Encore Capital Group Inc

Good day and thank you for standing by. Welcome to the Encore Capital Group's second quarter 2022 earnings conference call. At this time, all participants are in the 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 11 on your telephone. You will then hear an automated message advising that your hand is raised. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker for today, Mr. Bruce Thomas, Vice President of Global Investor Relations for Encore. Please go ahead.

Thank you, Operator. Good afternoon and welcome to Encore Capital Group's second 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 second quarter of 2022 and the second 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 investor 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 Mathi, our President and Chief Executive Officer.

Thanks, Bruce, and good afternoon, everyone. Thank you for joining us. Encore delivered another quarter of strong operating performance in Q2. To better understand our results, Let's begin with some important highlights. Our financial results in the second quarter were again impacted by better than expected collections within our MCM business in the US. This performance led to an increase in future period collection expectations and resulted in higher revenues in Q2, similar to the first quarter of this year, but on a much smaller scale. On a global basis, Our portfolio purchases were $173 million, up 21%, compared to the second quarter last year. We continue to purchase at attractive returns relative to our competitors. Looking forward, banks are reporting that the lending continues to grow and delinquencies are rising. In the past, lending growth and rising delinquency levels have been strong leading indicators of increased portfolio supply for our industry. Finally, consistent with our capital allocation priorities and as we continue to deliver strong returns and solid cash flows, we repurchased $25 million of Encore shares in the second quarter. 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 debt. 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 is 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 our 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. As the pandemic emerged in 2020, changes in consumer behavior and government support of the economy led to lower credit card balances and below average charge-offs, which in turn has resulted in lower portfolio sales by banks. However, since early 2021, outstandings have been rising as banks are now reporting growth in lending. In fact, revolving credit in the US has now surpassed pre-pandemic levels, while credit card balances continue to recover in the UK. We believe that continued lending growth 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 stands ready to support them. Turning now to our largest and most valuable market in the U.S. MCM collections in the second quarter were $355 million, down 19% compared to Q2 last year. This decline was primarily due to normalizing consumer behavior and lower portfolio purchasing in recent quarters. With regard to a back book, which contains all of the portfolios we purchased before this year, our collection operation continues to outperform expectations. This sustained overperformance at MCM led us to again raise future collection expectations, similar to the first quarter of this year, but on a much smaller scale. In Q2, This resulted in $60 million of additional estimated remaining collections, or ERC. NCM portfolio purchases in the second quarter were $116 million, an increase of 30% when compared to $90 million in the same quarter last year, and were the result of increased supply in the US market. We also believe the somewhat higher pricing we had seen recently in the US has plateaued. MCM's purchase price multiples continue to reflect a competitive advantage. Turning to a business in Europe, in the second quarter, Cabot collections were $142 million, down 16% compared to Q2 of last year, primarily due to the impact of foreign currency exchange and lower portfolio purchasing in recent quarters. In constant currency, Cabot collections were $158 million, representing a decline of only 6% compared to Q2 of last year. Cabot portfolio purchases in the second quarter were $57 million compared to $53 million in Q2 of last year. Market supply has been inconsistent, and portfolio purchasing remains highly competitive. In keeping with our strategy, we maintained discipline in buying portfolios. The second pillar of our strategy focuses on enhancing our competitive advantages. A competitive platform enables us to generate significant cash flow, although our cash generation has been impacted by lower portfolio purchasing in recent quarters, as well as the normalization of consumer behavior. Nonetheless, we expect this trend to begin to reverse after we resume purchasing higher volumes of portfolios that are more in line with pre-pandemic levels. Our competitive advantages also allow us to deliver differentiated returns. In addition to cash generation, another important measure of our business is the 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. Our ROIC performance continues to be favorably impacted by the revenue effect of our recent increases in ERC, reflecting higher returns on those portfolios for which we raised our collections expectations. The third pillar of our strategy makes the strength of a balance sheet a constant priority. A strong operating performance and focused capital deployment over many consecutive quarters have driven higher levels of cash flow and contributed to a lower level of debt, which in turn have reduced our leverage significantly over time. At the end of the second quarter, our leverage ratio was 2.0 times compared to 1.9 times a year ago. and remains near the lowest in the industry. We remain well positioned with sufficient liquidity and capacity to fund the opportunities that lie ahead. I'd now like to hand over the call to John for a more detailed look at our financial results.

Thank you, Ashish. When comparing the second quarter of this year to the second quarter a year ago, Keep in mind that the elevated level of collections in Q2 of 2021 was extraordinary and resulted in part from the US consumer behavior that is largely normalized since the beginning of 2022. The combination of collections over performance in the second quarter and higher collections expectations for the future increased our revenue and contributed to increases in earnings and returns in the quarter. In accounting for the additional ERC mentioned earlier, the corresponding changes and expected future recoveries contributed $15 million to the revenue line in the second quarter and added 43 cents of GAAP EPS in Q2. Collections were $498 million in Q2, down 19% compared to the extraordinary collections in the second quarter of last year, but were higher than we expected. The decline on a comparative basis was driven primarily by lower portfolio purchasing in recent quarters and normalizing consumer behavior. For portfolios owned at the end of 2021, Encore's global collections performance through the second quarter was 107% of our portfolio ERC forecast for the period as of December 31st, 2021. For MCM and for Cabot, collections through Q2 by this same measure were 116% and 91% respectively. With regard to collections in Europe, the weakening of the pound in relation to the US dollar has created a separation between reported and constant currency results. In this case, Cabot's collections performance through Q2 on a constant currency basis was 96% of our ERC forecast, with the underperformance largely the result of weakness in Spain. Collections in the UK through the second quarter of 2022 on a constant currency basis were generally in line with expectations. Revenues in Q2 were $357 million, down 17%, compared to the second quarter a year ago. Our global funding structure provides many benefits to Encore, including financial flexibility, diversity of capital sources, lower funding costs, and extended maturities. At the end of the second quarter, available capacity under our global RCF was $576 million, and we concluded the quarter with $135 million of non-client cash in the balance sheet, which is sufficient liquidity and capacity to fund the opportunities that lie ahead. We believe our strong balance sheet provides us very competitive funding costs relative to our peer group. Nonetheless, the cost of capital is increasing for all players in the industry due to the current rising interest rate environment, which should have a moderating effect on portfolio pricing. With that, I'd like to turn it back over to Ashish.

The second quarter for Encore was another period of strong operational performance, though comparisons to Q2 last year are difficult, as it was Encore's biggest collections quarter ever. But a lot has changed over the last 12 months. The consumer behavior that in part drove record collections in the U.S. last year, has largely returned to normal. It is important to note that this same consumer behavior also contributed to meaningfully reducing charge-offs in portfolio supply during the same time period. However, we are continuing to see the credit normalization that we have discussed in the previous quarters. As a result, we have started to see an increase in portfolio supply in the U.S. although the supply in Europe remains inconsistent. This, of course, means more consumers will need our support and we are ready to help them resolve their debts and restore the financial health, consistent with our mission and the critical role we play in the consumer credit ecosystem. As we look ahead, we anticipate a few key factors will unfold during the upcoming portion of the cycle. On the one hand, We expect pressure on our earnings for the next few quarters after two years of lower purchasing coupled with the normalization of consumer behavior. On the other hand, we expect to deploy increasing amounts of capital to purchase portfolios, particularly in the U.S., in line with the supply increase being driven by the same normalization of consumer behavior. I really like the position we are in. as we believe that players such as Encore, who are experienced operators and have strong balance sheets, liquidity, and access to capital, are best positioned to benefit from the portion of the cycle we are now entering. Now we'd be happy to answer any questions that you may have. Operator, please open up the lines for questions.

As a reminder to ask a question, you will need to press star 11 on your telephone Please stand by while we compile the Q&A roster. Your first question comes from the line of Mark Huge of Truist Company. Your line is open.

Yeah, thank you. Good afternoon.

Hello, Mark.

Ashish, you mentioned pressure on earnings the next couple of quarters.

desire to throw a few adjectives at that what what what do you think and when you're where should we think when we think about pressure on earnings year-over-year sequentially a market thanks for your question so as we have stated before we do not provide quarterly guidance because we think about a business over the long term and what I did say we did say Just to recap this, we expect our earnings will be under pressure over the next few quarters, but for our deployments to increase. And let me explain this further and elaborate on the prepared remarks that I had. So during the years of pandemic, 2020 and 21, consumers had excess savings in cash and they paid down their card balances and debts at much higher rates. And this had two effects, actually. First was this consumer behavior, particularly in U.S., helped drive our exceptional collections and earnings. And secondly, the same behavior, consumer behavior, also resulted in lower charge-offs, which for us led to well below historical levels of purchasing for an extended period of time, a full two years. However, now as we stand today in middle of 2022, we see consumer behavior normalizing Banks have called it credit normalization on the earnings calls, for example, and this is again going to impact both our collections and portfolio purchasing, but in opposite ways when compared to the prior two years. Consumer payment behavior is normalizing as it relates to collections, but the delinquencies and charge-offs are also rising, and we are observing meaningful improvements in portfolio supply, particularly in the U.S., and we are growing our purchasing as well. In just summary, it may take a few quarters for these trends to play out, fully play out, in terms of impact on collections and earnings. In summary, I would just want to kind of underscore and highlight the key message that I'd like you to take away and the audience to take away is that given our operational capabilities, our strong balance sheet, and the fact that supply is now increasing, we stand in a very good place today.

Very good. Jonathan, if we maybe just think about that, if we take this quarter's $2.29 and I think you mentioned the $0.43 benefit from the change in expected recoveries, if we just back that out, is that kind of a run rate starting point and then we apply other factors to that? Does that make any sense?

Yeah, we put that in there, Mark, so that everybody could understand what the impact was on the quarter. I think, you know, where you take that from here is really up to you. You know, we do want to avoid providing even soft guidance to people, right? We do take a long-term view. I expect it would be reasonable for you to back that number out, but I'll leave that to you.

Very good. And then the collection multiple for the new portfolios that you acquired in the second quarter, I don't know if the queue is out yet, but what number will we see in terms of multiple? I think you presented year-to-date. Can you share those numbers?

Yeah, the queue is out, Mark. What you will see is 2.2. That's for year-to-date purchasing for MCM. For Cabot, you'll see 2.1.

Okay, very good. And then, Jonathan, the tax rate in the quarter, high 20s, that's a good number going forward.

I think as we've said in the past, Mark, I think still peg us at mid to low 20s for the year.

Okay. And then just one more for me to share buybacks. How much capacity do you have or availability on the authorization? And then what should we think about PACE? Is this a good PACE, 25 million?

As we have said before, Mark, the authorization was $310 by our board. And at the end of Q2, $128 million is remaining. Any repurchases are subject to, it's a multi-year plan. As you've said, timing and purchase sizes are subject to kind of a strong balance sheet, liquidity, as well as continuation of strong financial performance. But $128 million remains in our $300 million authorization.

Thank you very much.

You're welcome. Thanks, Mark.

Your next question is from the line of Mike Grondahl from Northland Capital Markets. Your line is open.

Hey, guys. Thanks. And Ashish, could you just go into a little bit more detail? You said in the U.S. you're seeing more supply. Just maybe help us understand that a little bit better. Is that more banks, just you're bidding on more, a greater volume of paper? I just want to understand that better.

Yeah, Mike, that's a great question. So in U.S., as I've said before, all the banks used to sell before the pandemic continue to sell, and they're still selling. And what we are starting to see is For example, in some cases, you can observe pretty clearly in terms of forward flow agreements, kind of how the volumes are trending. And if you look back over the last several months, that trend is clearly upward in a very steady way from those contracts. And in general, we observe and we are reading the same earnings reports for all the banks, and the banks are reporting increased lending. And the charge-off rate is ticking up slowly. So the combination is what drives the dollar volume of charge-offs. And lending is back above pre-pandemic levels. So the combination is showing pretty steady and meaningful increases in charge-off supply and sales by the banks in the U.S.

Got it. And then how are you thinking about overall operating expenses today and the next few quarters? Are you at a level you want to be with operating expenses? Do you wish they were a little lower and tighter? How are you just thinking about that overall?

So the operating expenses, they have a fixed component relative and then the variable component, as you know. Overall, We think of operating expenses as part of our overall strategy to maximize returns on our portfolios, right? So we, of course, we are looking to decrease and control our fixed expenses and kind of minimize collections expenses for each of the channels, for example. And as we kind of migrate accounts to lower cost channels, that should improve. But it also depends on the portfolio mix of purchasing. The average balance, whether it's secured versus unsecured, whether it's paying versus nonpaying, as often happens in UK, for example. So that will drive the expense levels. In terms of any inflation impacts, we've been able to mitigate that by productivity improvements and automation and so forth. So in terms of the cash efficiency margin, that's the metric we have now been using. I would expect that to be somewhat under pressure as well. As I mentioned earlier, the collections will be under pressure, given the lower volume of purchasing that we've had for quite a while, but we're now starting to increase that.

Got it. And then maybe just lastly, you kind of mentioned the inflation impact on consumers was kind of, I don't want to take words, but muted or offset inflation. What more can you say about that so we can kind of understand how that's impacting, if any, the results?

Yeah, no, that's a great question. And inflation is front and center, as you can imagine. So inflation is, I would say, I alluded to it a little bit, but there are two types of impacts. The first is in our business. So to date, we have not seen any impact on collections, consumer behavior or consumer collections due to inflation directly. Now, overall, the consumer behavior is normalized coming down from the strong payment rates that we saw particularly in the U.S. a couple of years ago, a year ago. So on collections, we have not seen any impact. In terms of cost and wage inflation, as everybody is feeling, we have been able to mitigate that in terms of on our expense base. So that's kind of the business impact in terms of consumers. We've not seen the impact on collections, but we stand ready to help our consumers. As you can imagine, many of them are starting to face impact of expense increases. And as we always do, our business is helping consumers in financial difficulty, regardless of the reason. And inflation is just one new reason or a different reason that could cause them difficulty. So we have options for them in terms of payment flexibility, skipper payment, payment amount, the length of payment plan, and even our hardship policies that we have. So we have a whole range of tools to help consumers with for the ones who may be facing the impacts of those inflation on their kind of personal household expenses and financial situation.

Got it. Okay. Thank you.

And your next question is from Robert Dodd from Raymond James. Your line is open.

Hi, guys. On this theme, I mean, in the past, sometimes periods of economic stress on consumers often impact collections ahead of potentially supply coming. It can be a little bit of a timing mismatch. You said, I mean, inflation so far has not really impacted it. I mean, do you expect it to? Do you expect these kind of pressures? I mean, we're seeing it on Walmart earnings, for example. Do you expect that to have any impact on the collections level maybe ahead of the defaults going up, or do you just not think it's going to play out that way this cycle?

Robert, the cycle is a bit different this time. The Great Recessions We have talked about in the past, we did see, let's say in U.S., maybe a little bit of pressure on collections, 5%, 6%, and then we more than made it up pretty quickly over the long term. Now, this time, the economy feels a bit different. A normal recession, unemployment rate would be much higher right now. It's a very low unemployment rate. People can get jobs even if they lose it, given they got into financial difficulty. So it's hard to say. What we are seeing for sure is kind of normalization is happening, which is different than in the past because of the pandemic. People had excess savings. That payment behavior is kind of normalized. And that's also impacting the banks and credit card issuers. So their delinquency is in charge of rising. So we are seeing increases in supply from the bottom that we saw a year ago pretty steadily. Now, it's not back up to pre-pandemic levels. but it is rising in a very steady and meaningful way. So I don't know when the interplay of exactly if there is any impact, negative impact on collections from a recession, should it happen, combined with the increase in our supply. But as we stand and where we stand in the cycle, I really like the position we are in. Last couple of years, we've been able to strengthen our balance sheet, improve our operations, and we stand in a very good place if you notice our multiples and our cost efficiency and so forth as we look ahead to the continued growth and supply now.

Got it. Thank you. I appreciate that. Sort of related to that on the cost efficiency, I mean, legal expenses, I mean, obviously they've been a little lower. I mean, lower supply, obviously, right? They do tend to run ahead of collections when they ramp up but you know legal isn't your first choice of how to approach a consumer so I mean if if supply does continue supply is going to continue to rise when would you start contemplating increasing investments in in the legal channel

It's going to be difficult to predict. I mean, you are right, as supply continues to increase, some of the expenses are front-loaded, although increasingly, we're getting more for collections from non-legal channels, digital, call center. So therefore, it may have some increase. I don't know when. This quarter was also, the legal expenses were somewhat foreign exchange impacted for our European legal expenses. So that's the other effect on pretty much all our expenses you need to keep in mind. But increasingly we are using legal less and less, although it is a part of our collections approach. So it depends on the type of portfolios we will buy and so forth. Hard to say exactly when that would happen and if.

Okay. I appreciate that. Thank you.

Your next question is from the line of Spencer James from William Blair and Company. Your line is open.

Hi, team. This is Spencer James on for Bob Napoli at William Blair. I was wondering if you could expand on the softness you called out in Spain and then maybe Could you also provide an update on why loan growth has continued to be slower to return in Europe versus the U.S.?

So I'm going to let Craig Buick, who's on the line from London, respond on the Spain, but also touch on the supply increase being slower in Europe, and I can then add to it as appropriate. Craig?

Yeah, thanks, Ashish. Hi there, Spencer. Can you hear me okay? Yep, got you. Thank you. Perfect. Thanks for the question. In terms of the Iberian piece, I think the couple of pieces to call out, as Jonathan mentioned in his prepared remarks, one is just bear in mind the impact of the foreign exchange movements, the appreciation of the US dollar has led to a widening in the reported percentages. The underlying percentage across Europe is more like 96. And as Jonathan mentioned, in our UK business, collections are performing broadly in line with those expectations. In the Spanish business, what we see there is a number of our portfolios comprise what we call small and medium-sized enterprises or SME accounts. And the very nature of these accounts means the average ticket's a little bigger and you inherently have more volatility in those portfolios. And that's what we've seen in the first half of this year. So I call that sort of the natural volatility implicit in the portfolio there. If I think about the European loan growth, I guess my views on that one is if you look at most of the historic cycles, you'll see that the European financial services sector tends to probably recover slower than the U.S. sector. I think there are some structural differences around sort of the capital levels, et cetera, and the efficiencies there that tend to drive a slower recovery. You still see the same directional trends taking place. It just takes a little longer for those to move. But I'll pass it back to Ashish for any further thoughts on that one.

I think you've covered it, Craig. Spencer, if you have any follow-up on that, happy to address.

Could you maybe just comment on the disconnect between the normalization of credit quality in Europe? Is that lagging behind the normalization in the U.S., or is there a bit of a disconnect between the credit quality and the supply of paper in Europe? Is there anything distinct to call out there between the two markets?

Yes, I think in line with what Craig said, I mean, there are differences across kind of the European markets and US. So I'm not sure I would put it as credit quality, but the consumer behavior, while everyone faced similar impact in terms of being at home, saving money, not spending as much, the US support from government, was a bit different in terms of direct support to consumers. So either it was that or whatever reason, U.S. consumers paid their debts at kind of larger rates than some of the other countries, which led to charge-offs and delinquencies declining pretty rapidly as well and driving strong collections for us. And just a different consumer behavior in terms of U.K., for example, the programs that the government put in place were strong collections for us. And just a different consumer behavior in terms of UK, for example, the programs that the government put in place were different. They were more supporting job and salary payments as opposed to direct support. So there might be some structural differences, inherent differences due to that. But US consumers definitely behave differently and now pending more actively as well. And therefore, we're seeing the lending rise more rapidly in the U.S. that Craig alluded to compared to, let's say, U.K.

Thank you for the thoughts. I appreciate it.

Once again, you may press star 1-1 to ask a question. Your next question is from the line of Mark Huge from Trust Company. Your line is open.

Yeah, I don't know if this was in the presentation. I didn't see it. The cash efficiency margin this quarter versus the year ago quarter, what were those numbers?

Yes, I don't know if it's in the presentation. It's in the queue. So 57%, it's a trailing 12-month number. 57% for this quarter, and last year it was 57.8%, so very close.

It's also on page 29 of the slides, Mark.

Okay, yeah, very good. Thank you.

No further questions at this time. I would now like to turn the conference back to Mr. Ashish Massey for closing remarks.

Thank you. As we close the call today, I'd like to reiterate a couple of key points. A strategy of focusing on the right markets, executing effectively to deliver strong returns on our portfolios, and maintaining a strong balance sheet are key drivers of our best-in-class performance. Looking ahead, as credit continues to normalize, leading to higher portfolio supply, we expect to continue increasing our portfolio purchasing. We're also as committed as ever to the critical role we play in the credit ecosystem and to help consumers regain the financial freedom. It's what we do best. Thanks for taking the time to join us, and we look forward to providing a third quarter results in November.

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