Encore Capital Group Inc

Ladies and gentlemen, thank you for standing by. Welcome to the Encore Capital Group's Q1 2021 Earnings Conference Call. At this time, all participants are in the listen-only mode. After this speaker's presentation, there will be a question and answer session. To ask a question at this time, you will need to press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I'd like to turn it over to Mr. Bruce Thomas, Vice President for Investor Relations at Encore. Sir, you can go ahead.

Thank you, operator. Good afternoon, and welcome to Encore Capital Group's first quarter 2021 earnings call. Joining me on the call today are Ashish Masih, our President and Chief Executive Officer, Jonathan Clark, Executive Vice President and Chief Financial Officer, Ryan Bell, President of Midland Credit Management, and Craig Buick, CEO of Cabot Credit Management. Ashish and John will make prepared remarks today, and then we'll be happy to take your questions. Unless otherwise noted, comparisons made on this conference call will be between the first quarter of 2021 and the first quarter of 2020. In addition, today's discussion will include forward-looking statements subject to risks and uncertainties, Actual results could differ materially from these forward-looking statements. Please refer to our SEC filings for a detailed discussion of potential risks and uncertainties. During this call, we will use rounding and abbreviations for the sake of brevity. We will also be discussing non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are included in our earnings presentation, which was filed on Form 8K earlier today. As a reminder, this conference call will also be made available for replay on the Investors section of our website, where we will also post our prepared remarks following the conclusion of this call. With that, let me turn the call over to Ashish Massey, our President and Chief Executive Officer.

Thanks, Bruce, and good afternoon, everyone. Thank you for joining our earnings call. The first quarter for Encore was a period of strong operational and financial performance as we continued to execute on our strategy, improve our balance sheet, and focus on our capital allocation priorities. To better understand our results, let's begin with some important highlights from the first quarter. The principal driver of our financial performance was the record collections in Q1. Since the beginning of the pandemic, especially in the U.S., consumers have been contacting us at a much higher rate, resulting in a higher level of inbound call traffic and online digital interactions. This consumer behavior accelerated in the first quarter, generating significantly more collections than we had anticipated, and has continued into the beginning of Q2. Although it's uncertain how long this will last, the result was nearly $30 million of incremental gap net income for the quarter, or approximately $1 of incremental GAAP earnings per share. The higher level of collections from Q1 drove improvement in a number of aspects of our business, including higher cash flow, reduced cost to collect, lower leverage, and higher returns. The consumer behaviors that are driving such strong collections are also resulting in lower delinquency and charge-off rates for the banks and credit card issuers who sell portfolios to us. Having said that, we continue to see each of the US banks who were selling before the pandemic remain in the market as sellers. In Europe, most sellers are now back in the market as well. However, even though the banks are still selling, they're simply selling less because there are fewer delinquent accounts and subsequently fewer charge-offs. On a global basis, our portfolio purchases were $170 million in Q1, Despite the subdued supply in the market, which has begun to impact portfolio pricing, we have remained disciplined and continue to purchase at very attractive returns. We have worked diligently over the past several years to improve our collections effectiveness and cost efficiency, and that has in turn allowed us to mitigate the impacts of higher market pricing on our returns. As a result, in comparison to our peers, these competitive advantages enable us to deliver higher returns. A quarter ago, we articulated our capital allocation priorities for the business. You may recall that we listed three priorities, including share repurchases. In recent quarters, including Q1, we have generated a significant amount of excess capital. We have reduced our leverage to the low end of our target range of two to three times. As a result, in line with our capital allocation priorities, we repurchased $20 million of Encore shares during the first quarter. In addition, we have increased our share repurchase authorization from prior $50 million program to a $300 million multi-year program. We will continue to allocate capital according to our stated priorities, and any future share repurchases are subject to maintaining our strong balance sheet, liquidity, and the continuation of a strong financial performance. To further describe our results for the quarter, I would like to anchor the conversation to our strategy that we had previously outlined, and that allows us to consistently deliver best-in-class financial performance. Our core business is relatively straightforward. Our objective is to purchase portfolios of non-performing loans at attractive cash-on-cash returns using the lowest cost of funding available to us. We also strive to exceed our collection expectations for each of our portfolios, while ensuring the highest level of compliance and consumer focus, as well as maintaining an efficient cost structure. We achieve these objectives by maintaining focus on our three-pillar strategy. Our strategy enables us to consistently deliver outstanding financial performance, has positioned us well to capitalize on future opportunities, and is instrumental in building long-term shareholder value. The first pillar of our strategy, market focus, leads us to concentrate our efforts on our most valuable markets with the highest risk-adjusted returns. Our largest and most valuable market is in the US. NCM demonstrated improved operating leverage in the first quarter as we grew collections to a record level while continuing to drive a higher proportion of collections through our cost-efficient call center and digital channel. While this transition has been underway for a few years, it picked up pace over the past several quarters and accelerated again in Q1 as more for consumers are calling us and connecting with us online to resolve their debts. The impact of this transition is apparent in the increased effectiveness and scalability of MCM's collections operation. In the first quarter, we grew collections by $61 million compared to Q1 of 2020, while incurring only $2 million of added operating expense. While it's not clear how long this specific consumer behavior will last, the changes we have made operationally will benefit us in the long term. These factors combined drive a significantly lower cost to collect in the quarter. Although the impacts of the pandemic have reduced the supply of portfolios for purchase, the capital we did deploy continues to be at attractive returns. The industry rules announced by the CFPB are now expected to become effective in early 2022. As a result of our expertise in compliance and risk management, we are well positioned to fully implement these new rules. Turning now to our business in the UK and Europe. Our collections performance continues to normalize after a few quarters of COVID-related volatility. Collections in the first quarter grew 13%, compared to Q1 last year, and exceeded our expectations by 8%. Deployments of $78 million were higher compared to the first quarter last year, with portfolio prices generally returning to pre-COVID levels. Most major sellers in the UK and Europe are now back selling in the market in some capacity, though we expect supply to remain inconsistent over the foreseeable future. Our competitive platform enables us to consistently generate significant cash. Our cash generation for the 12 months ending in March increased 12%, reflecting the steady improvement in our business, of our operations, and the resilience of our portfolios. Our consistent growth in cash generation has contributed to a reduction in our borrowings and leverage ratio. Our strong cash generation also provides us with additional flexibility when we consider our capital allocation priorities, which include portfolio purchases at attractive returns, strategic and disciplined M&A, and share repurchases. Our competitive advantages also allow us to deliver differentiated returns. A quarter ago, we began to emphasize the importance of ROIC, which ultimately takes into account both the performance of our collections operation as well as our ability to appropriately price risk when investing our capital. We believe that it's important to demonstrate that our underlying business delivers strong long-term returns that we can maintain through the credit cycle. Our ROIC performance in the first quarter and over the last three years is a solid indicator of improvements in our business and our ability to deliver strong returns under current market conditions as well as over time. We continue to believe it is difficult to find such attractive returns at other companies in or around our industry. The third pillar of our strategy makes the strengthening of a balance sheet a constant priority. We believe a strong balance sheet is critical to success. Our continued focus on further strengthening a balance sheet has enabled us to reduce our debt to equity ratio to 2.5 times and reduce our leverage ratio to 2.1 times. which is now at the low end of a targeted range of two to three times and is near the lowest in the industry. A strong operating performance and focused capital deployment have driven higher levels of cash flow, which in turn has led to leverage reduction. As a result of our financing accomplishments over the last year, we have significantly lowered our cost of funds and we believe we have established a best-in-class capital structure that will allow us to capitalize on future opportunities. I'd now like to hand over the call to John for a more detailed look at our financial results.

Thank you, Ashish. In the first quarter, very strong collections along with expense control drove higher revenue, net income, and returns. Importantly, the resulting strong cash generation combined with the subdued market for purchases led to a significant drop in the leverage ratio and slightly lower ERC. Collections were a record $606 million in the first quarter, up 15% compared to Q1 last year. MCM collections grew 16% in the first quarter to a record $436 million. Within that total, MCM's call center and digital collections grew 25% compared to Q1 last year. Cabot collections, through our debt purchasing business in Europe in the first quarter were $163 million, up 13% compared to Q1 last year. Encore's global collections in the first quarter achieved 117% of our ERC as of December 31st, 2020. Revenues in the first quarter were up 44% to $417 million compared to $289 million in Q1 last year. Recall that a year ago, the uncertainty surrounding the coronavirus pandemic caused us to push out our collections forecast, which suppressed our revenues in the year-ago quarter. In the first quarter this year, revenues in the U.S. were up 38% to $288 million. In Europe, first quarter revenues were up 63% to $124 million. Our estimated remaining collections at the end of Q1 was $8.3 billion, down 2% compared to the end of Q1 last year, primarily as a result of very strong collections performance during the past year, as well as lower portfolio purchasing during this same time period. Our global funding structure provides many benefits to Encore, including lower funding costs, extended maturities, and more capital diversity. We now have access to more funding sources than ever to optimize our capital structure over time. In the first quarter, we repaid $161 million of outstanding principal on our convertible notes that matured in March using available liquidity. As a result, we've reduced the amount of convertible debt in our funding structure by $250 million over the last 12 months. Available capacity under our global RCF was $530 million at the end of the first quarter. and we concluded Q1 with $162 million of non-client cash on the balance sheet. The importance of financial flexibility and access to a variety of capital sources cannot be overstated in a business like ours. With this flexibility, we are well prepared for the opportunities that lie ahead. With that, I'd like to turn it back over to Ashish.

Thank you, John. As we look ahead to the rest of this year and beyond, I'm excited about what we have accomplished as well as what the future holds. With our global funding structure now well established, we remain focused on executing our strategy, which we believe will continue to be instrumental in driving strong results and building long-term shareholder value. I'd also like to highlight our financial priorities, which we articulated in our February report, A strong financial performance in Q1 improved our standing with respect to our balance sheet objectives, which include preserving our financial flexibility, targeting leverage in a range between two and three times, and maintaining a strong double B debt rating. Consistent with our capital allocation priorities, we purchased portfolios at attractive multiples in the first quarter, guided by a disciplined approach. And as I mentioned earlier, in the first quarter, we repurchased Encore shares in addition to receiving board approval to expand our repurchase authorization. Finally, with regard to operating and financial performance, our returns remain very strong, and we intend to deliver strong ROIC through the credit cycle. I'm excited about our business in 2021. We continue to operate at a high level with a solid liquidity position and a strong, flexible balance sheet. which will allow us to capitalize on future opportunities. Now we'd be happy to answer any questions that you may have. Operator, please open up the lines for questions.

Thank you so much. At this time, I would like to remind everyone, if you would like to ask a question, you can press star, then the number one on your telephone keypad. Again, that's star one to ask a question. We'll pause just for a moment to compile the Q&A roster. Our first question is coming from the line of David Scharf from JMP Securities. Your line is open. David? David, are you there?

Hello, can you hear me?

Yes, David, we can now.

Okay, thank you. couple things just just to start out. She's, I mean, obviously, the macro backdrop is largely unchanged from the last few quarters. But operationally, I'm wondering, can you, you know, I may have missed it, but you know, can you provide more insight into perhaps, you know, what percentage of collections is represented by digital now? And I guess at what point should we start to think about it as almost a reportable collection channel, the way you've historically broken out call center and legal?

Hi, David. So a quick question on digital. As we've said over time, it is something that's growing. Consumers prefer that channel as they work with their banks. What we are reporting is because of the way digital works, it's a multi-channel or an omni-channel experience, right? So it works in concert with a call center, and some things may start digitally but end up on a call center or start in a call center, and you kind of go online at the same time. So it's tough to break it out. I mean, so what we provide is a call center and digital channel share, and we do it by line of business. So that's been growing, as you know. As you noted, over the years, especially for MCM with much more of a homogenous mix, it's a majority of our collections are now coming from that channel. This quarter was about 62%. Several years ago, it used to be less than 50%, actually. So that's what we break out. That's what makes sense in terms of how to think about channels.

Got it. And is there anything... that stands out about, you know, perhaps the profile of the consumers that seem to be more willing to engage digitally? I mean, do they tend to be higher balance accounts versus lower balance that you're servicing, ones that may have had higher FICO scores pre-charge off, or is it pretty broad-based?

It's pretty broad-based as consumers have gotten comfortable and As I said, they're very used to dealing with their financial institution or the credit card company digitally. And they just, as we've seen, increased engagement, especially in Q1. And that trend was happening even more last year, but Q1 accelerated. A lot of consumers calling, but also just going online and engaging. So it's pretty broad-based across different balances and issuers and whatnot.

Got it. Hey, Shifting a completely different topic, I guess regulatory looks like the CFPB under kind of the new regime is once again delaying implementation of the collection rules. But are you hearing anything either out of Washington that could potentially be changed in what they're – contemplating? And in addition, is there anything at any state level that we should be aware of?

So on the federal rules, we have not heard anything. All we've heard is that proposed two-month delay, and there's a comment period for that. Our view is that we do not need the delay, and our understanding of most of the industry players and trade association is that we do not need the delay. But if it is, it would delay implementation from November 3rd to, I think, January 29th, 2022, something like that. So we've not heard any other potential changes or anything towards that. On the state front, nothing major new. I mean, just given the number of states, there's always some of the other activity happening in different states here and there, but nothing major on the horizon. that's concerning or a big change for us in terms of regulation.

Okay. And then just last question, curious, in this supply-demand environment where at least kind of near-term delinquencies remain at record lows and charge-off volume obviously light, are sellers less willing to enter into flow agreements? I'm wondering, in terms of you know, the amount of visibility you have through the end of the year, is it decreased not just based on the overall, you know, weakness in the market, but do you find that there are fewer opportunities to get sellers to commit to, you know, certain volumes over certain periods of time and flow arrangements?

So, no. I mean, in U.S., I think the behavior is very consistent with prior years. There's generally flows and sellers are doing that. They also have certain bulk portfolios at times, which they still bring to market. So no change. They always have a range of volume for a typical flow agreement. So typically, as you can imagine at this time, the volumes that are actually coming in are towards low end of those ranges. So we have not seen any changes in their desire or propensity to enter or not enter forward flows. All the sellers in the U.S. who were selling pre-pandemic are still selling into the market.

Got it. Understood. Great. Well, thank you.

Sure.

Again, if you would like to ask a question, you can press bars and the number one on your telephone keypad. Next question is coming from the line of Mark Hughes from Truist.

Your line is open. Yeah, thank you. Good afternoon. Hello, Mark. The 117% performance relative to your expectations, can you break that out, U.S. versus Cabot?

The percent, you mean the performance versus our ERC expectations? Correct. Mark, is that what you're referring to?

Yes.

So U.S. was 121% and Europe was 108%. Okay.

And then the share repurchases, is there a way that, should we assume that since you're at the low end of the market, of your leverage target range that whatever cash you generate kind of above and beyond would likely be used for share repurchases. Is that a reasonable way to think about it?

Generally the priority, as you just mentioned, is a reasonable way to think about it. We are generating excess capital over the last few quarters and on the balance sheet side, You're absolutely right. We are the lower end. So as we allocate capital, I just wouldn't assume that all the capital, as I think you mentioned. But you're absolutely right. As we look to buy portfolios, which is our first priority, we'll do that. Any M&A that may come across, it just has a high bar for us, by the way. And we will be focused on repurchasing shares with the excess capital. Of course, all the while maintaining capital, focus on a strong balance sheet, ensuring we have liquidity and continuation of strong financial performance. So those are conditions that will allow us to continue repurchasing shares.

Okay. And then you had mentioned the dollar and incremental gap earnings. Was that associated with the outperformance in the quarter, which is to say maybe the underlying performance was a dollar less, which would have been consistent with... I think what you discussed last quarter, is that the right way to think about it?

Yeah, Mark, this is John. Yeah, I would look at it that way, but just to kind of recap, I could make sure we're synced up. You know, as Ashish had mentioned, you know, consumers have been contacting us at a much higher rate. You know, the inbound call volume has been high and, and strong digital interactions as well. So we saw that behavior accelerate in Q1, and it's continued into Q2, although it's uncertain how long it will last. The result is, as you pointed out, you know, a $45 million incremental revenue benefit in Q1, and that can be seen obviously in our changes to unexpected current and future recoveries. And as you pointed out, this approximates $30 million, translates to roughly a buck, and so we still feel comfortable with what we said at Q4. a run rate of approximately $2.10. But I want to be clear, this is only a run rate. And obviously our performance has been and will continue to be heavily influenced by macro factors outside of our control. We can obviously control and expect what we will. our operational performance, and our balance sheet strength, as Ashish mentioned. But we can't control everything as much as we'd like to think we can, so a run rate of 210 on a go-forward basis would still be our touchdown.

I'll ask you this question, though. I think it's something I should do the math on, but from an EPS, that 210 standpoint, what is the Is there an indifference point between share repurchases and new portfolio acquisitions? I think you would always prefer to grow the business, and so maybe indifference points is a bad word or a bad way to phrase it. But in terms of that run rate, obviously if you're buying less in terms of portfolios than that, has a negative impact on the run rate. But if you're using extra capital to buy back stock, that's good for EPS, if not net income. So anyway, for us to think about that, you know, the offset there, if you're buying back more stock rather than buying portfolios.

Sorry, I interrupted you. This is Ashish. I'll take a stab at it and John can jump in. So the run rate that John mentioned was something we kind of described in the last quarter's call as kind of when you looked at 2020 and you took out the one-time charges from the financings and CFPB payment. That's what that yielded. We do not make any assumptions about future repurchases in any of these run rate calculations. So it is kind of inherent in the business what we talked about last quarter. I don't know if that helped.

It does. It was a question I don't think you'd be in a position to answer in this sort of forum. You might have touched on this, just saying the monthly collections trends, it sounds like April continued to be good. No reason to think that it peaked early and then tapered as time went along. Was it relatively, you know, this overperformance, was it steady throughout the quarter, or did it have any obvious monthly trajectory?

So we just have April information that we used to provide that commentary, so it continues to be strong. In the U.S., as you know, there's a tax kind of seasonality, and I think tax refunds and tax deadlines are somewhat delayed this year, so what would have been a Earlier peak is likely to be a lower peak. Now, all of that is kind of part of the broader phenomena that's happening to the consumer. In a time like this, U.S. consumers are behaving in a very unusual way as banks are discovering as well. So they're very high savings rate. They're taking care of their debts with companies like us, but also their existing current balances on the credit cards and other loans. So that consumer behavior is kind of outside the normal year-over-year kind of performance we have seen. But the tax portion of it, Mark, is definitely somewhat delayed this year.

Yeah. And then how about the final question on the collections multiples, what you're booking the Q1 purchases at. You gave us some data on that, the 2.4, 2.5. What were the comparable... full year 2020 multiples for those measures? I think you gave us the MCM, was it 2.5? What was that for 2020? And then overall with the 2.4, again, what are the comps on that?

Let me pull that up. So last year, the full year multiple was 2.5 for MCM. For Europe, it was 2.9. And, again, these are after some potential changes that may have happened through the year on ERC. But overall, for 2020, yeah, that was 2.5 and 2.9. And, John, you can add any color.

MCM multiple was 2.5, so for the full year unchanged.

Yep.

And then what was Europe in Q1? So from 2.9 to 2.3.

And Europe has, just to be clear, there's a lot of diversity and kind of variance in the types of portfolios we buy in Europe. In the U.S., it's much more homogenous. So we buy paying, we buy non-paying, we buy some secured, and we buy unsecured. So that mix can often change. heavily influence the multiple, right? And multiple is just one element of the returns, which are very strong for us. And the cost to collect is also for the corresponding portfolio is quite different, as you know, Mark.

Yep. Thank you very much.

You're welcome. Thank you.

Again, if you would like to ask a question, you can press star, then the number one on your telephone keypad. Again, to ask a question, press star, then the number one on your telephone keypad. Next question is from Mike Grondahl from Northland Securities.

Thanks. This is Michael on for Mike. Thanks for taking our questions. Maybe just One, call center and digital, and more specifically digital, how do we think about that sort of competitive environment, customer coming through there, and what that kind of margin profile looks like as that part of the business develops more?

So, Michael, the digital collections that are developed kind of omni-channel combined with call center, as I've mentioned before, and that continues to grow, especially in MCM. We can easily see that trend. It's a homogenous mix. It's growing for Cabot as well. The one thing I would point out is in my prepared remarks, for example, we talked about the incremental collections that came for MCM in Q1 compared to the year ago. We got significantly higher collections We got about $61 million more collections and the expenses were $2 million higher. So when consumers are calling us, we're engaging with them with our call center account managers who are trained and kind of just can we can redirect them to inbound conversations or digital, which is a kind of fixed cost channel. You can see the operating leverage that comes through. So I would point out that one factoid, if you would, that was in my prepared remarks, to show an example of kind of how much collections rose and impact on expenses for that. That's the best information we can provide. We do not provide other channel level kind of cost to collect or marginal costs to collect by channel.

Thanks. That's helpful.

Absolutely.

We don't have any questions at this time. I'll be handing it over to Mr. Masi.

Thank you. That concludes the call for today. Thanks for taking the time to join us, and we look forward to providing a second quarter 2021 results in August.

This concludes today's conference call. Thank you all for participating. You may now disconnect.