11. Fair Value Measurements

9 Months Ended

Sep. 30, 2012

Notes to Financial Statements

Note 11 - Fair Value Measurements

(11) Fair Value Measurements

ASC 820, "Fair Value Measurements" clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy.

ASC 820 defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The three levels are defined as follows: level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets; level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument; and level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.

At the time of issuance, five warrants issued between 2008 and 2010 in conjunction with various debt financing transactions contained features that make them subject to derivative accounting. We valued these warrants using a binomial valuation model using a weighted average volatility assumption of 41%, weighted average term of 8 years and a risk free rate of 3.3%. On March 29, 2012 we agreed with the holders to amend three of the five warrants to remove the price reset features that resulted in derivative accounting. On the date of the amendment, we valued each of the three warrants using a binomial pricing model as described above. The aggregate value of the three amended warrants of $1.1 million was then reclassified from Accounts payable to Common stock. On June 25, 2012 we agreed with the holder to amend one other warrant that contained the “down round,” or price reset, features to remove those specific price reset terms. The $250,000 aggregate value of this amended warrant was reclassified from Accounts payable to Common Stock on the date of the amendment. The remaining warrant subject to derivative accounting has not been amended, was valued at September 30, 2012 at $95,000, and is classified as a liability on our consolidated balance sheet as of September 30, 2012.

In September 2008 we sold automobile contracts in a securitization that was structured as a sale for financial accounting purposes. In that sale, we retained both securities and a residual interest in the transaction that are measured at fair value. We describe below the valuation methodologies we use for the securities retained and the residual interest in the cash flows of the transaction, as well as the general classification of such instruments pursuant to the valuation hierarchy. The residual interest in such securitization is $4.9 million as of September 30, 2012 and is classified as level 3 in the three-level valuation hierarchy. We determine the value of that residual interest using a discounted cash flow model that includes estimates for prepayments and losses. We use a discount rate of 20% per annum and a cumulative net loss rate of 13%. The assumptions we use are based on historical performance of automobile contracts we have originated and serviced in the past, adjusted for current market conditions. No gain or loss was recorded as a result of the re-securitization transaction described above.

Repossessed vehicle inventory, which is included in Other assets on our balance sheet, is measured at fair value using level 2 assumptions based on our actual loss experience on sale of repossessed vehicles. At September 30, 2012, the finance receivables related to the repossessed vehicles in inventory totaled $9.6 million. We have applied a valuation adjustment of $4.9 million, which is based on a recovery rate of 50%, resulting in an estimated fair value and carrying amount of $4.7 million.

We have no level 3 assets that are measured at fair value on a non-recurring basis. The table below presents a reconciliation for level 3 assets measured at fair value on a recurring basis using significant unobservable inputs:

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2012		2011			2012			2011
	(in thousands)					(in thousands)
Residual Interest in Securitizations:
Balance at beginning of period	$	4,850	$	4,048		$	4,414		$	3,841
Cash paid (received) during period		45		–			23			–
Included in earnings		–		171			458			378
Balance at end of period	$	4,895	$	4,219		$	4,895		$	4,219
Warrant Derivative Liability:
Balance at beginning of period	$	51	$	1,595		$	967		$	1,639
Included in earnings		44		(350	)		435			(394	)
Reclassification to equity		–		–			(1,307	)		–
Balance at end of period	$	95	$	1,245		$	95		$	1,245

In September 2011, we acquired $217.8 million of finance receivables from Fireside Bank for a purchase price of $201.3 million. The receivables were acquired by our wholly-owned special purpose subsidiary, CPS Fender Receivables, LLC, which issued a note for $197.3 million, with a fair value of $196.5 million. Since the Fireside receivables were originated by another entity with its own underwriting guidelines and procedures, we have elected to account for the Fireside receivables and the related debt secured by those receivables at their estimated fair values so that changes in fair value will be reflected in our results of operations as they occur. Interest income from the receivables and interest expense on the note are included in interest income and interest expense, respectively. Changes to the fair value of the receivables and debt are also to be included in interest income and interest expense, respectively. Our level 3, unobservable inputs reflect our own assumptions about the factors that market participants use in pricing similar receivables and debt, and are based on the best information available in the circumstances. They include such inputs as estimated net charge-offs and timing of the amortization of the portfolio of finance receivables. The table below presents a reconciliation of the acquired finance receivables and related debt measured at fair value on a recurring basis using significant unobservable inputs:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2012			2011			2012			2011
	(in thousands)						(in thousands)
Finance Receivables Measured at Fair Value:
Balance at beginning of period	$	102,366		$	–		$	160,253		$	–
Acquisitions		–			199,554						199,554
Payments on finance receivables at fair value		(22,449	)		(6,886	)		(86,556	)		(6,886	)
Charge-offs on finance receivables at fair value		(1,259	)		–			(5,309	)		–
Discount accretion		1,870			(50	)		7,272			(50	)
Mark to fair value		(3,044	)		–			1,824			–
Balance at end of period	$	77,484		$	192,618		$	77,484		$	192,618
Debt Secured by Finance Receivables Measured at Fair Value:
Balance at beginning of period	$	104,662		$	–		$	166,828		$	–
New issuances		–			196,473						196,473
Principal payments on debt at fair value		(26,902	)		–			(97,703	)		–
Premium accretion		1,687			240			5,552			240
Mark to fair value		(2,817	)		–			1,953			–
Balance at end of period		76,630			196,713			76,630			196,713
Reduction for principal payments collected and payable		(7,002	)		(8,313	)		(7,002	)		(8,313	)
Adjusted balance at end of period	$	69,628		$	188,400		$	69,628		$	188,400

The table below compares the fair values of the Fireside receivables and the related secured debt to their contractual balances for the periods shown:

	September 30, 2012				December 31, 2011
	Contractual		Fair		Contractual		Fair
	Balance		Value		Balance		Value
	(In thousands)
Fireside receivables portfolio	$	80,306	$	77,484	$	172,167	$	160,253
Debt secured by Fireside receivables portfolio		62,621		76,630		162,812		166,828

The following summary presents a description of the methodologies and assumptions used to estimate the fair value of our financial instruments. Much of the information used to determine fair value is highly subjective. When applicable, readily available market information has been utilized. However, for a significant portion of our financial instruments, active markets do not exist. Therefore, significant elements of judgment were required in estimating fair value for certain items. The subjective factors include, among other things, the estimated timing and amount of cash flows, risk characteristics, credit quality and interest rates, all of which are subject to change. Since the fair value is estimated as of September 30, 2012 and December 31, 2011, the amounts that will actually be realized or paid at settlement or maturity of the instruments could be significantly different. The estimated fair values of financial assets and liabilities at September 30, 2012 and December 31, 2011, were as follows:

	As of September 30, 2012
Financial Instrument	(In thousands)
	Carrying		Fair Value Measurements Using:
	Value		Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents	$	10,468	$	10,468	$	–	$	–	$	10,468
Restricted cash and equivalents		107,240		107,240		–		–		107,240
Finance receivables, net		670,150		–		–		671,022		671,022
Finance receivables measured at fair value		77,484		–		–		77,484		77,484
Residual interest in securitizations		4,895		–		–		4,895		4,895
Accrued interest receivable		8,819		–		–		8,819		8,819
Liabilities:
Warrant derivative liability	$	95	$	–	$	–	$	95	$	95
Warehouse lines of credit		20,398		–		–		20,398		20,398
Accrued interest payable		2,748		–		–		2,748		2,748
Residual interest financing		13,773		–		–		13,773		13,773
Securitization trust debt		721,396		–		–		743,878		743,878
Debt secured by receivables measured at fair value		76,630		–		–		76,630		76,630
Senior secured debt		54,452		–		–		54,452		54,452
Subordinated renewable notes		21,525		–		–		21,525		21,525

	As of December 31, 2011
Financial Instrument	(In thousands)
	Carrying		Fair Value Measurements Using:
	Value		Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents	$	10,094	$	10,094	$	–	$	–	$	10,094
Restricted cash and equivalents		159,228		159,228		–		–		159,228
Finance receivables, net		506,279		–		–		506,647		506,647
Finance receivables measured at fair value		160,253		–		–		160,253		160,253
Residual interest in securitizations		4,414		–		–		4,414		4,414
Accrued interest receivable		6,432		–		–		6,432		6,432
Liabilities:
Warrant derivative liability	$	967	$	–	$	–	$	967	$	967
Warehouse lines of credit		25,393		–		–		25,393		25,393
Accrued interest payable		1,239		–		–		1,239		1,239
Residual interest financing		21,884		–		–		21,884		21,884
Securitization trust debt		583,065		–		–		594,224		594,224
Debt secured by receivables measured at fair value		166,828		–		–		166,828		166,828
Senior secured debt		58,344		–		–		58,344		58,344
Subordinated renewable notes	$	20,750		–	$	–		20,750		20,750

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

Financial Instrument	Fair Values as of							Inputs as of
		September 30,		December 31,		Valuation	Unobservable	September 30,	December 31,
		2012		2011		Techniques	Inputs	2012	2011
	(In thousands)
Assets:
Finance receivables		$	77,484	$	160,253	Discounted	Discount rate	20.4%		20.4%
measured at fair value						cash flows	Cumulative net losses	5.5%		5.5%
							Monthly average prepayments	0.5%		0.5%
Residual interest in			4,895		4,414	Discounted	Discount rate	20.0%		20.0%
securitizations						cash flows	Cumulative net losses	13.5%		13.0%
							Monthly average prepayments	0.5%		0.5%
Liabilities:
Warrant derivative liability			95		967	Binomial	Stock price	$3.00 / sh	$.89 / sh
							Volatility	40.0%		38.9%
							Risk free rate	1.3%		1.3% -- 1.7%
Debt secured by receivables measured at fair value			76,630		166,828	Discounted  cash flows	Discount rate	16.2%		16.2%

Cash, Cash Equivalents and Restricted Cash

The carrying value equals fair value.

Finance Receivables, net

The fair value of finance receivables is estimated by discounting future cash flows expected to be collected using current rates at which similar receivables could be originated.

Fair Value Receivables and Receivable Financing Debt at Fair Value

The carrying value equals fair value.

Accrued Interest Receivable and Payable

The carrying value approximates fair value because the related interest rates are estimated to reflect current market conditions for similar types of instruments.

Warehouse Lines of Credit, Residual Interest Financing, Senior Secured Debt and Subordinated Renewable Notes

The carrying value approximates fair value because the related interest rates are estimated to reflect current market conditions for similar types of secured instruments.

Securitization Trust Debt

The fair value is estimated by discounting future cash flows using interest rates that we believe reflects the current market rates.