552 3,488
--------- --------- --------- --------- --------- ---------
Total delinquencies (2) ........ 5,368 36,376 6,024 28,405 3,422 19,915
Amount in repossession (3) ..... 1,242 11,751 1,402 10,835 787 5,757
--------- --------- --------- --------- --------- ---------
Total delinquencies and amount
in repossession (2) ......... 6,610 $ 48,127 7,426 $ 39,240 4,209 $ 25,672
========= ========= ========= ========= ========= =========
Delinquencies as a percentage of
gross servicing portfolio ... 6.3% 4.7% 6.9% 4.6% 7.8% 6.9%
Total delinquencies and
amount in repossession as
a percentage of gross
servicing portfolio ......... 7.8% 6.2% 8.5% 6.4% 9.6% 8.9%
CPS
DECEMBER 31, 2003 DECEMBER 31, 2002 DECEMBER 31, 2001
--------------------- --------------------- ---------------------
NUMBER OF NUMBER OF NUMBER OF
CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT
--------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Gross servicing portfolio (1)... 47,615 $543,776 43,244 $394,845 44,080 $288,756
Period of delinquency (2)
31-60 days ..................... 1,175 11,766 1,734 10,738 2,149 12,409
61-90 days ..................... 657 5,719 643 3,619 721 4,018
91+ days ....................... 393 3,105 282 1,508 552 3,488
--------- --------- --------- --------- --------- ---------
Total delinquencies (2) ........ 2,225 20,590 2,659 15,865 3,422 19,915
Amount in repossession (3) ..... 725 8,434 654 6,305 787 5,757
--------- --------- --------- --------- --------- ---------
Total delinquencies and amount
in repossession (2) ......... 2,950 $ 29,024 3,313 $ 22,170 4,209 $ 25,672
========= ========= ========= ========= ========= =========
Delinquencies as a percentage of
gross servicing portfolio.... 4.7% 3.8% 6.2% 4.0% 7.8% 6.9%
Total delinquencies and
amount in repossession as
a percentage of gross
servicing portfolio ......... 6.2% 5.3% 7.7% 5.6% 9.6% 8.9%
8
MFN
DECEMBER 31, 2003 DECEMBER 31, 2002
--------------------- ---------------------
NUMBER OF NUMBER OF
CONTRACTS AMOUNT CONTRACTS AMOUNT
--------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Gross servicing portfolio (1) .. 20,282 $ 77,717 43,696 $221,674
Period of delinquency (2)
31-60 days ..................... 769 2,128 1,924 7,650
61-90 days ..................... 327 843 898 2,976
91+ days ....................... 227 532 543 1,914
--------- --------- --------- ---------
Total delinquencies (2) ........ 1,323 3,503 3,365 12,540
Amount in repossession (3) ..... 369 1,899 748 4,530
--------- --------- --------- ---------
Total delinquencies and amount
in repossession (2) ......... 1,692 $ 5,402 4,113 $ 17,070
========= ========= ========= =========
Delinquencies as a percentage of
gross servicing portfolio ... 6.5% 4.5% 7.7% 5.7%
Total delinquencies and
amount in repossession
as a percentage of gross
servicing portfolio ......... 8.3% 7.0% 9.4% 7.7%
9
TFC
DECEMBER 31, 2003
--------------------------
NUMBER OF
CONTRACTS AMOUNT
--------- ---------
(DOLLARS IN THOUSANDS)
Gross servicing portfolio (1) ................ 16,963 $151,727
Period of delinquency (2)
31-60 days ................................... 562 4,088
61-90 days ................................... 356 2,380
91+ days ..................................... 902 5,815
--------- ---------
Total delinquencies (2) ...................... 1,820 12,283
Amount in repossession (3) ................... 148 1,418
--------- ---------
Total delinquencies and amount
in repossession (2) ....................... 1,968 $ 13,701
========= =========
Delinquencies as a percentage of
gross servicing portfolio ................. 10.7% 8.1%
Total delinquencies and amount
in repossession as a percentage
of gross servicing portfolio .............. 11.6% 9.0%
____________
(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, MFN AND TFC COMBINED
YEAR ENDED DECEMBER 31,
---------------------------------------
2003 2002 2001
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Average servicing portfolio outstanding ...... $ 674,523 $ 524,286 $ 341,498
Net charge-offs as a percentage of average
servicing portfolio (2) (3) .................. 6.8% 8.6% 6.2%
CPS
YEAR ENDED DECEMBER 31,
---------------------------------------
2003 2002 2001
----------- ----------- -----------
(DOLLARS IN THOUSANDS)
Average servicing portfolio outstanding ...... $ 483,647 $ 291,863 $ 341,498
Net charge-offs as a percentage of average
servicing portfolio (2) ...................... 4.7% 5.0% 6.2%
10
MFN
YEAR ENDED DECEMBER 31,
-------------------------
2003 2002
----------- -----------
(DOLLARS IN THOUSANDS)
Average servicing portfolio outstanding ...... $ 123,140 $ 278,908
Net charge-offs as a percentage of average
servicing portfolio (2) ...................... 12.6% 11.0%
TFC
YEAR ENDED DECEMBER 31, 2003
----------------------------
(DOLLARS IN THOUSANDS)
Average servicing portfolio outstanding ...... $ 133,428
Net charge-offs as a percentage of average
servicing portfolio (2) (4) .................. 11.3%
___________
(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) TFC Contracts are expected to charge off at rates greater than CPS. To
partially compensate for this higher risk, TFC Contracts are purchased with a
higher acquisition fee than CPS Contracts.
FLOW PURCHASE PROGRAM
From May 1999 through the second 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.
SECURITIZATION OF CONTRACTS
The Company purchases Contracts for resale in or to be financed through
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. During
2003, the Company funded such purchases primarily with proceeds from three
short-term revolving warehouse lines of credit. These warehouse lines of credit
included a $125 million floating rate variable funding note facility, a $75
million floating rate variable funding note facility and a $25 million floating
rate variable funding note facility. The first two warehouse facilities provided
funding for Contracts purchased under CPS' programs while the third facility
provided funding for Contracts purchased under TFC's programs. On February 21,
2004, the $75 million facility expired and, as a result, the Company's current
warehouse credit capacity is $150 million. These facilities are independent of
each other. Two different institutions purchased the notes issued by these
11
facilities and three different insurers insured the notes. Approximately 71.6%
to 73.0% 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. Long-term funding for the purchase of Contracts is achieved by
the Company through term securitization transactions, in which the liabilities
(the asset-backed securities) are repaid as the underlying Contracts amortize.
Proceeds from term securitization transactions are used primarily to repay the
warehouse facilities. The Company completed four term securitization
transactions in 2003 and three term securitization transactions in 2002.
In a securitization, 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 the principal balance plus accrued and unpaid
interest. 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 or financing of a portfolio of Contracts in a securitization
transaction, generally utilizing 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
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 Company is entitled under most of the Servicing Agreements to receive a base
monthly servicing fee between 2.5% and 5.0% per annum computed as a percentage
of the declining outstanding principal balance of the non-defaulted Contracts in
12
the pool. 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 pool 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 pool. The "Spread Account" is an account
established at the time the Company sells a pool 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 or other credit enhancement to the extent required, next, in
certain cases to cover deficiencies in Spread Accounts for other pools, 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 five scheduled installments past due or, in the case
of repossessions, the month that the proceeds from the liquidation of the
financed vehicle are received by the Company 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
pool 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 ("Note Insurers") in the event of certain defaults by the
Company and under certain other circumstances. Were a Note Insurer 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
vehicles, and captive finance companies affiliated with major automobile
manufacturers such as General Motors Acceptance Corporation, Ford Motor Credit
Corporation, Chrysler Finance 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.
13
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."
EMPLOYEES
As of December 31, 2003, the Company had 681 full-time and 11 part-time
employees, of whom 7 are senior management personnel, 404 are collections
personnel, 108 are Contract origination personnel, 56 are marketing personnel
(42 of whom are marketing representatives), 72 are operations and systems
personnel, and 34 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.
14
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 base rent is approximately $1.9 million through October 2003,
and increases to $2.1 million for the following five years. In addition to 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
$454,525 per year, increasing to $501,545 over a 10-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
STANWICH LITIGATION. CPS 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 CPS, 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. CPS 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 CPS.
In November 2001, one of the defendants in the Stanwich Case, Jonathan Pardee,
asserted claims for indemnity against CPS in a separate action, which is now
pending in federal district court in Rhode Island. CPS has filed counterclaims
in the Rhode Island federal court against Mr. Pardee. CPS is defending this
matter and pursuing its counterclaims vigorously.
In February 2002, CPS entered into a term sheet with Stanwich, the plaintiffs in
the Stanwich Case and others, which provides for CPS's release upon its
repayment of the amounts concededly owed to Stanwich, all of which amounts have
been recorded in CPS's financial statements as indebtedness.
The California court in December 2003 preliminarily approved a settlement of the
Stanwich Case. That settlement will result in CPS being released from all claims
pending in the California court, other than an alleged contractual indemnity in
favor of one of the financial institution co-defendants. As to that institution,
CPS has an agreement in principle to settle its cross-claim. The court-approved
settlement requires of CPS only that it repay the amounts it concededly owes to
Stanwich, all of which amounts have been recorded in CPS's financial statements
as indebtedness.
The reader should consider that any adverse judgment against CPS in the Stanwich
Case (or the related case in Rhode Island) for indemnification, in an amount
materially in excess of any liability already recorded in respect thereof, could
have a material adverse effect.
OTHER LITIGATION. On November 15, 2000, Denice and Gary Lang filed a lawsuit
against CPS 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, to the right to
purchase the vehicle by tender of the full amount owed under the retail
installment contract. They sought damages in an unspecified amount. CPS filed a
counterclaim to recover any delinquent amounts owed by the members of the
putative class in the event that the class were to be certified. In February
2004, CPS reached an agreement to settle that case on a class basis for payment
of attorneys' fees and other immaterial consideration.
15
On September 26, 2001, Maggie Chandler, Bobbie Mike and Mary Ann Benford each
commenced a lawsuit against subsidiaries of MFN (now subsidiaries of CPS) in
three different state courts in Mississippi. A similar case was filed in
December 2002 in a fourth Mississippi court. Plaintiffs in all four cases
alleged deceptive practices related to various loans and the related purchase
and sale of insurance, and sought unspecified damages. In September 2003, the
defendant subsidiaries reached an agreement in principle to settle all such
cases, and any similar cases that might be brought by other clients of the same
plaintiff law firms.
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:
CHARLES E. BRADLEY, JR., 44, 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., 51, 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, 59, has been Senior Vice President - Collections 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.
MARK A. CREATURA, 44, 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.
CURTIS K. POWELL, 47, 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.
ROBERT E. RIEDL, 40, has been Senior Vice President - Chief Financial Officer
since August 2003. Mr. Riedl joined the Company as Senior Vice President - Risk
Management in January 2003. Mr. Riedl was a Principal at Northwest Capital
Appreciation ("NCA"), a middle market private equity firm, from 2000 to 2002.
For a year prior to joining Northwest Capital, Mr. Riedl served as Senior Vice
President for one of NCA's portfolio companies, SLP Capital. Mr. Riedl was an
investment banker for ContiFinancial Services Corporation from 1995 until
joining SLP Capital in 1999.
CHRISTOPHER TERRY, 36, has been Senior Vice President - Asset Recovery since
January 2003. He joined the Company in January 1995 as a loan officer, held a
series of successively more responsible positions, and was promoted to Vice
President - Asset Recovery in June 1999. Mr. Terry was previously a branch
manager with Norwest Financial from 1990.
16
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, 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
January 1 - March 31, 2003.................................... 2.200 1.500
April 1 - June 30, 2003....................................... 3.455 1.630
July 1 - September 30, 2003................................... 3.700 2.480
October 1 - December 31, 2003................................. 4.180 2.750
As of March 15, 2004, there were 88 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 cash flow for use in the Company's operations.
The table below presents information regarding outstanding options to purchase
the Company's Common Stock.
WEIGHTED-AVERAGE EXERCISE NUMBER OF SECURITIES REMAINING
NUMBER OF SECURITIES TO PRICE OF OUTSTANDING AVAILABLE FOR FUTURE ISSUANCE
BE ISSUED UPON EXERCISE OPTIONS, WARRANTS AND UNDER EQUITY COMPENSATION
OF OUTSTANDING OPTIONS, RIGHTS PLANS (EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS AND RIGHTS DECEMBER 31, 2003 REFLECTED IN COLUMN (a))
------------- ----------------------- ------------------------- ------------------------------
(a) (b) (c)
Equity compensation plans
approved by security 3,872,269 $1.96 146,631
holders
Equity compensation plans
not approved by security None N/A N/A
holders
Total 3,872,269 $1.96 146,631
17
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
2003 2002 2001 2000 (1) 1999 (1)
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Gain (loss) on sale of Contracts, net (2) ......... $ 6,369 $ 16,444 $ 32,765 $ 16,234 $ (14,844)
Interest income ................................... 58,164 48,644 17,205 3,480 3,032
Servicing fees .................................... 17,058 14,621 10,666 15,848 27,761
Total revenue ..................................... 100,934 93,314 62,576 35,951 14,805
Operating expenses ................................ 103,973 93,252 62,256 68,354 86,968
Income (loss) before extraordinary item (3) ....... 395 2,996 320 (22,147) (44,532)
Extraordinary item (4) ............................ -- 17,412 -- -- --
Net income (loss) ................................. 395 20,408 320 (22,147) (44,532)
Basic income (loss) per share before ex. item ..... 0.02 0.15 0.02 (1.10) (2.38)
Diluted income (loss) per share before ex. item ... 0.02 0.14 0.02 (1.10) (2.38)
Basic income (loss) per share, ex. item ........... -- 0.87 -- -- --
Diluted income (loss) per share, ex. item ......... -- 0.83 -- -- --
Basic income (loss) per share ..................... 0.02 1.03 0.02 (1.10) (2.38)
Diluted income (loss) per share ................... 0.02 0.97 0.02 (1.10) (2.38)
DECEMBER 31,
-----------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and restricted cash ...................... $ 100,486 $ 51,859 $ 13,924 $ 24,315 $ 3,324
Finance receivables, net ...................... 266,189 84,592 -- 18,830 2,421
Residual interest in securitizations .......... 111,702 127,170 106,103 99,199 172,530
Total assets .................................. 492,470 285,448 151,204 175,694 220,314
Term debt ..................................... 384,622 175,942 82,555 102,614 119,173
Total liabilities ............................. 410,310 202,874 89,518 113,572 135,877
Total shareholders' equity .................... 82,160 82,574 61,686 62,122 84,437
____________
(1) Beginning with the year ended December 31, 1999 and through December 31,
2000, the Company did not sell any Contracts in securitization transactions.
(2) The decrease in 2003 is primarily the result of the change in securitization
structure implemented in the third quarter of 2003.
(3) Results for 2003 and 2002, include a tax benefit of $3.4 million and $2.9
million, respectively.
(4) 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.
18
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,
2003 include the results of operations of TFC Enterprises, Inc. for the period
subsequent to May 20, 2003, the TFC Merger date, through December 31, 2003. 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 MFN
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") specialize in 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 MFN Financial Corporation and its
subsidiaries in a merger (the "MFN Merger"). On May 20, 2003, the Company
acquired TFC Enterprises, Inc. and its subsidiaries in a second merger (the "TFC
Merger"). Each merger was accounted for as a purchase. MFN Financial Corporation
and its subsidiaries ("MFN") and TFC Enterprises, Inc. and its subsidiaries
("TFC") were engaged in businesses similar to that of the Company: buying
Contracts from Dealers, repackaging those Contracts in securitization
transactions, and servicing those Contracts. MFN ceased acquiring Contracts in
May 2002; TFC continues to acquire Contracts under its "TFC Programs," which
provide financing for vehicle purchases exclusively by members of the United
States armed forces.
The Company historically has generated revenue primarily from the gains
recognized on the sale or securitization of Contracts, servicing fees earned on
Contracts sold, interest earned on Residuals, as defined below, and interest on
finance receivables. During the years ended December 31, 2002 and 2001, the
Company sold some Contracts on a servicing released basis, as part of a program
(the "flow purchase program") in which the Company sold Contracts to
unaffiliated third parties immediately after purchasing such Contracts from
Dealers. The flow purchase program ended in May 2002. During the years ended
December 31, 2002 and 2001, the Company's gain on sale of Contracts included,
$5.7 million and $16.6 million, respectively, representing mark-up on Contracts
sold in the flow purchase program.
SECURITIZATION
GENERALLY
Throughout the periods for which information is presented in this report, the
Company has purchased Contracts with the intention of repackaging them in
securitizations. All such securitizations have involved identification of
specific Contracts, sale of those Contracts (and associated rights) to a special
purpose subsidiary of the Company, and issuance of asset-backed securities to
fund the transactions. Depending on the structure of the securitization, the
transaction may properly be accounted for as a sale of the Contracts, or as a
secured financing.
When structured to be treated as a secured financing, the subsidiary is
consolidated with the Company. Accordingly, the sold Contracts and the related
securitization trust debt appear as assets and liabilities, respectively, of the
19
Company on its Consolidated Balance Sheet. The Company then recognizes interest
and fee income on the receivables and interest expense on the securities issued
in the securitization, and records as expense a provision for probable credit
losses on the receivables and other expenses.
When structured to be treated as a sale, the subsidiary is not consolidated with
the Company. Accordingly, the securitization removes the sold Contracts from the
Company's Consolidated Balance Sheet, the asset-backed securities (debt of the
non-consolidated subsidiary) do not appear as debt of the Company, and the
Company shows, as an asset, a retained 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.
CHANGE IN POLICY
During August 2003 the Company announced that it would structure its future
securitization transactions to be reflected as secured financings for financial
accounting purposes. The first two term securitizations so structured occurred
in September and December 2003. The Company had structured all of its prior term
securitization transactions to be treated as sales for financial accounting
purposes. In the MFN Merger and in the TFC Merger the Company acquired finance
receivables that had been previously securitized in term securitization
transactions that were reflected as secured financings. As of December 31, 2003,
the Company's Consolidated Balance Sheet included net finance receivables of
approximately $119.6 million and securitization trust debt of $95.9 million
related to finance receivables acquired in the two mergers, out of totals of net
finance receivables of approximately $266.2 million and securitization trust
debt of approximately $245.1 million.
CREDIT RISK RETAINED
Whether a securitization is treated as a secured financing or as a sale for
financial accounting purposes, the related special purpose subsidiary may be
unable to release excess cash to the Company if the credit performance of the
securitized 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 securitized
Contracts could therefore have a material adverse effect on both the Company's
liquidity and its results of operations, regardless of whether such Contracts
are treated as having been sold or as having been financed. For estimation of
the magnitude of such risk, it may be appropriate to look to the size of the
Company's managed portfolio, which represents both financed and sold Contracts
as to which such credit risk is retained. The Company's managed portfolio as of
December 31, 2003 was approximately $741.1 million.
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 allowance 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 its portfolio
of finance receivable Contracts. Provision for loss is charged to the Company's
Consolidated Statement of Operations. Net losses incurred on finance receivables
are charged to the allowance. Management evaluates the adequacy of the allowance
20
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) TREATMENT OF SECURITIZATIONS
Gain on sale may be recognized on the disposition of Contracts either outright
or in securitization transactions. In those securitization transactions that
were treated as sales for financial accounting purposes, the Company, or a
wholly-owned, consolidated subsidiary of the Company, retains a residual
interest in the Contracts that were sold to a wholly-owned, unconsolidated
special purpose subsidiary. The Company's securitization transactions include
"term" securitizations (the purchaser holds the Contracts for substantially
their entire term) and "continuous" or "warehouse" securitizations (which
finance the acquisition of the Contracts for future sale into term
securitizations).
As of December 31, 2002 the line item "Residual interest in securitizations" on
the Company's Consolidated Balance Sheet includes residual interests in both
term and warehouse securitizations. As of December 31, 2003 the line item
"Residual interest in securitizations" on the Company's Consolidated Balance
Sheet represents the residual interests in certain term securitizations but no
residual interest in warehouse securitizations, because the Company's warehouse
securitizations were restructured in July 2003 as secured financings. Subsequent
term securitizations in September 2003 and December 2003 were also structured as
secured financings. The warehouse securitizations are accordingly reflected in
the line items "Finance receivables" and "Warehouse lines of credit" on the
Company's Consolidated Balance Sheet, and the term securitizations are reflected
in the line items "Finance receivables" and "Securitization trust debt." The
"Residual interest in securitizations" 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 residual interests in
securitizations as of December 31, 2003 and 2002 are included in the table
below. The pre-tax discount rate remained constant at 14%.
2003 2002
------------- -------------
Prepayment speed (Cumulative)......... 18.1% - 22.1% 19.8% - 22.9%
Credit losses (Cumulative)............ 11.8% - 18.0% 10.0% - 15.4%
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, 2003
-----------------
(DOLLARS IN
THOUSANDS)
Carrying amount/fair value of residual interest in securitizations............. $ 111,702
Weighted average life in years................................................. 3.74
Prepayment Speed Assumption (Cumulative)....................................... 18.1% - 22.1%
Estimated fair value assuming 10% adverse change............................... $ 110,938
Estimated fair value assuming 20% adverse change............................... 110,916
Expected Credit Losses (Cumulative)............................................ 11.8% - 18.0%
Estimated fair value assuming 10% adverse change............................... $ 100,907
Estimated fair value assuming 20% adverse change............................... 90,312
Residual Cash Flows Pre-tax Discount Rate (Annual)............................. 14.0%
Estimated fair value assuming 10% adverse change............................... $ 109,594
Estimated fair value assuming 20% adverse change............................... 107,477
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
21
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.
The Company's securitization structure has generally been as follows:
The Company sells Contracts it acquires 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 another entity, typically a statutory trust ("Trust"). 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 (a "Note Insurer").
In addition, the Company provides "Credit Enhancement" for the benefit of the
Note Insurer and the investors in the form of an initial cash deposit to an
account ("Spread Account") held by the Trust, in the form of
overcollateralization of the Notes, where the principal balance of the Notes
issued is less than the principal balance of the Contracts, in the form of
subordinated Notes, or some combination of such Credit Enhancements. The
agreements governing the securitization transactions (collectively referred to
as the "Securitization Agreements") require that the initial level of Credit
Enhancement be supplemented by a portion of collections from the Contracts until
the level of Credit Enhancement reaches 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 Contracts. The specified
levels at which the Credit Enhancement is to be maintained will vary depending
on the performance of the pools 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 various pools, 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 of the Contracts has amortized to a specified
percentage of the initial aggregate balance.
The prior securitizations that are treated as sales for financial accounting
purposes differ from secured financings in that the Trust to which the SPS sells
the Contracts meets the definition of a "qualified special purpose entity" under
Statement of Financial Accounting Standards No. 140 ("SFAS 140"). As a result,
assets and liabilities of the Trust are not consolidated into the Company's
Consolidated Balance Sheet.
The Company's warehouse securitization structures were similar to the above,
except that (i) the SPS that purchases the Contracts pledges the Contracts to
secure promissory notes which it issues, (ii) the promissory notes are in an
aggregate principal amount of not more than 71% to 73% of the aggregate
principal balance of the Contracts (that is, at least 27%
overcollateralization), and (iii) no increase in the required amount of Credit
Enhancement is contemplated unless certain portfolio performance tests are
breached. During the quarter ended September 30, 2003 the warehouse
securitizations related to the CPS programs were amended to cause the
transactions to be treated as secured financings for financial accounting
purposes. The Contracts held by the warehouse SPSs and the promissory notes that
they issue are therefore included in the Company's Consolidated Financial
Statements as of December 31, 2003 as assets and liabilities, respectively.
Upon each sale of Contracts in a securitization structured as a secured
financing, whether a term securitization or a warehouse securitization, the
Company retains on its Consolidated Balance Sheet the Contracts securitized as
assets and records the Notes issued in the transaction as indebtedness of the
Company.
22
Under the prior securitizations structured as sales for financial accounting
purposes, the Company removed from its Consolidated Balance Sheet the Contracts
sold and added to its Consolidated Balance Sheet (i) the cash received, if any,
and (ii) the estimated fair value of the ownership interest that the Company
retains in Contracts sold in the securitization. That retained or residual
interest (the "Residual") consists of (a) the cash held in the Spread Account,
if any, (b) overcollateralization, 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. Until the maturity of these transactions, the Company's Consolidated
Balance Sheet will reflect both securitization transactions structured as sales
and others structured as secured financings.
With respect to securitizations structured as sales for financial accounting
purposes, the Company allocates its basis in the Contracts between the Notes
sold and the Residuals 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 anticipated cash
flows include collections from both current and charged off receivables. The
Company has used an effective pre-tax discount rate of approximately 14% per
annum.
The Company receives periodic base servicing fees for the servicing and
collection of the Contracts. In addition, the Company is entitled to the cash
flows from the Trusts that represent collections on the Contracts in excess of
the amounts required to pay principal and interest on the Notes, the base
servicing fees, and certain other fees (such as trustee and custodial fees).
Required principal payments are generally 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),
or a pre-determined percentage of such balance. Where that percentage is less
than 100%, the related Securitization Agreements require accelerated payment of
principal until the principal balance of the Notes is reduced to the specified
percentage. Such accelerated principal payment is said to create
overcollateralization 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
withdrawn 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 or other form of Credit Enhancement, 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 total Credit
Enhancement amount is not at the required level, then the excess cash collected
is retained in the Trust 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 (in the case of securitization transactions structured as
sales for financial accounting purposes) or the Trusts (in the case of
securitization transactions structured as secured financings for financial
accounting purposes), 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 recovery rates, 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
18.1% to 22.1% 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
23
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
charge-offs as a percentage of the original principal balance will approximate
15.9% to 23.1% cumulatively over the lives of the related Contracts, with
recovery rates approximating 2.2% to 5.3% of the original principal balance.
Following a securitization that is structured as a sale for financial accounting
purposes, interest income is recognized on the balance of the Residuals at the
same rate as used for calculating the present value of the NIRs, which is 14%
per annum. In addition, the Company will recognize additional revenue from the
Residuals if the actual performance of the Contracts is better than the original
estimate. If the actual performance of the Contracts were worse than the
original estimate, then a downward adjustment to the carrying value of the
Residuals and a related expense would be required. In a securitization that is
structured as a secured financing for financial accounting purposes, interest
income is recognized when accrued under the terms of the related Contracts and,
therefore, presents less potential for fluctuations in performance when compared
to the approach used in a transaction structured as a sale for financial
accounting purposes.
In all the Company's term securitizations, whether treated as secured financings
or as sales, the Company has sold the receivables (through a subsidiary) to the
securitization Trust. The difference between the two structures is that in
securitizations that are treated as secured financings the Company reports the
assets and liabilities of the securitization Trust on its Consolidated Balance
Sheet. Under both structures 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.
(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 more likely than not.
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.
RESULTS OF OPERATIONS
ACQUISITIONS
The Company's Consolidated Balance Sheet and Consolidated Statement of
Operations as of and for the years ended December 31, 2003 and 2002 include the
results of operations of MFN Financial Corporation for the period subsequent to
March 8, 2002, the date on which the Company acquired that corporation and its
subsidiaries in the MFN Merger. See Note 2 of Notes to Consolidated Financial
Statements, Acquisition of MFN Financial Corporation.
24
The Company's Consolidated Balance Sheet and Consolidated Statement of
Operations as of and for the year ended December 31, 2003 include the results of
operations of TFC Enterprises, Inc. for the period subsequent to May 20, 2003,
the date on which the Company acquired that corporation and its subsidiaries in
the TFC Merger. See Note 2 of Notes to Consolidated Financial Statements,
Acquisition of TFC Enterprises, Inc.
EFFECTS OF CHANGE IN SECURITIZATION STRUCTURE
The Company's July 2003 decision to structure future securitization transactions
as borrowings secured by receivables for financial accounting purposes, rather
than as sales of receivables, has affected and will affect the way in which the
transactions are reported. The major effects are these: (i) the finance
receivables are shown as assets of the Company on its balance sheet; (ii) the
debt issued in the transactions is shown as indebtedness of the Company; (iii)
cash posted to enhance the credit of the securitization transactions ("Spread
Accounts") is shown as "Restricted cash" on the Company's balance sheet; (iv)
the servicing fee that the Company receives in connection with such receivables
is recorded as a portion of the interest earned on such receivables; (v) the
Company has initially and will periodically record as expense a provision for
estimated credit losses on the receivables; and (vi) the portion of scheduled
payments on the receivables representing interest is recorded as revenue as
accrued.
These changes collectively represent a deferral of revenue and acceleration of
expenses, and thus a more conservative approach to accounting for the Company's
operations. The changes initially have resulted in the Company's reporting lower
earnings than it would have reported if it had continued to structure its
securitizations to require recognition of gain on sale. As a result, reported
earnings have been less than they would have been had the Company continued to
structure its securitizations to record a gain on sale and, accordingly,
reported net earnings may be negative or nominally positive for approximately
the next year. Growth in the Company's portfolio of receivables in excess of
current expectations would further delay achievement of positive net earnings.
The Company's cash availability and cash requirements should be unaffected by
the change in structure.
The Company's first two term securitizations structured as secured financings
closed in September and December 2003. The Company's MFN and TFC subsidiaries
completed term securitizations structured as secured financings prior to
becoming subsidiaries of the Company. The structures of the Company's two
warehouse securitization transactions that relate to the CPS programs were
amended in July 2003 to be treated as secured financings for financial
accounting purposes. The Company's third warehouse securitization credit
facility, which relates to the TFC programs, has been structured as a secured
financing for financial accounting purposes since the date of the TFC Merger.
THE YEAR ENDED DECEMBER 31, 2003 COMPARED TO THE YEAR ENDED DECEMBER 31, 2002
REVENUES. During the year ended December 31, 2003, revenues were $100.9 million,
an increase of $7.6 million, or 8.2%, from the prior year revenue of $93.3
million. With the change in securitization structure and consequent end to
recording gain on sale revenue in the third quarter of 2003, net gain on sale of
Contracts decreased $10.1 million, or 61.3%, to $6.4 million in 2003, compared
to $16.4 million in 2002. The 2003 gain on sale amount is net of a negative fair
value adjustment of $4.1 million related to the Company's analysis and estimate
of the expected ultimate performance of the Company's previously securitized
pools which are held by non-consolidated subsidiaries. The decrease in gain on
sale from 2002 to 2003 was partially offset by a negative fair value adjustment
of approximately $2.5 million recorded during the first quarter of 2002 related
to the Company's residual interest in securitizations. Also in the first quarter
of 2002, the Company recognized a charge of approximately $500,000 related to a
loss realized upon the sale of a subordinated certificate ("B Piece") from the
Company's 2002-A securitization.
Interest income for the year ended December 31, 2003 increased $9.5 million, or
19.6%, to $58.2 million in 2003 from $48.6 million in 2002. The primary reasons
for the increase in interest income are the change in securitization structure,
25
the interest income earned on the portfolio of Contracts acquired in the TFC
Merger and an increase in residual interest income. This increase was partially
offset by the decline in the balance of the portfolio of Contracts acquired in
the MFN Merger.
Servicing fees totaling $17.1 million in the year ended December 31, 2003
increased $2.4 million, or 16.7%, from $14.6 million in the same period a year
earlier. The increase in servicing fees can be attributed to the growth of the
Company's managed portfolio held by non-consolidated subsidiaries related to the
CPS programs. For the year ended December 31, 2003, the Company's managed
portfolio held by non-consolidated subsidiaries had an average outstanding
principal balance approximating $489.9 million, compared to $347.3 for the year
ended December 31, 2002. At December 31, 2003, the Company's managed portfolio
held by consolidated subsidiaries had an outstanding principal balance
approximating $315.6 million, compared to $117.1 million as of December 31,
2002. As a result of the decision to structure future securitizations as secured
financings, the Company's managed portfolio held by non-consolidated
subsidiaries will decline in future periods, and servicing fee revenue is
anticipated to decline proportionately.
At December 31, 2003, the Company was generating income and fees on a managed
portfolio with an outstanding principal balance approximating $741.1 million,
compared to a managed portfolio with an outstanding principal balance
approximating $595.2 million as of December 31, 2002. As the portfolio of
Contracts acquired in the MFN Merger amortizes, the portfolio of Contracts
originated under the CPS and TFC programs continues to expand. At December 31,
2003 and 2002, the managed portfolio composition was as follows:
DECEMBER 31, 2003 DECEMBER 31, 2002
-------------------- --------------------
AMOUNT % AMOUNT %
--------- ------- --------- -------
ORIGINATING ENTITY ($ IN MILLIONS)
CPS .................. $ 543.8 73.4% $ 394.3 66.2%
TFC .................. 123.6 16.7 -- --
MFN .................. 73.7 9.9 200.9 33.8
--------- ------- --------- -------
Total ................ $ 741.1 100.0% $ 595.2 100.0%
========= ======= ========= =======
Other income increased 42% to $19.3 million in 2003 from $13.6 million in 2002.
The period over period increase can be attributed in part to the receipt of
state sales tax refunds of $3.2 million during third quarter of 2003 and
recoveries on previously charged off MFN Contracts totaling $12.2 million for
the year ended December 31, 2003, compared to $10.5 million for the comparable
period in 2002.
EXPENSES. 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 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 the unemployment level, and mix
of business between Contracts purchased on a flow basis and Contracts purchased
on an other than flow basis. The Company ceased to purchase Contracts on a flow
basis in May 2002.
Personnel costs include base salaries, commissions and bonuses paid to
employees, and certain expenses related to the accounting treatment of
outstanding stock options, and are one of the Company's most significant
operating expenses. These costs (other than those relating to stock options)
generally fluctuate with the level of applications and Contracts processed and
serviced.
Other operating expenses consist primarily of interest expense, provisions for
credit losses, 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.
Total operating expenses were $104.0 million for the year ended December 31,
2003, compared to $93.3 million for the same period in 2002. Total operating
26
expenses for the year ended December 31, 2003 would have been significantly
lower except for the $11.4 million provision for credit loss expense recorded
during the third and fourth quarters of 2003. Such provision for credit loss is
a result of the decision to structure securitizations as financings, rather than
as sales. Provisions for credit loss expense should be anticipated to increase
in future periods.
Personnel costs decreased to $37.1 million during the year ended December 31,
2003, representing 35.7% of total operating expenses, compared to $37.8 million
for the 2002 period, or 40.5% of total operating expenses. The decrease is
primarily the result of staff reductions since the MFN Merger in 2002 related to
the integration and consolidation of certain service and administrative
activities and the decline in the balance of the portfolio of Contracts acquired
in the MFN Merger. This decrease was partially offset by staff additions related
to the TFC Merger in May 2003.
In connection with the termination of MFN origination activities and the
integration and consolidation of certain activities (see above) related to the
MFN Merger and the TFC Merger, the Company has recognized certain liabilities
related to the costs to exit these activities and terminate the affected
employees of MFN and TFC. 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 to $21.3 million, or 20.5% of
total operating expenses, in the year ended December 31, 2003, from $20.1
million, or 21.6% of total operating expenses, in the same period of 2002. The
decrease as a percentage of total operating expenses is a result primarily of
the change in securitization structure during the third quarter of 2003 which
increased total expenses, and of continued general cost cutting during the
period, offset in part by an increase in legal and other corporate expenses.
Interest expense for the year ended December 31, 2003, decreased $64,000, or
0.3%, to $23.9 million in 2003. The slight decrease is the result of changes in
the amount and composition of securitization trust debt carried on the Company's
Consolidated Balance Sheet: such debt related to the MFN Merger declined as it
was paid down, partially offset by the addition of securitization trust debt
associated with the TFC Merger and with the securitizations subsequent to the
Company's change in securitization structure. As the Company continues to
structure future securitization transactions as secured financings, the balances
of securitization trust debt and the related interest expense are expected to
increase.
Marketing expenses decreased by $873,000, or 14.0%, and represented 5.2% of
total operating expenses. The decrease is primarily due to the decrease in
Contracts purchased by the Company during the year ended December 31, 2003.
Occupancy expenses decreased by $97,000, or 2.4%, and represented 3.8% of total
operating expenses. The decrease is primarily due to the closure during 2003 of
certain facilities acquired in the MFN Merger. The decrease was partially offset
by the addition of facilities acquired in the TFC Merger.
Depreciation and amortization expenses decreased by $138,000, or 12.1%, to $1.0
million from $1.1 million.
Income tax benefit of $3.4 million and $2.9 million was recorded in the 2003 and
2002 periods, respectively. The 2003 benefit is primarily the result of the
resolution of certain Internal Revenue Service examinations of previously filed
MFN tax returns, resulting in a tax benefit of $4.9 million, and other state tax
matters which have been included in the current period tax provision. The 2002
benefit is due to tax legislation passed in early 2002, which enabled the
Company to reverse a previously recorded valuation allowance of approximately
$3.2 million, as well as to record benefit during the same 2002 period. The
Company does not expect any comparable income tax benefit in future periods.
27
EXTRAORDINARY ITEM. The year ended December 31, 2002 included $17.4 million of
unallocated negative goodwill, which represented the difference between the net
assets acquired and the purchase price paid by the Company in connection with
the MFN Merger.
THE YEAR ENDED DECEMBER 31, 2002 COMPARED TO THE YEAR ENDED DECEMBER 31, 2001
REVENUE. During the year ended December 31, 2002, revenues increased $30.7
million, or 49.1%, to $93.3 million compared to $62.6 million for 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 decrease in Contract purchases to
$463.2 million in 2002 from $672.3 million in 2001. This reduction was primarily
a result of the termination of the flow purchase program in May 2002. 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 credit losses 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 credit
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 pre-tax charge to gain on sale of approximately $2.5 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 managed
portfolio held by consolidated subsidiaries, 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
managed portfolio, net of unearned income on pre-computed Contracts, was $595.2
million ($200.9 million represented Contracts acquired in the MFN Merger),
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 th