CONSUMER PORTFOLIO SERVICES, INC. 10-Q

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, 2022, we have originated a total of approximately $19.6 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: Contract Purchases and Outstanding Managed Portfolio $ in thousands Period Contracts Purchased in Period Managed Portfolio at Period End 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 2020 742,584 2,174,972 2021 1,146,321 2,249,069 Nine months ended September 30, 2022 1,426,302 2,838,858 In May 2021 we began purchasing some contracts for immediate sale to a third-party to whom we refer applications that don’t meet our lending criteria. We service all such contracts on behalf of the third-party. We earn fees for originating the receivable and also servicing fees on active accounts in the third-party portfolio. For the nine months ended September 30, 2022, we originated $126.8 million under this third-party program. As of September 30, 2022, our managed portfolio includes $151.5 million of such third-party receivables. 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. 24 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. Since 1994 we have conducted 94 term securitizations of automobile contracts that we originated. As of September 30, 2022, 19 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 2020, we closed only three term securitization transactions in that calendar year rather than four. 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 2016 4 1,214,997 2017 4 870,000 2018 4 883,452 2019 4 1,014,124 2020 3 741,867 2021 4 1,145,002 Nine months ended September 30, 2022 3 1,200,000 Generally, prior to a securitization transaction we fund our automobile contract purchases primarily with proceeds from warehouse credit facilities. We previously had short-term funding capacity of $200 million, comprising three credit facilities. The first credit facility was established in May 2012. This facility was most recently renewed in July 2022, extending the revolving period to July 2024, with an optional amortization period through July 2025. In addition, the capacity was doubled from $100 million to $200 million at the July 2022 renewal. In November 2015, we entered into another $100 million facility. This facility was most recently renewed in January 2022, extending the revolving period to January 2024, followed by an amortization period to January 2026. In June 2022, we doubled the capacity for this facility from $100 million to $200 million. In April 2015, we entered into a $100 million facility that was renewed in April 2017 and again in February 2019. We repaid the outstanding balance for this facility at its maturity date in February 2021 and elected not to renew it. We currently have short-term funding capacity of $400 million over two credit facilities. 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. 25 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. Receivables we originate and service for third-parties are not pledged to our warehouse facilities or included in our securitizations. 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, 2022, we were in compliance with all such covenants. Results of Operations Comparison of Operating Results for the three months ended September 30, 2022 with the three months ended September 30, 2021 Revenues . During the three months ended September 30, 2022, our revenues were $90.3 million, an increase of $21.7 million, or 31.7%, from the prior year revenue of $68.6 million. The primary reason for the increase in revenues is the increase in interest income resulting from the increase in the average outstanding balance of finance receivables measured at fair value. In addition, mark ups to the finance receivables measured at fair value also contributed to the increase in revenues during the quarter. Revenues for the three months ended September 30, 2022 include an $8.2 million mark up to the recorded value of the finance receivables measured at fair value. The marks are estimates based on our evaluation of the appropriate fair value and future earnings rate of existing receivables compared to recently acquired receivables and increases or decreases in our estimates of future net losses. During the three months ended September 30, 2022, we reduced our estimate for expected future losses in finance receivables measured at fair value as we have observed that our previous estimates for increased losses due to the pandemic had not materialized. The change in estimated losses resulted in the $8.2 million mark up for the three months ended September 30, 2022. There was no mark up or mark down to the fair value portfolio in the prior year period. Interest income for the three months ended September 30, 2022 increased $12.8 million, or 19.1%, to $79.8 million from $67.0 million in the prior year. The primary reason for the increase in interest income is the 37.0% increase in the average balance of finance receivables measured at fair value over the prior year period. 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, 2022 and 2021: Three Months Ended September 30, 2022 2021 (Dollars in thousands) Average Interest Average Interest Balance Interest Yield Balance Interest Yield Interest Earning Assets Finance receivables $ 130,546 $ 8,083 24.8% $ 305,820 $ 16,067 21.0% Finance receivables measured at fair value 2,517,663 71,734 11.4% 1,837,138 50,951 11.1% Total $ 2,648,209 $ 79,817 12.1% $ 2,142,958 $ 67,018 12.5% 26 Other income was $2.3 million for the three months ended September 30, 2022 compared to $1.5 million for the comparable period in 2021. This 49.0% increase was primarily driven by the origination and servicing fees we earned from third party receivables that began in May 2021. These fees were $2.0 million for the quarter ended September 30, 2022. 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 $56.0 million for the three months ended September 30, 2022, compared to $49.0 million for the prior period, an increase of $7.0 million, or 14.2%. The increase is primarily due to increases in interest expense, employee costs and general and administrative expenses. Employee costs were $20.7 million during the three months ended September 30, 2022 compared to $18.2 million for the same quarter in the prior year. 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, 2022 and 2021: Three Months Ended September 30, 2022 2021 (Dollars in millions) Contracts purchased (dollars) $ 468.2 $ 326.8 Contracts purchased (units) 20,888 14,741 Managed portfolio outstanding (dollars) $ 2,838.9 $ 2,184.1 Managed portfolio outstanding (units) 173,774 156,456 Number of Originations staff 187 170 Number of Sales staff 134 110 Number of Servicing staff 404 397 Number of other staff 67 74 Total number of employees 792 751 27 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 was $9.4 million, an increase from $7.5 million in the previous year and represented 16.8% of total operating expenses. Interest expense for the three months ended September 30, 2022 were $23.5 million and represented 42.0% of total operating expenses, compared to $18.3 million in the previous year, when it was 37.4% of total operating expenses. Interest on securitization trust debt increased by $3.2 million for the three months ended September 30, 2022 compared to the prior period. The average balance of securitization trust debt increased to $2,032.5 million for the three months ended September 30, 2022 compared to $1,819.8 million for the three months ended September 30, 2021. The annualized average rate on our securitization trust debt was 3.6% for the three months ended September 30, 2022 compared to 3.4% in the prior year period. The blended interest rates on new term securitizations have been increasing in 2022. For each 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 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% January 2021 1.11% April 2021 1.65% July 2021 1.55% October 2021 2.09% January 2022 2.54% April 2022 4.83% July 2022 6.02% Interest expense on warehouse credit line debt increased by $2.4 million to $3.3 million for the three months ended September 30, 2022 compared to $929,000 in the prior year period. The increase was due to the higher utilization of our credit lines during the quarter compared to last year. The average balance of our warehouse debt was $172.9 million during the three months ended September 30, 2022 compared to $39.4 million for the same period in 2021. 28 Interest expense on subordinated renewable notes was $572,000 for the three months ended September 30, 2022. The average balance of the outstanding subordinated debt increased 2.4% to $27.5 million for the three months ended September 30, 2022 compared to $26.9 million for the prior year. The average yield of subordinated notes decreased to 8.3% compared to 10.4% in the prior period. In May 2018 and June 2021, we completed two residual interest financings of our residual interests from previously issued securitizations in the amounts of $40.0 million and $50.0 million, respectively. Interest expense on these residual interest financings was $1.1 million for the three months ended September 30, 2022 compared to $1.4 million 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, 2022 and 2021: Three Months Ended September 30, 2022 2021 (Dollars in thousands) Annualized Annualized Average Average Average Average Balance (1) Interest Yield/Rate Balance (1) Interest Yield/Rate Interest Earning Assets Finance receivables gross (2) $ 130,546 $ 8,083 24.8% $ 305,820 $ 16,067 21.0% Finance receivables at fair value 2,517,663 71,734 11.4% 1,837,138 50,951 11.1% 2,648,209 79,817 12.1% 2,142,958 67,018 12.5% $ Interest Bearing Liabilities $ Warehouse lines of credit $ 172,895 3,342 7.7% $ 39,447 929 9.4% Residual interest financing 50,000 1,050 8.4% 66,824 1,413 8.5% Securitization trust debt 2,032,527 18,519 3.6% 1,819,789 15,292 3.4% Subordinated renewable notes 27,506 572 8.3% 26,868 700 10.4% $ 2,282,928 23,483 4.1% $ 1,952,928 18,334 3.8% $ Net interest income/spread $ $ 56,334 $ 48,684 Net interest yield (3) $ 8.0% 8.7% Ratio of average interest earning assets to average interest bearing liabilities $ 116% 110% (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. 29 Three Months Ended September 30, 2022 Compared to September 30, 2021 Total Change Due Change Due Change to Volume to Rate (In thousands) Interest Earning Assets $ Finance receivables gross $ (7,984 ) $ (9,224 ) $ 1,240 Finance receivables at fair value 20,783 18,895 1,888 12,799 9,671 3,128 Interest Bearing Liabilities $ Warehouse lines of credit 2,413 3,148 (735 ) Residual interest financing (363 ) (350 ) (13 ) Securitization trust debt 3,227 2,211 1,016 Subordinated renewable notes (128 ) 16 (144 ) 5,149 5,025 124 Net interest income/spread $ 7,650 $ 4,646 $ 3,004 The annualized yield on our finance receivables was 12.1% for the three months ended September 30, 2022 and 12.5% for the same period in 2021. 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 fair value receivables was $2,517.7 million for the three months ended September 30, 2022 compared to $1,837.1 million in the prior year period. For the three months ended September 30, 2022, we recorded a reduction to provision for credit losses on finance receivables in the amount of $6.0 million. The reserve decrease was primarily due to a decrease in lifetime expected credit losses resulting from improved credit performance as our previous estimates for future losses exceeded actual incurred losses. This compares to $1.6 million in reductions to provision for credit losses for the three months ended September 30, 2021. Our evaluation of the allowance for credit losses indicated that the reserves against future losses are adequate as of September 30, 2022. Although we have not yet seen a meaningful deterioration in the credit performance for these receivables, worsening economic conditions, inflation and a reversion to the mean for used car pricing could negatively affect credit performance in the future. 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. 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 increased by $1.7 million to $6.0 million during the three months ended September 30, 2022 and represented 10.7% of total operating expenses. We purchased $468.2 million of new contracts during the three months ended September 30, 2022 compared to $326.8 million in the prior year period. Occupancy expenses was $2.0 million for the three months ending September 30, 2022 and 2021. 30 Depreciation and amortization expenses decreased to $406,000 compared to $409,000 in the previous year and represented 0.8% of total operating expenses. For the three months ended September 30, 2022, we recorded income tax expense of $8.9 million, representing a 26% effective tax rate. In the prior period, our income tax expense was $5.9 million, representing a 30% effective tax rate. Comparison of Operating Results for the nine months ended September 30, 2022 with the nine months ended September 30, 2021 Revenues . During the nine months ended September 30, 2022, our revenues were $246.7 million, an increase of $48.2 million, or 24.3%, from the prior year revenue of $198.4 million. The primary reason for the increase in revenues is the increase in interest income resulting from the increase in the average outstanding balance of finance receivables measured at fair value. In addition, mark ups to the finance receivables measured at fair value also contributed to the increase in revenues during the period. Revenues for the nine months ended September 30, 2022 include a $15.3 million mark up to the recorded value of the finance receivables measured at fair value. This compares to a $4.4 million mark down in the prior year period. The marks are estimates based on our evaluation of the appropriate fair value and future earnings rate of existing receivables compared to recently acquired receivables and increases or decreases in our estimates of future net losses. During the nine months ended September 30, 2022, we reduced our estimate for expected future losses in finance receivables measured at fair value as we have observed that our previous estimates for increased losses due to the pandemic had not materialized. These changes resulted in the $15.3 million mark up for the nine months ended September 30, 2022. Interest income for the nine months ended September 30, 2022 increased $27.0 million, or 13.6%, to $225.5 million from $198.6 million in the prior year. The primary reason for the increase in interest income is the 30.7% increase in the average balance of finance receivables measured at fair value over the prior year period. The table below shows the average balances and interest yields of the two components of our loan portfolio for the nine months ended September 30, 2022 and 2021: Nine Months Ended September 30, 2022 2021 (Dollars in thousands) Average Interest Average Interest Balance Interest Yield Balance Interest Yield Interest Earning Assets Finance receivables $ 167,041 $ 29,343 23.4% $ 375,642 $ 56,669 20.1% Finance receivables measured at fair value 2,296,841 196,204 11.4% 1,757,787 141,882 10.8% Total $ 2,463,882 $ 225,547 12.2% $ 2,133,429 $ 198,551 12.4% Other income was $5.9 million for the nine months ended September 30, 2022. This marks a decrease of $1.5 million from other income of $4.3 million for the nine months ended September 30, 2021. 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. 31 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 $148.8 million for the nine months ended September 30, 2022, compared to $157.1 million for the prior period, a decrease of $8.3 million, or 5.3%. The decrease is primarily due to larger provision for credit loss reversals in 2022. Employee costs were $63.4 million during the nine months ended September 30, 2022 compared to $57.8 million for the same period in the prior year. 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, 2022 and 2021: Nine Months Ended September 30, 2022 2021 (Dollars in millions) Contracts purchased (dollars) $ 1,426.3 $ 818.3 Contracts purchased (units) 61,947 39,929 Managed portfolio outstanding (dollars) $ 2,838.9 $ 2,184.1 Managed portfolio outstanding (units) 173,774 156,456 Number of Originations staff 187 170 Number of Sales staff 134 110 Number of Servicing staff 404 397 Number of other staff 67 74 Total number of employees 792 751 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 $25.9 million, an increase from $23.0 million in the previous year and represented 17.4% of total operating expenses. Interest expense for the nine months ended September 30, 2022 were $58.7 million and represented 39.4% of total operating expenses, compared to $58.3 million in the previous year, when it was 37.1% of total operating expenses. 32 Interest on securitization trust debt decreased by $2.8 million for the nine months ended September 30, 2022 compared to the prior period. The average balance of securitization trust debt increased to $1,959.5 million for the nine months ended September 30, 2022 compared to $1,842.7 million for the nine months ended September 30, 2021. The annualized average rate on our securitization trust debt was 3.3% for the nine months ended September 30, 2022 compared to 3.7% in the prior year period. For each 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 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% January 2021 1.11% April 2021 1.65% July 2021 1.55% October 2021 2.09% January 2022 2.54% April 2022 4.83% July 2022 6.02% Interest expense on warehouse credit line debt was $5.9 million for the nine months ended September 30, 2022 compared to $3.3 million in the prior year period. Lower rates were offset by higher utilization of our credit lines during the quarter compared to last year. The average balance of our warehouse debt was $108.7 million during the nine months ended September 30, 2022 compared to $46.7 million for the same period in 2021. Interest expense on subordinated renewable notes decreased by $198,000. The average balance of the outstanding subordinated debt increased 9.2% to $26.9 million for the nine months ended September 30, 2022 compared to $24.6 million for the nine months ended September 30, 2021. The average yield of subordinated notes decreased to 8.8% in the nine-month period ended September 30, 2022 compared to 10.7% in the prior period. On May 16, 2018, we completed a $40.0 million securitization of residual interests from previously issued securitizations. On June 30, 2021, we completed a $50 million securitization of residual from other previously issued securitizations. Interest expense on these residual interest financings were $3.2 million for the nine months ended September 30, 2022 compared to $2.4 million in the prior year period. 33 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, 2022 and 2021: Nine Months Ended September 30, 2022 2021 (Dollars in thousands) Annualized Annualized Average Average Average Average Balance (1) Interest Yield/Rate Balance (1) Interest Yield/Rate Interest Earning Assets Finance receivables gross (2) $ 167,041 $ 29,343 23.4% $ 375,642 $ 56,669 20.1% Finance receivables at fair value 2,296,841 196,204 11.4% 1,757,787 141,882 10.8% 2,463,882 225,547 12.2% 2,133,429 198,551 12.4% $ Interest Bearing Liabilities $ Warehouse lines of credit $ 108,709 $ 5,887 7.2% $ 46,709 $ 3,265 9.3% Residual interest financing 50,652 3,193 8.4% 36,101 2,446 9.0% Securitization trust debt 1,959,452 47,792 3.3% 1,842,694 50,568 3.7% Subordinated renewable notes 26,910 1,783 8.8% 24,637 1,981 10.7% $ 2,145,723 58,655 3.6% $ 1,950,141 58,260 4.0% $ Net interest income/spread $ $ 166,892 $ 140,291 Net interest yield (3) $ 8.6% 8.4% Ratio of average interest earning assets to average interest bearing liabilities $ 115% 109% (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. Nine Months Ended September 30, 2022 Compared to September 30, 2021 Total Change Due Change Due Change to Volume to Rate (In thousands) Interest Earning Assets $ Finance receivables gross $ (27,326 ) $ (32,850 ) $ 5,524 Finance receivables at fair value 54,322 39,907 14,415 26,996 7,057 19,939 Interest Bearing Liabilities $ Warehouse lines of credit 2,622 4,905 (2,283 ) Residual interest financing 747 1,065 (318 ) Securitization trust debt (2,776 ) 5,198 (7,974 ) Subordinated renewable notes (198 ) 310 (508 ) 395 11,478 (11,083 ) Net interest income/spread $ 26,601 $ (4,421 ) $ 31,022 34 The annualized yield on our finance receivables was 12.2% for the nine months ended September 30, 2022 and 12.4% for the same period in 2021. 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 fair value receivables was $2,296.8 million for the nine months ended September 30, 2022 compared to $1,757.8 million in the prior year period. For the nine months ended September 30, 2022, we recorded a reduction to provision for credit losses on finance receivables in the amount of $23.4 million. The reserve decrease was primarily due to a decrease in lifetime expected credit losses resulting from improved credit performance as our previous estimates for future losses exceeded actual incurred losses. In the prior year period, reductions to provision for credit losses were $1.6 million. Our evaluation of the allowance for credit losses indicated that the reserves against future losses are adequate as of September 30, 2022. Although we have not yet seen a meaningful deterioration in the credit performance for these receivables, worsening economic conditions, inflation and a reversion to the mean for used car pricing could negatively affect credit performance in the future. 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. 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 increased by $4.7 million to $17.2 million during the nine months ended September 30, 2022 and represented 11.5% of total operating expenses. We purchased $1,426.3 million of new contracts during the nine months ended September 30, 2022 compared to $818.3 million in the prior year period. Occupancy expenses was $5.8 million for the nine months ending September 30, 2022 compared to $5.9 million for the same period in 2021. Depreciation and amortization expenses decreased to $1.2 million compared to $1.3 million in the previous year and represented 0.8% of total operating expenses. For the nine months ended September 30, 2022, we recorded income tax expense of $26.0 million, representing a 27% effective tax rate. In the prior period, our income tax expense was $12.8 million, representing a 31% effective tax rate. Credit Experience Our financial results are dependent on the performance of the automobile contracts in which we retain an ownership interest. Broad economic factors such as recession and significant changes in unemployment levels influence the credit performance of our portfolio, as does the weighted average age of the receivables at any given time. The tables below document the delinquency, repossession and net credit loss experience of all such automobile contracts that we originated or own an interest in as of the respective dates shown. 35 Delinquency, Repossession and Extension Experience (1) Total Owned Portfolio September 30, 2022 September 30, 2021 December 31, 2021 Number of Number of Number of Contracts Amount Contracts Amount Contracts Amount (Dollars in thousands) Delinquency Experience Gross servicing portfolio (1) 166,370 $ 2,687,308 156,456 $ 2,184,142 154,151 $ 2,209,430 . Period of delinquency (2) 31-60 days 11,642 $ 170,712 9,621 $ 127,900 10,895 $ 146,904 61-90 days 4,672 65,935 3,371 42,997 3,939 51,069 91+ days 1,795 24,527 961 11,745 1,171 14,280 Total delinquencies (2) 18,109 261,174 13,953 182,642 16,005 212,253 Amount in repossession (3) 2,331 30,479 1,792 21,803 1,882 22,912 Total delinquencies and amount in repossession (2) 20,440 $ 291,653 15,745 $ 204,445 17,887 $ 235,165 Delinquencies as a percentage of gross servicing portfolio 10.9% 9.7% 8.9% 8.4% 10.4% 9.6% . Total delinquencies and amount in repossession as a percentage of gross servicing portfolio 12.3% 10.9% 10.1% 9.4% 11.6% 10.6% Extension Experience Contracts with one extension, accruing 29,683 $ 397,622 23,730 $ 320,330 23,740 $ 328,128 Contracts with two or more extensions, accruing 58,254 794,789 48,840 548,609 46,541 513,183 87,937 1,192,411 72,570 868,939 70,281 841,311 Contracts with one extension, non-accrual (4) 833 9,958 530 6,440 597 7,736 Contracts with two or more extensions, non-accrual (4) 2,558 33,133 1,210 13,376 1,414 15,128 3,391 43,091 1,740 19,816 2,011 22,864 Total contracts with extensions 91,328 $ 1,235,502 74,310 $ 888,755 72,292 $ 864,175 ____________________________________ (1) All amounts and percentages are based on the amount remaining to be repaid on each automobile contract, including, for pre-computed automobile contracts, any unearned interest. The information in the table represents the gross principal amount of all automobile contracts we have purchased, including automobile contracts subsequently sold in securitization transactions that we continue to service. The table does not include certain contracts we have serviced for third parties on which we earn servicing fees only and have no credit risk. (2) We consider an automobile contract delinquent when an obligor fails to make at least 90% of a contractually due payment by the following due date, which date may have been extended within limits specified in the Servicing Agreements. The period of delinquency is based on the number of days payments are contractually past due. Automobile contracts less than 31 days delinquent are not included. The delinquency aging categories shown in the tables reflect the effect of extensions. (3) Amount in repossession represents financed vehicles that have been repossessed but not yet liquidated. (4) Amount in repossession and accounts past due more than 90 days are on non-accrual. 36 Net Charge-Off Experience (1) Total Owned Portfolio Finance Receivables Portfolio September 30, September 30, December 31, 2022 2021 2021 (Dollars in thousands) Average servicing portfolio outstanding $ 263,309 $ 305,820 $ 345,021 Annualized net charge-offs as a percentage of average servicing portfolio (2) 5.8% 3.8% 7.7% Fair Value Receivables Portfolio September 30, September 30, December 31, 2022 2021 2021 (Dollars in thousands) Average servicing portfolio outstanding $ 2,517,663 $ 1,837,138 $ 1,802,590 Annualized net charge-offs as a percentage of average servicing portfolio (2) 4.9% 2.7% 3.1% Total Owned Portfolio September 30, September 30, December 31, 2022 2021 2021 (Dollars in thousands) Average servicing portfolio outstanding $ 2,648,209 $ 2,142,958 $ 2,147,611 Annualized net charge-offs as a percentage of average servicing portfolio (2) 4.9% 2.8% 4.7% _________________________ (1) All amounts and percentages are based on the principal amount scheduled to be paid on each automobile contract, net of unearned income on pre-computed automobile contracts. (2) Net charge-offs include the remaining principal balance, after the application of the net proceeds from the liquidation of the vehicle (excluding accrued and unpaid interest) and amounts collected subsequent to the date of charge-off, including some recoveries which have been classified as other income in the accompanying interim consolidated financial statements. September 30, 2022 and September 30, 2021 percentages represent three months ended September 30, 2022 and September 30, 2021 annualized. December 31, 2021 represents 12 months ended December 31, 2021. Extensions In certain circumstances we will grant obligors one-month payment extensions to assist them with temporary cash flow problems. In general, we are bound by our securitization agreements to refrain from agreeing to more than two such extensions in any 12-month period and to more than six over the life of the contract. 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 some 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. Because financial regulatory authorities have encouraged obligors to expect payment deferrals as a response to the pandemic, we may seek amendments or waivers of our securitization agreements to relax the limits on extensions; however, we have not sought such changes in terms as of the date of this report, and if we do seek such changes, there can be no assurance that the other parties to our securitization agreements will agree to such amendments or waivers, nor as to the effect on credit performance that may result if such amendments or waivers are agreed to. 37 The basic question in deciding to grant an extension is whether or not we will (a) be delaying the inevitable repossession and liquidation or (b) risk losing the vehicle as a result of not being able to locate the obligor and vehicle. In both of those situations, the loss would likely be higher than if the vehicle had been repossessed without the extension. The benefits of granting an extension include minimizing current losses and delinquencies, minimizing lifetime losses, getting the obligor’s account current (or close to it) and building goodwill so that the obligor might prioritize us over other creditors on future payments. Our servicing staff are trained to identify when a past due obligor is facing a temporary problem that may be resolved with an extension. In some cases, the extension will be granted in conjunction with our receiving all or a portion of a past due payment from the obligor, thereby indicating an additional monetary and psychological commitment to the contract on the obligor’s part. The credit assessment for granting an extension is initially made by our collector, who bases the recommendation on the collector’s discussions with the obligor. In such assessments the collector will consider, among other things, the following factors: (1) the reason the obligor has fallen behind in payment; (2) whether or not the reason for the delinquency is temporary, and if it is, have conditions changed such that the obligor can begin making regular monthly payments again after the extension; (3) the obligor's past payment history, including past extensions if applicable; (4) the obligor’s willingness to communicate and cooperate on resolving the delinquency; and (5) a numeric score from our internal risk assessment system that indicating the likelihood that the extension will prove beneficial. If the collector believes the obligor is a good candidate for an extension, an approval is obtained from a supervisor, who will review the same factors stated above prior to offering the extension to the obligor. After receiving an extension, an account remains subject to our normal policies and procedures for interest accrual, reporting delinquency and recognizing charge-offs. We believe that a prudent extension program is an integral component to mitigating losses in our portfolio of sub-prime automobile receivables. The table below summarizes the status, as of September 30, 2022, for accounts that received extensions from 2008 through 2020: Period of Extension # Extensions Granted Active or Paid Off at September 30, 2022 % Active or Paid Off at September 30, 2022 Charged Off > 6 Months After Extension % Charged Off > 6 Months After Extension Charged Off <= 6 Months After Extension % Charged Off <= 6 Months After Extension Avg Months to Charge Off Post Extension 2008 35,588 10,708 30.1% 20,060 56.4% 4,819 13.5% 19 2009 32,226 10,273 31.9% 16,170 50.2% 5,783 17.9% 17 2010 26,167 12,159 46.5% 12,009 45.9% 1,999 7.6% 19 2011 18,786 10,972 58.4% 6,882 36.6% 932 5.0% 19 2012 18,783 11,320 60.3% 6,667 35.5% 796 4.2% 18 2013 23,398 11,147 47.6% 11,275 48.2% 976 4.2% 23 2014 25,773 10,494 40.7% 14,453 56.1% 826 3.2% 25 2015 53,319 22,434 42.1% 29,803 55.9% 1,082 2.0% 26 2016 80,897 37,032 45.8% 41,932 51.8% 1,933 2.4% 26 2017 133,881 62,142 46.4% 64,813 48.4% 6,926 5.2% 22 2018 121,531 66,971 55.1% 48,553 40.0% 6,007 4.9% 19 2019 71,548 51,658 72.2% 17,948 25.1% 1,942 2.7% 17 2020 83,170 66,338 79.8% 13,601 16.4% 2,099 2.5% 14 ______________________ Note: Table excludes extensions on portfolios serviced for third parties 38 We view these results as a confirmation of the effectiveness of our extension program. For example, of the accounts granted extensions in 2018, 55.1% were either paid in full or active and performing as of September 30, 2022. Each of these successful accounts represent continued payments of interest and principal (including payment in full in many cases), where without the extension we likely would have incurred a substantial loss and no interest revenue after the extension. For the extension accounts that ultimately charge off, we consider any that charged off more than six months after the extension to be at least partially successful. For example, of the accounts granted extensions in 2012 that subsequently charged off, such charge offs occurred, on average, 18 months after the extension, indicating that even in the cases of an ultimate loss, the obligor serviced the account with additional payments of principal and interest. Additional information about our extensions is provided in the tables below: Nine Months Ended September 30, Year Ended December 31, Nine Months Ended September 30, 2022 2021 2021 Average number of extensions granted per month 4,433 3,918 3,656 Average number of outstanding accounts 159,910 157,076 157,976 Average monthly extensions as % of average outstandings 2.8% 2.5% 2.3% ______________________ Note: Table excludes portfolios originated and owned by third parties September 30, 2022 September 30, 2021 December 31, 2021 Number of Contracts Amount Number of Contracts Amount Number of Contracts Amount (Dollars in thousands) Contracts with one extension 30,516 $ 407,580 24,260 $ 326,770 24,337 $ 335,864 Contracts with two extensions 22,795 310,724 16,888 216,878 15,861 200,705 Contracts with three extensions 17,058 235,319 12,155 144,035 11,755 136,970 Contracts with four extensions 11,282 155,514 9,379 97,391 9,272 95,182 Contracts with five extensions 6,332 84,695 6,782 63,531 6,531 59,651 Contracts with six extensions 3,345 41,669 4,846 40,149 4,536 35,803 91,328 $ 1,235,501 74,310 $ 888,754 72,292 $ 864,175 Managed portfolio (excluding originated and owned by 3rd parties) 166,370 $ 2,687,308 156,456 $ 2,184,142 154,151 $ 2,209,430 ______________________ Note: Table excludes portfolios originated and owned by third parties Since 2019, we have been able to reduce extensions by working with our servicing staff to be more selective in granting extensions including, where appropriate, to exhaust all possibilities of payment by the customer before granting an extension. However, as delinquency rates have risen, so has the average number of extensions granted for the nine month period ended September 30, 2022. 39 Non-Accrual Receivables It is not uncommon for our obligors to fall behind in their payments. However, with the diligent efforts of our Servicing staff and systems for managing our collection efforts, we regularly work with our customers to resolve delinquencies. Our staff are trained to employ a counseling approach to assist our customers with their cash flow management skills and help them to prioritize their payment obligations in order to avoid losing their vehicle to repossession. Through our experience, we have learned that once a customer becomes greater than 90 days past due, it is not likely that the delinquency will be resolved and will ultimately result in a charge-off. As a result, we do not recognize any interest income for contracts that are greater than 90 days past due. If a contract exceeds the 90 days past due threshold at the end of one period, and then makes the necessary payments such that it becomes less than or equal to 90 days delinquent at the end of a subsequent period, it would be restored to full accrual status for our financial reporting purposes. At the time a contract is restored to full accrual in this manner, there can be no assurance that full repayment of interest and principal will ultimately be made. However, we monitor each obligor’s payment performance and are aware of the severity of his delinquency at any time. The fact that the delinquency has been reduced below the 90-day threshold is a positive indicator. Should the contract again exceed the 90-day delinquency level at the end of any reporting period, it would again be reflected as a non-accrual account. Our policy for placing a contract on non-accrual status is independent of our policy to grant an extension. In practice, it would be an uncommon circumstance where an extension was granted and the account remained in a non-accrual status, since the goal of the extension is to bring the contract current (or nearly current). Liquidity and Capital Resources Our business requires substantial cash to support our purchases of automobile contracts and other operating activities. Our primary sources of cash have been cash flows from the proceeds from term securitization transactions and other sales of automobile contracts, amounts borrowed under various revolving credit facilities (also sometimes known as warehouse credit facilities), customer payments of principal and interest on finance receivables, fees for origination of automobile contracts, and releases of cash from securitization transactions and their related spread accounts. Our primary uses of cash have been the purchases of automobile contracts, repayment of amounts borrowed under lines of credit, securitization transactions and otherwise, operating expenses such as employee, interest, occupancy expenses and other general and administrative expenses, the establishment of spread accounts and initial overcollateralization, if any, the increase of credit enhancement to required levels in securitization transactions, and income taxes. There can be no assurance that internally generated cash will be sufficient to meet our cash demands. The sufficiency of internally generated cash will depend on the performance of securitized pools (which determines the level of releases from those pools and their related spread accounts), the rate of expansion or contraction in our managed portfolio, and the terms upon which we are able to acquire and borrow against automobile contracts. Net cash provided by operating activities for the nine-month period ended September 30, 2022 was $164.7 million, an increase of $1.6 million, compared to net cash provided by operating activities for the nine-month period ended September 30, 2021 of $163.1 million. Net cash from operating activities is generally provided by net income from operations adjusted for significant non-cash items such as our provision for credit losses and marks to finance receivables measured at fair value. Net cash used in investing activities was $566.5 million for the nine months ended September 30, 2022. Net cash provided by investing activities for the nine-month period ended September 30, 2021 was $50.2 million. Cash provided by investing activities primarily results from principal payments and other proceeds received on finance receivables. Cash used in investing activities generally relates to purchases of automobile contracts. Purchases of finance receivables excluding acquisition fees were $1,426.3 million and $818.3 million during the first nine months of 2022 and 2021, respectively. 40 Net cash provided by financing activities for the nine months ended September 30, 2022 was $397.9 million compared to net cash used in financing activities of $83.3 million in the prior year period. Cash provided by financing activities is primarily related to the issuance of securitization trust debt, reduced by the amount of repayment of securitization trust debt and net proceeds or repayments on our warehouse lines of credit and other debt. In the first nine months of 2022, we issued $1,104.0 million in new securitization trust debt compared to $761.5 million in the same period of 2021. We repaid $804.8 million in securitization trust debt in the nine months ended September 30, 2022 compared to repayments of securitization trust debt of $861.0 million in the prior year period. In the nine months ended September 30, 2022, we had net advances on warehouse lines of credit of $139.5 million, compared to net repayments of $22.1 million in the prior year’s period. We purchase automobile contracts from dealers for a cash price approximately equal to their principal amount, adjusted for an acquisition fee which may either increase or decrease the automobile contract purchase price. Those automobile contracts generate cash flow, however, over a period of years. We have been dependent on warehouse credit facilities to purchase automobile contracts and our securitization transactions for long term financing of our contracts. In addition, we have accessed other sources, such as residual financings and subordinated debt in order to finance our continuing operations. The acquisition of automobile contracts for subsequent financing in securitization transactions, and the need to fund spread accounts and initial overcollateralization, if any, and increase credit enhancement levels when those transactions take place, results in a continuing need for capital. The amount of capital required is most heavily dependent on the rate of our automobile contract purchases, the required level of initial credit enhancement in securitizations, and the extent to which the previously established trusts and their related spread accounts either release cash to us or capture cash from collections on securitized automobile contracts. Of those, the factor most subject to our control is the rate at which we purchase automobile contracts. We are and may in the future be limited in our ability to purchase automobile contracts due to limits on our capital. As of September 30, 2022, we had unrestricted cash of $12.9 million and $157.6 million aggregate available borrowings under our two warehouse credit facilities (assuming the availability of sufficient eligible collateral). As of September 30, 2022, we had approximately $40.3 million of such eligible collateral. Our plans to manage our liquidity include maintaining our rate of automobile contract purchases at a level that matches our available capital, and, as appropriate, minimizing our operating costs. During the nine-month period ended September 30, 2022, we completed three securitizations aggregating $1,104.0 million of notes sold. Our liquidity will also be affected by releases of cash from the trusts established with our securitizations. While the specific terms and mechanics of each spread account vary among transactions, our securitization agreements generally provide that we will receive excess cash flows, if any, only if the amount of credit enhancement has reached specified levels and the net losses related to the automobile contracts in the pool are below certain predetermined levels. In the event delinquencies or net losses on the automobile contracts exceed such levels, the terms of the securitization may require increased credit enhancement to be accumulated for the particular pool. There can be no assurance that collections from the related trusts will continue to generate sufficient cash. 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, 2022, we were in compliance with all such financial covenants. We have and will continue to have a substantial amount of indebtedness. At September 30, 2022, we had approximately $2,376.4 million of debt outstanding. Such debt consisted primarily of $2,057.1 million of securitization trust debt and $242.4 million of debt from warehouse lines of credit. Our securitization trust debt has increased by $297.1 million while our warehouse lines of credit debt has increased by $136.8 million since December 31, 2021 (each net of deferred financing costs). Since 2005, we have offered renewable subordinated notes to the public on a continuous basis, and such notes have maturities that range from six months to 10 years. We had $27.2 million and $26.5 million in subordinated renewable notes outstanding at September 30, 2022 and December 31, 2021, respectively. On June 30, 2021, we completed a $50.0 million securitization of residual interests from other previously issued securitizations. As of September 30, 2022, all $50.0 million of this debt remains outstanding. 41 Although we believe we are able to service and repay our debt, there is no assurance that we will be able to do so. If our plans for future operations do not generate sufficient cash flows and earnings, our ability to make required payments on our debt would be impaired. If we fail to pay our indebtedness when due, it could have a material adverse effect on us and may require us to issue additional debt or equity securities. Forward Looking Statements This report on Form 10-Q includes certain “forward-looking statements.” Forward-looking statements may be identified by the use of words such as “anticipates,” “expects,” “plans,” “estimates,” or words of like meaning. Our provision for credit losses is a forward-looking statement, as it is dependent on our estimates as to future chargeoffs and recovery rates. Factors that could affect charge-offs and recovery rates include changes in the general economic climate, which could affect the willingness or ability of obligors to pay pursuant to the terms of automobile contracts, changes in laws respecting consumer finance, which could affect our ability to enforce rights under automobile contracts, and changes in the market for used vehicles, which could affect the levels of recoveries upon sale of repossessed vehicles. Our valuation of receivables measured at fair value is a forward-looking statement, as it is dependent, among other things, on our estimates of cash to be received in the future with respect to such receivables. Each of the factors listed above as affecting charge-offs and recovery rates could have a similar effect on cash to be received in the future with respect to receivables measured at fair value. Factors that could affect our revenues in the current year include the levels of cash releases from existing pools of automobile contracts, which would affect our ability to purchase automobile contracts, the terms on which we are able to finance such purchases, the willingness of dealers to sell automobile contracts to us on the terms that we offer, and the terms on which and whether we are able to complete term securitizations once automobile contracts are acquired. Factors that could affect our expenses in the current year include competitive conditions in the market for qualified personnel and interest rates (which affect the rates that we pay on notes issued in our securitizations). The factors identified in this and other reports as “Risk Factors” could affect our revenues, expenses, liquidity and financial condition, and the timing and amount of cash received with respect to our automobile contracts.