Consolidated Results of Operations
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Income
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For the Three Months Ended September 30,
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Increases (Decreases)
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(In Thousands)
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2012
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|
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2011
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from 2011 to 2012
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Total interest income
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$
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20,377
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$
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35,073
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$
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(14,696
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)
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Interest expense
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(7,406
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)
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(10,282
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)
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2,876
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Fees and related income on earning assets:
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Fees on credit products
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5,316
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2,566
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2,750
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Changes in fair value of loans and fees receivable recorded at fair value
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10,742
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46,646
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(35,904
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)
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Changes in fair value of notes payable associated with structured financings recorded at fair value
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(10,469
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)
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(29,538
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)
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19,069
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Gains (losses) on investments in securities
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285
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(5,418
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)
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5,703
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Loss on sale of JRAS assets
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-
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-
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-
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Other
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(2,171
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)
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499
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(2,670
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)
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Other operating income:
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Servicing income
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1,002
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767
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235
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Ancillary and interchange revenues
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570
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1,429
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(859
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)
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Gain on repurchase of convertible senior notes
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-
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138
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(138
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)
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Gain on buy-out of equity-method investee members
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-
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-
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-
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Equity in income equity-method investees
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356
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6,630
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(6,274
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)
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Total
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$
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18,602
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$
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48,510
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(29,908
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)
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Losses upon charge off of loans and fees receivable recorded at fair value
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|
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8,790
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28,019
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19,229
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Provision for losses on loans and fees receivable recorded at net realizable value
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5,373
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96
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(5,277
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)
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Operating expenses:
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Salaries and benefits
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2,523
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4,520
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1,997
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Card and loan servicing
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10,428
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11,043
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615
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Marketing and solicitation
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223
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1,181
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|
958
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Depreciation
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1,518
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|
504
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(1,014
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)
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Other
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5,557
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7,231
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|
|
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1,674
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Net income
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|
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32,924
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1,422
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31,502
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Net loss attributable to noncontrolling interests
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287
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277
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10
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Net income attributable to controlling interests
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33,211
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1,699
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31,512
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Income
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For the Nine Months Ended September 30,
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Increases (Decreases)
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(In Thousands)
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2012
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|
|
2011
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|
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from 2011 to 2012
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Total interest income
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$
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68,768
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|
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$
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115,372
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|
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$
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(46,604
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)
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Interest expense
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|
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(25,582
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)
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(33,262
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)
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7,680
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Fees and related income on earning assets:
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Fees on credit products
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12,310
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7,332
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|
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4,978
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Changes in fair value of loans and fees receivable recorded at fair value
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93,613
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166,164
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(72,551
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)
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Changes in fair value of notes payable associated with structured financings recorded at fair value
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(35,859
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)
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(82,507
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)
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46,648
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Gains (losses) on investments in securities
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|
|
49
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|
|
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(5,277
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)
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|
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5,326
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Loss on sale of JRAS assets
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|
|
-
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|
|
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(4,648
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)
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4,648
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Other
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(2,112
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)
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1,213
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(3,325
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)
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Other operating income:
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Servicing income
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3,234
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2,593
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|
641
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Ancillary and interchange revenues
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2,021
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4,670
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(2,649
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)
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Gain on repurchase of convertible senior notes
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-
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607
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(607
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)
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Gain on buy-out of equity-method investee members
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-
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619
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(619
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)
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Equity in income equity-method investees
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9,912
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28,757
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(18,845
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)
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Total
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$
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126,354
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$
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201,633
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(75,279
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)
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Losses upon charge off of loans and fees receivable recorded at fair value
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81,693
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117,209
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35,516
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Provision for losses on loans and fees receivable recorded at net realizable value
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13,828
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(325
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)
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|
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(14,153
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)
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Operating expenses:
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|
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|
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Salaries and benefits
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12,990
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|
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16,545
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|
|
|
3,555
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Card and loan servicing
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31,618
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|
|
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36,018
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|
|
|
4,400
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|
Marketing and solicitation
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|
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1,669
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|
|
|
2,386
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|
|
|
717
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|
Depreciation
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|
|
2,294
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|
|
|
4,232
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|
|
|
1,938
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Other
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|
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18,755
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|
|
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20,450
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|
|
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1,695
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Net income
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|
|
22,462
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|
|
|
131,933
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|
|
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(109,471
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)
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Net loss (income) attributable to noncontrolling interests
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|
572
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|
|
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(1,013
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)
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|
|
1,585
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|
Net income attributable to controlling interests
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|
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23,034
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|
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130,920
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|
|
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(107,886
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)
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Three and Nine Months Ended September 30, 2012, Compared to Three and Nine Months Ended September 30, 2011
Total interest income.
Total interest income consists primarily of finance charges and late fees earned on our credit card, private label merchant credit, and auto finance receivables. The decline period over period is due to continued net liquidations of our credit card and auto finance receivables over the past year. Moreover, absent the effects of possible portfolio acquisitions, we expect our ongoing total interest income to decline in subsequent quarters along with continuing expected net liquidations of our credit card and auto finance receivables.
Interest expense.
The decrease is due to (1) our debt facilities being repaid commensurate with net liquidations of the underlying credit card receivables and auto finance receivables that serve as collateral for the facilities, and (2) the effects of our repurchases of our convertible senior notes throughout 2011 and our May 2012 repayment of substantially all of our 3.625% convertible senior notes as previously discussed in Note 8, “Convertible Senior Notes and Notes Payable,” in the accompanying notes to the consolidated financial statements.
We also note that notwithstanding the effects of our convertible senior notes issuance discount accretion in increasing monthly interest expense amounts in the future, we expect lower interest expense for these notes in future periods attributable to our 2011 repurchases and our May 2012 repayment of substantially all of our 3.625% convertible senior notes.
Fees and related income on earning assets.
The significant factors affecting our differing levels of fees and related income on earning assets include:
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slight 2012 increases in fees earned on our credit products, principally due to billings on test accounts in the U.K. offset by continued credit card receivables liquidations;
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·
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“Other” category losses arising in 2012 due to operating losses incurred by a small coal mining operation we were required to consolidate in the fourth quarter of 2011 based on workout efforts we have undertaken related to a loan we made to the mining operation;
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·
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our recognition of a $4.6 million loss in the three months ended March 31, 2011 corresponding to our sale of certain assets associated with our JRAS operations; and
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·
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our recognition of a $3.4 million loss in the three months ended September 30, 2011 on an investment that we made in non-marketable debt securities—such loss representing 100% of the face amount of the notes that we held from the issuer of the notes based on an other-than-temporary decline in their value, and our recognition of another $1.9 million loss in the three months ended September 30, 2011 due to an other-than-temporary decline in the value of another issuer’s non-marketable debt securities in which we had previously invested.
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We do not expect significant ongoing losses with respect to the coal mining operation mentioned above; the carrying amount of the operation’s net assets is negligible, and we are exploring alternatives to reduce the scope of its future operations and losses.
Given expected net liquidations in our credit card receivables (absent possible portfolio acquisitions) in the future, we expect our change in fair value of credit card receivables recorded at fair value and our change in fair value of notes payable associated with structured financings recorded at fair value amounts to gradually diminish (absent significant changes in the assumptions used to determine these fair values) in the future. These amounts, however, are subject to potentially high levels of volatility if we experience changes in the quality of our credit card receivables or if there are significant changes in market valuation factors (e.g., interest rates and spreads) in the future. Such volatility will be muted somewhat, however, by the offsetting nature of the receivables and underlying debt being recorded at fair value and with the expected reductions in the face amounts of such outstanding receivables and debt as we experience further credit card receivables liquidations and associated debt amortizing repayments.
Servicing income.
Our reported servicing income is comprised of servicing compensation paid to us by third parties associated with our servicing of their loans and fees receivable. Positively impacting 2012 is income from transitional services that we provided to the buyer of our Retail Micro-Loans segment, such services having substantially ended, and that we currently are providing to the buyer of our Investment in Previously Charged-Off Receivables and balance transfer card operations since our disposition of these operations in August 2012. Absent these revenues, servicing income would have declined commensurate with liquidations in the portfolios of loans and fees receivables that we service for third parties.
C
urrently, servicing income is not a significant income source for us, and unless we grow the number of contractual servicing relationships we have with other third parties, we will not experience sustained levels of growth and income within this category. Subsequent to the end of the quarter, however, we received an additional $10.0 million as compensation for excess servicing costs one of our subsidiaries incurred with respect to its underlying credit card portfolio. We will report this $10.0 million payment within our fourth quarter 2012 servicing income.
Ancillary and interchange revenues.
During periods, unlike our current period, in which we are broadly originating credit card accounts or in which a significant number of credit card accounts are open to cardholder purchases, we market to cardholders other ancillary products, including credit and identity theft monitoring, health discount programs, shopping discount programs and debt waivers. The decline in our ancillary revenues associated with these activities and our interchange revenues corresponds with our account closure actions and net liquidations we have experienced in all of our credit card receivables portfolios in recent years. Absent portfolio acquisitions, we do not expect significant ancillary and interchange revenues in the future.
Gain on repurchase of convertible senior notes.
In open market transactions during the three and nine months ended September 30, 2011, we repurchased $6.0 million and $39.6 million in face amount of our 3.625% notes for $5.7 million and $37.0 million (inclusive of transaction costs and accrued interest through the date of our repurchase of the notes), respectively, thereby resulting in the recognition of an aggregate gain during the three and nine months ended September 30, 2011 of $0.1 million and $0.6 million (net of the notes’ applicable share of deferred costs and debt discount, which were recovered in connection with the purchases), respectively. No such repurchases were made in the three and nine months ended September 30, 2012.
We remain open to the possibility of further repurchases of our convertible senior notes at prices we find attractive in the future, which could result in additional as of yet unknown gains or losses upon such repurchases.
Equity in income of equity-method investees.
The significant decrease in income associated with our equity-method investees is principally related to our 50.0% interest in the joint venture that purchased in March 2011 the outstanding notes issued out of our U.K. Portfolio structured financing trust. Contemporaneous with our March 2011 acquisition of our 50% interest in the joint venture, it elected to account for its investment in the U.K. Portfolio structured financing notes at their fair value, and it recognized a $34.2 million gain (of which our 50% share represented $17.1 million) equal to the excess of the fair value of the notes as of March 31, 2011 over the joint venture’s discounted purchase price of the notes.
We expect to see continued liquidations in the credit card receivables portfolios and structured financing notes held by our equity-method investees for the foreseeable future. As such, absent possible additional investments in our existing or in new equity-method investees in the future, we expect gradually declining effects from our equity-method investments on our operating results.
Losses upon charge off of loans and fees receivable recorded at fair value.
This account reflects charge offs of the face amount credit card receivables we record at fair value on our consolidated balance sheet. We have experienced a general trending decline in and we expect future trending declines in these charge offs as we continue to liquidate our credit card receivables. The effects of this general trending decline were muted for the nine months ended September 30, 2012, however, given our sale of a large volume of late-stage delinquent accounts and related receivables (which we treated as having been charged off contemporaneous with their sale) out of our U.K. credit card receivables portfolio during the first quarter of 2012. For this reason, our rate of decline in this category in the future will be more similar to the rate of decline experienced in the three months ended September 30, 2012 when compared to the same period in 2011 than to the rate of decline experienced in the three months ended June 30, 2012 when compared to the same period in 2011.
Provision for losses on loans and fees receivable recorded at net realizable value.
Our provision for losses on loans and fees receivable recorded at net realizable value covers aggregate loss exposures on (1) principal receivable balances, (2) finance charges and late fees receivable underlying income amounts included within our total interest income category, and (3) other fees receivable. We have recently experienced trending declines in our provisions for losses on loans and fees receivable recorded at net realizable value associated with contractions in our auto finance loans and fees receivable combined with some modest effects of an improved economy in recent quarters. However, we experienced a year over year increase in this category between 2011 and 2012 due to the effects of (1) disproportionately greater reductions in our allowance for uncollectible loans and fees receivables recorded in the three and nine months ended September 30, 2011 associated with significant performance improvements experienced at that time, and (2) elevated losses incurred on new credit product testing in the nine months ended September 30, 2012. Given our continued gradual net liquidation of our auto finance receivables, which is expected to outpace growth in receivables associated with other receivables associated with new products we are testing (e.g., private label merchant credit products) for the next several quarters, we do not expect any significant deviations in our credit risks, delinquencies and loss rates in 2012 versus 2011.
Total other operating expense.
Total other operating expense decreased for the three and nine months ended September 30, 2012 relative to the three and nine months ended September 30, 2011, reflecting the following:
·
|
diminished salaries and benefits costs resulting from our ongoing cost-cutting efforts as we continue to adjust our internal operations to reflect the declining size of our existing portfolios;
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·
|
lower card and loan servicing expenses reflecting the effects of continuing credit card and auto finance receivables portfolio liquidations;
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·
|
decreases in depreciation for the nine months ended September 30, 2012 reflecting a diminished level of capital investments by us, offset by higher depreciation expense in the three months ended September 30, 2012 due to the impairment of certain fixed assets held by a small coal mining operation we are required to consolidate based on workout efforts we have undertaken related to a loan we made to the mining operation; and
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·
|
decreases in marketing and solicitation and other expense levels consistent with the aforementioned receivables portfolio liquidations and our cost-cutting efforts.
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A large portion of our operating costs are variable based on the levels of accounts we market and receivables we service (both for our own account and for others) and the pace and breadth of our search for, acquisition of and introduction of new business lines, products and services. However, a number of our operating costs are fixed and will over time comprise a larger percentage of our total costs given the ongoing contraction of our credit card and auto finance loans and fees receivable levels. To this extent, our rate of cost reduction can be expected to slow relative to the rate of contraction in these loans and fees receivable. We do, however, attempt to maximize the utility that we get from our incurrence of fixed costs by our testing and exploration of new products and services and areas of investment, and we continue to perform extensive reviews of all areas of our businesses for cost savings opportunities to better align our costs with our net liquidating portfolio of managed receivables.
Notwithstanding our cost-cutting efforts and focus, while it is relatively easy for us to scale back our variable expenses, it is much more difficult (to which we alluded above) for us to appreciably reduce our fixed and other costs associated with an infrastructure (particularly within our Credit Cards and Other Investments segment) that was built to support growing managed receivables and levels of managed receivables that are significantly higher than both our current levels and the levels that we expect to see in the near future. At this point, our Credit Cards and Other Investments segment cash inflows are sufficient to cover its direct variable costs and a portion, but not all, of its share of overhead costs (including, for example, corporate-level executive and administrative costs and our convertible senior notes interest costs). As such, if we are not successful in further reducing overhead costs or expanding revenue-earning activities to levels commensurate with such costs, then, depending upon the sufficiency of excess cash flows and earnings generated from our Auto Finance subsidiary and those credit card portfolios that have repaid their underlying structured financing facilities, we may experience continuing pressure on our liquidity position and our ability to be profitable.
Noncontrolling interests.
We reflect the ownership interests of noncontrolling holders of equity in our majority-owned subsidiaries as noncontrolling interests in our consolidated statements of operations. Because of various transactions that took place in early 2011, unless we enter into significant new majority-owned subsidiary ventures with noncontrolling interest holders in the future, we expect to have negligible noncontrolling interests in our majority-owned subsidiaries and negligible allocations of income or loss to noncontrolling interest holders in future quarters. Transactions contributing to this development and the decline in net income attributable to noncontrolling interests in 2012 versus 2011 include:
·
|
Our collective January 2011 and April 2011 purchases of most of the noncontrolling interest holders’ ownership interests in our Credit Cards and Other Investments segment majority-owned subsidiaries; and
|
·
|
Our April 2011 sale of the majority-owned subsidiaries through which we owned our U.K. Internet micro-loan operations.
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Income taxes.
Computed considering results for only our continuing operations before income taxes, our effective income tax benefit rate was 25.5% and 28.8% for the three and nine months ended September 30, 2012, respectively, versus our negative effective income tax benefit rate of 15.2% for the three months ended September 30, 2011 and our positive effective income tax expense rate of 34.1% for the nine months ended September 30, 2011. We have experienced no material changes in effective tax rates associated with differences in filing jurisdictions, and the variations in our effective tax rates between the periods principally bear the effects of (1) changes in valuation allowances against income statement-oriented federal, foreign and state deferred tax assets, (2) variations in the level of our pre-tax income among the different reporting periods relative to the level of our permanent differences within such periods, and (3) the effects on our interim financial reporting results of intra-period tax allocations associated with our discontinued operations as required under GAAP. Computed without regard to the effects of the valuation allowance changes, our effective tax rates would have been a positive 24.8% and a positive 28.5% benefit rate in the three and nine months ended September 30, 2012, respectively, compared to a positive 9.5% benefit rate and a positive 99.1% expense rate, in the three and nine months ended September 30, 2011, respectively.
We recognize potential accrued interest and penalties related to unrecognized tax benefits in income tax expense. We recognized $0.6 million and $1.5 million in potential interest and penalties associated with uncertain tax positions during the three and nine months ended September 30, 2012, respectively, compared to $0.6 million and $1.7 million during the three and nine months ended September 30, 2011, respectively. To the extent such interest and penalties are not assessed as a result of a resolution of the underlying tax position, amounts accrued are reduced and reflected as a reduction of income tax expense. We recognized no such reductions in the three and nine months ended September 30, 2012 and 2011, respectively.
Credit Cards and Other Investments Segment
Our Credit Cards and Other Investments segment includes our continuing activities relating to investments in and servicing of our various credit card receivables portfolios, as well as other investments and products that are not yet material to our overall financial position but which generally utilize much of the same infrastructure as our credit card operations.
The revenues we earn from credit card activities primarily include finance charges, late fees, over-limit fees, annual fees, activation fees, monthly maintenance fees, returned-check fees and cash advance fees. Also, while insignificant currently, revenues (during previous periods of broad account origination and in which significant numbers of accounts were open to cardholder purchases) also have included those associated with (1) our sale of ancillary products such as memberships, subscription services and debt waiver, as well as (2) interchange fees representing a portion of the merchant fee assessed by card associations based on cardholder purchase volumes underlying credit card receivables.
We record the finance charges and late fees assessed on our Credit Cards and Other Investments segment credit products in the consumer loans, including past due fees category on our consolidated statements of operations, we include the over-limit, annual, monthly maintenance, returned-check, cash advance and other fees in the fees and other income on earning assets category on our consolidated statements of operations, and we reflect the charge offs within our provision for losses on loans and fees receivable on our consolidated statements of operations (for all credit product receivables other than those credit card receivables underlying formerly off-balance-sheet securitization structures) and within losses upon charge off of loans and fees receivable recorded at fair value on our consolidated statements of operations (for all of our other credit card receivables underlying formerly off-balance-sheet securitization structures for which we have elected the fair value option). Additionally, we show the effects of fair value changes for those credit card receivables for which we have elected the fair value option as a component of fees and related income on earning assets in our consolidated statements of operations.
We historically have originated and purchased credit card portfolios through subsidiary entities. Generally, if we control through direct ownership or exert a controlling interest in the entity, we consolidate it and reflect its operations as noted above. If we exert significant influence but do not control the entity, we record our share of its net operating results in the equity in income of equity-method investees category on our consolidated statements of operations.
Background
We make various references within our discussion of the Credit Cards and Other Investments segment to our managed receivables. In calculating managed receivables data, we include within managed receivables those receivables we manage for our consolidated subsidiaries, but we exclude from managed receivables any noncontrolling interest holders’ shares of the receivables during applicable periods. Additionally, we include within managed receivables only our economic share of the receivables that we manage for our equity-method investees.
Financial, operating and statistical data based on aggregate managed receivables are important to any evaluation of our performance in managing our credit card portfolios, including our underwriting, servicing and collecting activities and our valuing of purchased receivables. In allocating our resources and managing our business, management relies heavily upon financial data and results prepared on this “managed basis.” Analysts, investors and others also consider it important that we provide selected financial, operating and statistical data on a managed basis because this allows a comparison of us to others within the specialty finance industry. Moreover, our management, analysts, investors and others believe it is critical that they understand the credit performance of the entire portfolio of our managed receivables because it reveals information concerning the quality of loan originations and the related credit risks inherent within the portfolios.
Reconciliation of the managed receivables data to our GAAP financial statements requires: (1) an understanding that our managed receivables data are based on billings and actual charge offs as they occur, without regard to any changes in our allowance for uncollectible loans and fees receivable or any changes in the fair value of loans and fees receivable and their associated structured financing notes; (2) inclusion of our economic share of (or equity interest in) the receivables we manage for our equity-method investees; (3) removal of our noncontrolling interest holders’ shares of the managed receivables underlying our GAAP consolidated results; and (4) treatment of the transaction in which our 50%-owned equity-method investee acquired our U.K. Portfolio structured financing trust notes (a) as a deemed sale of the U.K. Portfolio trust receivables at their face amount, (b) followed by the 50%-owned equity-method investee’s deemed repurchase of such receivables for consideration equal to the discounted purchase price that it paid for the notes, and (c) as though the difference between the deemed face amount and the deemed discounted repurchase price of the receivables is to be treated as credit quality discount to be accreted into managed earnings as a reduction of net charge offs over the remaining life of the receivables.
We typically have purchased credit card receivables portfolios at substantial discounts. In our managed basis statistical data, we apply a portion of these discounts against receivables acquired for which charge off is considered likely, including accounts in late stages of delinquency at the date of acquisition; this portion is measured based on our acquisition date estimate of the shortfall of cash flows expected to be collected on the acquired portfolios relative to the face amount of receivables represented within the acquired portfolios. We refer to the balance of the discount for each purchase not needed for credit quality as accretable yield, which we accrete into net interest margin in our managed basis statistical data using the interest method over the estimated life of each acquired portfolio. As of the close of each financial reporting period, we evaluate the appropriateness of the credit quality discount component and the accretable yield component of our acquisition discount based on actual and projected future results.
Asset Quality
Our delinquency and charge-off data at any point in time reflect the credit performance of our managed receivables. The average age of the accounts underlying our receivables, the timing of portfolio purchases, the success of our collection and recovery efforts and general economic conditions all affect our delinquency and charge-off rates. The average age of the accounts underlying our receivables portfolio also affects the stability of our delinquency and loss rates. We consider this delinquency and charge-off data in our determination of the fair value of our credit card receivables underlying formerly off-balance-sheet securitization structures, as well as our allowance for uncollectible loans and fees receivable in the case of our other credit product receivables that we report at net realizable value. Our strategy for managing delinquency and receivables losses consists of account management throughout the customer relationship. This strategy includes credit line management and pricing based on the risks. See also our discussion of collection strategies under the heading “How Do We Collect from Our Customers?” in Item 1, “Business,” of our Annual Report on Form 10-K for the year ended December 31, 2011.
The following table presents the delinquency trends of the receivables we manage within our Credit Cards and Other Investments segment, as well as charge-off data and other managed loan statistics (in thousands; percentages of total):
|
|
At or for the Three Months Ended
|
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
|
Sept. 30
|
|
|
Jun. 30
|
|
|
Mar. 31
|
|
|
Dec. 31
|
|
|
Sept. 30
|
|
|
Jun. 30
|
|
|
Mar. 31
|
|
|
Dec. 31
|
|
Period-end managed receivables
|
|
$
|
326,557
|
|
|
$
|
356,897
|
|
|
$
|
401,394
|
|
|
$
|
480,355
|
|
|
$
|
540,023
|
|
|
$
|
613,747
|
|
|
$
|
698,226
|
|
|
$
|
776,770
|
|
Period-end managed accounts
|
|
|
281
|
|
|
|
309
|
|
|
|
340
|
|
|
|
390
|
|
|
|
431
|
|
|
|
481
|
|
|
|
543
|
|
|
|
603
|
|
Percent 30 or more days past due
|
|
|
11.0
|
%
|
|
|
9.9
|
%
|
|
|
10.4
|
%
|
|
|
13.0
|
%
|
|
|
12.6
|
%
|
|
|
11.9
|
%
|
|
|
12.5
|
%
|
|
|
15.2
|
%
|
Percent 60 or more days past due
|
|
|
8.1
|
%
|
|
|
6.9
|
%
|
|
|
7.9
|
%
|
|
|
9.7
|
%
|
|
|
8.9
|
%
|
|
|
8.7
|
%
|
|
|
9.5
|
%
|
|
|
11.6
|
%
|
Percent 90 or more days past due
|
|
|
5.8
|
%
|
|
|
4.6
|
%
|
|
|
5.9
|
%
|
|
|
6.9
|
%
|
|
|
6.2
|
%
|
|
|
6.2
|
%
|
|
|
7.0
|
%
|
|
|
8.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average managed receivables
|
|
$
|
340,628
|
|
|
$
|
378,227
|
|
|
$
|
438,601
|
|
|
$
|
511,834
|
|
|
$
|
580,212
|
|
|
$
|
659,686
|
|
|
$
|
754,300
|
|
|
$
|
845,084
|
|
Combined gross charge-off ratio
|
|
|
15.3
|
%
|
|
|
20.7
|
%
|
|
|
53.9
|
%
|
|
|
19.3
|
%
|
|
|
20.9
|
%
|
|
|
24.2
|
%
|
|
|
29.7
|
%
|
|
|
36.4
|
%
|
Net charge-off ratio
|
|
|
13.1
|
%
|
|
|
16.8
|
%
|
|
|
47.4
|
%
|
|
|
15.2
|
%
|
|
|
16.7
|
%
|
|
|
19.8
|
%
|
|
|
24.1
|
%
|
|
|
28.9
|
%
|
Adjusted charge-off ratio
|
|
|
11.4
|
%
|
|
|
15.1
|
%
|
|
|
30.6
|
%
|
|
|
12.2
|
%
|
|
|
13.9
|
%
|
|
|
16.7
|
%
|
|
|
22.9
|
%
|
|
|
28.6
|
%
|
Total yield ratio
|
|
|
23.5
|
%
|
|
|
24.2
|
%
|
|
|
22.9
|
%
|
|
|
23.2
|
%
|
|
|
19.2
|
%
|
|
|
21.8
|
%
|
|
|
22.0
|
%
|
|
|
24.9
|
%
|
Gross yield ratio
|
|
|
19.2
|
%
|
|
|
19.9
|
%
|
|
|
18.9
|
%
|
|
|
18.6
|
%
|
|
|
19.3
|
%
|
|
|
18.9
|
%
|
|
|
18.6
|
%
|
|
|
18.8
|
%
|
Net interest margin
|
|
|
13.5
|
%
|
|
|
13.3
|
%
|
|
|
10.4
|
%
|
|
|
12.6
|
%
|
|
|
13.4
|
%
|
|
|
12.8
|
%
|
|
|
11.9
|
%
|
|
|
11.9
|
%
|
Other income ratio
|
|
|
3.9
|
%
|
|
|
3.5
|
%
|
|
|
2.7
|
%
|
|
|
3.7
|
%
|
|
|
-1.0
|
%
|
|
|
2.1
|
%
|
|
|
2.2
|
%
|
|
|
3.3
|
%
|
Operating ratio
|
|
|
18.5
|
%
|
|
|
18.2
|
%
|
|
|
15.3
|
%
|
|
|
12.1
|
%
|
|
|
12.3
|
%
|
|
|
12.5
|
%
|
|
|
11.0
|
%
|
|
|
10.1
|
%
|
Managed receivables.
The consistent quarterly declines in our period-end and average managed receivables over the last eight quarters reflect the net liquidating state of our credit card receivables portfolios given the closure of substantially all credit card accounts underlying the portfolios. Moreover, with the exception of some limited product testing in the U.K., we have curtailed our credit card marketing efforts in light of (1) dislocation in the liquidity markets and uncertainty as to when and if these markets will rebound sufficiently to facilitate organic growth in our credit card receivables operations and (2) an unfavorable credit card account origination regulatory climate in our primary U.S. market. We do not anticipate meaningful account or receivables additions in the near term to offset the receivables balance contractions noted above.
Delinquencies.
Delinquencies have the potential to impact net income in the form of net credit losses. Delinquencies also are costly in terms of the personnel and resources dedicated to resolving them. We intend for the account management strategies we use on our portfolio to manage and, to the extent possible, reduce the higher delinquency rates that can be expected in a more mature managed portfolio such as ours. These account management strategies include conservative credit line management, purging of inactive accounts and collection strategies intended to optimize the effective account-to-collector ratio across delinquency categories. We further describe these collection strategies under the heading “How Do We Collect from Our Customers?” in Item 1, “Business” of our Annual Report on Form 10-K for the year ended December 31, 2011. We measure the success of these efforts by measuring delinquency rates. These rates exclude accounts that have been charged off.
Our lower-tier credit card receivables typically experience substantially higher delinquency rates and charge-off levels than those of our other originated and purchased portfolios. Our delinquency statistics recently have benefited from a mix change whereby disproportionately higher charge-off levels for our lower-tier credit card portfolios relative to those of our other credit card receivables have caused a decline in lower-tier credit card receivables as a percentage of our aggregate managed credit card receivables.
Given that our accounts primarily consist of closed credit card accounts with no significant account actions taken in the past several quarters, one would logically expect to see the relatively lower delinquency and charge-off benefits of our more mature portfolios. This trend is bearing out as noted in the trending year-over-year declines in our 2012 and late 2011 delinquency statistics relative to corresponding dates in prior years and is consistent with our expectations for the next few quarters. We do note, however, that we participated in a unique transaction opportunity during the first quarter of 2012, whereby we sold for a total of $10.4 million, a price that we viewed as attractive, $44.0 million in face value of our U.K. portfolio credit cards receivable associated with late-stage delinquent accounts that had not yet reached the 180-day charge-off threshold. These receivables had a GAAP carrying value of $9.8 million on the sale date, thereby rendering an insignificant gain upon their sale. This transaction had two effects on our managed receivables data: (1) the future periods’ charge off of these receivables was accelerated into the first quarter of 2012 through our treatment of the accounts as having been charged off in all of our managed receivables charge-off ratios contemporaneous with the sale of these receivables; and (2) the removal of these late-stage delinquent accounts from our March 31, 2012 managed receivables balances contributed to a better-than-typical improvement in our delinquency statistics as of March 31, 2012 and June 30, 2012. Given this acceleration we expected to see a slight increase in our delinquency rates as the impact of this isolated transaction diminishes. We experienced this increase in delinquencies as of September 30, 2012, in part due to the aforementioned transaction, but also in part to the effects of higher delinquency rates associated with credit card product testing in the U.K. (the effects of which are also evident in the table of current loans receivable, current fees receivable and delinquent loans and fees receivable as of September 30, 2012 and December 31, 2011 presented within Note 2, “Significant Accounting Policies and Consolidated Financial Statement Components,” to our consolidated financial statements). Nevertheless, we still expect to see continuing future trending declines in our delinquency rates when compared to similar prior year periods.
Charge offs.
We generally charge off our Credit Card and Other Investments segment receivables when they become contractually 180 days past due or within 30 days of notification and confirmation of a customer’s bankruptcy or death. However, if a cardholder makes a payment greater than or equal to two minimum payments within a month of the charge-off date, we may reconsider whether charge-off status remains appropriate. Additionally, in some cases of death, receivables are not charged off if, with respect to the deceased customer’s account, there is a surviving, contractually liable individual or an estate large enough to pay the debt in full.
Our lower-tier credit card offerings have higher charge offs relative to their average managed receivables balances, than do our other portfolios. Due to the recent higher rate of decline in these receivables relative to all of our other outstanding credit card receivables, all things being equal, one would expect reduced charge-off ratios. This is supported by the above overall trend of declining charge-off rates in all quarters but the first quarter of 2012. This trend is muted to some degree, however, for our net charge-off ratio and our adjusted charge-off ratio (as discussed in more detail below) simply due to a change in the mix of our charge offs toward a higher relative level of principal charge offs versus finance and fee charge offs.
All of our charge-off ratios were skewed higher during the first quarter of 2012 by reason of the unique transaction opportunity mentioned in our
Delinquencies
discussion above. In future quarters (and absent any unique transaction opportunities like that experienced in the first quarter of 2012), we expect the general rate of decline in our charge-off ratios to moderate and our charge-off ratios to generally stabilize (subject to normal seasonal variations). Our expectation of a reduced rate of decline in our charge-off ratios is based on (1) the age, maturity and stability of our portfolio of liquidating receivables associated with closed credit card accounts, coupled with (2) an expectation of higher charge off rates on a relatively small dollar balance of credit card receivables underlying test accounts in the U.K.
Combined gross charge-off ratio.
See the above general
Charge Offs
discussion.
Net charge-off ratio.
See the above general
Charge Offs
discussion.
Adjusted charge-off ratio.
This ratio reflects our net charge offs, less credit quality discount accretion with respect to our acquired portfolios. Therefore, its trend line should follow that of our net charge-off ratio, adjusted for the diminishing impact of past portfolio acquisitions and for the additional impact of new portfolio acquisitions. In the first and second quarters of 2011, the gap between the net charge-off ratio and the adjusted charge-off ratio widened (as it typically does following each portfolio acquisition at a discounted purchase price) because we determine our managed receivables statistics by treating the transaction in which our 50%-owned equity-method investee acquired our U.K. Portfolio structured financing trust notes as a deemed sale of the U.K. Portfolio trust receivables at their face amount, followed by the 50%-owned equity-method investee’s repurchase of such receivables for consideration equal to the discounted purchase price that it paid for the notes. Although one would expect the gap between the net charge-off ratio and the adjusted charge-off ratio to gradually narrow (as we saw in the last two quarters of 2011) absent another portfolio acquisition, the unique transaction opportunity mentioned in our
Delinquencies
discussion above caused a significant widening of the gap between the net charge-off ratio and the adjusted net charge-off ratio in the first quarter of 2012. That transaction opportunity caused our first quarter 2012 charge offs to be comprised of a disproportionally higher level of U.K. Portfolio charge offs than normal (for which significant levels of credit quality discount were accreted in the adjusted net charge-off ratio computation in the first quarter of 2012).
Total yield ratio and gross yield ratio
.
As noted previously, the mix of our managed receivables generally has shifted away from those receivables of our lower-tier credit card offerings. Those receivables have higher delinquency rates and late and over-limit fee assessments than do our other portfolios, and thus have higher total yield and gross yield ratios as well. Accordingly, we would expect to see a slight generally trending decline in our total yield and gross yield ratios consistent with disproportionate reductions in our lower-tier credit card receivables due to their higher charge-off levels over the past several quarters. However, our addition of lower-tier test credit card accounts in the U.K. in 2012 has temporarily reversed and delayed our generally declining total and gross yield ratio trends. While the addition of these accounts has resulted in temporary increases in our total and gross yield ratios, we expect these accounts to also reduce the rate of decline in our charge-off rates as the accounts season, mature, and charge off at higher rates than we experience on our liquidating pool of credit card receivables associated with closed credit card accounts.
Our total and gross yield ratios also have been adversely affected over the past several quarters by our 2007 U.K. Portfolio acquisition. Its total and gross yields are below average as compared to our other portfolios, and the rate of decline in receivables in this portfolio has lagged behind the rate of decline in receivables in our other portfolios, thus continuing to suppress our yield ratios.
Notwithstanding the above factors causing slight trending declines in our total and gross yield ratios, the total yield ratio is skewed higher in the fourth quarter of 2010 due to gains associated with debt repurchases in that quarter as detailed and quantified in the discussion of our other income ratio below. Negatively impacting our third quarter 2011 total yield ratio were $5.3 million of losses we recognized due to other-than-temporary declines in the values of non-marketable debt securities in which we had previously invested (as also addressed in our
Other income ratio
discussion below.)
Net interest margin
.
Because of the significance of the late fees charged on our lower-tier credit card receivables as a percentage of outstanding receivables balances, we generally would expect our net interest margin to increase as our lower-tier credit card receivables become a larger percentage and to decrease as they become a smaller percentage of our overall managed receivables. Accordingly, the disproportionate reductions we have experienced in our lower-tier credit card receivables levels is the principal factor that has contributed to the continued general declining trend in our net interest margins relative to those experienced in prior years.
Our net interest margin also is affected by the effects of our 2007 U.K. Portfolio acquisition. The net interest margin for this portfolio is below the weighted average rate of our other portfolios, and the impact of this portfolio continues to be felt as our originated portfolios continue to decline in size at a faster pace than our acquired U.K. Portfolio, thus increasing the impact of this portfolio’s lower net interest margin on the overall results.
Consistent with our experiences in past few quarters, we expect a relatively stable low-double-digit net interest margin for the foreseeable future.
Other income ratio.
We generally expect our other income ratio to increase as our lower-tier receivables become a larger percentage, and to decrease as our lower-tier receivables become a smaller percentage, of our overall managed receivables. When underlying open accounts, these receivables generate significantly higher annual membership, over-limit, monthly maintenance and other fees than do our other portfolios. Consequently, the closure of credit card accounts and the mix change discussed above under which our lower-tier receivables comprise a much smaller percentage of our total receivables accounts in significant part for our low other income ratios.
Our fourth quarter 2010 other income ratio was skewed higher by gains realized on the repurchase of our convertible senior notes and a $4.1 million recovery in the fourth quarter of losses we experienced several years ago on an investment that we had made in a third-party’s asset-backed securities; absent these gains, our other income ratios would have been 1.2% for the three months ended December 31, 2010. Like in the first, second and fourth quarters of 2011, we expect a positive generally low single-digit other income ratio for the foreseeable future unless we experience further material gains associated with future debt repurchases, which could cause an increase in the ratio. We note that we experienced only immaterial gains associated with our convertible senior note repurchases in 2011—gains which were not material enough effect to warrant pro forma computations of the other income ratios in 2011 quarters without the effects of such gains. Negatively affecting our other income ratio for the third quarter of 2011 were $5.3 million of losses that we recognized due to other-than-temporary declines in the values of non-marketable debt securities in which we had previously invested; excluding the impact of these write downs, our other income ratio would have been 2.1%.
Operating ratio.
While we have been highly focused on expense reduction and cost control efforts, our managed receivables levels are generally falling at faster rates than the rates at which we have been able thus far to reduce our costs (particular when considering our fixed infrastructure costs). This phenomenon is reflected in our operating ratio statistics over the 2010 and 2011 quarters, and has recently been exacerbated as seen in the 2012 operating ratios computation by the effects of our late 2011 consolidation of a small coal mining operation that we have financed and its underlying costs—such operation and costs bearing no relationship to managed receivables levels.
Future Expectations
Because the accounts underlying substantially all of our credit card receivables are closed, because of expected liquidations within each of our credit card receivables portfolios, and because of ongoing challenges to the U.S. and U.K. economies and continually high unemployment rates within both countries, we generally do not expect our yield-oriented managed receivables statistics to improve significantly from their current levels for the foreseeable future.
Our credit card operations within our Credit Cards and Other Investments segment are separate and distinct from our other operations. As such, if we were ever to conclude that the ongoing costs of these operations exceeded their benefits (i.e., cash flows to us and residual asset values), we could liquidate our credit card operations (either by continuing to allow them to decline in size or through more aggressive action) with minimal impact on future financial performance of our other operations. We reference the table included in Note 8, “Convertible Senior Notes and Notes Payable,” to our consolidated financial statements, which quantifies the risk to our consolidated total equity position associated with a complete liquidation of our credit cards receivables portfolios.
Auto Finance Segment
Our Auto Finance segment historically included a variety of auto sales and lending activities.
Our original platform, CAR, acquired in April 2005, purchases auto loans at a discount and services auto loans for a fee; its customer base includes a nationwide network of pre-qualified auto dealers in the buy-here, pay-here used car business.
We also historically owned substantially all of JRAS, a buy-here, pay-here dealer we acquired in 2007 and operated from that time until our disposition of certain JRAS operating assets in the first quarter of 2011.
Lastly, our ACC platform acquired during 2007 historically purchased retail installment contracts from franchised car dealers. We ceased origination efforts within the ACC platform during 2009 and outsourced the collection of its portfolio of auto finance receivables.
Collectively, we currently serve more than 680 dealers through our Auto Finance segment in 34 states.
Managed Receivables Background
Like with our Credit Cards and Other Investments segment, we make various references to our managed receivables within our Auto Finance segment discussion.
Financial, operating and statistical data based on aggregate managed receivables are vital to any evaluation of our performance in managing our auto finance receivables portfolios, including our underwriting, servicing and collecting activities and our valuing of purchased receivables. In allocating our resources and managing our business, management relies heavily upon financial data and results prepared on this “managed basis.” Analysts, investors and others also consider it important that we provide selected financial, operating and statistical data on a managed basis because this allows a comparison of us to others within the specialty finance industry. Moreover, our management, analysts, investors and others believe it is critical that they understand the credit performance of the entire portfolio of our managed receivables because it reveals information concerning the quality of loan originations and the related credit risks inherent within the portfolios.
Reconciliation of the auto finance managed receivables data to our GAAP financial statements requires an understanding that our managed receivables data are based on billings and actual charge offs as they occur, without regard to any changes in our allowance for uncollectible loans and fees receivable.
Analysis of Statistical Data
Financial, operating and statistical metrics for our Auto Finance segment are detailed (dollars and numbers of accounts in thousands; percentages of total) in the following tables:
|
|
At or for the Three Months Ended
|
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
|
Sept. 30
|
|
|
Jun. 30
|
|
|
Mar. 31
|
|
|
Dec. 31
|
|
|
Sept. 30
|
|
|
Jun. 30
|
|
|
Mar. 31
|
|
|
Dec. 31
|
|
Period-end managed receivables
|
|
$
|
67,858
|
|
|
$
|
72,886
|
|
|
$
|
75,275
|
|
|
$
|
87,755
|
|
|
$
|
99,237
|
|
|
$
|
113,316
|
|
|
$
|
128,254
|
|
|
$
|
154,191
|
|
Period-end managed accounts
|
|
|
23
|
|
|
|
24
|
|
|
|
24
|
|
|
|
26
|
|
|
|
27
|
|
|
|
29
|
|
|
|
30
|
|
|
|
33
|
|
Percent 30 or more days past due
|
|
|
13.3
|
%
|
|
|
10.7
|
%
|
|
|
8.3
|
%
|
|
|
12.8
|
%
|
|
|
11.9
|
%
|
|
|
10.2
|
%
|
|
|
8.6
|
%
|
|
|
12.8
|
%
|
Percent 60 or more days past due
|
|
|
5.4
|
%
|
|
|
3.6
|
%
|
|
|
3.3
|
%
|
|
|
4.9
|
%
|
|
|
4.7
|
%
|
|
|
3.8
|
%
|
|
|
3.6
|
%
|
|
|
5.3
|
%
|
Percent 90 or more days past due
|
|
|
2.4
|
%
|
|
|
1.1
|
%
|
|
|
1.6
|
%
|
|
|
2.1
|
%
|
|
|
2.3
|
%
|
|
|
1.5
|
%
|
|
|
1.5
|
%
|
|
|
2.4
|
%
|
Average managed receivables
|
|
$
|
69,538
|
|
|
$
|
75,877
|
|
|
$
|
80,503
|
|
|
$
|
92,719
|
|
|
$
|
106,881
|
|
|
$
|
120,773
|
|
|
$
|
140,132
|
|
|
$
|
165,286
|
|
Gross yield ratio
|
|
|
35.3
|
%
|
|
|
35.2
|
%
|
|
|
33.9
|
%
|
|
|
36.3
|
%
|
|
|
35.5
|
%
|
|
|
32.6
|
%
|
|
|
29.2
|
%
|
|
|
29.1
|
%
|
Adjusted charge-off ratio
|
|
|
3.9
|
%
|
|
|
4.2
|
%
|
|
|
8.2
|
%
|
|
|
8.3
|
%
|
|
|
9.8
|
%
|
|
|
10.9
|
%
|
|
|
21.1
|
%
|
|
|
20.3
|
%
|
Recovery ratio
|
|
|
3.9
|
%
|
|
|
4.7
|
%
|
|
|
6.0
|
%
|
|
|
7.1
|
%
|
|
|
5.6
|
%
|
|
|
7.0
|
%
|
|
|
3.4
|
%
|
|
|
3.6
|
%
|
Net interest margin
|
|
|
23.8
|
%
|
|
|
32.0
|
%
|
|
|
17.0
|
%
|
|
|
24.4
|
%
|
|
|
25.6
|
%
|
|
|
23.8
|
%
|
|
|
20.5
|
%
|
|
|
19.8
|
%
|
Other income ratio
|
|
|
2.7
|
%
|
|
|
2.3
|
%
|
|
|
2.3
|
%
|
|
|
1.4
|
%
|
|
|
1.2
|
%
|
|
|
0.9
|
%
|
|
|
-11.2
|
%
|
|
|
0.6
|
%
|
Operating ratio
|
|
|
24.7
|
%
|
|
|
24.0
|
%
|
|
|
29.9
|
%
|
|
|
21.3
|
%
|
|
|
19.5
|
%
|
|
|
18.7
|
%
|
|
|
18.7
|
%
|
|
|
20.7
|
%
|
Managed receivables.
Period-end managed receivables have gradually declined as we have curtailed significant purchasing and origination activities. As of September 30, 2012, only CAR continues to purchase/originate loans. Given liquidations of the ACC and JRAS portfolios, managed receivables within this segment will continue to decline for the next several quarters.
Delinquencies.
Our ACC and JRAS receivables portfolios are liquidating and becoming less significant relative to our better performing CAR portfolios which have significantly lower late stage (60 or more days past due) delinquency and charge-off rates; this fact and a recovering economy accounted for the modest year-over-year general improvement in delinquency statistics through the end of the second quarter of 2012. Because the JRAS and ACC portfolios are now of lesser significance, we do not expect any material further improvements in our delinquency statistics associated with the liquidating nature of these portfolios. Delinquencies have risen somewhat within our CAR receivables portfolio in the third quarter of 2012, and delinquencies as of September 30, 2012 are higher than they were at the end of prior 2012 quarters and at September 30, 2011. However, because we earn significant yields on CAR’s receivables and have significant dealer reserves (i.e., retainages or holdbacks on the amount of funding CAR provides to its dealer customers) to protect against credit losses, we are not currently concerned about this rise in delinquencies.
Gross yield ratio, net interest margin and other income ratio.
The effects of higher JRAS and ACC delinquencies and charge offs depressed our net interest margin in the fourth quarter of 2010. With the exception of the three months ended March 31, 2012, a general trend line of improving net interest margins is evident relative to comparable prior year periods due in part to the gradual liquidation of the JRAS and ACC receivables portfolios, thereby causing the better-performing CAR portfolio to comprise a greater percentage of average managed auto finance receivables. The terms of our ACC debt facility provide that 37.5% of any cash flows (net of contractual servicing compensation) generated on the ACC auto finance receivables portfolio after repayment of the notes will be allocated to the note holders as additional compensation for the use of their capital. Significant recent improvements in performance of the ACC portfolio have caused us to resume significant accruals of contingent interest expense under the debt facility, and our accrual of $2.0 million of such additional interest during the three months ended March 31, 2012 caused the decline in our net interest margin relative to the prior quarters’ improving net interest margin trend line. This additional interest charge abated modestly in the second quarter of 2012 resulting in a reduction in the amount of contingent interest recorded and providing additional lift to our net interest margin. We do not expect any significant future effects on our net interest margin associated with contingent interest under the ACC portfolio debt facility.
Consistent with our recent experiences, as our ACC and JRAS receivables continue their decline in relative significance as a percentage of our total portfolio of auto finance receivables, the higher gross yields we achieve within our CAR operations generally are expected to continue to result in slightly higher trending gross yield ratios and net interest margins in future quarters relative to comparable prior year quarterly levels.
The principal component of our other income ratio before 2011 was the gross profit that our JRAS buy-here, pay-here operations generated from their auto sales prior to our sale of these operations in February 2011. As such, the other income ratio historically moved in relative tandem with the volume of JRAS’s auto sales. Our other income ratio in the first quarter of 2011 reflects the $4.6 million loss recognized on the sale of our JRAS operating assets in February 2011. Because of the sale of these operations (and the commensurate elimination of the principal source of other income), we expect an insignificant other income ratio for the foreseeable future in line with what we have experienced in 2012 quarters.
Adjusted charge-off ratio and recovery ratio.
We generally charge off auto finance receivables when they are between 120 and 180 days past due, unless the collateral is repossessed and sold before that point, in which case we will record a charge off when the proceeds are received. The adjusted charge-off ratio reflects our net charge offs, less credit quality discount accretion with respect to our acquired portfolios. A general trending increase in our adjusted charge-off ratio through the first quarter of 2011, therefore, reflected (1) the passage of time since our acquisition of ACC’s Patelco portfolio at a significant purchase price discount to the face amount of the acquired receivables, (2) the adverse macro-economic effects being seen throughout the auto finance industry, and (3) the adverse effects of five 2010 JRAS lot closures and the corresponding negative impact this had on JRAS collections. Because our ACC receivables and the receivables of our JRAS operations that we retained in connection with our sale of our JRAS operations in February 2011 have declined in relative significance as a percentage of our total portfolio of auto finance receivables and because of significantly improved performance of the ACC and JRAS receivables due both to the aging of the portfolios and some economic recovery and better than expected tax refund seasonal effects, our adjusted charge-off ratio has declined significantly subsequent to the first quarter of 2011. Our CAR receivables, which experience significantly lower charge offs, now comprise a more significant proportion of our average managed auto finance receivables—a factor that not only contributed to the 2011 decline in our adjusted charge-off ratio, but is also expected to result in lower adjusted charge-off ratios in future quarters. Also serving to reduce our second quarter 2011 adjusted charge-off ratio as well as increase our second quarter 2011 recovery ratio was a large sale of repossessed autos at auction related to the receivables of our former JRAS operations, which had accumulated a growing inventory of such vehicles leading into the second quarter of 2011 as well as increased recoveries experienced in our ACC portfolio. A similar increase in recoveries was seen during the fourth quarter of 2011 in our ACC portfolio. We expect our recovery rate to fluctuate modestly from quarter to quarter due to the timing of the sale of repossessed autos, but more importantly, we expect our recovery rate to fall gradually with the declining effects of ACC and JRAS on our operations; CAR experiences significantly lower charge offs and recoveries than experienced in ACC’s and JRAS’s operations.
Operating ratio.
We have experienced a modest general trend line of increasing year-over-year operating ratios, which largely reflects the higher costs of our CAR operations as a percentage of receivables than such operating costs of our ACC and JRAS operations as a percentage of their receivables in prior periods. (Such higher costs correspond with the significantly higher gross yield ratios and net interest margins within our CAR operations as well.) As noted above, our CAR receivables and operating costs now comprise a greater percentage of respective total Auto Finance segment receivables and operating costs given the gradual liquidation of ACC and JRAS receivables. Notwithstanding this general trend line, we do not expect a significantly higher operating ratio for the foreseeable future. The spike in the first quarter of 2012 operating ratio arose due to an impairment charge of $1.2 million recognized during that quarter associated with unfavorable terms on the sublease of our former ACC offices and certain non-recurring costs we incurred in the collection of our JRAS receivables.
Future Expectations
Our CAR operations are performing well in the current environment (achieving consistent profitability) and are expected to continue at current levels for the foreseeable future. Generally offsetting these positive results are ACC and JRAS operations, which are expected to modestly depress overall Auto Finance segment results relative to CAR’s stand-alone results for 2012. As ACC’s and JRAS’s receivables gradually liquidate, however, they should have a diminishing adverse effect on the positive results we are experiencing within our CAR operations.
Liquidity, Funding and Capital Resources
We continue to see dislocation in the availability of attractively priced and termed liquidity as a result of the market disruptions that began in 2007. This ongoing disruption has resulted in a decline in liquidity available to sub-prime market participants, including us, wider spreads above the underlying interest indices (typically LIBOR for our borrowings) for the loans that lenders are willing to make, and a decrease in advance rates for those loans.
Although we are hopeful liquidity markets ultimately will return to more traditional levels, we are not able to predict when or if that will occur, and we are managing our business with the assumption that liquidity markets will not return to more traditional levels in the near term. Specifically, we have curtailed or limited growth in many parts of our business and have closed substantially all of our credit card accounts (other than those associated with our U.K. test accounts). To the extent possible given constraints thus far on our ability to reduce expenses at the same rate as our managed receivables are liquidating, we are managing our receivables portfolios with a goal of generating the necessary cash flows over the coming quarters for us to use in de-leveraging our business, while continuing to enhance shareholder value to the greatest extent possible.
All of our Credit Cards and Other Investments segment’s structured financing facilities are expected to amortize down with collections on the receivables within their underlying trusts with no bullet repayment requirements or refinancing risks to us. Additionally, with the exception of our new CAR structured finance facility into which we entered in October of 2011 and which does not mature until October 2014, our remaining Auto Finance segment structured financing facilities are likewise expected to amortize down with collections on the receivables that serve as collateral for the facilities with no bullet repayment requirements or refinancing risks to us. Our continuing challenge within our Credit Cards and Other Investments segment is to reduce our overhead cost infrastructure to match our incoming servicing compensation cash flows under our amortizing credit card structured financing facilities, the cash flows we receive from our 50%-owned equity-method investees, and the modest cash flows we are receiving from unencumbered credit card receivables portfolios that have already generated enough cash to allow for the repayment of their underlying structured financing facilities. Furthermore, the values of our credit card receivables that are pledged as collateral against our currently outstanding structured financing facilities could prove insufficient to provide for any residual value that ultimately would be payable to us. In such a case, we could experience further impairments to the recorded value of our credit card receivables, although we note that the recorded value has been substantially written down already leaving significantly less exposure to write-downs in the future.
Our current focus on liquidity has resulted in and will continue to result in growth and profitability trade-offs. For example, as noted throughout this report, we have closed substantially all of our credit card accounts (other than those underlying our test accounts in the U.K.); consequently, each of our managed credit card receivables portfolios is expected to show fairly rapid net liquidations in balances for the foreseeable future.
At September 30, 2012, we had $47.9 million in unrestricted cash. Because the characteristics of our assets and liabilities change, liquidity management has been a dynamic process for us affected by the pricing and maturity of our assets and liabilities. We historically have financed our business through cash flows from operations, asset-backed structured financings and the issuance of debt and equity. Details concerning our cash flows for the nine months ended September 30, 2012 are as follow:
·
|
During the nine months ended September 30, 2012, we generated $26.6 million in cash flows from operations compared to $93.2 million of cash flows from operations generated during the nine months ended September 30, 2011. The decrease was principally related to (1) lower collections of credit card finance charge receivables in the nine months ended September 30, 2012 relative to the same period in 2011 given diminished receivables levels, (2) the lack of any finance and fee collections associated with our U.K. Internet micro-loan operations in the nine months ended September 30, 2012 given our sale of these operations in April 2011, (3) reduced net liquidations of receivables associated with our JRAS operations in 2012 versus 2011.
|
·
|
During the nine months ended September 30, 2012, we generated $162.2 million of cash through our investing activities, compared to generating $344.2 million of cash in investing activities during the nine months ended September 30, 2011. This decrease is primarily due to the reduced levels of our outstanding investments and the cash returns thereof in 2012 based on the shrinking size our liquidating credit card and auto finance receivable portfolios, as well as the net proceeds we received from the sale of our MEM and JRAS operations during the nine months ended September 30, 2011. Offsetting this decline are net proceeds received during the nine months ended September 30, 2012 from the sale of our sale Investments in Previously Charged-Off Receivables segment, including its balance transfer card operations.
|
·
|
During the nine months ended September 30, 2012, we used $286.0 million of cash in financing activities, compared to our use of $406.6 million of cash in financing activities during the nine months ended September 30, 2011. In both periods, the data reflect net repayments of debt facilities corresponding with net declines in our loans and fees receivable that serve as the underlying collateral for the facilities (principally credit card and auto loans and fees receivable). Beyond the effects of higher 2011 than 2012 repayment levels based on receivables liquidations under our structured financing facilities, the $105.0 million in proceeds used to repurchase stock in our April 2011 tender offer also contributed to the higher use of cash in financing activities in 2011 compared to our use of $82.5 million used to repurchase 8,250,000 shares of our common stock at a purchase price of $10.00 per share in September 2012. These effects were partially offset, however, by the fact that we used only $31.3 million of cash for convertible senior notes repurchases in the nine months ended September 30, 2011, versus the $83.5 million we used to repay our 3.625% convertible senior notes upon the exercise of note holder put rights in May 2012.
|
We note that the $47.9 million in aggregate September 30, 2012 unrestricted cash mentioned herein represents the sum of all unrestricted cash from among all of our various business subsidiaries.
The most recent global financial crisis differs in key respects from our experiences during other down economic and financing cycles. First, while we had difficulty obtaining asset-backed financing for our originated portfolio activities at attractive advance rates in the last down cycle (2001 through 2003), the credit spreads (above base pricing indices like LIBOR) at that time were not as wide (expensive) as those seen during the recent crisis. Additionally, while we were successful during that down cycle in obtaining asset-backed financing for portfolio acquisitions at attractive advance rates, pricing and other terms, that financing has not been available from traditional market participants since the advent of the most recent crisis. Last and most significant is the adverse impact that the most recent global liquidity crisis has had on the U.S. and worldwide economies (including real estate and other asset values and the labor markets). Unemployment is still significantly higher than during 2001 through 2003 and is forecasted by many economists not to decline in any meaningful way for several more quarters. Lower assets values and higher rates of job loss and levels of unemployment have translated into reduced payment rates within the credit card industry generally and for us specifically.
Beyond our immediate financing efforts discussed throughout this report, shareholders should expect us to evaluate debt and equity issuances as a means to fund our investment opportunities. We expect to take advantage of any opportunities to raise additional capital if terms and pricing are attractive to us. Any proceeds raised under these efforts or additional liquidity available to us could be used to fund (1) potential portfolio acquisitions, which may represent attractive opportunities for us in the current liquidity environment, (2) further repurchases of our convertible senior notes and common stock, (3) further dividends similar to the one on December 31, 2009, and (4) investments in certain financial and non-financial assets or businesses. Pursuant to a share repurchase plan authorized by our Board of Directors on May 11, 2012, we are authorized to repurchase 10,000,000 shares of our common stock through June 30, 2014.
Lastly, we note that as of this Report date the only remaining material refunding or refinancing risks to us are those of the CAR financing facility into which we entered in October 2011 and which does not mature until October 2014 and our 5.875% convertible senior notes which are due in November 2035.
Contractual Obligations, Commitments and Off-Balance-Sheet Arrangements
See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2011.
In May of 2012, substantially all of the investors in our 3.625% convertible senior notes exercised then-existing put rights, under which we repaid $83.5 million in face amount of such notes outstanding at par.
Commitments and Contingencies
We also have certain contractual arrangements that would require us to make payments or provide funding if certain circumstances occur (“contingent commitments”). We do not currently expect that these contingent commitments will result in any material amounts being paid by us. See Note 9, “Commitments and Contingencies,” to our consolidated financial statements included herein for further discussion of these matters.
Recent Accounting Pronouncements
See Note 2, “Significant Accounting Policies and Consolidated Financial Statement Components,” to our consolidated financial statements included herein for a discussion of recent accounting pronouncements.
Critical Accounting Estimates
We have prepared our financial statements in accordance with GAAP. These principles are numerous and complex. We have summarized our significant accounting policies in the notes to our consolidated financial statements. In many instances, the application of GAAP requires management to make estimates or to apply subjective principles to particular facts and circumstances. A variance in the estimates used or a variance in the application or interpretation of GAAP could yield a materially different accounting result. It is impracticable for us to summarize every accounting principle that requires us to use judgment or estimates in our application. Nevertheless, we described below the areas for which we believe that the estimations, judgments or interpretations that we have made, if different, would have yielded the most significant differences in our consolidated financial statements.
On a quarterly basis, we review our significant accounting policies and the related assumptions, in particular, those mentioned below, with the audit committee of the Board of Directors.
Measurements for Loans and Fees Receivable at Fair Value and Notes Payable Associated with Structured Financings at Fair Value
Our valuation of loans and fees receivable, at fair value is based on the present value of future cash flows using a valuation model of expected cash flows and the estimated cost to service and collect those cash flows. We estimate the present value of these future cash flows using a valuation model consisting of internally developed estimates of assumptions third-party market participants would use in determining fair value, including estimates of net collected yield, principal payment rates, expected principal credit loss rates, costs of funds, discount rates and servicing costs. Similarly, our valuation of notes payable associated with structured financings, at fair value is based on the present value of future cash flows utilized in repayment of the outstanding principal and interest under the facilities using a valuation model of expected cash flows net of the contractual service expenses within the facilities. We estimate the present value of these future cash flows using a valuation model consisting of internally developed estimates of assumptions third-party market participants would use in determining fair value, including: estimates of net collected yield, principal payment rates and expected principal credit loss rates on the credit card receivables that secure the non-recourse notes payable; costs of funds; discount rates; and contractual servicing fees.
The aforementioned credit losses, payment rates, servicing costs, contractual servicing fees, costs of funds, discount rates and yields earned on credit card receivables estimates significantly affect the reported amount of our loans and fees receivable, at fair value and our notes payable associated with structured financings, at fair value on our consolidated balance sheet, and they likewise affect our changes in fair value of loans and fees receivable recorded at fair value and changes in fair value of notes payable associated with structured financings recorded at fair value categories within our fees and related income on earning assets line item on our consolidated statement of operations.
Allowance for Uncollectible Loans and Fees
Through our analysis of loan performance, delinquency data, charge-off data, economic trends and the potential effects of those economic trends on our customers, we establish an allowance for uncollectible loans and fees receivable as an estimate of the probable losses inherent within those loans and fees receivable that we do not report at fair value. To the extent that actual results differ from our estimates of uncollectible loans and fees receivable, our results of operations and liquidity could be materially affected.
Recognition and Measurements with Respect to Uncertain Tax Positions
Our businesses and the tax accounting for our businesses are very complex, thereby giving rise to a number of uncertain tax positions, several of which are matters that are under consideration, and in some cases under dispute, in audits of our operations by various taxing authorities (including the Internal Revenue Service at the federal level with respect to net operating losses that we incurred in 2007 and 2008 and that we carried back to obtain tentative refunds of federal taxes paid in earlier years dating back to 2003).
In determining whether we are entitled to recognize, and in measuring the level of benefits that we are entitled to recognize associated with, uncertain tax positions, we (and experts we have hired to advise us) make an evaluation of the technical merits of a tax position derived from sources of authorities in the tax law (legislation and statutes, legislative intent, regulations, rulings, and case law) and their applicability to the facts and circumstances underlying our tax position. Although we believe we are several years away from ultimate resolution, and possible settlement and payment, with respect to our uncertain tax positions, including those taken in the 2007 and 2008 years under audit by the Internal Revenue Service, it is possible that we may ultimately settle with the Internal Revenue Service on one or more uncertain tax positions in a manner that differs from the liabilities we have recorded associated with such positions under our recognition and measurement determinations.
To the extent that our ultimate settlements result in less liability than we have recorded associated with our uncertain tax positions, we could experience a material release of liability, increase in income, and greater liquidity than our investors might otherwise expect. Alternatively, to the extent that our ultimate settlements result in more liability than we have recorded, our results of operations and liquidity could be materially adversely affected.
Related Party Transactions
In our September 2012 tender offer, we purchased the following shares from our executive officers, members of our Board of Directors, and a 10-percent shareholder at $10 per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David G. Hanna, Chief Executive Officer and Chairman of the Board
|
|
|
2,344,323
|
|
|
$
|
23,443,230
|
|
Richard R. House, Jr., President and Director
|
|
|
100,240
|
|
|
$
|
1,002,400
|
|
Richard W. Gilbert, Chief Operating Officer and Vice Chairman of the Board
|
|
|
212,023
|
|
|
$
|
2,120,230
|
|
J.Paul Whitehead, III, Chief Financial Officer
|
|
|
49,949
|
|
|
$
|
499,490
|
|
|
|
|
|
|
|
|
|
|
Deal W. Hudson
|
|
|
18,700
|
|
|
$
|
187,000
|
|
Mack F. Mattingly
|
|
|
20,726
|
|
|
$
|
207,260
|
|
Thomas G. Rosencrants
|
|
|
16,172
|
|
|
$
|
161,720
|
|
|
|
|
|
|
|
|
|
|
Frank J. Hanna, III
|
|
|
2,344,324
|
|
|
$
|
23,443,240
|
|
In our April 2011 tender offer, we purchased the following shares from our executive officers and then-members of our Board of Directors at $8 per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David G. Hanna, Chief Executive Officer and Chairman of the Board
|
|
|
3,656,028
|
|
|
$
|
29,248,224
|
|
Richard R. House, Jr., President and Director
|
|
|
202,610
|
|
|
$
|
1,620,880
|
|
Richard W. Gilbert, Chief Operating Officer and Vice Chairman of the Board
|
|
|
330,654
|
|
|
$
|
2,645,232
|
|
J.Paul Whitehead, III, Chief Financial Officer
|
|
|
23,984
|
|
|
$
|
191,872
|
|
|
|
|
|
|
|
|
|
|
Frank J. Hanna, III
|
|
|
3,656,028
|
|
|
$
|
29,248,224
|
|
Deal W. Hudson
|
|
|
19,231
|
|
|
$
|
153,848
|
|
Mack F. Mattingly
|
|
|
20,974
|
|
|
$
|
167,792
|
|
Thomas G. Rosencrants
|
|
|
13,871
|
|
|
$
|
110,968
|
|
Gregory J. Corona
|
|
|
29,574
|
|
|
$
|
236,592
|
|
Under a shareholders’ agreement into which we entered with David G. Hanna, Frank J. Hanna, III, Richard R. House, Jr., Richard W. Gilbert and certain trusts that were or are Hanna affiliates following our initial public offering (1) if one or more of the shareholders accepts a bona fide offer from a third party to purchase more than 50% of the outstanding common stock, each of the other shareholders that are a party to the agreement may elect to sell their shares to the purchaser on the same terms and conditions, and (2) if shareholders that are a party to the agreement owning more than 50% of the common stock propose to transfer all of their shares to a third party, then such transferring shareholders may require the other shareholders that are a party to the agreement to sell all of the shares owned by them to the proposed transferee on the same terms and conditions.
In June 2007 we entered into a sublease for 1,000 square feet of excess office space at our Atlanta headquarters office location, to HBR Capital, Ltd., a corporation co-owned by David G. Hanna and Frank J. Hanna, III. The sublease rate of $24.30 per square foot is the same as the rate that we pay on the prime lease. This sublease expires in May of 2022.
Forward-Looking Information
We make forward-looking statements in this report and in other materials we file with the SEC or otherwise make public. This Item 2, “Management’s Discussion and Analysis of Financial Conditions and Results of Operations,” of this report contains forward-looking statements. In addition, our senior management might make forward-looking statements to analysts, investors, the media and others. Statements with respect to potential receipt of contingent consideration from the sale of our Investments in Previously Charged-Off Receivables segment, expected revenue, income, receivables, income ratios, net interest margins, acquisitions and other growth opportunities, divestitures and discontinuations of businesses, loss exposure and loss provisions, delinquency and charge-off rates, impacts of account actions we may take or have taken, changes in collection programs and practices, changes in the credit quality and fair value of our credit card loans and fees receivable and the fair value of their underlying structured financing facilities, the impact of actions by the Federal Deposit Insurance Corporation (“FDIC”), Federal Trade Commission (“FTC”), Consumer Financial Protection Bureau (“CFPB”) and other regulators on both us and banks that issue credit cards on our behalf, account growth, the performance of investments that we have made, operating expenses, the impact of bankruptcy law changes, marketing plans and expenses, the performance of our Auto Finance segment, growth and performance of receivables originated over the Internet, our plans in the U.K., the impact of our U.K. Portfolio on our financial performance, sufficiency of available liquidity, the prospect for improvements in the liquidity markets, future interest costs, sources of funding operations and acquisitions, our entry into international markets, our ability to raise funds or renew financing facilities, results associated with our equity-method investees, our servicing income levels, gains and losses from investments in securities, experimentation with new products and other statements of our plans, beliefs or expectations are forward-looking statements. These and other statements using words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” and similar expressions also are forward-looking statements. Each forward-looking statement speaks only as of the date of the particular statement. The forward-looking statements we make are not guarantees of future performance, and we have based these statements on our assumptions and analyses in light of our experience and perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. Forward-looking statements by their nature involve substantial risks and uncertainties that could significantly affect expected results, and actual future results could differ materially from those described in such statements. Management cautions against putting undue reliance on forward-looking statements or projecting any future results based on such statements or present or prior earnings levels.
Although it is not possible to identify all factors, we continue to face many risks and uncertainties. Among the factors that could cause actual future results to differ materially from our expectations are the risks and uncertainties described under “Risk Factors” set forth in Part II, Item 1A, and the risk factors and other cautionary statements in the other documents that we file with the SEC, including the following:
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the extent to which federal, state, local and foreign governmental regulation of our various business lines and products limits or prohibits the operation of our businesses;
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current and future litigation and regulatory proceedings against us;
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the effect of adverse economic conditions on our revenues, loss rates and cash flows;
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the fragmentation of our industry and competition from various other sources providing similar financial products, or other alternative sources of credit, to consumers;
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the adequacy of our allowances for uncollectible loans and fees receivable and estimates of loan losses;
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the availability of adequate financing;
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the possible impairment of assets;
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our ability to reduce or eliminate overhead and other costs to lower levels consistent with the contraction of our loans and fees receivable and other income-producing assets;
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our relationship with the banks that provide certain services that are needed to operate our businesses; and
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theft and employee errors.
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Most of these factors are beyond our ability to predict or control. Any of these factors, or a combination of these factors, could materially affect our future financial condition or results of operations and the ultimate accuracy of our forward-looking statements. There also are other factors that we may not describe (generally because we currently do not perceive them to be material) that could cause actual results to differ materially from our expectations.
We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
In this report, except as the context suggests otherwise, the words “Company,” “CompuCredit Holdings Corporation,” “CompuCredit,” “we,” “our,” “ours” and “us” refer to CompuCredit Holdings Corporation and its subsidiaries and predecessors. CompuCredit owns Aspire®, CompuCredit®, Embrace®, Emerge®, Imagine®, Majestic®, Monument®, Salute®, Tribute® and other trademarks and service marks in the U.S. and the U.K.