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Table of Contents

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

or

¨Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

 

For the transition period from __________ to __________

For the quarterly period ended September 30, 2020

 

Commission file number: 1-11416

 

CONSUMER PORTFOLIO SERVICES, INC.

(Exact name of registrant as specified in its charter)

 

California 33-0459135
(State or other jurisdiction of incorporation or organization) (IRS Employer Identification No.)
   

3800 Howard Hughes Parkway, Suite 1400,

Las Vegas, Nevada

89169
(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including Area Code: (949) 753-6800

 

Former name, former address and former fiscal year, if changed since last report: N/A

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class Trading Symbol(s) Name of each exchange on which registered
Common Stock, no par value CPSS The Nasdaq Stock Market LLC (Global Market)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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  ☒    No  ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

 

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 
Emerging growth company   

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ☐    No  ☒ 

 

As of October 28, 2020 the registrant had 22,565,112 common shares outstanding.

 

 

 

 

 

 

 

 

   

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

INDEX TO FORM 10-Q

For the Quarterly Period Ended September 30, 2020

 

    Page
PART I. FINANCIAL INFORMATION
     
Item 1. Financial Statements  
  Unaudited Condensed Consolidated Balance Sheets as of September 30, 2020 and December 31, 2019 3
  Unaudited Condensed Consolidated Statements of Operations for the three-month and nine-month periods ended September 30, 2020 and 2019 4
  Unaudited Condensed Consolidated Statements of Comprehensive Income for the three-month and nine-month periods ended September 30, 2020 and 2019 5
  Unaudited Condensed Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 2020 and 2019 6
  Unaudited Condensed Consolidated Statements of Shareholders’ Equity for the three-month and nine-month periods ended September 30, 2020 and 2019 7
  Notes to Unaudited Condensed Consolidated Financial Statements 8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 26
Item 4. Controls and Procedures 46
 
PART II. OTHER INFORMATION
     
Item 1. Legal Proceedings 47
Item 1A. Risk Factors 47
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 50
Item 6. Exhibits 50
  Signatures

51

 

 

 

 

 

 

 

 

 

 2 

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

 

   September 30,   December 31, 
   2020   2019 
ASSETS          
Cash and cash equivalents  $11,253   $5,295 
Restricted cash and equivalents   200,912    135,537 
Finance receivables measured at fair value   1,540,955    1,444,038 
           
Finance receivables   577,281    897,530 
Less: Allowance for finance credit losses   (94,218)   (11,640)
Finance receivables, net   483,063    885,890 
           
Furniture and equipment, net   988    1,512 
Deferred tax assets, net   31,026    15,480 
Accrued interest receivable   6,291    11,645 
Other assets   34,744    39,852 
Total Assets  $2,309,232   $2,539,249 
           
LIABILITIES AND SHAREHOLDERS' EQUITY          
Liabilities          
Accounts payable and accrued expenses  $49,056   $47,077 
Warehouse lines of credit   31,201    134,791 
Residual interest financing   32,000    39,478 
Securitization trust debt   2,048,089    2,097,728 
Subordinated renewable notes   20,242    17,534 
Total Liabilities   2,180,588    2,336,608 
COMMITMENTS AND CONTINGENCIES          
Shareholders' Equity          
Preferred stock, $1 par value; authorized 4,998,130 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; none issued        
Common stock, no par value; authorized 75,000,000 shares; 22,508,862 and 22,530,918 shares issued and outstanding at September 30, 2020 and December 31, 2019, respectively   72,197    71,257 
Retained earnings   64,868    139,805 
Accumulated other comprehensive loss   (8,421)   (8,421)
Total stockholders' equity   128,644    202,641 
           
Total liabilities and stockholders' equity  $2,309,232   $2,539,249 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

 

 

 3 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

 

 

                     
   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2020   2019   2020   2019 
Revenues:                    
Interest income  $72,582   $82,924   $227,271   $253,218 
Mark to finance receivables measured at fair value   (3,152)   604    (23,051)   604 
Other income   1,239    1,994    4,508    6,255 
Total revenues   70,669    85,522    208,728    260,077 
                     
Expenses:                    
Employee costs   19,155    20,251    60,826    59,030 
General and administrative   7,846    8,185    24,352    25,109 
Interest   24,901    27,940    78,377    82,933 
Provision for credit losses   7,400    19,874    14,113    64,319 
Sales   3,202    4,407    10,710    13,877 
Occupancy   1,838    1,760    5,362    5,745 
Depreciation and amortization   438    276    1,344    789 
Total operating expenses   64,780    82,693    195,084    251,802 
Income before income tax expense (benefit)   5,889    2,829    13,644    8,275 
Income tax expense (benefit)   2,121    991    (3,888)   2,898 
Net income  $3,768   $1,838   $17,532   $5,377 
                     
Earnings per share:                    
Basic  $0.17   $0.08   $0.77   $0.24 
Diluted   0.16    0.08    0.74    0.22 
                     
Number of shares used in computing earnings per share:                    
Basic   22,666    22,526    22,630    22,378 
Diluted   23,908    24,066    23,825    24,102 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

 

 

 4 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

 

 

                     
   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2020   2019   2020   2019 
Net income  $3,768   $1,838   $17,532   $5,377 
                     
Other comprehensive income/(loss); change in funded status of pension plan                
Comprehensive income  $3,768   $1,838   $17,532   $5,377 

 

 

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 5 

 

 

CONSUMER PORTFOLIO SERVICES, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

           
   Nine Months Ended 
   September 30, 
   2020   2019 
Cash flows from operating activities:          
Net income  $17,532   $5,377 
Adjustments to reconcile net income to net cash provided by operating activities:          
Accretion of deferred acquisition fees and origination costs   910    1,374 
Net interest income accretion on fair value receivables   98,060    64,131 
Depreciation and amortization   1,344    789 
Amortization of deferred financing costs   6,128    6,226 
Mark to finance receivables measured at fair value   23,051    (604)
Provision for credit losses   14,113    64,319 
Stock-based compensation expense   1,437    1,496 
Changes in assets and liabilities:          
Accrued interest receivable   5,354    19,240 
Deferred tax assets, net   18,985    3,063 
Other assets   1,673    2,708 
Accounts payable and accrued expenses   1,979    1,870 
Net cash provided by operating activities   190,566    169,989 
           
Cash flows from investing activities:          
Payments received on finance receivables held for investment   260,804    379,365 
Purchases of finance receivables measured at fair value   (572,938)   (756,555)
Payments received on finance receivables at fair value   354,910    200,889 
Change in repossessions held in inventory   3,435    (733)
Purchase of furniture and equipment   (820)   (654)
Net cash provided by (used in) investing activities   45,391    (177,688)
           
Cash flows from financing activities:          
Proceeds from issuance of securitization trust debt   714,543    726,188 
Proceeds from issuance of subordinated renewable notes   5,120    1,452 
Payments on subordinated renewable notes   (2,412)   (3,213)
Net advances (repayments) of warehouse lines of credit   (104,685)   20,914 
Repayment of residual interest financing debt   (7,757)    
Repayment of securitization trust debt   (764,075)   (723,205)
Payment of financing costs   (4,861)   (6,099)
Purchase of common stock   (967)   (1,440)
Exercise of options and warrants   470    347 
Net cash provided by (used in) financing activities   (164,624)   14,944 
Increase in cash and cash equivalents   71,333    7,245 
Cash and restricted cash at beginning of period   140,832    130,110 
Cash and restricted cash at end of period  $212,165   $137,355 
           
Supplemental disclosure of cash flow information:          
Cash paid (received) during the period for:          
Interest  $72,565   $76,269 
Income taxes  $(17,561)  $(3,231)
Non-cash financing activities:          
Right-of-use asset, net  $   $(21,869)
Lease liability  $   $23,327 
Deferred office rent  $   $(1,458)

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

 

 

 6 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In thousands)

 

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2020   2019   2020   2019 
Common Stock (Shares Outstanding)                    
Balance, beginning of period   22,715    22,526    22,531    22,422 
Common stock issued upon exercise of options and warrants   13        269    483 
Repurchase of common stock   (219)       (291)   (379)
Balance, end of period   22,509    22,526    22,509    22,526 
                     
Common Stock                    
Balance, beginning of period  $72,402   $70,299   $71,257   $70,273 
Common stock issued upon exercise of options and warrants   18        470    347 
Repurchase of common stock   (762)       (967)   (1,440)
Stock-based compensation   539    377    1,437    1,496 
Balance, end of period  $72,197   $70,676   $72,197   $70,676 
                     
Retained Earnings                    
Balance, beginning of period  $61,100   $137,938   $139,805   $134,399 
Cumulative change in accounting principle (Note 2)           (92,469)    
Balance, beginning of period (as adjusted for change in accounting principle)  $61,100   $137,938   $47,336   $134,399 
Net income   3,768    1,838    17,532    5,377 
Balance, end of period  $64,868   $139,776   $64,868   $139,776 
                     
Accumulated Other Comprehensive Loss                    
Balance, beginning of period  $(8,421)  $(7,554)  $(8,421)  $(7,554)
Pension benefit obligation                
Balance, end of period  $(8,421)  $(7,554)  $(8,421)  $(7,554)
                     
Balance, beginning of period                   
Pension benefit obligation                   
Total Shareholders' Equity  $128,644   $202,898   $128,644   $202,898 

 

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

 

 

 

 7 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

(1) Summary of Significant Accounting Policies

 

Description of Business

 

We were formed in California on March 8, 1991. We specialize in purchasing and servicing retail automobile installment sale contracts (“automobile contracts” or “finance receivables”) originated by licensed motor vehicle dealers located throughout the United States (“dealers”) in the sale of new and used automobiles, light trucks and passenger vans. Through our purchases, we provide indirect financing to dealer customers for borrowers with limited credit histories or past credit problems (“sub-prime customers”). We serve as an alternative source of financing for dealers, allowing sales to customers who otherwise might not be able to obtain financing. In addition to purchasing installment purchase contracts directly from dealers, we have also (i) lent money directly to consumers for loans secured by vehicles, (ii) purchased immaterial amounts of vehicle purchase money loans from non-affiliated lenders, and (iii) acquired installment purchase contracts in four merger and acquisition transactions. In this report, we refer to all of such contracts and loans as "automobile contracts."

 

Basis of Presentation

 

Our Unaudited Condensed Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America, with the instructions to Form 10-Q and with Article 10 of Regulation S-X of the Securities and Exchange Commission, and include all adjustments that are, in management’s opinion, necessary for a fair presentation of the results for the interim periods presented. All such adjustments are, in the opinion of management, of a normal recurring nature. Results for the nine-month period ended September 30, 2020 are not necessarily indicative of the operating results to be expected for the full year.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted from these Unaudited Condensed Consolidated Financial Statements. These Unaudited Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2019.

 

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.

 

Finance Receivables Measured at Fair Value

 

Effective January 1, 2018, we adopted the fair value method of accounting for finance receivables acquired on or after that date. For each finance receivable acquired after 2017, we consider the price paid on the purchase date as the fair value for such receivable.  We estimate the cash to be received in the future with respect to such receivables, based on our experience with similar receivables acquired in the past.  We then compute the internal rate of return that results in the present value of those estimated cash receipts being equal to the purchase date fair value. Thereafter, we recognize interest income on such receivables on a level yield basis using that internal rate of return as the applicable interest rate. Cash received with respect to such receivables is applied first against such interest income, and then to reduce the recorded value of the receivables.

 

 

 

 

 8 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

We re-evaluate the fair value of such receivables at the close of each measurement period. If the reevaluation were to yield a value materially different from the recorded value, an adjustment would be required. Results for the third quarter include the estimated potential effect on credit performance resulting from the COVID-19 pandemic. We recorded a $3.2 million mark down to the recorded value of the portion of the receivables portfolio accounted for at fair value in the third quarter, $9.5 million in the second quarter, and $10.4 million in the first quarter. The mark down is reflected as a reduction in revenue for each period.

 

Anticipated credit losses are included in our estimation of cash to be received with respect to receivables.  Because such credit losses are included in our computation of the appropriate level yield, we do not thereafter make periodic provision for credit losses, as our best estimate of the lifetime aggregate of credit losses is included in that initial computation. Also, because we include anticipated credit losses in our computation of the level yield, the computed level yield is materially lower than the average contractual rate applicable to the receivables. Because our initial recorded value is fixed as the price we pay for the receivable, rather than as the contractual principal balance, we do not record acquisition fees as an amortizing asset related to the receivables, nor do we capitalize costs of acquiring the receivables. Rather we recognize the costs of acquisition as expenses in the period incurred.

 

Other Income

 

The following table presents the primary components of Other Income for the three-month and nine-month periods ending September 30, 2020 and 2019:

 

  Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2020   2019   2020   2019 
   (In thousands)   (In thousands) 
Direct mail revenues  $760  $1,121   $2,444   $3,508 
Convenience fee revenue   280    600    1,340    1,870 
Recoveries on previously charged-off contracts   4    30    79    132 
Sales tax refunds   192    200    601    631 
Other   3    43    44    114 
Other income for the period  $1,239  $1,994   $4,508   $6,255 

 

Leases

 

The Company has operating leases for corporate offices, equipment, software and hardware. The Company has entered into operating leases for the majority of its real estate locations, primarily office space. These leases are generally for periods of three to seven years with various renewal options. The depreciable life of leased assets is limited by the expected lease term. Leases with an initial term of 12 months or less are not recorded on the balance sheet and the related lease expense is recognized on a straight-line basis over the lease term.

 

 

 

 

 9 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

The following table presents the supplemental balance sheet information related to leases:

 

  September,   December 31, 
   2020   2019 
   (In thousands) 
Operating Leases          
Operating lease right-of-use assets  $23,735   $23,735 
Less: Accumulated amortization right-of-use assets   (11,280)   (6,600)
Operating lease right-of-use assets, net  $12,455   $17,135 
           
Operating lease liabilities  $(13,698)  $(18,527)
           
Finance Leases          
Property and equipment, at cost  $3,352   $876 
Less: Accumulated depreciation   (945)   (150)
Property and equipment, net  $2,407   $726 
           
Finance lease liabilities  $(2,457)  $(718)
           
Weighted Average Discount Rate          
Operating lease   5.0%   5.0%
Finance lease   6.5%   6.4%

 

Maturities of lease liabilities were as follows:

          
(In thousands)  Operating   Finance 
Year Ending December 31,  Lease   Lease 
2020 (excluding the nine months ended September 30, 2020)  $1,959   $305 
2021   7,458    1,217 
2022   6,066    1,038 
2023   1,397    71 
2024   419    14 
Thereafter   282     
Total undiscounted lease payments   17,581    2,645 
Less amounts representing interest   (4,524)   (188)
Lease Liability  $13,698   $2,457 

 

 

 

 

 10 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

The following table presents the lease expense included in General and administrative and Occupancy expense on our Unaudited Condensed Consolidated Statement of Operations:

 

                    
  Three Months Ended   Nine Months Ended 
  September 30,   September 30, 
   2020   2019   2020   2019 
   (In thousands)   (In thousands) 
Operating lease cost  $1,885  $1,884   $5,654   $5,659 
Finance lease cost   299    46    871    90 
Total lease cost  $2,184  $1,930   $6,525   $5,749 

 

The following table presents the supplemental cash flow information related to leases:

 

                    
  Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2020   2019   2020   2019 
Cash paid for amounts included in the measurement of lease liabilities:  (In thousands)   (In thousands) 
Operating cash flows from operating leases  $1,945  $1,901   $5,803   $5,678 
Operating cash flows from finance leases   256    37    737    73 
                     
Financing cash flows from finance leases   42    9    133    17 

 

Stock-based Compensation

 

We recognize compensation costs in the financial statements for all share-based payments based on the grant date fair value estimated in accordance with the provisions of ASC 718 “Stock Compensation”.

 

For the three and nine months ended September 30, 2020, we recorded stock-based compensation costs in the amount of $539,000 and $1.4 million respectively. These stock-based compensation costs were $377,000 and $1.5 million for the three and nine months ended September 30, 2019. As of September 30, 2020, unrecognized stock-based compensation costs to be recognized over future periods equaled $3.7 million. This amount will be recognized as expense over a weighted-average period of 2.4 years.

 

 

 

 

 

 11 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

The following represents stock option activity for the nine months ended September 30, 2020:

 

  Number of Shares (in thousands)   Weighted Average Exercise Price   Weighted Average Remaining Contractual Term
Options outstanding at the beginning of period   15,348   $4.59   N/A
Granted   1,600    2.47   N/A
Exercised   (269)   1.75   N/A
Forfeited   (215)   5.55   N/A
Options outstanding at the end of period   16,464   $4.41   3.07 years
              
Options exercisable at the end of period   12,816   $4.78   2.30 years

 

At September 30, 2020, the aggregate intrinsic value of options outstanding and exercisable was $5.5 million and $4.1 million, respectively. There were 269,100 options exercised for the nine months ended September 30, 2020 compared to 482,500 for the comparable period in 2019. The total intrinsic value of options exercised was $308,000 and $1.4 million for the nine-month periods ended September 30, 2020 and 2019. There were 72,581 shares available for future stock option grants under existing plans as of September 30, 2020.

 

Purchases of Company Stock

 

The table below describes the purchase of our common stock for the nine-month ended September 30, 2020 and 2019:

 

  Nine Months Ended 
   September 30, 2020   September 30, 2019 
   Shares   Avg. Price   Shares   Avg. Price 
Open market purchases   44,247   $2.94    335,546   $3.95 
Shares redeemed upon net exercise of stock options   46,909    2.86    18,424    3.76 
Other purchases   200,000    3.51    24,500    4.20 
Total stock purchases   291,156   $3.32    378,470   $3.97 

 

Reclassifications

 

Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications had no effect on net income or shareholders’ equity.

 

 

 

 

 12 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

Financial Covenants

 

Certain of our securitization transactions, our warehouse credit facilities and our residual interest financing contain various financial covenants requiring minimum financial ratios and results. Such covenants include maintaining minimum levels of liquidity and net worth and not exceeding maximum leverage levels. As of September 30, 2020, we were in compliance with all such covenants. In addition, certain of our debt agreements other than our term securitizations contain cross-default provisions. Such cross-default provisions would allow the respective creditors to declare a default if an event of default occurred with respect to other indebtedness of ours, but only if such other event of default were to be accompanied by acceleration of such other indebtedness.

 

Provision for Contingent Liabilities

 

We are routinely involved in various legal proceedings resulting from our consumer finance activities and practices, both continuing and discontinued. Our legal counsel has advised us on such matters where, based on information available at the time of this report, there is an indication that it is both probable that a liability has been incurred and the amount of the loss can be reasonably determined.

 

Adoption of New Accounting Standards

 

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") 2016-13, which changes the criteria under which credit losses on financial instruments (such as the Company’s finance receivables) are measured. ASU 2016-3 introduces a new credit reserving model known as the Current Expected Credit Loss (“CECL”) model, which replaces the incurred loss impairment methodology previously used under U.S. GAAP with a methodology that records currently the expected lifetime credit losses on financial instruments. To establish such lifetime credit loss estimates, consideration of a broadened range of reasonable and supportable information to establish credit loss estimates is required. ASU 2016-13 was initially scheduled to become effective for interim and annual reporting periods beginning after December 15, 2019, however on October 16, 2019, the FASB changed the effective date for smaller reporting companies to interim and annual reporting periods beginning after December 15, 2022, with early adoption permitted.

 

Effective January 1, 2020, the Company adopted the CECL model. The adoption of CECL required that we establish an allowance for the remaining expected lifetime credit losses on the portion of the Company’s receivable portfolio for which the Company was not already using fair value accounting. We refer to that portion, which is those receivables that were originated prior to January 2018, as our “legacy portfolio”. To comply with CECL, the Company recorded an addition to its allowance for finance credit losses of $127.0 million. In accordance with the rules for adopting CECL, the offset to the addition to the allowance for finance credit losses was a tax affected reduction to retained earnings using the modified retrospective method, and not a current period expense.

 

Coronavirus Pandemic

 

In December 2019, a new strain of coronavirus (the “COVID-19 virus”) originated in Wuhan, China. Since its discovery, the COVID-19 virus has spread throughout the world, and the outbreak has been declared to be a pandemic by the World Health Organization. We refer from time to time in this report to the outbreak and spread of the COVID-19 virus as “the pandemic.”

 

Results for the nine-month period ending September 30, 2020 include the estimated potential effect on credit performance resulting from the pandemic. We recorded a $14.1 million charge to the provision for credit losses for the legacy portfolio accounted for under CECL and a $23.1 million mark down to the recorded value of the finance receivables measured at fair value.

 

 

 

 

 13 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

The pandemic itself, if sufficient numbers of people were to be afflicted, could cause obligors under our automobile contracts to be unable to pay their contractual obligations. As the future course of the COVID-19 pandemic is as yet unknown, its direct effect on future obligor payments is likewise uncertain.

 

The mandatory shutdown of large portions of the United States economy pursuant to emergency restrictions has impaired and will impair the ability of obligors under our automobile contracts to pay their contractual obligations. The extent to which that ability will be impaired, and the extent to which public ameliorative measures such as stimulus payments and enhanced unemployment benefits may restore such ability, cannot be estimated.

 

We measure our portfolio of finance receivables carried at fair value with consideration for unobservable inputs that reflect our own assumptions about the factors that market participants use in pricing similar receivables and are based on the best information available in the circumstances. They include such inputs as estimates for the magnitude and timing of net charge-offs and the rate of amortization of the portfolio. The pandemic and the adverse effect it may have on the U.S. economy and our obligors may cause us to consider significant changes in any of those inputs, which in turn may have a significant effect on our fair value measurement.

 

(2) Finance Receivables

 

Our portfolio of finance receivables consists of small-balance homogeneous contracts comprising a single segment and class that is collectively evaluated for impairment on a portfolio basis according to delinquency status. Our contract purchase guidelines are designed to produce a homogenous portfolio. For key terms such as interest rate, length of contract, monthly payment and amount financed, there is relatively little variation from the average for the portfolio. 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.

 

In January 2018 the Company adopted the fair value method of accounting for finance receivables acquired after 2017. Finance receivables measured at fair value are recorded separately on the Company’s Balance Sheet and are excluded from all tables in this footnote.

 

The following table presents the components of Finance Receivables, net of unearned interest:

 

  September 30,   December 31, 
   2020   2019 
   (In thousands) 
Finance receivables    
Automobile finance receivables, net of unearned interest  $576,227   $895,566 
Unearned acquisition fees and originations costs   1,054    1,964 
Finance receivables  $577,281   $897,530 

 

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, as extended where applicable. Automobile contracts less than 31 days delinquent are not included. In certain circumstances we will grant obligors one-month payment extensions to assist them with temporary cash flow problems. The only modification of terms is to advance the obligor’s next due date by one month and extend the maturity date of the receivable by one month. In certain limited cases, a two-month extension may be granted. There are no other concessions such as a reduction in interest rate, forgiveness of principal or of accrued interest. Accordingly, we consider such extensions to be insignificant delays in payments rather than troubled debt restructurings. The following table summarizes the delinquency status of finance receivables as of September 30, 2020 and December 31, 2019:

 

 

 

 14 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

 

  September 30,   December 31, 
   2020   2019 
   (In thousands) 
Delinquency Status          
Current   $490,096   $698,870 
31 - 60 days   57,463    107,951 
61 - 90 days   21,760    57,395 
91 + days   6,908    31,350 
   $576,227   $895,566 

 

Finance receivables totaling $6.9 million and $31.4 million at September 30, 2020 and December 31, 2019, respectively, including all receivables greater than 90 days delinquent, have been placed on non-accrual status as a result of their delinquency status.

 

Allowance for Credit Losses – Finance Receivables

 

The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of finance receivables to present the net amount expected to be collected. Charge offs are deducted from the allowance when management believes that collectability is unlikely.

 

Management estimates the allowance using relevant available information, from internal and external sources, relating to past events, current conditions and, reasonable and supportable forecasts. We believe our historical credit loss experience provides the best basis for the estimation of expected credit losses. Consequently, we use historical loss experience for older receivables, aggregated into vintage pools based on their calendar quarter of origination, to forecast expected losses for less seasoned quarterly vintage pools.

 

We measure the weighted average monthly incremental change in cumulative net losses for the vintage pools in the relevant historical period. For the pools in the relevant historical period, we consider each pool’s performance from its inception through the end of the current period. We then apply the results of the historical analysis to less seasoned vintage pools beginning with each vintage pool’s most recent actual cumulative net loss experience and extrapolating from that point based on the historical data. We believe the pattern and magnitude of losses on older vintages allows us to establish a reasonable and supportable forecast of less seasoned vintages.

 

Our contract purchase guidelines are designed to produce a homogenous portfolio. For key credit characteristics of individual contracts such as obligor credit history, job stability, residence stability and ability to pay, there is relatively little variation from the average for the portfolio. Similarly, for key structural characteristics such as loan-to-value, length of contract, monthly payment and amount financed, there is relatively little variation from the average for the portfolio. Consequently, we do not believe there are significant differences in risk characteristics between various segments of our portfolio.

 

Our methodology incorporates historical pools that are sufficiently seasoned to capture the magnitude and trends of losses within those vintage pools. Furthermore, the historical period encompasses a substantial volume of receivables over periods that include fluctuations in the competitive landscape, the Company’s rates of growth, size of our managed portfolio and fluctuations in economic growth and unemployment.

 

In consideration of the depth and breadth of the historical period, and the homogeneity of our portfolio, we generally do not adjust historical loss information for differences in risk characteristics such as credit or structural composition of segments of the portfolio or for changes in environmental conditions such as changes in unemployment rates, collateral values or other factors. However, we have considered how certain qualitative factors may affect future credit losses and have incorporated our judgement of the effect of such factors into our estimates.

 

 

 

 15 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

The following table presents the amortized cost basis of our finance receivables by annual vintage as of September 30, 2020 and December 31, 2019.

 

 

  September 30,   December 31, 
   2020   2019 
Annual Vintage Pool  (In thousands) 
2012 and prior  $851   $2,432 
2013   6,212    15,489 
2014   29,878    61,290 
2015   95,522    162,242 
2016   190,788    292,360 
2017   252,976    361,753 
   $576,227   $895,566 

 

At the adoption of CECL, the Company recorded an addition to its allowance for finance credit losses of $127.0 million. In accordance with the rules for adopting CECL, the offset to the addition to the allowance for finance credit losses was a tax affected reduction to retained earnings using the modified retrospective method.

 

In consideration of the uncertainty associated with the pandemic, the Company made additional provision for credit losses on finance receivables for the for the three-month and nine-month periods ended September 30, 2020, in the amounts of $7.4 million and $14.1 million, respectively.

 

The following table presents a summary of the activity for the allowance for finance credit losses for the three-month and nine-month periods ended September 30, 2020 and 2019:

 

                     
 

  Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2020   2019   2020   2019 
   (In thousands)   (In thousands) 
Balance at beginning of period  $98,602  $32,664   $11,640   $67,376 
Early adoption of CECL       n/a    127,000    n/a 
Provision for credit losses on finance receivables   7,400    19,874    14,113    64,319 
Charge-offs   (15,574)   (46,118)   (73,096)   (149,038)
Recoveries   3,790    6,320    14,561    30,083 
Balance at end of period  $94,218  $12,740   $94,218   $12,740 

 

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 finance credit losses:

 

 

  September 30,   December 31, 
   2020   2019 
   (In thousands) 
Gross balance of repossessions in inventory  $17,005   $28,933 
Allowance for losses on repossessed inventory   (12,896)   (21,389)
Net repossessed inventory included in other assets  $4,109   $7,544 

 

 

 

 

 16 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

(3) Securitization Trust Debt

 

We have completed many securitization transactions that are structured as secured borrowings for financial accounting purposes. The debt issued in these transactions is shown on our Unaudited Condensed Consolidated Balance Sheets as “Securitization trust debt,” and the components of such debt are summarized in the following table:

 

 

                      Weighted 
                       Average 
   Final   Receivables       Outstanding   Outstanding   Contractual 
   Scheduled   Pledged at       Principal at   Principal at   Interest Rate at 
   Payment   September 30,   Initial   September 30,   December 31,   September 30, 
Series  Date (1)   2020 (2)   Principal   2020   2019   2020 
   (Dollars in thousands)     
CPS 2014-C   December 2021   $   $273,000   $   $19,758     
CPS 2014-D   March 2022        267,500        23,755    0.00%
CPS 2015-A   June 2022    14,892    245,000    13,337    26,713    5.95%
CPS 2015-B   September 2022    22,065    250,000    21,661    36,338    5.71%
CPS 2015-C   December 2022    33,602    300,000    33,634    53,579    6.44%
CPS 2016-A   March 2023    41,934    329,460    44,498    71,599    6.87%
CPS 2016-B   June 2023    53,268    332,690    53,973    82,667    7.30%
CPS 2016-C   September 2023    54,865    318,500    54,750    83,696    7.31%
CPS 2016-D   April 2024    44,381    206,325    42,622    65,021    5.63%
CPS 2017-A   April 2024    49,404    206,320    47,265    71,450    5.58%
CPS 2017-B   December 2023    61,113    225,170    47,090    76,201    4.82%
CPS 2017-C   September 2024    63,388    224,825    54,006    80,315    4.68%
CPS 2017-D   June 2024    65,532    196,300    55,937    83,801    4.16%
CPS 2018-A   March 2025    70,923    190,000    60,777    91,258    3.98%
CPS 2018-B   December  2024    84,265    201,823    76,306    111,188    4.39%
CPS 2018-C   September 2025    98,583    230,275    87,227    130,064    4.51%
CPS 2018-D   June 2025    116,839    233,730    101,011    149,470    4.45%
CPS 2019-A   March 2026    147,942    254,400    130,663    186,900    4.28%
CPS 2019-B   June 2026    143,956    228,275    134,066    184,308    3.84%
CPS 2019-C   September 2026    167,813    243,513    158,699    216,650    3.18%
CPS 2019-D   December  2026    212,273    274,313    202,755    265,035    2.73%
CPS 2020-A   March 2027    210,936    260,000    207,905        2.72%
CPS 2020-B   June 2027    203,947    202,343    179,851        2.92%
CPS 2020-C (3)   November 2027    193,242    252,200    252,200        1.58%
       $2,155,163   $5,945,962   $2,060,233   $2,109,766      

_________________

(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 $225.1 million in 2020, $717.6 million in 2021, $510.7 million in 2022, $396.7 million in 2023, $92.0 million in 2024, $86.8 million in 2025, and $18.7 million in 2026.
  
(2)Includes repossessed assets that are included in Other assets on our Unaudited Condensed Consolidated Balance Sheet.
  
(3)An additional $63.7 million of receivables were pledged to CPS 2020-C in October 2020.

 

 

 

 17 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

Debt issuance costs of $12.1 million and $12.0 million as of September 30, 2020 and December 31, 2019, respectively, have been excluded from the table above. These debt issuance costs are presented as a direct deduction to the carrying amount of the securitization trust debt on our Unaudited Condensed Consolidated Balance Sheets.

 

All of the securitization trust debt was sold in private placement transactions to qualified institutional buyers. The debt was issued through our wholly-owned bankruptcy remote subsidiaries and is secured by the assets of such subsidiaries, but not by our other assets.

 

The terms of the securitization agreements related to the issuance of the securitization trust debt and the warehouse credit facilities require that we meet certain delinquency and credit loss criteria with respect to the pool of receivables, and certain of the agreements require that we maintain minimum levels of liquidity and not exceed maximum leverage levels. As of September 30, 2020, we were in compliance with all such covenants.

 

We are responsible for the administration and collection of the automobile contracts. The securitization agreements also require certain funds be held in restricted cash accounts to provide additional collateral for the borrowings, to be applied to make payments on the securitization trust debt or as pre-funding proceeds from a term securitization prior to the purchase of additional collateral. As of September 30, 2020, restricted cash under the various agreements totaled approximately $200.91 million. Interest expense on the securitization trust debt consists of the stated rate of interest plus amortization of additional costs of borrowing. Additional costs of borrowing include facility fees, amortization of deferred financing costs and discounts on notes sold. Deferred financing costs and discounts on notes sold related to the securitization trust debt are amortized using a level yield method. Accordingly, the effective cost of the securitization trust debt is greater than the contractual rate of interest disclosed above.

 

Our wholly-owned bankruptcy remote subsidiaries were formed to facilitate the above asset-backed financing transactions. Similar bankruptcy remote subsidiaries issue the debt outstanding under our credit facilities. 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.

 

On September 15, 2020 we completed our third securitization transaction of 2020. In the transaction, qualified institutional buyers purchased $252.2 million of asset-backed notes secured by $260 million in automobile receivables purchased by us. The sold notes, issued by CPS Auto Receivables Trust 2020-C, consist of six classes. Ratings of the notes were provided by Moody’s and DBRS, and were based on the structure of the transaction, the historical performance of similar receivables and CPS’s experience as a servicer. The weighted average yield on the notes is approximately 2.39%.

 

 

 

 

 18 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

(4) Debt

 

The terms and amounts of our other debt outstanding at September 30, 2020 and December 31, 2019 are summarized below:

 

 

         Amount Outstanding at 
          September   December 31, 
          2020   2019 
          (In thousands) 
Description  Interest Rate  Maturity         
Warehouse lines of credit  5.50% over one month Libor (Minimum 6.50%)   February 2021   $11,539   $40,558 
                   
   3.00% over one month Libor (Minimum 3.75%)   November 2020    20,559    96,225 
                   
   4.00% over a commercial paper rate (Minimum 5.00%)   December 2021         
                   
Residual interest financing  8.60%   January 2026    32,243    40,000 
                   
Subordinated renewable notes  Weighted average rate of 10.24% and 9.75% at September 30, 2020 and December 31, 2019 , respectively   Weighted average maturity of December 2022 and April 2022 at September 30, 2020 and December 31, 2019, respectively    20,242    17,534 
           $84,583   $194,317 

 

Unamortized debt issuance costs of $243,000 and $522,000 as of September 30, 2020 and December 31, 2019, respectively, have been excluded from the amount reported above for residual interest financing. Similarly, unamortized debt issuance costs of $897,000 and $2.0 million as of September 30, 2020 and December 31, 2019, respectively, have been excluded from the Warehouse lines of credit amounts in the table above. These debt issuance costs are presented as a direct deduction to the carrying amount of the debt on our Unaudited Condensed Consolidated Balance Sheets.

 

 

 

 

 19 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

(5) Interest Income and Interest Expense

 

The following table presents the components of interest income:

 

 

                    
   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2020   2019   2020   2019 
   (In thousands)   (In thousands) 
Interest on finance receivables  $29,753   $49,912   $101,333   $167,862 
Interest on finance receivables at fair value   42,808    32,903    125,273    83,696 
Mark to finance receivables measured at fair value   (3,152)       (23,051)    
Other interest income   21    713    665    2,264 
Interest income  $69,430   $83,528   $204,220   $253,822 

 

The following table presents the components of interest expense:

 

                    
   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2020   2019   2020   2019 
   (In thousands)   (In thousands) 
Securitization trust debt  $21,605   $24,208   $67,770   $72,662 
Warehouse lines of credit   1,856    2,407    6,294    6,387 
Residual interest financing   876    956    2,734    2,867 
Subordinated renewable notes   564    369    1,579    1,017 
Interest expense  $24,901   $27,940   $78,377   $82,933 

 

(6) Earnings Per Share

 

Earnings per share for the three-month and nine-month periods ended September 30, 2020 and 2019 were calculated using the weighted average number of shares outstanding for the related period. The following table reconciles the number of shares used in the computations of basic and diluted earnings per share for the three-month and nine-month periods ended September 30, 2020 and 2019:

 

                    
   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2020   2019   2020   2019 
   (In thousands)   (In thousands) 
Weighted average number of common shares outstanding during the period used to compute basic earnings per share   22,666    22,526    22,630    22,378 
Incremental common shares attributable to exercise of outstanding options and warrants   1,242    1,540    1,195    1,724 
Weighted average number of common shares used to compute diluted earnings per share  23,908    24,066    23,825    24,102 

 

 

 

 20 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

If the anti-dilutive effects of common stock equivalents were considered, shares included in the diluted earnings per share calculation for the three-month and nine-month periods ended September 30, 2020 would have included an additional 14.2 million and 13.5 million shares, respectively, attributable to the exercise of outstanding options and warrants. For the three-month and nine-month periods ended September 30, 2019, an additional 10.6 million and 10.6 million shares, respectively, would be included in the diluted earnings per share calculation.

 

(7) Income Taxes

 

We file numerous consolidated and separate income tax returns with the United States and with many states. With few exceptions, we are no longer subject to U.S. federal, state, or local examinations by tax authorities for years before 2013.

 

On March 27, 2020, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was adopted, providing wide ranging economic relief for individuals and businesses. One component of the CARES Act provides the Company with an opportunity to carry back net operating losses (“NOLs”) arising from 2018, 2019 and 2020 to the prior five tax years. The Company has such NOLs reflected on its balance sheet as a portion of deferred tax assets. The Company has previously valued its NOLs at the federal corporate income tax rate of 21%. However, the provisions of the CARES Act provide for NOL carryback claims to be calculated based on a rate of 35%, which was the federal corporate tax rate in effect for the carryback years. Consequently, the Company has revalued the benefit from its NOLs to reflect a 35% tax rate. The result of the revaluation of NOLs and other tax adjustments is a net tax benefit of $8.8 million, which is reflected in income taxes for the nine-month period ending September 30, 2020.

 

As of September 30, 2020, and December 31, 2019, we had no unrecognized tax benefits for uncertain tax positions. We do not anticipate that total unrecognized tax benefits will significantly change due to any settlements of audits or expirations of statutes of limitations over the next 12 months.

 

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 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.

 

Deferred tax assets are recognized subject to management’s judgment that realization is more likely than not. A valuation allowance is recognized for a deferred tax asset if, based on the weight of the available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized. In making such judgments, significant weight is given to evidence that can be objectively verified. Although realization is not assured, we believe that the realization of the recognized net deferred tax asset of $31.0 million as of September 30, 2020 is more likely than not based on forecasted future net earnings. Our net deferred tax asset of $31.0 million consists of approximately $20.3 million of net U.S. federal deferred tax assets and $10.7 million of net state deferred tax assets.

 

Income tax expense was $2.1 million for the three months ended September 30, 2020. Income tax benefit was $3.9 million (3,888) for the nine months ended September 30, 2020, which includes net tax benefits of $8.8 million. Excluding the tax benefit, income tax expense would have been $8.7 million for the nine months ended September 30, 2020, representing an effective income tax rate of 36%. For the prior year period, income tax expense was $991,000 and $2.9 million for the three months and nine months ended September 30, 2019 and represents an effective income tax rate of 35%.

 

 

 

 

 21 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

(8) Legal Proceedings

 

Consumer Litigation. We are routinely involved in various legal proceedings resulting from our consumer finance activities and practices, both continuing and discontinued. Consumers can and do initiate lawsuits against us alleging violations of law applicable to collection of receivables, and such lawsuits sometimes allege that resolution as a class action is appropriate.

 

For the most part, we have legal and factual defenses to consumer claims, which we routinely contest or settle (for immaterial amounts) depending on the particular circumstances of each case.

 

Wage and Hour Claim. On September 24, 2018, a former employee filed a lawsuit against us in the Superior Court of Orange County, California, alleging that we incorrectly classified our sales representatives as outside salespersons exempt from overtime wages, mandatory break periods and certain other employee protective provisions of California and federal law. The complaint seeks injunctive relief, an award of unpaid wages, liquidated damages, and attorney fees and interest. The plaintiff purports to act on behalf of a class of similarly situated employees and ex-employees. As of the date of this report, no motion for class certification has been filed or granted.

 

We believe that our compensation practices with respect to our sales representatives are compliant with applicable law. Accordingly, we have defended and intend to continue to defend this lawsuit. We have not recorded a liability with respect to this claim on the accompanying consolidated financial statements.

 

In General. There can be no assurance as to the outcomes of the matters described or referenced above. We record at each measurement date, most recently as of September 30, 2020, our best estimate of probable incurred losses for legal contingencies, including the matters identified above, and consumer claims. The amount of losses that may ultimately be incurred cannot be estimated with certainty. However, based on such information as is available to us, we believe that the total of probable incurred losses for legal contingencies as of September 30, 2020 is immaterial, and that the range of reasonably possible losses for the legal proceedings and contingencies we face, including those described or identified above, as of September 30, 2020 does not exceed $3 million.

 

Accordingly, we believe that the ultimate resolution of such legal proceedings and contingencies should not have a material adverse effect on our consolidated financial condition. We note, however, that in light of the uncertainties inherent in contested proceedings there can be no assurance that the ultimate resolution of these matters will not be material to our operating results for a particular period, depending on, among other factors, the size of the loss or liability imposed and the level of our income for that period.

 

(9) Fair Value Measurements

 

ASC 820, "Fair Value Measurements" 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.

 

 

 

 

 22 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

ASC 820 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.

 

Effective January 2018 we have elected to use the fair value method to value our portfolio of finance receivables acquired in January 2018 and thereafter.

 

Our valuation policies and procedures have been developed by our Accounting department in conjunction with our Risk department and with consultation with outside valuation experts. Our policies and procedures have been approved by our Chief Executive and our Board of Directors and include methodologies for valuation, internal reporting, calibration and back testing. Our periodic review of valuations includes an analysis of changes in fair value measurements and documentation of the reasons for such changes. There is little available third-party information such as broker quotes or pricing services available to assist us in our valuation process.

 

Our level 3, unobservable inputs reflect our own assumptions about the factors that market participants use in pricing similar receivables and are based on the best information available in the circumstances. They include such inputs as estimates for the magnitude and timing of net charge-offs and the rate of amortization of the portfolio of finance receivable. Significant changes in any of those inputs in isolation would have a significant effect on our fair value measurement.

 

For the period ended September 30, 2020, the Company considered the effect of the pandemic on the portfolio of finance receivables carried at fair value and recorded a mark down to that portfolio of $23.1 million.

 

The table below presents a reconciliation of the finance receivables measured at fair value on a recurring basis using significant unobservable inputs:

 

                    
   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2020   2019   2020   2019 
   (In thousands)   (In thousands) 
Balance at beginning of period  $1,537,649  $1,158,365   $1,444,038   $821,066 
Finance receivables at fair value acquired during period   173,209    261,929    572,938    756,555 
Payments received on finance receivables at fair value   (132,847)   (83,384)   (354,910)   (200,889)
Net interest income accretion on fair value receivables   (33,904)   (24,309)   (98,060)   (64,131)
Mark to fair value   (3,152)   604    (23,051)   604 
Balance at end of period  $1,540,955  $1,313,205   $1,540,955   $1,313,205 

 

 

 

 

 23 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

The table below compares the fair values of these finance receivables to their contractual balances for the periods shown:

 

 

  September 30, 2020   December 31, 2019 
   Contractual   Fair   Contractual   Fair 
   Balance   Value   Balance   Value 
   (In thousands) 
Finance receivables measured at fair value  $1,658,662   $1,540,955   $1,492,803   $1,444,038 

 

The following table provides certain qualitative information about our level 3 fair value measurements:

 

            
Financial Instrument  Fair Values as of     Inputs as of
   September 30,  December 31,     September 30,  December 31,
   2020  2019  Unobservable Inputs  2020  2019
   (In thousands)         
Assets:            
Finance receivables measured at fair value  $1,540,955   $1,444,038   Discount rate   10.5% - 11.1%    8.9% - 11.1% 
             Cumulative net losses   16.4% - 18.4%    15.0% - 16.1% 

 

 

The following table summarizes the delinquency status of these finance receivables measured at fair value as of September 30, 2020 and December 31, 2019:

 

 
  September 30,   December 31, 
   2020   2019 
   (In thousands) 
Delinquency Status          
Current   $1,530,301   $1,344,883 
31 - 60 days   76,208    81,262 
61 - 90 days   27,616    34,280 
91 + days   9,159    15,167 
Repo   15,378    17,211 
   $1,658,662   $1,492,803 

 

Repossessed vehicle inventory, which is included in Other assets on our unaudited condensed consolidated balance sheet, is measured at fair value using level 2 assumptions based on our actual loss experience on sale of repossessed vehicles. At September 30, 2020 the finance receivables related to the repossessed vehicles in inventory totaled $17.0 million. We have applied a valuation adjustment, or loss allowance, of $12.9 million, which is based on a recovery rate of approximately 24.2%, resulting in an estimated fair value and carrying amount of $4.1 million. The fair value and carrying amount of the repossessed inventory at December 31, 2019 was $7.5 million after applying a valuation adjustment of $21.4 million.

 

There were no transfers in or out of level 1, level 2 or level 3 assets and liabilities for the three months ended September 30, 2020 and 2019.

 

 

 

 

 24 

 

 

CONSUMER PORTFOLIO SERVICES, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands)

 

 

The estimated fair values of financial assets and liabilities at September 30, 2020 and December 31, 2019, were as follows:

 

                         
   As of September 30, 2020 
Financial Instrument  (In thousands) 
   Carrying   Fair Value Measurements Using:     
   Value   Level 1   Level 2   Level 3   Total 
Assets:                         
Cash and cash equivalents  $11,253   $11,253   $   $   $11,253 
Restricted cash and equivalents   200,912    200,912            200,912 
Finance receivables, net   483,063            450,325    450,325 
Accrued interest receivable   6,291            6,291    6,291 
Liabilities:                         
Warehouse lines of credit  $31,201   $   $   $31,201   $31,201 
Accrued interest payable   4,937            4,937    4,937 
Residual interest financing   32,000            32,000    32,000 
Securitization trust debt   2,048,089            2,137,877    2,137,877 
Subordinated renewable notes   20,242            20,242    20,242 

 

                          
   As of December 31, 2019 
Financial Instrument  (In thousands) 
   Carrying   Fair Value Measurements Using:     
   Value   Level 1   Level 2   Level 3   Total 
Assets:                         
Cash and cash equivalents  $5,295   $5,295   $   $   $5,295 
Restricted cash and equivalents   135,537    135,537            135,537 
Finance receivables, net   885,890            841,160    841,160 
Accrued interest receivable   11,645            11,645    11,645 
Liabilities:                         
Warehouse lines of credit  $134,791   $   $   $134,791   $134,791 
Accrued interest payable   5,254            5,254    5,254 
Residual interest financing   39,478            39,478    39,478 
Securitization trust debt   2,097,728            2,116,520    2,116,520 
Subordinated renewable notes   17,534       $    17,534    17,534

 

 

 

 25 

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

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 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 also originate vehicle purchase money loans by lending directly to consumers and have (i) acquired installment purchase contracts in four merger and acquisition transactions, and (ii) purchased immaterial amounts of vehicle purchase money loans from non-affiliated lenders. 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 September 30, 2020, we have originated a total of approximately $16.8 billion of automobile contracts, primarily by purchasing retail installment sales contracts from dealers, and to a lesser degree, by originating loans secured by automobiles directly with consumers. In addition, we acquired a total of approximately $822.3 million of automobile contracts in mergers and acquisitions in 2002, 2003, 2004 and 2011. Recent contract purchase volumes and managed portfolio levels are shown in the table below:

 

     $ in thousands 
  Period  Contracts Purchased in Period   Managed Portfolio at Period End 
  2015   1,060,538    2,031,136 
  2016   1,088,785    2,308,070 
  2017   859,069    2,333,530 
  2018   902,416    2,380,847 
  2019   1,002,782    2,416,042 
  Nine months ended September 30, 2020   575,876    2,250,395 

 

Since April 2020, due to the onset of the pandemic, we have seen a decrease in the monthly volumes of our contract purchases compared to the prior year period and also compared to our first quarter of 2020.

 

Our principal executive offices are in Las Vegas, Nevada. Most of our operational and administrative functions take place in Irvine, California. Credit and underwriting functions are performed primarily in that California branch with certain of these functions also performed in our Florida and Nevada branches. We service our automobile contracts from our California, Nevada, Virginia, Florida and Illinois branches.

 

The programs we offer to dealers and consumers are intended to serve a wide range of sub-prime customers, primarily through franchised new car dealers. We originate 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 subsidiary of ours, which in turn issues asset-backed securities to fund the purchase of the pool of contracts from us.

 

 

 

 

 26 

 

 

Securitization and Warehouse Credit Facilities

 

Throughout the period 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 be purchased by institutional investors. 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. All of our active securitizations are structured 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, and (ii) recognize interest expense on the securities issued in the transaction. For automobile contracts acquired after 2017 we take account of estimated credit losses in our computation of a level yield used to determine recognition of interest on the contracts. For contracts acquired before 2018, we adopted CECL on January 1, 2020 and we may, as circumstances warrant, record as expense provisions for credit losses, as we did during the three-month and nine-month periods ended September 30, 2020 as a result of the uncertainty related to the pandemic.

 

Since 1994 we have conducted 87 term securitizations of automobile contracts that we originated. As of September 30, 2020, 22 of those securitizations are active and all are structured as secured financings. Since September 2010 we have utilized senior subordinated structures without any financial guarantees. We have generally conducted our securitizations on a quarterly basis, near the end of each calendar quarter, resulting in four securitizations per calendar year. However, in 2015, we elected to defer what would have been our December securitization in favor of a securitization in January 2016, and since that time have generally conducted our securitizations near the beginning of each calendar quarter.

 

Our recent history of term securitizations is summarized in the table below:

 

Recent Asset-Backed Term Securitizations

 

     $ in thousands 
  Period  Number of Term Securitizations   Receivables Pledged in Term Securitizations 
  2015   3   $795,000 
  2016   4    1,214,997 
  2017   4    870,000 
  2018   4    883,452 
  2019   4    1,014,124 
  Nine months ended September 30, 2020   3    741,867 

 

Generally, prior to a securitization transaction we fund our automobile contract purchases primarily with proceeds from warehouse credit facilities. Our current short-term funding capacity is $300 million, comprising three credit facilities. The first $100 million credit facility was established in May 2012. This facility was most recently renewed in September 2018, extending the revolving period to September 2020, with an optional amortization period through September 2021. The revolving period for this facility was extended to November 2020. In April 2015, we entered into a second $100 million facility. This facility was renewed in April 2017 and again in February 2019, extending the revolving period to February 2021, followed by an amortization period to February 2023. In November 2015, we entered into a third $100 million facility. This facility was renewed in November 2017 and again in December 2019, extending the revolving period to December 2021, followed by an amortization period to December 2023.

 

 

 

 

 27 
 

 

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.

 

In a securitization, 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.

 

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. In addition, certain of our debt agreements other than our term securitizations contain cross-default provisions. Such cross-default provisions would allow the respective creditors to declare a default if an event of default occurred with respect to other indebtedness of ours, but only if such other event of default were to be accompanied by acceleration of such other indebtedness. As of September 30, 2020, we were in compliance with all such covenants.

 

Results of Operations

 

Comparison of Operating Results for the three months ended September 30, 2020 with the three months ended September 30, 2019

 

Revenues. During the three months ended September 30, 2020, our revenues were $70.7 million, a decrease of $14.9 million, or 17.4%, from the prior year revenue of $85.5 million. The primary reason for the decrease in revenues is a decrease in interest income and a mark down to the recorded value of the portion of the receivables portfolio accounted for at fair value. Interest income for the three months ended September 30, 2020 decreased $10.9 million, or 13.1%, to $72.6 million from $83.5 million in the prior year. The primary reason for the decrease in interest income is the continued runoff of our portfolio of finance receivables originated prior to January 2018, which accrued interest at an average of 18.5%, which is offset only in part by the increase in our portfolio of receivables measured at fair value, which are those originated since January 2018. The interest yield on receivables measured at fair value is reduced to take account of expected losses and is therefore less than the yield on other finance receivables. The table below shows the average balances and interest yields of the two components of our loan portfolio for the three months ended September 30, 2020 and 2019:

 

   Three Months Ended September 30, 
   2020   2019 
   (Dollars in thousands) 
   Average       Interest   Average       Interest 
   Balance   Interest   Yield   Balance   Interest   Yield 
Interest Earning Assets                              
Finance receivables  $624,532  $29,775    19.1%   $1,105,087   $50,625    18.3% 
Finance receivables measured at fair value   1,646,022    42,807    10.4%    1,304,012    32,903    10.1% 
Total  $2,270,554  $72,582    12.8%   $2,409,099   $83,528    13.9% 

 

 

 

 

 28 
 

 

Revenues for the third quarter of 2020 include a $3.2 million mark down to the recorded value of the finance receivables measured at fair value. The mark down is an estimate based on our evaluation of the appropriate fair value and future earnings rate of existing receivables compared to recently acquired receivables and our assessment of potential additional future net losses arising from the pandemic.

 

In the three months ended September 30, 2020, other income of $1.2 million decreased by $755,000, or 37.9% compared to the prior year. The three-month period ended September 30, 2020 includes a decrease of $361,000 in revenues associated with direct mail and other related products and services that we offer to our dealers and a decrease of $320,000 in payments from third-party providers of convenience fees paid by our customers for web based and other electronic payments.

 

Expenses. Our operating expenses consist largely of interest expense, provision for credit losses, employee costs, sales and general and administrative expenses. Provision for credit losses is affected by the balance and credit performance of our portfolio of finance receivables (other than our portfolio of finance receivables measured at fair value, as to which expected credit losses have the effect of reducing the internal rate of return or the recorded value applicable to such receivables). Interest expense is significantly affected by the volume of automobile contracts we purchased during the trailing 12-month period and the use of our warehouse facilities and asset-backed securitizations to finance those contracts. 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 changes in the unemployment level.

 

Employee costs include base salaries, commissions and bonuses paid to employees, and certain expenses related to the accounting treatment of outstanding stock options and are one of our most significant operating expenses. These costs (other than those relating to stock options) generally fluctuate with the level of applications and automobile contracts purchased and serviced.

 

Other operating expenses consist largely of facilities expenses, telephone and other communication services, credit services, computer services, sales and advertising expenses, and depreciation and amortization.

 

Total operating expenses were $64.8 million for the three months ended September 30, 2020, compared to $82.7 million for the prior period, a decrease of $17.9 million, or 21.7%. The decrease is primarily due to a decrease in provision for credit losses.

 

Employee costs decreased by $1.1 million or 5.4%, to $19.2 million during the three months ended September 30, 2020, representing 29.6% of total operating expenses, from $20.3 million for the prior year, or 24.5% of total operating expenses. The table below summarizes our employees by category as well as contract purchases and units in our managed portfolio as of, and for the three-month periods ended, September 30, 2020 and 2019:

 

   September 30, 2020   September 30, 2019 
   Amount   Amount 
   ($ in millions) 
Contracts purchased (dollars)  $174.0   $262.1 
Contracts purchased (units)   9,106    14,353 
Managed portfolio outstanding (dollars)  $2,250.4   $2,412.6 
Managed portfolio outstanding (units)   168,071    177,575 
           
Number of Originations staff   161    203 
Number of Sales staff   94    118 
Number of Servicing staff   472    622 
Number of other staff   73    75 
Total number of employees   800    1,018 

 

During the second quarter, we laid off 114 staff members due to the decrease in our business caused by the pandemic. Throughout the third quarter we experienced further staff reductions due in part to the fact that our contract purchases have not returned to pre-pandemic levels. If our contract purchase volumes remain at current levels, we expect somewhat lower employee costs in future periods.

 

 

 

 29 
 

 

General and administrative expenses include costs associated with purchasing and servicing our portfolio of finance receivables, including expenses for facilities, credit services, and telecommunications. General and administrative expenses were $7.8 million, a decrease from $8.2 million in the previous year and represented 12.1% of total operating expenses.

 

Interest expense for the three months ended September 30, 2020 were $24.9 million and represented 38.4% of total operating expenses, compared to $27.9 million in the previous year, when it was 33.8% of total operating expenses.

 

Interest on securitization trust debt decreased by $2.6 million for the three months ended September 30, 2020 compared to the prior period. The average balance of securitization trust debt decreased to $1,979.5 million for the three months ended September 30, 2020 compared to $2,165.9 million for the three months ended September 30, 2019. The blended interest rates on new term securitizations have generally increased in 2017 and 2018 before declining in 2019 and 2020. For any particular quarterly securitization transaction, the blended cost of funds is ultimately the result of many factors including the market interest rates for benchmark swaps of various maturities against which our bonds are priced and the margin over those benchmarks that investors are willing to accept, which in turn, is influenced by investor demand for our bonds at the time of the securitization. These and other factors have resulted in fluctuations in our securitization trust debt interest costs. The blended interest rates of our recent securitizations are summarized in the table below:

 

Blended Cost of Funds on Recent Asset-Backed Term Securitizations
     
Period   Blended Cost of Funds
January 2017   3.91%
April 2017   3.45%
July 2017   3.52%
October 2017   3.39%
January 2018   3.46%
April 2018   3.98%
July 2018   4.18%
October 2018   4.25%
January 2019   4.22%
April 2019   3.95%
July 2019   3.36%
October 2019   2.95%
January 2020   3.08%
June 2020   4.09%
September 2020   2.39%

 

The annualized average rate on our securitization trust debt was 4.4% for the three months ended September 30, 2020 compared to 4.5% in the prior year period. The annualized average rate is influenced by the manner in which the underlying securitization trust bonds are repaid. The rate tends to increase over time on any particular securitization since the structures of our securitization trusts generally provide for sequential repayment of the shorter term, lower interest rate bonds before the longer term, higher interest rate bonds.

 

Interest expense on subordinated renewable notes increased by $194,000. The average balance of the outstanding subordinated debt increased 30.4% to $19.7 million for the three months ended September 30, 2020 compared to $15.1 million for the three months ended September 30, 2019. The average yield of subordinated notes increased to 11.4% in the three-month period ended September 30, 2020 compared to 9.8% in the prior period.

  

 

 

 30 
 

 

Interest expense on warehouse debt decreased by $550,000 to $1.9 million for the three months ended September 30, 2020 compared to $2.4 million in the prior year period. The average rate on the debt also declined to 8.2% for the third quarter of 2020 compared to 9.8% for the same quarter in 2019.

 

On May 16, 2018, we completed a $40.0 million securitization of residual interests from previously issued securitizations. Interest expense on this residual interest financing was $876,000 for the three months ended September 30, 2020 compared to $956,000 in the prior year period.

 

The following table presents the components of interest income and interest expense and a net interest yield analysis for the three-month periods ended September 30, 2020 and 2019:

 

   Three Months Ended September 30, 
   2020   2019 
   (Dollars in thousands) 
   Average Balance (1)   Interest   Annualized Average Yield/Rate    Average Balance (1)   Interest   Annualized Average Yield/Rate 
Interest Earning Assets                              
Finance receivables gross (2)  $624,532   $29,775    19.1%   $1,105,087   $50,625    18.3% 
Finance receivables at fair value   1,646,022    42,807    10.4%    1,304,012    32,903    10.1% 
    2,270,554    72,582    12.8%    2,409,099    83,528    13.9% 
                             $ 
Interest Bearing Liabilities   $                          
Warehouse lines of credit  $90,697    1,857    8.2%   $98,520    2,407    9.8% 
Residual interest financing   36,407    876    9.6%    40,000    956    9.6% 
Securitization trust debt   1,979,491    21,605    4.4%    2,165,927    24,208    4.5% 
Subordinated renewable notes   19,737    563    11.4%    15,133    369    9.8% 
   $2,126,332    24,901    4.7%   $2,319,580    27,940    4.8% 
                             $ 
Net interest income/spread   $   $47,681             $55,588      
Net interest yield (3)   $         8.1%              9.1% 
Ratio of average interest earning assets to average interest bearing liabilities   $         107%              104% 

  

(1)Average balances are based on month end balances except for warehouse lines of credit, which are based on daily balances.
(2)Net of deferred fees and direct costs.
(3)Annualized net interest income divided by average interest earning assets.

 

 

 

 

 31 
 

 

  

Three Months Ended September 30, 2020

Compared to September 30, 2019

 
$  Total   Change Due   Change Due 
$  Change   to Volume   to Rate 
   (In thousands) 
Interest Earning Assets   $           
Finance receivables gross  $(20,850)  $(22,099)  $1,249 
Finance receivables at fair value   9,904    8,669    1,235 
    (10,946)   (13,430)   2,484 
Interest Bearing Liabilities   $           
Warehouse lines of credit   (550)   (187)   (363)
Residual interest financing   (80)   (80)    
Securitization trust debt   (2,603)   (2,108)   (495)
Subordinated renewable notes   194    115    79 
    (3,039)   (2,260)   (779)
                
Net interest income/spread  $(7,907)  $(11,170)  $3,263 

 

The reduction in the annualized yield on our finance receivables for the three months ended September 30, 2020 compared to the prior year period is the result of the lower interest yield on the receivables measured at fair value. The interest yield on receivables measured at fair value is reduced to take account of expected losses and is therefore less than the yield on other finance receivables. The average balance of these receivables was $1,646.0 million for the three months ended September 30, 2020 compared to $1,304.0 million in the prior year period.

 

Effective January 1, 2020, the Company adopted Accounting Standards Update 2016-13 - Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments. The amendment introduces a new credit reserving model known as the Current Expected Credit Loss model, generally referred to as CECL. Adoption of CECL required the establishment of an allowance for the remaining expected lifetime credit losses on the portion of the Company’s receivable portfolio that was originated prior to January 2018. To comply with CECL, the Company recorded an addition to its allowance for finance credit losses of $127.0 million. In accordance with the rules for adopting CECL, the offset to the addition to the allowance for finance credit losses was a tax affected reduction to retained earnings using the modified retrospective method.

 

Provision for credit losses was $7.4 million for the three months ended September 30, 2020. The provision represents our estimate of additional forecasted losses that may be incurred on the portfolio of finance receivables resulting from the pandemic. Such losses were not considered in our initial estimate of remaining lifetime losses that we recorded with the adoption of CECL in January 2020. In the prior year period, prior to the adoption of CECL, provision for credit losses was $19.9 million.

 

The allowance applies only to our finance receivables originated through December 2017, which we refer to as our legacy portfolio.  Finance receivables that we have originated since January 2018 are accounted for at fair value. Under the fair value method of accounting, we recognize interest income net of expected credit losses. Thus, no provision for credit loss expense is recorded for finance receivables measured at fair value.

 

 

 

 

 32 
 

 

Sales expense consists primarily of commission-based compensation paid to our employee sales representatives. Our sales representatives earn a salary plus commissions based on volume of contract purchases and sales of ancillary products and services that we offer our dealers, such as training programs, internet lead sales, and direct mail products. Sales expense decreased by $1.2 million to $3.2 million during the three months ended September 30, 2020 and represented 4.9% of total operating expenses. We purchased $174.0 million of new contracts during the three months ended September 30, 2020 compared to $262.1 million in the prior year period. In our second quarter of 2020, we experienced a significant reduction in contract purchases due to the pandemic and partial shutdown of the economy. In our third quarter our contract purchase volumes increased but have not recovered to pre-pandemic levels.

 

Occupancy expenses was $1.8 million for the three months ending September 30, 2020 and 2019.

 

Depreciation and amortization expenses increased to $438,000 compared to $276,000 in the previous year and represented 0.7% of total operating expenses.

 

For the three months ended September 30, 2020 we recorded income tax expense of $2.1 million, representing a 36% effective tax rate. In the prior year period, we our income tax expense was $991,000, for an effective income tax rate of 35%.

 

Comparison of Operating Results for the nine months ended September 30, 2020 with the nine months ended September 30, 2019

 

Revenues. During the nine months ended September 30, 2020, our revenues were $208.7 million, a decrease of $51.3 million, or 19.7%, from the prior year revenue of $260.1 million. The primary reason for the decrease in revenues is a decrease in interest income and a mark down to the recorded value of the portion of the receivables portfolio accounted for at fair value. Interest income for the nine months ended September 30, 2020 decreased $26.5 million, or 10.5%, to $227.3 million from $253.8 million in the prior year. The primary reason for the decrease in interest income is the continued runoff of our portfolio of finance receivables originated prior to January 2018, which accrued interest at an average of 18.5%, which is offset only in part by the increase in our portfolio of receivables measured at fair value, which are those originated since January 2018. The interest yield on receivables measured at fair value is reduced to take account of expected losses and is therefore less than the yield on other finance receivables. The table below shows the average balances and interest yields of our loan portfolio for the nine months ended September 30, 2020 and 2019:

 

   Nine Months Ended September 30, 
   2020   2019 
   (Dollars in thousands) 
   Average       Interest   Average       Interest 
   Balance   Interest   Yield   Balance   Interest   Yield 
Interest Earning Assets                              
Finance receivables  $734,195  $101,998    18.5%   $1,268,190   $170,126    17.9% 
Finance receivables measured at fair value   1,619,399    125,273    10.3%    1,131,888    83,696    9.9% 
Total  $2,353,594  $227,271    12.9%   $2,400,078   $253,822    14.1% 

 

Revenues for the nine months ended September 30, 2020 include a $23.1 million mark down to the recorded value of the finance receivables measured at fair value. The mark down is an estimate based on our evaluation of the appropriate fair value and future earnings rate of existing receivables compared to recently acquired receivables and our assessment of potential additional future net losses arising from the pandemic.

 

 

 

 

 33 
 

 

In the nine months ended September 30, 2020, other income of $4.5 million decreased by $1.7 million, or 27.9% compared to the prior year. The nine-month period ended September 30, 2020 includes a decrease of $1.3 million in revenues associated with direct mail and other related products and services that we offer to our dealers and a decrease of $530,000 in payments from third-party providers of convenience fees paid by our customers for web based and other electronic payments.

 

Expenses.  Our operating expenses consist largely of interest expense, provision for credit losses, employee costs, sales and general and administrative expenses. Provision for credit losses is affected by the balance and credit performance of our portfolio of finance receivables (other than our portfolio of finance receivables measured at fair value, as to which expected credit losses have the effect of reducing the internal rate of return or the recorded value applicable to such receivables). Interest expense is significantly affected by the volume of automobile contracts we purchased during the trailing 12-month period and the use of our warehouse facilities and asset-backed securitizations to finance those contracts. 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 changes in the unemployment level.

 

Employee costs include base salaries, commissions and bonuses paid to employees, and certain expenses related to the accounting treatment of outstanding stock options, and are one of our most significant operating expenses. These costs (other than those relating to stock options) generally fluctuate with the level of applications and automobile contracts purchased and serviced.

 

Other operating expenses consist largely of facilities expenses, telephone and other communication services, credit services, computer services, sales and advertising expenses, and depreciation and amortization.

 

Total operating expenses were $195.1 million for the nine months ended September 30, 2020, compared to $251.8 million for the prior period, a decrease of $56.7 million, or 22.5%. The decrease is primarily due to a decrease in provision for credit losses.

 

Employee costs increased by $1.8 million or 3.0%, to $60.8 million during the nine months ended September 30, 2020, representing 31.2% of total operating expenses, from $59.0 million for the prior year, or 23.4% of total operating expenses. The table below summarizes our employees by category as well as contract purchases and units in our managed portfolio as of, and for the nine-month periods ended, September 30, 2020 and 2019:

 

   September 30, 2020   September 30, 2019 
   Amount   Amount 
   ($ in millions) 
Contracts purchased (dollars)  $575.9   $755.3 
Contracts purchased (units)   31,475    42,534 
Managed portfolio outstanding (dollars)  $2,250.4   $2,412.6 
Managed portfolio outstanding (units)   168,071    177,575 
           
Number of Originations staff   161    203 
Number of Sales staff   94    118 
Number of Servicing staff   472    622 
Number of other staff   73    75 
Total number of employees   800    1,018 

 

In the first Quarter of 2020, prior to the onset of the pandemic, our employee costs were greater than in the first quarter of 2019. Those increases have been partially offset by decreases since the first quarter of 2020, which are the result of staff reductions due in part to the fact that our contract purchases have not returned to pre-pandemic levels. If our contract purchase volumes remain at current levels, we expect somewhat lower employee costs in future periods.

 

 

 

 34 
 

 

General and administrative expenses include costs associated with purchasing and servicing our portfolio of finance receivables, including expenses for facilities, credit services, and telecommunications. General and administrative expenses were $24.4 million, a decrease from $25.1 million in the previous year and represented 12.5% of total operating expenses.

 

Interest expense for the nine months ended September 30, 2020 were $78.4 million and represented 40.2% of total operating expenses, compared to $82.9 million in the previous year.

 

Interest on securitization trust debt decreased by $4.9 million for the nine months ended September 30, 2020 compared to the prior period. The average balance of securitization trust debt decreased to $2,058.1 million for the nine months ended September 30, 2020 compared to $2,178.4 million for the nine months ended September 30, 2019. The blended interest rates on new term securitizations have generally increased in 2017 and 2018 before declining in 2019 and 2020. For any particular quarterly securitization transaction, the blended cost of funds is ultimately the result of many factors including the market interest rates for benchmark swaps of various maturities against which our bonds are priced and the margin over those benchmarks that investors are willing to accept, which in turn, is influenced by investor demand for our bonds at the time of the securitization. These and other factors have resulted in fluctuations in our securitization trust debt interest costs. The blended interest rates of our recent securitizations are summarized in the table below:

 

Blended Cost of Funds on Recent Asset-Backed Term Securitizations
     
Period   Blended Cost of Funds
January 2017   3.91%
April 2017   3.45%
July 2017   3.52%
October 2017   3.39%
January 2018   3.46%
April 2018   3.98%
July 2018   4.18%
October 2018   4.25%
January 2019   4.22%
April 2019   3.95%
July 2019   3.36%
October 2019   2.95%
January 2020   3.08%
June 2020   4.09%
September 2020   2.39%

  

The annualized average rate on our securitization trust debt was 4.4% for the nine months ended September 30, 2020 and 2019. The annualized average rate is influenced by the manner in which the underlying securitization trust bonds are repaid. The rate tends to increase over time on any particular securitization since the structures of our securitization trusts generally provide for sequential repayment of the shorter term, lower interest rate bonds before the longer term, higher interest rate bonds.

 

 

 

 35 
 

 

Interest expense on subordinated renewable notes increased by $563,000. The average balance of the outstanding subordinated debt increased 30.0% to $18.8 million for the nine months ended September 30, 2020 compared to $14.5 million for the nine months ended September 30, 2019. The average yield of subordinated notes increased to 11.2% in the nine-month period ended September 30, 2020 compared to 9.3% in the prior period.

 

Interest expense on warehouse debt decreased by $93,000 for the nine months ended September 30, 2020 compared to the prior period. The average rate on the debt was 7.8% in 2020 compared to 10.0% in the prior year while the average balance of the warehouse debt increased to $107.4 million from $85.3 million.

 

On May 16, 2018, we completed a $40.0 million securitization of residual interests from previously issued securitizations. Interest expense on this residual interest financing was $2.7 million for the current year period and $2.9 million in the prior year period as the average outstanding balance has decreased.

 

The following table presents the components of interest income and interest expense and a net interest yield analysis for the nine-month periods ended September 30, 2020 and 2019:

 

   Nine Months Ended September 30, 
   2020   2019 
   (Dollars in thousands) 
   Average Balance (1)   Interest   Annualized Average Yield/Rate    Average Balance (1)   Interest   Annualized Average Yield/Rate 
Interest Earning Assets                              
Finance receivables gross (2)  $734,195   $101,998    18.5%   $1,233,413   $170,125    18.4% 
Finance receivables at fair value   1,619,399    125,273    10.3%    1,131,888    83,696    9.9% 
    2,353,594    227,271    12.9%    2,365,301    253,821    14.3% 
                             $ 
Interest Bearing Liabilities   $                          
Warehouse lines of credit  $107,388    6,294    7.8%   $85,289    6,387    10.0% 
Residual interest financing   37,959    2,734    9.6%    40,000    2,867    9.6% 
Securitization trust debt   2,058,110    67,770    4.4%    2,178,437    72,662    4.4% 
Subordinated renewable notes   18,847    1,580    11.2%    14,513    1,017    9.3% 
   $2,222,304    78,378    4.7%   $2,318,239    82,933    4.8% 
                             $ 
Net interest income/spread   $   $148,893             $170,888      
Net interest yield (3)   $         8.2%              9.5% 
Ratio of average interest earning assets to average interest bearing liabilities   $         106%              102% 

  

(1)Average balances are based on month end balances except for warehouse lines of credit, which are based on daily balances.
(2)Net of deferred fees and direct costs.
(3)Annualized net interest income divided by average interest earning assets.

 

 

 

 

 36 
 

 

  

Nine Months Ended September 30, 2020

Compared to September 30, 2019

 
$  Total   Change Due   Change Due 
$  Change   to Volume   to Rate 
   (In thousands) 
Interest Earning Assets   $           
Finance receivables gross  $(68,127)  $(69,033)  $906 
Finance receivables at fair value   41,577    34,867    6,710 
    (26,550)   (34,166)   7,616 
Interest Bearing Liabilities   $           
Warehouse lines of credit   (93)   2,254    (2,347)
Residual interest financing   (133)   (133)    
Securitization trust debt   (4,892)   (4,695)   (197)
Subordinated renewable notes   563    209    354 
    (4,555)   (2,365)   (2,190)
                
Net interest income/spread  $(21,995)  $(31,801)  $9,806 

 

The reduction in the annualized yield on our finance receivables for the nine months ended September 30, 2020 compared to the prior year period is the result of the lower interest yield on the receivables measured at fair value. The interest yield on receivables measured at fair value is reduced to take account of expected losses and is therefore less than the yield on other finance receivables. The average balance of these receivables was $1,619.4 million for the nine months ended September 30, 2020 compared to $1,131.9 million in the prior year period.

 

Effective January 1, 2020, the Company adopted Accounting Standards Update 2016-13 - Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments. The amendment introduces a new credit reserving model known as the Current Expected Credit Loss model, generally referred to as CECL. Adoption of CECL required the establishment of an allowance for the remaini