| COMPUCREDIT CORP ITEM 1A RISK FACTORS An investment in our common stock involves a number of risks |
| You should carefully consider each of the risks described below before deciding to invest in our common stock |
| If any of the following risks develops into actual events, our business, financial condition or results of operations could be negatively affected, the market price of our common stock could decline and you may lose all or part of your investment |
| The collectibility of the receivables underlying our securitizations and those that we hold and do not securitize is a function of many factors including the criteria used to select who is issued credit, the pricing of the credit products, the lengths of the relationships, general economic conditions, the rate at which customers repay their accounts or become delinquent and the rate at which cardholders use their cards |
| To the extent we have over estimated collectibility, in all likelihood we have over estimated our financial performance |
| We may not successfully evaluate the creditworthiness of our customers and may not price our credit products so as to remain profitable |
| The creditworthiness of our target market generally is considered “sub-prime” based on guidance issued by the agencies that regulate the banking industry |
| Thus, our customers generally have a higher frequency of delinquencies, higher risk of nonpayment and, ultimately, higher credit losses than consumers who are served by more traditional providers of consumer credit |
| Some of the consumers included in our target market are consumers who are dependent upon finance companies, consumers with only retail store credit cards and/or lacking general purpose credit cards, consumers who are establishing or expanding their credit and consumers who may have had a delinquency, a default or, in some instances, a bankruptcy in their credit histories, but have, in our view, demonstrated recovery |
| If our estimates are incorrect, customer default rates will be higher, we will receive less cash from our securitizations and other credit products, which will result in a decrease in the value of our retained interests (which are based on expected future cash flows) and our loans receivable, and we will experience reduced levels of net income |
| An economic slowdown could increase credit losses and/or decrease our growth |
| Because our business is directly related to consumer spending, any period of economic slowdown or recession could make it more difficult for us to add or retain accounts or account balances |
| In addition, during periods of economic slowdown or recession, we expect to experience an increase in rates of delinquencies and frequency and severity of credit losses |
| Our actual rates of delinquencies and frequency and severity of credit losses may be higher under adverse economic conditions than those experienced in the consumer finance industry generally because of our focus on the sub-prime market |
| Changes in credit use, payment patterns and the rate of defaults by account holders may result from a variety of unpredictable social, economic and geographic factors |
| Social factors include, among other things, changes in consumer confidence levels, the public’s perception of the use of credit and changing attitudes about incurring debt and the stigma of personal bankruptcy |
| Economic factors include, among other things, the rates of inflation, the unemployment rates and the relative interest rates offered for various types of loans |
| Moreover, adverse changes in economic conditions in states where account holders are located, including as a result of severe weather, could have a direct impact on the timing and amount of payments on our credit card accounts |
| Because a significant portion of our reported income is based on management’s estimates of the future performance of securitized receivables, differences between actual and expected performance of the receivables may cause fluctuations in net income |
| Income from the sale of credit card receivables and other credit products in securitization transactions and income from retained interests in receivables securitized have constituted, and are likely to continue to constitute, a significant portion of our income |
| Portions of this income are based on management’s estimates of cash flows we expect to receive from the interests that we retain when we securitize receivables |
| Differences between actual and expected performance of the receivables will occur and 16 ______________________________________________________________________ [57]Table of Contents [58]Index to Financial Statements may cause fluctuations in our net income |
| The expected cash flows are based on management’s estimates of interest rates, default rates, payment rates, new purchases, costs of funds paid to investors in the securitizations, servicing costs, discount rates and required amortization payments |
| These estimates are based on a variety of factors, many of which are not within our control |
| Increases in expected losses and delinquencies may prevent us from continuing to securitize receivables in the future on similar terms |
| Greater than expected delinquencies and losses also could impact our ability to complete other securitization transactions on acceptable terms or at all, thereby decreasing our liquidity and forcing us to either decrease or stop our growth or rely on alternative, and potentially more expensive, funding sources if even available |
| Increased utilization of existing credit lines by cardholders would require us to establish additional securitization facilities or curtail credit lines |
| Our existing commitments to extend credit to cardholders exceeded our available securitization facilities at December 31, 2005 |
| If all of our cardholders were to use their entire lines of credit at the same time, we would not have sufficient capacity to fund card use |
| However, in that event, we could either reduce our cardholders’ available credit lines or establish additional securitization facilities |
| Increases beyond expected losses and delinquencies may cause us to incur losses on our retained interests |
| If the actual amounts of delinquencies and losses that occur in our securitized receivables are greater than our expectations, the value of our retained interests in the securitization transactions will decrease |
| Since we derive a portion of our income from these retained interests, higher than expected rates of delinquency and loss could cause our net income to be lower than expected |
| In addition, under the terms of our securitizations agreements, levels of loss and delinquency could result in us being required to repay our securitization investors earlier than expected, reducing funds available to us for future growth |
| Our portfolio of receivables is not diversified and originates from customers whose creditworthiness is considered sub-prime |
| We obtain the receivables that we securitize in one of two ways—we either originate receivables or purchase receivables from other credit card issuers |
| In either case, substantially all of our securitized receivables originate from sub-prime borrowers |
| Our reliance on sub-prime receivables has in the past (and may in the future) negatively impacted our performance |
| For example, in the fourth quarter of 2001, we suffered a substantial loss after we increased our discount rate to reflect the higher rate of return required by investors in sub-prime markets |
| Because our receivables portfolios are all of substantially the same character (ie, sub-prime), the increased discount rate resulted in a decrease in the value of our retained interests in our securitized receivables portfolios |
| These losses might have been mitigated had our portfolios consisted of higher-grade receivables in addition to our sub-prime receivables |
| Because our portfolios are undiversified, negative market forces have the potential to cause a widespread adverse impact |
| We have no immediate plans to issue or acquire significant receivables of a higher quality |
| Seasonal consumer spending may result in fluctuations in our net income |
| Our quarterly income may substantially fluctuate as a result of seasonal consumer spending |
| In particular, our customers may charge more and carry higher balances during the year-end holiday season and during the late summer vacation and back-to-school period, resulting in corresponding increases in the receivables we manage and subsequently securitize during those periods |
| Increases in interest rates will increase our cost of funds and may reduce the payment performance of our customers |
| Increases in interest rates will increase our cost of funds, which could significantly affect our results of operations and financial condition |
| Our credit card accounts have variable interest rates |
| Significant increases in these variable interest rates may reduce the payment performance of our customers |
| Due to the lack of historical experience with Internet customers, we may not be able to successfully target these customers or evaluate their creditworthiness |
| There is less historical experience with respect to the credit 17 ______________________________________________________________________ [59]Table of Contents [60]Index to Financial Statements risk and performance of customers acquired over the Internet |
| As part of our growth strategy, we are expanding our origination of accounts over the Internet; however, we may not be able to successfully target and evaluate the creditworthiness of these potential customers |
| Therefore, we may encounter difficulties managing the expected delinquencies and losses and appropriately pricing our products |
| All of our securitization facilities are of finite duration (and ultimately will need to be extended or replaced) and contain conditions that must be fulfilled in order for funding to be available |
| Although our primary credit card receivables facility with Merrill Lynch alleviates for the foreseeable future our principal exposure to advance rate fluctuations, in the event that future advance rates (ie, the percentage on a dollar of receivables that lenders will lend us) for securitizations are reduced, investors in securitizations require a greater rate of return, we fail to meet the requirements for continued funding or securitizations otherwise become unavailable to us, we may not be able to maintain or grow our base of receivables or it may be more expensive for us to do so |
| In addition, because of advance rate limitations, we retain subordinate interests in our securitizations, the “retained interests,” that must be funded through profitable operations, equity raised from third parties or funds borrowed elsewhere |
| The cost and availability of equity and borrowed funds is dependent upon our financial performance, the performance of our industry generally and general economic and market conditions, and has at times been both expensive and difficult to obtain |
| Our growth is dependent on our ability to add new securitization facilities |
| We finance most of our receivables through securitizations |
| To the extent we grow our receivables significantly, our cash requirements are likely to exceed the amount of cash we generate from operations, thus requiring us to add new securitization facilities |
| Our historic and projected performance impact whether, on what terms and at what cost we can sell interests in our securitizations |
| If additional securitization facilities are not available on terms we consider acceptable, or if existing securitization facilities are not renewed on terms as favorable as we have now or are not renewed at all, we may not be able to grow |
| As our securitization facilities mature, they will be required to accumulate cash that therefore will not be available for operations |
| Repayment for our securitization facilities begins as early as one year prior to their maturity dates |
| Once repayment begins and until the facility is paid, payments from customers on receivables are accumulated to repay the investors and are no longer reinvested in new receivables |
| When a securitization facility matures, the underlying trust continues to own the receivables and effectively the maturing facility maintains its priority in its right to payments following collections on the underlying receivables until it is repaid in full |
| As a result, new purchases need to be funded using debt, equity or a replacement facility subordinate to the maturing facility’s interest in the underlying receivables |
| Although this subordination historically has not made it more difficult to obtain replacement facilities, it may do so in the future |
| If our securitization facilities begin to accumulate cash and we also are unable to obtain additional sources of liquidity, such as debt, equity or new securitization facilities that are structurally subordinate to the facilities accumulating cash, we may be forced to prohibit new purchases in some or all of our accounts in order to significantly reduce our need for any additional cash |
| The documents under which the securitization facilities are established provide that, upon the occurrence of certain adverse events known as early redemption events, the timing of payments to the investors could be accelerated |
| Early redemption events include portfolio performance triggers, the termination of the affinity agreement with CB&T, breach of certain representations, warranties and covenants, insolvency or receivership, servicer defaults, and may include the occurrence of an early redemption event with respect to another securitization transaction |
| In the Merrill Lynch facility, an early redemption event also may be triggered based on a total consolidated equity test or a change of control in CompuCredit |
| If an early redemption event occurs, principal payments would be made to investors to reduce their interests in our securitizations |
| As investors’ interests in our securitizations decrease, our liquidity would be negatively impacted and our financial results may suffer |
| We would need to obtain alternative sources of funding, and there is no certainty that we would be able to do so |
| 18 ______________________________________________________________________ [61]Table of Contents [62]Index to Financial Statements We may be unable to obtain capital from third parties needed to fund our existing securitizations or may be forced to rely on more expensive funding sources |
| We need equity or debt capital to fund our retained interests in our securitizations |
| Investors should be aware of our dependence on third parties for funding and our exposure to increases in costs for that funding |
| External factors, including the general economy, impact our ability to obtain funds |
| For instance, in late 2001, we needed additional liquidity to fund our operations and the growth in our retained interests, and we had a difficult time obtaining the needed cash |
| If in the future we need to raise cash by issuing additional debt or equity or by selling a portion of our retained interests, there is no certainty that we will be able to do so or that we will be able to do so on favorable terms |
| Our ability to raise cash will depend on factors such as our performance and creditworthiness, the performance of our industry, the performance of issuers of other non-credit card-based asset backed securities and the general economy |
| The timing and volume of securitizations may cause fluctuations in quarterly income |
| Fluctuations in the timing or the volume of receivables securitized will cause fluctuations in our quarterly income |
| Factors that affect the timing or volume of our securitizations include the growth in our receivables, market conditions and the approval by all parties of the terms of the securitization |
| The performance of our competitors may impact the costs of our securitization |
| Investors in our securitizations compare us to other sub-prime credit card issuers and, to some degree, our performance is tied to many of the factors that impact their performance |
| Generally speaking, our securitizations investors also invest in our competitors’ securitizations |
| These investors broadly invest in receivables, and when they evaluate their investments, they typically do so on the basis of overall industry performance |
| Thus, when our competitors perform poorly, we typically experience negative investor sentiment, and the investors in our securitizations require greater returns, particularly with respect to subordinated interests |
| In the fourth quarter of 2001, for instance, investors demanded unprecedented returns |
| In the event that investors require higher returns and we sell our retained interests at that time, the total return to the buyer may be greater than the discount rate we are using to value the retained interests in our financial statements |
| This would result in a loss for us at the time of the sale as the total proceeds from the sale would be less than the carrying amount of the retained interests in our financial statements |
| We also might increase the discount rate used to value all of our other retained interests, which also would result in further losses |
| Conversely, if we sold our retained interests for a total return to the investor that was less than our current discount rate, we would record income from the sale, and we would potentially decrease the rate used to value all of our other retained interests, which would result in additional income |
| We may be required to pay to investors in our securitizations an amount equal to the amount of securitized receivables if representations and warranties made to us by sellers of the receivables are inaccurate |
| The representations and warranties made to us by sellers of receivables we purchased may be inaccurate |
| We rely on these representations and warranties when we securitize these purchased receivables |
| In securitization transactions, we make representations and warranties to investors and, generally speaking, if there is a breach of our representations and warranties, then under the terms of the applicable investment agreement we could be required to pay the investors the amount of the non-compliant receivables |
| Thus, our reliance on a representation or warranty of a receivables seller, which proves to be false and causes a breach of one of our representations or warranties, could subject us to a potentially costly liability |
| Our Financial Performance Is, in Part, a Function of the Aggregate Amount of Receivables That Are Outstanding |
| The aggregate amount of outstanding receivables is a function of many factors including purchase rates, payment rates, interest rates, seasonality, general economic conditions, competition from other credit card issuers and other sources of consumer financing, access to funding as noted above and the success of our marketing efforts |
| To the extent that we have over estimated the size or growth of our receivables, in all likelihood we have over estimated our future financial performance |
| 19 ______________________________________________________________________ [63]Table of Contents [64]Index to Financial Statements Intense competition for customers may cause us to lose receivables to competitors |
| We may lose receivables to competitors that offer lower interest rates and fees or other more attractive terms or features |
| We believe that customers choose credit card issuers and other lenders largely on the basis of interest rates, fees, credit limits and other product features |
| For this reason, customer loyalty is often limited |
| Our future growth depends largely upon the success of our marketing programs and strategies |
| Our credit card business competes with national, regional and local bank card issuers and with other general purpose credit card issuers, including American Express^®, Discover^® and issuers of Visa^® and MasterCard^® credit cards |
| Our other businesses have substantial competitors as well |
| Some of these competitors already may use or may begin using many of the programs and strategies that we have used to attract new accounts |
| In addition, many of our competitors are substantially larger than we are and have greater financial resources |
| Further, the Gramm-Leach-Bliley Act of 1999, which permits the affiliation of commercial banks, insurance companies and securities firms, may increase the level of competition in the financial services market, including the credit card business |
| We may experience fluctuations in net income or sustain net losses if we are not able to sustain or effectively manage our growth |
| Growth is a product of a combination of factors, many of which are not in our control |
| Factors include: • growth in both existing and new receivables; • the degree to which we lose receivables to competitors; • levels of delinquencies and charge offs; • the availability of funding, including securitizations, on favorable terms; • our ability to sell retained interests on favorable terms; • our ability to attract new customers through originations or portfolio purchases; • the level of costs of soliciting new customers; • the level of response to our solicitations; • our ability to employ and train new personnel; • our ability to maintain adequate management systems, collection procedures, internal controls and automated systems; and • general economic and other factors beyond our control |
| Our decisions regarding marketing can have a significant impact on our growth |
| We can increase or decrease the size of our outstanding receivables balances by increasing or decreasing our marketing efforts |
| Marketing is expensive, and during periods when we have less liquidity than we like or when prospects for continued liquidity in the future do not look promising, we may decide to limit our marketing and thereby our growth |
| We decreased our marketing during 2003, although we increased our marketing in 2004 and 2005 because of our improved access to capital attributable to our Merrill Lynch securitization facility |
| Our operating expenses and our ability to effectively service our accounts are dependent on our ability to estimate the future size and general growth rate of the portfolio |
| One of our servicing agreements causes us to make additional payments if we overestimate the size or growth of our business |
| These additional payments compensate the servicer for increased staffing expenses it incurs in anticipation of our growth |
| If we grow more slowly than anticipated, we still may have higher servicing expenses than we actually need, thus reducing our net income |
| We Operate in a Heavily Regulated Industry |
| Changes in bankruptcy, privacy or other consumer protection laws, or to the prevailing interpretation thereof, may expose us to litigation, adversely affect our ability to collect account balances in connection with 20 ______________________________________________________________________ [65]Table of Contents [66]Index to Financial Statements our traditional credit card business, Jefferson Capital’s charged-off receivables operations, auto finance and micro-loan activities, or otherwise adversely affect our operations |
| Similarly, regulatory changes could adversely affect our ability or willingness to market credit cards and other products and services to our customers |
| The accounting rules that govern our business are exceedingly complex, difficult to apply and in a state of flux |
| As a result, how we value our receivables and otherwise account for our business (including whether we consolidate our securitizations) is subject to change depending upon the interpretation of, and changes in, those rules |
| Enforcement actions or inquiries by regulatory authorities under consumer protection laws and regulations may result in changes to our business practices, may make collection of account balances more difficult or may expose us to the risk of fines and litigation |
| Our operations and the operations of CB&T and the other issuing banks through which we originate certain receivables are subject to the jurisdiction of federal, state and local government authorities, including the SEC, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, state regulators having jurisdiction over financial institutions and debt origination and debt collection and state attorneys general |
| Our business practices, including our marketing, servicing and collection practices and in some cases the terms of our products, are subject to review by these regulatory and enforcement authorities |
| Because of the consumer-oriented nature of our business, from time to time we receive inquiries and requests for information from these regulatory and enforcement authorities that can range from the investigations of specific consumer complaints or concerns to broader inquiries into our practices generally |
| Recently, we received and responded to inquiries relating to our use of marketing and other materials in our solicitation of consumers and our servicing and collection practices |
| The investigating authority has taken the position that certain specific practices are not in compliance with its interpretation of applicable law and has suggested that we take various remedial actions as a result |
| We believe that our compliance with the suggested remedial actions will not result in a material adverse change in our financial condition, results of operations or business |
| However, if any additional deficiencies or violations of law or regulations with respect to our practices or marketing or other materials are identified by us or any regulatory or enforcement agency as a result of this particular inquiry, or any other communications or inquiries, there can be no assurance that the correction of such deficiencies or violations would not have a material adverse effect on our financial condition, results of operations or business |
| In addition, notwithstanding our policy of full cooperation, a regulatory or enforcement authority could require us to change our practices in specific ways or take remedial action with respect to affected customers, or it could take other action against us, such as the imposition of a fine or penalty |
| Furthermore, negative publicity relating to the announcement of any specific inquiry or investigation could hurt our ability to conduct business with various industry participants or attract new accounts and could negatively affect our stock price, which would adversely affect our ability to raise additional capital or raise our costs of doing business |
| The imposition of significant fines or burdensome remedial actions, or the negative consequences of any significant or high profile regulatory or enforcement actions could adversely affect our financial condition, results of operations or business |
| In addition, whether or not we modify our practices when a regulatory or enforcement authority requests or requires that we do so, there is a risk that we or other industry participants may be named as defendants in litigation involving alleged violations of federal and state laws and regulations, including consumer protection laws |
| Any failure to comply with legal requirements by us or any other issuer of credit products, including CB&T, or by us or our agents as the servicer of our accounts, could significantly impair our ability to collect the full amount of the account balances |
| The institution of any litigation of this nature, or any judgment against us or any other industry participant in any litigation of this nature, could adversely affect our business and financial condition in a variety of ways |
| Required changes in minimum payment levels could impact our business adversely |
| Recently, regulators of credit card issuers have requested or required that the issuers increase their minimum monthly payment requirements to prevent so-called “negative amortization |
| ” To date, none of our issuing banks has required that we change our minimum payment practices, although it is possible that they will |
| We have not made any assessment of the impact of a change in our minimum payment practices on our business, although a change in 21 ______________________________________________________________________ [67]Table of Contents [68]Index to Financial Statements response to the requirements of our issuing banks could adversely impact our delinquency and charge off statistics and the amounts ultimately collected from cardholders |
| Adverse regulatory action with respect to issuing banks would adversely impact our business |
| It is possible that a regulatory position or action taken with respect to CB&T, or another issuing bank through which we originate receivables or for whom we service receivables, might result in CB&T’s, or the other bank’s, inability or unwillingness to originate receivables on our behalf or in partnership with us |
| For instance, in February 2006 the FDIC effectively asked insured financial institutions not to issue cash advance and installment micro loans through third-party servicers |
| Immediately after this request the issuing bank for which we provide services in four states stopped making new loans |
| In the future, the FDIC or other regulators may find other aspects of the products that we originate or service objectionable, including, for instance, the terms of the credit offerings (particularly for our high fee products) or the manner in which we market them |
| We are entirely dependent in our issuing relationships with these institutions, and their regulators could at any time limit their ability to issue some or all products on our behalf, or that we service on their behalf, or to modify those products significantly |
| Any significant interruption of those relationships would result in our being unable to originate new receivables, which would have a materially adverse impact on our business |
| Changes to consumer protection laws or changes in their interpretation may impede collection efforts or otherwise adversely impact our business practices |
| Federal and state consumer protection laws regulate the creation and enforcement of consumer credit card receivables and other loans |
| As an originator and servicer of sub-prime receivables, we typically charge higher interest rates and fees than lenders serving consumers with higher credit scores |
| Sub-prime lenders are commonly the target of legislation (and revised legislative interpretations) intended to prohibit or curtail these and other industry-standard practices as well as non-standard practices |
| Among others, changes in the consumer protection laws could result in the following: • receivables not originated in compliance with law (or revised interpretations) could become unenforceable and uncollectible under their terms against the obligors; • we may be required to refund previously collected amounts; • certain of our collection methods could be prohibited, forcing us to revise our practices or adopt more costly or less effective practices; • federal and state laws may limit our ability to recover on charged-off receivables regardless of any act or omission on our part; • reductions in statutory limits for fees and finance charges could cause us to reduce our fees and charges; • some of our products and services could be banned in certain states or at the federal level; for example, in 2004 the State of Georgia made certain micro-loan practices illegal and regulatory action and litigation has been brought in North Carolina alleging that certain micro-loan practices are prohibited in that state; and • federal or state bankruptcy or debtor relief laws could offer additional protections to customers seeking bankruptcy protection, providing a court greater leeway to reduce or discharge amounts owed to us |
| Accordingly, our business is always subject to changes in the regulatory environment |
| Changes or additions to the consumer protection laws and related regulations, or to the prevailing interpretations thereof, could invalidate or call into question a number of our existing products, services and business practices, including our credit card origination, charged-off receivable collection, auto finance and micro-loan activities |
| Any material regulatory developments could adversely impact our results from operations |
| Changes in law may increase our credit losses and administrative expenses, restrict the amount of interest and other charges imposed on the credit card accounts or limit our ability to make changes to existing accounts |
| Numerous legislative and regulatory proposals are advanced each year that, if adopted, could harm our profitability or limit the manner in which we conduct our activities |
| Changes in federal and state bankruptcy and 22 ______________________________________________________________________ [69]Table of Contents [70]Index to Financial Statements debtor relief laws may increase our credit losses and administrative expenses |
| More restrictive laws, rules and regulations may be adopted in the future that could make compliance more difficult or expensive, further restrict the amount of interest and other charges we can impose on the credit products we originate or market, target sub-prime lenders, limit our ability to make changes to the terms of existing accounts or otherwise significantly harm our business |
| Recent changes in bankruptcy laws may have an adverse impact on our performance |
| Effective October 17, 2005, the federal bankruptcy code was amended in several respects |
| One of the changes made it substantially more difficult for individuals to obtain a complete release from their debts through a bankruptcy filing |
| As a result, immediately prior to the effective date of the amendments there was a substantial increase in bankruptcy filings by individuals |
| We are not yet able to fully assess the impact of this increase |
| Much of the impact appears to have been to simply accelerate the bankruptcy filings by individuals who otherwise would have filed in due course |
| Also, the individuals who filed in many cases already were delinquent in payments, whether to us or to others, and their receivables already may have been considered uncollectible |
| We do not expect the amendments to have a material long-term impact on our business |
| The Retail Micro-Loans segment of our business operates in an increasingly hostile regulatory environment |
| Most states have specific laws regulating micro-loan activities and practices (one form of these activities is sometimes referred to as “payday” lending) |
| Moreover, during the last few years, legislation has been adopted in some states that prohibits or severely restricts micro-loan cash advance services |
| For example, in May 2004, a new law became effective in Georgia that effectively prohibits certain micro-loan practices in the state |
| Several other state legislatures have introduced bills to restrict or prohibit “cash advance” micro-loans |
| In addition, Mississippi and Arizona have sunset provisions in their laws permitting micro-loans that require renewal of the laws by the state legislatures at periodic intervals |
| Although states provide the primary regulatory framework under which we conduct our micro-loan services, certain federal laws also impact our business |
| In March 2005 the FDIC issued guidance limiting the frequency of borrower usage of cash advance micro-loans offered by FDIC supervised institutions and the period a customer may have cash advance micro-loans outstanding from any lender to three months during the previous 12-month period; subsequently, we have only recently learned that, during February 2006, the FDIC asked FDIC-insured financial institutions to cease cash advance and installment micro-loan activities conducted through a processing and servicing agent such as us |
| We are evaluating the impact of this regulatory development on our business, and it could have a material adverse effect on our business, results of operations and financial condition |
| Moreover, future laws or regulations (at the state, federal or local level) prohibiting micro-loan services or making them unprofitable could be passed at any time or existing micro-loan laws could expire or be amended, any of which could have a material adverse effect on our business, results of operations and financial condition |
| Additionally, state attorneys general, banking regulators, and others continue to scrutinize the micro-loan industry and may take actions that could require us to cease or suspend operations in their respective states |
| For example, a group of plaintiffs has brought a series of putative class action lawsuits in North Carolina claiming, among other things, that the cash advance micro-loan activities of the defendants violate numerous North Carolina consumer protection laws |
| The lawsuits seek various remedies including treble damages |
| One of these lawsuits is pending against CompuCredit and five of our subsidiaries |
| If these cases are determined adversely to us, there could be significant consequences to us, including the inability to continue cash advance micro-loan servicing activities in North Carolina, the inability to collect loans outstanding in North Carolina, a potential impairment in the value of the goodwill attendant to the micro-loan business, and the payment of monetary damages |
| We also might secede voluntarily (or with the encouragement of a regulator) to withdraw from a particular state which could have a similar effect |
| Negative publicity may impair acceptance of our products |
| Critics of sub-prime credit and micro-loan providers have in the past focused on marketing practices that they claim encourage consumers to borrow more money than they should, as well as on pricing practices that they claim are either confusing or result in prices that are too high |
| Consumer groups, Internet chat sites and media reports frequently characterize sub-prime lenders as predatory or abusive toward consumers and may misinform consumers regarding their rights |
| If these negative 23 ______________________________________________________________________ [71]Table of Contents [72]Index to Financial Statements characterizations and misinformation become widely accepted by consumers, demand for our products and services could be adversely impacted |
| Increased criticism of the industry or criticism of us in the future could hurt customer acceptance of our products or lead to changes in the law or regulatory environment, either of which would significantly harm our business |
| We routinely consider acquisitions of, or investments in, portfolios and other businesses as well as the sale of portfolios and portions of our business |
| There are a number of risks attendant to any acquisition, including the possibility that we will overvalue the assets to be purchased, that we will not be able to successfully integrate the acquired business or assets and that we will not be able to produce the expected level of profitability from the acquired business or assets |
| Similarly, there are a number of risks attendant to sales, including the possibility that we will undervalue the assets to be sold |
| As a result, the impact of any acquisition or sale on our future performance may not be as favorable as expected and actually may be adverse |
| Our portfolio purchases may cause fluctuations in reported managed receivables data, which may reduce the usefulness of historical managed loan data in evaluating our business |
| Our reported managed receivables data may fluctuate substantially from quarter to quarter as a result of recent and future portfolio acquisitions |
| As of December 31, 2005, portfolio acquisitions account for 30dtta4prca of our total portfolio based on our ownership percentages |
| Receivables included in purchased portfolios are likely to have been originated using credit criteria different from our criteria |
| As a result, some of these receivables have a different credit quality than receivables we originated |
| Receivables included in any particular purchased portfolio may have significantly different delinquency rates and charge off rates than the receivables previously originated and purchased by us |
| These receivables also may earn different interest rates and fees as compared to other similar receivables in our receivables portfolio |
| These variables could cause our reported managed receivables data to fluctuate substantially in future periods making the evaluation of our business more difficult |
| Any acquisition or investment that we make, including our recent acquisition of Wells Fargo Financial’s CAR business unit and our pending acquisition of CardWorks, Inc, will involve risks different from and in addition to the risks to which our business is currently exposed |
| These include the risks that we will not be able to successfully integrate and operate new businesses, that we will have to incur substantial indebtedness and increase our leverage in order to pay for the acquisitions, that we will be exposed to, and have to comply with, different regulatory regimes and that we will not be able to apply our traditional analytical framework (which is what we expect to be able to do) in a successful and value-enhancing manner |
| Other Risks of Our Business Unless we obtain a bank charter, we cannot issue credit cards other than through agreements with banks |
| Because we do not have a bank charter, we currently cannot issue credit cards other than through agreements with banks, and substantially all of our new credit card issuances are made under an agreement with CB&T Previously we applied for permission to acquire a bank and our application was denied |
| Unless we obtain a bank or credit card bank charter, we will continue to rely upon banking relationships like the CB&T relationship to provide for the issuance of credit cards to our customers |
| Our current agreement with CB&T is scheduled to expire on March 31, 2009 |
| If we are unable to execute a new agreement with CB&T at the expiration of the current agreement or if our existing or new agreement with CB&T were terminated or otherwise disrupted, there is a risk that we would not be able to enter into an agreement with an alternate provider on terms that we consider favorable or in a timely manner without disruption of our business |
| We may not be able to purchase charged-off receivables at sufficiently favorable prices or terms for our Jefferson Capital operations to be successful |
| The charged-off receivables that are acquired and serviced by 24 ______________________________________________________________________ [73]Table of Contents [74]Index to Financial Statements Jefferson Capital or sold to third parties pursuant to forward flow contracts have been deemed uncollectible and written off by the originators |
| Jefferson Capital seeks to purchase charged-off receivables portfolios where our projected collections or purchase price received for the sale of such charged-off receivables will exceed our acquisition costs |
| Accordingly, factors causing the acquisition price of targeted portfolios to increase could reduce the ratio of collections (or purchase price received) to acquisitions costs for a given portfolio, and thereby negatively affect Jefferson Capital’s profitability |
| The availability of charged-off receivables portfolios at favorable prices and on favorable terms depends on a number of factors, including the continuation of the current growth and charge off trends in consumer receivables, our ability to develop and maintain long-term relationships with key charged-off receivable sellers, our ability to obtain adequate data to appropriately evaluate the collectibility of portfolios and competitive factors affecting potential purchasers and sellers of charged-off receivables, including pricing pressures, which may increase the cost to us of acquiring portfolios of charged-off receivables and reduce our return on such portfolios |
| Additionally, sellers of charged-off receivables generally make numerous attempts to recover on their non-performing receivables, often using a combination of their in-house collection and legal departments as well as third-party collection agencies |
| Charged-off receivables are difficult to collect, and we may not be successful in collecting amounts sufficient to cover the costs associated with purchasing the receivables and funding our Jefferson Capital operations |
| The analytical model we use to project credit quality may prove to be inaccurate |
| We assess credit quality using an analytical model that we believe predicts the likelihood of payment more accurately than traditional credit scoring models |
| For instance, we have identified factors (such as delinquencies, defaults and bankruptcies) that under some circumstances we weight differently than do other credit providers |
| We believe our analysis enables us to better identify consumers within the underserved market who are likely to be better credit risks than otherwise would be expected |
| Similarly, we apply our analytical model to entire portfolios in order to identify those that may be more valuable than the seller or other potential purchasers might recognize |
| There can be no assurance, however, that we will be able to achieve the collections forecasted by our analytical model |
| If any of our assumptions underlying our model proves materially inaccurate or changes unexpectedly, we may not be able to achieve our expected levels of collection, and our revenues will be reduced, which could result in a reduction of our earnings |
| Because we outsource account-processing functions that are integral to our business, any disruption or termination of that outsourcing relationship could harm our business |
| We outsource account and payment processing pursuant to agreements with CB&T and its affiliates |
| In 2005, we paid CB&T and its affiliates dlra32dtta0 million for these services |
| If these agreements were not renewed or terminated or the services provided to us otherwise disrupted, we would have to obtain these services from an alternative provider |
| There is a risk that we would not be able to enter into a similar agreement with an alternate provider on terms that we consider favorable or in a timely manner without disruption of our business |
| We rely on Visionary Systems, Inc |
| for software design and support, and any disruption of our relationship with Visionary Systems would negatively impact our business |
| During 2005, we paid Visionary Systems dlra6dtta1 million for software development, account origination and consulting services |
| In the event that Visionary Systems no longer provides us with software and support, our business would be negatively impacted until we retained replacement vendors |
| We believe that a number of vendors are qualified to perform the services performed by Visionary Systems and believe that this impact would be only temporary |
| If we obtain a bank charter, any changes in applicable state or federal laws could adversely affect our business |
| CardWorks, Inc |
| owns a bank, and as part of our proposed acquisition of CardWorks, Inc |
| we have applied for permission to acquire that bank |
| We may or may not receive permission to acquire that bank, and in the future we may apply for other charters as well |
| If we obtain a bank or credit card bank charter, we will be subject to the various state and federal regulations generally applicable to similar institutions, including restrictions on the ability of the banking subsidiary to pay dividends to us |
| We are unable to predict the effect of any future changes of applicable state and federal laws or regulations, but such changes could adversely affect the bank’s business and operations |
| 25 ______________________________________________________________________ [75]Table of Contents [76]Index to Financial Statements If we ever consolidate the entities that hold our receivables, the changes to our financial statements are likely to be significant |
| When we securitize receivables, they are owned by special purpose entities that are not consolidated with us for financial reporting purposes |
| The rules governing whether these entities are consolidated are complex and evolving |
| These rules at some point could be changed or interpreted in a manner that requires us to consolidate these entities |
| In addition, we might at some point modify how we securitize receivables, or propose modifications to existing securitization facilities, such that the consolidation of these entities could be required |
| If this occurred, we would include the receivables as assets on our balance sheets and also would include a loan loss reserve |
| Similarly, we no longer would include the corresponding retained interests as assets |
| There also would be significant changes to our statements of operations and cash flows |
| The net effect of consolidation would be dependent upon the amount and nature of the receivables at the time they were consolidated, and although it is difficult to predict the net effect of consolidation, it is likely to be material |
| Internet security breaches could damage our reputation and business |
| Internet security breaches could damage our reputation and business |
| As part of our growth strategy, we may expand our origination of credit card accounts over the Internet |
| The secure transmission of confidential information over the Internet is essential to maintaining consumer confidence in our products and services offered online |
| Advances in computer capabilities, new discoveries or other developments could result in a compromise or breach of the technology used by us to protect customer application and transaction data transmitted over the Internet |
| Security breaches could damage our reputation and expose us to a risk of loss or litigation |
| Moreover, consumers generally are concerned with security and privacy on the Internet, and any publicized security problems could inhibit the growth of the Internet as a means of conducting commercial transactions |
| Our ability to solicit new account holders over the Internet would be severely impeded if consumers become unwilling to transmit confidential information online |
| We recently entered the automobile lending business |
| On April 1, 2005, we acquired Wells Fargo Financial’s CAR business unit |
| We are operating these assets in forty-two states through twelve branches, three regional processing centers and one national collection center based in Lake Mary, Florida under the name CAR Financial Services, Inc |
| Automobile lending is a new business for us, and we expect to expand further in this business over time |
| As a new business, we may not be able to integrate or manage the business effectively |
| In addition, automobile lending exposes us to a range of risks to which we previously have not been exposed, including the regulatory scheme that governs installment loans and those attendant to relying upon automobiles and their liquidation value as collateral |
| In addition, this business acquires loans on a wholesale basis from used car dealers, for which we will be relying upon the legal compliance and credit determinations by those dealers |
| Risks Relating to an Investment in Our Common Stock The price of our common stock may fluctuate significantly, and this may make it difficult for you to resell your shares of our common stock when you want or at prices you find attractive |
| The price of our common stock on the NASDAQ Global Market constantly changes |
| We expect that the market price of our common stock will continue to fluctuate |
| The market price of our common stock may fluctuate in response to numerous factors, many of which are beyond our control |
| These factors include the following: • actual or anticipated fluctuations in our operating results; • changes in expectations as to our future financial performance, including financial estimates by securities analysts and investors; • the operating and stock performance of our competitors; • announcements by us or our competitors of new products or services or significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments; • changes in interest rates; • the announcement of enforcement actions or investigations against us or our competitors or other negative publicity relating to us or our industry; 26 ______________________________________________________________________ [77]Table of Contents [78]Index to Financial Statements • changes in accounting principles generally accepted in the United States of America (“GAAP”), laws, regulations or the interpretations thereof that affect our various business activities and segments; • general domestic or international economic, market and political conditions; • additions or departures of key personnel; and • future sales of our common stock and the share lending agreement |
| In addition, the stock markets from time to time experience extreme price and volume fluctuations that may be unrelated or disproportionate to the operating performance of companies |
| These broad fluctuations may adversely affect the trading price of our common stock, regardless of our actual operating performance |
| Future sales of our common stock or equity-related securities in the public market, including sales of our common stock pursuant to share lending agreements or in short sales transactions by purchasers of convertible notes securities, could adversely affect the trading price of our common stock and our ability to raise funds in new stock offerings |
| Sales of significant amounts of our common stock or equity-related securities in the public market, including sales pursuant to share lending agreements, or the perception that such sales will occur, could adversely affect prevailing trading prices of our common stock and could impair our ability to raise capital through future offerings of equity or equity-related securities |
| No prediction can be made as to the effect, if any, that future sales of shares of common stock or the availability of shares of common stock for future sale, including sales of our common stock in short sales transactions by purchasers of the notes, will have on the trading price of our common stock |
| We have the ability to issue preferred shares without shareholder approval |
| Our common shares may be subordinate to classes of preferred shares issued in the future in the payment of dividends and other distributions made with respect to common shares, including distributions upon liquidation or dissolution |
| Our articles of incorporation permit our board of directors to issue preferred shares without first obtaining shareholder approval |
| If we issued preferred shares, these additional securities may have dividend or liquidation preferences senior to the common shares |
| If we issue convertible preferred shares, a subsequent conversion may dilute the current common shareholders’ interest |
| Our executive officers, directors and parties related to them, in the aggregate, control a majority of our voting stock and may have the ability to control matters requiring shareholder approval |
| Our executive officers, directors and parties related to them own a large enough stake in us to have an influence on, if not control of, the matters presented to shareholders |
| As a result, these shareholders may have the ability to control matters requiring shareholder approval, including the election and removal of directors, the approval of significant corporate transactions, such as any merger, consolidation or sale of all or substantially all of our assets, and the control of our management and affairs |
| Accordingly, this concentration of ownership may have the effect of delaying, deferring or preventing a change of control of us, impede a merger, consolidation, takeover or other business combination involving us or discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of us, which in turn could have an adverse effect on the market price of our common stock |
| Note Regarding Risk Factors The risks factors presented above are all of the ones that we currently consider material |
| However, they are not the only ones facing our company |
| Additional risks not presently known to us, or which we currently consider immaterial, may also adversely affect us |
| There may be risks that a particular investor views differently from us, and our analysis might be wrong |
| If any of the risks that we face actually occur, our business, financial condition and operating results could be materially adversely affected and could differ materially from any possible results suggested by any forward-looking statements that we have made or might make |
| In such case, the trading price of our common stock could decline, and you could lose part or all of your investment |
| 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 |
| 27 ______________________________________________________________________ [79]Table of Contents [80]Index to Financial Statements |