Encore Capital Group Inc

Good day and thank you for standing by. Welcome to Encore Capital Group's Q2 2023 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 this session, you'll need to press star 1-1 on your telephone. You'll then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Bruce Thomas, Vice President of Global Investor Relations. Please go ahead.

Thank you, Operator. Good afternoon and welcome to Encore Capital Group's second quarter 2023 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, and Ryan Bell, President of Midland Credit Management. Ashish and John will make prepared remarks today, and then we'll be happy to take your questions. Unless otherwise noted, comparisons on this conference call will be made between the second quarter of 2023 and the second quarter of 2022. In addition, today's discussion will include forward-looking statements subject to risks and uncertainties. Actual future 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 Musti, our President and Chief Executive Officer.

Thanks, Bruce, and good afternoon, everyone. Thank you for joining us. I'll begin today's call with a few Q2 highlights. Encore's second quarter performance reflected normalized consumer behavior and a stable collections environment in each of our key markets. In the U.S., with lending and charge-off rates continuing to steadily increase, the growth in portfolio supply and improvements in portfolio pricing also continue. Consequently, MCM portfolio purchases in the U.S. in the second quarter matched our Q1 total of $213 million. Our cash generation grew sequentially again in the second quarter, the result of increases in collections from purchasing portfolios at attractive returns over the past several quarters, especially in the U.S. Earnings comparisons to the second quarter of 2022 are challenging due to the positive impact of collections over performance and ERC forecast increases in that quarter. As a result of the continued disciplined execution of our strategy, Encore remains well positioned with the operational capability and balance sheet to capitalize on the growing portfolio purchasing opportunities currently available in the U.S. market. I believe it's helpful to reiterate the critical role we play in the consumer credit ecosystem by assisting in the resolution of unpaid debts. which are an expected and necessary outcome of the lending business model. Our mission is to help create pathways to economic freedom for the consumers we serve by helping them resolve their past due debts. We do that by engaging consumers in honest, empathetic, and respectful conversations. Our business is 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 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 and positions us well to capitalize on future opportunities. We believe this is instrumental for 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. Let's now take a look at our two largest markets, beginning with the US. Changes to consumer behavior during the pandemic led to unusually low credit card balances and below-average charge-offs, which in turn resulted in a reduced level of portfolio sales by banks. However, since early 2021, outstandings have been rising. Revolving credit in the U.S. surpassed pre-pandemic levels in early 2022. And each month thereafter, the U.S. Federal Reserve has reported a new record level of outstandings. We're now back to the steady growth in lending we've historically seen in the U.S. market. This growth is also evident in the second quarter financial results of U.S. banks. which continue to report increases in credit card outstandings. In addition to the upward trend in credit card outstandings, credit card delinquency rates in the U.S. have continued to rise in recent quarters and are now at or near pre-pandemic levels. This sustained increase in delinquency rates is now leading to higher charge-offs and increased supply of portfolios in the U.S. for debt buyers such as Encore. With this favorable environment as a backdrop, MCM's portfolio purchasing in Q2 of $213 million matched our record level of capital deployment in the U.S. set last quarter. Over the past four quarters, MCM has deployed $772 million at strong returns. To put that figure into proper context, MCM's largest portfolio purchases for a full calendar year was $682 million in 2019. MCM collections in Q2 were $336 million, which met our expectations entering the quarter. As market supply growth continues in the U.S., MCM continues to expand internal collections capacity, which we believe generates industry-leading liquidation of purchased portfolios. As market supply remains elevated in the U.S. and the pricing environment continues to improve, MCMs ERC is steadily growing. Importantly, as pricing continues to improve, we expect to collect more for every dollar of capital deployed. The portfolio supply pipeline for the remainder of 2023 is expected to remain favorable. and MCM will continue to focus on maximizing returns in this environment. Turning to a business in Europe, Cabot's collections were $139 million in Q2, a decline of 2% and in line with our expectations. Overall, we are still not seeing any changes in consumer behavior due to macroeconomic headwinds. With UK credit card outstandings still 10% below pre-pandemic level, the markets in the UK and continental Europe remain very competitive. Cabot portfolio purchases in Q2 were $61 million. Importantly, we have started to see a slight improvement in market portfolio pricing. However, we still do not yet see the full impact of higher funding costs from higher interest rates reflected in portfolio pricing. As a result, we remain disciplined in our approach to portfolio purchasing. As we have said in the past, ultimately, pricing will need to align with higher funding costs before we allocate additional capital toward growing our deployments in Europe. We believe that our ability to generate significant cash provides us an important competitive advantage, which is a key component of the second pillar of our strategy. In the US, from 2020 through the first half of 2022, Lower consumer spending, credit card balances, and charge-off rates drove reduced market supply in our industry and led to higher collections for our business. While consumer behavior began to normalize and incremental cash generation from these higher collections began to subside, our cash generation came under pressure as a prolonged period of lower portfolio purchases then led to reduced overall collections. More recently, However, higher portfolio purchases and improving pricing over the past few quarters have now reversed this trend, enabling a cash generation to grow sequentially again in Q2 as expected. Executing on the three-pillar strategy ensures that the strength of a balance sheet remains a constant priority. When compared to the pre-pandemic years, Encore has become a much stronger company. We now have a unified global funding structure that provides us with financial flexibility, diversified sources of financing, and extended maturities. Over the past several years, a strong operating performance and focused capital deployment drove higher levels of cash generation and contributed to a lower level of debt, which reduced our leverage significantly. More recently, our leverage has risen, driven by both lower collections and increased portfolio purchasing over the past few quarters. But now, as the collections environment has stabilized, we expect to see our leverage continue to level off. Through a strong balance sheet, we remain well positioned to fund the portfolio purchasing opportunities that lie ahead. I'd now like to hand the call over to John for a more detailed look at our financial results.

Thank you, Ashish. When comparing Q2 results to those from a year ago, keep in mind that the elevated level of collections last year was atypical and resulted in part from U.S. consumer behavior that has since normalized. In addition, in the second quarter of last year, our revenues and earnings benefited from $25 million of changes and recoveries. I'd also like to highlight a few other items. Interest expense in Q2 was $50 million, which has steadily grown over the past several quarters, primarily due to rising interest rates in 2022, followed by higher borrowings related to our increased purchasing in 2023. We expect interest expense to be roughly $50 million per quarter for the rest of 2023. Collections in Q2 were very near our expectations and resulted in half a million dollars of recoveries below forecast. thus reducing Q2 EPS by one cent. Changes in expected future recoveries, totaling $3 million, was mainly the result of changes in the timing of existing ERC, which reduced Q2 EPS by 10 cents. It bears repeating that CECL accounting can cause significant fluctuations in quarterly reported results, but they do converge with cash results over the long term. This is yet another reason that we believe it's important to take the long view of our financial metrics. This is consistent with the way we run the business and make decisions, employing a long-term perspective to building shareholder value. Portfolio purchasing in Q2 grew by over $100 million compared to the second quarter last year, as we have transitioned to a new phase of the credit cycle in the U.S. This growth in purchasing is also reflected in our estimated remaining collections, or ERC, which grew 6% to $8 billion and is expected to continue to grow. Collections were $477 million in Q2, down 4% compared to the second quarter a year ago. Breaking that result down into our two major businesses, MCM's collections in the US declined 5% compared to Q2 last year, primarily due to lower portfolio purchasing in prior years and the normalization of consumer behavior. Cabot's collections in the second quarter declined 2%. For both MCM and Cabot, collections in Q2 were generally in line with expectations. For portfolios owned at the end of 2022, Encore's global collections performance year-to-date through the second quarter was 97% of our year-end portfolio ERC. For MCM and for Cabot, collections through Q2 by this same measure were 97% and 98%, respectively. With higher interest rates and continued challenging conditions in the bond market, the importance of our global funding structure cannot be overstated. Our funding structure provides us financial flexibility and diversified funding sources to compete effectively in this growing supply environment. We believe our balance sheet also provides us very competitive funding costs when compared to our peers and competitors. In May, we amended our global senior facility, increasing its size by $40 million, and extending its maturity out to September 2027 with no change to interest terms. In this environment, we believe higher financing costs are having a moderating effect on portfolio pricing in the U.S. as debt buyers adapt their bidding behaviors to their higher cost of capital. Having said that, we believe current pricing in Europe still does not fully reflect this moderating effect, but we expect it will over time. With that, I'd like to turn it back over to Ashish.

Before I close, I'd like to remind everyone of our commitment to a consistent set of financial priorities that we established long ago. The importance of a strong, diversified balance sheet in our industry cannot be overstated, especially as highly anticipated growth in market supply has arrived in the U.S. We will continue to be good stewards of your capital by always taking the long view and prioritizing portfolio purchases at attractive returns in order to build long-term shareholder value. In closing, we believe we are well positioned to capitalize on the significant opportunities that lie ahead. We remain confident in our view of the business and our markets. Operationally, we believe our ability to liquidate portfolios is unrivaled leading to solid cash generation. This is especially important when the cost of capital for every participant in the market is at a premium. In addition, our consistent, disciplined purchasing approach continues to build upon the foundation of strong back returns. Looking ahead, the favorable supply pipeline and pricing improvements in the U.S. are expected to continue. In Europe, We believe our disciplined approach to portfolio purchasing best positions us for success when caverns markets become more constructive. With higher portfolio purchases and strengthening returns in the U.S., we expect a steady growth in ERC and earnings to continue. Now, we'd be happy to answer any questions that you may have. Operator, please open up the lines for questions.

Yes, thank you. We'll now conduct a question and answer session, and as a reminder, To ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Mark Hughes of Truist Securities. Please proceed.

Yeah, thank you. Good afternoon.

Mark?

Hello, Mark. Jonathan, those percentages you gave us, the collections relative to forecast, the 97, 98, was that for six months or was that for the quarter itself?

That's for year to date, so six months. It's from the beginning of the year ERC.

Right. So since MCM, I think, was 95% in Q1, Presumably it was pretty close to 100 for the 2Q. Is that fair?

That's fair.

Okay. The 2021 and 2022 paper looked like it had been struggling a little bit. How has that performed here over the last quarter?

Mark, those two vintages, we're still seeing some challenges in that. But we are seeing very good performance in the 2023 vintage, which is still early. So those had, if you remember, we had talked about some consumers having kind of making lower cash down payments, but establishing longer term payment plans, which are actually better than expected. So that behavior is kind of continuing. but the 2023 vintage has started to perform very well out of the gate.

And then I probably disclosed here in the release of the queue, but the collections multiple on the 2023 paper for the six months relative to the three months?

It is, I believe, 2.2, and that's where it started at. Now, I would say, as you look at that and think about kind of the pricing comments we made, we buy on forward flows, as you know. And some of the purchases that we are showing now in Q2 are from older flows. And as they drop off and the newer portfolio purchases that we're now signing take effect, we expect the purchase multiple and MCM to start steadily growing over time.

Okay, thank you. One moment for our next question. This question comes from John Rowan of Janney Montgomery Scott. Please proceed.

Good evening.

Hi, John.

I apologize if you went over this. My phone dropped out for a couple of minutes. Did you give guidance for U.S. purchasing going forward? I know last quarter you gave guidance that it would remain around the same. I was wondering if you provided any similar guidance this quarter.

John, we did not provide any specific guidance. We did say that market continues to grow and we're buying at attractive returns. And also, we kind of mentioned, which you have said many times in the past, is you get more for your dollar that you spend. So, we continue to add materially more ERC for the same dollar spent as we look into the future.

Now, I'm curious if you could disclose, you mentioned that the multiples right now are still a little suppressed because of forward flow agreements that were signed. I'm wondering if you could disclose what the difference in the money multiples are for what's coming to auction now versus what was on forward flow.

That's something we have not talked about, John. So all I would say is they are improving. and just depends on which flows drop off, which ones take place, kind of start taking effect. So the impact of that mixed change will show up steadily quarter over quarter. So that's the most I can say at this time.

Okay, and then lastly, are you seeing any new entrants at any of the auctions?

We have not seen any new entrants. It's a very stable market participant list. And some of the entrants, as we had talked maybe a year ago, for being somewhat more aggressive in purchasing, we've seen some of them back off as well. So it's a very stable set of players who are participating in the U.S. market.

Thank you. One moment for our next question. This is from Mike Grondahl with Northland Securities. Please proceed.

Hey guys, thanks. So hey, just so I have the right takeaway on purchases, you expect the second half to remain pretty robust, but you're not providing any color kind of in the 3Q. Is that fair?

That is correct. We typically do not provide specific numbers. A couple of times we have just to make sure people understood how the change was and the transition was happening. supply is growing and we are very focused on maximizing returns as well for on course so that's what I can tell you at this point Mike got it um and then in terms of collections should we read into the fact that over the last couple quarters your

Cecil impairments or kind of let's just say the cleanup has gotten smaller and smaller and smaller, I think, the last three quarters. I mean, can we read into that that, hey, maybe we're going to get a push next quarter or maybe it flips the other way? Or is that direction something that shouldn't be read into?

So a couple of things there, Mike. I would say our ERC is our best estimate as of now, so it reflects everything we know. Again, what you said was accurate as well. I would say given the change in consumer behavior was happening kind of interesting times during the pandemic, and then subsequent steady normalization of the U.S. consumer, forecasting sometimes can lag, and you try to do the best you can, which is what was happening. So there was more volatility. Now, every quarter, we make our best estimates, so I cannot say what it will be in the future or not, but you've correctly observed that some of that volatility has subsided as the consumer has become more stable, and as a result, we are able to predict the future better, too. But again, things can change and vintages can act differently. So we do our best by vintage level. And what you see is the aggregate impact of all of those forecast changes by vintages.

Got it. Is there anything you can call out on July and give us any insight into that month?

No, we typically have not done that. So I'd be unable to do that, Mike, right now.

Okay. Fair enough. And then last question, and maybe this is for Jonathan, put him on the spot a little bit. But first call estimates, you know, really have an inflection in 3Q and 4Q, you know, from, you know, roughly the low dollar and change level to 3Q, I don't know, roughly $1.65, $1.80 for 4Q. Any comment on that, Jonathan? I mean, you kind of got a chance here to level set a little bit. How do you feel about those?

I think, as we said, we expect steady growth. That's really all I can share at this point, right? We know we're being thoughtful and pragmatic as we buy portfolios and move through the cycle. And that's all I can say.

Thank you. As a reminder, to ask a question, press star 1 1 on your telephone and wait for your name to be announced. In order to withdraw your question, press star 1 1 again. So one moment for our next question. This question comes from Robert Dodge of Raymond James. Please proceed.

Hi, guys. Congrats on the quarter. On a couple questions. On the legal expense, obviously, I mean, it ticked off a little bit this quarter. It's been on a trend. I mean, it's something you can do. Are we reaching an inflection point in kind of that trend? that figure is is the consumer gets more predictable is it is it uh easier to predict who's going to need to go into the um the legal channel versus um the the the non-legal channel um uh and and you know is are we going to see an inflection and a ramp in in that expense item as erc is growing and and the consumer gets more predictable uh robert so i wouldn't

Looking at the numbers you provided in the queue, it's a very moderate or modest change, and things can change based on how the vintages are maturing, what's getting placed into the legal channel. I wouldn't draw too much conclusion from that change. Now, in terms of use of legal, I mean, overall, if collections start growing again, as they have been, I mean, the legal expenses will also grow because a decent amount of collections come through the legal channel. Now, as you know, also, we've been working very hard to increase the share of call center and digital channels, which kind of grew too much in the pandemic time as consumers were paying down their debt, so call center had grown, and now it's become, as a percent, kind of more normal. Now, over time, we'll still work to continue increasing that share, but legal will remain a pretty significant part of the collections channel, both in Europe and in the US. So, again, back to your original question, I wouldn't draw too much conclusion, and as collections grow, legal collections will also grow, and some of that expense will come through as part of that.

Got it. Thank you. And then the other one, on Europe, you said that pricing still hasn't nationalized to the cost of funds, but it does seem, I think, from what Jonathan said, that there's been a slight impact. In the past, the European market has shown an ability to remain irrational perhaps longer than I would have expected it to be able to. So where do you think it stands now in terms of a remaining capacity to not factor in costs of funds on pricing? or not fully factoring cost funds. I mean, do you think that the European market can still remain aggressively competitive for another 12, 18 months, or is it six months and they have to move?

Yeah, I mean, that's a great question, Robert. It is still competitive in UK and Europe, I would say. There are quite a few players. That said, as you correctly noted, John did indicate in his comments, we have seen slight indications. I would say we have seen certain deals priced better than in the past. So that's what we talked about. It's not a sustained or a broad change yet at this point, but it's encouraging. Now, in terms of predicting what will happen, hard to say. I think what's probably not driving decisions at some of the other players is their cost of incremental funding or refinancing, how that's going to be higher. That kind of depends on when they have to refinance and when some of the bonds are becoming due. So some of that one would have expected to reflect. And maybe for some of them, it may be. That's why we're seeing some price improvement. But I think it'll take a while. for all of that to go through. Now, things can change rapidly as well, but until some of those players really face the higher cost of fund truly flowing through, given where the bond markets are, it may take a little bit of time. But we are staying patient. We are still buying in Europe and UK, but we are staying patient and disciplined, and we are buying to make sure we are getting the right returns for our invested capital. And we are able to allocate capital, just a reminder, compared to all of the players, we can allocate capital across countries in a seamless way. And we see more opportunities in U.S., and that's exactly what we're doing.

Thank you. One moment for our next question. This question is from Bob Napoli with William Blair. Please proceed.

Hi, this is Spencer James on for Bob Napoli. Thank you for taking the question. Apologies if this has been asked already, but it seems like the change in expected recoveries this quarter was modest, similar to last quarter. Were there any puts and takes by vintage within that relatively small change you could provide cover on?

Spencer, yes. Changes were very modest, if you actually consider all things considered. I mean, there were some vintages, as we've mentioned, about the US 21 and 22 vintages that had a negative change. So net for all of US, it was 1.4 million or so. And for Europe, it's about 2 million negative. But that was fairly broadly dispersed, including some significant positives and some significant negatives, all adding up to negative 2 million for Europe. So no pattern in Europe, but in U.S., 21 and 22, we had the negative, but also 23, we had a positive one.

Okay, that's helpful. Thank you. And one quick follow-up. Did you provide any commentary on purchase activity in the month of July?

We did not. All I would say is, as I indicated earlier, we're seeing continued growth in supply in the U.S. So we are excited to see that and fully participating in that.

Thank you. One moment for our next question. This is from Mark Hughes with Truist. Please proceed.

Jonathan, on the collections cost, year over year, the change was much improved compared to Q1. How do you think that trends through the balance of the year, maybe on an absolute basis? I'm still thinking ratios as the percentage of collections and fee income, but how do you think that compares or trends kind of sequentially or year over year? Year over year is only up 120 bits. How's the second half look?

Yeah, we, you know, I expect most of our, if you look across our general operating expenses, you know, there are some puts and takes and most of it is somewhat, most of it is flat, I guess I would say. How it's going to – the trajectory going forward, obviously, there's some operating leverage here, as you're aware. So, to the extent that volume collections increase, you may have some benefit on a percentage basis, but I don't expect any erode changes in expenses.

Yeah, yeah.

Q1 also had a one-time cabot restructuring charge of $6 million, I think. So that's the variance you might have noticed, Mark.

Yeah, yeah, good point. Thank you. And then the, you alluded to moderating, in the U.S., there's a moderating impact on pricing from interest expense, capital costs. Do you notice any change in behavior of the competition under the circumstances?

Yeah, I think the behavior change is what's leading to the price reductions. So it seems to be a fairly rational market. And buyers are acting in terms of their either cost of capital or capacity. I would expect cost of capital and just simple supply-demand economics, increased portfolio supplies leading to some reductions in price. And we saw it to be fairly broad-based this quarter compared to the prior couple of quarters when it was a bit more sporadic.

Appreciate it. Thank you.

Absolutely.

Thank you. I'm showing no further questions at this time and would now like to turn the conference back to Mr. Masai for closing remarks.

Thank you. As we close the call today, I'd like to reiterate a couple of important points. As the consumer credit cycles in our key markets each evolve in their own unique ways, we continue our disciplined purchasing approach by allocating capital to our markets with the highest returns. When combined with our effective collections operation, this approach has enabled us to continue to grow our cash generation. This is the portion of the credit cycle we have been anticipating. Driven by our mission, vision, and values, and through the consistently great work by our colleagues around the world, we are as committed as ever to the essential role we play in the credit ecosystem and to help consumers restore their financial health. Thanks for taking the time to join us. and we look forward to providing a third quarter 2023 results in November.

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