Consumer Portfolio Services
Annual Report 2010

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2010 Annual Report Consumer Portfolio Services, Inc. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ________________ [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FORM 10-K (abridged) For the fiscal year ended December 31, 2010 Commission file number: 001-14116 CONSUMER PORTFOLIO SERVICES, INC. (Exact name of registrant as specified in its charter) California (State or other jurisdiction of incorporation or organization) 33-0459135 (I.R.S. Employer Identification No.) 19500 Jamboree Road, Irvine, California (Address of principal executive offices) 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 Common Stock, no par value Name of Each Exchange on Which Registered The Nasdaq Stock Market LLC (Global Market) Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [ X ] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [ ] No [ X ] 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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [ X ] No [ ] Indicate by check mark 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. [ X ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer”,”accelerated filer" and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [ X ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ] The aggregate market value of the 13,966,256 shares of the registrant’s common stock held by non-affiliates, based upon shares outstanding and the closing price of the registrant’s common stock of $1.37 per share reported by Nasdaq as of June 30, 2010, was approximately $19,133,771. For purposes of this computation, a registrant sponsored pension plan and all directors and executive officers are deemed to be affiliates. Such determination is not an admission that such plan, directors and executive officers are, in fact, affiliates of the registrant. The number of shares of the registrant’s Common Stock outstanding on April 27, 2011, was 18,119,810. This annual report to shareholders consists of selected portions of the information that we filed with the U.S. Securities and Exchange Commission on our Form 10-K, as amended, together with director identification information, as set forth below. The entire report may be accessed at our website, www.consumerportfolio.com, and at the website of the Commission, www.sec.gov. TABLE OF CONTENTS Item Description Page Item 1. Business ................................................................................................................................................. 1 Directors and Executive Officers ......................................................................................................... 11 Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities .............................................................................................................................. 13 Item 6. Selected Financial Data ........................................................................................................................ 14 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations ............... 16 Item 7A. Quantitative and Qualitative Disclosures About Market Risk ............................................................. 33 Item 8. Financial Statements and Supplementary Data .............................................................. (indexed below) Item 9A. Controls and Procedures ...................................................................................................................... 33 Index to Financial Statements.................................................................................................................. F-1 Report of Independent Registered Public Accounting Firm – Crowe Horwath LLP ..................................... F-2 Consolidated Balance Sheets as of December 31, 2010 and 2009 ................................................................. F-3 Consolidated Statements of Operations for the years ended December 31, 2010 and 2009 ........................... F-4 Consolidated Statements of Comprehensive Income/(Loss) for the years ended December 31, 2010 and 2009 .................................................................................................................................................... F-5 Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2010 and 2009........... F-6 Consolidated Statements of Cash Flows for the years ended December 31, 2010 and 2009.......................... F-7 Notes to Consolidated Financial Statements. ................................................................................................. F-9 Item 1. BUSINESS Overview PART I We are a specialty finance company. Our business is to purchase and service retail automobile contracts originated primarily by franchised automobile dealers and, to a lesser extent, by select independent dealers in the United States in the sale of new and used automobiles, light trucks and passenger vans. Through our automobile contract purchases, we provide indirect financing to the customers of dealers who have limited credit histories, low incomes or past credit problems, who we refer to as sub-prime customers. We serve as an alternative source of financing for dealers, facilitating sales to customers who otherwise might not be able to obtain financing from traditional sources, such as commercial banks, credit unions and the captive finance companies affiliated with major automobile manufacturers. In addition to purchasing installment purchase contracts directly from dealers, we have also (i) acquired installment purchase contracts in three merger and acquisition transactions, (ii) purchased immaterial amounts of vehicle purchase money loans from non-affiliated lenders, and (iii) directly originated an immaterial amount of vehicle purchase money loans by lending money directly to consumers. In this report, we refer to all of such contracts and loans as "automobile contracts." We were incorporated and began our operations in March 1991. From inception through December 31, 2010, we have purchased a total of approximately $8.8 billion of automobile contracts from dealers. In addition, we obtained a total of approximately $605.0 million of automobile contracts in mergers and acquisitions in 2002, 2003 and 2004. In 2004 and 2009, we were appointed as a third-party servicer for certain portfolios of automobile receivables originated and owned by entities not affiliated with us. Beginning in 2008, our managed portfolio has decreased each year due to our strategy of limiting contract purchases to conserve our liquidity in response to adverse economic conditions, as discussed further below. However, since October 2009, we have gradually increased contract purchases resulting in aggregate purchases of $113.0 million in 2010, compared to $8.6 million in 2009. Our total managed portfolio was $756.2 million at December 31, 2010, compared to $1,194.7 million at December 31, 2009, $1,664.1 million as of December 31, 2008 and $2,162.2 million as of December 31, 2007. We are headquartered in Irvine, California, where most operational and administrative functions are centralized. All credit and underwriting functions are performed in our California headquarters, and we service our automobile contracts from our California headquarters and from three servicing branches in Virginia, Florida and Illinois. We direct our marketing efforts primarily to dealers, rather than to consumers. We establish relationships with dealers through our employee marketing representatives who contact a prospective dealer to explain our automobile contract purchase programs, and thereafter provide dealer training and support services. Our marketing representatives represent us exclusively. They may be located either in our Irvine headquarters, or in the field, in which case they work from their homes and support dealers in their geographic area. Our marketing representatives present dealers with a marketing package, which includes our promotional material containing the terms offered by us for the purchase of automobile contracts, a copy of our standard-form dealer agreement, and required documentation relating to automobile contracts. As of December 31, 2010, we had 18 marketing representatives and we were actively receiving applications from 3,568 dealers in 44 states. Current levels of marketing representatives and dealers are a significant reduction from December 31, 2007, when we had 134 marketing representatives and were actively receiving applications from 10,255 dealers. During 2008 and thereafter, we significantly reduced our presence in the marketplace in response to economic conditions as discussed further below. As of December 31, 2010, approximately 88% of our dealers were franchised new car dealers that sell both new and used vehicles, and the remainder were independent used car dealers. For the year ended December 31, 2010, approximately 87% of the automobile contracts purchased under our programs consisted of financing for used cars and 13% consisted of financing for new cars, as compared to 92% financing for used cars and 8% for new cars in the year ended December 31, 2009. We purchase contracts in our own name (“CPS”) and, until July 2008, also purchased contracts in the name of our wholly-owned subsidiary, The Finance Company ("TFC"). Programs marketed under the CPS name serve a wide range of sub-prime customers, primarily through franchised new car dealers. Our TFC program served vehicle purchasers enlisted in the U.S. Armed Forces, primarily through independent used car dealers. In July 2008, we ceased to purchase contracts under our TFC program. We purchase automobile contracts with the intention of financing them on a long-term basis through securitizations. Securitizations are transactions in which we sell a specified pool of contracts to a special purpose entity of ours, which in turn issues asset-backed securities to fund the purchase of the pool of contracts from us. Depending on the structure of the securitization, the transaction may be treated, for financial accounting purposes, as a sale of the contracts or as a secured financing. 1 Historically, we have depended upon the availability of short-term warehouse credit facilities and access to long- term financing through the issuance of asset-backed securities collateralized by our automobile contracts. Since 1994, we have completed 50 term securitizations of approximately $6.7 billion in contracts. We conducted four term securitizations in 2006, four in 2007, two in 2008, none in 2009 and one in 2010. From July 2003 through April 2008 all of our securitizations were structured as secured financings. The second of our two securitization transactions in 2008 (completed in September 2008) was in substance a sale of the related contracts, and is treated as a sale for financial accounting purposes. The remaining receivables from that September 2008 securitization were re-securitized in September 2010 in a structure that maintained sale treatment for accounting purposes. From the fourth quarter of 2007 through the end of 2009, we observed unprecedented adverse changes in the market for securitized pools of automobile contracts. These changes included reduced liquidity, and reduced demand for asset-backed securities, particularly for securities carrying a financial guaranty and for securities backed by sub- prime automobile receivables. Moreover, many of the firms that previously provided financial guarantees, which were an integral part of our securitizations, suspended offering such guarantees. The adverse changes that took place in the market from the fourth quarter of 2007 through the end of 2009 caused us to conserve liquidity by significantly reducing our purchases of automobile contracts. However, since October 2009 we have gradually increased our contract purchases by utilizing one $50 million credit facility established in September 2009 and another $50 million term funding facility established in March 2010. In September 2010 we took advantage of the improvement in the market for asset-backed securities by re-securitizing the remaining underlying receivables from our unrated September 2008 securitization. By doing so we were able to pay off the bonds associated with the September 2008 transaction and issue rated bonds with a significantly lower weighted average coupon. The September 2010 transaction was our first rated term securitization since 1993 that did not utilize a financial guaranty. More recently, we significantly increased our short-term contract financing resources by entering into a $100 million credit facility in December 2010 and another $100 million credit facility in February 2011. Despite the improvements we have seen in the capital markets, if the trend of improvement in the markets for asset-backed securities should reverse, or should we be unable to complete term securitization(s) of automobile contracts that we now hold or those we will seek to purchase in the future, we might be required to curtail or cease our purchases of new automobile contracts, which in turn could have a material adverse effect on our operations. Sub-Prime Auto Finance Industry Automobile financing is the second largest consumer finance market in the United States. The automobile finance industry can be divided into two principal segments: a prime credit market and a sub-prime credit market. Traditional automobile finance companies, such as commercial banks, savings institutions, credit unions and captive finance companies of automobile manufacturers, generally lend to the most creditworthy, or so-called prime, borrowers. The sub-prime automobile credit market, in which we operate, provides financing to less creditworthy borrowers, at higher interest rates. Historically, traditional lenders have not served the sub-prime market or have done so through programs that were not consistently available. Independent companies specializing in sub-prime automobile financing and subsidiaries of larger financial services companies currently compete in this segment of the automobile finance market, which we believe remains highly fragmented, with no single company having a dominant position in the market. Recent past economic conditions have negatively affected many aspects of our industry. First, as stated above, throughout 2008 and 2009 there was reduced demand for asset-backed securities secured by consumer finance receivables, including sub-prime automobile receivables. Second, lenders who previously provided short-term warehouse financing for sub-prime automobile finance companies such as ours were reluctant to provide such short- term financing due to the uncertainty regarding the prospects of obtaining long-term financing through the issuance of asset-backed securities. In addition, many capital market participants such as investment banks, financial guaranty providers and institutional investors who previously played a role in the sub-prime auto finance industry withdrew from the industry, or in some cases, have ceased to do business. Finally, broad economic weakness and high levels of unemployment during 2008, 2009 and 2010 made many of the obligors under our receivables less willing or able to pay, resulting in higher delinquency, charge-offs and losses. Each of these factors has adversely affected our results of operations. However, as stated above, since October 2009, improvements in the capital markets have allowed us to enter into a total of $300 million in new financing commitments, and to complete our first rated term securitization since April 2008. Nevertheless, should existing economic conditions worsen, both our ability to purchase new contracts and the performance of our existing managed portfolio may be impaired, which, in turn, could have a further material adverse effect on our results of operations. 2 Our Operations Our automobile financing programs are designed to serve sub-prime customers, who generally have limited credit histories, low incomes or past credit problems. Because we serve customers who are unable to meet certain credit standards, we incur greater risks, and generally receive interest rates higher than those charged in the prime credit market. We also sustain a higher level of credit losses because we provide financing in a relatively high risk market. Originations 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. We believe the dealer’s decision to choose a financing source is based primarily on: (i) the monthly payment made available to the dealer's customer; (ii) the purchase price offered to the dealer for the contract; (iii) the timeliness, consistency and predictability of response; (iv) funding turnaround time; (v) any conditions to purchase; and (vi) the financial stability of the financing source. Dealers can send credit applications to us by entering the necessary data on our website or through one of several third-party application aggregators. For the year ended December 31, 2010, we received approximately 84% of all applications through DealerTrack (the industry leading dealership application aggregator), 3% via our website and 13% via other aggregators. Our automated application decisioning system produced our response within minutes to about 97% of those applications. Upon receipt of information from a dealer, we immediately order a credit report to document the buyer's credit history. If, upon review by our proprietary automated decisioning system, or in some cases, one of our credit analysts, we determine that the automobile contract meets our underwriting criteria, or would meet such criteria with modification, we request and review further information and, ultimately, decide whether to approve the automobile contract for purchase. When presented with an application, we attempt to notify the dealer within one hour as to whether we would purchase the related automobile contract. Dealers with which we do business are under no obligation to submit any automobile contracts to us, nor are we obligated to purchase any automobile contracts from them. During the year ended December 31, 2010, no dealer accounted for more than 2% of the total number of automobile contracts we purchased. The following table sets forth the geographical sources of the automobile contracts purchased by us (based on the addresses of the customers as stated on our records) during the years ended December 31, 2010 and 2009. See "Management's Discussion and Analysis." California Texas Pennsylvania Florida Other States Total Contracts Purchased During the Year Ended December 31, 2010 December 31, 2009 Number 1,199 646 565 431 4,692 7,533 Percent (1) 15.9% 8.6% 7.5% 5.7% 62.3% 100.0% Number 154 40 49 44 308 595 Percent (1) 25.9% 6.7% 8.2% 7.4% 51.8% 100.0% (1) Percentages may not total to 100.0% due to rounding. The following table sets forth the geographic concentrations of our outstanding managed portfolio as of December 31, 2010 and 2009. State based on obligor's residence California Texas Florida Pennsylvania Illinois Ohio All others Total December 31, 2010 December 31, 2009 Amount Percent (1) Amount Percent (1) $ $ $ $ $ $ 100.2 76.2 54.8 42.8 42.3 39.6 400.3 756.2 ($ in millions) 13.3% $ 10.1% 7.2% 5.7% 5.6% 5.2% 52.9% 100.0% $ 145.9 127.6 89.5 64.2 73.4 64.1 630.0 1,194.7 12.2% 10.7% 7.5% 5.4% 6.1% 5.4% 52.7% 100.0% (1) Percentages may not total to 100.0% due to rounding. 3 We purchase automobile contracts from dealers at a price generally computed as the total amount financed under the automobile contracts, adjusted for an acquisition fee, which may either increase or decrease the automobile contract purchase price paid by us. The amount of the acquisition fee, and whether it results in an increase or decrease to the automobile contract purchase price, is based on the perceived credit risk of and, in some cases, the interest rate on the automobile contract. For the years ended December 31, 2010, 2009 and 2008, the average acquisition fee charged per automobile contract purchased under our CPS programs was $1,382, $1,508 and $592, respectively, or 9.2%, 11.7% and 3.9%, respectively, of the amount financed. We believe that the significant increase in acquisition fees since 2008 is a result of less competition in the marketplace for the types of sub-prime contracts that we typically purchase. We offer seven different financing programs to our dealership customers, and price each program according to the relative credit risk. Our programs cover a wide band of the credit spectrum and are labeled as follows: First Time Buyer – This program accommodates an applicant who has limited significant past credit history, such as a previous auto loan. Since the applicant has little or no credit history, the contract interest rate and dealer acquisition fees tend to be higher, and the loan amount, loan-to-value ratio, down payment and payment-to-income ratio requirements tend to be more restrictive compared to our other programs. Mercury / Delta – This program accommodates an applicant who may have had significant past non-performing credit including recent derogatory credit. As a result, the contract interest rate and dealer acquisition fees tend to be higher, and the loan amount, loan-to-value ratio, down payment, payment-to-income ratio and income requirements tend to be more restrictive compared to our other programs. Standard – This program accommodates an applicant who may have significant past non-performing credit, but who has also exhibited some performing credit in their history. The contract interest rate and dealer acquisition fees are comparable to the First Time Buyer and Mercury/Delta programs, but the loan amount, loan-to-value ratio, down payment, payment-to-income ratio and income requirements are somewhat less restrictive. Alpha – This program accommodates applicants who may have a discharged bankruptcy, but who have also exhibited performing credit. In addition, the program allows for homeowners who may have had other significant non-performing credit in the past. The contract interest rate and dealer acquisition fees are lower than the Standard program, and the loan-to-value ratio, down payment, payment-to-income ratio and income requirements are somewhat less restrictive. Alpha Plus – This program accommodates applicants with past non-performing credit, but with a stronger history of recent performing credit, including auto related credit, and higher incomes than the Alpha program. Contract interest rates and dealer acquisition fees are lower than the Alpha program. Super Alpha – This program accommodates applicants with past non-performing credit, but with a somewhat stronger history of recent performing credit, including auto related credit, and higher incomes than the Alpha Plus program. Contract interest rates and dealer acquisition fees are lower, and the maximum loan amount is somewhat higher, than the Alpha Plus program. Preferred - This program accommodates applicants with past non-performing credit, but who meet a certain minimum FICO score threshold. Other requirements include a somewhat stronger history of recent performing credit than the Super Alpha program. Contract interest rates and dealer acquisition fees are lower than the Super Alpha program. Our upper credit tier products, which are our Preferred, Super Alpha, Alpha Plus and Alpha programs, accounted for approximately 77% of our new contract originations in 2010, 76% in 2009 and 78.5% in 2008, measured by aggregate amount financed. The following table identifies the credit program, sorted from highest to lowest credit quality, under which we purchased automobile contracts during the years ended December 31, 2010, 2009 and 2008. 4 December 31, 2010 December 31, 2008 Contracts Purchased During the Year Ended (1) December 31, 2009 (dollars in thousands) Amount Financed $ Amount Financed $ Preferred Super Alpha Alpha Plus Alpha Standard Mercury / Delta First Time Buyer Amount Financed $ 3,208 15,018 17,824 47,341 13,726 8,244 7,662 113,023 Percent (2) 2.8% 13.3% 15.8% 41.9% 12.1% 7.3% 6.8% 100.0% 204 1,158 1,527 3,738 830 560 582 8,599 Percent (2) 2.4% 13.5% 17.8% 43.5% 9.7% 6.5% 6.8% 100.0% 13,211 33,726 50,823 123,933 15,332 25,635 19,695 282,355 Percent (2) 4.7% 11.9% 18.0% 43.9% 5.4% 9.1% 7.0% 100.0% $ $ $ (1) Automobile contracts purchased by TFC are not included because such purchases accounted for less than 10% of the total purchases during the year and are not representative of automobile contracts purchased under our CPS programs. (2) Percentages may not total to 100.0% due to rounding. We attempt to control misrepresentation regarding the customer's credit worthiness by carefully screening the automobile contracts we purchase, 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, we may require the dealer to repurchase any automobile 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 us. In addition to our purchases of installment contracts from dealers, we purchased from 2006 through 2008 an immaterial number of vehicle purchase money loans, evidenced by promissory notes and security agreements. A non-affiliated lender originated all such loans directly to vehicle purchasers, and sold the loans to us. We began financing vehicle purchases by lending money directly to consumers in January 2008, on terms similar to those that we offered through dealers, though without a down payment requirement and with more restrictive loan-to-value and credit score requirements. In October 2008 we suspended purchases of loans from other lenders and direct lending to consumers. There can be no assurance as to whether or not we will recommence these programs, the extent to which we may make such loans, or as to their future performance. Underwriting To be eligible for purchase by us, an automobile contract must have been originated by a dealer that has entered into a dealer agreement to sell automobile contracts to us. The automobile contract must be secured by a first priority lien on a new or used automobile, light truck or passenger van and must meet our underwriting criteria. In addition, each automobile contract requires the customer to maintain physical damage insurance covering the financed vehicle and naming us as a loss payee. We may, nonetheless, suffer a loss upon theft or physical damage of any financed vehicle if the customer fails to maintain insurance as required by the automobile 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 automobile contract. We believe that our underwriting criteria enable us to evaluate effectively the creditworthiness of sub-prime customers and the adequacy of the financed vehicle as security for an automobile contract. The underwriting 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 automobile contract in relation to the value of the vehicle; customer income level, employment and residence stability, credit history and debt service ability, as well as other factors. Specifically, the underwriting guidelines for our CPS programs generally limit the maximum principal amount of a purchased automobile 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. We generally do not finance vehicles that are more than eight model years old or have in excess of 99,999 miles. Under most of our programs, the maximum term of a purchased contract is 72 months; a shorter maximum term may be applicable based on the program, mileage and age of the vehicle. Automobile contracts with the maximum term of 72 months may be purchased if the customer is among the more creditworthy of our obligors and the vehicle is generally not more than four model years old and has less than 45,000 miles. Automobile contract purchase criteria are subject to change 5 from time to time as circumstances may warrant. In 2008 we made our contract purchase criteria more restrictive as part of our strategy to decrease new contract purchases in order to conserve liquidity. Prior to purchasing an automobile contract, our underwriters verify the customer's employment, income, residency, and credit information by contacting various parties noted on the customer's application, credit information bureaus and other sources. In addition, we contact each customer by telephone to confirm that the customer understands and agrees to the terms of the related automobile contract. During this "welcome call," we also ask the customer a series of open ended questions about his application and the contract, which may uncover potential misrepresentations. Credit Scoring. We use proprietary scoring models to assign each automobile contract several "credit scores" 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 scores are based on a variety of parameters including the customer's credit history, employment and residence stability, income, and the specific dealer. Once a vehicle is selected by the customer and a proposed deal structure is provided to us by the dealer, our scores will then consider the loan-to-value ratio, payment-to-income ratio, down payment amount and the sales price and make of the vehicle. We have developed the credit scores utilizing statistical risk management techniques and historical performance data from our managed portfolio. We believe this improves our allocation of credit evaluation resources, enhances our competitiveness in the marketplace and manages the risk inherent in the sub-prime market. Characteristics of Contracts. All of the automobile contracts purchased by us are fully amortizing and provide for level payments over the term of the automobile contract. All automobile contracts may be prepaid at any time without penalty. The average original principal amount financed, under the CPS programs and in the year ended December 31, 2010, was $15,004, with an average original term of 61 months and an average down payment amount of 14.8%. Based on information contained in customer applications for this 12-month period, the retail purchase price of the related automobiles averaged $15,599 (which excludes tax, license fees and any additional costs such as a maintenance contract) and the average age of the vehicle at the time the automobile contract was purchased was four years. The average age of our customers is approximately 41, with approximately $52,000 in average annual household income and an average of six years tenure with his or her current employer. 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 us as secured party with respect to the vehicle, was effected by the time of sale of the related automobile contract to us, and that all necessary steps have been taken to obtain a perfected first priority security interest in each financed vehicle in favor of us under the laws of the state in which the financed vehicle is registered. To the extent that we do not receive such state registration within three months of purchasing the automobile contract, our dealer compliance group will work with the dealer in an attempt to rectify the situation. If these efforts are unsuccessful, we generally will require the dealer to repurchase the automobile contract. Servicing and Collection We currently service all automobile contracts that we own as well as those automobile contracts that are included in portfolios that we have sold in securitizations or service for third parties. We organize our servicing activities based on the tasks performed by our personnel. Our 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; collecting deficiency balances; and generally monitoring each automobile contract and the related collateral. We are typically entitled to receive a base monthly servicing fee equal to 2.5% per annum computed as a percentage of the declining outstanding principal balance of the non-charged-off automobile contracts in the securitization pools. The servicing fee is included in interest income for those securitization transactions that are treated as financings. Collection Procedures. We believe that our ability to monitor performance and collect payments owed from sub-prime customers is primarily a function of our collection approach and support systems. We believe that if payment problems are identified early and our collection staff works closely with customers to address these problems, it is possible to correct many problems before they deteriorate further. To this end, we utilize 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 our collection activities, we maintain a computerized collection system specifically designed to service automobile contracts with sub-prime customers and similar consumer obligations. 6 We attempt to make telephonic contact with delinquent customers from one to 29 days after their monthly payment due date, depending on our proprietary behavioral scorecards which assess the customer’s likelihood of payment during early stages of delinquency. Our contact priorities may be based on the customers' physical location, stage of delinquency, size of balance or other parameters. Our collectors inquire of the customer the reason for the delinquency and when we can expect to receive the payment. The collector will attempt to get the customer to make an electronic payment over the phone or a promise for the payment for a time generally not to exceed one week from the date of the call. If the customer makes such a promise, the account is routed to a promise queue and is not contacted until the outcome of the promise is known. If the payment is made by the promise date and the account is no longer delinquent, the account is routed out of the collection system. If the payment is not made, or if the payment is made, but the account remains delinquent, the account is returned to the queue for subsequent contacts. If a customer fails to make or keep promises for payments, or if the customer is uncooperative or attempts to evade contact or hide the vehicle, a supervisor will review the collection activity relating to the account to determine if repossession of the vehicle is warranted. Generally, such a decision will occur between the 45th and 90th day past the customer's payment due date, but could occur sooner or later, depending on the specific circumstances. At the time the vehicle is repossessed we will stop accruing interest on this automobile contract, and reclassify the remaining automobile contract balance to other assets. In addition we will apply a specific reserve to this automobile contract so that the net balance represents the estimated fair value less costs to sell. If we elect to repossess the vehicle, we assign 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 automobile auction, where it is kept until sold. Financed vehicles that have been repossessed are generally resold by us through unaffiliated automobile auctions, which are attended principally by car dealers. Net liquidation proceeds are applied to the customer's outstanding obligation under the automobile contract. Such proceeds usually are insufficient to pay the customer's obligation in full, resulting in a deficiency. In most cases we will continue to contact our customers to recover all or a portion of this deficiency for up to several years after charge-off. Once an automobile contract becomes greater than 90 days delinquent, we do not recognize additional interest income until the borrower under the automobile contract makes sufficient payments to be less than 90 days delinquent. Any payments received by a borrower that are greater than 90 days delinquent are first applied to accrued interest and then to principal reduction. We generally charge off the balance of any contract by the earlier of the end of the month in which the automobile 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 us or if the vehicle has been in repossession inventory for more than three months. In the case of repossession, the amount of the charge-off is the difference between the outstanding principal balance of the defaulted automobile contract and the net repossession sale proceeds. Credit Experience Our financial results are dependent on the performance of the automobile contracts in which we retain an ownership interest. The tables below document the delinquency, repossession, extension and net credit loss experience of all automobile contracts that we hold and service (the tables exclude certain contracts we have serviced for third-parties on which we earn servicing fees only, and have no credit risk). While broad economic weakness and the high levels of unemployment experienced since 2008 have resulted in higher delinquencies and net charge-offs, the increase in the percentage levels is also partially attributable to the decrease in the size and the increase in the average age of our managed portfolio. 7 Delinquency, Repossession and Extension Experience Delinquency Experience 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……………….… Extension Experience Contracts with one extension (4) Contracts with two or more extensions (4)……...………. Total contracts with extensions December 31, 2010 December 31, 2009 December 31, 2008 Number of Contracts Amount Number of Contracts Amount Number of Contracts Amount (Dollars in thousands) 84,601 $ 681,157 111,105 $ 1,057,348 145,564 $ 1,665,036 2,856 1,537 1,233 5,626 3,263 . 19,168 . 10,872 . 9,067 . 39,107 . 23,290 . . 2,787 1,824 1,205 5,816 4,305 24,628 16,840 10,358 51,826 40,815 3,733 2,376 2,424 8,533 4,262 39,798 26,549 27,243 93,590 49,357 8,889 $ 62,397 10,121 $ 92,641 12,795 $ 142,947 6.7 % 5.7 10.5 % 9.2 . % . . . % 5.2 % 4.9 % 5.9 % 5.6 % 9.1 % 8.8 % 8.8 % 8.6 % 17,749 $ 135,204 . . 26,528 $ 266,081 30,160 $ 354,330 13,226 30,975 $ 105,637 240,841 12,884 39,412 $ 126,853 392,934 8,639 38,799 $ 88,988 443,318 (1) All amounts and percentages are based on the amount remaining to be repaid on each automobile contract, including, for pre-computed automobile contracts, any unearned interest. The information in the table represents the gross principal amount of all automobile contracts we purchased, including automobile contracts we subsequently sold in securitization transactions that we continue to service. The table does not include certain contracts we have serviced for third-parties on which we earn servicing fees only, and have no credit risk. (2) We consider an automobile contract delinquent when an obligor fails to make at least 90% of a contractually due payment by the following due date, which date may have been extended within limits specified in the servicing agreements. The period of delinquency is based on the number of days payments are contractually past due. Automobile contracts less than 31 days delinquent are not included. (3) Amount in repossession represents the contract balance on financed vehicles that have been repossessed but not yet liquidated. This amount is not netted with the specific reserve to arrive at the estimated asset value less costs to sell. (4) The delinquency aging categories shown in the tables reflect the effect of extensions. Extensions We may offer a customer an extension, under which the customer agrees with us to move past due payments to the end of the automobile contract term. In such cases the customer must sign an agreement for the extension, and may pay a fee representing partial payment of accrued interest. Our policies, and contractual arrangements for our warehouse and securitization transactions, limit the number of extensions that may be granted. In general, a customer may arrange for an extension no more than twice every 12 months, not to exceed six extensions over the life of the contract. If a customer is granted such an extension, the date next due is advanced. Subsequent delinquency aging classifications would be based on the future payment performance of the automobile contract. 8 Net Credit Loss Experience (1) 2010 Year Ended December 31, 2009 (Dollars in thousands) 2008 Average servicing portfolio outstanding………………… $ Net charge-offs as a percentage of average $ servicing portfolio (2)…….………………………..………$ 827,176 $ 1,319,106 $ 1,934,003 9.0 % 11.0 % 7.7 % (1) All amounts and percentages are based on the principal amount scheduled to be paid on each automobile contract, net of unearned income on pre-computed automobile contracts. The information in the table represents all automobile contracts serviced by us, excluding certain contracts we have serviced for third- parties on which we earn servicing fees only, and have no credit risk. (2) Net charge-offs include the remaining principal balance, after the application of the net proceeds from the liquidation of the vehicle (excluding accrued and unpaid interest) and amounts collected subsequent to the date of charge-off, including some recoveries which have been classified as other income in the accompanying financial statements. Securitization of Automobile Contracts We purchase automobile contracts with the intention of financing them on a long-term basis through securitizations. All such securitizations have involved identification of specific automobile contracts, sale of those automobile contracts (and associated rights) to a special purpose subsidiary, and issuance of asset−backed securities to fund the transactions. Upon the securitization of a portfolio of automobile contracts, we retain the obligation to service the contracts, and receive a monthly fee for doing so. We have been a regular issuer of asset-backed securities since 1994, completing 50 securitizations totaling over $6.7 billion through December 31, 2010. Depending on the structure of the securitization, the transaction may be treated as a sale of the automobile contracts or as a secured financing for financial accounting purposes. From July 2003 through April 2008, we structured our securitizations as secured financings rather than as sales of contracts. The second of our two securitizations completed in 2008 (September 2008) was in substance a sale of the related contracts, and is treated as a sale for financial accounting purposes. In September 2010 we took advantage of improvement in the market for asset- backed securities by re-securitizing the underlying receivables from our unrated September 2008 securitization. By doing so we were able to pay off the bonds associated with the September 2008 transaction and issue rated bonds with a significantly lower weighted average coupon. The September 2010 transaction was our first rated term securitization since 1993 that did not utilize a financial guaranty. When structured to be treated as a secured financing, the subsidiary is consolidated and, accordingly, the automobile contracts and the related securitization trust debt appear as assets and liabilities, respectively, on our consolidated balance sheet. We then recognize interest income on the contracts and interest expense on the securities issued in the securitization and record as expense a provision for probable credit losses on the contracts. When structured to be treated as a sale, the subsidiary is not consolidated. Accordingly, the securitization removes the sold automobile contracts from our consolidated balance sheet, the related debt does not appear as our debt, and our consolidated balance sheet shows, as an asset, a retained residual interest in the sold automobile contracts. The residual interest represents the discounted value of what we expect will be the excess of future collections on the automobile contracts over principal and interest due on the asset-backed securities. That residual interest appears on our consolidated balance sheet as "residual interest in securitizations," and the determination of its value is dependent on our estimates of the future performance of the sold automobile contracts. Historically, prior to a securitization transaction, we funded our automobile contract purchases primarily with proceeds from warehouse credit facilities. As of December 31, 2007, we had $425 million in warehouse credit capacity, in the form of two $200 million senior facilities and one $25 million subordinated facility. Both warehouse credit facilities provided funding for automobile contracts purchased under the CPS programs, while one facility also provided funding for automobile contracts purchased under the TFC programs. Up to 93% of the principal balance of the automobile contracts was advanced to us under these facilities, subject to collateral tests and certain other conditions and covenants. In April 2008, the subordinated facility expired and the subordinated lenders were fully repaid. In November 2008, one of the two senior facilities expired and the lender was fully repaid. The remaining warehouse facility was amended in December 2008 to eliminate further advances and to provide for 9 repayment from proceeds collected under the related pledged receivables, and certain other scheduled principal reductions until its lenders were fully repaid in September 2009. Since October 2009, we have gradually increased our contract purchases by utilizing one $50 million credit facility and another $50 million term funding facility. More recently, we significantly increased our short-term contract financing resources by entering into agreements for one new $100 million credit facility in December 2010 and for another $100 million credit facility in February 2011. We have in the past secured long-term financing for our automobile contract purchases through securitization transactions. We have used the proceeds from such securitization transactions primarily to repay the warehouse credit facilities. We expect to conduct one or more securitizations of newly purchased contracts in 2011. In a securitization and in our warehouse credit facilities, we are required to make certain representations and warranties, which are generally similar to the representations and warranties made by dealers in connection with our purchase of the automobile contracts. If we breach any of our representations or warranties, we will be obligated to repurchase the automobile contract at a price equal to the principal balance plus accrued and unpaid interest. We may then be entitled under the terms of our dealer agreement to require the selling dealer to repurchase the contract at a price equal to our purchase price, less any principal payments made by the customer. Subject to any recourse against dealers, we will bear the risk of loss on repossession and resale of vehicles under automobile contracts that we repurchase. 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 us if the credit performance of the securitized automobile contracts falls short of pre-determined standards. Such releases represent a material portion of the cash that we use to fund our operations. An unexpected deterioration in the performance of securitized automobile contracts could therefore have a material adverse effect on both our liquidity and results of operations, regardless of whether such automobile 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 our "managed portfolio," which represents both financed and sold automobile contracts as to which such credit risk is retained. Our managed portfolio as of December 31, 2010 was approximately $756.2 million, including $75.1 million of receivables on which we earn only servicing fees. Competition The automobile financing business is highly competitive. We compete with a number of national, regional and local finance companies with operations similar to ours. 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. Many of our competitors and potential competitors possess substantially greater financial, marketing, technical, personnel and other resources than we do. Moreover, our future profitability will be directly related to the availability and cost of our capital in relation to the availability and cost of capital to our competitors. Our 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 us. 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 we do not offer. We believe that the principal competitive factors affecting a dealer's decision to offer automobile contracts for sale to a particular financing source are the monthly payment amount made available to the dealer’s customer, the purchase price offered for the automobile contracts, the timeliness of the response to the dealer upon submission of the initial application, the reasonableness of the financing source's documentation requests, the predictability and timeliness of purchases and the financial stability of the funding source. While we believe that we can obtain from dealers sufficient automobile contracts for purchase at attractive prices by consistently applying reasonable underwriting criteria and making timely purchases of qualifying automobile contracts, there can be no assurance that we will do so. 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 automobile contracts and impose certain other restrictions on dealers. In many states, a license is required to engage in the business of purchasing automobile 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. 10 The so-called Lemon Laws enacted by various states provide certain rights to purchasers with respect to automobiles 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 us and purchasers of automobile contracts from us. The dealer agreement contains representations by the dealer that, as of the date of assignment of automobile contracts, no such claims or defenses have been asserted or threatened with respect to the automobile 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 automobile 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. Certain of these laws also regulate our servicing activities, including our methods of collection. Although we believe that we are currently in material compliance with applicable statutes and regulations, there can be no assurance that we 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 us. Furthermore, the adoption of additional statutes and regulations, changes in the interpretation and enforcement of current statutes and regulations or the expansion of our business into jurisdictions that have adopted more stringent regulatory requirements than those in which we currently conduct business could have a material adverse effect upon us. In addition, due to the consumer- oriented nature of the industry in which we operate 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 us or within the industry in connection with any such litigation could have a material adverse effect on our financial condition, results of operations or liquidity. Employees As of December 31, 2010, we had 435 employees. The breakdown of the employees is as follows: eight are senior management personnel; 300 are servicing personnel; 47 are automobile contract origination personnel; 26 are marketing personnel (18 of whom are marketing representatives); 28 are operations and systems personnel; and 26 are administrative personnel. We believe that our relations with our employees are good. We are not a party to any collective bargaining agreement. DIRECTORS AND EXECUTIVE OFFICERS Directors Our directors and their principal occupations are as follows: Charles E. Bradley, Jr., chief executive officer of Consumer Portfolio Services, Inc.; Chris A. Adams, owner and chief executive of Latrobe Pattern Company and K Castings Inc., which are firms engaged in the business of fabricating metal parts; Brian J. Rayhill, a practicing attorney in New York state; William B. Roberts, president of Monmouth Capital Corp., an investment firm that specializes in management buyouts; Gregory S. Washer, owner and president of Clean Fun Promotional Marketing LLC, a promotional marketing company; and Daniel S. Wood, retired president of Carclo Technical Plastics, a manufacturer of custom injection moldings. Executive Officers Charles E. Bradley, Jr., 51, has been our President and a director since our formation in March 1991, and was elected Chairman of the Board of Directors in July 2001. In January 1992, Mr. Bradley was appointed Chief Executive Officer. From April 1989 to November 1990, he served as Chief Operating Officer of Barnard and Company, a private investment firm. From September 1987 to March 1989, Mr. Bradley, Jr. was an associate of The Harding Group, a private investment banking firm. Mr. Bradley does not currently serve on the board of directors of any other publicly-traded companies. Mark A. Creatura, 52, 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. Jeffrey P. Fritz, 51, has been Senior Vice President - Chief Financial Officer since April 2006. He was Senior Vice President - Accounting from August 2004 through March 2006. He served as a consultant to us from May 2004 to August 2004. Previously, he was the Chief Financial Officer of SeaWest Financial Corp. from February 2003 to May 2004, and the Chief Financial Officer of AFCO Auto Finance from April 2002 to February 2003. He practiced public accounting with Glenn M. Gelman & Associates from March 2001 to April 2002 and was Chief Financial Officer of Credit Services Group, Inc. from May 1999 to November 2000. He previously served as our Chief Financial Officer from our inception through May 1999. 11 Robert E. Riedl, 47, has been Senior Vice President - Chief Investment Officer since April 2006. Mr. Riedl was Senior Vice President - Chief Financial Officer from August 2003 until assuming his current position. Mr. Riedl joined the Company as Senior Vice President - Risk Management in January 2003. Previously, 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, Jefferies & Company and PaineWebberfrom 1986 to 1999. Christopher Terry, 43, has been Senior Vice President - Servicing since May 2005, and prior to that was Senior Vice President - Asset Recovery since January 2003. He joined us 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 to October 1994. Teri L. Clements, 48, has been the Senior Vice President of Originations since April 2007. Prior to that, she held the position of Vice President of Originations since August 1998. She joined the Company in June 1991 as an Operations Specialist. Previously, Ms. Clements held an administrative position at Greco & Associates. Michael L. Lavin, 39, has been Senior Vice President – Legal since May 2009. Prior to that, he was our Vice President – Legal since joining the Company in November 2001. Mr. Lavin was previously engaged as a law clerk and an associate with the San Diego law firm (now defunct) of Edwards, Sooy & Byron from 1996 through 2000 and then as an associate with the Orange County firm of Trachtman & Trachman from 2000 through 2001. Mr. Lavin also clerked for the San Diego District Attorney’s office and Orange County Public Defender’s office. 12 Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES The Company’s Common Stock is traded on the Nasdaq Global Market, under the symbol "CPSS." The following table sets forth the high and low sale prices as reported by Nasdaq for our Common Stock for the periods shown. January 1 - March 31, 2009…………………………………….………$ April 1 - June 30, 2009………………………………………….………. July 1 - September 30, 2009…………………………………...……… . October 1 - December 31, 2009……………………………….……… . January 1 - March 31, 2010…………………………………….………. April 1 - June 30, 2010………………………………………….………. July 1 - September 30, 2010…………………………………...……… . October 1 - December 31, 2010……………………………….……… . High 0.80 1.15 1.65 1.30 2.25 2.27 1.37 1.34 Low 0.25 0.40 0.46 0.95 1.00 1.25 0.59 0.56 As of March 21, 2010, there were 56 holders of record of the Company’s Common Stock. To date, we have not declared or paid any dividends on our Common Stock. The payment of future dividends, if any, on our Common Stock is within the discretion of the Board of Directors and will depend upon our income, capital requirements and financial condition, and other relevant factors. The instruments governing our outstanding debt place certain restrictions on the payment of dividends. We do not intend to declare any dividends on our Common Stock in the foreseeable future, but instead intend to retain any cash flow for use in our operations. The table below presents information regarding outstanding options to purchase our Common Stock as of December 31, 2010: 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 Weighted average exercise price of outstanding options, warrants and rights Number of securities remaining available for future issuance under equity compensation plans 12,816,448 $ 1.31 - 12,816,448 $ - 1.31 829,500 - 829,500 Issuer Purchases of Equity Securities in the Fourth Quarter Total Number of Shares Purchased 4,440 3,397 - 7,837 Period(1) October 2010…… $ November 2010……$ December 2010……$ Total Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(2) $ $ 0.89 0.82 - 1.22 4,440 3,397 - 7,837 Approximate Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs $ 2,067,439 2,064,659 2,064,659 (1) Each monthly period is the calendar month. (2) Through December 31, 2010, our board of directors had authorized the purchase of up to $34.5 million of our outstanding securities, which program was first announced in our annual report for the year 2002, filed on March 26, 2003. All purchases described in the table above were under the plan announced in March 2003, which has no fixed expiration date. 13 Item 6. SELECTED FINANCIAL DATA The following table presents our selected consolidated financial data and operating data as of and for the dates indicated. The data under the captions "Statement of Operations Data" and "Balance Sheet Data" have been derived from our audited and unaudited consolidated financial statements. The remainder is derived from other records of ours. You should read the selected consolidated financial data together with "Management’s Discussion and Analysis of Financial Condition and Results of Operations" and our audited and unaudited financial statements and notes thereto that are included in this report. (dollars in thousands, except per share data) 2010 As of and For the Year Ended December 31, 2008 2009 2007 2006 Statement of Operations Data Revenues: Interest income ……………………………………… Servicing fees ………………………………………… Other income ………………………………………… Total revenues ……………………………………… Expenses: Employee costs ……………………………………….. General and administrative …………………………… Interest expense ………………………………………. Provision for credit losses ……………………………. Loss on sale of receivables ……………………………. Total expenses …………………………………….. Income (loss) before income tax expense (benefit) …………… Income tax expense (benefit) …………………………………… Net income (loss) …………………………………………. $ 137,090 7,657 10,438 155,185 33,814 26,068 82,226 29,921 - 172,029 (16,844) 16,982 (33,826) $ 208,196 4,640 11,059 223,895 $ 351,551 2,064 14,796 368,411 $ 370,265 1,218 23,067 394,550 $ 263,566 2,894 12,403 278,863 37,306 32,217 111,768 92,011 - 273,302 (49,407) 7,800 (57,207) $ 48,874 44,368 156,253 148,408 13,963 411,866 (43,455) (17,364) (26,091) $ 46,716 47,416 139,189 137,272 38,483 42,011 93,112 92,057 370,593 23,957 10,099 13,858 $ 265,663 13,200 (26,355) 39,555 $ $ Earnings (loss) per share-basic …………………………… Earnings (loss) per share-diluted ………………………… Pre-tax income (loss) per share-basic (1) ……………….. Pre-tax income (loss) per share-diluted (2) ……………… Weighted average shares outstanding-basic ……………. Weighted average shares outstanding-diluted ………….. $ $ $ $ (1.94) (1.94) (0.96) (0.96) 17,477 17,477 $ $ $ $ (3.07) (3.07) (3.07) (3.07) 18,643 18,643 $ $ $ $ (1.36) (1.36) (2.26) (2.26) 19,230 19,230 $ $ $ $ 0.66 0.61 1.15 1.06 20,880 22,595 $ $ $ $ 1.82 1.64 0.61 0.55 21,759 24,052 Balance Sheet Data Total assets ………………………………………………. Cash and cash equivalents ……………………………….. Restricted cash and equivalents …………………………. Finance receivables, net ………………………………….. Residual interest in securitizations ………………………. Warehouse lines of credit ………………………………… Residual interest financing ……………………………….. Securitization trust debt ………………………………….. Long-term debt ……………………………………………. Shareholders' equity ………………………………………. $ 742,884 16,252 123,958 552,453 3,841 45,564 39,440 567,722 65,210 4,554 $ 1,068,261 12,433 128,511 840,092 4,316 4,932 56,930 904,833 48,083 35,577 $ 1,638,807 22,084 153,479 1,339,307 3,582 9,919 67,300 1,404,211 45,826 89,849 $ 2,282,813 20,880 170,341 1,967,866 2,274 235,925 70,000 1,798,302 28,134 114,355 $ 1,728,594 14,215 193,001 1,401,414 13,795 72,950 31,378 1,442,995 38,574 111,512 (1) Income (loss) before income tax benefit divided by weighted average shares outstanding-basic. Included for illustrative purposes because some of the periods presented include significant income tax benefits while other periods have neither income tax benefit nor expense. (2) Income (loss) before income tax benefit divided by weighted average shares outstanding-diluted. Included for illustrative purposes because some of the periods presented include significant income tax benefits while other periods have neither income tax benefit nor expense. 14 (dollars in thousands, except per share data) 2010 2009 2008 2007 2006 As of and For the Year Ended December 31, Contract Purchases/Securitizations Automobile contract purchases……………………………… Automobile contracts securitized - structured as sales………………………………………………….… Automobile contracts securitized - structured as secured financings…………………………………..… $ 113,023 $ 8,599 $ 296,817 $ 1,282,311 $ 1,019,018 103,772 - - - 198,662 - - 310,360 1,118,097 957,681 Managed Portfolio Data Contracts held by consolidated subsidiaries………………… Contracts held by non-consolidated subsidiaries………….. Third party portfolios (1)…………………………………… Total managed portfolio…………………………………… Average managed portfolio……………………………….… $ $ 597,142 83,964 75,097 756,203 928,977 $ 922,681 134,894 137,146 1,194,721 1,342,410 $ $ $ 1,477,810 186,233 79 1,664,122 1,934,003 $ 2,125,755 - 422 2,126,177 1,906,605 $ $ $ 1,527,285 34,850 3,770 1,565,905 1,376,781 Weighted average fixed effective interest rate (total managed portfolio) (2)………………………..…… Core operating expense (% of average managed portfolio) (3)…………………… Allowance for loan losses………………………………..… Allowance for loan losses (% of total contracts held by consolidated subsidiaries)……………………… Total delinquencies (2) (4)………………………………… Total delinquencies and repossessions (2) (4)……………… Net charge-offs (2) (5)……………………………………… 16.2% 15.8% 18.0% 18.2% 18.5% 6.4% 13,168 $ 5.2% 38,274 $ 4.8% 78,036 $ 4.9% 100,138 $ 5.8% 79,380 $ 2.2% 5.7% 9.2% 9.0% 4.1% 4.9% 8.8% 11.0% 5.3% 5.6% 8.6% 7.7% 4.7% 4.7% 6.3% 5.3% 5.2% 4.0% 5.5% 4.5% (1) Receivables related to the third party portfolios, on which we earn only a servicing fee. (2) Excludes receivables related to the third party portfolios. (3) Total expenses excluding provision for credit losses, interest expense, loss on sale of receivables and impairment loss on residual assets. (4) For further information regarding delinquencies and the managed portfolio, see the table captioned "Delinquency Experience," in Item 1, Part I of this report and the notes to that table. (5) Net charge-offs include the remaining principal balance, after the application of the net proceeds from the liquidation of the vehicle (excluding accrued and unpaid interest) and amounts collected subsequent to the date of the charge-off, including some recoveries which have been classified as other income in the accompanying financial statements. For further information regarding charge-offs, see the table captioned "Net Charge-Off Experience," in Item I, Part I of this report and the notes to that table. 15 Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with our consolidated financial statements and notes thereto and other information included or incorporated by reference herein. Overview We are a specialty finance company. Our business is to purchase and service retail automobile contracts originated primarily by franchised automobile dealers and, to a lesser extent, by select independent dealers in the United States in the sale of new and used automobiles, light trucks and passenger vans. Through our automobile contract purchases, we provide indirect financing to the customers of dealers who have limited credit histories, low incomes or past credit problems, who we refer to as sub-prime customers. We serve as an alternative source of financing for dealers, facilitating sales to customers who otherwise might not be able to obtain financing from traditional sources, such as commercial banks, credit unions and the captive finance companies affiliated with major automobile manufacturers. In addition to purchasing installment purchase contracts directly from dealers, we have also (i) acquired installment purchase contracts in three merger and acquisition transactions, (ii) purchased immaterial amounts of vehicle purchase money loans from non-affiliated lenders, and (iii) directly originated an immaterial amount of vehicle purchase money loans by lending money directly to consumers. In this report, we refer to all of such contracts and loans as "automobile contracts." We were incorporated and began our operations in March 1991. From inception through December 31, 2010, we have purchased a total of approximately $8.8 billion of automobile contracts from dealers. In addition, we obtained a total of approximately $605.0 million of automobile contracts in mergers and acquisitions in 2002, 2003 and 2004. In 2004 and 2009, we were appointed as a third-party servicer for certain portfolios of automobile receivables originated and owned by entities not affiliated with us. Beginning in 2008, our managed portfolio has decreased each year due to our strategy of limiting contract purchases to conserve our liquidity in response to adverse economic conditions, as discussed further below. However, since October 2009, we have gradually increased contract purchases resulting in aggregate purchases of $113.0 million in 2010, compared to $8.6 million in 2009. Our total managed portfolio was $756.2 million at December 31, 2010 compared to $1,194.7 million at December 31, 2009, $1,664.1 million at December 31, 2008, $2,162.2 million at December 31, 2007 and $1,565.9 million at December 31, 2006. We are headquartered in Irvine, California, where most operational and administrative functions are centralized. All credit and underwriting functions are performed in our California headquarters, and we service our automobile contracts from our California headquarters and from three servicing branches in Virginia, Florida and Illinois. We purchase contracts in our own name (“CPS”) and, until July 2008, also in the name of our wholly-owned subsidiary, TFC. Programs marketed under the CPS name are intended to serve a wide range of sub-prime customers, primarily through franchised new car dealers. Our TFC program served vehicle purchasers enlisted in the U.S. Armed Forces, primarily through independent used car dealers. In July 2008, we ended our TFC program. We purchase automobile contracts with the intention of financing them on a long-term basis through securitizations. Securitizations are transactions in which we sell a specified pool of contracts to a special purpose entity of ours, which in turn issues asset-backed securities to fund the purchase of the pool of contracts from us. Depending on the structure of the securitization, the transaction may be treated, for financial accounting purposes, as a sale of the contracts or as a secured financing. Securitization and Warehouse Credit Facilities Throughout the periods for which information is presented in this report, we have purchased automobile contracts with the intention of financing them on a long-term basis through securitizations, and on an interim basis through warehouse credit facilities. All such financings have involved identification of specific automobile contracts, sale of those automobile contracts (and associated rights) to one of our special-purpose subsidiaries, and issuance of asset- backed securities to fund the transactions. Depending on the structure, these transactions may be accounted for under generally accepted accounting principles as sales of the automobile contracts or as secured financings. When structured to be treated as a secured financing for accounting purposes, the subsidiary is consolidated with us. Accordingly, the sold automobile contracts and the related debt appear as assets and liabilities, respectively, on our consolidated balance sheet. We then periodically: (i) recognize interest and fee income on the contracts, (ii) recognize interest expense on the securities issued in the transaction, and (iii) record as expense a provision for credit losses on the contracts. From July 2003 through April 2008, all of our securitizations were structured in this 16 manner. In September 2008, we securitized automobile contracts in a transaction that was in substance a sale, that was treated as a sale for accounting purposes, and in which we retained a residual interest in the automobile contracts. The remaining receivables from that September 2008 securitization were re-securitized in September 2010 in a structure that maintained sale treatment for accounting purposes. When structured to be treated as a sale for accounting purposes, the assets and liabilities of the special-purpose subsidiary are not consolidated with us. Accordingly, the transaction removes the sold automobile contracts from our consolidated balance sheet, the related debt does not appear as our debt, and our consolidated balance sheet shows, as an asset, a retained residual interest in the sold automobile contracts. The residual interest represents the discounted value of what we expect will be the excess of future collections on the automobile contracts over principal and interest due on the asset-backed securities. That residual interest appears on our consolidated balance sheet as "residual interest in securitizations," and the determination of its value is dependent on our estimates of the future performance of the sold automobile contracts. Of our managed portfolio outstanding at December 31, 2010, only our September 2010 securitization was structured to be treated as a sale for accounting purposes. Credit Risk Retained Whether a sale of automobile contracts in connection with a securitization or warehouse credit facility 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 us if the credit performance of the related automobile contracts falls short of pre-determined standards. Such releases represent a material portion of the cash that we use to fund our operations. An unexpected deterioration in the performance of such automobile contracts could therefore have a material adverse effect on both our liquidity and our results of operations, regardless of whether such automobile contracts are treated for financial accounting purposes 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 our "managed portfolio," which represents both financed and sold automobile contracts as to which such credit risk is retained. Our managed portfolio as of December 31, 2010 was approximately $756.2 million, which includes a third party servicing portfolio of $75.1 million on which we earn only servicing fees and have no credit risk. Critical Accounting Policies We believe that our accounting policies related to (a) Allowance for Finance Credit Losses, (b) Amortization of Deferred Originations Costs and Acquisition Fees, (c) Residual Interest in Securitizations and Gain on Sale of Automobile Contracts and (d) Income Taxes are the most critical to understanding and evaluating our reported financial results. Such policies are described below. Allowance for Finance Credit Losses In order to estimate an appropriate allowance for losses to be incurred on finance receivables, we use a loss allowance methodology commonly referred to as "static pooling," which stratifies our finance receivable portfolio into separately identified pools based on the period of origination. Using analytical and formula driven techniques, we estimate an allowance for finance credit losses, which we believe is adequate for probable credit losses that can be reasonably estimated in our portfolio of automobile contracts. Provision for losses is charged to our consolidated statement of operations. Net losses incurred on finance receivables are charged to the allowance. We evaluate the adequacy of the allowance by examining current delinquencies, the characteristics of the portfolio, prospective liquidation values of the underlying collateral and general economic and market conditions. As circumstances change, our level of provisioning and/or allowance may change as well. We observed deterioration in performance of automobile contracts held in our portfolio since 2008, which we attribute to a general recession that began in December 2007. Accordingly, we increased our provision for credit losses in the fourth quarter of 2009. Our allowance as a percentage of finance receivables has decreased in recent years due primarily to the continued seasoning of our portfolio. Our historical static loss data shows that, in general, incremental monthly losses increase through approximately the 28th month of the life of a static portfolio, after which such monthly incremental losses tend to decrease. As of December 31, 2010 the weighted average age of our portfolio of finance receivables was 37 months. In addition, for receivables originated beginning with the third quarter of 2008, we have found the early credit performance of those static portfolios to be significantly better than earlier portfolios at similar vintage time frames. Amortization of Deferred Originations Costs and Acquisition Fees Upon purchase of a contract from a dealer, we generally either charge or advance the dealer an acquisition fee. In addition, we incur certain direct costs associated with originations of our contracts. All such acquisition fees and 17 direct costs are applied to the carrying value of finance receivables and are accreted into earnings as an adjustment to the yield over the estimated life of the contract using the interest method. Term Securitizations Our term securitization structure has generally been as follows: We sell automobile contracts we acquire to a wholly-owned special purpose subsidiary, which has been established for the limited purpose of buying and reselling our automobile contracts. The special-purpose subsidiary then transfers the same automobile contracts to another entity, typically a statutory trust. The trust issues interest- bearing asset-backed securities, in a principal amount equal to or less than the aggregate principal balance of the automobile contracts. We typically sell these automobile contracts to the trust at face value and without recourse, except that representations and warranties similar to those provided by the dealer to us are provided by us to the trust. One or more investors purchase the asset-backed securities issued by the trust; the proceeds from the sale of the asset-backed securities are then used to purchase the automobile contracts from us. We may retain or sell subordinated asset-backed securities issued by the trust or by a related entity. Historically we have purchased external credit enhancement for most of our term securitizations in the form of a financial guaranty insurance policy, guaranteeing timely payment of interest and ultimate payment of principal on the senior asset-backed securities, from an insurance company. In addition, we structure our securitizations to include internal credit enhancement for the benefit of the insurance company and the investors (i) in the form of an initial cash deposit to an account ("spread account") held by the trust, (ii) in the form of overcollateralization of the senior asset-backed securities, where the principal balance of the senior asset-backed securities issued is less than the principal balance of the automobile contracts, (iii) in the form of subordinated asset-backed securities, or (iv) some combination of such internal credit enhancements. The agreements governing the securitization transactions require that the initial level of internal credit enhancement be supplemented by a portion of collections from the automobile contracts until the level of internal credit enhancement reaches specified levels, which are then maintained. The specified levels are generally computed as a percentage of the principal amount remaining unpaid under the related automobile contracts. The specified levels at which the internal credit enhancement is to be maintained will vary depending on the performance of the portfolios of automobile contracts held by the trusts and on other conditions, and may also be varied by agreement among us, our special purpose subsidiary, the insurance company and the trustee. Such levels have increased and decreased from time to time based on performance of the various portfolios, and have also varied from one transaction to another. The agreements governing the securitizations generally grant us the option to repurchase the sold automobile contracts from the trust when the aggregate outstanding balance of the automobile contracts has amortized to a specified percentage of the initial aggregate balance. Our September 2008 securitization and the subsequent re-securitization of the remaining receivables from such transaction in September 2010 were each in substance sales of the underlying receivables, and have been treated as sales for financial accounting purposes. They differ from those treated as secured financings in that the trust to which our special-purpose subsidiaries sold the automobile contracts met the definition of a "qualified special- purpose entity" under Statement of Financial Accounting Standards No. 140 ("SFAS 140") (ASC 860 10 65-2) As a result, assets and liabilities of those trusts are not consolidated into our consolidated balance sheet. Historically, our warehouse credit facility structures were similar to the above, except that (i) our special-purpose subsidiaries that purchased the automobile contracts pledged the automobile contracts to secure promissory notes that they issued, (ii) no increase in the required amount of internal credit enhancement was contemplated, and (iii) we did not purchase financial guaranty insurance. Through November 2008, we depended substantially on two warehouse credit facilities: (i) a $200 million warehouse credit facility, which we established in November 2005 and expired by its terms in November 2008; and (ii) a $200 million warehouse credit facility, which we established in June 2004 and which was amended in December 2008 to eliminate future advances and to provide for repayment of the related notes from the cash collections on the underlying pledged contracts, and certain other principal reductions until it was fully repaid in September 2009. Since October 2009, we have gradually increased our contract purchases by utilizing a $50 million credit facility we established in September 2009 and $50 million term funding facility that we established in March 2010. More recently, we increased our short-term contract financing resources by $200 million by entering into agreements for a $100 million credit facility in December 2010 and for another $100 million credit facility in February 2011. Upon each sale of automobile contracts in a transaction structured as a secured financing for financial accounting purposes, whether a term securitization or a warehouse financing, we retain on our consolidated balance sheet the related automobile contracts as assets and record the asset-backed notes issued in the transaction as indebtedness. 18 Under the September 2008 and September 2010 securitizations, and other term securitizations completed prior to July 2003 that were structured as sales for financial accounting purposes, we removed from our consolidated balance sheet the automobile contracts sold and added to our consolidated balance sheet (i) the cash received, if any, and (ii) the estimated fair value of the ownership interest that we retained in the automobile contracts sold in the transaction. That retained or residual interest consisted of (a) the cash held in the spread account, if any, (b) overcollateralization, if any, (c) asset-backed securities retained, if any, and (d) receivables from the trust, which include the net interest receivables. Net interest receivables 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 asset-backed notes, the premium paid to the insurance company, if any, and certain other expenses. The excess of the cash received and the assets we retained over the carrying value of the automobile contracts sold, less transaction costs, equaled the net gain on sale of automobile contracts we recorded. We receive periodic base servicing fees for the servicing and collection of the automobile contracts. Under our securitization structures treated as secured financings for financial accounting purposes, such servicing fees are included in interest income from the automobile contracts. In addition, we are entitled to the cash flows from the trusts that represent collections on the automobile contracts in excess of the amounts required to pay principal and interest on the asset-backed securities, base servicing fees, and certain other fees and expenses (such as trustee and custodial fees). Required principal payments on the asset-backed notes are generally defined as the payments sufficient to keep the principal balance of such notes equal to the aggregate principal balance of the related automobile contracts (excluding those automobile 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 asset-backed securities is reduced to the specified percentage. Such accelerated principal payment is said to create overcollateralization of the asset-backed notes. If the amount of cash required for payment of fees, expenses, interest and principal on the senior asset-backed notes 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 plus required principal payments on the subordinated asset-backed notes, and there is no shortfall in the related spread account or the required overcollateralization level, the excess is released to us. If the spread account and overcollateralization 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 our special-purpose subsidiaries as the owner of the residual interests (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), we are restricted in use of the cash in the spread accounts. 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 automobile contracts is significantly greater than the interest rate on the asset-backed notes. As a result, the residual interests described above historically have been a significant asset of ours. In all of our term securitizations and warehouse credit facilities, whether treated as secured financings or as sales, we have sold the automobile contracts (through a subsidiary) to the securitization entity. The difference between the two structures is that in securitizations that are treated as secured financings we report the assets and liabilities of the securitization trust on our consolidated balance sheet. Under both structures, recourse to us by holders of the asset- backed securities and by the trust, for failure of the automobile contract obligors to make payments on a timely basis, is limited to the automobile contracts included in the securitizations or warehouse credit facilities, the spread accounts and our retained interests in the respective trusts. Since the third quarter of 2003, we have conducted 25 term securitizations. Of these 25, 19 were periodic (generally quarterly) securitizations of automobile contracts that we purchased from automobile dealers under our regular programs. In addition, in March 2004 and November 2005, we completed securitizations of our retained interests in other securitizations that we and our affiliates previously sponsored. The debt from the March 2004 transaction was repaid in August 2005, and the debt from the November 2005 transaction was repaid in May 2007. Also, in June 2004, we completed a securitization of automobile contracts purchased under our TFC program and acquired in a bulk purchase. Further, in December 2005 and May 2007 we completed securitizations that included automobile contracts purchased under the TFC programs, automobile contracts purchased under the CPS programs and automobile contracts we repurchased upon termination of prior securitizations. Since July 2003 all such securitizations have been structured as secured financings, except that our September 2008 and September 2010 securitizations were in substance sales of the underlying receivables, and were treated as sales for financial accounting purposes. 19 Income Taxes We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. Deferred tax assets are recognized subject to management’s judgment that realization is more likely than not. Although realization is not assured, we believe that the realization of the recognized net deferred tax asset of $15.0 million is more likely than not based on available tax planning strategies that could be implemented if necessary to prevent a carryforward from expiring. Our net deferred tax asset of $15.0 million is net of a valuation allowance of $56.6 million and consists of approximately $11.5 million of net U.S. federal deferred tax assets and $3.5 million of net state deferred tax assets. The major components of the deferred tax asset are $67.0 million in net operating loss carryforwards and built in losses and $11.5 million in net deductions which have not yet been taken on a tax return. We estimate that we would need to generate approximately $37.5 million of taxable income during the applicable carryforward periods to realize fully our federal and state net deferred tax assets. As a result of recent net losses, we are in a three-year cumulative pretax loss position at December 31, 2010. A cumulative loss position is considered significant negative evidence in assessing the realizability of a deferred tax asset. In determining the possible future realization of deferred tax assets, we have considered future taxable income from the following sources: (a) reversal of taxable temporary differences; and (b) tax planning strategies available to us in accordance with SFAS 109 (FASB ASC 740, “Income Taxes”) that, if necessary, would be implemented to accelerate taxable income into years in which net operating losses might otherwise expire. Our tax planning strategies include the prospective sale of certain assets such as finance receivables, residual interests in securitized finance receivables, charged off receivables and base servicing rights. The expected proceeds for such asset sales have been estimated based on our expectation of what buyers of the assets would consider to be reasonable assumptions for net cash flows and required rates of return for each of the various asset types. Our estimates for net cash flows and required rates of return are subjective and inherently subject to future events which may significantly impact actual net proceeds we may receive from executing our tax planning strategies. Nevertheless, we believe such asset sales can produce significant taxable income within the relevant carryforward period. Such strategies could be implemented without significant impact on our core business or our ability to generate future growth. The costs related to the implementation of these tax strategies were considered in evaluating the amount of taxable income that could be generated in order to realize our deferred tax assets. Based upon the tax planning opportunities and other factors discussed below, we have concluded that the U.S. and state net operating loss carryforward periods provide enough time to utilize the deferred tax assets pertaining to the existing net operating loss carryforwards and any net operating loss that would be created by the reversal of the future net deductions which have not yet been taken on a tax return. Although our core business has produced strong earnings in the past, even with intermittent loss periods resulting from economic cycles not unlike, although not as severe as, the current economic downturn we have not used expected future taxable income in our evaluation of the value of our net deferred tax asset. We have already taken steps to reduce our cost structure and have adjusted the contract interest rates and purchase prices applicable to our purchases of automobile contracts from dealers. We have been able to increase our acquisition fees and reduce our purchase prices because of lessened competition for our services. Our estimates of taxable income that may be derived from the implementation of our tax planning strategies is a forward-looking statement, and there can be no assurance that our estimates of such taxable income will be correct. Factors discussed under "Risk Factors," and in particular under the subheading "Risk Factors -- Forward-Looking Statements" may affect whether such projections prove to be correct. We recognize interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying consolidated statement of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheet. Uncertainty of Capital Markets and General Economic Conditions Historically, we have depended upon the availability of warehouse credit facilities and access to long-term financing through the issuance of asset-backed securities collateralized by our automobile contracts. Since 1994, we have completed 50 term securitizations of approximately $6.7 billion in contracts. We conducted four term securitizations in 2006, four in 2007, two 2008 and one in 2010. From July 2003 through April 2008 all of our securitizations were structured as secured financings. The second of our two securitization transactions in 2008 20 (completed in September 2008) and our most recent securitization in September 2010 (a re-securitization of the remaining receivables from the September 2008 transaction) were each in substance a sale of the related contracts, and have been treated as sales for financial accounting purposes. Since the fourth quarter of 2007 through the end of 2009, we observed unprecedented adverse changes in the market for securitized pools of automobile contracts. These changes included reduced liquidity, and reduced demand for asset-backed securities, particularly for securities carrying a financial guaranty and for securities backed by sub- prime automobile receivables. Moreover, many of the firms that previously provided financial guarantees, which were an integral part of our securitizations, suspended offering such guarantees. The adverse changes that took place in the market from the fourth quarter of 2007 through the end of 2009 caused us to conserve liquidity by significantly reducing our purchases of automobile contracts. However, since October 2009, we have gradually increased our contract purchases by utilizing one $50 million credit facility that we established in September 2009 and another $50 million term funding facility that we established in March 2010. In September 2010 we took advantage of improvement in the market for asset-backed securities by re-securitizing the remaining underlying receivables from our unrated September 2008 securitization. By doing so we were able to pay off the bonds associated with the September 2008 transaction and issue rated bonds with a significantly lower weighted average coupon. The September 2010 transaction was our first rated term securitization since 1993 that did not utilize a financial guaranty. More recently, we increased our short-term funding capacity by $200 million with the establishment of a new $100 million credit facility in December 2010 and an additional $100 million credit facility in February 2011. In addition, we expect to complete one or more term securitization transactions in 2011. In spite of the improvements we have seen in the capital markets, if the trend of improvement in the markets for asset- backed securities should reverse, or if we should be unable to obtain additional contract financing facilities or to complete a term securitization of our recently originated receivables, we may curtail or cease our purchases of new automobile contracts, which could lead to a material adverse effect on our operations. The downturn in economic conditions and the capital markets that began in the fourth quarter of 2007 has negatively affected many aspects of our industry. First, throughout 2008 and 2009 there was reduced demand for asset-backed securities secured by consumer finance receivables, including sub-prime automobile receivables, as compared to 2007 and earlier. During 2010, however, we observed that yield requirements for investors that purchase securities backed by consumer finance receivables, including sub-prime automobile receivables, have decreased significantly and are approaching pre-2008 levels, albeit with significantly fewer transactions in the market. Second, there have been fewer lenders who provide short term warehouse financing for sub-prime automobile finance companies due to more uncertainty regarding the prospects of obtaining long-term financing through the issuance of asset-backed securities than before 2008. Many capital market participants such as investment banks, financial guaranty providers and institutional investors who previously played a role in the sub-prime auto finance industry have withdrawn from the industry, or in some cases, have ceased to do business. These developments resulted in our incurring higher interest costs for receivables we financed in 2009 and 2010 compared to pre-2008 levels. However, on December 23, 2010 we entered into a $100 million two-year warehouse credit line with a significantly lower cost of funds than the facilities we used in 2009 and 2010. Finally, broad economic weakness and high levels of unemployment in 2008, 2009 and 2010 have made many of our customers less willing or able to pay, resulting in higher delinquency, charge-offs and losses. Each of these factors has adversely affected our results of operations. Should existing economic conditions worsen, both our ability to purchase new contracts and the performance of our existing managed portfolio may be impaired, which, in turn, could have a further material adverse effect on our results of operations. Financial Covenants Certain of our securitization transactions and our warehouse credit facilities contain various financial covenants requiring certain minimum financial ratios and results. Such covenants include maintaining minimum levels of liquidity and net worth and not exceeding maximum leverage levels and maximum financial losses. In addition, certain securitization and non-securitization related debt contain cross-default provisions that would allow certain creditors to declare a default if a default occurred under a different facility. The agreements under which we receive periodic fees for servicing automobile contracts in securitizations are terminable by the respective financial guaranty insurance companies (also referred to as note insurers) upon defined events of default, and, in some cases, at the will of the insurance company. In August 2010, we agreed with the note insurer for eight of our twelve currently outstanding securitizations to amend the applicable agreements to remove the financial covenants that were contained in three of the related agreements. In return for such amendments, we 21 agreed to increase the required credit enhancement amounts in those three deals through increased spread account requirements. The remaining five transactions insured by this particular note insurer do not contain financial covenants. For the remaining four securitizations insured by different parties, we have been receiving waivers for certain financial and operating covenants on a monthly and/or quarterly basis as summarized below: Financial covenant Applicable Standard Status Requiring Waiver (as of or for the quarter ended December 31, 2010) Warehouse financing capacity $200 million of warehouse capacity $150 million of warehouse capacity Adjusted net worth (I) $87.6 million Leverage Not greater than 4.5:1 Maximum net loss Adjusted net worth (II) $7.5 million $95.3 million $4.6 million 25.5:1 $33.8 million $4.6 million The covenant regarding warehouse financing capacity is a covenant to maintain one or more credit facilities that allow us to finance acquisition of automobile contracts on a revolving basis, with a minimum aggregate capacity of $200 million. The adjusted net worth covenants are covenants to maintain minimum levels of adjusted net worth, defined as our consolidated book value under GAAP with the exclusion of intangible assets such as goodwill. There are two separate adjusted net worth covenants because there are two separate note insurers that have this covenant in their related securitization agreements. The leverage covenant requires that we not exceed the specified ratio of debt over the defined adjusted net worth. Debt is defined in this covenant to mean consolidated liabilities less warehouse lines of credit and securitization trust debt; using this definition at December 31 2010, we had debt of $125.0 million. The maximum net loss covenant requires that we not exceed $7.5 million in net losses for any quarter or year. Without the waivers we have received from the related note insurers, we would have been in violation of covenants relating to minimum net worth, maximum financial losses, maximum leverage levels and maintenance of active warehouse facilities with respect to four of our 12 currently outstanding securitization transactions. Upon such an event of default, and subject to the right of the related note insurers to waive such terms, the agreements governing the securitizations call for payment of a default insurance premium, ranging from 25 to 100 basis points per annum on the aggregate outstanding balance of the related insured senior notes, and for the diversion of all excess cash generated by the assets of the respective securitization pools into the related spread accounts to increase the credit enhancement associated with those transactions. The cash so diverted into the spread accounts would otherwise be used to make principal payments on the subordinated notes in each related securitization or would be released to us. As of the date of this report, cash is being diverted to the related spread accounts in seven transactions. In addition, upon an event of default, the note insurers have the right to terminate us as servicer. Although our termination as servicer has been waived, we are paying default premiums, or their equivalent, with respect to insured notes representing $347.0 million of the $567.7 million of securitization trust debt outstanding at December 31, 2010. It should be noted that the principal amount of such securitization trust debt is not increased, but that the increased insurance premium is reflected as increased interest expense. Furthermore, such waivers are temporary, and there can be no assurance as to their future extension. We do, however, believe that we will obtain such future extensions of our servicing agreements because it is generally not in the interest of any party to the securitization transaction to transfer servicing. Nevertheless, there can be no assurance as to our belief being correct. Were an insurance company in the future to exercise its option to terminate such agreements or to pursue other remedies, such remedies could have a material adverse effect on our liquidity and results of operations, depending on the number and value of the affected transactions. Our note insurers continue to extend our term as servicer on a monthly and/or quarterly basis, pursuant to the servicing agreements. 22 Results of Operations Comparison of Operating Results for the Year Ended December 31, 2010 with the Year Ended December 31, 2009 Revenues. During the year ended December 31, 2010, revenues were $155.2 million, a decrease of $68.7 million, or 30.7%, from the prior year revenue of $223.9 million. The primary reason for the decrease in revenues is a decrease in interest income. Interest income for the year ended December 31, 2010 decreased $71.1 million, or 34.2%, to $137.1 million from $208.2 million in the prior year. The primary reason for the decrease in interest income is the decrease in finance receivables held by consolidated subsidiaries. At December 31, 2010 the aggregate outstanding balance of finance receivables held by consolidated subsidiaries was $597.1 million compared to $922.7 million at December 31, 2009, resulting in a decrease of $70.9 million in interest income. We also experienced a decrease in interest income on our residual interest in securitizations of $348,000, which was partially offset by an increase in interest earned on cash deposits (including restricted cash deposits) of $86,000. Servicing fees totaling $7.7 million in the year ended December 31, 2010 increased $3.0 million, or 65.0%, from $5.0 million in the prior year. The increase in servicing fees is the result our appointment in November 2009 as a third-party servicer for a portfolio of sub-prime automobile receivables owned by a subsidiary of CompuCredit Corporation. As of December 31, 2010 and 2009, our managed portfolio owned by consolidated vs. non- consolidated subsidiaries and third parties was as follows: December 31, 2010 December 31, 2009 Amount % Amount % Total Managed Portfolio Owned by Consolidated Subsidiaries……..……$ Owned by Non-Consolidated Subsidiaries……$ Third-Party Servicing Portfolios $ Total……………………………….……………$ 597.1 84.0 75.1 756.2 ($ in millions) 79.0% $ 11.1% 9.9% 100.0% $ 922.7 134.9 137.1 1,194.7 77.2% 11.3% 11.5% 100.0% At December 31, 2010, we were generating income and fees on a managed portfolio with an outstanding principal balance of $756.2 million compared to a managed portfolio with an outstanding principal balance of $1,194.7 million as of December 31, 2009. At December 31, 2010 and 2009, the managed portfolio composition was as follows: December 31, 2010 December 31, 2009 Amount % Amount % Originating Entity CPS……………………………………….……$ TFC………………………………..……………$ Third-Party Servicing Portfolios $ Total………………………………….…………$ 672.2 8.9 75.1 756.2 ($ in millions) 88.9% $ 1.2% 9.9% 100.0% $ 1,034.2 23.4 137.1 1,194.7 86.6% 2.0% 11.5% 100.0% Other income decreased $620,000, or 5.6%, to $10.4 million in the year ended December 31, 2010 from $11.1 million during the prior year. The year-over-year decrease is the result of a variety of factors including a decrease of $1.6 million in convenience fees charged to our customers for web-based and other electronic payments and a decrease of $617,000 in income from direct mail and related products and services that we offer to our dealers. The decreases were offset by an increase of $2.4 million in sales tax refunds. Expenses. Our operating expenses consist primarily of provisions for credit losses, interest expense, employee costs and general and administrative expenses. Provisions for credit losses and interest expense are significantly affected by the volume of automobile contracts we purchased during a period and by the outstanding balance of finance receivables held by consolidated subsidiaries. Employee costs and general and administrative expenses are incurred as applications and automobile contracts are received, processed and serviced. Factors that affect margins and net income include changes in the automobile and automobile finance market environments, and macroeconomic factors such as interest rates and the unemployment level. Employee 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 one of our most significant operating 23 expenses. These costs (other than those relating to stock options) generally fluctuate with the level of applications and automobile contracts processed and serviced. Other operating expenses consist primarily of facilities expenses, telephone and other communication services, credit services, computer services, marketing and advertising expenses, and depreciation and amortization. Total operating expenses were $172.0 million for the year ended December 31, 2010, compared to $273.3 million for the prior year, a decrease of $101.3 million, or 37.1%. The decrease is primarily due to decreases in provision for credit losses and interest expense, which decreased by $62.1 million and $29.5 million, or 67.5% and 26.4%, respectively. Employee costs decreased by 9.4% to $33.8 million during the year ended December 31, 2010, representing 19.7% of total operating expenses, from $37.3 million for the prior year, or 13.7% of total operating expenses. The decrease in employee costs is due to the reduction in our workforce, primarily in the areas related to contract servicing throughout both 2010 and 2009 as a result of the reduction in our managed portfolio over those periods. As of December 31, 2010 we had 435 employees, compared to 523 employees at December 31, 2009. General and administrative expenses decreased by 23.7% to $18.5 million and represented 10.7% of total operating expenses in the year ending December 31, 2010, as compared to the prior year when such expenses represented 8.9% of total operating expenses. General and administrative expenses include telecommunications costs, postage and delivery costs and other costs associated with servicing our managed portfolio. Provision for credit losses was $29.9 million for the year ended December 31, 2010, a decrease of $62.1 million, or 67.5%, compared to the prior year and represented 17.4% of total operating expenses. The provision for credit losses maintains the allowance for loan losses at levels that we feel are adequate for the probable credit losses that can be reasonably estimated. The decrease in provision expense compared to the prior year is caused by the decrease in the size and continued aging of our portfolio of finance receivables. Interest expense for the year ended December 31, 2010 decreased $29.5 million, or 26.4%, to $82.2 million, compared to $111.8 million in the previous year. The decrease is primarily the result of the decline in our portfolio owned by consolidated subsidiaries. Interest on securitization trust debt decreased by $34.2 million in 2010 compared to the prior year. Interest expense on our residual interest financing also decreased by $1.5 million as the balance outstanding has dropped from $56.9 million at the end of 2009 to $39.4 million at then end of 2010 . Decreases in interest expense for securitization debt and residual interest debt were partially offset by an increase of $5.0 million in interest expense for warehouse debt and $1.2 million on senior secured debt. In November 2009 we issued $5 million in new senior secured debt. Marketing expenses consist primarily of commission-based compensation paid to our employee marketing representatives. These expenses increased by $44,000, or 1.2%, to $3.8 million, compared to $3.8 million in the previous year and represented 2.2% of total operating expenses. Although we purchased 7,507 contracts in 2010 compared to 595 in 2009, the increase in volume was offset by changes in the compensation rates for our marketing representatives. Occupancy expenses decreased by $457,000 or 13.0%, to $3.1 million compared to $3.5 million in the previous year and represented 1.8% of total operating expenses. The reduction in occupancy expense is primarily attributable to the amendment in July 2009 of the lease for our Irvine headquarters to reduce our square footage from approximately 90,000 to approximately 60,000 square feet. Depreciation and amortization expenses decreased by $58,000, or 8.2%, to $649,000 from $707,000 in the previous year. For the year ended December 31, 2010, we recorded a tax benefit of $6.1 million resulting from operating losses and an additional $4.9 million resulting from changes in state tax rates. The benefit was offset by an increase of $28.0 to our valuation allowance for deferred taxes. For the year ended December 31, 2009, we recorded a tax benefit of $19.2 million. The benefit was offset by an increase of $27.0 to our valuation allowance for deferred taxes. 24 Liquidity and Capital Resources Liquidity Our business requires substantial cash to support purchases of automobile contracts and other operating activities. Our primary sources of cash have been cash flows from operating activities, including proceeds from term securitization transactions and other sales of automobile contracts, amounts borrowed under warehouse credit facilities, servicing fees on portfolios of automobile contracts previously sold in securitization transactions or serviced for third parties, customer payments of principal and interest on finance receivables, fees for origination of automobile contracts, and releases of cash from securitized portfolios of automobile contracts in which we have retained a residual ownership interest and from the spread accounts associated with such pools. Our primary uses of cash have been the purchases of automobile contracts, repayment of amounts borrowed under warehouse credit facilities 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 our cash demands. The sufficiency of internally generated cash will depend on the performance of securitized pools (which determines the level of releases from those portfolios and their related spread accounts), the rate of expansion or contraction in our managed portfolio, and the terms upon which we are able to purchase, sell, and borrow against automobile contracts. Net cash provided by operating activities for the years ended December 31, 2010 and 2009 was $38.1 million and $74.5 million, respectively. Net cash provided by investing activities for the year ended December 31, 2010 was $272.9 million compared to $443.7 million in 2009. Cash provided by investing activities primarily results from principal payments and other proceeds received on finance receivables held for investment. Cash used in investing activities generally relates to purchases of automobile contracts. Purchases of finance receivables held for investment were $113.3 million and $8.6 million in 2010 and 2009, respectively. The significant increase in contract purchases in 2010 was made possible by the establishment of a $50 million secured revolving credit facility in September 2009 and a $50 million term funding facility in March 2010. Net cash used by financing activities for the year ended December 31, 2010 was $307.2 million compared with $527.8 million in 2009. Cash used or provided by financing activities is primarily attributable to the issuance or repayment of debt, and in particular, securitization trust debt. We issued $42.5 million in new securitization trust debt in 2010 in conjunction with the $50 million term funding facility. We did not issue any new securitization trust debt in 2009. Repayments of securitization debt were $385.2 million and $511.0 million in 2010 and 2009, respectively. We purchase automobile contracts from dealers for a cash price approximating their principal amount, adjusted for an acquisition fee which may either increase or decrease the automobile contract purchase price. Those automobile contracts generate cash flow, however, over a period of years. As a result, we have been dependent on warehouse credit facilities to purchase automobile contracts, and on the availability of cash from outside sources in order to finance our continuing operations, as well as to fund the portion of automobile contract purchase prices not financed under revolving warehouse credit facilities. On September 25, 2009 we established a $50 million secured revolving credit facility with Fortress Credit Corp., which will mature on September 25, 2011. The facility is structured to allow us to fund a portion of the purchase price of automobile contracts by drawing against a floating rate variable funding note issued by our consolidated subsidiary Page Four Funding LLC. The facility provides for advances up to 75% of eligible finance receivables and the notes under it accrue interest at a rate of one-month LIBOR plus 12.00% per annum, with a minimum rate of 14.00% per annum. At December 31, 2010, $45.6 million was outstanding under this facility. As part of the consideration given to Fortress for committing to make loans under this facility, we issued a 10-year warrant to purchase up to 1,158,087 of our common shares, at an exercise price of $0.879 per share (we refer to this as the Fortress Warrant). Issuance of the Fortress Warrant required an adjustment to the terms of an existing outstanding warrant regarding 1,564,324 shares, reducing the exercise price of that other warrant from $1.44 per share to $1.40702 per share and increasing the number of shares available for purchase to 1,600,991. In December 2010 we entered into a $100 million two-year warehouse credit line with affiliates of Goldman, Sachs & Co. and Fortress Investment Group. The facility is structured to allow us to fund a portion of the purchase price of automobile contracts by drawing against a floating rate variable funding note issued by our consolidated subsidiary Page Six Funding, LLC. The facility provides for advances up to 75% of eligible finance receivables and 25 the notes under it accrue interest at a rate of one-month LIBOR plus 5.00% per annum, with a minimum rate of 6.5% per annum. There were no amounts outstanding under this facility at December 31, 2010. Subsequent to the reporting period covered by this report, on February 24, 2011, we entered into an additional $100 million two-year warehouse credit line with UBS Real Estate Securities, Inc. The facility revolves during the first year and amortizes during the second year. The facility is structured to allow us to fund a portion of the purchase price of automobile contracts by drawing against a floating rate variable funding note issued by our consolidated subsidiary Page Seven Funding, LLC. The facility provides for advances up to 76.5% of eligible finance receivables and the notes under it accrue interest at one-month LIBOR plus 6.00% per annum. In March 2010, we entered into a $50 million term funding facility with a syndicate of note purchasers including affiliates of Angelo, Gordon & Co., L.P. and an affiliate of Cohen & Company Securities. Under the term funding facility, the note purchasers agreed to purchase up to $50 million in asset-backed notes through December 31, 2010, subject to collateral eligibility and other terms and conditions, through the end of 2010. Amounts outstanding bear interest at a fixed rate of 11.00%, which may be decreased to 9.00% should the notes receive investment grade ratings from at least two of the following three credit rating agencies: Moody's, Standard & Poor's, or Fitch. Principal payments on the notes are due as the underlying receivables are paid or charged off, and the final maturity is July 17, 2017. In connection with the establishment of this term funding facility, we paid a closing fee of $750,000 and issued to certain of the note purchasers or their designees warrants to purchase 500,000 shares of our common stock at an exercise price of $1.41 per share (we refer to this as the Page Five Warrant). Issuance of the Page Five Warrant required adjustments to the terms of two existing outstanding warrants. The first warrant related to 1,600,991 shares, on which the exercise price was decreased from $1.407 per share to $1.398 per share and the number of shares available for purchase was increased to 1,611,114. The second affected warrant related to 283,985 shares, which was increased to 285,781 shares. As of December 31, 2010, there was $42.5 million outstanding under the facility and no additional advances are expected to be made. In July 2007, we established a combination term and revolving residual credit facility and have used eligible residual interests in securitizations as collateral for floating rate borrowings. The amount that we were able to borrow was computed using an agreed valuation methodology of the residuals, subject to an overall maximum principal amount of $120 million, represented by (i) a $60 million Class A-1 variable funding note (the “revolving note”), and (ii) a $60 million Class A-2 term note (the “term note”). The term note was fully drawn in July 2007 and was originally due in July 2009. As of July 2008, we had drawn $26.8 million on the revolving note. The facility’s revolving feature expired in July 2008. On July 10, 2008 we amended the terms of the combination term and revolving residual credit facility, (i) eliminating the revolving feature and increasing the interest rate, (ii) consolidating the amounts then owing on the Class A-1 note with the Class A-2 note, (iii) establishing an amortization schedule for principal reductions on the Class A-2 note, and (iv) providing for an extension, at our option if certain conditions were met, of the Class A-2 note maturity from June 2009 to June 2010. In June 2009 we met all such conditions and extended the maturity. In conjunction with the amendment, we reduced the principal amount outstanding to $70 million by delivering to the lender (i) warrants valued as being equivalent to 2,500,000 common shares, or $4,071,429, and (ii) cash of $12,765,244. The warrants represent the right to purchase 2,500,000 CPS common shares at a nominal exercise price, at any time prior to July 10, 2018. In May 2010, we extended the maturity date from June 2010 to May 2011. As of December 31, 2010 the aggregate indebtedness under this facility was $39.4 million. On June 30, 2008, we entered into a series of agreements pursuant to which an affiliate of Levine Leichtman Capital Partners purchased a $10 million five-year, fixed rate, senior secured note from us. The indebtedness is secured by substantially all of our assets, though not by the assets of our special-purpose financing subsidiaries. In July 2008, in conjunction with the amendment of the combination term and revolving residual credit facility as discussed above, the lender purchased an additional $15 million note with substantially the same terms as the $10 million note. Pursuant to the June 30, 2008 securities purchase agreement, we issued to the lender 1,225,000 shares of common stock. In addition, we issued the lender two warrants: (i) warrants that we refer to as the FMV Warrants, which are exercisable for 1,611,114 shares of our common stock, at an exercise price of $1.39818 per share, and (ii) warrants that we refer to as the N Warrants, which are exercisable for 285,781 shares of our common stock, at a nominal exercise price. Both the FMV Warrants and the N Warrants are exercisable in whole or in part and at any time up to and including June 30, 2018. We valued the warrants using the Black-Scholes valuation model and recorded their value as a liability on our balance sheet because the terms of the warrants also included a provision whereby the lender could require us to purchase the warrants for cash. That provision was eliminated by mutual agreement in September 2008. The FMV Warrants were initially exercisable to purchase 1,500,000 shares for $2.573 per share, were adjusted in connection with the July 2008 issuance of other warrants to become 26 exercisable to purchase 1,564,324 shares at $2.4672 per share, and were further adjusted in connection with a July 2009 amendment of our option plan to become exercisable at $1.44 per share. Upon issuance in September 2009 of the Fortress Warrant, the FMV Warrant was further adjusted to become exercisable to purchase 1,600,991 shares at an exercise price of $1.407 per share. Upon issuance in March 2010 of the Page Five Warrant, the FMV Warrant was further adjusted to become exercisable to purchase 1,611,114 shares at an exercise price of $1.39818 per share. In November 2009 we entered into an additional agreement with this lender whereby they purchased an additional $5 million note. The note accrued interest at 15.0% and was repaid in December 2010 at which time the lender purchased a new $27.8 million note under substantially the same terms as the $10 million and $15 million notes already outstanding. The $27.8 million note accrues interest at 16.0% and matures in December 2013. Concurrent with the issuance of the $27.8 million note, the term $10 and $15 million notes were amended to change their maturity dates to December 2013. In conjunction with the issuance of the $27.8 million note, we issued to the lender 880,000 shares of common stock and 1,870 shares of Series B convertible preferred stock. Each share of the Series B convertible preferred stock may become exchangeable for 1,000 shares of our common stock, upon shareholder approval of such exchange, but not without shareholder approval. At the time of issuance, the value of the common stock and Series B preferred stock was $753,000 and $1.6 million, respectively. The acquisition of automobile 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 our automobile contract purchases, the required level of initial credit enhancement in securitizations, and the extent to which the previously established trusts and their related spread accounts either release cash to us or capture cash from collections on securitized automobile contracts. Of those, the factor most subject to our control is the rate at which we purchase automobile contracts. We are and may in the future be limited in our ability to purchase automobile contracts due to limits on our capital. As of December 31, 2010, we had unrestricted cash of $16.3 million. We had $4.4 million available under our Fortress facility and $100 million available under the Goldman facility (in both facilities advances are subject to available eligible collateral). As stated above, we established a second $100 million revolving credit facility in February 2011. In September 2010 we completed a securitization of previously securitized receivables, and we intend to complete securitizations regularly beginning in 2011, although there can be no assurance that we will be able to so. Our plans to manage our liquidity include maintaining our rate of automobile contract purchases at a level that matches our available capital, and, wherever appropriate, reducing our operating costs. If we are unable to complete such securitizations, we may be unable to increase our rate of automobile contract purchases, in which case our interest income and other portfolio related income would decrease. Our liquidity will also be affected by releases of cash from the trusts established with our securitizations. While the specific terms and mechanics of each spread account vary among transactions, our securitization agreements generally provide that we will receive excess cash flows, if any, only if the amount of credit enhancement has reached specified levels and/or the delinquency, defaults or net losses related to the automobile contracts in the pool are below certain predetermined levels. In the event delinquencies, defaults or net losses on the automobile 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 us of excess cash flows associated with other pools; or (iii) in certain circumstances, may permit the insurers to require the transfer of servicing on some or all of the automobile contracts to another servicer. There can be no assurance that collections from the related trusts will continue to generate sufficient cash. Moreover, most of our spread account balances are pledged as collateral to our residual interest financing. As such, most of the current releases of cash from our securitization trusts are directed to pay the obligations of our residual interest financing. Certain of our securitization transactions, our warehouse credit facilities and our residual interest financing contain various financial covenants requiring certain minimum financial ratios and results. Such covenants include maintaining minimum levels of liquidity and net worth and not exceeding maximum leverage levels and maximum financial losses. In addition, certain securitization and non-securitization related debt contain cross-default provisions that would allow certain creditors to declare a default if a default occurred under a different facility. The agreements under which we receive periodic fees for servicing automobile contracts in securitizations are terminable by the respective insurance companies upon defined events of default, and, in some cases, at the will of the insurance company. We have received waivers regarding the potential breach of certain such covenants relating to minimum net worth, financial loss in any one period and maintenance of active warehouse credit facilities. Without such waivers, certain credit enhancement providers would have had the right to terminate us as servicer 27 with respect to certain of our outstanding securitization pools. Although such rights have been waived, such waivers are temporary, and there can be no assurance as to their future extension. We do, however, believe that we will obtain such future extensions because it is generally not in the interest of any party to the securitization transaction to transfer servicing. Nevertheless, there can be no assurance as to our belief being correct. Were an insurance company in the future to exercise its option to terminate such agreements, such a termination could have a material adverse effect on our liquidity and results of operations, depending on the number and value of the terminated agreements. Our note insurers continue to extend our term as servicer on a monthly and/or quarterly basis, pursuant to the servicing agreements. The agreements for our residual interest financing, revolving credit facility and term funding facility include financial covenants which, if breached, would be an event of default. We have entered into an amendment that avoided the potential breach of a minimum net worth covenant on the revolving credit facility. Without such amendment, the lender could have, among other things, ceased providing funding to us for new contract purchases, terminated us as servicer of the pledged receivables and sold the pledged contracts to satisfy the debt. Our plan for future operations and meeting the obligations of our financing arrangements includes returning to profitability by gradually increasing the amount of our contract purchases with the goal of increasing the balance of our outstanding managed portfolio. Our plans also include financing future contract purchases with credit facilities and term securitizations that offer a lower overall cost of funds compared to the facilities we used in 2009 and 2010. To illustrate, in the last six months of 2009 we purchased $6.1 million in contracts and our sole credit facility had a minimum interest rate of 14.00% per annum. By comparison, in 2010, we purchased $113.0 million in contracts and, in March 2010, entered into the $50 million term funding facility which has an interest rate of 11.00% per annum and the ability to decrease such rate to 9.00% per annum if certain conditions are met. In December 2010 we entered into a $100 million credit facility with an interest rate of one-month LIBOR plus 5.00% per annum, with a minimum rate of 6.5% per annum, and in February 2011 we added another $100 million credit facility with an interest rate of one-month LIBOR plus 6.00% per annum. Moreover, the weighted average effective coupon of our September 2010 term securitization was 3.21% and did not include a financial guaranty policy. This transaction demonstrates our ability to access the lower cost of funds available in the current market environment without the financial guaranties we historically incorporated into our term securitization structures. We expect to complete one or more term securitizations in 2011. In addition, less competition in the auto financing marketplace has resulted in better terms for our recent contract purchases compared to prior years. For the years ended December 31, 2010, 2009 and 2008, the average acquisition fee we charged per automobile contract purchased under our CPS programs was $1,382, $1,508 and $592, respectively, or 9.2%, 11.7%, and 3.9%, respectively, of the amount financed. Similarly, the weighted average annual percentage rate of interest payable by our customers on newly purchased contracts has increased significantly: to 20.05% for 2010 from 19.9%, and 18.5% in 2009 and 2008, respectively. We have and will continue to have a substantial amount of indebtedness. At December 31, 2010, we had approximately $717.9 million of debt outstanding. Such debt consisted primarily of $567.7 million of securitization trust debt, and also included $45.6 million of a warehouse line of credit, $39.4 million of residual interest financing, $44.9 million of senior secured related party debt and $20.3 million in subordinated notes. We are also currently offering the subordinated notes to the public on a continuous basis, and such notes have maturities that range from three months to 10 years. The residual interest financing facility matures in May 2011 and we are in discussions with the lender regarding the extension or restructuring of the facility, as to which there can be no assurance. Our recent operating results include net losses of $33.8 million and $57.2 million in 2010 and 2009, respectively. We believe that our results have been materially and adversely affected by the disruption in the capital markets that began in the fourth quarter of 2007, by the recession that began in December 2007, and by related high levels of unemployment. Our ability to repay or refinance maturing debt may be adversely affected by prospective lenders’ consideration of our recent operating losses. Although we believe we are able to service and repay our debt, there is no assurance that we will be able to do so. If our plans for future operations do not generate sufficient cash flows and operating profits, our ability to make required payments on our debt would be impaired. Failure to pay our indebtedness when due could have a material adverse effect and may require us to issue additional debt or equity securities. 28 Contractual Obligations The following table summarizes our material contractual obligations as of December 31, 2010 (dollars in thousands): Payment Due by Period (1) Total Less than 1 Year 1 to 3 Years 4 to 5 Years More than 5 Years Long Term Debt (2)…………..……….. $ 104,650 Operating Leases……………………………$ 13,520 $ $ 50,948 3,185 $ $ 53,400 5,195 $ $ 256 3,789 $ $ 46 1,351 (1) Securitization trust debt, in the aggregate amount of $567.7 million as of December 31, 2010, is omitted from this table because it becomes due as and when the related receivables balance is reduced by payments and charge-offs. Expected payments, which will depend on the performance of such receivables, as to which there can be no assurance, are $283.5 million in 2011, $191.2 million in 2012, $59.3million in 2013, $17.2 million in 2014 and $16.5 million in 2015. (2) Long-term debt includes residual interest debt, senior secured debt and subordinated renewable notes. Warehouse Credit Facilities The terms on which credit has been available to us for purchase of automobile contracts have varied in recent years, as shown in the following summary of our warehouse credit facilities: Facility Established in September 2009. On September 25, 2009 we established a $50 million secured revolving credit facility with Fortress Credit Corp. that will mature on September 25, 2011. The facility is structured to allow us to fund a portion of the purchase price of automobile contracts by drawing against a floating rate variable funding note issued by our consolidated subsidiary Page Four Funding LLC. The facility provides for advances up to 75% of eligible finance receivables and the notes under it accrue interest at a rate of one-month LIBOR plus 12.00% per annum, with a minimum rate of 14.00% per annum. At December 31, 2010, $45.6 million was outstanding under this facility. Facility Established in December 2010. On December 23, 2010 we entered into a $100 million two-year warehouse credit line with affiliates of Goldman, Sachs & Co. and Fortress Investment Group. The facility is structured to allow us to fund a portion of the purchase price of automobile contracts by drawing against a floating rate variable funding note issued by our consolidated subsidiary Page Six Funding, LLC. The facility provides for advances up to 75% of eligible finance receivables and the notes under it accrue interest at a rate of one-month LIBOR plus 5.00% per annum, with a minimum rate of 6.5% per annum. There were no amounts outstanding under this facility at December 31, 2010. Facility Established in February 2011. On February 24, 2011 we entered into a $100 million two-year warehouse credit line with affiliates of UBS AG. The facility is structured to allow us to fund a portion of the purchase price of automobile contracts by drawing against a floating rate variable funding note issued by our consolidated subsidiary Page Seven Funding, LLC. The facility provides for advances up to 76.5% of eligible finance receivables and the notes under it accrue interest at a rate of one-month LIBOR plus 6.00% per annum. There were no amounts outstanding under this facility at December 31, 2010, as it had not yet been established. Capital Resources Securitization trust debt is repaid from collections on the related receivables, and becomes due in accordance with its terms as the principal amount of the related receivables is reduced. Although the securitization trust debt also has alternative final maturity dates, those dates are significantly later than the dates at which repayment of the related receivables is anticipated, and at no time in our history have any of our sponsored asset-backed securities reached those alternative final maturities. The acquisition of automobile contracts for subsequent transfer 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 our automobile contract purchases, the required level of initial credit enhancement in securitizations, and the extent to which the trusts and related spread accounts either release cash to us or capture cash from collections on securitized automobile contracts. We plan to adjust our levels of automobile contract purchases and the related capital requirements to match anticipated releases of cash from the trusts and related spread accounts. 29 Capitalization Over the period from January 1, 2009 through December 31, 2010 we have managed our capitalization by issuing and refinancing debt as summarized in the following table: RESIDUAL INTEREST FINANCING: Beginning balance…………………..…………………..…… $ Issuances…………………………………..……………… Payments…………………………………..……………… Ending balance………………………………...…………… $ SECURITIZATION TRUST DEBT: Beginning balance…………………..…………………..…… $ Issuances…………………………………..……………… Payments…………………………………..……………… Ending balance………………………………...…………… $ SENIOR SECURED DEBT, RELATED PARTY: Beginning balance…………………..…………………..…… $ Issuances…………………………………..……………… Payments…………………………………..……………… Debt discount net of amortization………...……………… Ending balance……………………………...……………… $ SUBORDINATED RENEWABLE NOTES: Beginning balance…………………..…………………..…… $ Issuances…………………………………..……………… Payments…………………………………..……………… Ending balance………………………………...…………… $ Year Ended December 31, 2010 2009 (Dollars in thousands) 56,930  (17,490) 39,440 904,833 42,465 (379,576) 567,722 26,118 27,750 (5,000) (3,995) 44,873 21,965 2,685 (4,313) 20,337 $ $ $ $ $ $ $ $ 67,300  (10,370) 56,930 1,404,211  (499,378) 904,833 20,105 5,000  1,013 26,118 25,721 2,424 (6,180) 21,965 Residual Interest Financing. In July 2007, we established a combination term and revolving residual credit facility and have used eligible residual interests in securitizations as collateral for floating rate borrowings. The amount that we were able to borrow was computed using an agreed valuation methodology of the residuals, subject to an overall maximum principal amount of $120 million, represented by (i) a $60 million Class A-1 variable funding note (the “revolving note”), and (ii) a $60 million Class A-2 term note (the “term note”). The term note was fully drawn in July 2007 and was originally due in July 2009. As of July 2008, we had drawn $26.8 million on the revolving note. The facility’s revolving feature expired in July 2008. On July 10, 2008 we amended the terms of the combination term and revolving residual credit facility, (i) eliminating the revolving feature and increasing the interest rate, (ii) consolidating the amounts then owing on the Class A-1 note with the Class A-2 note, (iii) establishing an amortization schedule for principal reductions on the Class A-2 note, and (iv) providing for an extension, at our option if certain conditions were met, of the Class A-2 note maturity from June 2009 to June 2010. In June 2009 we met all such conditions and extended the maturity. In conjunction with the amendment, we reduced the principal amount outstanding to $70 million by delivering to the lender (i) warrants valued as being equivalent to 2,500,000 common shares, or $4,071,429, and (ii) cash of $12,765,244. The warrants represent the right to purchase 2,500,000 CPS common shares at a nominal exercise price, at any time prior to July 10, 2018. In May 2010, we extended the maturity date from June 2010 to May 2011. As of December 31, 2010 the aggregate indebtedness under this facility was $39.4 million. Securitization Trust Debt. From July 2003 through April 2008, we have, for financial accounting purposes, treated securitizations of automobile contracts as secured financings, and the asset-backed securities issued in such securitizations remain on our balance sheet as securitization trust debt. Our two most recent securitizations, in September 2008 and the re-securitization of the remaining receivables from such transaction in September 2010, were each structured as a sale for financial accounting purposes and the asset-backed securities issued in those transactions have not been and are not on our balance sheet. 30 Senior Secured Debt. From 1998 to 2005, we entered into a series of financing transactions with Levine Leichtman Capital Partners II, L.P. In July 2007 we repaid the final amounts due under these financing transactions. On June 30, 2008, we entered into a series of agreements pursuant to which a different but related lender Levine Leichtman Capital Partners IV, L.P., purchased a $10 million five-year, fixed rate, senior secured note from us. The indebtedness is secured by substantially all of our assets, though not by the assets of our special-purpose financing subsidiaries. In July 2008, in conjunction with the amendment of the combination term and revolving residual credit facility as discussed above, the lender purchased an additional $15 million note with substantially the same terms as the $10 million note. Pursuant to the June 30, 2008 securities purchase agreement, we issued to the lender 1,225,000 shares of common stock. In addition, we issued the lender two warrants: (i) warrants that we refer to as the FMV Warrants, which are exercisable for 1,611,114 shares of our common stock, at an exercise price of $1.39818 per share, and (ii) warrants that we refer to as the N Warrants, which are exercisable for 285,781 shares of our common stock, at a nominal exercise price. Both the FMV Warrants and the N Warrants are exercisable in whole or in part and at any time up to and including June 30, 2018. We valued the warrants using the Black-Scholes valuation model and recorded their value as a liability on our balance sheet because the terms of the warrants also included a provision whereby the lender could require us to purchase the warrants for cash. That provision was eliminated by mutual agreement in September 2008. The FMV Warrants were initially exercisable to purchase 1,500,000 shares for $2.573 per share, were adjusted in connection with the July 2008 issuance of other warrants to become exercisable to purchase 1,564,324 shares at $2.4672 per share, and were further adjusted in connection with a July 2009 amendment of our option plan to become exercisable at $1.44 per share. Upon issuance in September 2009 of the Fortress Warrant, the FMV Warrant was further adjusted to become exercisable to purchase 1,600,991 shares at an exercise price of $1.407 per share. Upon issuance in March 2010 of the Page Five Warrant, the FMV Warrant was further adjusted to become exercisable to purchase 1,611,114 shares at an exercise price of $1.39818 per share. In November 2009 we entered into an additional agreement with this lender under which they purchased an additional $5 million note. The note accrued interest at 15.0% and was repaid in December 2010, at which time the lender purchased a new $27.8 million note under substantially the same terms as the $10 million and $15 million notes already outstanding. The $27.8 million note accrues interest at 16.0% and matures in December 2013. Concurrent with the issuance of the $27.8 million note, the term of the $10 and $15 million notes were amended to change their maturity dates to December 2013. In conjunction with the issuance of the $27.8 million note, we issued to the lender 880,000 shares of common stock and 1,870 shares of Series B convertible preferred stock. Each share of the Series B convertible preferred stock may become exchangeable for 1,000 shares of our common stock, upon shareholder approval of such exchange, but not without shareholder approval. At the time of issuance, the value of the common stock and Series B preferred stock was $753,000 and $1.6 million, respectively. Subordinated Renewable Notes Debt. In June 2005, we began issuing registered subordinated renewable notes in an ongoing offering to the public. Upon maturity, the notes are automatically renewed for the same term as the maturing notes, unless we elect not to have the notes renewed or unless the investor notifies us within 15 days after the maturity date for his notes that he wants his notes repaid. Renewed notes bear interest at the rate we are offering at that time to other investors with similar note maturities. Based on the terms of the individual notes, interest payments may be required monthly, quarterly, annually or upon maturity. In July 2010, we discovered that, under a rule of the SEC, we were no longer permitted to offer and sell our subordinated renewable notes in reliance on the registration statement (the “Former Registration Statement”) that we initially filed in January 2005. Consequently, purchasers who acquired such notes between January 1, 2010 and December 13, 2010 (the effective date of a new registration statement that we then filed to register such sales) may have had at December 31, 2010, a statutory right to rescind their purchases. At any time, such potential rescission right may relate to any such notes sold (i) within the one-year period immediately preceding, and (ii) prior to the December 13, 2010 effectiveness of the new registration statement. As a result of such sales, we could be required to repurchase some or all of such notes at the original sale price plus statutory interest, less the amount of any income received by the purchasers. From January 1, 2010 to December 13, 2010, we sold a total of $11.3 million of notes, including renewals of previously sold notes, but excluding notes that we repaid. We have not received any indication that any purchaser of such notes intends to seek rescission. We must comply with certain affirmative and negative covenants related to debt facilities, which require, among other things, that we maintain certain financial ratios related to liquidity, net worth, capitalization, investments, acquisitions, restricted payments and certain dividend restrictions. In addition, certain securitization and non- securitization related debt contain cross-default provisions that would allow certain creditors to declare default if a default occurred under a different facility. We have received waivers regarding the potential breach of financial covenants for our residual financing facility and certain of our securitization debt structures. 31 Forward-looking Statements This report on Form 10-K includes certain "forward-looking statements". Forward-looking statements may be identified by the use of words such as "anticipates," "expects," "plans," "estimates," or words of like meaning. 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 our ability 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 our revenues in the current year include the levels of cash releases from existing pools of contracts, which would affect our ability to purchase contracts, the terms on which we are able to finance such purchases, the willingness of dealers to sell contracts to us on the terms that it offers, and the terms on which we are able to complete term securitizations once contracts are acquired. Factors that could affect our expenses in the current year include competitive conditions in the market for qualified personnel, investor demand for asset-backed securities and interest rates (which affect the rates that we pay on asset- backed securities issued in our securitizations). The statements concerning structuring securitization transactions as secured financings and the effects of such structures on financial items and on future profitability also are forward- looking statements. Any change to the structure of our securitization transaction could cause such forward-looking statements not to be accurate. Both the amount of the effect of the change in structure on our profitability and the duration of the period in which our 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 we purchase and sell 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 our profitability. New Accounting Pronouncements In June 2009, the FASB issued ASU 2009-17, Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities (FAS 167, Amendments to FASB Interpretation No. 46(R)). This standard amends several key consolidation provisions related to variable interest entity (“VIE”), which are included in FASB ASC 810, Consolidation to require a company to analyze whether its interest in a VIE gives it a controlling financial interest. A company must assess whether it has an implicit financial responsibility to ensure that the VIE operates as designed when determining whether it has the power to direct the activities of the VIE that significantly impact its economic performance. Ongoing reassessment of whether a company is the primary beneficiary is also required by the standard. This standard amends the criteria to qualify as a primary beneficiary as well as how to determine the existence of a VIE. This standard is effective for us beginning with the first quarter in 2010. Comparative disclosures will be required for periods after the effective date. The Company adopted this new accounting pronouncement as of January 1, 2010 and the impact of adoption was not material on the consolidated financial statements. In July 2010, the FASB issued FASB ASU 2010-20, Receivables (Topic 310) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, which required more information about credit quality. The ASU introduces the term “financing receivables”, which includes loans, trade accounts receivable, notes receivable, credit cards, leveraged leases, direct financing leases, and sales-type leases. The term does not include receivables measured at fair value or the lower of cost of fair value and debt securities among others. It also defines two levels of disaggregation for disclosure: portfolio segment and class of financing receivables. A portfolio segment is defined as the level at which an entity determines its allowance for credit losses. A class of financing receivable is defined as a group of finance receivables determined on the basis of their initial measurement attribute (i.e., amortized cost of purchased credit impaired), risk characteristics, and an entity’s method for monitoring and assessing credit risk. The ASU requires an entity to provide additional disclosures including, but not limited to, a rollforward schedule of the allowance for credit losses (with the ending allowance balance further disaggregated based on impairment methodology) and the related ending balance of the finance receivable presented by portfolio segment, and the aging of past due financing receivables at the end of the period, the nature and extent of troubled debt restructurings that occurred during the period and their impact on the allowance for credit losses, the nature and extend of troubled debt restructurings that occurred within the last year, that have defaulted in the current reporting period, and their impact on the allowance for credit losses, the nonaccrual status of financing receivables, and impaired financing receivables, presented by class. The extensive new disclosures of information as of the end of a reporting period will become effective for both interim and annual reporting periods ending after December 15, 2010 for public companies. Specific items regarding activity that occurred before the issuance of the ASU, such as the allowance rollforward and modification disclosures will be required for periods beginning after December 15, 2010 for public companies. We adopted this pronouncement as disclosed in Note 7. 32 In January 2011, the FASB issued FASB ASU 2011-01, Receivables (Topic 310) – Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20, which deferred the effective date of the disclosure requirements for public entities about troubled debt restructurings in ASU 2010-20, to be concurrent with the effective date of the guidance for troubled debt restructuring which is currently anticipated to be effective for interim and annual periods after June 15, 2011. The Company does not anticipate the new guidance will have a material impact on the consolidated financial statements. Off-Balance Sheet Arrangements From July 2003 through April 2008 all of our securitizations were structured as secured financings for financial accounting purposes. In September 2008, we securitized $198.7 million of our automobile contracts in a structure that is treated as a sale of the receivables for financial accounting purposes. The terms of the September 2008 securitization provide for us (1) to continue servicing the sold portfolio, (2) to retain a 5.0% interest in the bonds issued by the trust to which we sold the automobile contracts and (3) to earn additional compensation contingent upon (a) the return to the holders of the senior bonds issued by the trust reaching certain targets or (b) “lifetime” cumulative net charge-offs on the automobile contracts being below a pre-determined level. In September 2010 we re-securitized the remaining receivables from the September 2008 transaction in a similar "off balance sheet" structure. The September 2010 transaction is treated as a sale of the receivables for financial accounting purposes. See "Critical Accounting Policies" for a detailed discussion of our securitization structure. Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rate Risk We are 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 rate due on our warehouse credit facilities are adjustable while the interest rates on the contracts are fixed. Historically, our term securitizations have had fixed rates of interest. To mitigate some of this risk, we have in the past, and generally intend to continue to structure our term 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 we sell the additional contracts to the trust in amounts up to the balance of the pre-funded escrow account. In pre-funded securitizations, we lock in the borrowing costs with respect to the contracts we subsequently deliver to the trust. However, we incur an expense in pre-funded securitizations equal to the difference between the money market yields earned on the proceeds held in escrow prior to subsequent delivery of contracts and the interest rate paid on the notes outstanding, the amount as to which there can be no assurance. 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, in the "Index to Financial Statements." Item 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures. Under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, management of the Company has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act") as of December 31, 2010 (the "Evaluation Date"). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures were not effective (i) to ensure that information required to be disclosed by us in reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission; and (ii) to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to our management, including the Company’s Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures. The valuation allowance for deferred taxes as of December 31, 2010 was not sufficient to reserve for the amount of deferred tax asset that is not more than likely to be realized. As a result of our external audit, management has increased the deferred tax asset valuation allowance at December 31, 2010. The certifications of our chief executive officer and chief financial officer required under Section 302 of the Sarbanes-Oxley Act have been filed as Exhibits 31.1 and 31.2 to this report. 33 Internal Control. Management’s Report on Internal Control over Financial Reporting is included in this Annual Report, immediately below. During the fiscal quarter ended December 31, 2010, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Management’s Report on Internal Control over Financial Reporting. We are responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is designed to provide reasonable assurance to our management and Board of Directors regarding the preparation and fair presentation of published financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can only provide reasonable assurance with respect to financial statement preparation and presentation. Management, with the participation of the chief executive and chief financial officers, assessed the effectiveness of our internal control over financial reporting as of December 31, 2010. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control — Integrated Framework. Based on this assessment, management, with the participation of the chief executive and chief financial officers, believes that, as of December 31, 2010, our internal control over financial reporting was not effective based on those criteria. This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securites and Exchange Commission that permit us to provide only management’s report in this annual report. 34 INDEX TO FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm – Crowe Horwath LLP ...................................... Consolidated Balance Sheets as of December 31, 2010 and 2009 .................................................................. Consolidated Statements of Operations for the years ended December 31, 2010 and 2009 ........................... Page Reference F-2 F-3 F-4 Consolidated Statements of Comprehensive Income/(Loss) for the years ended December 31, 2010 and 2009 ..................................................................................................................................................... F-5 Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2010 and 2009 ........... Consolidated Statements of Cash Flows for the years ended December 31, 2010 and 2009 .......................... Notes to Consolidated Financial Statements. .................................................................................................. F-6 F-7 F-9 F-1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders Consumer Portfolio Services, Inc. We have audited the accompanying consolidated balance sheets of Consumer Portfolio Services, Inc. (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations, comprehensive income (loss), shareholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. 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. as of December 31, 2010 and 2009, and the results of its operations and its cash flows for the years then ended in conformity with U.S. generally accepted accounting principles. The Company is currently in compliance with debt covenants or has obtained waivers for all potential covenant violations as of December 31, 2010. The waivers are temporary and will expire during 2011. See Note 1, Uncertainty of Capital Markets and General Economic Conditions and Financial Covenants, Note 7 and Note 15 for a discussion of potential consequences associated with the failure to obtain renewed waivers or inability to service or repay debt. /s/ CROWE HORWATH LLP Costa Mesa, California March 30, 2011 F-2 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data) ASSETS Cash and cash equivalents Restricted cash and equivalents Finance receivables Less: Allowance for finance credit losses Finance receivables, net Residual interest in securitizations Furniture and equipment, net Deferred financing costs Deferred tax assets, net Accrued interest receivable Other assets LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Accounts payable and accrued expenses Warehouse lines of credit Residual interest financing Securitization trust debt Senior secured debt, related party Subordinated renewable notes Commitments and contingencies 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; none issued Series B preferred stock, $1 par value; authorized 1,870 shares; 1,870 and 0 shares issued and outstanding at December 31, 2010 and 2009, respectively Common stock, no par value; authorized 75,000,000 shares; 18,122,810 and 18,034,909 shares issued and outstanding at December 31, 2010 and 2009, respectively Additional paid in capital, warrants Accumulated Deficit Accumulated other comprehensive loss $ $ $ December 31, 2010 December 31, 2009 $ $ $ 16,252 123,958 565,621 (13,168) 552,453 3,841 1,143 6,179 15,000 6,165 17,893 742,884 20,394 45,564 39,440 567,722 44,873 20,337 738,330 - - 1,601 55,496 9,141 (56,330) (5,354) 4,554 12,433 128,511 878,366 (38,274) 840,092 4,316 1,509 5,717 33,450 8,573 33,660 1,068,261 17,906 4,932 56,930 904,833 26,118 21,965 1,032,684 - - - 55,346 8,371 (22,504) (5,636) 35,577 $ 742,884 $ 1,068,261 See accompanying Notes to Consolidated Financial Statements. F-3 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) Revenues: Interest income Servicing fees Other income Expenses: Employee costs General and administrative Interest Provision for credit losses Marketing Occupancy Depreciation and amortization Loss before income tax expense Income tax expense Net loss Loss per share: Basic Diluted Number of shares used in computing loss per share: Basic Diluted $ $ $ Year Ended December 31, 2010 2009 $ 137,090 7,657 10,438 155,185 208,196 4,640 11,059 223,895 33,814 18,526 82,226 29,921 3,826 3,067 649 172,029 (16,844) 16,982 (33,826) (1.94) (1.94) $ $ 37,306 24,204 111,768 92,011 3,782 3,524 707 273,302 (49,407) 7,800 (57,207) (3.07) (3.07) 17,477 17,477 18,643 18,643 See accompanying Notes to Consolidated Financial Statements F-4 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(LOSS) (In thousands) Net loss Other comprehensive income; minimum pension liability, net of tax Comprehensive loss Year Ended December 31, 2010 2009 $ $ (33,826) 282 (33,544) $ $ (57,207) 1,391 (55,816) See accompanying Notes to Consolidated Financial Statements. F-5 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (In thousands) Balance at December 31, 2008 Common stock issued upon exercise of options and warrants Purchase of common stock Pension benefit obligation Valuation of warrants issued Stock-based compensation Net loss Balance at December 31, 2009 Common stock issued upon exercise of options and warrants Common stock issued upon issuance of debt Preferred stock issued upon issuance of debt Purchase of common stock Pension benefit obligation Valuation of warrants issued Stock-based compensation Net loss Balance at December 31, 2010 Series B Preferred Stock Amount Shares Common Stock Shares Amount Additional Paid-in Capital, Warrants Retained Earnings/ (Accumulated Deficit) Accumulated Other Comprehensive Loss Total - - - - - - - - - - 2 - - - - - 2 $ $ $ - - - - - - - - - - 1,601 - - - - - 1,601 19,111 $ 54,702 $ 7,471 $ 34,703 $ (7,027) $ 89,849 11 (1,087) - - - - 18,035 500 880 - (1,292) - - - - 18,123 $ $ 7 (999) - - 1,636 - 55,346 - 753 - (2,201) - - 1,598 - 55,496 $ $ - - - 900 - - 8,371 - - - - - 770 - - 9,141 $ $ - - - - - (57,207) (22,504) - - - - - - - (33,826) (56,330) $ $ - - 1,391 - - - (5,636) - - - - 282 - - - (5,354) $ $ 7 (999) 1,391 900 1,636 (57,207) 35,577 - 753 1,601 (2,201) 282 770 1,598 (33,826) 4,554 See accompanying Notes to Consolidated Financial Statements. F-6 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Cash flows from operating activities: Net Loss Adjustments to reconcile net income (loss) to net cash provided by operating activities: Accretion of deferred acquisition fees Amortization of discount on securitization notes Amortization of discount on senior secured debt, related party Depreciation and amortization Amortization of deferred financing costs Provision for credit losses Stock-based compensation expense Interest income on residual assets Change in market value of warrants Changes in assets and liabilities: Accrued interest receivable Other assets Deferred tax assets Accounts payable and accrued expenses Net cash provided by operating activities Cash flows from investing activities: Purchases of finance receivables held for investment Payments received on finance receivables held for investment Change in repo inventory Decreases in restricted cash and cash equivalents, net Purchase of furniture and equipment Net cash provided by investing activities Cash flows from financing activities: Proceeds from issuance of securitization trust debt Proceeds from issuance of subordinated renewable notes Proceeds from issuance of senior secured debt, related party Payments on subordinated renewable notes Net proceeds from (repayments to) warehouse lines of credit Repayment of residual financing debt Repayment of securitization trust debt Repayment of senior secured debt, related party Payment of financing costs Repurchase of common stock Issuance of common in conjunction with new debt Net cash used in financing activities Increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period Year Ended December 31, 2010 2009 $ (33,826) $ (57,207) (5,954) 5,655 1,109 649 4,090 29,921 1,598 (1,039) - 2,409 12,311 18,449 2,769 38,141 (113,023) 376,695 4,969 4,553 (283) 272,911 42,465 2,685 25,000 (4,313) 40,632 (17,490) (385,229) (5,000) (3,782) (1,448) (753) (307,233) 3,819 12,433 16,252 $ $ (7,306) 11,613 1,013 707 3,236 92,011 1,636 (1,542) 77 6,330 7,034 19,277 (2,404) 74,475 (8,600) 423,110 5,025 24,968 (812) 443,691 - 2,424 5,000 (6,180) (4,987) (10,370) (510,983) - (1,722) (999) - (527,817) (9,651) 22,084 12,433 See accompanying Notes to Consolidated Financial Statements. F-7 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Supplemental disclosure of cash flow information: Cash paid (received) during the period for: Interest Income taxes Non-cash financing activities: Pension benefit obligation, net Common stock issued in connection with new senior secured debt, related party Preferred stock issued in connection with new senior secured debt, related party Warrants issued in connection with warehouse line of credit Year Ended December 31, 2010 2009 $ $ 74,188 (9,252) 98,257 (12,397) (282) 753 1,601 770 (1,391) - - 822 See accompanying Notes to Consolidated Financial Statements. F-8 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES 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 and servicing retail automobile installment sale contracts ("Contracts") originated by licensed motor vehicle dealers ("Dealers") located throughout the United States. Dealers located in California, Texas, Pennsylvania, and Florida represented 15.9%, 8.6%, 7.5% and 5.7%, respectively, of contracts purchased during 2010 compared with 25.9%, 6.7%, 8.2% and 7.4%, respectively in 2009. No other state had a concentration in excess of 5.6%. We specialize in Contracts with borrowers who generally would not be expected to qualify for traditional financing provided by commercial banks or automobile manufacturers’ captive finance companies. We are subject to various regulations and laws as they relate to the extension of credit in consumer credit transactions. Although we believe we are currently in material compliance with these regulations and laws, there can be no assurance that we will be able to maintain such compliance. Failure to comply with such laws and regulations could have a material adverse effect on the Company. Acquisitions On March 8, 2002, we acquired MFN Financial Corporation and its subsidiaries in a merger (the "MFN Merger"). On May 20, 2003, we 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 similar businesses: buying contracts from Dealers, financing those contracts through securitization transactions, and servicing those contracts. MFN ceased acquiring contracts in March 2002; TFC acquired contracts under its "TFC Programs" until July 2008 when such purchases were suspended. On April 2, 2004, we purchased a portfolio of contracts and certain other assets (the "SeaWest Asset Acquisition") from SeaWest Financial Corporation ("SeaWest"). In addition, we were named the successor servicer for three term securitization transactions originally sponsored by SeaWest (the "SeaWest Third Party Portfolio"). We do not offer financing programs similar to those previously offered by SeaWest. 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 we purchase and securitize our 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. Cash and Cash Equivalents For purposes of the statements of cash flows, we consider 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. Substantially all of our cash is deposited at two financial institutions. We maintain cash due from banks in excess of the banks' insured deposit limits. We do not believe we are exposed to any significant credit risk on these deposits. As part of certain financial covenants related to debt facilities, we are required to maintain a minimum unrestricted cash balance. As of December 31, 2010, our unrestricted cash balance was $16.3 million. Finance Receivables Finance receivables, which we have the intent and ability to hold for the foreseeable future or until maturity or payoff, are presented at cost. All finance receivable contracts are held for investment. Interest income is accrued on the unpaid principal balance. Origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the interest method without anticipating prepayments. 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 F-9 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS delinquency period are charged off immediately. Management may authorize an extension of payment terms if collection appears likely during the next calendar month. Our portfolio of finance receivables consists of small-balance homogeneous contracts that are collectively evaluated for impairment on a portfolio basis. We report delinquency on a contractual basis. Once a Contract becomes greater than 90 days delinquent, we do not recognize additional interest income until the obligor under the Contract makes sufficient payments to be less than 90 days delinquent. Any payments received on a Contract that is greater than 90 days delinquent are first applied to accrued interest and then to principal reduction. Finance Receivables Held for Sale Finance receivables originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. We had no finance receivables held for sale at December 31, 2010 and 2009. Allowance for Finance Credit Losses In order to estimate an appropriate allowance for losses likely incurred on finance receivables, we use a loss allowance methodology commonly referred to as "static pooling," which stratifies the finance receivable portfolio into separately identified pools based on their period of origination, then uses historical performance of seasoned pools to estimate future losses on current pools. Historical loss experience is adjusted as necessary for current economic conditions. We consider our portfolio of finance receivables to be relatively homogenous and consequently we analyze credit performance primarily in the aggregate rather than stratification by any particular credit quality indicator. Using analytical and formula driven techniques, we estimate an allowance for finance credit losses, which we believe is adequate for probable credit losses that can be reasonably estimated in our portfolio of finance receivable contracts. Such allowance for loss is charged to expense on a monthly basis. Net losses incurred on finance receivables are charged to the allowance. We evaluate the adequacy of the allowance by examining current delinquencies, the characteristics of the portfolio, the value of the underlying collateral and historical loss trends. As conditions change, our level of provisioning and/or allowance may change as well. We observed deterioration in performance of automobile contracts held in our portfolio during 2009 and 2010, which we attribute to a general recession that began in December 2007. Charge Off Policy Delinquent Contracts for which the related financed vehicle has been repossessed are generally charged off at the earliest of (1) the month in which the proceeds from the sale of the financed vehicle are received, (2) the month in which 90 days have passed from the date of repossession or (3) the month in which the Contract becomes seven scheduled payments past due (see Repossessed and Other Assets below). The amount charged off is the remaining principal balance of the Contract, after the application of the net proceeds from the liquidation of the financed vehicle. With respect to delinquent Contracts for which the related financed vehicle has not been repossessed, the remaining principal balance thereof is generally charged off no later than the end of the month that the Contract becomes five scheduled payments past due, and no later than the end of the month that the Contract becomes eight scheduled payments past due for other receivables. Contract Acquisition Fees and Origination Costs Upon purchase of a Contract from a Dealer, we generally either charge or advance the Dealer an acquisition fee. Dealer acquisition fees and deferred origination costs are applied to the carrying value of finance receivables and are accreted into earnings as an adjustment to the yield over the estimated life of the Contract using the interest method. Repossessed and Other Assets If a Contract obligor fails to make or keep promises for payments, or if the obligor is uncooperative or attempts to evade contact or hide the vehicle, a supervisor will review the collection activity relating to the account to determine if repossession of the vehicle is warranted. Generally, such a decision will occur between the 45th and 90th day past the obligor’s payment due date, but could occur sooner or later, depending on the specific circumstances. At the time the vehicle is repossessed we stop accruing interest on the Contract, and reclassify the remaining Contract balance to the line item "Other assets" on our Consolidated Balance Sheet at its estimated fair value less costs to sell. Included in other assets in the accompanying balance sheets are repossessed vehicles pending sale of $4.8 million and $9.7 million at December 31, 2010 and 2009, respectively. F-10 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In addition, other assets as of December 31, 2009 included 5% of the structured notes issued by our subsidiary in connection with our $199 million loan sale completed in September 2008. These notes were held for investment and earned interest at a rate of LIBOR plus 5%. The amount outstanding as of December 31, 2009 was $5.0 million. These notes were sold in September 2010. Treatment of Securitizations Our term securitization structure has generally been as follows: We sell Contracts we acquire to a wholly-owned special purpose subsidiary ("SPS"), which has been established for the limited purpose of buying and reselling our contracts. The SPS then transfers the same Contracts to another entity, typically a statutory trust ("Trust"). The Trust issues interest-bearing asset-backed securities ("Notes"), in a principal amount equal to or less than the aggregate principal balance of the contracts. We typically sell these contracts to the Trust at face value and without recourse, except that representations and warranties similar to those provided by the Dealer to us are provided by us to the Trust. One or more investors purchase the Notes issued by the Trust (the "Noteholders"); the proceeds from the sale of the Notes are then used to purchase the contracts from us. We may retain or sell subordinated Notes issued by the Trust. Historically we have purchased a financial guaranty insurance policy for most of our term securitizations, guaranteeing timely payment of interest and ultimate payment of principal on the senior Notes, from an insurance company (a "Note Insurer"). In addition, we have provided "Credit Enhancement" for the benefit of the Note Insurer and the Noteholders in three forms: (1) an initial cash deposit to a bank account (a "Spread Account") held by the Trust, (2) overcollateralization of the Notes, where the principal balance of the Notes issued is less than the principal balance of the contracts, and (3) in the form of subordinated Notes. 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, which are then maintained. 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 portfolios of contracts held by the Trusts and on other conditions, and may also be varied by agreement among the Company, the SPS, the Note Insurers and the trustee. Such levels have increased and decreased from time to time based on performance of the various portfolios, and have also varied by from one Trust to another. Our warehouse securitization structures are similar to the above, except that (i) the SPS that purchases the contracts pledges the contracts to secure promissory notes that it issues, (ii) no increase in the required amount of Credit Enhancement is contemplated, and (iii) we do not purchase financial guaranty insurance. Upon each sale of contracts in a securitization structured as a secured financing, we retain as assets on our Consolidated Balance Sheet the securitized contracts and record as indebtedness the Notes issued in the transaction. Under the September 2008 and September 2010 securitizations and other term securitizations completed prior to July 2003 (which were structured as sales for financial accounting purposes), we removed from our Consolidated Balance Sheet the contracts sold and added to our Consolidated Balance Sheet (i) the cash received, if any, and (ii) the estimated fair value of the ownership interest that we retained 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) Notes retained, if any, and (d) receivables from the 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, the premium paid to the Note Insurer, if any, and certain other expenses. We recognize gains or losses attributable to any changes in the estimated fair value of the Residuals. Gains in fair value are recognized as Other Income in the income statement, and losses are recorded as an impairment loss in the income statement. We are not aware of an active market for the purchase or sale of interests such as the Residuals; accordingly, we determine the estimated fair value of the Residuals by discounting the amount of anticipated cash flows that we estimate will be released to us in the future (the cash out method), using a discount rate that we believe is appropriate for the risks involved. The anticipated cash flows may include collections from both current and charged off receivables. Historically we have used an effective pre-tax discount rate of 14% per annum for cash flows from current receivables and of 25% per annum for cash flows from charged-off receivables. As a result of changing market conditions as discussed below, we have used an effective pre-tax discount rate of 20% per annum for the September 2010 Residual. F-11 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS We receive periodic base servicing fees for the servicing and collection of the contracts. In addition, we are 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 the premium paid to the Note Insurer, and certain other fees (such as trustee and custodial fees). Required principal payments on the Notes 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 on the senior Notes exceeds the amount collected during the collection period, the shortfall is generally withdrawn from the Spread Account, if any. If the cash collected during the period exceeds the amount necessary for the above allocations plus required principal payments on the subordinated Notes, if any, and there is no shortfall in the related Spread Account or other form of Credit Enhancement, the excess is released to us. 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. Cash in the Spread Accounts is restricted from our use. Cash held in the various Spread Accounts is invested in high quality, liquid investment securities, as specified in the Securitization Agreements. In determining the value of the Residuals, we have estimated the future rates of prepayments, delinquencies, defaults, default loss severity, and recovery rates, as all of these factors affect the amount and timing of the estimated cash flows. Our estimates are based on historical performance of comparable contracts. Following a securitization that is structured as a sale for financial accounting purposes, we recognize interest income on the balance of the Residuals. In addition, we will recognize additional revenue in other income if the actual performance of the contracts related to the Residuals is better than our estimate of the value of the Residual. If the actual performance of the contracts is worse than our estimate, then a reduction to the carrying value of the Residuals and a related impairment charge would be required. In a securitization 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 of our term securitizations, whether treated as secured financings or as sales, we have 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 we report the assets and liabilities of the securitization Trust on our Consolidated Balance Sheet. Under both structures the Noteholders’ and the related securitization Trusts’ recourse to us for failure of the contract obligors to make payments on a timely basis is limited, in general, to our Finance receivables, Spread Accounts and Residuals. Under a two-year multiple draw credit facility established in September 2009, the Noteholders have limited recourse against us in the event of a borrowing base deficiency for up to 10% of the amount outstanding at the time of the borrowing base deficiency ) in addition to recourse against the assets of the SPS that is the note issuer under that facility. Servicing We consider the contractual servicing fee received on our managed portfolio held by non-consolidated subsidiaries to be equal to adequate compensation. Additionally, we consider that these fees would fairly compensate a substitute servicer, should one be required. As a result, no servicing asset or liability has been recognized. Servicing fees received on the managed portfolio held by non-consolidated subsidiaries are reported as income when earned. Servicing fees received on the managed portfolio held by consolidated subsidiaries are included in interest income when earned. Servicing costs are charged to expense as incurred. Servicing fees receivable, which are included in Other Assets in the accompanying balance sheets, represent fees earned but not yet remitted to us by the trustee. Furniture and Equipment Furniture and equipment are stated at cost net of accumulated depreciation. We calculate 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. Amortization expense on assets acquired under capital lease is included with depreciation expense on owned assets. F-12 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of Long-lived assets and certain identifiable intangibles are 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 The following table presents the primary components of Other Income: Sales tax refunds………………………………………………………….. $ Convenience fees charged to obligors……………...……….………………$ Direct mail revenues………………………….………………..…………. $ Recoveries on previously charged-off contracts……………………………$ Other……………………………………………………………………… $ Other income for the year…….………………………………………...… $ December 31, 2010 2009 (In thousands) 3,269 $ 2,937 2,001 1,456 775 10,438 $ 904 4,512 2,618 1,560 1,465 11,059 Earnings (Loss) Per Share The following table illustrates the computation of basic and diluted earnings (loss) per share: Numerator: Numerator for basic and diluted earnings (loss) per share………..…$ Denominator: Denominator for basic earnings (loss) per share - 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 (loss) per share………………… $ Basic earnings (loss) per share……………………..….….…………$ Diluted earnings (loss) per share…………….……………..……… $ Year Ended December 31, 2010 2009 (In thousands, except per share data) (33,826) $ (57,207) 17,477 18,643 - 17,477 (1.94) (1.94) $ $ - 18,643 (3.07) (3.07) Incremental shares of 3.2 million and 5.5 million related to stock options and warrants have been excluded from the diluted earnings per share calculation for the year ended December 31, 2010 and 2009, respectively, because the effect is anti-dilutive. The exercise prices of these stock options were greater than the average market price of the Company’s common shares or the Company was in a net loss position and, therefore, the effect would be anti- dilutive to earnings (loss) per share. Deferral and Amortization of Debt Issuance Costs Costs related to the issuance of debt are deferred and amortized using the interest method over the contractual or expected term of the related debt. Income Taxes The Company and its subsidiaries file a consolidated federal income tax return and combined or stand-alone state franchise tax returns for certain states. We utilize the asset and liability method of accounting for income taxes, under which deferred income taxes are recognized for the future tax consequences attributable to the differences between the financial statement values of existing assets and liabilities and their respective tax bases. Deferred tax F-13 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. We have estimated a valuation allowance against that portion of the deferred tax asset whose utilization in future periods is not more than likely. Purchases of Company Stock We record purchases of our own common stock at cost and treat the shares as retired. Stock Option Plan We recognize compensation costs in the financial statements for all share-based payments granted subsequent to January 1, 2006 based on the grant date fair value estimated in accordance with the provisions of FASB ASC 718 “Accounting for Stock Based Compensation”. Compensation cost is recognized over the required service period, generally defined as the vesting period. The per share weighted-average fair value of stock options granted during the years ended December 31, 2010 and 2009 was $1.11 and $0.51, respectively. That fair value was estimated using the Black-Scholes option pricing model using the weighted average assumptions noted in the following table. We estimate the expected life of each option as the average of the vesting period and the contractual life of the option. The volatility estimate is based on the historical volatility of our stock over the period that equals the expected life of the option. Volatility assumptions ranged from 78% to 125% for 2010 and 74% to 111% for 2009. The risk-free interest rate is based on the yield on a U.S. Treasury bond with a maturity comparable to the expected life of the option. The dividend yield is estimated to be zero based on our intention not to issue dividends for the foreseeable future. Expected life (years)…………………………………...…. Risk-free interest rate…………………………………… . Volatility………………………………………….………. Expected dividend yield……………………………..……. New Accounting Pronouncements Year Ended December 31, 2010 5.67 2.31 % % 82 - 2009 5.42 1.99 % % 79 - In June 2009, the FASB issued ASU 2009-17, Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities (FAS 167, Amendments to FASB Interpretation No. 46(R)). This standard amends several key consolidation provisions related to variable interest entity (“VIE”), which are included in FASB ASC 810, Consolidation to require a company to analyze whether its interest in a VIE gives it a controlling financial interest. A company must assess whether it has an implicit financial responsibility to ensure that the VIE operates as designed when determining whether it has the power to direct the activities of the VIE that significantly impact its economic performance. Ongoing reassessment of whether a company is the primary beneficiary is also required by the standard. This standard amends the criteria to qualify as a primary beneficiary as well as how to determine the existence of a VIE. This standard is effective for us beginning with the first quarter in 2010. Comparative disclosures will be required for periods after the effective date. The Company adopted this new accounting pronouncement as of January 1, 2010 and the impact of adoption was not material on the consolidated financial statements. In July 2010, the FASB issued FASB ASU 2010-20, Receivables (Topic 310) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, which required more information about credit quality. The ASU introduces the term “financing receivables”, which includes loans, trade accounts receivable, notes receivable, credit cards, leveraged leases, direct financing leases, and sales-type leases. The term does not include receivables measured at fair value or the lower of cost of fair value and debt securities among others. It also defines two levels of disaggregation for disclosure: portfolio segment and class of financing receivables. A portfolio segment is defined as the level at which an entity determines its allowance for credit losses. A class of financing receivable is defined as a group of finance receivables determined on the basis of their initial measurement attribute (i.e., amortized cost of purchased credit impaired), risk characteristics, and an entity’s method for monitoring and assessing credit risk. The ASU requires an entity to provide additional disclosures including, but not limited to, a rollforward schedule of the allowance for credit losses (with the ending allowance balance further disaggregated based on impairment methodology) and the related ending balance of the finance receivable presented F-14 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS by portfolio segment, and the aging of past due financing receivables at the end of the period, the nature and extent of troubled debt restructurings that occurred during the period and their impact on the allowance for credit losses, the nature and extend of troubled debt restructurings that occurred within the last year, that have defaulted in the current reporting period, and their impact on the allowance for credit losses, the nonaccrual status of financing receivables, and impaired financing receivables, presented by class. The extensive new disclosures of information as of the end of a reporting period will become effective for both interim and annual reporting periods ending after December 15, 2010 for public companies. Specific items regarding activity that occurred before the issuance of the ASU, such as the allowance rollforward and modification disclosures will be required for periods beginning after December 15, 2010 for public companies. We adopted this pronouncement as disclosed in Note 7. In January 2011, the FASB issued FASB ASU 2011-01, Receivables (Topic 310) – Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20, which deferred the effective date of the disclosure requirements for public entities about troubled debt restructurings in ASU 2010-20, to be concurrent with the effective date of the guidance for troubled debt restructuring which is currently anticipated to be effective for interim and annual periods after June 15, 2011. The Company does not anticipate the new guidance will have a material impact on the 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 us to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of income and expenses during the reported periods. Specifically, a number of estimates were made in connection with determining an appropriate allowance for finance credit losses, valuing the Residuals, accreting discounts and acquisition fees, amortizing deferred costs, the recording of deferred tax assets and reserves for uncertain tax positions. These are material estimates that could be susceptible to changes in the near term and, accordingly, actual results could differ from those estimates. Reclassification Certain amounts for the prior years have been reclassified to conform to the current year’s presentation with no effect on previously reported earnings or shareholders’ equity. Uncertainty of Capital Markets and General Economic Conditions Historically, we have depended upon the availability of short-term warehouse credit facilities and access to long- term financing through the issuance of asset-backed securities collateralized by our automobile contracts. Since 1994, we have completed 50 term securitizations of approximately $6.7 billion in contracts. We conducted four term securitizations in 2006, four in 2007, and two in 2008 and one in 2010. From July 2003 through April 2008 all of our securitizations were structured as secured financings. The second of our two securitization transactions in 2008 (completed in September 2008), and our most recent securitization in 2010 (a re-securitization of the remaining receivables from the September 2008 transaction) were each in substance a sale of the related contracts, and have been treated as sales for financial accounting purposes. Since the fourth quarter of 2007 through the end of 2009, we observed unprecedented adverse changes in the market for securitized pools of automobile contracts. These changes included reduced liquidity, and reduced demand for asset-backed securities, particularly for securities carrying a financial guaranty and for securities backed by sub- prime automobile receivables. Moreover, many of the firms that previously provided financial guarantees, which were an integral part of our securitizations, suspended offering such guarantees. The adverse changes that took place in the market from the fourth quarter of 2007 through the end of 2009 caused us to conserve liquidity by significantly reducing our purchases of automobile contracts. However, since October 2009, we have gradually increased our contract purchases by utilizing one $50 million credit facility that we established in September 2009 and another $50 million term funding facility that we established in March 2010. In September 2010 we took advantage of improvement in the market for asset-backed securities by re-securitizing the remaining underlying receivables from our unrated September 2008 securitization. By doing so we were able to pay off the bonds associated with the September 2008 transaction and issue rated bonds with a significantly lower weighted average coupon. The September 2010 transaction was our first rated term securitization since 1993 that did not utilize a financial guaranty. More recently, we increased our short-term funding capacity by $200 million with the F-15 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS establishment of a new $100 million credit facility in December 2010 and an additional $100 million credit facility in February 2011. In addition, we expect to complete one or more term securitization transactions in 2011. In spite of the improvements we have seen in the capital markets, if the trend of improvement in the markets for asset- backed securities should reverse, or if we should be unable to obtain additional contract financing facilities or to complete a term securitization of our recently originated receivables, we may curtail or cease our purchases of new automobile contracts, which could lead to a material adverse effect on our operations. The downturn in economic conditions and the capital markets that began in the fourth quarter of 2007 has negatively affected many aspects of our industry. First, throughout 2008 and 2009 there was reduced demand for asset-backed securities secured by consumer finance receivables, including sub-prime automobile receivables, as compared to 2007 and earlier. During 2010, however, we observed that yield requirements for investors that purchase securities backed by consumer finance receivables, including sub-prime automobile receivables, have decreased significantly and are approaching pre-2008 levels, albeit with significantly fewer transactions in the market. Second, there have been fewer lenders who provide short term warehouse financing for sub-prime automobile finance companies due to more uncertainty regarding the prospects of obtaining long-term financing through the issuance of asset-backed securities than before 2008. Many capital market participants such as investment banks, financial guaranty providers and institutional investors who previously played a role in the sub- prime auto finance industry have withdrawn from the industry, or in some cases, have ceased to do business. These developments resulted in our incurring higher interest costs for receivables we financed in 2009 and 2010 compared to pre-2008 levels. However, on December 23, 2010 we entered into a $100 million two-year warehouse credit line with a significantly lower cost of funds than the facilities we used in 2009 and 2010. Finally, broad economic weakness and high levels of unemployment in 2008, 2009 and 2010 have made many of our customers less willing or able to pay, resulting in higher delinquency, charge-offs and losses. Each of these factors has adversely affected our results of operations. Should existing economic conditions worsen, both our ability to purchase new contracts and the performance of our existing managed portfolio may be impaired, which, in turn, could have a further material adverse effect on our results of operations. Financial Covenants Certain of our securitization transactions, our residual interest financing and our warehouse credit facilities contain various financial covenants requiring certain minimum financial ratios and results. Such covenants include maintaining minimum levels of liquidity and net worth and not exceeding maximum leverage levels and maximum financial losses. In addition, certain securitization and non-securitization related debt contain cross-default provisions that would allow certain creditors to declare a default if a default occurred under a different facility. The agreements under which we receive periodic fees for servicing automobile contracts in securitizations are terminable by the respective financial guaranty insurance companies (also referred to as note insurers) upon defined events of default, and, in some cases, at the will of the insurance company. In August 2010, we agreed with the note insurer for eight of our twelve currently outstanding securitizations to amend the applicable agreements to remove the financial covenants that were contained in three of the related agreements. In return for such amendments, we agreed to increase the required credit enhancement amounts in those three deals through increased spread account requirements. The remaining five transactions insured by this particular note insurer do not contain financial covenants. For the remaining four securitizations insured by different parties we have been receiving waivers for certain financial and operating covenants on a monthly and/or quarterly basis as summarized below: Financial covenant Applicable Standard Status Requiring Waiver (as of or for the quarter ended December 31, 2010) Warehouse financing capacity $200 million of warehouse capacity $150 million of warehouse capacity Adjusted net worth (I) $87.6 million Leverage Not greater than 4.5:1 Maximum net loss Adjusted net worth (II) $7.5 million $95.3 million $4.6 million 25.5:1 $33.8 million $4.6 million F-16 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The covenant regarding warehouse financing capacity is a covenant to maintain one or more credit facilities that allow us to finance acquisition of automobile contracts on a revolving basis, with a minimum aggregate capacity of $200 million. The adjusted net worth covenants are covenants to maintain minimum levels of adjusted net worth, defined as our consolidated book value under GAAP with the exclusion of intangible assets such as goodwill. There are two separate adjusted net worth covenants because there are two separate note insurers that have this covenant in their related securitization agreements. The leverage covenant requires that we not exceed the specified ratio of debt over the defined adjusted net worth. Debt is defined in this covenant to mean consolidated liabilities less warehouse lines of credit and securitization trust debt; using this definition at December 31 2010, we had debt of $125 million. The maximum net loss covenant requires that we not exceed $7.5 million in net losses for any quarter or year. Without the waivers we have received from the related note insurers, we would have been in violation of covenants relating to minimum net worth, maximum financial losses, maximum leverage levels and maintenance of active warehouse facilities with respect to four of our 12 currently outstanding securitization transactions. Upon such an event of default, and subject to the right of the related note insurers to waive such terms, the agreements governing the securitizations call for payment of a default insurance premium, ranging from 25 to 100 basis points per annum on the aggregate outstanding balance of the related insured senior notes, and for the diversion of all excess cash generated by the assets of the respective securitization pools into the related spread accounts to increase the credit enhancement associated with those transactions. The cash so diverted into the spread accounts would otherwise be used to make principal payments on the subordinated notes in each related securitization or would be released to us. As of the date of this report, cash is being diverted to the related spread accounts in seven transactions. In addition, upon an event of default, the note insurers have the right to terminate us as servicer. Although our termination as servicer has been waived, we are paying default premiums, or their equivalent, with respect to insured notes representing $347.0 million of the $567.7 million of securitization trust debt outstanding at December 31, 2010. It should be noted that the principal amount of such securitization trust debt is not increased, but that the increased insurance premium is reflected as increased interest expense. Furthermore, such waivers are temporary, and there can be no assurance as to their future extension. We do, however, believe that we will obtain such future extensions of our servicing agreements because it is generally not in the interest of any party to the securitization transaction to transfer servicing. Nevertheless, there can be no assurance as to our belief being correct. Were an insurance company in the future to exercise its option to terminate such agreements or to pursue other remedies, such remedies could have a material adverse effect on our liquidity and results of operations, depending on the number and value of the affected transactions. Our note insurers continue to extend our term as servicer on a monthly and/or quarterly basis, pursuant to the servicing agreements. (2) Restricted Cash Restricted cash consists of cash and cash equivalent accounts relating to our outstanding securitization trusts and credit facilities. The amount of restricted cash on our consolidated balance sheets was $124.0 million and $128.5 million as of December 31, 2010 and 2009, respectively. Certain of our financing agreements require that we establish cash reserves for the benefit of the creditors to protect against unforeseen credit losses on the Contracts. These cash reserves, which are included in restricted cash, were $95.2 million and $90.1 million as of December 31, 2010 and 2009, respectively. (3) Finance Receivables We consider our portfolio of finance receivables to be homogenous and consist of a single segment and class. Consequently we analyze credit performance primarily in the aggregate rather than stratification by any particular credit quality indicator. The following table presents the components of Finance Receivables, net of unearned interest: Finance Receivables Automobile finance receivables, net of unearned interest……………. $ Less: Unearned acquisition fees and discounts……………………… . Finance Receivables……………………………………………………. $ December 31, 2010 2009 (In thousands) 576,090 (10,469) 565,621 $ $ 884,819 (6,453) 878,366 F-17 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS We consider an automobile contract delinquent when an obligor fails to make at least 90% of a contractually due payment by the following due date, which date may have been extended within limits specified in the servicing agreements. The period of delinquency is based on the number of days payments are contractually past due. Automobile contracts less than 31 days delinquent are not included. The following table summarizes the delinquency status of finance receivables as of December 31, 2009 and 2010: Deliquency Status Current ……………………….………… $ 31 - 60 days……………………………… 61 - 90 days……………………………… 91 + days………………………………… $ December 31, 2010 2009 (In thousands) 541,375 16,784 9,453 8,478 576,090 $ $ 837,737 22,325 15,258 9,499 884,819 Finance receivables totaling $13.3 million and $16.1 million at December 31, 2010 and 2009, respectively, have been placed on non-accrual status as a result of their delinquency status. The following table presents a summary of the activity for the allowance for credit losses, for the years ended December 31, 2010 and 2009: December 31, 2010 2009 Balance at beginning of year……………...……….……………………...…$ Provision for credit losses………………………….………………..………$ Charge-offs………………………………….………………….…………. $ Recoveries…………………………………………………………...………$ Balance at end of year…….………………………………………...………$ (In thousands) $ 38,274 29,921 (82,585) 27,558 13,168 $ 78,036 92,011 (160,174) 28,401 38,274 Excluded from finance receivables are contracts that were previously classified as finance receivables but were reclassified as other assets because we have repossessed the vehicle securing the Contract. The following table presents a summary of such repossessed inventory together with the allowance for losses in repossessed inventory that is not included in the allowance for credit losses: Gross balance of repossessions in inventory……………...……….………$ Allowance for losses on repossessed inventory……………………………$ Net repossessed inventory included in other assets…….………………… $ 21,046 (16,278) 4,768 $ $ 37,821 (28,084) 9,737 December 31, 2010 2009 (In thousands) (4) Residual Interest in Securitizations In September 2008 we completed a structured loan sale in which we retained a residual interest. The remaining receivables from that September 2008 securitization were re-securitized in September 2010. The residual interest in the cash flows from this transaction was $3.8 million and $4.2 million as of December 31, 2010 and 2009, respectively, and was determined using a discounted cash flow model that included estimates for prepayments and losses. The discount rate utilized was 20%. The assumptions utilized were based on our historical performance adjusted for current market conditions. (5) Furniture and Equipment The following table presents the components of furniture and equipment: F-18 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2010 2009 Furniture and fixtures…………………………….….. $ Computer and telephone equipment……………………$ Leasing assets………………………………..………. $ Leasehold improvements………………………….…. $ Other fixed assets………………………….…………. $ Less: accumulated depreciation and amortization………$ $ $ (In thousands) 4,133 6,857 673 1,301 - 12,964 (11,821) 1,143 $ 4,133 6,294 673 1,301 280 12,681 (11,172) 1,509 Depreciation expense totaled $649,000 and $707,000 for the years ended December 31, 2010 and 2009, respectively. (6) Securitization Trust Debt We have completed a number of term securitization transactions that are structured as secured borrowings for financial accounting purposes. The debt issued in these transactions is shown on our consolidated balance sheets as “Securitization trust debt,” and the components of such debt are summarized in the following table: Final Scheduled Payment Date (1) Receivables Pledged at December 31, 2010 (2) Initial Principal Outstanding Principal at December 31, 2010 Outstanding Principal at December 31, 2009 Weighted Average Interest Rate at December 31, 2010 February 2011 April 2011 October 2011 February 2012 May 2012 July 2012 July 2012 November 2012 January 2013 July 2013 August 2013 November 2013 December 2013 January 2014 May 2014 October 2014 July 2017 $ $ - - - - 5,249 - 6,151 16,082 23,861 29,226 35,141 57,736 14,871 75,942 91,356 107,417 56,501 96,369 $ (Dollars in thousands) - - - - 5,481 - 6,573 16,765 29,196 35,499 38,493 64,166 17,029 86,355 100,107 125,593 42,465 100,000 137,500 130,625 183,300 72,525 145,000 245,000 257,500 247,500 220,000 290,000 113,293 314,999 327,499 310,359 9,174 $ 1,254 1,989 6,924 10,021 19,661 5,330 19,295 41,546 56,664 64,332 69,584 107,011 31,087 135,602 158,955 175,578 - - - - - 5.13% - 5.69% 5.33% 6.92% 6.24% 5.89% 5.92% 6.04% 6.48% 6.60% 7.81% 11.00% $ 519,533 $ 3,200,643 $ 567,722 $ 904,833 Series CPS 2004-B CPS 2004-C CPS 2005-A CPS 2005-B CPS 2005-C CPS 2005-TFC CPS 2005-D CPS 2006-A CPS 2006-B CPS 2006-C CPS 2006-D CPS 2007-A CPS 2007-TFC CPS 2007-B CPS 2007-C CPS 2008-A Delayed Draw Notes _________________________ (1) The Final Scheduled Payment Date represents final legal maturity of the securitization trust debt. Securitization trust debt is expected to become due and to be paid prior to those dates, based on amortization of the finance receivables pledged to the Trusts. Expected payments, which will depend on the performance of such receivables, as to which there can be no assurance, are $283.5 million in 2011, $191.2 million in 2012, $59.3 million in 2013, $17.2 million in 2014, and $16.5 million in 2015. (2) Includes repossessed assets that are included in Other Assets on our Consolidated Balance Sheet. All of the securitization trust debt was issued in private placement transactions to qualified institutional investors. The debt was issued through wholly-owned, bankruptcy remote subsidiaries of CPS and is secured by the assets of F-19 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS such subsidiaries, but not by other assets of the Company. Principal and interest payments on the senior notes 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 we maintain minimum levels of liquidity and net worth and not exceed maximum leverage levels and maximum financial losses. We were in compliance with all such covenants as of December 31, 2010, in some cases only after giving effect to waivers of otherwise applicable standards. We are 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, 2010, restricted cash under the various agreements totaled approximately $124.0 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 premiums, amortization of transaction costs, and amortization of discounts required on the notes at the time of issuance. Deferred financing costs related to the securitization trust debt are amortized using the interest method. 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 were formed to facilitate the above asset-backed financing transactions. Similar bankruptcy remote subsidiaries issue the debt outstanding under our warehouse line 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. (7) Debt The terms of our debt outstanding at December 31, 2010 and 2009 are summarized below: Residual interest financing Notes secured by our residual interests in securitizations. In May 2010, the maturity was extended from June 2010 to May 2011. The aggregate indebtedness under this facility was $39.4 million at December 31, 2010. It bears interest at 12.875% over LIBOR. Senior secured debt, related party Notes payable to Levine Leichtman Capital Partners IV, L.P. (“LLCP”). The notes consisted of a $10 million term note, a $15 million term note and a $27.75 million term note all due in December 2013. The notes accrue interest at 16% per annum. The amount outstanding at December 31, 2010 is net of the unamortized debt discount of $7.9 million relating to the valuation of 1,225,000 shares of stock, warrants to purchase 1,611,114 shares of our common stock at an exercise price of $1.3982, warrants to purchase 285,781 of our common stock at an exercise price of $0.01 and $1.4 million in cash paid to the lender at issuance. In addition, the unamortized debt discount includes the valuation of 880,000 shares of common stock and 1,870 shares of Series B convertible preferred stock and $2.75 million in cash paid to the lender at issuance of the $27.75 million note. F-20 December 31, 2010 2009 (In thousands) $39,440 $56,930 44,873 26,118 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Subordinated renewable notes Notes bearing interest ranging from 6.85% to 16.00%, with a weighted average rate of 13.83%, and with maturities from January 2011 to March 2020 with a weighted average maturity of April 2013. We began issuing the notes in June 2005 and incurred issuance costs of $250,000. Payments are made monthly, quarterly, annually or upon maturity based on the terms of the individual notes. December 31, 2010 2009 (In thousands) 20,337 $104,650 21,965 $105,013 The outstanding debt on our credit facilities was $45.6 million as of December 31, 2010, compared to $4.9 million outstanding as of December 31, 2009. See Note 15 for a discussion of our warehouse lines of credit. The costs incurred in conjunction with the above debt are recorded as deferred financing costs on the accompanying balance sheets and are more fully described in Note 1. We must comply with certain affirmative and negative covenants related to debt facilities, which require, among other things, that we maintain certain financial ratios related to liquidity, net worth, capitalization and maximum financial losses. Further covenants include matters relating to investments, acquisitions, restricted payments and certain dividend restrictions. See the discussion of financial covenants in footnote 1. The following table summarizes the contractual and expected maturity amounts of debt as of December 31, 2010: Contractual maturity date Residual interest financing Senior secured debt (1) Subordinated renewable notes Total (In thousands) $ $ $ 2011………………………$ 2012…………………… $ 2013…………………… $ 2014…………………… $ 2015…………………… $ Thereafter……………… $ Total…….………………$ _________________________ 39,440 - - - - - 39,440 $ - - 44,873 - - - 44,873 $ 11,508 4,396 4,131 242 60 - 20,337 50,948 4,396 49,004 242 60 - 104,650 $ $ $ (1) The senior secured debt maturing in 2013 is shown net of unamortized debt discounts of $7.9 million. On a gross basis the scheduled maturity of this debt in 2013 is $52.8 million. (8) Shareholders’ Equity Common Stock Holders of common stock are entitled to such dividends as our 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. We are required to comply with various operating and financial covenants defined in the agreements governing the warehouse lines of credit, senior debt, residual interest financing and subordinated debt. The covenants restrict the payment of certain distributions, including dividends (See Note 7). F-21 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Included in compensation expense for the years ended December 31, 2010 and 2009, is $1.6 million related to the amortization of deferred compensation expense and valuation of stock options. Stock Purchases At five different times between 2000 and 2010, our Board of Directors authorized us to purchase a total of up to $34.5 million of our securities. As of December 31, 2010, we had purchased $5.0 million in principal amount of debt securities, and $27.5 million of our common stock, representing 9,005,724 shares. Options and Warrants In 2006, the Company adopted and its shareholders approved the CPS 2006 Long-Term Equity Incentive Plan (the “2006 Plan”) pursuant to which our Board of Directors, or a duly-authorized committee thereof, may grant stock options, restricted stock, restricted stock units and stock appreciation rights to our employees or our subsidiaries, to directors of the Company, and to individuals acting as consultants to the Company or its subsidiaries. In June 2008, the shareholders of the Company approved an amendment to the 2006 Plan to increase the maximum number of shares that may be subject to awards under the 2006 Plan from 3,000,000 to 5,000,000. Options that have been granted under the 2006 Plan have been granted at an exercise price equal to (or greater than) the stock’s fair market value at the date of the grant, with terms generally of 10 years and vesting generally over five years. For the year ended December 31, 2010, we recorded stock-based compensation costs in the amount of $1.6 million. As of December 31, 2010, unrecognized stock-based compensation costs to be recognized over future periods was equal to $3.0 million. This amount will be recognized as expense over a weighted-average period of 3.1 years. At December 31, 2010, the options outstanding and exercisable had intrinsic values of $538,000 and $168,000, respectively. The total intrinsic value of options exercised was $7,000 for the year ended December 31, 2009. No options were exercised in 2010. New shares were issued for all options exercised during the year ended December 2009. At December 31, 2010, there were a total of 830,000 additional shares available for grant under the 2006 Plan. Stock option activity for the year ended December 31, 2010, including the activity related to the option exchange described above, is as follows: Options outstanding at the beginning of period………… Granted……………………………………………… Exercised…………………………………………… Forfeited……………………………………………. Options outstanding at the end of period……………… Number of Shares (in thousands) 6,874 720 - (604) 6,990 Options exercisable at the end of period……………… 4,749 Weighted Average Exercise Price 1.62 1.64 - 1.73 1.61 1.78 $ $ $ Weighted Average Remaining Contractual Term N/A N/A N/A N/A 5.65 years 4.47 years The per share weighted average fair value of stock options granted whose exercise price was equal to the market price of the stock on the grant date during the years ended December 31, 2010 and 2009, was $1.11 and $0.78, respectively. The per share weighted average fair value of stock options granted whose exercise price was above the market price of the stock on the grant date during the year ended December 31, 2009 was $0.17. The per share weighted average exercise price of stock options granted whose exercise price was above the market price of the stock on the grant date during the year ended December 31, 2009 was $1.50. We have not issued any stock options with an exercise price below the market price of the stock on the grant date. On June 30, 2008, we entered into a series of agreements pursuant to which a lender purchased a $10 million five- year, fixed rate, senior secured note from us. In July 2008, in conjunction with the amendment of the combination term and revolving residual credit facility as discussed above, the lender purchased an additional $15 million note F-22 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS with substantially the same terms as the $10 million note. Pursuant to the June 30, 2008 securities purchase agreement, we issued to the lender 1,225,000 shares of common stock. In addition, we issued the lender two warrants: (i) warrants that we refer to as the FMV Warrants, which are exercisable for 1,611,114 shares of our common stock, at an exercise price of $1.39818 per share, and (ii) warrants that we refer to as the N Warrants, which are exercisable for 285,781 shares of our common stock, at a nominal exercise price. Both the FMV Warrants and the N Warrants are exercisable in whole or in part and at any time up to and including June 30, 2018. We valued the warrants using the Black-Scholes valuation model. In connection with the amendment to our residual credit facility discussed in Note 15, we issued warrants valued as being equivalent to 2,500,000 common shares, or $4,071,429. The warrants represented the right to purchase 2,500,000 CPS common shares at a nominal exercise price, at any time prior to July 10, 2018. In March 2010 we re- purchased 500,000 shares for $1.0 million. (9) Interest Income The following table presents the components of interest income: Year Ended December 31, 2010 2009 (In thousands) Interest on finance receivables……………………...…………. $ Residual interest income …………………….……………….…$ Other interest income……………..…………………..……….. $ Net interest income………………..…………………….………$ 135,013 1,063 1,014 137,090 $ $ 205,892 1,376 928 208,196 (10) Income Taxes Income taxes consist of the following: Year Ended December 31, 2010 2009 (In thousands) Current federal tax expense (benefit)……………………… $ Current state tax expense (benefit)………………………… $ Deferred federal tax (benefit)……………………………… $ Deferred state tax expense (benefit)…………………………$ Change in valuation allowance……………………..……… $ $ (1,518) (28) (4,107) (5,331) 27,966 (28,110) (2,814) 11,294 (191) 27,621 Income tax expense (benefit)………………………………. $ 16,982 $ 7,800 Income tax expense/(benefit) for the years ended December 31, 2010 and 2009 differs from the amount determined by applying the statutory federal rate of 35% to income before income taxes as follows: Expense at federal tax rate………………………...……………$ State taxes, net of federal income tax benefit………………… $ Other adjustments to tax reserve……………………………… $ Effect of change in state tax rate……………………………… $ Valuation allowance……………………………….……………$ Stock-based compensation……………………………….…… $ Other…………………………………………………..……… $ $ Year Ended December 31, 2010 2009 (In thousands) (5,896) 734 (1,344) (4,931) 27,966 535 (82) 16,982 $ $ (17,293) (2,187) (827) - 27,621 540 (54) 7,800 The tax effected cumulative temporary differences that give rise to deferred tax assets and liabilities as of December 31, 2010 and 2009 are as follows: F-23 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Deferred Tax Assets: Finance receivables…………………………………… $ Accrued liabilities…………………………………….…$ Furniture and equipment……………………………… $ NOL carryforwards and BILs………………………...…$ Pension Accrual……………………………………...…$ Other……………………………………………...…… $ Total deferred tax assets………………………….……$ Valuation allowance……………………………………$ $ Deferred Tax Liabilities: $ Other……………………………….……………………$ Total deferred tax liabilities……………………..……$ $ Net deferred tax asset……………….…………………$ December 31, 2010 2009 (In thousands) $ 7,562 1,476 281 66,994 2,214 - 78,527 (56,587) 21,940 (6,940) (6,940) 11,779 1,613 274 48,170 2,347 - 64,183 (28,621) 35,562 (2,112) (2,112) 15,000 $ 33,450 As part of the MFN and TFC Mergers, CPS acquired certain net operating losses and built-in loss assets. Moreover, both MFN and TFC have 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 (that is, 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. In determining the possible future realization of deferred tax assets, we have considered the taxes paid in the current and prior years that may be available to recapture, as well as future taxable income from the following sources: (a) reversal of taxable temporary differences; and (b) tax planning strategies that, if necessary, would be implemented to accelerate taxable income into years in which net operating losses might otherwise expire. Our tax planning strategies include the prospective sale of certain assets such as finance receivables, residual interests in securitized finance receivables, charged off receivables and base servicing rights. The expected proceeds for such asset sales have been estimated based on our expectation of what buyers of the assets would consider to be reasonable assumptions for net cash flows and required rates of return for each of the various asset types. Our estimates for net cash flows and required rates of return are subjective and inherently subject to future events which may significantly impact actual net proceeds we may receive from executing our tax planning strategies. A summary of the assets, key assumptions and estimated taxable income is shown in the table below: Asset Category Key Assumptions Base servicing rights Net cash flows discounted at 12% Residual interests in securitized receivables Net cash flows discounted at 20% Finance receivables Charged off receivables Note receivable Net cash flows discounted at 25% Assumed value of 1.5% Net cash flows discounted at 11% Estimated Taxable Income $ 15,965 5,084 7,842 6,171 2,464 $ 37,526 We believe such asset sales can produce at least $37.5 million in taxable income within the relevant carryforward period. Such strategies could be implemented without significant impact on our core business or our ability to generate future growth. The costs related to the implementation of these tax strategies were considered in evaluating the amount of taxable income that could be generated in order to realize our deferred tax assets. At December 31, 2010 we have established a $56.6 million valuation allowance against that portion of the deferred tax asset whose utilization in future periods is not more than likely. F-24 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2010, we had net operating loss carryforwards for federal and state income tax purposes of $115.1 million and $185.8 million, respectively. The federal net operating losses begin to expire in 2022. The state net operating losses begin to expire in 2013. The following is a tabular reconciliation of the total amounts of unrecognized tax benefits including interest and penalties for the year: Unrecognized tax benefit - opening balance……………$ Gross increases - tax positions in prior period…………$ Gross decreases - tax positions in prior period…………$ Gross increases - tax positions in current period………$ Settlements…………………………………………… $ Lapse of statute of limitations……………………..……$ 2010 2009 (In thousands) 4,319 157 - - - (1,454) $ $ $ $ $ $ 8,183 - (2,165) - (532) (1,167) Unrecognized tax benefit - ending balance…………… $ 3,022 $ 4,319 Included in the balance of unrecognized tax benefits at December 31, 2010, are $2.6 million of tax benefits that, if recognized, would affect the effective tax rate. Also included in the balance of unrecognized tax benefits at December 31, 2010 are $400,000 of tax benefits that, if recognized, would result in adjustments to other tax accounts, primarily deferred taxes. We recognize potential interest and penalties related to unrecognized tax benefits as income tax expense. Related to the uncertain tax benefits noted above, we reduced penalties by $200,000 and increased gross interest by $200,000 during 2010 and in total, as of December 31, 2010, have recognized a liability for penalties of $300,000 million and gross interest of $700,000. We do not anticipate a significant change in unrecognized tax positions within the coming year. In addition, we believe that it is reasonably possible that none of our currently remaining unrecognized tax positions, each of which is individually insignificant, may be recognized by the end of 2010 as a result of a lapse of the statute of limitations. We are subject to taxation in the US and various states and foreign jurisdictions. The Company’s tax years for 2006 through 2009 are subject to examination by the tax authorities. With few exceptions, we are no longer subject to U.S. federal, state, or local examinations by tax authorities for years before 2006. (11) Related Party Transactions Director Purchase of Retail Note In December 2007, one of our directors purchased a $4.0 million subordinated renewable note pursuant to our ongoing program of issuing such notes to the public. The note was purchased through the registered agent and under the same terms and conditions, including the interest rate, that were offered to other purchasers at the time the note was issued. As of December 31, 2010, $4.0 million remains outstanding on this note. (12) Commitments and Contingencies Leases The Company leases its facilities and certain computer equipment under non-cancelable operating leases, which expire through 2016. Future minimum lease payments at December 31, 2010, under these leases are due during the years ended December 31 as follows: F-25 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2011…………………………………...……………………….……………… $ 2012…………………………………...……………………….……………… $ 2013…………………………………...……………………….……………… $ 2014…………………………………...……………………….……………… $ 2015…………………………………...……………………….……………… $ Thereafter…………………………………...……………………….………… $ Amount (In thousands) 3,185 2,737 2,458 1,973 1,816 1,351 Total minimum lease payments………………………………….………………$ 13,520 Rent expense for the years ended December 31, 2010 and 2009, was $3.6 million and $4.1 million, respectively. Our facility leases contain 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 terms of the leases. Litigation Stanwich Litigation. CPS was for some time a defendant in a class action (the “Stanwich Case”) brought in the California Superior Court, Los Angeles County. The original plaintiffs in that case were persons entitled to receive regular payments (the “Settlement Payments”) pursuant to earlier settlements of claims, generally personal injury claims, against unrelated defendants. Stanwich Financial Services Corp. (“Stanwich”), an affiliate of the former chairman of the board of directors of CPS, is the entity that was obligated to pay the Settlement Payments. Stanwich defaulted on its payment obligations to the plaintiffs and in June 2001 filed for reorganization under the Bankruptcy Code, in the federal bankruptcy court in Connecticut. By February 2005, CPS had settled all claims brought against it in the Stanwich Case. In November 2001, one of the defendants in the Stanwich Case, Jonathan Pardee, asserted claims for indemnity against the Company in a separate action, which is now pending in federal district court in Rhode Island. The Company has filed counterclaims in the Rhode Island federal court against Mr. Pardee, and has filed a separate action against Mr. Pardee's Rhode Island attorneys, in the same court. The litigation between Mr. Pardee and CPS is stayed, awaiting resolution of an adversary action brought against Mr. Pardee in the bankruptcy court, which is hearing the bankruptcy of Stanwich. CPS has reached an agreement in principle with the representative of creditors in the Stanwich bankruptcy to resolve the adversary action. Under the agreement in principle, CPS is to pay the bankruptcy estate $800,000 and abandon its claims against the estate, while the estate is to abandon its adversary action against Mr. Pardee. We believe that resolution of the adversary action will result in (i) limitation of its exposure to Mr. Pardee to no more than some portion of his attorneys fees incurred and (ii) stays in Rhode Island being lifted, causing those cases to become active again. The reader should consider that an adverse judgment against CPS in the Rhode Island case for indemnification, if in an amount materially in excess of any liability already recorded in respect thereof, could have a material adverse effect on our financial condition. Other Litigation. We are routinely involved in various legal proceedings resulting from our consumer finance activities and practices, both continuing and discontinued. We believe that there are substantive legal defenses to such claims, and intend to defend them vigorously. There can be no assurance, however, as to their outcomes. We have recorded a liability as of December 31, 2010 that we believe represents a sufficient allowance for legal contingencies. Any adverse judgment against us, if in an amount materially in excess of the recorded liability, could have a material adverse effect on our financial position or results of operations. (13) 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). We may, at our discretion, match 100% of employees’ contributions up to $1,500 per employee per calendar year. Our contributions F-26 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS to the 401(k) Plan were $74,000 for the year ended December 31, 2010. We did not make any contributions to the plan in 2009 rather we utilized the plan’s forfeiture account to match $438,000 in employee contributions. We also sponsor the MFN Financial Corporation Pension Plan (the “Plan”). The Plan benefits were frozen June 30, 2001. The following tables represents a reconciliation of the change in the plan’s benefit obligations, fair value of plan assets, and funded status at December 31, 2010 and 2009: December 31, 2010 2009 (In thousands) Change in Projected Benefit Obligation Projected benefit obligation, beginning of year………………………………….………………… $ Service cost………………………………………………………………………………………… $ Interest cost………………………………………………………………………………………… $ Actuarial gain (loss)……………………………………………………………….…………………$ Settlements……………………………………………………………………………………………$ Benefits paid……………………………………………………………………………………..… $ Projected benefit obligation, end of year………………………………………………………… $ Change in Plan Assets Fair value of plan assets, beginning of year…………………………………………………………$ Return on assets………………………………………………………………………………………$ Employer contribution………………………………………………………………………..………$ Expenses………………………………………………………………………..………………….. $ Settlements……………………………………………………………………………………………$ Benefits paid…………………………………………………………………………………………$ Fair value of plan assets, end of year…..………………………………………………………...…$ 16,642 - 931 981 (937) (560) 17,057 10,465 1,391 847 (51) (937) (560) 11,155 Funded Status at end of year………………………………………………………………………$ (5,902) $ $ $ $ $ 16,085 - 947 243 - (633) 16,642 8,515 2,626 - (43) (633) 10,465 (6,177) Additional Information Weighted average assumptions used to determine benefit obligations and cost at December 31, 2010 and 2009 were as follows: Weighted average assumptions used to determine benefit obligations Discount rate……………………………………………………………………………………… . 5.45% 5.90% Weighted average assumptions used to determine net periodic benefit cost Discount rate……………………………………………………………………………………… . Expected return on plan assets……………………………………………………………...………. 5.90% 8.50% 6.00% 8.50% December, 31 2010 2009 Our overall expected long-term rate of return on assets is 8.50% per annum as of December 31, 2010. The expected long-term rate of return is based on the weighted average of historical returns on individual asset categories, which are described in more detail below. F-27 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts recognized on Consolidated Balance Sheet Other assets…………………………………………………………………………………………$ Other liabilities…….…………………………………………………………..…………..……… $ Net amount recognized……………………………………………………………………………$ Amounts recognized in accumulated other comprehensive income consists of: Net loss (gain)………………………………………………………………………………………$ Unrecognized transition asset………………..…………………………………………………… $ Net amount recognized……………………………………………………………………………$ Components of net periodic benefit cost Interest Cost………………………………………………………………………..………………$ Expected return on assets…………………………………………………………...………………$ Amortization of transition asset………………………………..……………………………………$ Amortization of net loss...……………………………………………………………………..……$ Net periodic benefit cost..……………..…..……………………………….……….………………$ Settlement (gain)/loss..……………..…..……………………………….……….…………………$ $ Total..……………..…..……………………………….……….………………….……. Benefit Obligation Recognized in Other Comprehensive Income Net loss (gain)……………………………………………………………………..……………… $ Prior service cost (credit)…………………………………………………………………………. $ Amortization of prior service cost…………………………………………………….……………$ Net amount recognized in other comprehensive income……………..…..………………………$ December 31, 2010 2009 (In thousands) - (5,902) (5,902) 8,575 - 8,575 931 (851) - 475 555 471 1,026 (454) - - (454) $ $ $ $ $ $ $ $ - (6,177) (6,177) 9,029 - 9,029 947 (697) - 675 925 - 925 (2,318) - - (2,318) The weighted average asset allocation of our pension benefits at December 31, 2010 and 2009 were as follows: Weighted Average Asset Allocation at Year-End Asset Category Equity securities……………………………………………………………………...…………$ Debt securities……………………………………………………….…………………………$ Cash and cash equivalents……………………………………………………….………………$ Total……………………………………………………………………………………………$ December 31, 2010 2009 81% 19% 0% 100% 76% 24% 0% 100% Our investment policies and strategies for the pension benefits plan utilize a target allocation of 75% equity securities and 25% fixed income securities. Our investment goals are to maximize returns subject to specific risk management policies. We address 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. F-28 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Cash Flows Estimated Future Benefit Payments (In thousands) 2011…………………………………………………………………………...…………………$ 2012…………………………………………………………………………...…………………$ 2013…………………………………………………………………………...…………………$ 2014…………………………………………………………………………...…………………$ 2015…………………………………………………………………………...…………………$ Years 2016 - 2020………………………………………………………………………..…… $ Anticipated Contributions in 2011……………………………………………..………………$ 666 699 749 791 899 4,896 653 The fair value of plan assets at December 31, 2010, by asset category, is as follows: Level 1 (1) Level 2 (2) Level 3 (3) Total Investment Name: Core Bond……………………………………… $ Fundamental Value………………………………$ Mid Cap Growth…………………………………$ Focus Value………………………………………$ Small Co. Value…………………………………$ Growth……………………………………………$ Income……………………………………………$ International Growth…………………………… $ Inflation Protected Bond…………………………$ Money Market……………………………………$ Company Common Stock……………………… $ Total……………………………………………$ $ - - - - - - - - - 11 1,039 1,050 $ ________________________ (1) Assets with quoted prices in active markets for identical assets (2) Assets with significant observable inputs (3) Assets with significant unobservable inputs (14) Fair Value Measurements $ $ (in thousands) 1,371 1,843 555 555 548 2,386 290 2,143 371 43 - 10,105 $ $ $ - - - - - - - - - - - - $ $ 1,371 1,843 555 555 548 2,386 290 2,143 371 54 1,039 11,155 In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS No. 157") (ASC 820 10 65). SFAS No. 157 (ASC 820 10 65) clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS No. 157 (ASC 820 10 65) defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The three levels are defined as follows: level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets; level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument; and level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement. In September 2008 we sold automobile contracts in a securitization that was structured as a sale for financial accounting purposes. In that sale, we retained both securities and a residual interest in the transaction that are measured at fair value. We describe below the valuation methodologies we use for the securities retained and the residual interest in the cash flows of the transaction, as well as the general classification of such instruments pursuant to the valuation hierarchy. The securities retained, which is included in Other Assets as of December 31, 2009, were sold in September 2010 in the re-securitization transaction described in Note 1. In the same transaction, the residual interest was reduced by $1.5 million. The residual interest in such securitization is $3.9 million as of F-29 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2010 and is classified as level 3 in the three-level valuation hierarchy. We determine the value of that residual interest using a discounted cash flow model that includes estimates for prepayments and losses. We use a discount rate of 20% per annum and a cumulative net loss rate of 13%. The assumptions we use are based on historical performance of automobile contracts we have originated and serviced in the past, adjusted for current market conditions. No gain or loss was recorded as a result of the re-securitization transaction described above. Repossessed vehicle inventory, which is included in Other Assets on our balance sheet, is measured at fair value using Level 2 assumptions based on our actual loss experience on sale of repossessed vehicles. At December 31, 2010, the finance receivables related to the repossessed vehicles in inventory totaled $21.0 million. We have applied a valuation adjustment of $16.3 million, resulting in an estimated fair value and carrying amount of $4.7 million. The table below presents a reconciliation for Level 3 assets measured at fair value on a recurring basis using significant unobservable inputs: Residual Interest in Securitizations: Balance at January 1……………………………………………………$ Reduction of residual interest as a result of re-securitization……………$ Included in earnings…………………………………………………… $ Balance at December 31…………………………………………………$ 2010 (in thousands) $ 4,316 (1,497) 1,022 3,841 $ 2009 (in thousands) $ 3,582 - 734 4,316 $ The following summary presents a description of the methodologies and assumptions used to estimate the fair value of our financial instruments. Much of the information used to determine fair value is highly subjective. When applicable, readily available market information has been utilized. However, for a significant portion of our financial instruments, active markets do not exist. Therefore, 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, 2010 and 2009, 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, 2010 and 2009, were as follows: December 31, 2010 2009 Carrying Value Fair Value Carrying Value Fair Value $ 16,252 123,958 552,453 3,841 6,165 45,564 3,897 39,440 567,722 44,873 20,337 $ $ $ $ $ $ (In thousands) 16,252 123,958 551,652 3,841 6,165 45,564 3,897 39,440 593,041 44,873 20,337 $ $ $ $ $ 12,433 128,511 840,092 4,316 8,573 4,932 4,267 56,930 904,833 26,118 21,965 12,433 128,511 806,154 4,316 8,573 4,932 4,267 56,930 942,075 26,118 21,965 Financial Instrument Cash and cash equivalents………………………$ Restricted cash and equivalents…………………$ Finance receivables, net…………………….… $ Residual interest in securitizations………...……$ Accrued interest receivable…………….………$ Warehouse lines of credit…………………….. $ Accrued interest payable……………………. $ Residual interest financing………………..……$ Securitization trust debt……………...…………$ Senior secured debt………………….…………$ Subordinated renewable notes…………………$ Cash, Cash Equivalents and Restricted Cash The carrying value equals fair value. Finance Receivables,net The fair value of finance receivables is estimated by discounting future cash flows expected to be collected using current rates at which similar receivables could be originated. F-30 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Residual Interest in Securitizations The fair value is estimated by discounting future cash flows using credit and discount rates that we believe reflect the estimated credit, interest rate and prepayment risks associated with similar types of instruments. Accrued Interest Receivable and Payable The carrying value approximates fair value because the related interest rates are estimated to reflect current market conditions for similar types of instruments. Warehouse Lines of Credit, Notes Payable, Residual Interest Financing, and Senior Secured Debt and Subordinated Renewable Notes The carrying value approximates fair value because the related interest rates are estimated to reflect current market conditions for similar types of secured instruments. Securitization Trust Debt The fair value is estimated by discounting future cash flows using interest rates that we believe reflects the current market rates. (15) Liquidity, Results of Operations and Management’s Plans Our business requires substantial cash to support purchases of automobile contracts and other operating activities. Our primary sources of cash have been cash flows from operating activities, including proceeds from term securitization transactions and other sales of automobile contracts, amounts borrowed under warehouse credit facilities, servicing fees on portfolios of automobile contracts previously sold in securitization transactions or serviced for third parties, customer payments of principal and interest on finance receivables, fees for origination of automobile contracts, and releases of cash from securitized portfolios of automobile contracts in which we have retained a residual ownership interest and from the spread accounts associated with such pools. Our primary uses of cash have been the purchases of automobile contracts, repayment of amounts borrowed under warehouse credit facilities 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 our cash demands. The sufficiency of internally generated cash will depend on the performance of securitized pools (which determines the level of releases from those portfolios and their related spread accounts), the rate of expansion or contraction in our managed portfolio, and the terms upon which we are able to purchase, sell, and borrow against automobile contracts. We purchase automobile contracts from dealers for a cash price approximating their principal amount, adjusted for an acquisition fee which may either increase or decrease the automobile contract purchase price. Those automobile contracts generate cash flow, however, over a period of years. As a result, we have been dependent on warehouse credit facilities to purchase automobile contracts, and on the availability of cash from outside sources in order to finance our continuing operations, as well as to fund the portion of automobile contract purchase prices not financed under revolving warehouse credit facilities. On September 25, 2009 we established a $50 million secured revolving credit facility with Fortress Credit Corp., which will mature on September 25, 2011. The facility is structured to allow us to fund a portion of the purchase price of automobile contracts by drawing against a floating rate variable funding note issued by our consolidated subsidiary Page Four Funding LLC. The facility provides for advances up to 75% of eligible finance receivables and the notes under it accrue interest at a rate of one-month LIBOR plus 12.00% per annum, with a minimum rate of 14.00% per annum. At December 31, 2010, $45.6 million was outstanding under this facility. As part of the consideration given to Fortress for committing to make loans under this facility, we issued a 10-year warrant to purchase up to 1,158,087 of our common shares, at an exercise price of $0.879 per share (we refer to this as the Fortress Warrant). Issuance of the Fortress Warrant required an adjustment to the terms of an existing outstanding warrant regarding 1,564,324 shares, reducing the exercise price of that other warrant from $1.44 per share to $1.40702 per share and increasing the number of shares available for purchase to 1,600,991. In December 2010 we entered into a $100 million two-year warehouse credit line with affiliates of Goldman, Sachs & Co. and Fortress Investment Group. The facility is structured to allow us to fund a portion of the purchase price of automobile contracts by drawing against a floating rate variable funding note issued by our consolidated subsidiary Page Six Funding, LLC. The facility provides for advances up to 75% of eligible finance receivables and F-31 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS the notes under it accrue interest at a rate of one-month LIBOR plus 5.00% per annum, with a minimum rate of 6.5% per annum. There were no amounts outstanding under this facility at December 31, 2010. Subsequent to the reporting period covered by this report, on February 24, 2011, we entered into an additional $100 million two-year warehouse credit line with UBS Real Estate Securities, Inc. The facility revolves during the first year and amortizes during the second year. The facility is structured to allow us to fund a portion of the purchase price of automobile contracts by drawing against a floating rate variable funding note issued by our consolidated subsidiary Page Seven Funding, LLC. The facility provides for advances up to 76.5% of eligible finance receivables and the notes under it accrue interest at one-month LIBOR plus 6.00% per annum. In March 2010, we entered into a $50 million term funding facility with a syndicate of note purchasers including affiliates of Angelo, Gordon & Co., L.P. and an affiliate of Cohen & Company Securities. Under the term funding facility, the note purchasers agreed to purchase up to $50 million in asset-backed notes through December 31, 2010, subject to collateral eligibility and other terms and conditions, through the end of 2010. Amounts outstanding bear interest at a fixed rate of 11.00%, which may be decreased to 9.00% should the notes receive investment grade ratings from at least two of the following three credit rating agencies: Moody's, Standard & Poor's, or Fitch. Principal payments on the notes are due as the underlying receivables are paid or charged off, and the final maturity is July 17, 2017. In connection with the establishment of this term funding facility, we paid a closing fee of $750,000 and issued to certain of the note purchasers or their designees warrants to purchase 500,000 shares of our common stock at an exercise price of $1.41 per share (we refer to this as the Page Five Warrant). Issuance of the Page Five Warrant required adjustments to the terms of two existing outstanding warrants. The first warrant related to 1,600,991 shares, on which the exercise price was decreased from $1.407 per share to $1.398 per share and the number of shares available for purchase was increased to 1,611,114. The second affected warrant related to 283,985 shares, which was increased to 285,781 shares. As of December 31, 2010, there was $42.5 million outstanding under the facility and no additional advances are expected to be made. In July 2007, we established a combination term and revolving residual credit facility and have used eligible residual interests in securitizations as collateral for floating rate borrowings. The amount that we were able to borrow was computed using an agreed valuation methodology of the residuals, subject to an overall maximum principal amount of $120 million, represented by (i) a $60 million Class A-1 variable funding note (the “revolving note”), and (ii) a $60 million Class A-2 term note (the “term note”). The term note was fully drawn in July 2007 and was originally due in July 2009. As of July 2008, we had drawn $26.8 million on the revolving note. The facility’s revolving feature expired in July 2008. On July 10, 2008 we amended the terms of the combination term and revolving residual credit facility, (i) eliminating the revolving feature and increasing the interest rate, (ii) consolidating the amounts then owing on the Class A-1 note with the Class A-2 note, (iii) establishing an amortization schedule for principal reductions on the Class A-2 note, and (iv) providing for an extension, at our option if certain conditions were met, of the Class A-2 note maturity from June 2009 to June 2010. In June 2009 we met all such conditions and extended the maturity. In conjunction with the amendment, we reduced the principal amount outstanding to $70 million by delivering to the lender (i) warrants valued as being equivalent to 2,500,000 common shares, or $4,071,429, and (ii) cash of $12,765,244. The warrants represent the right to purchase 2,500,000 CPS common shares at a nominal exercise price, at any time prior to July 10, 2018. In May 2010, we extended the maturity date from June 2010 to May 2011. As of December 31, 2010 the aggregate indebtedness under this facility was $39.4 million. On June 30, 2008, we entered into a series of agreements pursuant to which an affiliate of Levine Leichtman Capital Partners purchased a $10 million five-year, fixed rate, senior secured note from us. The indebtedness is secured by substantially all of our assets, though not by the assets of our special-purpose financing subsidiaries. In July 2008, in conjunction with the amendment of the combination term and revolving residual credit facility as discussed above, the lender purchased an additional $15 million note with substantially the same terms as the $10 million note. Pursuant to the June 30, 2008 securities purchase agreement, we issued to the lender 1,225,000 shares of common stock. In addition, we issued the lender two warrants: (i) warrants that we refer to as the FMV Warrants, which are exercisable for 1,611,114 shares of our common stock, at an exercise price of $1.39818 per share, and (ii) warrants that we refer to as the N Warrants, which are exercisable for 285,781 shares of our common stock, at a nominal exercise price. Both the FMV Warrants and the N Warrants are exercisable in whole or in part and at any time up to and including June 30, 2018. We valued the warrants using the Black-Scholes valuation model and recorded their value as a liability on our balance sheet because the terms of the warrants also included a provision whereby the lender could require us to purchase the warrants for cash. That provision was eliminated by mutual agreement in September 2008. The FMV Warrants were initially exercisable to purchase 1,500,000 shares for F-32 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS $2.573 per share, were adjusted in connection with the July 2008 issuance of other warrants to become exercisable to purchase 1,564,324 shares at $2.4672 per share, and were further adjusted in connection with a July 2009 amendment of our option plan to become exercisable at $1.44 per share. Upon issuance in September 2009 of the Fortress Warrant, the FMV Warrant was further adjusted to become exercisable to purchase 1,600,991 shares at an exercise price of $1.407 per share. Upon issuance in March 2010 of the Page Five Warrant, the FMV Warrant was further adjusted to become exercisable to purchase 1,611,114 shares at an exercise price of $1.39818 per share. In November 2009 we entered into an additional agreement with this lender whereby they purchased an additional $5 million note. The note accrued interest at 15.0% and was repaid in December 2010 at which time the lender purchased a new $27.8 million note under substantially the same terms as the $10 million and $15 million notes already outstanding. The $27.8 million note accrues interest at 16.0% and matures in December 2013. Concurrent with the issuance of the $27.8 million note, the terms of the $10 and $15 million notes were amended to change their maturity dates to December 2013. In conjunction with the issuance of the $27.8 million note, we issued to the lender 880,000 shares of common stock and 1,870 shares of Series B convertible preferred stock. Each share of the Series B convertible preferred stock may become exchangeable for 1,000 shares of our common stock, upon shareholder approval of such exchange, but not without shareholder approval. At the time of issuance, the value of the common stock and Series B preferred stock was $753,000 and $1.6 million, respectively. The acquisition of automobile 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 our automobile contract purchases, the required level of initial credit enhancement in securitizations, and the extent to which the previously established trusts and their related spread accounts either release cash to us or capture cash from collections on securitized automobile contracts. Of those, the factor most subject to our control is the rate at which we purchase automobile contracts. We are and may in the future be limited in our ability to purchase automobile contracts due to limits on our capital. As of December 31, 2010, we had unrestricted cash of $16.3 million. We had $4.4 million available under our Fortress facility and $100 million available under the Goldman facility (in both facilities advances are subject to available eligible collateral). As stated above, we established a second $100 million revolving credit facility in February 2011. In September 2010 we completed a securitization of previously securitized receivables, and we intend to complete securitizations regularly beginning in 2011, although there can be no assurance that we will be able to so. Our plans to manage our liquidity include maintaining our rate of automobile contract purchases at a level that matches our available capital, and, wherever appropriate, reducing our operating costs. If we are unable to complete such securitizations, we may be unable to increase our rate of automobile contract purchases, in which case our interest income and other portfolio related income would decrease. Our liquidity will also be affected by releases of cash from the trusts established with our securitizations. While the specific terms and mechanics of each spread account vary among transactions, our securitization agreements generally provide that we will receive excess cash flows, if any, only if the amount of credit enhancement has reached specified levels and/or the delinquency, defaults or net losses related to the automobile contracts in the pool are below certain predetermined levels. In the event delinquencies, defaults or net losses on the automobile 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 us of excess cash flows associated with other pools; or (iii) in certain circumstances, may permit the insurers to require the transfer of servicing on some or all of the automobile contracts to another servicer. There can be no assurance that collections from the related trusts will continue to generate sufficient cash. Moreover, most of our spread account balances are pledged as collateral to our residual interest financing. As such, most of the current releases of cash from our securitization trusts are directed to pay the obligations of our residual interest financing. Certain of our securitization transactions, our warehouse credit facilities and our residual interest financing contain various financial covenants requiring certain minimum financial ratios and results. Such covenants include maintaining minimum levels of liquidity and net worth and not exceeding maximum leverage levels and maximum financial losses. In addition, certain securitization and non-securitization related debt contain cross-default provisions that would allow certain creditors to declare a default if a default occurred under a different facility. The agreements under which we receive periodic fees for servicing automobile contracts in securitizations are terminable by the respective insurance companies upon defined events of default, and, in some cases, at the will of the insurance company. We have received waivers regarding the potential breach of certain such covenants relating F-33 CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS to minimum net worth, financial loss in any one period and maintenance of active warehouse credit facilities. Without such waivers, certain credit enhancement providers would have had the right to terminate us as servicer with respect to certain of our outstanding securitization pools. Although such rights have been waived, such waivers are temporary, and there can be no assurance as to their future extension. We do, however, believe that we will obtain such future extensions because it is generally not in the interest of any party to the securitization transaction to transfer servicing. Nevertheless, there can be no assurance as to our belief being correct. Were an insurance company in the future to exercise its option to terminate such agreements, such a termination could have a material adverse effect on our liquidity and results of operations, depending on the number and value of the terminated agreements. Our note insurers continue to extend our term as servicer on a monthly and/or quarterly basis, pursuant to the servicing agreements. The agreements for our residual interest financing, revolving credit facility and term funding facility include financial covenants which, if breached, would be an event of default. We have entered into an amendment that avoided the potential breach of a minimum net worth covenant on the revolving credit facility. Without such amendment, the lender could have, among other things, ceased providing funding to us for new contract purchases, terminated us as servicer of the pledged receivables and sold the pledged contracts to satisfy the debt. Our plan for future operations and meeting the obligations of our financing arrangements includes returning to profitability by gradually increasing the amount of our contract purchases with the goal of increasing the balance of our outstanding managed portfolio. Our plans also include financing future contract purchases with credit facilities and term securitizations that offer a lower overall cost of funds compared to the facilities we used in 2009 and 2010. To illustrate, in the last six months of 2009 we purchased $6.1 million in contracts and our sole credit facility had a minimum interest rate of 14.00% per annum. By comparison, in 2010, we purchased $113.0 million in contracts and, in March 2010, entered into the $50 million term funding facility which has an interest rate of 11.00% per annum and the ability to decrease such rate to 9.00% per annum if certain conditions are met. In December 2010 we entered into a $100 million credit facility with an interest rate of one-month LIBOR plus 5.00% per annum, with a minimum rate of 6.5% per annum and in February 2011, we added another $100 million credit facility with an interest rate of one-month LIBOR plus 6.00% per annum. Moreover, the weighted average effective coupon of our September 2010 term securitization was 3.21% and did not include a financial guaranty policy. This transaction demonstrates our ability to access the lower cost of funds available in the current market environment without the financial guaranties we historically incorporated into our term securitization structures. We expect to complete one or more term securitizations in 2011. In addition, less competition in the auto financing marketplace has resulted in better terms for our recent contract purchases compared to prior years. For the years ended December 31, 2010, 2009 and 2008, the average acquisition fee we charged per automobile contract purchased under our CPS programs was $1,382, $1,508 and $592, respectively, or 9.2%, 11.7%, and 3.9%, respectively, of the amount financed. Similarly, the weighted average annual percentage rate of interest payable by our customers on newly purchased contracts has increased significantly: to 20.05% for 2010 from 19.9%, and 18.5% in 2009 and 2008, respectively. We have and will continue to have a substantial amount of indebtedness. At December 31, 2010, we had approximately $717.9 million of debt outstanding. Such debt consisted primarily of $567.7 million of securitization trust debt, and also included $45.6 million of a warehouse line of credit, $39.4 million of residual interest financing, $44.9 million of senior secured related party debt and $20.3 million owed in subordinated notes. We are also currently offering the subordinated notes to the public on a continuous basis, and such notes have maturities that range from three months to 10 years. The residual interest financing facility matures in May 2011 and we are in discussions with the lender regarding the extension or restructuring of the facility, as to which there can be no assurance. Our recent operating results include net losses of $33.8 million and $57.2 million in 2010 and 2009, respectively. We believe that our results have been materially and adversely affected by the disruption in the capital markets that began in the fourth quarter of 2007, by the recession that began in December 2007, and by related high levels of unemployment. Our ability to repay or refinance maturing debt may be adversely affected by prospective lenders’ consideration of our recent operating losses. Although we believe we are able to service and repay our debt, there is no assurance that we will be able to do so. If our plans for future operations do not generate sufficient cash flows and operating profits, our ability to make required payments on our debt would be impaired. Failure to pay our indebtedness when due could have a material adverse effect and may require us to issue additional debt or equity securities. F-34 [This page intentionally left blank.] [This page intentionally left blank.]

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