Encore Capital Group Inc

Good day. Thank you for standing by and welcome to the Encore Capital Group's Q1 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference call is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Bruce Thomas, Vice President of Investor Relations. Thank you. Please go ahead.

Thank you, Operator. Good afternoon and welcome to Encore Capital Group's first quarter 2022 earnings call. Joining me on the call today are Ashish Massey, 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 will be happy to take your questions. Unless otherwise noted, comparisons made on this conference call will be between the first quarter of 2022 and the first quarter of 2021. 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 8 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.

Ashish Massey Thanks, Bruce, and good afternoon, everyone. Thank you for joining us. In the first quarter, we continued to execute our strategy and deliver on our financial objectives. To better understand our results, let's begin with some important highlights. Our business continued to perform extremely well in the first quarter, delivering best in class returns and solid cash flows. Our exceptional financial performance in Q1 was primarily driven by better than expected collections within our MCM business. This strong performance led to an increase in future period collection expectations and higher revenues in the current period. On a global basis, our portfolio purchases were $170 million in line with the purchase total from Q1 a year ago. The market continues to be impacted by lower supply as a result of fewer charge-offs. In spite of these conditions, we have remained disciplined in our purchasing approach. Importantly, we continue to purchase at attractive returns due to ongoing improvements in our collections operations as well as our focus on cost efficiency over the past several years. These initiatives have allowed us to mitigate the impact of higher market pricing. Looking forward, banks are reporting that the lending continues to grow. In the past, lending growth has been a strong leading indicator for increased supply of portfolios for our industry. Last year, we articulated our financial priorities and balance sheet objectives, which included our capital allocation strategy. Consistent with this strategy, as we continue to deliver strong returns and solid cash flows, we repurchased $26 million of OnCore shares in the first quarter. In total, over the past five quarters, including open market purchases and a tender offer in November, we have repurchased 24% of OnCore's outstanding shares for $415 million. As context, I believe it's helpful to understand the critical role we play in the consumer credit ecosystem by assisting in the resolution of unpaid debts, which are an expected outcome of the lending business model. Our mission is to help consumers resolve their debts so they can regain the freedom to focus on what's important to them. And we do that by engaging consumers in honest, empathetic, and respectful conversations. We look to purchase portfolios of non-performing loans at attractive returns. while minimizing funding costs. For each portfolio that we own, we strive to exceed our collection expectations while both maintaining an efficient cost structure as well as ensuring the highest level of compliance and consumer focus. We achieve these objectives through a three-pillar strategy. This strategy enables us to consistently deliver outstanding financial performance, positions us well to capitalize on future opportunities, and we believe is instrumental in building long-term shareholder value. The first pillar of our strategy, market focus, concentrates our efforts on the markets where we can achieve the highest risk-adjusted returns. Since the emergence of the pandemic, changes in consumer behavior and government support of the economy have led to lower credit card balances and below average charge-offs. which in turn has resulted in lower portfolio sales by banks. However, it is now clear that credit card balances are rising again in the U.S. and the U.K., and we expect their continued normalization toward pre-COVID levels and beyond. We strongly believe that the increased lending will translate into more charge-offs and lead to higher levels of portfolio sales by banks in due course. This also means that more consumers will be looking to resolve their debts in order to regain their economic freedom. And our team is ready to support them to do just that. Turning now to a larger and more valuable market in the U.S. The ongoing effects of the pandemic caused a greater number of consumers to reassess their financial circumstances. Many consumers chose to improve their financial standing by either reducing or eliminating the credit card debt, as well as resolving the charged-off debts. We continue to be well-positioned to support consumers, providing hardship relief when appropriate, and also providing solutions for a large number of consumers who are able to pay off their debts. Importantly, even as the drivers of this changed consumer behavior move further into the past, our collections performance in the U.S. continues to outperform expectations. MCM's collections in Q1 2022 for all portfolios owned at the end of 2021 were 115% of ERC. You may recall that MCM's full year 2021 collections were 124% of ERC. This sustained overperformance at MCM led us to raise future collection expectations resulting in $225 million of additional ERC. MCM portfolio purchases in the first quarter were $94 million at an average purchase price multiple of 2.3 times. In a market, the supply remains limited by the impacts of the pandemic. Even though we encountered somewhat higher pricing toward the end of 2021, pricing has stabilized, and we continue to deploy capital and best returns in the industry. Our industry-leading returns are the culmination of years of consistently applying a business strategy. Our disciplined purchasing and superior collections effectiveness enable us to consistently purchase portfolios at strong purchase price multiples. Then over time, our continuous collection improvement efforts have enabled us to collect substantially more than initial expectations, which raises our multiple for each vintage even higher and helps drive our differentiated returns. This relationship is reflected in the higher purchase price multiples for certain NCM vintages due to the increase in collections expectation that I mentioned earlier. Turning to a business in Europe, in the first quarter, Cabot collections were $148 million, down 9% compared to Q1 of last year, primarily due to lower portfolio purchasing in recent quarters. Cabot portfolio purchases in the first quarter was $75 million at an average purchase price multiple of 2.2 times in a market where supply has been inconsistent and buying portfolios has been highly competitive. In keeping with our strategy, we maintained our return-focused discipline in purchasing portfolios. The second pillar of our strategy focuses on enhancing our competitive advantages. Our competitive platform enables us to generate significant cash flow. Our cash generation has been impacted by low portfolio purchasing in recent quarters. However, we expect this trend to begin to reverse when market supply starts to increase. Our competitive advantages also allow us to deliver differentiated returns. In addition to cash generation, another important measure of our business is return on invested capital. which considers both the performance of our collections operation as well as our ability to price risk appropriately when investing our capital. Accordingly, one of our fundamental financial priorities is that our underlying business delivers strong long-term returns and that we maintain these strong returns through the credit cycle. Our ROIC performance in the first quarter was favorably impacted by our increase in ERC reflecting the higher returns on those portfolios for which we raised our collections expectations. Our performance over time is a solid indicator of how we execute in comparison to our peers. In simple terms, we deliver the highest return per invested dollar in the industry. The third pillar of our strategy makes the strength of our balance sheet a constant priority. A strong operating performance and focused capital deployment have driven higher levels of cash flow and contributed to a lower level of debt, which in turn have reduced our leverage substantially over time. At the end of the first quarter, our leverage ratio was 1.9 times compared to 2.1 times a year ago, and near the lowest in the industry even after the repurchase of $415 million of our shares over the past five quarters. I'd now like to hand the call over to John for a more detailed look at our financial results.

Thank you, Ashish. In comparing the first quarter this year to the first quarter a year ago, keep in mind that the elevated level of collections in Q1 of 2021 was extraordinary. The combination of collections over performance in the first quarter and increased collections expectations for the future increased our revenue and contributed to significant increases in earnings and returns in the quarter. Collections were $519 million in Q1, which was considerably higher than we expected. For all portfolios owned at the end of 2021, Encore's global collections performance in Q1 was 108 percent of our year seed forecast. For MCN and for Cabot, Q1 collections by the same measure were 115 percent and 94 percent, respectively. As previously mentioned, persistence stronger than expected U.S. collections in Q1, as well as in recent quarters, led to the addition of $225 million of ERC. These higher expectations are near term from a timing perspective, with 75% of the incremental collections expected by the end of 2023. This is very positive news. We expect to collect $225 million more from portfolios that we already own. Revenues in Q1 were $500 million, up 20 percent compared to the first quarter a year ago. The previously mentioned $225 million ERC increase in the U.S. will also lead to a revenue increase of $225 million, assuming we achieve collections expectations. CTO accounting requires us to recognize the revenues associated with this increase in two parts. The first part is the present value of the ERC increase. which is $123 million in revenue, and is both included in our Q1 2022 results and added to the basis of the beneficially impacted vintages. This increased basis would then lead to the second part of the revenue increase, the remaining $102 million, which we expect to be recognized over time. Today, we are introducing a new metric, cash efficiency margin, to enhance visibility into our operating expense management. Cash efficiency margin replaces cost to collect as a more comprehensive measure that includes all on-core operating expenses. It uses cash receipts, which is the sum of collections and servicing revenues. Cash efficiency margin is simply the ratio of cash receipts minus operating expenses divided by cash receipts. We believe our cash efficiency margin is a simpler and more useful measure of efficiency. In addition, the components of the calculations are readily available in our disclosures with no adjustments required. We will be presenting this measure each quarter on a last 12-month basis to match our long-term view of the business. However, it's important to note that cash efficiency margin should not be viewed in isolation. We are a returns-focused business. At times, we will spend more and generate a lower cost efficiency margin in order to achieve higher returns. In addition, this metric will be impacted by portfolio and account characteristics, such as high versus low balance, paying versus nonpaying, fresh versus seasoned accounts, secured versus unsecured, and so forth. And so a combination of these factors may lead to volatility in cost efficiency margin across reporting. Our global funding structure provides many benefits to Encore, including lower funding costs and extended maturities. In the first quarter, we further strengthened our diversified funding structure by amending and extending our global senior facility to expand its capacity by $90 million to $1.1 billion and extend its maturity from 2025 to 2026. In addition, we retired $150 million principal amount of convertible notes that matured in March with cash. reducing the proportion of our debt funded by convertible bonds. As Ashish mentioned earlier, consistent with our capital allocation strategy, we also repurchased $26 million of Encore shares in the period. At the end of the first quarter, available capacity under our global RCF was $560 million, and we concluded the quarter with $134 million of non-client cash in the balance sheet, which is sufficient liquidity and capacity to fund the opportunities that lie ahead. With that, I'd like to turn it back over to Ashish.

OnCore is committed to high standards and transparency around our environmental, social, and governance priorities, which are underpinned by our five ESG pillars, consumer, people, environment, community, and operating responsibly. We are proud of the progress we've made to date, and we are looking forward to advancing our ESG program in 2022. This year, we plan to focus on three main areas. First, performing our inaugural global greenhouse gas baseline assessment. Second, gathering and assessing data across our global business in order to set future targets against well-established frameworks. And third, publishing our first ESG annual report. The first quarter for Encore has proven to be an excellent start to the year in the consistent execution of our strategy and in continuing to deliver on our financial priorities. With a strong balance sheet and the best returns in the industry, we are well positioned for the future to continue delivering strong results and building shareholder value. Looking ahead, the largest impacts of COVID-19 from the last two years appear to be subsiding. and the lives of consumers are increasingly returning to normal. Banks are reporting that revolving credit and credit card balances are rising, underpinning a belief that portfolio supply for our industry will start increasing. But this also means that more consumers will be looking for help in resolving their debts to regain their economic freedom. Our mission is specifically focused on this need, and our colleagues are ready to continue to support them just as they already do each and every day all around the world. Now, we'd be happy to answer any questions that you may have. Operator, please open up the line for questions.

As a reminder, to ask a question, you will need to press star 1 on your telephone keypad. Again, that's star, then the number 1 on your telephone. All right. Your first question comes in the line of Mark Hughes from Truist. Your line is now open.

Thank you very much. Good afternoon. Hello, Mark. Could you disclose what's available on the share repurchase authorization and kind of what's the strategy on that going forward? Will that be a early use of capital for you, depending on the purchase environment, of course?

Yeah, we have up to 300 million authorizations. There is 153 million remaining out of that. And in terms of our plans going forward, we continue to allocate capital according to our priorities, Mark. I just want to reiterate kind of what we've done to date. Since January 2021, over the last five quarters, we have returned $400 million through share repurchases, and that's equivalent to 24% of shares outstanding. So going forward, our capital allocation priorities will dictate what we do, and any future repurchases are subject to our strategy, which is kind of three main parts to it, maintaining a strong balance sheet, liquidity, and continuation of strong financial performance.

Jonathan, the interest expense in the quarter, is this a reasonable run rate, assuming borrowing remains relatively steady?

We have, as you've noticed quarter on quarter, we've continued to go down. I expect that we are we had some Little bit of noise in this one, this quarter, but I'd say it's roughly akin to what would be a good run rate. Now, bear in mind, I'll state the obvious, right? Although we're heavily skewed to fixed and hedged, we do have a floating rate component in our stack, so there will be some impact on rising rates, right?

Yeah, okay. The cash efficiency margin Could you – I wonder if you might just talk about the cost structure. Should we assume the cost structure in absolute terms is relatively steady here? Obviously, some of that's going to be influenced by your collections volume. But are there likely to be any cost cutting measures? I'm just a little – outlook on that efficiency would be helpful.

Mark, this is Ashish. On expenses, if you look at the long-term trend, we've continued to improve our efficiency. This metric, which I think is a much better metric and more useful from an outside-in perspective to get a sense of kind of because it incorporates all our expenses. So we look at expenses two ways, right? On Kind of non-collections expenses, we continue to kind of drive them down and try to maintain efficiency and improve them and get scale effected as well. On collections or operating kind of expenses, we think we continue to focus on those as well, whether it's automation, technology, increased use of digital collections in our main markets in US and UK. All of that has helped what we used to have the cost to collect metric trend down. Now, you have to keep in mind, and I kind of remind every time, our team here and everyone I speak to about this cost metric, we do not consider cash efficiency margin or cost in isolation. It's very important to put it in perspective at times. Spending more, which means lower efficiency margin, can generate better returns. We are very returns focused. It's just one element of that. And the other thing is, It's also influenced, as we said in our prepared remarks, by portfolio mix, what kind of paper we're buying, paying versus non-paying, secured versus unsecured, or the kind of evolving mix of channels that use as well. So it's more of an output, but coming out of focus on costs on both overhead and operations expenses.

And then when we think about you've been running pretty – in a pretty narrow range, 58, 59 and a half percent. Any reason that would change?

We're not providing an outlook on that, Mark. Again, it can depend on many factors. We are managing, continuing to manage our costs pretty well, given what's happening in the market in terms of inflation and whatnot. We continue to improve productivity. Our head count is down, even though our collections are up. So we're managing all of that pretty efficiently. But we're not guiding on a metric or a range on that one.

Understood. And a final question, if I might. The cab at the level of competition that you're seeing there, your collections multiple was down fractionally. That doesn't look like a meaningful change. But I wonder if you could comment about the level of competition.

Yes. Craig, you want to take that? Yeah, certainly. Hi, Mark. Thanks for the question. The way I'd characterize the competitive environment covered across the European landscape, it's stable, it's competitive, it has been competitive for a while, it's stable. The money multiple we printed here at 2.2 is, I think, pretty much aligned to what we printed last year. So I'd say things are stable at this point from that competitive dynamic perspective.

Thank you very much.

Your next question comes to the line of Mike Grondahl from Northland Securities. Your line is now open.

Yeah, thanks, guys, and congratulations. My first question, Ashish, is your outlook today for purchases, how does that compare to kind of 90 days ago or 180 days ago, roughly?

Good question, Mike, on purchases. I mean, I think where the environment is, as we follow banks' recent earnings reports and what they tell us, consumers are spending more. Lending is growing in both U.S. and U.K. pretty materially and for a while now. So one of the drivers of future charge-offs continues to rise. Now, delinquencies, which are a leading indicator in many of the U.S. credit card banks, are actually have been ticking upward slowly as well, and some are a little bit flat. Eventually, as that plays out, we believe, just physics after that, volumes will rise, which is volumes will start increasing as well. All the banks who used to sell before the pandemic are continuing to sell through forward flows. It's just the volumes are low on the range that are in the contracts, and that will eventually start rising as the mass of higher lending and higher delinquency rates eventually start flowing through.

So do you feel better than 90 days ago or kind of the same?

I think the market is what we observed 90 days ago, bank lending was rising at that time for a few quarters. That is still continuing. There has been no change. And The recent reports from all the banks are very consistent and delinquency trends are pretty similar. So we feel pretty similar on what we said and what we felt rather 90 days ago.

Got it. And then secondly, you know, you talked about really strong collections and, you know, they've been robust for a while. And I think we understood the really robust collections last year with the stimulus and whatnot. So, you know, this first quarter, you know, a pleasant surprise. What one or two things in the U.S. would you maybe attribute that to? Any sense?

Yeah, I mean, that's been an interesting phenomenon. Consumers continue to perform kind of pretty well. I would attribute it to two things, right? Consumer strength is continuing, although probably not at the level as last year, but also our operations and our strategies, how we work with them to set up a payment that works, how we deal with them, how easy we make it for them to interact with us, whether through call center or digital means. So I think that's a big part of it as well. That said, consumer strength continues. Even though they're borrowing more, they're spending a lot more. purchasing volumes are up, and as I look at some bank reports, just anecdotal reading through some of them very quickly, payment rates continue to be pretty strong as well. So that phenomenon continues. But I would also credit our operations that have been very responsive to the consumer needs and working with them to drive collections.

Got it. And maybe lastly, and related to the previous question, are you seeing higher gas prices, inflation, is that affecting your consumer and collections at all? Or would you say you really haven't seen it yet?

Across the main markets, U.S., U.K., we have not seen any impact of that yet on collections.

Great. Thank you.

You're welcome.

Again, everyone, if you have questions, please press star 1 on your telephone. Your next question comes in the line of Bob Napoli from William Blair. Your line is now open.

Hi, this is Spencer James on for Bob Napoli.

Hi, Spencer.

Hi, I just wanted to ask about the change in recoveries. It was larger than any quarter before. in 2021, and I'm just wondering what incrementally would lead to such a change of greater magnitude. What changed in the macro environment to cause it to sort of be lumpier by quarter?

Yeah, Spencer, great question. So to answer that, let me just provide a broader context and kind of what's happening here on this important issue. So as I said earlier, kind of our collective First thing, U.S. collections continue to be very strong. And I just mentioned the reasons, consumer strength, but also our operations. So U.S. collections continue to be very strong. And the example of that is, for example, in this recent quarter, they were 115% of prior years of quarters ending ERC. And if you look back another quarter, we had disclosed at that time, 2021 for full-year collections were 124% of prior years ending ERC. That's a very strong trend. And so therefore, driven in part by this kind of persistent overperformance, we felt confident to increase expectations for the U.S. back book to the tune of $225 million. This is the back book at the end of 2021. And also, it As we said in our presentation, and you can go back and look, one key thing of this is this is a relatively near-term increase. Seventy-five percent of this increase will come, per our forecast, in the next seven quarters by the end of 2023. And so that's the increase in collections on a book that we already own and have paid for. The revenue impact of this is driven by CECL, and it comes in two parts, right? So the first part is the present value of all these changes, which is $123 million, as we said in our presentation. And that has been accounted for in Q1 results that we just released. The remainder, $102 million, will come over time, and that comes from the basis of the portfolios will also rise because of the $122 million revenue increase. So that basis will lead to the rest of the revenue increase over the coming quarters, and that will be $102 million. So $225 million expectation, of collections increase will lead to also $225 million increase in revenues over time, including Q1 that we just disclosed. So just bottom line, I just want to make sure I say it clear enough, this is very positive news. And bottom line, we're expecting to collect $225 million more from the book that we already own and have paid for And by the way, it will also result in higher multiples, purchase price multiples that we talked about in our presentation.

Okay. Definitely good to see. Thank you for elaborating. And then what would you call out by geography between the US and Europe? I think you mentioned 115% of your expectation at the time in the US, but less than 100% in Europe. worth calling out by geography?

Yeah, in terms of European collections, I mean, that's multiple countries, heavily, of course, in the UK. And that was 94%. For 2021 full year, I believe it was 100%. I'm going by memory. So it's been fairly consistent, a little bit lower in Q1. As I said, we haven't seen effects of inflation or energy prices yet, but that is something that's Possibly the consumers are feeling more in Europe, given the situation with energy prices and whatnot. So, again, U.S. consumer continues to be very strong and continues to perform very well, and our operations have been very responsive to them.

Thank you.

Your next question comes to the line of Robert Dodd from Raymond James. Your line is now open.

Hi, guys. On the 225 in terms of upward revision, 75% of that kind of coming over the next seven quarters. Is the reason it's over the next seven quarters because you expect a certain account to perhaps be fully collected over that period, or is it an element of you feel comfortable with the visibility over the next seven quarters, but you're not yet comfortable maybe raising the curve over a full 15-year lifespan or anything like that? Are you being conservative further out, or do you not think that collections longer term are going to be elevated as well.

Yeah, so let me just take it at a high level, then I'll let Ryan respond to this as well. So it comes from multiple vintages of different types of accounts, some on payment plans and some that we expect to pay fully over time. So it's a mix of things. I don't think you can pin it that specifically. But given the previous forecast and the revision, based on the performance we've seen, we have a high degree of confidence that this will come in the near term. Ryan, you want to add some color to this?

Yeah, I mean, primarily it's just the shapes of our curves that are near-term weighted. So as we raise them, you know, the front end of the curve is going to have a higher collection expectation than the back end. So that's just kind of the math of how the curve shapes work. And then obviously we're just more confident in the near term. So, you know, when you're predicting out the future, the more near-term we have a much higher level of confidence in terms of the ability to collect on those accounts.

Got it. Understood. Thank you. This other question is not related to the first one. It might sound like it is in a way. In NCM, in the U.S., in Q1, I mean, collections are up sequentially. That's normal seasonality. Tax rebates, though, or tax refunds were up significantly more um this year than in in a typical year um but you didn't see excess seasonality versus q4 and then also you mentioned obviously the the 115 kind of over performance in terms of collection versus the 124 last year is it is is there an indicator that the oh the consumer is overpaying by less than they were last year which On the one hand, it might mean a slowdown in collections. On the other hand, a strained consumer is a good thing for your supply. So can you give us any color on that?

So on the tax, Ryan, do you have any color? Yeah, for Q1, we saw nothing different or abnormal in terms of tax refunds and ability or inability to pay is kind of at expectation. So we didn't see that in Q1. Yeah.

And the other one is Q1 at 115% compared to forecast or expectations and the prior year being at 124. As you can imagine, one part is how the consumer is behaving, what the top line collections are. The other part is the forecast. So as we try to do our best forecast every quarter for the year, it is a collection of four quarters of comparison. So I wouldn't try to draw too much conclusion on that, although I think your broader notion that a consumer's ability to repay is decreasing, one would imagine with inflation and other things that's starting to happen, but we haven't seen anything in the collections yet. Perhaps that's driving them to borrow more from cards, which we're seeing, which will be a positive thing for supply, a positive driver for supply, as you said. But nothing that we can discern at this point in terms of consumer behavior.

Okay, I appreciate that. Thank you.

Again, everyone, if you have questions, please press star 1. I am showing no further questions at this time. I would now like to turn the conference back to Masi.

So thank you for that. As we close the call today, I'd like to reiterate a couple of key points. Our strategy in focusing on the right markets, executing effectively to deliver strong returns in our portfolios, and maintaining a strong balance sheet are key drivers of our best-in-class performance. I believe you can see the evidence of this success in our continued strong results. Looking ahead, as credit continues to normalize and supply starts rising again, We stand ready to increase our portfolio purchases to drive OnCore's continued success. Thanks for taking the time to join us, and we look forward to providing our second quarter results in August.

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