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
(State or other jurisdiction of
incorporation or organization)
16355 Laguna Canyon Road, Irvine, California
(Address of principal executive offices)
33-0459135
(I.R.S. Employer
Identification No.)
92618
(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
Rising Interest Subordinated Redeemable Securities due 2006
New York Stock Exchange
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.
This annual report of Consumer Portfolio Services, Inc. consists of Items 1 through 9 of our report on Form 10-K as
filed with the Securities and Exchange Commission.
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.
Texas ...................................................
Louisiana .............................................
Pennsylvania........................................
Illinois..................................................
California.............................................
Ohio .....................................................
Florida .................................................
North Carolina .....................................
Michigan..............................................
Maryland .............................................
Georgia ................................................
Kentucky .............................................
New York ............................................
Alabama...............................................
Other States .........................................
Total.....................................................
____________
Percent (2)
Percent (2)
Contracts Purchased During the Year Ended (1)
December 31, 2003
December 31, 2002
Number
Number
3,313
2,333
1,680
1,637
1,539
1,567
2,274
1,466
2,111
1,461
1,733
1,398
1,453
1,343
1,979
1,281
1,776
1,258
945
1,070
1,831
1,046
1,449
948
1,215
932
1,288
814
5,346
7,669
23,900
32,255
9.8%
6.8
6.6
6.1
6.1
5.8
5.6
5.4
5.3
4.5
4.4
4.0
3.9
3.4
22.4
10.3%
5.2
4.8
7.1
6.5
5.4
4.5
6.1
5.5
2.9
5.7
4.5
3.8
4.0
23.7
100.0%
100.0%
(1) Excludes purchases under the TFC programs.
(2) Amounts may not total 100% due to rounding.
3
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 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
4
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. 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
5
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.
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
6
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.
Delinquency Experience (1)
CPS, MFN and TFC Combined
December 31, 2003
Number of
Contracts
Amount
December 31, 2002
Number of
Contracts
Amount
(Dollars in thousands)
December 31, 2001
Number of
Contracts
Amount
Gross servicing portfolio (1) ..... 84,860
Period of delinquency (2)
2,506
31-60 days .................................
61-90 days ................................. 1,340
91+ days .................................... 1,522
Total delinquencies (2) .............. 5,368
Amount in repossession (3) ....... 1,242
Total delinquencies and
$ 773,220
86,940
$ 616,519
44,080
$ 288,756
17,982
8,942
9,452
36,376
11,751
3,658
1,541
825
6,024
1,402
18,388
6,595
3,422
28,405
10,835
2,149
721
552
3,422
787
12,409
4,018
3,488
19,915
5,757
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%
7
CPS
December 31, 2003
Number of
Contracts
Amount
Gross servicing portfolio (1) ..... 47,615
Period of delinquency (2)
1,175
31-60 days .................................
61-90 days ................................. 657
91+ days .................................... 393
Total delinquencies (2) .............. 2,225
Amount in repossession (3) .......
725
Total delinquencies and
$543,776
11,766
5,719
3,105
20,590
8,434
December 31, 2002
Number of
Amount
Contracts
(Dollars in thousands)
43,244
$394,845
December 31, 2001
Number of
Contracts
Amount
44,080
$ 288,756
1,734
643
282
2,659
654
10,738
3,619
1,508
15,865
6,305
2,149
721
552
3,422
787
12,409
4,018
3,488
19,915
5,757
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%
MFN
December 31, 2003
Number of
Contracts
December 31, 2002
Number of
Amount
Contracts
(Dollars in thousands)
$77,717
43,696
$ 221,674
Amount
2,128
843
532
3,503
1,899
1,924
898
543
3,365
748
7,650
2,976
1,914
12,540
4,530
Gross servicing portfolio (1) ..... 20,282
Period of delinquency (2)
769
31-60 days .................................
327
61-90 days .................................
91+ days ....................................
227
Total delinquencies (2) .............. 1,323
Amount in repossession (3) .......
369
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%
8
TFC
December 31, 2002
Number of
Contracts
Amount
(Dollars in thousands)
$ 151,727
16,963
562
356
902
1,820
148
4,088
2,380
5,815
12,283
1,418
1,968
$ 13,701
10.7%
8.1%
11.6%
9.0%
Gross servicing portfolio (1)....
Period of delinquency (2)
31-60 days................................
61-90 days................................
91+ days...................................
Total delinquencies (2) ............
Amount in repossession (3) .....
Total delinquencies and
amount in repossession (2)...
Delinquencies as a percentage
of gross servicing portfolio ..
Total delinquencies and
amount in repossession as a
percentage of gross
servicing portfolio ................
____________
(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
2003
Average servicing portfolio outstanding .......................................... $ 674,523
Net charge-offs as a percentage of average
servicing portfolio (2) (3).................................................................
6.8%
Year Ended December 31,
2002
(Dollars in thousands)
$ 524,286
2001
$ 341,498
8.6%
6.2%
CPS
2003
Year Ended December 31,
2002
(Dollars in thousands)
$ 291,863
483,647
2001
$ 341,498
4.7%
5.0%
6.2%
Average servicing portfolio outstanding .......................................... $
Net charge-offs as a percentage of average
servicing portfolio (2).......................................................................
9
MFN
Year Ended
December 31, 2003
(Dollars in thousands)
Average servicing portfolio outstanding ......................................... $ 123,140
Net charge-offs as a percentage of average
servicing portfolio (2)......................................................................
12.6%
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%
___________
Year Ended
December 31, 2002
(Dollars in thousands)
$ 278,908
11.0%
(1) All amounts and percentages are based on the principal amount scheduled to be paid on each Contract, net of unearned
income on pre-computed Contracts. The information in the table represents all Contracts serviced by the Company.
(2) Net charge-offs include the remaining principal balance, after the application of the net proceeds from the liquidation of the
vehicle (excluding accrued and unpaid interest).
(3) The fluctuation in net charge-offs as a percentage of the average servicing portfolio between 2002 and 2001 is primarily due
to the addition of MFN Contracts, which are anticipated to charge off at rates greater than CPS Contracts.
(4) 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
10
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 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-
11
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.
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
12
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.
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.
13
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.
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
14
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.
15
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company’s Common Stock is traded on the Nasdaq National Market System, under the symbol “CPSS.”
The following table sets forth the high and low sales prices reported by Nasdaq for the Common Stock for the
periods shown.
January 1 - March 31, 2002......................................................................................................................
April 1 - June 30, 2002.............................................................................................................................
July 1 - September 30, 2002.....................................................................................................................
October 1 - December 31, 2002 ...............................................................................................................
January 1 - March 31, 2003......................................................................................................................
April 1 - June 30, 2003.............................................................................................................................
July 1 - September 30, 2003.....................................................................................................................
October 1 - December 31, 2003 ...............................................................................................................
High
2.000
3.250
2.650
2.290
2.200
3.455
3.700
4.180
Low
1.110
1.750
1.410
1.550
1.500
1.630
2.480
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.
Plan category
Equity compensation
plans approved by
security holders
Equity compensation
plans not approved by
security holders
Total
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
(a)
3,872,269
None
3,872,269
Weighted-average
exercise price of
outstanding options,
warrants and rights
December 31, 2003
(b)
$1.96
N/A
$1.96
Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column (a))
(c)
146,631
N/A
146,631
16
ITEM 6. SELECTED FINANCIAL DATA
2003
Year Ended December 31,
2000 (1)
2001
(In thousands, except per share data)
2002
1999 (1)
Statement of Operations Data:
Gain (loss) on sale of Contracts, net (2)..................... $
Interest income...........................................................
Servicing fees.............................................................
Total revenue .............................................................
Operating expenses ....................................................
Income (loss) before extraordinary item (3) ..............
Extraordinary item (4) ..............................................
Net income (loss) ......................................................
Basic income (loss) per share before ex. item............
Diluted income (loss) per share before ex. item.........
Basic income (loss) per share, ex. item......................
Diluted income (loss) per share, ex. item...................
Basic income (loss) per share.....................................
Diluted income (loss) per share..................................
6,369
58,164
17,058
100,934
103,973
395
—
395
0.02
0.02
—
—
0.02
0.02
$ 16,444
48,644
14,621
93,314
93,252
2,996
17,412
20,408
0.15
0.14
0.87
0.83
1.03
0.97
$ 32,765
17,205
10,666
62,576
62,256
320
—
320
0.02
0.02
—
—
0.02
0.02
$ 16,234
3,480
15,848
35,951
68,354
(22,147)
—
(22,147)
(1.10)
(1.10)
—
—
(1.10)
(1.10)
$ (14,844)
3,032
27,761
14,805
86,968
(44,532)
—
(44,532)
(2.38)
(2.38)
—
—
(2.38)
(2.38)
2003
2002
December 31,
2001
(In thousands)
2000
1999
Balance Sheet Data:
Cash and restricted cash............................................. $ 100,486
266,189
Finance receivables, net .............................................
111,702
Residual interest in securitizations.............................
492,470
Total assets.................................................................
384,622
Term debt...................................................................
410,310
Total liabilities ...........................................................
82,160
Total shareholders’ equity..........................................
$ 51,859
84,592
127,170
285,448
175,942
202,874
82,574
____________
$ 13,924 $ 24,315 $ 3,324
2,421
172,530
220,314
119,173
135,877
84,437
18,830
99,199
175,694
102,614
113,572
62,122
—
106,103
151,204
82,555
89,518
61,686
(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.
17
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following analysis of the financial condition of the Company should be read in conjunction with “Selected
Financial Data” and the Company’s Consolidated Financial Statements and the Notes thereto and the other
financial data included elsewhere in this report. The Company's Consolidated Balance Sheet and Consolidated
Statement of Operations as of and for the year ended December 31, 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,
18
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 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
19
the allowance. Management evaluates the adequacy of the allowance by examining current delinquencies, the
characteristics of the portfolio and the value of the underlying collateral. As conditions change, the Company’s
level of provisioning and/or allowance may change as well.
(b) 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%.
Prepayment speed (Cumulative).............................................
Credit losses (Cumulative) .....................................................
18.1% - 22.1%
11.8% - 18.0%
2003
2002
19.8% - 22.9%
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:
Carrying amount/fair value of residual interest in securitizations........................ $
Weighted average life in years .............................................................................
111,702
3.74
December 31, 2003
(Dollars in
thousands)
Prepayment Speed Assumption (Cumulative)......................................................
Estimated fair value assuming 10% adverse change............................................ $
Estimated fair value assuming 20% adverse change............................................
18.1% - 22.1%
110,938
110,916
Expected Credit Losses (Cumulative)..................................................................
Estimated fair value assuming 10% adverse change............................................ $ 100,907
90,312
Estimated fair value assuming 20% adverse change............................................
11.8% - 18.0%
Residual Cash Flows Pre-tax Discount Rate (Annual) ........................................
14.0%
Estimated fair value assuming 10% adverse change ............................................ $ 109,594
107,477
Estimated fair value assuming 20% adverse change............................................
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
20
relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the
effect of a variation in a particular assumption on the fair value of the retained interest is calculated without
changing any other assumption; in reality, changes in one factor may result in changes in another (for example,
increases in market rates may result in lower prepayments and increased credit losses), which could magnify or
counteract the sensitivities.
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.
21
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
22
characteristics of the Contracts purchased by the Company. The Company estimates recovery rates of
previously charged off receivables using available historical recovery data and projected future recovery
levels. In valuing the Residuals, the Company estimates that 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.
23
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, the interest income earned on the portfolio of Contracts acquired in the TFC Merger
24
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
million 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 $595.2 million as of December 31, 2002. As the portfolio of
Contracts acquired in the MFN Merger amortizes, the portfolio of Contracts originated under the CPS and TFC
programs continues to expand. At December 31, 2003 and 2002, the managed portfolio composition was as
follows:
Amount
December 31, 2003
%
($ in millions)
December 31, 2002
%
Amount
Originating Entity
CPS.................................................................. $ 543.8
TFC..................................................................
123.6
MFN ................................................................
73.7
Total................................................................. $ 741.1
73.4 %
16.7
9.9
$ 394.3
—
200.9
66.2%
—
33.8
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 expenses for the year ended December 31, 2003 would
25
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.
26
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 the year ended December 31, 2001. Servicing fees consist of base fees, which are
payable at the rate of 2.5% per annum on the principal balance of the outstanding CPS Contracts (5.0% on
MFN Contracts) in the related Trusts, plus any other fees collected by the Company, such as late fees and
returned check fees. The increase in servicing fees is primarily due to the increase in the Company’s managed
portfolio held by non-consolidated subsidiaries. At December 31, 2002, the Company’s managed portfolio
held by non-consolidated subsidiaries had an outstanding principal balance approximating $478.1 million,
compared to $281.5 million as of December 31, 2001. At December 31, 2002, the Company’s managed
portfolio held by consolidated subsidiaries had an outstanding principal balance approximating $117.1 million,
compared to $4.0 million as of December 31, 2001. Although the Company is paid a servicing fee on
receivables held by consolidated subsidiaries, such servicing fee is not recorded separately as revenue, but is
included in the interest accrued on such receivables.
Other income increased to $13.6 million in 2002 from $1.9 million in 2001. The period over period increase
can be attributed primarily to the recoveries on previously charged off MFN Contracts totaling $10.5 million
for the year ended December 31, 2002.
27
Expenses. During the year ended December 31, 2002, operating expenses increased by $31.0 million, or
49.8%, to $93.3 million, compared to the year ended December 31, 2001 operating expenses of $62.3 million.
The Company's operating expenses consist primarily of personnel costs and other operating expenses, which
are incurred as applications and Contracts are received, processed and serviced. Factors that affect margins and
net income include changes in the automobile and automobile finance market environments, macroeconomic
factors such as interest rates, and mix of business between Contracts purchased on a flow basis and Contracts
purchased on an other than flow basis. The overall increase in expenses is primarily attributable to the MFN
Merger. Personnel costs increased $13.8 million, or 57.4%, to $37.8 million in 2002 from $24.0 million in
2001. Personnel costs include base salaries, commissions and bonuses paid to employees, and certain expenses
related to the accounting treatment of outstanding warrants and stock options, and are the Company’s most
significant operating expenses, representing approximately 40.5% of 2002 operating expenses. These costs
generally fluctuate with the level of applications and Contracts processed and serviced, with the mix of
revenue and with overall portfolio performance. Other material operating expenses include facilities expenses,
telephone and other communication services, credit services, computer services (including personnel costs
associated with information technology support), professional services, marketing and advertising expenses,
and depreciation and amortization.
In connection with the termination of MFN origination activities and the integration and consolidation of
certain activities related to the MFN Merger (see above), the Company has recognized certain liabilities related
to the costs to exit these activities and terminate the affected employees of MFN. These activities include
service departments such as accounting, finance, human resources, information technology, administration,
payroll and executive management. Such exit and termination costs have been charged against these liabilities
and are not reflected in the Company’s Consolidated Statement of Operations.
General and administrative expenses increased by $7.5 million, or 59.2%, and represented 21.6% of total
operating expenses. The increase in general and administrative expenses is primarily due to the MFN Merger
and an increase in costs associated with servicing the Company’s expanded portfolio. Also included in 2002
general and administrative expenses is $669,000 related to the write off a related party receivable from
CARSUSA, Inc. See Note 13 of Notes to Consolidated Financial Statements.
Interest expense increased by $9.6 million, or 66.9%, and represented 25.7% of total operating expenses. The
increase is due to the interest expense resulting from the MFN acquisition, including interest expense related to
acquisition debt and the interest expense related to its managed portfolio held by consolidated subsidiaries. See
“Liquidity and Capital Resources.”
Marketing expenses decreased by $843,000, or 11.9%, and represented 6.7% of total operating expenses. The
decrease is primarily due to the decrease in Contracts purchased during the year ended December 31, 2002.
Occupancy expenses increased by $860,000, or 27.2%, and represented 4.3% of total operating expenses. The
increase is primarily due to the addition of facilities acquired in the MFN Merger.
Depreciation and amortization expenses increased by $119,000, or 11.7%, to $1.1 million from $1.0 million.
The results for the years ended December 31, 2002 and 2001, include net income of $116,732 and $161,710,
respectively, from the Company’s subsidiary CPS Leasing, Inc.
Income tax benefit of $2.9 million, including the elimination of the valuation allowance of $3.2 million, was
recorded in the 2002 period pursuant to relevant tax statutes and regulations. The Company’s provision for
income taxes was zero for the year ended December 31, 2001.
28
Liquidity and Capital Resources
Liquidity
The Company's business requires substantial cash to support its purchases of Contracts and other operating
activities. The Company's primary sources of cash have been cash flows from operating activities, including
proceeds from sales of Contracts, amounts borrowed under various revolving credit facilities (also sometimes
known as warehouse credit facilities), servicing fees on portfolios of Contracts previously sold in securitization
transactions, customer payments of principal and interest on finance receivables, fees for origination of
Contracts, and releases of cash from securitized pools of Contracts in which the Company has retained a
residual ownership interest, and from the Spread Accounts associated with such pools. The Company's primary
uses of cash have been the purchases of Contracts, repayment of amounts borrowed under lines of credit and
otherwise, operating expenses such as employee, interest, occupancy expenses and other general and
administrative expenses, the establishment of Spread Accounts and initial overcollateralization, if any, and the
increase of Credit Enhancement to required levels in securitization transactions, and income taxes. There can
be no assurance that internally generated cash will be sufficient to meet the Company's cash demands. The
sufficiency of internally generated cash will depend on the performance of securitized pools (which determines
the level of releases from those pools and their related Spread Accounts), the rate of expansion or contraction
in the Company's managed portfolio, and the terms upon which the Company is able to acquire, sell, and
borrow against Contracts.
Net cash provided by operating activities for the years ended December 31, 2003, 2002 and 2001 was $99.8
million, $146.9 million and $5.7 million, respectively. Cash from operating activities is generally provided by
the net releases from the Company’s securitization Trusts and from the amortization and liquidation of
Contracts offset by the purchase of finance receivables. The decrease in 2003 vs. 2002 is primarily a result of
lower cash releases from the MFN Trusts as the principal balance of the Contracts in those two pools has
decreased significantly year-over-year. The increase in net cash from operating activities in 2002 compared to
2001 is primarily a result of the decrease in purchases of contracts held for sale from $672.3 million in 2001 to
$463.3 in 2002.
On May 20, 2003, the Company completed the TFC Merger (see Note 2 of Notes to Consolidated Financial
Statements). The acquisition cost was approximately $23.7 million, and was substantially funded by existing
cash. Cash flows from the underlying purchased assets are expected to provide adequate liquidity to repay the
assumed liabilities and generate positive cash flows from which to fund the Company's operating activities. On
March 8, 2002, the Company completed the MFN Merger (see Note 2 of Notes to Consolidated Financial
Statements). The acquisition cost was approximately $123.2 million, and was substantially funded by existing
cash and borrowings. Cash flows from the underlying purchased assets are expected to provide adequate
liquidity to repay the acquisition borrowings, as well as generate positive cash flows from which to fund the
Company's operating activities.
Net cash used in investing activities for the years ended December 31, 2003, 2002 and 2001, was $179.8
million, $29.8 million and $536,000, respectively. With the change in the securitization structure implemented
in the third quarter of 2003, $175.3 million of Contracts were purchased for investment in 2003 as compared to
none in 2002 and 2001. Cash used in the TFC Merger, net of the cash acquired in the transaction, totaled
$10.2 million for the year ended December 31, 2003. Cash used in the acquisition of MFN Financial
Corporation, net of the cash acquired in the transaction, totaled $29.5 million for the year ended December 31,
2002.
Net cash provided by financing activities for the year ended December 31, 2003, was $80.3 million compared
with net cash used in financing activities of $86.8 million and $21.7 million for the years ended December 31,
2002 and 2001, respectively. Cash used or provided by financing activities is primarily attributable to the
repayment or issuance of debt. In connection with the TFC Merger the Company assumed securitization trust
debt related to three securitization transactions held by consolidated subsidiaries (see Note 7 of Notes to
29
Consolidated Financial Statements) and assumed additional subordinated debt (see Note 8 of Notes to
Consolidated Financial Statements). In connection with the MFN Merger the Company assumed securitization
trust debt related to one securitization transaction held by a consolidated subsidiary and one securitization
transaction held by a non-consolidated subsidiary (see Note 7 of Notes to Consolidated Financial Statements)
and incurred additional senior secured debt (see Note 8 of Notes to Consolidated Financial Statements). Cash
used in financing activities is primarily attributable to the repayment of outstanding debt. With the change in
the securitization structure implemented in the third quarter of 2003, $154.4 million of securitization trust debt
was issued in 2003 as compared to none in 2002 and 2001. In connection with the MFN Merger the amount of
outstanding debt, securitization trust debt and senior secured debt, and the required repayment thereof,
increased compared to prior years.
The Company believes that cash flows generated as a result of the TFC Merger and the MFN Merger will be
sufficient to meet the obligations assumed or incurred as a result of such mergers. There can be no assurance
that internally generated cash will be sufficient to meet such cash demands. The sufficiency of internally
generated cash will depend on the performance of the securitized pools. At the time of the TFC Merger, TFC
had outstanding $6.3 million in principal amount of subordinated debt, which the Company assumed as part of
the TFC Merger. Such debt bears interest at the rate of 13.25% per annum payable monthly in arrears, requires
monthly amortization and is due in June 2005. At the time of the MFN Merger, MFN had outstanding $22.5
million in principal amount of senior subordinated debt, which was due and repaid in full on March 23, 2002.
Such debt bore interest at the rate of 11.00% per annum, payable quarterly in arrears.
Contracts are purchased from Dealers for a cash price approximating their principal amount, and generate cash
flow over a period of years. As a result, the Company has been dependent on warehouse credit facilities to
purchase Contracts, and on the availability of cash from outside sources in order to finance its continuing
operations, as well as to fund the portion of Contract purchase prices not financed under revolving warehouse
credit facilities. As of December 31, 2003, the Company had $225 million in warehouse credit capacity, in the
form of a $125 million facility, a $75 million facility and a $25 million facility. The first two warehouse
facilities provide funding for Contracts purchased under CPS’ programs while the third facility provides
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.
Through May 2002, the Company's Contract purchasing program consisted of both (i) flow purchases for
immediate resale to non-affiliates and (ii) purchases for the Company's own account made on other than a flow
basis, funded primarily by advances under a revolving warehouse credit facility. Flow purchases allowed the
Company to purchase Contracts with minimal demands on liquidity. The Company's revenues from the resale
of flow purchase Contracts, however, were materially less than those that may be received by holding
Contracts to maturity or by selling Contracts in securitization transactions. During the year ended December
31, 2003 the Company purchased $357.3 million of Contracts for its own account, compared to $282.2 million
for its own account and $181.1 million of Contracts on a flow basis in 2002. For the year ended December 31,
2001, the Company purchased $134.4 million of Contracts for its own account and $537.9 million on a flow
basis. The Company’s flow purchase program ended in May 2002.
The $125 million warehouse facility is structured to allow CPS to fund a portion of the purchase price of
Contracts by drawing against a floating rate variable funding note issued by CPS Warehouse Trust. This
facility was established on March 7, 2002, in the maximum amount of $100 million. Such maximum amount
was increased to $125 million in November 2002. Approximately 73% of the principal balance of Contracts
may be advanced to the Company under this facility, subject to collateral tests and certain other conditions and
covenants. Notes under this facility accrue interest at a rate of one-month commercial paper plus 1.18% per
annum. This facility expires on April 4, 2004. The Company is currently in discussions with the related parties
to renew such facility.
The $75 million warehouse facility, was similarly structured to allow CPS to fund a portion of the purchase
price of Contracts by drawing against a floating rate variable funding note issued by CPS Funding LLC.
30
Approximately 72.5% of the principal balance of Contracts could be advanced to the Company under this
facility, subject to collateral tests and certain other conditions and covenants. Notes under this facility accrued
interest at a rate of one-month LIBOR plus 0.75% per annum. This facility expired on February 21, 2004. The
Company is currently in discussions with several parties regarding a replacement facility.
The $25 million warehouse facility is similarly structured to allow TFC to fund a portion of the purchase price
of Contracts by drawing against a floating rate variable funding note issued by TFC Warehouse I LLC.
Approximately 71% of the principal balance of Contracts may be advanced to TFC under this facility, subject
to collateral tests and certain other conditions and covenants. Notes under this facility accrue interest at a rate
of one-month LIBOR plus 1.75% per annum. This facility was entered into as part of the TFC Merger on May
20, 2003 and has a 364-day term. The Company is currently in discussions with the related parties to renew
such facility.
These facilities are independent of each other. Two different financial institutions purchase the notes issued by
these facilities, and three different insurers insure the notes. Up through June 30, 2003, sales of Contracts to
the special purpose subsidiaries (“SPS”) related to the first two facilities had been treated as sales for financial
accounting purposes. The Company, therefore, removed these securitized Contracts and related debt from its
Consolidated Balance Sheet and recognized a gain on sale in the Company’s Consolidated Statement of
Operations. Indebtedness related to Contracts funded by the third facility, however, was retained on the
Company’s Consolidated Balance Sheet and no gain on sale has ever been recognized in the Company’s
Consolidated Statement of Operations. During July 2003, each of the first two facilities was amended, with the
effect that subsequent use of such facilities is treated for financial accounting purposes as borrowing secured
by such receivables, rather than as a sale of receivables. The effects of that amendment are similar to those
discussed above with respect to the change in securitization structure.
The Company securitized $416.9 million of Contracts in four private placement transactions during the year
ended December 31, 2003. The first two such transactions were structured as sales for financial accounting
purposes, resulting in a gain on sale of $6.4 million (net of a negative fair value adjustment of $4.1 million
related to the performance of previously securitized pools). The final two transactions of 2003 were structured
as secured financings and, therefore, resulted in no gain on sale. The Company securitized $281.2 million of
Contracts in three private placement transactions during the year ended December 31, 2002. All of these
transactions were structured as sales for financial accounting purposes, resulting in a gain on sale of $16.9
million (net of a pre-tax charge of $2.5 million related to the performance of previously securitized pools).
$141.7 million of Contracts were securitized in one private placement transaction during the year ended
December 31, 2001, resulting in a gain on sale of $9.2 million. In March 2004 a wholly-owned bankruptcy
remote consolidated subsidiary of the Company issued $44 million of asset-backed notes secured by its
retained interest in eight term securitization transactions. The notes, which have an interest rate of 10% per
annum and a final maturity in October 2009, are required to be repaid from the distributions on the underlying
retained interests. In connection with the issuance of the notes, the Company incurred and capitalized issuance
costs of $1.2 million.
Prior to June 2002, the Company also purchased Contracts on a flow basis, which, as compared with purchases
of Contracts for the Company’s own account, involved a materially reduced demand on the Company’s cash.
The Company’s plan for meeting its liquidity needs is to match its levels of Contract purchases to its
availability of cash.
Cash used to increase Credit Enhancement amounts to required levels for the years ended December 31, 2003,
2002 and 2001 was $20.9 million, $24.2 million and $24.6 million, respectively. Cash released from Trusts
and their related Spread Accounts to the Company for the years ended December 31, 2003, 2002 and 2001,
was $25.9 million, $60.4 million and $43.7 million, respectively. Changes in the amount of Credit
Enhancement required for term securitization transactions and releases from Trusts and their related Spread
Accounts are affected by the relative size, seasoning and performance of the various pools of Contracts
securitized that make up the Company’s managed portfolio to which the respective Spread Accounts are
31
related. During the year ended December 31, 2003 the Company made initial deposits to Spread Accounts and
funded initial overcollateralization of $18.7 million related to its term securitization transactions, compared to
$16.7 million in the 2002 period and $2.5 million in the 2001 period. The acquisition of Contracts for
subsequent sale in securitization transactions, and the need to fund Spread Accounts and initial
overcollateralization, if any, and increase Credit Enhancement levels when those transactions take place,
results in a continuing need for capital. The amount of capital required is most heavily dependent on the rate of
the Company's Contract purchases (other than flow purchases), the required level of initial Credit
Enhancement in securitizations, and the extent to which the previously established Trusts and their related
Spread Accounts either release cash to the Company or capture cash from collections on securitized Contracts.
The Company is currently limited in its ability to purchase Contracts due to certain liquidity constraints. As of
December 31, 2003, the Company had cash on hand of $33.2 million and available Contract purchase
commitments from its warehouse credit facilities of $200.7 million. The Company's plans to manage the need
for liquidity include the completion of additional term securitizations that would provide additional credit
availability from the warehouse credit facilities, and matching its levels of Contract purchases to its availability
of cash. There can be no assurance that the Company will be able to complete term securitizations on favorable
economic terms or that the Company will be able to complete term securitizations at all. If the Company is
unable to complete such securitizations, interest income and other portfolio related income would decrease.
The Company’s primary means of ensuring that its cash demands do not exceed its cash resources is to match
its levels of Contract purchases to its availability of cash. The Company’s ability to adjust the quantity of
Contracts that it purchases and securitizes will be subject to general competitive conditions and the continued
availability of warehouse credit facilities. There can be no assurance that the desired level of Contract
acquisition can be maintained or increased. Obtaining releases of cash from the Trusts and their related Spread
Accounts is dependent on collections from the related Trusts generating sufficient cash to maintain the Spread
Accounts and other Credit Enhancement in excess of their respective requisite levels. There can be no
assurance that collections from the related Trusts will continue to generate sufficient cash.
Certain of the Company’s securitization transactions and the warehouse credit facilities contain various
financial covenants requiring certain minimum financial ratios and results. The Company was in violation of
four of these covenants as of December 31, 2003, including maximum leverage, minimum equity, maximum
financial loss and interest coverage. As of December 31, 2003, the Company had received a waiver of such
non-compliance from the controlling party. In March 2004, each of these financial covenants was amended
with the controlling party such that all breaches have been cured.
The Servicing Agreements of the Company’s securitization transactions and warehouse credit facilities 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.
Contractual Obligations
The following table summarizes the Company’s material contractual obligations as of December 31, 2003
(dollars in thousands):
32
Payment due by period
Total
Less than
1 Year
1 to 3
Years
3 to 5
Years
More than
5 Years
Long Term Debt ...............................
$ 102,465
$ 83,328
$ 14,000
$ 5,137
$ —
Operating Leases ..............................
$ 16,948
$ 4,511
$ 7,894
$ 4,543
$ —
Long term debt includes Senior secured, subordinated and related party debt.
Credit Facilities
The terms on which credit has been available to the Company for purchase of Contracts have varied over the
three-year period ended December 31, 2003, as shown in the following recapitulation:
In November 2000, the Company (through its subsidiary CPS Funding LLC) entered into a floating rate
variable note purchase facility under which up to $75 million of notes may be outstanding at any time subject
to collateral tests and other conditions. The Company uses funds derived from this facility to purchase
Contracts under the CPS programs, which are pledged to secure the notes. The collateral tests and other
conditions generally allow the Company to borrow up to approximately 72.5% of the price paid for such
Contracts. Notes issued under this facility bear interest at one-month LIBOR plus 0.75% per annum. The
balance of notes outstanding related to this facility at December 31, 2003 was zero. This facility expired on
February 21, 2004. The Company is currently in discussions with several parties regarding a replacement
facility.
Additionally, in March 2002, the Company (through its subsidiary CPS Warehouse Trust) entered into a
second floating rate variable note purchase facility, under which up to $125.0 million of notes may be
outstanding at any time, subject to collateral tests and other conditions. The Company uses funds derived from
this facility to purchase Contracts under the CPS programs, which are pledged to secure the notes. The
collateral tests and other conditions generally allow the Company to borrow up to approximately 73% of the
price paid for such Contracts. Notes issued under this facility bear interest at commercial paper plus 1.18% per
annum. The balance of notes outstanding related to this facility at December 31, 2003 was $13.2 million. This
facility expires on April 4, 2004. The Company is currently in discussions with the related parties to renew
such facility.
One of the covenants within this warehouse credit facility and four of the six term securitizations insured by
this Note Insurer requires that the Company maintain additional warehouse facilities with minimum borrowing
capacity of $75.0 million. With the expiration of the CPS Funding LLC facility described above, the Company
is in breach of such covenant. The Company has until June 20, 2004 to cure such breach prior to it becoming
an event of default under this warehouse facility and four term securitizations. While the Company is currently
in discussions with several parties about a replacement facility and believes that it will be successful in
replacing the facility within the required time frame, there can be no assurances that it will do so. If the
Company is unsuccessful in these efforts, the Note Insurer will have the right to declare an event of default.
Remedies available to the Note Insurer in such event include, among other things, transferring the servicing
rights to the portfolio that it insures to another servicer and trapping excess cash releases to the Company from
its warehouse facility and four term securitizations that it insures. To the extent that the Note Insurer was to
follow either of these remedies, it would have a material adverse effect on the liquidity and the operations of
the Company.
In connection with the TFC Merger in May 2003, the Company (through its subsidiary TFC Warehouse I
LLC) entered in to a third floating rate variable note purchase facility, under which up to $25.0 million of notes
may be outstanding at any time, subject to collateral tests and other conditions. The Company uses funds
derived from this facility to purchase Contracts under the TFC programs, which are pledged to secure the
notes. The collateral tests and other conditions generally allow the Company to borrow up to approximately
71% of the price paid for such Contracts. Notes issued under this facility bear interest at LIBOR plus 1.75%
33
per annum. The balance of notes outstanding related to this facility at December 31, 2002 was $20.5 million.
This facility expires on May 19, 2004. The Company is currently in discussions with the related parties to
renew such facility.
Capital Resources
Prior to 1999, and again in 2001, 2002 and 2003, the Company has funded increases in its managed portfolio
through securitization transactions, as discussed above, and funded its other capital needs with cash from
operations and with the proceeds from the issuance of long-term debt and/or equity.
The acquisition of Contracts for subsequent sale in securitization transactions, and the need to fund Spread
Accounts and initial overcollateralization, if any, when those transactions take place, results in a continuing
need for capital. The amount of capital required is most heavily dependent on the rate of the Company’s
Contract purchases (other than purchases made on a flow basis), the required level of initial credit
enhancement in securitizations, and the extent to which the Trusts and related Spread Accounts either release
cash to the Company or capture cash from collections on secruritized Contracts. The Company plans to adjust
its levels of Contract purchases so as to match anticipated releases of cash from the Trusts and related Spread
Accounts with its capital requirements.
Capitalization
Over the three-year period ended December 31, 2003, the Company has managed its capitalization by issuing
and restructuring debt and issuing/purchasing common stock and equivalents, as summarized in the following
table:
2003
Years Ended December 31,
2002
(In thousands)
2001
Securitization trust debt:
Beginning balance ................................................................... $ 71,630
115,597
Assumption in connection with MFN & TFC Merger..........
154,375
Issuances .............................................................................
(96,484)
Payments .............................................................................
Ending balance ......................................................................... $ 245,118 $ 71,630 $
$
—
156,923
—
(85,293)
$
—
—
—
—
—
Senior secured debt:
Beginning balance ...................................................................
Issuances ............................................................................
Payments............................................................................
Ending balance ........................................................................
$ 50,072
25,000
(25,107)
$ 49,965
$ 26,000
46,242
(22,170)
$ 38,000
—
(12,000)
$ 50,072 $ 26,000
Subordinated debt:
Beginning balance ................................................................... $ 36,000
—
(1,000)
$ 35,000
Assumption in connection with MFN & TFC Merger ........
Payments.............................................................................
Ending balance ........................................................................
$ 37,699
$ 36,989
—
22,500
(23,489)
(710)
$ 36,000 $ 36,989
Related party debt:
Beginning balance ................................................................... $ 17,500
—
—
$ 21,500
—
(4,000)
Ending balance ........................................................................ $ 17,500 $ 17,500 $ 17,500
Issuances .............................................................................
Payments.............................................................................
$ 17,500
—
—
Increase (decrease) of Common Stock and equivalents...........
$
23
$
2,074
$
(757)
The assumption of debt related to the TFC Merger is included in the 2003 activity in the table above. The
assumption of debt related to the MFN Merger is included in the 2002 activity in the table above.
34
During the first quarter of 2001, the Company purchased a total of $8,000,000 of outstanding indebtedness
held by Levine Leichtman Capital Partners II, L.P. (“LLCP”) and Stanwich Financial Services Corp.
(“SFSC”). The Company purchased and retired $4,000,000 of subordinated debt held by SFSC in exchange for
payment of $3,920,000, and purchased and retired $4,000,000 of senior secured debt held by LLCP in
exchange for payment of $4,200,000. The LLCP debt by its terms called for a prepayment penalty of 3% (or
$120,000); the additional 2% (or $80,000) paid in connection with its February 2001 prepayment was absorbed
by SFSC.
In March 2002, the Company and LLCP entered into an additional series of agreements under which LLCP
provided additional funding to enable the Company to acquire MFN Financial Corporation. Under the March
2002 agreements, the Company borrowed $35 million from LLCP as a Bridge Note (Bridge Note) and
approximately $8.5 million (“Term C”) on a deemed principal amount of approximately $11.2 million. The
Bridge Note requires principal payments of $2.0 million a month, which began in June 2002, with a final
balloon payment in the amount of $17.0 million, which was made pursuant to the terms of the Bridge Note in
February 2003. The Term C Note repayment schedule is based on the performance of a certain securitized
pool. As the subordinated Note of the pool is repaid from the Trust, principal payments are due on the Term C
Note. The maturity date of the Term C Note is March 2008. Interest is due monthly on the Bridge Note at a
rate of 13.5% per annum and on the Term C Note at a rate of 12.0% per annum. In connection with the March
2002 agreements and the acquisition of MFN, the Company paid LLCP a structuring fee of $1.75 million and
an investment banking fee of $1.0 million, and paid LLCP's out-of-pocket expenses of approximately
$315,000. In addition, the Company paid LLCP certain other fees and interest amounting to $426,181.
Approximately $1.4 million of the fees and other amounts paid to LLCP were deferred as financing costs and
are being amortized over the life of the related debt. The remaining fees and other costs were included in the
purchase price of MFN. At December 31, 2003, there was $5.1 million principal outstanding on the Term C.
At the time of the MFN Merger, MFN had outstanding $22.5 million in principal amount of senior
subordinated debt, which was due and repaid in full on March 23, 2002. Such debt bore interest at the rate of
11.00% per annum, payable quarterly in arrears. At the time of the TFC Merger, TFC had outstanding $6.3
million in principal amount of subordinated debt, which the Company assumed as part of the TFC Merger.
Such debt bears interest at the rate of 13.25% per annum payable monthly in arrears, requires monthly
amortization and is due in June 2005.
On February 3, 2003, the Company borrowed $25.0 million from LLCP, net of fees and expenses of $1.05
million. The indebtedness, represented by the “Term D Note,” was originally due in April 2003, with
Company options to extend the maturity to May 2003 and January 2004, upon payment of successive
extension fees of $125,000. The Company has paid the fees to extend the maturity to January 2004. Interest on
the Term D Note is payable monthly at rates that averaged 4.79% per annum through June 30, 2003, and
12.0% per annum thereafter. In a separate transaction, the Bridge Note issued to LLCP in connection with the
acquisition of MFN, in an original principal amount of $35.0 million, was due on February 28, 2003. The
outstanding principal balance of $17.0 million was paid in February 2003. In addition, the maturity of the
Term B Note was extended in October 2003 from November 2003 to January 2004. As of December 31, 2003,
the outstanding principal balances of the Term B Note and the Term C Note were $19.8 million and $5.3
million, respectively. The Company repaid in full the Term C Note on January 29, 2004 and repaid $10.0
million of the Term D Note on January 15, 2004. In addition, on January 29, 2004 the maturities of the Term B
Note and the Term D Note were extended to December 15, 2005 and the coupons on both notes were
decreased to 11.75% per annum. The Company paid LLCP fees equal to $921,000 for these amendments,
which will be amortized over the remaining life of the notes.
LLCP holds approximately 22.1% of the Company’s outstanding common shares. SFSC is an affiliate of
Charles E. Bradley, Sr., the Company’s former chairman and father of the company’s current chairman and
Chief Executive Officer, and SFSC and Mr. Bradley, Sr. together hold approximately 14.6% of the Company’s
outstanding common shares.
35
The Company must comply with certain affirmative and negative covenants related to debt facilities, which
require, among other things, that the Company maintain certain financial ratios related to liquidity, net worth,
capitalization, investments, acquisitions, restricted payments and certain dividend restrictions. The Company
was in compliance with all of its debt covenants with respect to non-securitization related debt as of December
31, 2003. The Company was in violation of four covenants related to securitization debt as of December 31,
2003, including maximum leverage, minimum equity, maximum financial loss and interest coverage. As of
December 31, 2003, the Company had received a waiver of such non-compliance from the controlling party. In
March 2004, each of these financial covenants was amended with the controlling party such that all breaches
have been cured.
In July 2000, the Board of Directors authorized the purchase of up to $5,000,000 of outstanding debt and
equity securities of the Company, inclusive of the mandatory annual purchase or redemption of $1,000,000 of
the Company’s outstanding “RISRS” subordinated debt securities, due 2006. In October 2002, the Board of
Directors authorized the purchase of an additional $5,000,000 of outstanding debt or equity securities. As of
December 31, 2003, the Company had purchased $4.0 million in principal amount of the RISRS, and $3.9
million of its common stock, representing 2,141,037 shares.
Forward-looking Statements
This report on Form 10-K includes certain "forward-looking statements," including, without limitation, the
statements or implications to the effect that prepayments as a percentage of original balances will approximate
18.1% to 22.1% cumulatively over the lives of the related Contracts, that charge-offs as a percentage of
original balances 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 original principal balances. Other forward-looking statements
may be identified by the use of words such as “anticipates,” “expects,” “plans,” “estimates,” or words of like
meaning. As to the specifically identified forward-looking statements, factors that could affect charge-offs and
recovery rates include changes in the general economic climate, which could affect the willingness or ability of
obligors to pay pursuant to the terms of Contracts, changes in laws respecting consumer finance, which could
affect the ability of the Company to enforce rights under Contracts, and changes in the market for used
vehicles, which could affect the levels of recoveries upon sale of repossessed vehicles. Factors that could affect
the Company's revenues in the current year include the levels of cash releases from existing pools of Contracts,
which would affect the Company's ability to purchase Contracts, the terms on which the Company is able to
finance such purchases, the willingness of Dealers to sell Contracts to the Company on the terms that it offers,
and the terms on which the Company is able to complete term securitizations once Contracts are acquired.
Factors that could affect the Company's expenses in the current year include competitive conditions in the
market for qualified personnel, and interest rates (which affect the rates that the Company pays on Notes
issued in its securitizations). The statements concerning the Company structuring future securitization
transactions as secured financings and the effects of such structures on financial items and on the Company’s
future profitability also are forward-looking statements. Any change to the structure of the Company’s
securitization transaction could cause such forward-looking statements not to be accurate. Both the amount of
the effect of the change in structure on the Company’s profitability and the duration of the period in which the
Company’s profitability would be affected by the change in securitization structure are estimates. The accuracy
of such estimates will be affected by the rate at which the Company purchases and sells Contracts, any changes
in that rate, the credit performance of such Contracts, the financial terms of future securitizations, any changes
in such terms over time, and other factors that generally affect the Company’s profitability.
Additional risk factors, any of which could have a material effect on the Company’s performance, are set forth
below:
Dependence on Warehouse Financing. The Company's primary source of day-to-day liquidity is continuous
securitization of Contracts, under which it sells or pledges Contracts, as often as once a week, to one special-
purpose affiliated entity in the case of CPS, or a different special-purpose affiliated entity in the case of TFC.
Such transactions function as a “warehouse,” in which Contracts are held. The Company expects to continue to
36
effect similar transactions (or to obtain replacement or additional financing) as current arrangements expire or
become fully utilized; however, there can be no assurance that such financing will be obtainable on favorable
terms. To the extent that the Company is unable to maintain its existing structure or is unable to arrange new
warehouse facilities, the Company may have to curtail Contract purchasing activities, which could have a
material adverse effect on the Company's financial condition and results of operations. In addition, the Company
is currently in breach of a covenant under one of its warehouse facilities to maintain $75 million in additional
minimum warehouse borrowing capacity. The Company has until June 20, 2004 to cure such breach prior to it
becoming an event of default under one warehouse facility and four term securitizations. While the Company
is currently in discussions with several parties about a replacement facility and believes that it will be
successful in replacing the facility within the required time frame, there can be no assurances that it will do so.
If the Company is unsuccessful in these efforts, the Note Insurer will have the right to declare an event of
default. Remedies available to the Note Insurer in such event include, among other things, transferring the
servicing rights to the portfolio that it insures to another servicer and trapping excess cash releases to the
Company from its warehouse facility and four term securitizations that it insures. To the extent that the Note
Insurer were to pursue either of these remedies, it would have a material adverse effect on the liquidity and
operations of the Company.
Dependence on Securitization Program. The Company is dependent upon its ability to continue to finance
pools of Contracts in term securitizations in order to generate cash proceeds for new purchases. Adverse
changes in the market for securitized Contract pools, or a substantial lengthening of the warehousing period,
would burden the Company's financing capabilities, could require the Company to curtail its purchase of
Contracts, and could have a material adverse effect on the Company. In addition, as a means of reducing the
percentage of cash collateral that the Company would otherwise be required to deposit and maintain in Spread
Accounts and overcollateralization, all of the Company's securitizations since June 1994 have utilized credit
enhancement in the form of financial guaranty insurance policies issued by monoline financial guaranty
insurers. The Company believes that financial guaranty insurance policies reduce the costs of securitizations
relative to alternative forms of credit enhancements available to the Company. No insurer is required to insure
Company-sponsored securitizations and there can be no assurance that any will continue to do so. Similarly,
there can be no assurance that any securitization transaction will be available on terms acceptable to the
Company, or at all. The timing of any securitization transaction is affected by a number of factors beyond the
Company's control, any of which could cause substantial delays, including, without limitation, market
conditions and the approval by all parties of the terms of the securitization.
Risk of General Economic Downturn. The Company's business is directly related to sales of new and used
automobiles, which are affected by employment rates, prevailing interest rates and other domestic economic
conditions. Delinquencies, repossessions and losses generally increase during economic slowdowns or recessions.
Because of the Company's focus on Sub-Prime Customers, the actual rates of delinquencies, repossessions and
losses on such Contracts could be higher under adverse economic conditions than those experienced in the
automobile finance industry in general. Any sustained period of economic slowdown or recession could
adversely affect the Company's ability to sell or securitize pools of Contracts. The timing of any economic
changes is uncertain, and sluggish sales of automobiles and weakness in the economy could have an adverse
effect on the Company's business and that of the Dealers from which it purchases Contracts.
Dependence on Performance of Securitized Contracts. Under the financial structures the Company has used to
date in its term securitizations, certain excess cash flows generated by the Contracts sold in the term
securitizations are used to increase overcollateralization or retained in a Spread Account within the securitization
trusts to provide liquidity and credit enhancement. While the specific terms and mechanics of each Spread
Account vary among transactions, the Company's Securitization Agreements generally provide that the Company
will receive excess cash flows only if the amount of Credit Enhancement has reached specified levels and/or the
delinquency, defaults or net losses related to the Contracts in the pool are below certain predetermined levels. In
the event delinquencies, defaults or net losses on the Contracts exceed such levels, the terms of the securitization:
(i) may require increased Credit Enhancement to be accumulated for the particular pool; (ii) may restrict the
distribution to the Company of excess cash flows associated with other pools; or (iii) in certain circumstances,
37
may permit the insurers to require the transfer of servicing on some or all of the Contracts to another servicer.
Any of these conditions could materially adversely affect the Company's liquidity and financial condition.
Creditworthiness of Consumers. The Company specializes in the purchase, sale and servicing of Contracts to
finance automobile purchases by Sub-Prime Customers, which entail a higher risk of non-performance, higher
delinquencies and higher losses than Contracts with more creditworthy customers. While the Company believes
that the underwriting criteria and collection methods it employs enable it to control the higher risks inherent in
Contracts with Sub-Prime Customers, no assurance can be given that such criteria and methods will afford
adequate protection against such risks. The Company has experienced fluctuations in the delinquency and charge-
off performance of its Contracts. In the event that portfolios of Contracts securitized and serviced by the
Company experience greater defaults, higher delinquencies or higher net losses than anticipated, the Company's
income could be negatively affected. A larger number of defaults than anticipated could also result in adverse
changes in the structure of the Company's future securitization transactions, such as a requirement of increased
cash collateral or other Credit Enhancement in such transactions.
Probable Increase in Cost of Funds. The Company's profitability is determined by, among other things, the
difference between the rate of interest charged on the Contracts purchased by the Company and the rate of
interest payable to purchasers of Notes issued in securitizations. The Contracts purchased by the Company
generally bear finance charges close to or at the maximum permitted by applicable state law. The interest rates
payable on such Notes are fixed, based on interest rates prevailing in the market at the time of sale.
Consequently, increases in market interest rates tend to reduce the “spread” or margin between Contract finance
charges and the interest rates required by investors and, thus, the potential operating profits to the Company from
the purchase, securitization and servicing of Contracts. Operating profits expected to be earned by the Company
on portfolios of Contracts previously securitized are insulated from the adverse effects of increasing interest rates
because the interest rates on the related Notes were fixed at the time the Contracts were sold. With interest rates
near historical lows as of the date of this report, it is probable that interest rates will increase in the near to
intermediate term. Any future increases in interest rates would likely increase the interest rates on Notes issued in
future term securitizations and could have a material adverse effect on the Company's results of operations.
Prepayments and Credit Losses. Gains from the sale of Contracts in the Company’s past securitization
transactions structured as sales for financial accounting purposes have constituted a significant portion of the
revenue of the Company. A portion of the gains is based in part on management’s estimates of future
prepayments and credit losses and other considerations in light of then-current conditions. If actual
prepayments with respect to Contracts occur more quickly than was projected at the time such Contracts were
sold, as can occur when interest rates decline, or if credit losses are greater than projected at the time such
Contracts were sold, a charge to income may be required and would be taken in the period of adjustment. If
actual prepayments occur more slowly or if net losses are lower than estimated with respect to Contracts sold,
total revenue would exceed previously estimated amounts. Provisions for credit losses are recorded in
connection with the origination and throughout the life of Contracts that are held on the Company’s
Consolidated Balance Sheet. Such provisions are based on management’s estimates of future credit losses in
light of then-current conditions. If actual credit losses in a given period exceed the allowance for credit losses,
a bad debt expense during the period would be required.
Competition. The automobile financing business is highly competitive. The Company competes with a number
of national, local and regional finance companies. 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 and Ford Motor Credit 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 relative to that of 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
38
investment grade rated debt instruments, and to other funding sources which may be unavailable to the
Company. Many of these companies also have long-standing relationships with Dealers and may provide other
financing to Dealers, including floor plan financing for the Dealers’ purchases of automobiles from
manufacturers, which is not offered by the Company. There can be no assurance that the Company will be able
to continue to compete successfully.
Litigation. Because of 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 class-
action 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. Although the
Company is not involved in any such material consumer protection litigation, a significant judgment against
the Company or within the industry in connection with any such litigation, or an adverse outcome in the
litigation identified under the caption “Legal Proceedings” in this report, could have a material adverse effect
on the Company’s financial condition and results of operations.
Dependence on Dealers. The Company is dependent upon establishing and maintaining relationships with
unaffiliated Dealers to supply it with Contracts. During the year ended December 31, 2003, no Dealer
accounted for more than 1.0% of the Contracts purchased by the Company. The Dealer Agreements do not
require Dealers to submit a minimum number of Contracts for purchase by the Company. The failure of
Dealers to submit Contracts that meet the Company’s underwriting criteria would have a material adverse
effect on the Company’s financial condition and results of operations.
Government Regulations. The Company’s business is subject to numerous federal and state consumer protection
laws and regulations, which, among other things: (i) require the Company to obtain and maintain certain licenses
and qualifications; (ii) limit the interest rates, fees and other charges the Company is allowed to charge; (iii) limit
or prescribe certain other terms of its Contracts; (iv) require the Company to provide specified disclosures; and
(v) regulate certain servicing and collection practices and define its rights to repossess and sell collateral. An
adverse change in existing laws or regulations, or in the interpretation thereof, the promulgation of any additional
laws or regulations, or the failure to comply with such laws and regulations could have a material adverse effect
on the Company’s financial condition and results of operations.
New Accounting Pronouncements
The Company will adopt in future periods new accounting pronouncements. For information on how adoption
has affected and will affect the Financial Statements, see Note 1 of Notes to Consolidated Financial
Statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
The Company is subject to interest rate risk during the period between when Contracts are purchased from
Dealers and when such Contracts become part of a term securitization. Specifically, the interest rates on the
warehouse facilities are adjustable while the interest rates on the Contracts are fixed. Historically, the
Company’s term securitization facilities have had fixed rates of interest. To mitigate some of this risk, the
Company has in the past, and intends to continue to, structure certain of its securitization transactions to
include pre-funding structures, whereby the amount of Notes issued exceeds the amount of Contracts initially
sold to the Trusts. In pre-funding, the proceeds from the pre-funded portion are held in an escrow account until
the Company sells the additional Contracts to the Trust in amounts up to the balance of the pre-funded escrow
account. In pre-funded securitizations, the Company locks in the borrowing costs with respect to the Contracts
it subsequently delivers to the Trust. However, the Company incurs an expense in pre-funded securitizations
equal to the difference between the money market yields earned on the proceeds held in escrow prior to
39
subsequent delivery of Contracts and the interest rate paid on the Notes outstanding, the amount as to which
there can be no assurance.
The Company is subject to market risks due to fluctuations in interest rates primarily through its outstanding
indebtedness and to a lesser extent its outstanding interest earning assets, and commitments to enter into new
Contracts. The table below outlines the carrying values and estimated fair values of such financial instruments:
Financial Instrument
December 31,
2003
2002
Carrying
Value
Fair
Value
Carrying
Value
Fair
Value
(In thousands)
Finance receivables, net ................................................. $ 266,189 $ 266,189 $ 84,592
Notes payable .................................................................
673
3,330
71,630
Securitization trust debt.................................................. 245,118
50,072
Senior secured debt ........................................................ 49,965
36,000
Subordinated debt........................................................... 35,000
17,500
Related party debt........................................................... 17,500
3,330
245,118
49,965
35,506
17,763
$ 84,592
673
71,630
50,072
32,800
15,400
Much of the information used to determine fair value is highly subjective. When applicable, readily available
market information has been utilized. However, for a significant portion of the Company’s financial
instruments, active markets do not exist. Therefore, considerable judgments were required in estimating fair
value for certain items. The subjective factors include, among other things, the estimated timing and amount of
cash flows, risk characteristics, credit quality and interest rates, all of which are subject to change. Since the
fair value is estimated as of the dates shown in the table, the amounts that will actually be realized or paid at
settlement or maturity of the instruments could be significantly different.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
This report includes Consolidated Financial Statements, notes thereto and an Independent Auditors’ Report, at
the pages indicated below. Certain unaudited quarterly financial information is included in the Notes to
Consolidated Financial Statements, as Note 18.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
40
INDEX TO FINANCIAL STATEMENTS
Independent Auditors’ Report .................................................................................................................
Consolidated Balance Sheets as of December 31, 2003 and 2002..........................................................
Consolidated Statements of Operations for the years ended December 31, 2003, 2002, and 2001 ........
Page
Reference
F-2
F-3
F-4
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31,
2003, 2002, and 2001 .........................................................................................................................
F-5
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2003, 2002,
and 2001 .............................................................................................................................................
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002, and 2001.......
F-6
F-7
Notes to Consolidated Financial Statements for the years ended December 31, 2003, 2002, and
2001 ....................................................................................................................................................
F-9
F-1
INDEPENDENT AUDITORS’ REPORT
The Board of Directors
Consumer Portfolio Services, Inc.:
We have audited the accompanying consolidated balance sheets of Consumer Portfolio Services, Inc. and
subsidiaries (the “Company”) as of December 31, 2003 and 2002, and the related consolidated statements of
operations, comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the
three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of
the Company’s management. Our responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of
America. Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects,
the financial position of Consumer Portfolio Services, Inc. and subsidiaries as of December 31, 2003 and 2002,
and the results of their operations and their cash flows for each of the years in the three-year period ended
December 31, 2003, in conformity with accounting principles generally accepted in the United States of
America.
/s/ KPMG LLP
Orange County, California
March 15, 2004
F-2
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
December 31,
2003
December 31,
2002
ASSETS
Cash ......................................................................................................................................
Restricted cash ......................................................................................................................
$
33,209
67,277
$
32,947
18,912
Finance receivables...............................................................................................................
Less: Allowance for finance credit losses .............................................................................
Finance receivables, net ........................................................................................................
302,078
(35,889)
266,189
110,420
(25,828)
84,592
Servicing fees receivable ......................................................................................................
Residual interest in securitizations........................................................................................
Furniture and equipment, net ................................................................................................
Deferred financing costs .......................................................................................................
Deferred interest expense......................................................................................................
Other assets...........................................................................................................................
3,942
111,702
826
1,529
—
7,796
$ 492,470
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Accounts payable & accrued expenses .................................................................................
Warehouse lines of credit......................................................................................................
Tax liabilities, net .................................................................................................................
Capital lease obligation.........................................................................................................
Notes payable........................................................................................................................
Securitization trust debt ........................................................................................................
Senior secured debt ...............................................................................................................
Subordinated debt ................................................................................................................
Related party debt .................................................................................................................
$
Shareholders’ Equity
Preferred stock, $1 par value; authorized 5,000,000 shares; none issued .............................
Series A preferred stock, $1 par value;
authorized 5,000,000 shares; 3,415,000 shares issued; none outstanding ........................
Common stock, no par value; authorized 30,000,000 shares; 20,588,924 and 20,528,270
22,920
33,709
2,768
—
3,330
245,118
49,965
35,000
17,500
410,310
—
—
3,407
127,170
1,612
1,671
2,695
12,442
$ 285,448
$
18,132
—
8,800
67
673
71,630
50,072
36,000
17,500
202,874
—
—
shares issued and outstanding at December 31, 2003 and December 31, 2002,
respectively........................................................................................................................
64,397
Retained earnings..................................................................................................................
20,992
Comprehensive loss – minimum pension benefit obligation, net .......................................... (2,426)
Deferred compensation ......................................................................................................... (803)
82,160
63,929
20,597
(1,594)
(358)
82,574
See accompanying Notes to Consolidated Financial Statements.
$ 492,470
$ 285,448
F-3
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Year Ended December 31,
2002
2001
2003
Revenues:
Gain on sale of contracts, net ................................................................... $
Interest income.........................................................................................
Servicing fees...........................................................................................
Other income............................................................................................
6,369
58,164
17,058
19,343
100,934
Expenses:
Employee costs ........................................................................................
General and administrative ......................................................................
Interest .....................................................................................................
Provision for credit losses........................................................................
Marketing.................................................................................................
Occupancy ...............................................................................................
Depreciation and amortization .................................................................
Income (loss) before income taxes (benefit) ............................................
Income tax expense (benefit) ...................................................................
Income before extraordinary item............................................................
37,141
21,271
23,861
11,390
5,380
3,930
1,000
103,973
(3,039)
(3,434)
395
—
395
Extraordinary item, unallocated negative goodwill .................................
Net income............................................................................................... $
Earnings per share before extraordinary item:
Basic ...................................................................................................... $
Diluted ...................................................................................................
Earnings per share, extraordinary item:
Basic ...................................................................................................... $
Diluted ...................................................................................................
Earnings per share after extraordinary item:
Basic ...................................................................................................... $
Diluted ...................................................................................................
Number of shares used in computing earnings per share:
Basic ......................................................................................................
Diluted ...................................................................................................
0.02
0.02
—
—
0.02
0.02
$
$
$
0.15
0.14
0.87
0.83
1.03
0.97
20,263
21,578
19,902
20,987
19,480
21,018
$
16,444
48,644
14,621
13,605
93,314
37,778
20,131
23,925
—
6,253
4,027
1,138
93,252
62
(2,934)
2,996
17,412
$ 20,408
$
32,765
17,205
10,666
1,940
62,576
23,994
12,645
14,335
—
7,096
3,167
1,019
62,256
320
—
320
—
320
$
$ 0.02
0.02
$ —
—
$ 0.02
0.02
See accompanying Notes to Consolidated Financial Statements.
F-4
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
Year Ended December 31,
2002
2001
2003
Net income ......................................................................................... $
Other comprehensive loss:
Minimum pension liability, net of tax ...............................................
Comprehensive income (loss) ............................................................. $
395
$
20,408
$
(832)
(437)
(1,594)
$ 18,814
$
320
—
320
See accompanying Notes to Consolidated Financial Statements.
F-5
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In thousands)
Preferred Stock
Shares
Amount
Series A Preferred Stock
Amount
Shares
Common Stock
Shares
Amount
Balance at December 31, 2000 ..........................
—
$
—
—
$
—
19,646
$
62,987
Common stock issued upon exercise
of options, including tax benefit .....................
Purchase of common stock ................................
Increase in deferred compensation
on stock options ..............................................
Amortization of stock compensation .................
Net income .........................................................
—
—
—
—
—
—
—
—
498
(863)
312
(1,348)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(77)
—
—
Balance at December 31, 2001 ..........................
—
—
—
—
19,281
61,874
Common stock issued upon exercise
of options, including tax benefit .....................
Purchase of common stock ................................
Pension benefit obligation .................................
Increase in deferred compensation
on stock options ..............................................
Amortization of stock compensation .................
Net income .........................................................
Balance at December 31, 2002 ..........................
Common stock issued upon exercise
of options, including tax benefit .....................
Purchase of common stock ................................
Pension benefit obligation .................................
Repurchase of warrants issued...........................
Increase in deferred compensation
on stock options ..............................................
Amortization of stock compensation .................
Net income .........................................................
—
—
—
—
—
—
—
—
—
—
—
—
1,255
(8)
—
893
(15)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
1,177
—
—
—
—
—
—
20,528
63,929
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
Retained
Earnings
(Deficit)
—
—
—
—
609
(548)
—
—
974
(1,195)
—
(896)
—
—
—
—
—
—
1,585
—
—
$
—
20,589
$
64,397
Total
Balance at December 31, 2003 ..........................
—
$
—
Pension Benefit
Obligation
Deferred
Compensation
Balance at December 31, 2000 .......................... $
—
$
(734)
$
(131)
$ 62,122
Common stock issued upon exercise
of options, including tax benefit .....................
Purchase of common stock ................................
Increase in deferred compensation
on stock options ..............................................
Amortization of stock compensation .................
Net income .........................................................
—
—
—
—
—
—
312
(1,348)
—
—
—
77
280
—
—
—
320
—
280
320
Balance at December 31, 2001 ..........................
—
(377)
189
61,686
Common stock issued upon exercise
of options, including tax benefit .....................
Purchase of common stock ................................
Pension benefit obligation .................................
Increase in deferred compensation
on stock options ..............................................
Amortization of stock compensation .................
Net income .........................................................
Balance at December 31, 2002 ..........................
—
—
(1,594)
—
—
—
—
—
—
893
(15)
(1,594)
—
—
—
(1,177)
1,196
—
—
—
20,408
—
1,196
20,408
(1,594)
(358)
20,597
82,574
Common stock issued upon exercise
of options, including tax benefit .....................
Purchase of common stock ................................
Pension benefit obligation .................................
Repurchase of warrants issued...........................
Increase in deferred compensation
on stock options ..............................................
Amortization of stock compensation .................
Net income .........................................................
Balance at December 31, 2003 .......................... $
—
—
(832)
—
—
—
—
—
—
—
—
—
—
—
—
974
(1,195)
(832)
(896)
(1,585)
1,140
—
—
—
395
—
1,140
395
(2,426)
See accompanying Notes to Consolidated Financial Statements.
$ 82,160
20,992
(803)
$
$
F-6
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December 31,
2003
2002
2001
395
33,518
—
1,000
2,695
11,916
(4,381)
—
—
1,140
25,934
(18,736)
(20,867)
Cash flows from operating activities:
Net income ................................................................................................ $
Adjustments to reconcile net income to net cash
provided by operating activities:
Extraordinary gain, excess of assets acquired
over purchase price..................................................................................
Depreciation and amortization...................................................................
Amortization of deferred financing costs ..................................................
Provision for (recovery of) credit losses....................................................
NIR gains recognized ................................................................................
Write off of related party receivables ........................................................
Loss on sale of furniture and equipment....................................................
Deferred compensation..............................................................................
Releases of cash from Trusts to Company.................................................
Initial deposits to Trusts ............................................................................
Net deposits to Trusts to increase Credit Enhancement.............................
(Increase) decrease in receivables from Trusts and
investment in subordinated certificates...................................................
Changes in assets and liabilities:
Restricted cash...........................................................................................
Purchases of Contracts held for sale..........................................................
Amortization and liquidation of Contracts held for sale............................
Other assets ...............................................................................................
Accounts payable and accrued expenses ...................................................
Tax asset/liability ......................................................................................
Net cash provided by operating activities..................................................
Cash flows from investing activities:
Net related party receivables .....................................................................
Purchase of Contracts held for investment ................................................
Amortization of Contracts held for investment .........................................
Purchase of furniture and equipment.........................................................
Purchase of subsidiary, net of cash acquired .............................................
Net cash used in investing activities.....................................................
Cash flows from financing activities:
25,000
Proceeds from issuance of senior secured debt.........................................
154,375
Proceeds from issuance of securitization trust debt ...................................
31,332
Net proceeds from warehouse lines of credit.............................................
(96,484)
Repayment of securitization trust debt ......................................................
(25,107)
Repayment of senior secured debt.............................................................
(1,000)
Repayment of subordinated debt ...............................................................
(84)
Repayment of capital lease obligations .....................................................
(3,664)
Repayment of notes payable......................................................................
—
Repayment of related party debt................................................................
(2,553)
Payment of financing costs........................................................................
(1,195)
Purchase of common stock ........................................................................
(896)
Repurchase of warrants issued ..................................................................
584
Exercise of options and warrants...............................................................
80,308
Net cash provided by (used in) financing activities..............................
262
Increase (decrease) in cash ............................................................................
Cash at beginning of period............................................................................
32,947
Cash at end of period...................................................................................... $ 33,209
(30,641)
(182,045)
283,423
6,936
(3,363)
(7,162)
99,762
—
(175,275)
5,741
(93)
(10,181)
(179,808)
$ 20,408
$
320
(17,412)
1,138
4,547
2,639
(16,873)
669
5
1,196
60,393
(16,749)
(24,236)
—
1,019
890
(5,695)
(9,211)
—
—
280
43,652
(2,477)
(24,581)
8,884
(14,287)
17,940
(463,253)
566,124
5,016
(16,113)
12,570
146,893
—
—
—
(285)
(29,467)
(29,752)
46,242
—
—
(85,293)
(22,170)
(23,489)
(409)
(917)
—
(1,037)
(15)
—
324
(86,764)
30,377
2,570
$ 32,947
(6,090)
(672,281)
693,258
5,164
(3,995)
(240)
5,726
230
—
—
(766)
—
(536)
—
—
(2,003)
—
(12,000)
(710)
(522)
(824)
(4,000)
(576)
(1,348)
—
312
(21,671)
(16,481)
19,051
$ 2,570
See accompanying Notes to Consolidated Financial Statements.
F-7
CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December 31,
2003
2002
2001
Supplemental disclosure of cash flow information:
Cash paid (received) during the period for:
Interest .............................................................................................................. $ 18,677
3,728
Income taxes .....................................................................................................
Supplemental disclosure of non-cash investing and financing activities:
Stock compensation ..........................................................................................
Pension benefit obligation, net..........................................................................
Deferred income taxes ......................................................................................
Purchase of common stock with notes ..............................................................
1,140
832
944
—
$ 19,255
(15,565)
$ 10,780
22
1,196
1,594
1,632
479
280
—
—
—
See accompanying Notes to Consolidated Financial Statements.
F-8
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
Description of Business
Consumer Portfolio Services, Inc. (“CPS”) was incorporated in California on March 8, 1991. CPS and its
subsidiaries (collectively, the “Company”) specialize in purchasing, selling and servicing retail automobile
installment sale contracts (“Contracts”) originated by licensed motor vehicle dealers (“Dealers”) located
throughout the United States. The Company specializes in Contracts with obligors who generally would not be
expected to qualify for traditional financing, such as that provided by commercial banks or automobile
manufacturers’ captive finance companies.
Acquisitions
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 March 2002;
TFC continues to acquire Contracts under its "TFC Programs."
Recent Developments
In July 2003, the Company agreed with the other parties to its continuous, or “warehouse”, securitization
facilities to amend the terms of such facilities. The effect of the amendments was to cause use of those
facilities to be treated for financial accounting purposes as borrowings secured by pledged Contracts, rather
than as sales of such Contracts.
In addition, the Company announced in August 2003 that it would structure its future term securitization
transactions so that they will be treated for financial accounting purposes as borrowings secured by
receivables, rather than as sales of receivables. The new structure for the warehouse facilities described in the
preceding paragraph and the intended future structure of the Company’s term securitizations has affected and
will affect the way in which the transactions are reported. The major effects are these: (i) the finance
receivables will be shown as assets of the Company on its balance sheet; (ii) the debt issued in the transactions
will be shown as indebtedness of the Company; (iii) cash posted to enhance the credit of the securitization
transactions will be shown as “restricted cash” on the Company’s balance sheet; (iv) the servicing fee that the
Company receives in connection with such receivables will be recorded as a portion of the interest earned on
such receivables; (v) the Company will initially and 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 will be 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 will result in the
Company’s reporting lower earnings than it would report if it were to continue to structure its securitizations to
require recognition of gain on sale.
Principles of Consolidation
The Consolidated Financial Statements include the accounts of Consumer Portfolio Services, Inc. and its
wholly-owned subsidiaries, certain of which are Special Purpose Subsidiaries (“SPS”), formed to
accommodate the structures under which the Company purchases and securitizes its Contracts. The
Consolidated Financial Statements also include the accounts of CPS Leasing, Inc., an 80% owned subsidiary.
All significant intercompany balances and transactions have been eliminated in consolidation.
F-9
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments with
original maturities of three months or less to be cash equivalents. Cash equivalents consist of cash on hand and
due from banks and money market accounts.
Finance Receivables, net of unearned income
Finance receivables are presented at cost. Finance receivable Contracts include automobile installment sales
contracts on which interest is pre-computed and added to the amount financed. The interest on such Contracts
is included in unearned finance charges. Unearned finance charges are amortized using the interest method
over the remaining period to contractual maturity. Generally, payments received on finance receivables are
restricted to certain securitized pools, and the related Contracts cannot be resold. Finance receivables are
charged off pursuant to the controlling documents of certain securitized pools, generally before they become
contractually delinquent five payments. Contracts that are deemed uncollectible prior to the maximum charge
off period are charged off immediately. Management may authorize a temporary extension of payment terms if
collection appears likely during the next calendar month.
The method selected to measure impairment is made on a loan-by-loan basis, unless repossession of the
collateral has occurred, in which case the net realizable value is used.
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 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.
Contract Acquisition Fees
Upon purchase of a Contract from a Dealer, the Company generally charges or advances the Dealer an
acquisition fee. For Contracts securitized in pools which were structured as sales for financial accounting
purposes, the acquisition fees associated with Contract purchases were deferred until the Contracts were
securitized, at which time the deferred acquisition fees were recognized as a component of the gain on sale.
For Contracts securitized in pools which are structured as secured financings for financial accounting purposes,
the acquisition fees associated with Contract purchases are deferred and revenue is recognized over the life of
the Contracts using a method that approximates a level yield. The Company also charged the purchaser an
origination fee for those Contracts that were sold on a flow basis. Those fees were recognized at the time the
Contracts were sold and were also a component of the gain on sale.
Flow Purchase Program
Through May 2002, the Company purchased Contracts 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 being conveyed to the purchaser. Those 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
F-10
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of such representations or warranties, the Company may 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).
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 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 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.
F-11
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 are 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 71.6% to 73% of the aggregate principal balance
of the Contracts (that is, up to 28.4% 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.
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.
F-12
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 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
transferred 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.
Servicing
The Company considers the servicing fee received on its managed portfolio held by non-consolidated
subsidiaries to approximate adequate compensation. As a result, no servicing asset or liability has been
recognized. Servicing fees received on its managed portfolio held by non-consolidated subsidiaries are
reported as income when earned. Servicing fees received on its managed portfolio held by consolidated
subsidiaries are included in interest income when earned. Servicing costs are charged to expense as incurred.
Servicing fees receivable represent fees earned but not yet remitted to the Company by the trustee.
F-13
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Furniture and Equipment
Furniture and equipment are stated at cost net of accumulated depreciation. The Company calculates
depreciation using the straight-line method over the estimated useful lives of the assets, which range from three
to five years. Assets held under capital leases and leasehold improvements are amortized over the lesser of the
estimated useful lives of the assets or the related lease terms.
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
The Company accounts for long-lived assets in accordance with the provisions of SFAS No. 144, “Accounting
for the Impairment of Long-Lived Assets.” This Statement requires that long-lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated
by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed
of are reported at the lower of carrying amount or fair value less costs to sell.
Other Income
Other Income consists primarily of recoveries on previously charged off MFN contracts. These recoveries
totaled $12.2 million and $10.5 million for the years ended December 31, 2003 and 2002, respectively. There
were no such recoveries for the year ended December 31, 2001.
Earnings Per Share
The following table illustrates the computation of basic and diluted earnings per share:
Year ended December 31,
2002
(In thousands, except per share data)
2003
2001
$ 395
$ 2,996
Numerator:
Numerator for basic and diluted earnings
per share before extraordinary item..........................
Denominator:
Denominator for basic earnings per share
before extraordinary item — weighted average
number of common shares outstanding during the
year...........................................................................
Incremental common shares attributable to
exercise of outstanding options and warrants.............
Denominator for diluted earnings
before extraordinary item per share...........................
21,018
Basic earnings per share before extraordinary item ..... $ 0.02 $ 0.15 $ 0.02
Diluted earnings per share before extraordinary item .. $ 0.02 $ 0.14 $ 0.02
1,085
1,315
20,263
19,902
$ 320
21,578
20,987
19,480
1,538
Incremental shares of 1.1 million related to the conversion of subordinated debt have been excluded from the
calculation for the years ended December 31, 2003, 2002 and 2001, because the impact of assumed conversion
of such subordinated debt is anti-dilutive.
Incremental shares of 908,000, 595,000 and 1.5 million shares related to stock options have been excluded
from the calculation for the years ended December 31, 2003, 2002, and 2001, respectively, because the impact
of assumed exercise is anti-dilutive. In addition, incremental shares of 2.5 million related to warrants have
been excluded from the calculation for the years ended December 31, 2002 and 2001, because the impact of
assumed exercise is anti-dilutive.
F-14
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferral and Amortization of Debt Issuance Costs
Costs related to the issuance of debt are amortized on a straight-line basis over the shorter of the actual or
expected term of the related debt.
Income Taxes
The Company and its subsidiaries file a consolidated federal income and combined state franchise tax returns.
The Company utilizes the asset and liability method of accounting for income taxes, under which deferred
income taxes are recognized for the future tax consequences attributable to the differences between the
financial statement values of existing assets and liabilities and their respective tax bases. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in
tax rates is recognized in income in the period that includes the enactment date. The Company has estimated a
valuation allowance against that portion of the deferred tax asset whose utilization in future periods is not more
than likely.
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 operating losses might otherwise expire.
Purchases of Company Stock
The Company records purchases of its own common stock at cost.
Stock Option Plan
As permitted by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based
Compensation” (“SFAS No. 123”), the Company accounts for stock-based employee compensation plans in
accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”
and related interpretations, whereby stock options are recorded at intrinsic value equal to the excess of the
share price over the exercise price at the date of grant. The Company provides the pro forma net income (loss),
pro forma earnings per share, and stock based compensation plan disclosure requirements set forth in SFAS
No. 123. The Company accounts for repriced options as variable awards.
The per share weighted-average fair value of stock options granted during the years ended December 31, 2003,
2002 and 2001, was $2.09, $1.39, and $1.79, respectively, at the date of grant. That fair value was computed
using the Black-Scholes option-pricing model with the following weighted average assumptions:
Expected life (years).....................................................
Risk-free interest rate ...................................................
Volatility.......................................................................
Year ended December 31,
2002
8.21
4.19%
107.56%
2003
7.63
4.16%
100.82%
2001
6.50
4.70%
128.56%
Expected dividend yield ...............................................
—
—
—
Compensation cost has been recognized for certain stock options in the Consolidated Financial Statements in
accordance with APB Opinion No. 25. Had the Company determined compensation cost based on the fair
value at the grant date for its stock options under Statement of Financial Accounting Standards No. 123
(“SFAS 123”), “Accounting for Stock Based Compensation,” the Company’s net income and earnings per
share would have been reduced to the pro forma amounts indicated below.
F-15
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Year ended December 31,
2002
(In thousands, except per share data)
2001
2003
Net income (loss)
As reported .................................................................
Pro forma ......................................................................
Earnings (loss) per share — basic
As reported .................................................................
Pro forma ......................................................................
Earnings (loss) per share — diluted
As reported .................................................................
Pro forma ......................................................................
$ 395
175
$ 20,408
20,109
$ 320
(1,040)
$
$
0.02
0.01
1.03
1.01
$ 0.02
(0.05)
$
0.02
0.01
$
0.97
0.96
$ 0.02
(0.05)
Pro forma net income (loss) and earnings (loss) per share reflect only options granted in the years ended
December 31, 1996 to 2003. Therefore, the full effect of calculating compensation cost for stock options under
SFAS No. 123 is not reflected in the pro forma amounts presented above, because compensation cost is
reflected over the options’ vesting period and compensation cost for options granted prior to 1996 is not
considered.
Segment Reporting
Operations are managed and financial performance is evaluated on a Company-wide basis by a chief decision
maker. Accordingly, all of the Company’s operations are aggregated in one reportable operating segment.
New Accounting Pronouncements
The FASB issued Statement of Financial Accounting Standards No. 148 “Accounting for Stock-Based
Compensation—Transition and Disclosure” amends FASB Statement No. 123, “Accounting for Stock-Based
Compensation” (“SFAS 123”) in December 2002. SFAS 148 is designed to provide alternative methods of
transition for enterprises that elect to change to the SFAS 123 fair value method of accounting for stock-based
employee compensation. SFAS 148 will permit two additional transition methods for entities that adopt the
preferable SFAS 123 fair value method of accounting for stock-based employee compensation. Both of those
methods avoid the ramp-up effect arising from prospective application of the fair value method under the
existing transition provisions of SFAS 123. In addition, under the provisions of SFAS 148, the original
Statement 123 prospective method of transition for changes to the fair value method will no longer be
permitted in fiscal periods beginning after December 15, 2003.
SFAS 148 will also amend the disclosure requirements of SFAS 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The provisions of SFAS 148 are effective
for fiscal years ended after December 15, 2002. The adoption of SFAS No. 148 did not have a material effect
on the Company.
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003, FIN 46R),
Consolidation of Variable Interest Entities, which addresses how a business enterprise should evaluate whether
it has a controlling financial interest in an entity through means other than voting rights and accordingly should
consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, Consolidation of Variable Interest
Entities, which was issued in January 2003. The Company will be required to apply FIN 46R to variable
interests in VIEs created after December 31, 2003. For variable interests in VIEs created before January 1,
2004, the Interpretation will be applied beginning on January 1, 2005. For any VIEs that must be consolidated
under FIN 46R that were created before January 1, 2004, the assets, liabilities and noncontrolling interests of
the VIE initially would be measured at their carrying amounts with any difference between the net amount
added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of
an accounting change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R
first applies may be used. Certain of the Company’s subsidiaries are qualifying special purpose entities formed
F-16
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
in connection with off-balance sheet securitizations and are not subject to the requirements of FIN 46R. The
Company’s subsidiaries that are considered variable interest entities subject to the requirements of FIN 46R,
Trusts related to the Company’s on-balance sheet securitizations, are currently being consolidated and are
included in the Company’s consolidated financial statements. The adoption of FIN 46R is not expected to have
a material effect on the Company.
On April 30, 2003, the FASB issued statement of Financial Accounting Standards No. 149, “Amendment of
Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS 149”). The purpose of SFAS 149 is
to amend and clarify financial accounting and reporting for derivative instruments and hedging activities under
SFAS No.133. These amendments clarify the definition of a derivative, expand the nature of exemptions from
SFAS No.133, clarify the application of hedge accounting when using certain instruments, clarify the
application of paragraph 13 of SFAS No.133 to embedded derivative instruments in which the underlying is an
interest rate, and modify the cash flow presentation of derivative instruments that contain financing elements.
SFAS 149 is effective for derivative transactions and hedging relationships entered into or modified after June
30, 2003. The adoption of SFAS 149 did not have a material impact on the Company’s financial statements.
FASB Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity” (“SFAS 150”), was issued in May 2003. This Statement establishes standards for the
classification and measurement of certain financial instruments with characteristics of both liabilities and
equity. The Statement also includes required disclosures for financial instruments within its scope. For the
Company, the Statement was effective for instruments entered into or modified after May 31, 2003 and
otherwise will be effective as of January 1, 2004, except for mandatorily redeemable financial instruments. For
certain mandatorily redeemable financial instruments, the Statement will be effective for the Company on
January 1, 2005. The effective date has been deferred indefinitely for certain other types of mandatorily
redeemable financial instruments. The Company adopted the provisions of SFAS 150 on July 1, 2003. The
adoption of SFAS 150 did not have a material impact on the Company’s consolidated financial statements.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the
United States of America requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of
income and expenses during the reported periods. Specifically, a number of estimates were made in connection
with determining an appropriate allowance for finance credit losses, valuing the Residuals and computing the
related gain on sale on the transactions that created the Residuals, and deferred tax asset valuation allowance.
Actual results could differ from those estimates depending on the future performance of the related Contracts.
Reclassification
Certain amounts for the prior years have been reclassified to conform to the current year’s presentation.
(2) Acquisitions
Acquisition of MFN Financial Corporation
On March 8, 2002, CPS acquired 100% of MFN Financial Corporation, a Delaware corporation ("MFN") and
its subsidiaries, by the merger (the "MFN Merger") of a direct wholly–owned subsidiary of CPS with and into
MFN. MFN thus became a wholly-owned subsidiary of CPS, and CPS thus acquired the assets of MFN, which
consisted principally of interests in automobile installment sales finance Contracts and the facilities for
originating and servicing such Contracts. The MFN Merger was accounted for as a purchase.
MFN, through its primary operating subsidiary, Mercury Finance Company LLC, was in the business of
purchasing automobile installment sales finance Contracts from Dealers, and securitizing and servicing such
F-17
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Contracts. CPS continues to use the assets acquired in the MFN Merger in the automobile finance business, but
has disposed of a portion of such assets. MFN has ceased to purchase automobile installment sales finance
Contracts, and does not anticipate recommencing such purchasing. In connection with the termination of MFN
origination activities and the integration and consolidation of certain activities, the Company has recognized
certain liabilities related to the costs to exit these activities and terminate the affected employees of MFN.
These activities include service departments such as accounting, finance, human resources, information
technology, administration, payroll and executive management. These costs include the following:
December 31,
2003
Activity
December 31,
2002
(In thousands)
Activity
March 8,
2001
Termination of contracts,
Severance payments and consulting
contracts.............................................. $ —
Facilities closures (1)..........................
1,889
leases,
services and other obligations.............
Acquisition expenses accrued but
unpaid .................................................
—
Total liabilities assumed ..................... $ 1,889
____________
—
$ 571
106
$ 571
1,995
$ 2,644
157
$ 3,215
2,152
323
323
274
597
51
$ 1,051
51
$ 2,940
199
$ 3,274
$ 250
$ 6,214
(1) For the period from March 8, 2002 to December 31, 2002 the activity resulting in a net charge of $157,000, includes charges
against liability of $1.4 million, and the “reclassification” of an existing accrual for offices closed prior to the Merger Date of
approximately $1.2 million.
(2) Approximately $1.9 million of remaining accrual is recorded in the Consolidated Balance Sheet of the Company at December
31, 2003. The Company believes that this amount provides adequately for anticipated remaining costs related to exiting certain
activities of MFN, and that amounts indicated above are reasonably allocated.
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 balance sheet accounts of MFN Financial Corporation as of
December 31, 2003 and 2002 and the results of operations subsequent to March 8, 2002, the merger date.
The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the
date of acquisition.
Cash ................................................................................................................................... $
Restricted cash...................................................................................................................
Finance Contracts, net .......................................................................................................
Residual interest in securitizations ....................................................................................
Other assets........................................................................................................................
Total assets acquired..................................................................................................
Securitization trust debt .....................................................................................................
Subordinated debt..............................................................................................................
Accounts payable and other liabilities...............................................................................
Total liabilities assumed ............................................................................................
Net assets acquired ....................................................................................................
Less: purchase price ..................................................................................................
Excess of net assets acquired over purchase price..................................................... $
March 8, 2002
(In thousands)
93,782
25,499
186,554
32,485
12,006
350,326
156,923
22,500
30,242
209,665
140,661
123,249
17,412
Acquisition of TFC Enterprises, Inc.
On May 20, 2003, CPS acquired TFC Enterprises, Inc., a Delaware corporation (“TFC”) and its subsidiaries,
by the merger (the “TFC Merger”) of a direct, wholly-owned subsidiary of CPS, with and into TFC. In the
TFC Merger, TFC became a wholly-owned subsidiary of CPS. CPS thus acquired the assets of TFC and its
subsidiaries, which consisted principally of interests in motor vehicle installment sales, finance Contracts,
F-18
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
interests in securitized pools of such Contracts, and the facilities for originating and servicing such Contracts.
The merger was accounted for as a purchase.
TFC, through its primary operating subsidiary, “The Finance Company,” purchases motor vehicle installment
sales finance Contracts from automobile Dealers, and securitizes and services such Contracts. CPS intends to
continue to use the assets acquired in the TFC Merger in the automobile finance business.
In connection with the integration and consolidation of certain activities between CPS and TFC, the Company
has recognized certain liabilities related to the costs to integrate certain activities and terminate the affected
employees of TFC. These activities include service departments such as accounting, finance, human resources,
information technology, administration, payroll and executive management. The total of these liabilities
recognized by the Company at the time of the merger were $4.5 million. These costs include the following:
Severance payments and consulting contracts .......................
Facilities closures ..................................................................
Other obligations ...................................................................
Total liabilities assumed.................................................
___________
December 31,
2003(1)
$ 2,326
1,231
234
$ 3,791
Activity
(In thousands)
$ 357
190
206
$ 753
May 20,
2001
$ 2,683
1,421
440
$ 4,544
(1) The Company believes that this amount provides adequately for anticipated remaining costs related to exiting certain
activities of TFC, and that amounts indicated above are reasonably allocated.
At the closing of the TFC Merger, each outstanding share of common stock of TFC became a right to receive
$1.87 per share in cash. The total merger consideration payable to stockholders of TFC was approximately
$21.6 million. The recipients of the total merger consideration had no material relationship with CPS, its
directors, its officers or any associates of such directors or officers, to the best of CPS's knowledge. The
merger consideration was paid with existing cash of CPS. The aggregate purchase price, including expenses
related to the transaction, was approximately $23.7 million.
The Company's Consolidated Balance Sheet and Consolidated Statement of Operations as of and for the year
ended December 31, 2003, include the balance sheet accounts of TFC Enterprises, Inc. as of December 31,
2003 and the results of operations subsequent to May 20, 2003, the merger date. The Company has recorded
certain purchase accounting adjustments on its Consolidated Balance Sheet, which are estimates based on
available information.
The following table summarizes the recorded amounts of the assets acquired and liabilities assumed at the date
of acquisition.
Cash ..................................................................................................................
Restricted cash..................................................................................................
Finance Contracts, net ......................................................................................
Other assets.......................................................................................................
Total assets acquired.................................................................................
Securitization trust debt ....................................................................................
Notes Payable ...................................................................................................
Capital lease obligations...................................................................................
Accounts payable and other liabilities..............................................................
Total liabilities assumed ...........................................................................
Purchase price...........................................................................................
May 20, 2003
(In thousands)
$
13,545
17,723
125,108
5
156,878
115,597
6,32
11,217
133,152
23,726
$
F-19
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Pro Forma Results of Operations
Selected unaudited pro forma combined results of operations for the years ended December, 2003 and 2002,
assuming the MFN Merger and TFC Merger occurred on January 1, 2003 and 2002, are as follows:
Pro Forma Presentation (Unaudited)
Year Ended December 31,
2003
2002
(In thousands)
Total revenue ............................................................................................. $ 107,598 $ 130,212
Net income (loss) before Merger-related expenses and extraordinary
item ........................................................................................................
Net income (loss).......................................................................................
824
824
(1,695)
(1,695)
Basic net income (loss) per share before Merger-related expenses and
extraordinary item..................................................................................
$ (0.09)
$ 0.04
Extraordinary item (loss) ........................................................................... —
—
Basic net income per share ........................................................................ $ 0.04 $ (0.09)
Diluted net income (loss) per share before Merger-related expenses
and extraordinary item ...........................................................................
$ (0.08)
$ 0.04
Extraordinary item..................................................................................... —
—
Diluted net income (loss) per share ........................................................... $ 0.04 $ (0.08)
(3) Restricted Cash
Restricted cash comprised the following components:
Securitization trust accounts......................................... $ 60,550
5,503
Litigation reserve..........................................................
Note purchase facility reserve ......................................
1,074
Other.............................................................................
150
Total restricted cash...................................................... $ 60,550
December 31,
2003
2002
$ 11,881
5,503
968
560
$ 18,912
Certain of the Company’s operating agreements require that the Company establish cash reserves for the
benefit of the other parties to the agreements, in case those parties are subject to any claims or exposure. In
addition, certain of these agreements require that the Company establish amounts in reserve related to
outstanding litigation.
(4) Finance Receivables
The following table presents the components of Finance Receivables, net of unearned interest:
December 31,
2003
December 31,
2002
Finance Receivables
Automobile
Simple interest .............................................................................. $
Pre-compute or “Rule of 78’s”, net of unearned interest..............
Finance Receivables, net of unearned interest..............................
Less: Unearned acquisition fees and discounts ............................
Finance Receivables ..................................................................... $
(In thousands)
178,679
133,339
312,018
(9,940)
302,078
$
$
31,372
79,094
110,466
(46)
110,420
F-20
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the contractual maturities of Finance Receivables, net of unearned income, as of
December 31, 2003:
Due within one year.......................................................................... $
Due within two years........................................................................
Due within three years......................................................................
Due within four years .......................................................................
Due within five years........................................................................
Due after five years ..........................................................................
Total.............................................................................................. $
Amount
%
(Dollars in thousands)
23,329
38,876
38,890
46,319
128,880
35,624
312,018
7.48%
12.46%
12.49%
14.84%
41.31%
11.42%
100.00%
The following table presents a summary of the activity for the allowance for credit losses, for the years ended
December 31, 2003 and 2002:
December 31,
2003
2002
(In thousands)
Balance at beginning of year ......................................................................... $ 25,828 $ —
Addition to allowance for credit losses due to acquisition of TFC ...............
—
59,261
Addition to allowance for credit losses due to acquisition of MFN ..............
Provision for credit losses .............................................................................
2,639
(35,732)
Net charge offs ..............................................................................................
Net amount transferred from allowance for repossessed assets ....................
(340)
Balance at end of year ................................................................................... $ 35,889 $ 25,828
24,271
—
11,667
(25,950)
73
(5) Residual Interest in Securitizations
The following table presents the components of the residual interest in securitizations:
December 31,
2003
2002
(In thousands)
Cash, commercial paper, United States government securities and other
$ 35,693
qualifying investments (Spread Account) .................................................
20,959
Receivable from Trusts.................................................................................
38,548
Overcollateralization ....................................................................................
Investment in subordinated certificates ........................................................
16,502
Residual interest in securitizations ............................................................... $ 111,702
$ 27,218
33,214
59,366
7,372
$ 127,170
The following table presents the estimated remaining undiscounted credit losses included in the fair value
estimate of the Residuals as a percentage of the Company’s managed portfolio held by non-consolidated
subsidiaries subject to recourse provisions:
2003
Undiscounted estimated credit losses ...................... $ 47,935
Managed portfolio held by non-consolidated
subsidiaries ...............................................................
Undiscounted estimated credit losses as
percentage of managed portfolio held by non
consolidated subsidiaries ..........................................
425,534
11.3%
December 31,
2002
(In thousands)
$ 54,363
2001
$ 16,210
478,136
281,493
11.4%
5.8%
The key economic assumptions used in measuring all residual interest in securitizations as of December 31,
2003 and 2002 are included in the table below. The pre-tax discount rate remained constant at 14%.
F-21
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Prepayment speed (Cumulative).......................................
Credit losses (Cumulative) ...............................................
2003
18.1% - 22.1%
11.8% - 18.0%
2002
19.8% - 22.9%
10.0% - 15.4%
Static pool losses are calculated by summing the actual and projected future credit losses and dividing them by
the original balance of each pool of assets.
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 .....................................
Weighted average life in years...........................................................................................
$ 111,702
3.74
Prepayment Speed Assumption (Cumulative) ...................................................................
Estimated fair value assuming 10% adverse change .........................................................
Estimated fair value assuming 20% adverse change .........................................................
18.1% - 22.1%
110,938
$
110,116
Expected Credit Losses (Cumulative) ...............................................................................
Estimated fair value assuming 10% adverse change ........................................................... $
Estimated fair value assuming 20% adverse change .........................................................
11.8% -18.0%
100,907
90,312
Residual Cash Flows Discount Rate (Annual).....................................................................
Estimated fair value assuming 10% adverse change .........................................................
Estimated fair value assuming 20% adverse change .........................................................
14.0%
109,594
$
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 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 following table summarizes the cash flows received from (paid to) securitization Trusts:
Releases of cash from Spread Accounts........................ $ 25,934
17,039
Servicing fees received..................................................
(20,867)
Net deposits to increase Credit Enhancement ...............
(18,736)
Initial funding of Credit Enhancement ..........................
(45,747)
Purchase of delinquent or foreclosed assets ..................
Repurchase of trust assets..............................................
—
2003
For the Year Ended December 31,
2002
2001
(In thousands)
$ 60,393
13,761
(24,236)
(16,749)
(34,365)
(97,946)
$ 43,652
10,208
(24,581)
(2,477)
(37,620)
(2,936)
F-22
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the historical loss and delinquency amounts for the serviced portfolio:
Total Principal
Amount of
Contracts
Principal Amount of
Contracts 60 Days
or More Past Due
2003
At December 31,
2003
2002
2002
Net Credit Losses
for the Year Ended
December 31,
2002
2003
(In thousands)
$ 425,534
$ 478,136
$ 13,969
$ 14,835
$ 40,096
$ 15,605
315,598
117,075
16,176
6,017
4,210
29,566
$ 741,132 $ 595,211 $ 30,145 $ 20,852 $ 44,306 $ 45,171
Contracts held by non-
consolidated
subsidiaries ....................
Contracts held by
consolidated
subsidiaries ....................
Total managed
portfolio .........................
(6) Furniture and Equipment
The following table presents the components of furniture and equipment:
December 31,
2003
2002
(In thousands)
Furniture and fixtures .................................................................................. $ 2,994
4,034
Computer equipment ...................................................................................
673
Leasing assets ..............................................................................................
637
Leasehold improvements.............................................................................
50
Other fixed assets ........................................................................................
8,388
(7,562)
826
$
Less: accumulated depreciation and amortization
$ 2,994
3,980
729
637
17
8,357
(6,745)
$ 1,612
Depreciation expense totaled $878,000, $1.0 million and $1.0 million for the years ended December 31, 2003,
2002 and 2001, respectively.
(7) Securitization Trust Debt
The Company’s MFN and TFC subsidiaries have completed a number of securitization transactions that
are treated as secured borrowings for financial accounting purposes, rather than as sales. In addition, CPS
completed two such term securitization transactions in 2003. The debt issued in these transactions is
shown on the Company’s balance sheet as “Securitization Trust Debt,” and the components of such debt
are summarized in the following table:
F-23
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Series:
Issue Date
Initial
Principal
Outstanding
Principal at
December 31,
2003
Outstanding
Principal at
December 31,
2002
(Dollars in thousands)
Interest Rate
Range
CPS2003-D
December 16, 2003
$ 71,250
$ 71,250
$ —
1.76 – 3.56 %
CPS2003-C
September 30, 2003
TFC2003-1
May 20, 2003
TFC2002-2
October 9, 2002
TFC2002-1
March 19, 2002
83,125
52,365
62,589
64,552
77,928
37,114
25,436
12,403
—
—
—
—
1.55 – 3.99 %
2.69 %
2.95 %
4.23 %
MFN2001-A
June 28, 2001
301,000
20,987
71,630
4.05 – 5.07 %
$ 634,881
$ 245,118
$ 71,630
All of the securitization trust debt was sold in private placement transactions to qualified institutional buyers.
The debt was issued through wholly-owned, bankruptcy remote subsidiaries of CPS, TFC or MFN, and is
secured by the assets of such subsidiaries, but not by other assets of the Company. Principal and interest
payments are guaranteed by financial guaranty insurance policies.
The terms of the various Securitization Agreements related to the issuance of the securitization trust debt
require that certain delinquency and credit loss criteria be met with respect to the collateral pool, and require
that the Company maintain a minimum net worth, and meet other financial tests. As of December 31, 2003, the
Company was in default of four financial covenants, including maximum leverage, minimum equity,
maximum financial loss and interest coverage. As of December 31, 2003, the Company had received a waiver
on these covenant breaches from the controlling party. On March 15, 2004, each of these financial covenants
was amended with the controlling party such that all breaches have been cured.
The Company is responsible for the administration and collection of the Contracts. The Securitization
Agreements also require certain funds be held in restricted cash accounts to provide additional collateral for
the borrowings or to be applied to make payments on the securitization trust debt. As of December 31, 2003,
restricted cash under the various agreements totaled approximately $60.6 million. Interest expense on the
securitization trust debt is composed of the stated rate of interest plus amortization of additional costs of
borrowing. Additional costs of borrowing include facility fees, insurance and amortization of deferred
financing costs. Deferred financing costs related to the securitization trust debt are amortized in proportion to
the principal distributed to the noteholders. Accordingly, the effective cost of borrowing of the securitization
trust debt is greater than the stated rate of interest.
The wholly-owned, bankruptcy remote subsidiaries of CPS, MFN and TFC were formed to facilitate the above
asset-backed financing transactions. Similar bankruptcy remote subsidiaries issue the debt outstanding under
the Company’s warehouse lines of credit. Bankruptcy remote refers to a legal structure in which it is expected
that the applicable entity would not be included in any bankruptcy filing by its parent or affiliates. All of the
assets of these subsidiaries have been pledged as collateral for the related debt. All such transactions, treated as
secured financings for accounting and tax purposes, are treated as sales for all other purposes, including legal
and bankruptcy purposes. None of the assets of these subsidiaries are available to pay other creditors of the
Company or its affiliates.
On March 15, 2004 a wholly-owned, bankruptcy remote consolidated subsidiary of the Company issued $44
million of asset-backed notes secured by its retained interest in eight term securitization transactions. The
notes, which have an interest rate of 10% per annum and a final maturity in October 2009, are required to be
repaid from the distributions on the underlying retained interests. In connection with the issuance of the notes,
the Company incurred and capitalized issuance costs of $1.2 million.
F-24
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(8) Debt
On December 20, 1995, the Company issued $20.0 million in rising interest subordinated redeemable
securities due January 1, 2006 (the “Notes”). The Notes are unsecured general obligations of the Company.
Interest on the Notes is payable on the first day of each month, commencing February 1, 1996, at an interest
rate of 10.0% per annum. The interest rate increases 0.25% on each January 1 for the first nine years and
0.50% in the last year. In connection with the issuance of the Notes, the Company incurred and capitalized
issuance costs of $1.1 million. The Notes are subordinated to certain existing and future indebtedness of the
Company as defined in the indenture agreement. The Company is required to redeem on an annual basis,
subject to certain adjustments, $1.0 million of the aggregate principal amount of the Notes through the
operation of a sinking fund on or before of January 1, 2000, 2001, 2002, 2003, 2004 and 2005. The Company
may at its option elect to redeem the Notes from the registered holders of the Notes, in whole or in part at
100% of their principal amount, plus accrued interest to and including the date of redemption. During each of
the years 1999 through 2003, the Company redeemed $1.0 million of principal amount of the notes in
conjunction with the requirements of the related sinking fund agreement. The balance outstanding of the Notes
at December 31, 2003 and 2002, was $15.0 million and $16.0 million, respectively.
On April 15, 1997, the Company issued $20.0 million in subordinated participating equity notes (“PENs”) due
April 15, 2004. The PENs are unsecured general obligations of the Company. Interest on the PENs is payable
on the fifteenth of each month, commencing May 15, 1997, at an interest rate of 10.5% per annum. In
connection with the issuance of the PENs, the Company incurred and capitalized issuance costs of $1.2
million. The Company recognizes interest and amortization expense related to the PENs using the effective
interest method over the expected redemption period. The PENs are subordinated to certain existing and future
indebtedness of the Company as defined in the indenture agreement. The Company may at its option elect to
redeem the PENs from the registered holders, in whole but not in part, at any time on or after April 15, 2000, at
100% of their principal amount, subject to limited conversion rights, plus accrued interest to and including the
date of redemption. At maturity, upon the exercise by the Company of an optional redemption, or upon the
occurrence of a “Special Redemption Event,” each holder will have the right to convert into common stock of
the Company (“Common Stock”), 25% of the aggregate principal amount of the PENs held by such holder at
the conversion price of $10.15 per share of Common Stock. “Special Redemption Events” are certain events
related to a change in control of the Company.
In November 1998, the Company issued $25.0 million of subordinated promissory notes due November 30,
2003, to an affiliate of Levine Leichtman Capital Partners, Inc., Levine Leichtman Capital Partners II, L.P.
(“LLCP”), and received the proceeds (net of $1.3 million of capitalized issuance costs), of approximately
$23.7 million. The Company also issued warrants to purchase up to 3,450,000 shares of common stock at
$3.00 per share, exercisable through November 30, 2005 (See Note 13). The debt bears interest at 13.5% per
annum, and may not be prepaid without penalty prior to November 1, 2002. Simultaneously with the
consummation of that transaction, certain affiliates of the Company, who had lent the Company an aggregate
of $5.0 million on a short-term basis in August and September 1998, agreed to subordinate their indebtedness
to the indebtedness in favor of LLCP, to extend the maturity of their debt until June 2004, and to reduce their
interest rate from 15% to 12.5%. Such affiliates received in return the option to convert such debt into an
aggregate of 1,666,667 shares of common stock at the rate of $3.00 per share through maturity at June 30,
2004. Additionally, SFSC also agreed to subordinate $6.0 million, or 40%, of its related party loan in favor of
LLCP (See Note 13.).
In April 1999, the Company issued an additional $5.0 million of subordinated promissory notes due April 30,
2004, to the same affiliate of LLCP as noted above, and received proceeds (net of $312,000 of capitalized
issuance costs) of $4.7 million. The Company also issued warrants to purchase 1,335,000 shares of the
Company’s common stock at $0.01 per share to LLCP, exercisable through April 2009. The debt bears interest
at 14.5% per annum, and may be prepaid without penalty at anytime. As part of the purchase agreement, the
interest rate on the previously issued LLCP notes was increased to 14.5% per annum, and the warrant to
F-25
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
purchase 3,450,000 shares of the Company’s common stock at $3.00 per share was exchanged for a warrant to
purchase 3,115,000 shares at a price of $0.01 per share.
In March 2000, the Company issued $16.0 million of senior secured debt to LLCP (“Term B”). The proceeds
from the issuance were used to repay in full all amounts owed under the Senior Secured Line. As part of the
agreement, all of LLCP’s existing debt of $30.0 million was restructured as senior secured debt, making the
Company’s aggregate principal indebtedness to LLCP equal to $46.0 million. The $16.0 million bears interest
at 12.5% per annum and the interest rate on the $30.0 million is unchanged at 14.5% per annum. As part of the
agreement, all prior defaults were either waived or cured. As of December 31, 2000, the amount outstanding of
the $16.0 million portion of senior secured debt was $8.0 million. The outstanding balance on the $16.0
million LLCP debt was repaid during the first quarter of 2001. In addition, during the first quarter of 2001, the
Company made a $4.0 million principal prepayment on the remaining outstanding LLCP debt, incurring
$200,000 in prepayment penalties and waiver fees. The outstanding balance of Term B debt at December 31,
2003 was $19.8 million.
In March 2002, the Company and LLCP entered into an additional series of agreements under which LLCP
provided additional funding to enable the Company to acquire MFN Financial Corporation. Under the March
2002 agreements, the Company borrowed $35 million from LLCP as a Bridge Note (Bridge Note) and
approximately $8.5 million (“Term C”) on a deemed principal amount of approximately $11.2 million. The
Bridge Note requires principal payments of $2.0 million a month, which began in June 2002, with a final
balloon payment in the amount of $17.0 million, which was made pursuant to the terms of the Bridge Note in
February 2003. The Term C Note repayment schedule is based on the performance of a certain securitized
pool. As the subordinated Note of the pool is repaid from the Trust, principal payments are due on the Term C
Note. The maturity date of the Term C Note is March 2008. Interest is due monthly on the Bridge Note at a
rate of 13.5% per annum and on the Term C Note at a rate of 12.0% per annum. In connection with the March
2002 agreements and the acquisition of MFN, the Company paid LLCP a structuring fee of $1.75 million and
an investment banking fee of $1.0 million, and paid LLCP's out-of-pocket expenses of approximately
$315,000. In addition, the Company paid LLCP certain other fees and interest amounting to $426,181.
Approximately $1.4 million of the fees and other amounts paid to LLCP were deferred as financing costs and
are being amortized over the life of the related debt. The remaining fees and other costs were included in the
purchase price of MFN. At December 31, 2003, there was $5.1 million principal outstanding on the Term C
note.
On February 3, 2003, the Company borrowed $25.0 million from LLCP, net of fees and expenses of $1.05
million. The indebtedness, represented by the “Term D Note,” was originally due in April 2003, with
Company options to extend the maturity to May 2003 and January 2004, upon payment of successive
extension fees of $125,000. The Company has paid the fees to extend the maturity to January 2004. Interest on
the Term D Note is payable monthly at rates that averaged 4.79% per annum through June 30, 2003, and
12.0% per annum thereafter. In a separate transaction, the Bridge Note issued to LLCP in connection with the
acquisition of MFN, in an original principal amount of $35.0 million, was due on February 28, 2003. The
outstanding principal balance of $17.0 million was paid in February 2003. In addition, the maturity of the
Term B Note was extended in October 2003 from November 2003 to January 2004. As of December 31, 2003,
the outstanding principal balances of the Term B Note and the Term C Note were $19.8 million and $5.3
million, respectively. The Company repaid in full the Term C Note on January 29, 2004 and repaid $10.0
million of the Term D Note on January 15, 2004. In addition, on January 29, 2004 the maturities of the Term B
Note and the Term D Note were extended to December 15, 2005 and the coupons on both notes were
decreased to 11.75% per annum. The Company paid LLCP fees equal to $921,000 for these amendments,
which will be amortized over the remaining life of the notes.
During the year ended December 31, 1997 the Company acquired CPS Leasing, Inc. At December 31, 2003
and 2002, CPS Leasing, Inc., had borrowings to banks of $74,000 and $673,000, respectively.
F-26
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At the time of the MFN Merger, MFN had outstanding $22.5 million in principal amount of senior
subordinated debt, which was due and repaid in full on March 23, 2002. Such debt bore interest at the rate of
11.00% per annum, payable quarterly in arrears. At the time of the TFC Merger, TFC had outstanding $6.3
million in principal amount of subordinated debt, which the Company assumed as part of the TFC Merger.
Such debt bears interest at the rate of 13.25% per annum payable monthly in arrears, requires monthly
amortization and is due in June 2005.
The Company must comply with certain affirmative and negative covenants related to debt facilities, which
require, among other things, that the Company maintain certain financial ratios related to liquidity, net worth,
capitalization, investments, acquisitions, restricted payments and certain dividend restrictions. The Company
was in compliance with all of its debt covenants with respect to non-securitization related debt as of December
31, 2003. The Company was in violation of four covenants related to securitization debt as of December 31,
2003, including maximum leverage, minimum equity, maximum financial loss and interest coverage. The
Company has received a waiver of such non-compliance from the controlling party. On March 15, 2004, each
of these financial covenants was amended with the controlling party such that all breaches have been cured.
The following table summarizes the amount of senior secured, subordinated and related party debt maturing
over the next 5 years and thereafter as of December 31, 2003:
Principal
Amount
(In thousands)
83,328
2004 ...................................................................................................................... $
—
2005 ......................................................................................................................
2006 ......................................................................................................................
14,000
2007 ...................................................................................................................... —
5,137
2008 ......................................................................................................................
Thereafter ............................................................................................................. —
102,465
Total............................................................................................................... $
(9) Shareholders’ Equity
Common Stock
Holders of common stock are entitled to such dividends as the Company’s Board of Directors, in its discretion,
may declare out of funds available, subject to the terms of any outstanding shares of preferred stock and other
restrictions. In the event of liquidation of the Company, holders of common stock are entitled to receive, pro
rata, all of the assets of the Company available for distribution, after payment of any liquidation preference to
the holders of outstanding shares of preferred stock. Holders of the shares of common stock have no
conversion or preemptive or other subscription rights and there are no redemption or sinking fund provisions
applicable to the common stock.
The Company is required to comply with various operating and financial covenants defined in the agreements
governing the warehouse lines, senior debt, subordinated debt, and related party debt. The covenants restrict
the payment of certain distributions, including dividends (See Note 8.).
Included in common stock at December 31, 2003 and 2002, is additional paid in capital of $1,585,000 and
$1,770,000 related to the valuation of certain stock options as required by Financial Interpretation No. 44
(“FIN 44”) or the valuation of conditionally granted options as required under Accounting Principals Board
Opinion No. 25 (“APB 25”). Included in compensation expense for December 31, 2003 and 2002, is
$1,141,000 and $1,196,000 related to the amortization of deferred compensation expense and valuation of
stock options.
F-27
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Purchases
During 2000, the Company’s Board of Directors authorized the Company to purchase up to $5 million of
Company securities. In October 2002, the Board of Directors authorized the purchase of an additional $5
million of outstanding debt or equity securities. As of December 31, 2003, the Company had purchased $4.0
million in principal amount of the Notes, and $3.9 million of its common stock, representing 2,141,037 shares.
Options and Warrants
In 1991, the Company adopted and its sole shareholder approved the 1991 Stock Option Plan (the “1991
Plan”) pursuant to which the Company’s Board of Directors may grant stock options to officers and key
employees. The Plan, as amended, authorizes grants of options to purchase up to 2,700,000 shares of
authorized but unissued common stock. Stock options are granted with an exercise price equal to the stock’s
fair market value at the date of grant. Stock options have terms that range from 7 to 10 years and vest over a
range of 0 to 7 years. In addition to the 1991 Plan, in fiscal 1995, the Company granted 60,000 options to
certain directors of the Company that vest over three years and expire nine years from the grant date. The Plan
terminated in December 2001, without affecting the validity of the outstanding options.
In July 1997, the Company adopted and its shareholders approved the 1997 Long-Term Incentive Plan (the
“1997 Plan”) pursuant to which the Company’s Board of Directors may grant stock options, restricted stock
and stock appreciation rights to employees, directors or employees of entities in which the Company has a
controlling or significant equity interest. Options that have been granted under the 1997 Plan have in all cases
been granted at an exercise price equal to the stock’s fair market value at the date of the grant, with terms of 10
years and vesting over 5 years. In 2001, the shareholders of the Company approved an amendment to the 1997
Plan providing that an aggregate maximum of 3,400,000 shares of the Company’s common shares may be
subject to awards under the 1997 Plan. In 2003, the shareholders of the Company approved an amendment to
the 1997 Plan to further increase the aggregate maximum number of shares that may be granted within the Plan
to 4,900,000 shares.
In October 1998, the Company’s Board of Directors approved a plan to cancel and reissue certain stock
options previously granted to key employees of the Company. All options granted prior to October 22, 1998,
with an option price greater than $3.25 per share, were repriced to $3.25 per share. In conjunction with the
repricing, a one-year period of non-exercisability was placed on all repriced options, which period ended on
October 21, 1999.
In October 1999, the Company’s Board of Directors approved a plan to cancel and reissue certain stock
options previously granted to key employees of the Company. All options granted prior to October 29, 1999,
with an option price greater than $0.625 per share, were repriced to $0.625 per share. In conjunction with the
repricing, a six-month period of non-exercisability was placed on all repriced options, which period ended on
April 29, 2000.
At December 31, 2003, there were a total of 146,631 additional shares available for grant under the 1997 Plan
and the 1991 Plan. Of the options outstanding at December 31, 2003, 2002 and 2001, 1,168,042, 920,101, and
1,715,767, respectively, were then exercisable, with weighted-average exercise prices of $1.71, $1.30, and
$0.84, respectively.
F-28
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock option activity during the periods indicated is as follows:
Balance at December 31, 2000 .......................................................
Granted ......................................................................................
Exercised ...................................................................................
Canceled ....................................................................................
Balance at December 31, 2001 .......................................................
Granted ......................................................................................
Exercised ...................................................................................
Canceled ....................................................................................
Balance at December 31, 2002 .......................................................
Granted ......................................................................................
Exercised ...................................................................................
Canceled ....................................................................................
Balance at December 31, 2003 .......................................................
Number of
Shares
Weighted
Average
Exercise Price
(In thousands,
except per share data)
3,501
1,097
501
275
3,822
1,804
1,254
340
4,032
1,013
609
564
3,872
$
$
0.86
2.53
0.63
1.05
1.35
1.55
0.64
1.63
1.64
2.46
0.93
1.69
1.96
During 2002, the Company’s Board of Directors approved a program whereby officers of the Company would
be loaned amounts sufficient to enable them to exercise certain of their outstanding options. See Note 13.
At December 31, 2003, the range of exercise prices, the number, weighted-average exercise price and
weighted-average remaining term of options outstanding and the number and weighted-average price of
options currently exercisable are as follows:
Options Outstanding
Options Exercisable
Range of Exercise Prices
(per share)
Number
Outstanding
$ 0.63 - $ 0.63 .........................
$ 0.69 - $ 1.50 .........................
$ 1.54 - $ 2.39 .........................
$ 2.50 - $ 3.28 .........................
$ 4.25 - $ 4.25 .........................
301
1,245
1,175
929
222
Weighted
Average
Remaining
Term
(Years)
Weighted
Average
Exercise
Price Per
Share
(In thousands, except term and per share data)
$ 0.63
$ 1.49
$ 1.80
$ 2.69
$ 4.25
Number
Exercisable
4.44
8.45
7.79
8.93
7.05
168
322
502
131
45
Weighted
Average
Exercise
Price Per
Share
$ 0.63
$ 1.47
$ 1.77
$ 2.59
$ 4.25
On November 17, 1998, in conjunction with the issuance of a $25.0 million subordinated promissory note to
an affiliate of LLCP, the Company issued warrants to purchase up to 3,450,000 shares of common stock at
$3.00 per share, exercisable through November 30, 2005. In April 1999, in conjunction with the issuance of
$5.0 million of an additional subordinated promissory note to an affiliate of LLCP, the Company issued
additional warrants to purchase 1,335,000 shares of the Company’s common stock at $0.01 per share to LLCP.
As part of the purchase agreement, the existing warrants to purchase 3,450,000 shares at $3.00 per share were
exchanged for warrants to purchase 3,115,000 shares at a price of $0.01 per share. The aggregate value of the
warrants, $12.9 million, which is comprised of $3.0 million from the original warrants issued in November
1998 and $9.9 million from the repricing and additional warrants issued in April 1999, is reported as deferred
interest expense to be amortized over the expected life of the related debt, five years. As of December 31,
2003, 1,000 warrants remained unexercised. Such warrants, and the 4,449,000 shares of common stock have,
upon the exercise of such warrants, not been registered for public sale. However, the holder has the right to
require the Company register the warrants and common stock for public sale in the future.
Also in November 1998, the Company entered into an agreement with the Note Insurer of its asset-backed
securities. The agreement committed the Note Insurer to provide insurance for the securitization of $560.0
million in asset-backed securities, of which $250.0 million remained at December 31, 1998. The agreement
F-29
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
provides for a 3% initial Spread Account deposit. As consideration for the agreement, the Company issued
warrants to purchase up to 2,525,114 shares of common stock at $3.00 per share, subject to anti-dilution
adjustments. The warrants were fully exercisable on the date of grant and expired in December 2003. In
November 2003, the Company purchased the warrants from the Note Insurer for $896,415.
(10) Gain on Sale of Contracts
The following table presents the components of the net gain on sale of Contracts:
Year ended December 31,
2003
2002
2001
Gain on sale of Contracts .................................................... $
Deferred acquisition fees and discounts ..............................
Expenses related to sales .....................................................
(Provision for) recovery of credit losses..............................
Net gain on sale of Contracts............................................... $
(11) Interest Income
(In thousands)
$ 17,480
5,285
(3,682)
(2,639)
$ 16,444
4,381
4,590
(2,076)
(526)
6,369
$ 25,803
2,816
(1,549)
5,695
$ 32,765
The following table presents the components of interest income:
Year ended December 31,
2002
2001
2003
2,249
Interest on Finance Receivables .......................................... $ 40,380 $ 32,851 $
14,648
Residual interest income......................................................
Other interest income...........................................................
308
Net interest income.............................................................. $ 58,164 $ 48,644 $ 17,205
16,178
1,606
15,392
401
(In thousands)
(12) Income Taxes
Income taxes consist of the following:
2003
Year ended December 31,
2002
(In thousands)
2001
Current:
Federal ................................................................... $ 2,781 $ (11,295) $
State .......................................................................
356
3,137
(715)
(12,010)
Deferred:
Federal ...................................................................
State .......................................................................
Change in valuation allowance..............................
(25,345)
(4,141)
22,915
(6,571)
10,867
1,428
(3,219)
9,076
366
(126)
240
(277)
485
(448)
(240)
Income tax benefit ............................................. $
(3,434) $
(2,934) $
—
F-30
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company’s effective tax expense benefit for the years ended December 31, 2003, 2002 and 2001, differs
from the amount determined by applying the statutory federal rate of 35% to income (loss) before income taxes
as follows:
Year ended December 31,
2002
2001
2003
(In thousands)
Expense (benefit) at federal tax rate .................... $ (1,064) $ 6,116
California franchise tax, net of federal income
tax benefit.........................................................
Other....................................................................
Negative Goodwill...............................................
Debt Forgiveness .................................................
Valuation allowance ............................................
(2,460)
92
—
(22,917)
22,915
233
103
—
—
(448)
$ (3,434) $ (2,934) $ —
459
(196)
(6,094)
—
(3,219)
$
112
The tax effected cumulative temporary differences that give rise to deferred tax assets and liabilities as of
December 31, 2003 and 2002, are as follows:
December 31,
2003
2002
(In thousands)
Deferred Tax Assets:
Accrued liabilities................................................................................. $ 11,185 $ 2,760
2,335
Furniture and equipment.......................................................................
82
Equity investment .................................................................................
36,979
NOL carryforwards and BILs...............................................................
334
Minimum tax credit ..............................................................................
1,383
Provision for loan loss
1,063
Pension Accrual....................................................................................
Other.....................................................................................................
110
45,046
Total deferred tax assets ...................................................................
(8,563)
Valuation allowance .............................................................................
36,483
1,465
82
31,397
481
(2,125)
1,617
461
44,563
(37,363)
7,200
Deferred Tax Liabilities:
NIRs......................................................................................................
Debt Forgiveness ..................................................................................
Total deferred tax liabilities..............................................................
(6,789)
—
(6,789)
(13,568)
(29,629)
(43,197)
Net deferred tax asset (liability) .......................................................
$ 411
$ (6,714)
As part of the MFN Merger, CPS acquired certain net operating losses, debt forgiveness, as discussed below,
and built in loss assets. Moreover, MFN has undergone an ownership change for purposes of Internal Revenue
Code (“IRC”) section 382. In general, IRC section 382 imposes an annual limitation on the ability of a loss
corporation (i.e., a corporation with a net operating loss (“NOL”) carryforward, credit carryforward, or certain
built-in losses (“BILs”)) to utilize its pre-change NOL carryforwards or BILs to offset taxable income arising
after an ownership change. During 1999, MFN recorded an extraordinary gain from the discharge of
indebtedness related to the emergence from Bankruptcy. This gain was not taxable under IRC section 108. In
accordance with the rules under IRC section 108, MFN has reduced certain tax attributes including unused net
operating losses and tax basis in certain MFN assets. Deferred taxes have been provided for the estimated tax
effect of the future reversing timing differences related to the discharge of indebtedness gain as reduced by the
tax attributes. Additionally, the Company has established a valuation allowance of $8.6 million against MFN’s
deferred tax assets, as it is not more than likely that these amounts will be realized in the future. In
determining the possible future realization of deferred tax assets, future taxable income from the following
sources are taken into account: (a) 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 years in which net operating losses might otherwise expire.
F-31
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As part of the TFC Merger, CPS acquired certain built in loss assets. Moreover, TFC has undergone an
ownership change for purposes of Internal Revenue Code (“IRC”) section 382. In general, IRC section 382
imposes an annual limitation on the ability of a loss corporation (i.e., a corporation with a net operating loss
(“NOL”) carryforward, credit carryforward, or certain built-in losses (“BILs”)) to utilize its pre-change NOL
carryforwards or BILs to offset taxable income arising after an ownership change. Additionally, the Company
has established a valuation allowance of $5.9 million against TFC’s deferred tax assets, as it is not more than
likely that these amounts will be realized in the future. In determining the possible future realization of
deferred tax assets, future taxable income from the following sources are taken into account: (a) 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 years in which
net operating losses might otherwise expire.
As of December 31, 2003, the Company has net operating loss carryforwards for federal and state income tax
purposes of $29 million and $8 million, respectively, which are available to offset future taxable income, if
any, subject to IRC section 382 limitations, through 2021 and 2013, respectively. In addition, the Company has
an alternative minimum tax credit carry forward of approximately $481,000, which is available to reduce
future federal regular income taxes, if any, over an indefinite period.
The Company’s tax returns are open for audits by various tax authorities. Therefore, from time-to-time there
may be differences in opinions with respect to the tax treatment accorded to certain transactions. When, and if,
such differences occur and become probable and estimatable, such amounts will be recognized. The Company
filed its tax returns on a fiscal year ending March 31 through March 31, 2002. It changed its tax fiscal year to a
calendar year effective December 31, 2002.
(13) Related Party Transactions
Related Party Receivables
As of December 31, 2001, the Company had receivables of $669,000 from CARSUSA, Inc. (“CARSUSA”),
which owned and operated a Mitsubishi automobile dealership in Southern California, and is owned by
Charles E. Bradley, Sr. and Charles E. Bradley, Jr. During 2002, CARSUSA became insolvent, sold its assets
to an unaffiliated party, partially paid its secured creditors, and wound up its business. The Company
determined that the receivable was uncollectible, and wrote down its value to zero. The writedown-related
expense of $669,000 is reflected in the Company’s Consolidated Statement of Operations for the year ended
December 31, 2002 in general and administrative expenses. The Company purchased seven and 16 Contracts
from CARSUSA, with an aggregate principal balance of approximately $99,996 and $233,431, respectively, in
2002 and 2001. The Company did not purchase any contracts from CARSUSA in 2003.
CPS Leasing, Inc. Related Party Direct Lease Receivables
Included in other assets recorded in the Company’s Consolidated Balance Sheet are direct lease receivables
due to CPS Leasing, Inc. from related parties, primarily companies affiliated with the Company’s former
Chairman of the Board of Directors. Such related party direct lease receivables totaled approximately $1.9
million and $2.2 million at December 31, 2003 and 2002, respectively.
Related Party Debt
In June 1997 the Company borrowed $15.0 million on an unsecured and subordinated basis from Stanwich
Financial Services Corp. (“SFSC”), an affiliate of Charles E. Bradley, Sr., the former Chairman of the
Company’s Board of Directors. This loan (“RPL”) is due 2004, and has a fixed rate of interest of 9% per
annum, payable monthly beginning July 1997. The Company may pre-pay the RPL without penalty at any time
after three years. At maturity or repayment of the RPL, the holder thereof will have an option to convert 20%
F-32
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of the principal amount into common stock of the Company, at a conversion rate of $11.86 per share. The
balance of the RPL at December 31, 2003 and 2002, was $15.0 million.
During 1998, the Company borrowed an additional $4 million on an unsecured basis from SFSC. This loan
(“RPL2”) is due 2004, and has a fixed rate of interest of 12.5% per annum payable monthly beginning
December 1998. The Company had the right to pre-pay the RPL2, without penalty, at any time after June 12,
2000. At maturity or repayment of the RPL2, the holder thereof would have the option to convert the entire
principal balance of the note, or a portion thereof, into common stock of the Company, at a conversion rate of
$3 per share. The balance of the RPL2 was repaid during the first quarter of 2001.
During 1998, the Company borrowed $1.0 million on an unsecured basis from John G. Poole, a director of the
Company. The terms of this note (“RPL3”) are the same as the RPL2. The balance of the RPL3 at December
31, 2003 and 2002 was $1.0 million.
During 1999, the Company borrowed $1.5 million on an unsecured basis from SFSC. This loan (“RPL4”) is
due 2004, has a fixed rate of interest of 14.5% per annum payable monthly beginning October 1999. In
conjunction with the issuance of the RPL4, the Company issued warrants to purchase 103,500 shares of the
Company’s common stock at a price of $0.01 per share. The balance of the RPL4 at December 31, 2003 and
2002 was $1.5 million.
Loans to Officers to Exercise Certain Stock Options
During 2002, the Company’s Board of Directors approved a program under which officers of the Company
would be advanced amounts sufficient to enable them to exercise certain of their outstanding options. Such
loans were available for a limited period of time, and available only to exercise previously repriced options.
The loans bear interest at a rate of 5.50% per annum, and are due in 2007. At December 31, 2003, there was
$458,531 outstanding related to these loans. Such amounts have been recorded as contra-equity in the
Shareholders’ Equity section of the Company’s Consolidated Balance Sheet.
(14) Commitments and Contingencies
Leases
The Company leases its facilities and certain computer equipment under non-cancelable operating leases,
which expire through 2008. Future minimum lease payments at December 31, 2003, under these leases are as
follows:
2004 .........................................................................................................
2005 .........................................................................................................
2006 .........................................................................................................
2007 .........................................................................................................
2008 .........................................................................................................
Thereafter ................................................................................................
Operating
(In thousands)
$ 4,511
4,37
3,52
2,79
1,74
—
Total minimum lease payments ...............................................................
$ 16,948
Rent expense for the years ended December 31, 2003, 2002 and 2001, was $3.9 million, $4.0 million, and $2.6
million, respectively.
The Company’s facility lease contains certain rental concessions and escalating rental payments, which are
recognized as adjustments to rental expense and are amortized on a straight-line basis over the term of the
lease.
F-33
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During 2003, 2002 and 2001, the Company received $169,777, $140,537 and $270,486, respectively, of
sublease income, which is included in occupancy expense. Future minimum sublease payments totaled
$587,854 at December 31, 2003.
Litigation
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.
Investors 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 on the ability of CPS to perform its servicing and
indemnification obligations.
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.
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.
F-34
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(15) Employee Benefits
The Company sponsors a pretax savings and profit sharing plan (the “401(k) Plan”) qualified under section
401(k) of the Internal Revenue Code. Under the 401(k) Plan, eligible employees are able to contribute up to
15% of their compensation (subject to stricter limitation in the case of highly compensated employees). The
Company, may, at its discretion, match 100% of employees’ contributions up to $1,000 per employee per
calendar year. The Company’s contributions to the 401(k) Plan were $213,045 for the year ended December
31, 2000. The Company did not make a matching contribution in 2003, 2002 or 2001, other than to employees
eligible for the MFN Financial Corporation Retirement Savings Plan. Such contribution amounted to $250,682
for the period from the Merger Date through December 31, 2002. The MFN Financial Corporation Retirement
Savings Plan was merged into the Company’s 401(k) Plan in February 2003.
The Company also sponsors the MFN Financial Corporation Pension Plan (“the Plan”). The Plan benefits were
frozen June 30, 2001. The following table sets forth the plan’s benefit obligations, fair value of plan assets, and
funded status at December 31, 2003 and 2002:
December 31,
2003
(Dollars in thousands)
2002
Change in Projected Benefit Obligation
Projected benefit obligation, beginning of year......................................... $
Service cost................................................................................................
Interest cost................................................................................................
Settlements ................................................................................................
Actuarial gain ............................................................................................
Benefits paid..............................................................................................
Projected benefit obligation, end of year................................................ $
13,743
—
902
0
1,578
(1,200)
15,023
$
12,223
—
853
(826)
2,964
(1,471)
13,743
$
The accumulated benefit obligation for the pension plan was $15.0 million and $13.7 million at December
31, 2003 and 2002, respectively.
Change in Plan Assets
9,906
Fair value of plan assets, beginning of year .............................................. $
1,001
Return on assets.........................................................................................
1,546
Employer contribution...............................................................................
Benefits paid..............................................................................................
(1,200)
Fair value of plan assets, end of year...................................................... $ 11,253
$
12,013
(636)
—
(1,471)
$ 9,906
Reconciliation of accrued pension cost and total amount
recognized
Funded status of the plan........................................................................... $
Unrecognized loss .....................................................................................
Unrecognized transition asset....................................................................
Unrecognized prior service cost ................................................................
Accrued pension cost.............................................................................. $
(3,770) $
4,136
(80)
—
286
(3,836)
2,771
(115)
—
(1,180)
$
Weighted average assumptions used to determine benefit obligations at December 31, 2003 and 2002
were as follows:
Weighted average assumptions as of December 31, 2002
Discount rate..............................................................................................
Expected return on plan assets ..................................................................
Rate of compensation increase ..................................................................
6.25%
9.00%
N/A
6.50%
9.00%
N/A
The Company’s overall expected long-term rate of return on assets is 9.00% per annum. The expected
long-term rate of return is based on the weighted average of historical returns on individual asset
F-35
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
categories, which are described in more detail below.
Amounts recognized in Consolidated Balance Sheet
Prepaid benefit cost ................................................................................... $
286
Accrued minimum pension obligation.......................................................
(4,055)
Intangible asset ..........................................................................................
—
Accumulated other comprehensive income, pretax...................................
4,055
Net amount recognized........................................................................... $ 286
$ —
(3,836)
—
2,656
$ (1,180)
Total cost
Service cost................................................................................................ $
Interest cost................................................................................................
Expected return on assets ..........................................................................
Amortization of unrecognized loss............................................................
Amortization of transition obligation ........................................................
Amortization of prior service cost .............................................................
Net periodic pension income .....................................................................
Loss due to settlement ...............................................................................
Total benefit income............................................................................... $
—
902
(872)
98
(35)
—
93
—
93
$
—
853
(1,052)
—
(25)
—
(224)
224
—
$
Accumulated Benefit Obligation and Fair Value of Assets
(13,743)
Projected Benefit Obligation ..................................................................... $
(13,743)
Accumulated Benefit Obligation ...............................................................
Fair Value of Assets ..................................................................................
9,906
Unfunded Accumulated Benefit Obligation .............................................. $ (3,770) $ (3,837)
(15,023) $
(15,023)
11,253
The weighted average asset allocation of the Company’s pension benefits at December 31, 2003 and
2002 were as follows:
Plan Assets
Asset Category
Equity securities ........................................................................................
Fixed income securities .............................................................................
CPS stock ..................................................................................................
Cash ...........................................................................................................
Total........................................................................................................
Plan Assets at
December 31, .
2003
61.73%
29.14%
9.07%
0.06%
100.00%
2002
—
—
5.27%
94.73%
100.00%
The Company’s investment policies and strategies for the pension benefits plan utilize a target allocation of
70% equity securities and 30% fixed income securities. The Company’s investment goals are to maximize
returns subject to specific risk management policies. The Company addresses risk management and
diversification by the use of a professional investment advisor and several sub-advisors which invest in
domestic and international equity securities and domestic fixed income securities. Each sub-advisor focuses its
investments within a specific sector of the equity or fixed income market. For the sub-advisors focused on the
equity markets, the sectors are differentiated by the market capitalization and the relative valuation of the
underlying issuer. For the sub-advisors focused on the fixed income markets, the sectors are differentiated by
the credit quality and the maturity of the underlying fixed income investment. The investments made by the
sub-advisors are readily marketable and can be sold to fund benefit payment obligations as they become
payable.
(16) Fair Value of Financial Instruments
The following summary presents a description of the methodologies and assumptions used to estimate the fair
value of the Company’s financial instruments. Much of the information used to determine fair value is highly
subjective. When applicable, readily available market information has been utilized. However, for a significant
F-36
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
portion of the Company’s financial instruments, active markets do not exist. Therefore, considerable
judgments were required in estimating fair value for certain items. The subjective factors include, among other
things, the estimated timing and amount of cash flows, risk characteristics, credit quality and interest rates, all
of which are subject to change. Since the fair value is estimated as of December 31, 2003 and 2002, the
amounts that will actually be realized or paid at settlement or maturity of the instruments could be significantly
different. The estimated fair values of financial assets and liabilities at December 31, 2003 and 2002, were as
follows:
December 31,
2003
2002
Financial Instrument
Carrying
Value or
Notional
Amount
Fair
Value
Carrying
Value or
Notional
Amount
(In thousands)
Cash ........................................................... $ 33,209
67,277
Restricted cash...........................................
266,189
Finance receivables, net.............................
111,702
Residual interest in securitizations ............
3,330
Notes payable ............................................
245,118
Securitization trust debt .............................
49,965
Senior secured debt....................................
35,000
Subordinated debt......................................
17,500
Related party debt......................................
$ 33,209
67,277
266,189
111,702
3,330
245,118
49,965
35,506
17,763
$ 32,947
18,912
84,592
127,170
673
71,630
50,072
36,000
17,500
Fair
Value
$ 32,947
18,912
84,592
127,170
673
71,630
50,072
32,800
15,400
Cash and Restricted Cash
The carrying value equals fair value.
Finance Receivables, net
The carrying value approximates fair value because the related interest rates are estimated to reflect current
market conditions for similar types of instruments.
Residual Interest in Securitizations
The fair value is estimated by discounting future cash flows using credit and discount rates that the Company
believes reflect the estimated credit, interest rate and prepayment risks associated with similar types of
instruments.
Commitments
The fair value of commitments to purchase contracts from Dealers is determined by purchase commitments
from investors and prevailing market rates.
Notes Payable, Securitization Trust Debt and Senior Secured Debt
The carrying value approximates fair value because the related interest rates are estimated to reflect current
market conditions for similar types of secured instruments.
Subordinated Debt
The fair value is based on a market quote.
F-37
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Related Party Debt
The fair value is based on the fair value of subordinated debt, as the terms and structure are similar.
(17) Liquidity
The Company's business requires substantial cash to support its purchases of Contracts and other operating
activities. The Company's primary sources of cash have been cash flows from operating activities, including
proceeds from sales of Contracts, amounts borrowed under various revolving credit facilities (also sometimes
known as warehouse credit facilities), servicing fees on portfolios of Contracts previously sold in securitization
transactions, customer payments of principal and interest on finance receivables, fees for origination of
Contracts, and releases of cash from securitized pools of Contracts in which the Company has retained a
residual ownership interest, and from the Spread Accounts associated with such pools. The Company's primary
uses of cash have been the purchases of Contracts, repayment of amounts borrowed under lines of credit and
otherwise, operating expenses such as employee, interest, occupancy expenses and other general and
administrative expenses, the establishment of Spread Accounts and initial overcollateralization, if any, and the
increase of Credit Enhancement to required levels in securitization transactions, and income taxes. There can
be no assurance that internally generated cash will be sufficient to meet the Company's cash demands. The
sufficiency of internally generated cash will depend on the performance of securitized pools (which determines
the level of releases from those pools and their related Spread Accounts), the rate of expansion or contraction
in the Company's managed portfolio, and the terms upon which the Company is able to acquire, sell, and
borrow against Contracts.
Contracts are purchased from Dealers for a cash price approximating their principal amount, and generate cash
flow over a period of years. As a result, the Company has been dependent on warehouse credit facilities to
purchase Contracts, and on the availability of cash from outside sources in order to finance its continuing
operations, as well as to fund the portion of Contract purchase prices not financed under revolving warehouse
credit facilities. As of December 31, 2003, the Company had $225 million in warehouse credit capacity, in the
form of a $125 million facility, a $75 million facility and a $25 million facility. The first two warehouse
facilities provide funding for Contracts purchased under CPS’ programs while the third facility provides
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 and provide funding equal to 71-73% of the principal balance of the Contracts
pledged, subject to collateral tests and certain other conditions and covenants.
On February 21, 2004 the CPS Funding LLC $75 million revolving warehouse credit facility expired. One of
the covenants within the Company’s $125 million warehouse credit facility and four of the six term
securitizations insured by one Note Insurer requires that the Company maintain additional warehouse facilities
with minimum borrowing capacity of $75.0 million. With the expiration of the CPS Funding LLC facility
described above, the Company is in breach of such covenant. The Company has until June 20, 2004 to cure
such breach prior to it becoming an event of default under this warehouse facility and four term securitizations.
While the Company is currently in discussions with several parties about a replacement facility and believes
that it will be successful in replacing the facility within the required time frame, there can be no assurances that
it will do so. If the Company is unsuccessful in these efforts, the Note Insurer will have the right to declare an
event of default. Remedies available to the Note Insurer in such event include, among other things,
transferring the servicing rights to the portfolio that it insures to another servicer and trapping excess cash
releases to the Company from its warehouse facility and four term securitizations that it insures. To the extent
that the Note Insurer was to follow either of these remedies, it would have a material adverse effect on the
liquidity and the operations of the Company.
Through May 2002, the Company's Contract purchasing program consisted of both (i) flow purchases for
immediate resale to non-affiliates and (ii) purchases for the Company's own account made on other than a flow
basis, funded primarily by advances under a revolving warehouse credit facility. Flow purchases allowed the
F-38
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company to purchase Contracts with minimal demands on liquidity. The Company's revenues from the resale
of flow purchase Contracts, however, were materially less than those that may be received by holding
Contracts to maturity or by selling Contracts in securitization transactions. During the year ended December
31, 2003 the Company purchased $357.3 million of Contracts for its own account, compared to $282.2 million
for its own account and $181.1 million of Contracts on a flow basis in 2002. For the year ended December 31,
2001, the Company purchased $134.4 million of Contracts for its own account and $537.9 million on a flow
basis. The Company’s flow purchase program ended in May 2002.
The $125 million warehouse facility is structured to allow CPS to fund a portion of the purchase price of
Contracts by drawing against a floating rate variable funding note issued by CPS Warehouse Trust. This
facility was established on March 7, 2002, in the maximum amount of $100 million. Such maximum amount
was increased to $125 million in November 2002. Approximately 73% of the principal balance of Contracts
may be advanced to the Company under this facility, subject to collateral tests and certain other conditions and
covenants. Notes under this facility accrue interest at a rate of one-month commercial paper plus 1.18% per
annum. This facility expires on April 4, 2004. The Company is currently in discussions with the related parties
to renew such facility.
The $75 million warehouse facility which expired on February 21, 2004, was similarly structured to allow CPS
to fund a portion of the purchase price of Contracts by drawing against a floating rate variable funding note
issued by CPS Funding LLC. Approximately 72.5% of the principal balance of Contracts could be advanced to
the Company under this facility, subject to collateral tests and certain other conditions and covenants. Notes
under this facility accrued interest at a rate of one-month LIBOR plus 0.75% per annum. This facility expired
on February 21, 2004. The Company is currently in discussions with several parties regarding a replacement
facility.
The $25 million warehouse facility is similarly structured to allow TFC to fund a portion of the purchase price
of Contracts by drawing against a floating rate variable funding note issued by TFC Warehouse I LLC.
Approximately 71% of the principal balance of Contracts may be advanced to TFC under this facility, subject
to collateral tests and certain other conditions and covenants. Notes under this facility accrue interest at a rate
of one-month LIBOR plus 1.75% per annum. This facility was entered into as part of the TFC Merger on May
20, 2003 and has a 364-day term. The Company is currently in discussions with the related parties to renew
such facility.
These facilities are independent of each other. Two different financial institutions purchase the notes issued by
these facilities, and three different insurers insure the notes. Up through June 30, 2003, sales of Contracts to
the special purpose subsidiaries (“SPS”) related to the first two facilities had been treated as sales for financial
accounting purposes. The Company, therefore, removed these securitized Contracts and related debt from its
Consolidated Balance Sheet and recognized a gain on sale in the Company’s Consolidated Statement of
Operations. Indebtedness related to Contracts funded by the third facility, however, were on the Company’s
Consolidated Balance Sheet and no gain on sale has ever been recognized in the Company’s Consolidated
Statement of Operations. During July 2003, each of the first two facilities was amended, with the effect that
subsequent use of such facilities is treated for financial accounting purposes as borrowing secured by such
receivables, rather than as a sale of receivables. The effects of that amendment are similar to those discussed
above with respect to the change in securitization structure.
The Company’s primary means of ensuring that its cash demands do not exceed its cash resources is to match
its levels of Contract purchases to its availability of cash. The Company’s ability to adjust the quantity of
Contracts that it purchases and securitizes will be subject to general competitive conditions and the continued
availability of warehouse credit facilities. There can be no assurance that the desired level of Contract
acquisition can be maintained or increased. Obtaining releases of cash from the Trusts and their related Spread
Accounts is dependent on collections from the related Trusts generating sufficient cash to maintain the Spread
Accounts and other Credit Enhancement in excess of their respective requisite levels. There can be no
assurance that collections from the related Trusts will continue to generate sufficient cash.
F-39
CONSUMER PORTFOLIO SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Certain of the Company’s securitization transactions and the warehouse credit facilities contain various
financial covenants requiring certain minimum financial ratios and results. The Company was in violation of
four of these covenants as of December 31, 2003, including maximum leverage, minimum equity, maximum
financial loss and interest coverage. As of December 31, 2003 the Company had received a waiver of such
non-compliance from the controlling party. On March 15, 2004, each of these financial covenants was
amended with the controlling party such that all breaches have been cured.
The Servicing Agreements of the Company’s securitization transactions and warehouse credit facilities 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.
(18) Selected Quarterly Data (Unaudited)
Quarter
Ended
March 31,
Quarter
Ended
June 30,
Quarter
Ended
September 30,
Quarter
Ended
December 31,
(In thousands, except per share data)
22,547
2,354
6,278
0.31
0.29
$
$
23,715
3,132
2,642
0.13
0.12
$
$
26,487
(2,852)
(2,852)
(0.14)
(0.14)
$
$
28,184
(5,674)
(5,674)
(0.28)
(0.28)
13,136
$ 27,216
$
26,040
$
25,560
(6,775)
17,412
16,431
(0.05)
(0.05)
0.90
0.90
0.85
0.85
1,279
—
739
0.04
0.04
—
—
0.04
0.04
16,320
241
241
0.01
0.01
$
$
$
$
$
2,240
—
1,300
0.07
0.06
—
—
0.07
0.06
14,271
253
253
0.01
0.01
$
$
$
$
$
3,318
—
1,938
0.09
0.09
—
—
0.09
0.09
14,089
(480)
(360)
(0.01)
(0.01)
$
$
$
$
$
2003
Revenues .........................................................
Income (loss) before income taxes..................
Net income (loss) ............................................
Income (loss) per share:
Basic.............................................................. $
Diluted...........................................................
$
$
2002
Revenues ...........................................................
Income (loss) before income taxes
and extraordinary item ......................................
Extraordinary item ............................................
Net income .......................................................
Income (loss) per share
before extraordinary item:
Basic................................................................ $
Diluted...........................................................
Extraordinary item per share:
Basic.............................................................. $
Diluted...........................................................
Income per share:
Basic.............................................................. $
Diluted...........................................................
2001
Revenues .........................................................
Income (loss) before income taxes..................
Net income (loss) ............................................
Income (loss) per share:
Basic.............................................................. $
Diluted...........................................................
$
17,325
306
186
0.01
0.01
F-40