Earnings Call Transcript - ECPG Q1 2022

Operator, Operator

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. Please be advised that today's conference call is being recorded. 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.

Bruce Thomas, Vice President of Investor Relations

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 Masih, our President and Chief Executive Officer; Jonathan Clark, Executive Vice President and Chief Financial Officer; Ryan Bell, President of Midland Credit Management; and Craig Buick, CEO of Cabot Credit Management. Ashish and Jon 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-K 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 Masih, our President and Chief Executive Officer.

Ashish Masih, CEO

Thanks Bruce and good afternoon, everyone. Thank you for joining us. In the first quarter, we continue 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 a 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 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 Encore 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 Encore'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 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 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 UK, 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 debt in order to regain their economic freedom, and our team is ready to support them to do just that. Turning now to our largest and most 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 their credit card debt, as well as resolving their charged-off debt. 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 where supply remains limited by the impacts of the pandemic. Even though we encountered somewhat higher pricing towards the end of 2021, pricing has stabilized, and we continue to deploy capital at the best returns in the industry. Our industry-leading returns are the culmination of years of consistently applying our 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 MCM vintages due to the increase in collection expectations that I mentioned earlier. Turning to our 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 were $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 lower 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 collection 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. Our 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 Jon for a more detailed look at our financial results.

Jonathan C. Clark, CFO

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% of our ERC forecast. For MCM and for Cabot, Q1 collections by this same measure were 115% and 94% respectively. As previously mentioned, persistent 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% 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 collection expectations. CECL 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 Encore 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-months 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 non-paying, 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 have concluded the quarter with $134 million of non-client cash on 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.

Ashish Masih, CEO

Encore 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're proud of the progress we've made to date, and we're 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 our 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 lines for questions.

Operator, Operator

Alright, your first question comes from the line of Mark Hughes from Truist. Your line is now open.

Mark Hughes, Analyst

Thank you very much. Good afternoon. 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 an early use of capital for you depending on the purchase environment of course?

Ashish Masih, CEO

Yes, we have of the $300 million authorization, 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.

Mark Hughes, Analyst

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

Jonathan C. Clark, CFO

Yes, as you've noticed, we've continued to decrease quarter-on-quarter.

Mark Hughes, Analyst

Yes.

Jonathan C. Clark, CFO

I expect that we had a bit of noise this quarter, but it’s roughly similar to what would be considered a good run rate. It's important to remember that while we are mostly positioned with fixed and hedged rates, we do have a floating rate component, so there will be some effects from rising rates.

Mark Hughes, Analyst

Could you discuss the cost structure? Should we assume it's relatively steady in absolute terms, given that some of it will be influenced by your collections volume? Are there likely to be any cost-cutting measures, and can you provide an outlook on that efficiency?

Ashish Masih, CEO

Mark, this is Ashish. When looking at expenses over the long term, we’ve shown continued improvement in our efficiency with this new metric, which provides a clearer view as it accounts for all our expenses. We assess expenses in two primary ways. For non-collections expenses, we are actively reducing them while maintaining efficiency and benefiting from scale. In terms of collections, we also focus on operating expenses, implementing automation, leveraging technology, and increasing our digital collections in our main markets like the U.S. and UK. This has contributed to a decline in the cost-to-collect metric. However, it’s important to remember that we do not evaluate cash efficiency margin or costs independently; context is essential. Occasionally, higher spending, which could lower our efficiency margin, may yield better returns, and our focus is on returns as a whole. Furthermore, as noted in our prepared remarks, this metric is also affected by our portfolio mix, including the types of accounts we manage, whether they are paying or non-paying, and secured versus unsecured assets. Therefore, while we emphasize cost management across both overhead and operational expenses, it’s more about the overall outcomes.

Mark Hughes, Analyst

And then when we think about the operating margin, you've been running in a pretty narrow range, 58%, 59.5%. Any reason that would change?

Ashish Masih, CEO

We are not providing an outlook on that, Mark. Again, it can depend on many factors. We are managing or 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 headcount 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.

Mark Hughes, Analyst

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

Ashish Masih, CEO

Yes. Craig, you want to take that?

Craig Buick, CEO of Cabot Credit Management

Yes, certainly. Hi Mark, thanks for the question. The way I'd characterize the competitive environment at Cabot across the European landscape, is stable, it's competitive, and it has been competitive for a while. It's stable. The money multiple we printed here at 2.2 is, I think, not aligned to what we printed last year. So, I'd say things are stable at this point from that competitive dynamic perspective.

Mark Hughes, Analyst

Thank you very much.

Operator, Operator

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

Michael Grondahl, Analyst

Yes, thanks guys and congratulations. Just 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?

Ashish Masih, CEO

Good question, Mike, regarding purchases. Currently, based on recent bank earnings reports, we observe that purchasing consumers are increasing their spending, and lending has been growing significantly in both the U.S. and the UK for some time. This trend is one of the factors driving future charge-offs. Delinquencies, which serve as a leading indicator, have been gradually rising for many U.S. credit card banks, with some remaining stable. As this situation develops, we expect volumes to increase as well. Banks that were active before the pandemic are continuing to engage in forward sales, although the current volumes are low within the contracts they have, but this is likely to change as higher lending and increasing delinquency rates take effect.

Michael Grondahl, Analyst

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

Ashish Masih, CEO

I think the market is similar to what we observed 90 days ago when bank lending was rising for a few quarters, and that trend is still continuing. There has been no change. Recent reports from all the banks are very consistent and delinquency trends are quite similar. So, we have the same perspective now as we did 90 days ago.

Michael Grondahl, Analyst

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

Ashish Masih, CEO

Yes, it's been an interesting situation. Consumers are performing relatively well. I would attribute this to two main factors: consumer strength is ongoing, although not quite at last year's level, and our operational strategies in how we facilitate payments and interact with consumers through various channels. This also plays a significant role. While consumers are borrowing more, they are also increasing their spending. Purchasing volumes are on the rise, and based on some bank reports I quickly reviewed, payment rates remain strong. This trend continues. Additionally, I would credit our operations for being responsive to consumer needs and effectively driving collections.

Michael Grondahl, Analyst

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

Ashish Masih, CEO

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

Michael Grondahl, Analyst

Great, thank you.

Ashish Masih, CEO

You are welcome.

Operator, Operator

Your next question comes from the line of Bob Napoli from William Blair. Your line is now open.

Spencer James, Analyst

Hi, this is Spencer James on for Bob Napoli. I just want to ask about the change in recoveries. It was larger than any quarter 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?

Ashish Masih, CEO

Yes, Spencer, great question. So to answer that, let me just provide a broader context on kind of what's happening here on this important issue. So as I said earlier, kind of our first thing, U.S. collections continue to be very strong. And I just mentioned the reasons consumer trend but also our operations. So U.S. collections continue to be very strong and example of that is, for example, in this recent quarter, they were 115% of prior years or 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 persistence or persistent over performance, we felt confident to increase expectations for the U.S. back book to the tune of $225 million. And this is the back book at the end of 2021. And also, 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. 75% of those increases will come for 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 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 kind of disclosed. So just bottom line, I just want to make sure I say 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 of purchase price multiples that we talked about in our presentation.

Spencer James, Analyst

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

Ashish Masih, CEO

Yes, regarding our collections in Europe, which includes multiple countries with a significant emphasis on the UK, we've seen 94%. For the full year of 2021, I believe it was 100%. I'm recalling from memory, so it has been quite stable, although it was a bit lower in the first quarter. As I mentioned, we haven't yet noticed inflation impacting our energy prices, but consumers in Europe might be feeling the pinch due to the current energy price situation. On the other hand, the U.S. consumer remains robust and continues to perform exceptionally well, and our operations have been very responsive to their needs.

Spencer James, Analyst

Thank you.

Operator, Operator

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

Robert Dodd, Analyst

Hi everyone. Regarding the $225 million in upward revisions, 75% of that is expected to occur over the next seven quarters. Is this timeframe due to the anticipation that certain accounts will be fully collected during this period, or is it because you are confident in the visibility over the next seven quarters but prefer not to raise expectations for a full 15-year duration? Are you being conservative about the long-term outlook, or do you believe that collections over a longer term will also be strong?

Ashish Masih, CEO

Yes. So let me just take it at a high level, and 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 have 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?

Ryan Bell, President of Midland Credit Management

Yes. I mean primarily just the shapes of our curves that are near-term weighted. So as we raise down, 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 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.

Robert Dodd, Analyst

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 MCM 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 this year than in a typical year, but you didn't see excess seasonality versus Q4. And then also, you mentioned, obviously, the 115% kind of over performance in terms of collection versus the 124% last year. Is there an indicator that the consumer is overpaying by less than they were last year, which on the one hand 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?

Ashish Masih, CEO

So on the tax, Ryan, do you have any color?

Ryan Bell, President of Midland Credit Management

Yes. For Q1, we saw nothing different or abnormal in terms of tax refunds and ability or inability to pay is kind of that expectation. So, we didn't see that in Q1.

Ashish Masih, CEO

And the other one is Q1 at 115% compared to forecast or expectations and the prior year being at 124%, as you can imagine it, 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 comparisons. So, I wouldn't try to draw too much conclusion on that, although I think your broader notion that consumers' ability to repay, is it 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 are 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.

Robert Dodd, Analyst

Okay, I appreciate that. Thank you.

Operator, Operator

I'm showing no further questions at this time. I would now like to turn the conference back to Masih.

Ashish Masih, CEO

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 on 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 Encore's continued success. Thanks for taking the time to join us. And we look forward to providing our second quarter results in August.

Operator, Operator

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