Pra Group Inc Q2 FY2022 Earnings Call

Thank you. Good evening, everyone, and thank you for joining us. With me today are Kevin Stevenson, President and Chief Executive Officer; and Pete Graham, Executive Vice President and Chief Financial Officer. We will make forward-looking statements during the call, which are based on management's current beliefs, projections, assumptions and expectations. We assume no obligation to revise or update these statements. We caution listeners that these forward-looking statements are subject to risks, uncertainties, assumptions and other factors that could cause our actual results to differ materially from our expectations. Please refer to the earnings press release and our SEC filings for a detailed discussion of these factors. The earnings release, the slide presentation that we will use during today's call and our SEC filings can all be found on the Investors section of our website at www.pregroup.com. Additionally, a replay of this call will be available shortly after its conclusion, and the replay dial-in information is included in the press release. All comparisons mentioned today will be between Q2 2022 and Q2 2021, unless otherwise noted, and our Americas results include Australia. During our call, we will discuss adjusted EBITDA and debt to adjusted EBITDA for the 12 months ended June 30, 2022, and December 31, 2021. Please refer to today's earnings release and the appendix of the slide presentation used during this call for a reconciliation of these non-GAAP financial measures to the most directly comparable U.S. GAAP financial measures. Before we begin, I would like to take a minute to welcome Gen Mosman as our new Vice President of Investor Relations. As we announced via press release last month, he will report to me and lead our Investor Relations program. Najim has a wealth of IR experience and will play a critical role in expanding our investment story to new audiences while deepening our current investor and analyst relationships. We are very excited to have him join our team and meet you all. And with that, I'd now like to turn the call over to Kevin Stevenson, our President and Chief Executive Officer.

Okay. Well, thank you, Lori, and thank you, everyone, for joining us this evening. I want to start off by briefly discussing what we're doing in the community. In June, we had the official grand opening of our new net zero carbon Taylor facility in Kilmarnock, Scotland. Many of our senior leadership team members from both the U.S. and Europe attended, and it was truly a proud day for PRA. Members of Scotland's parliament and community leaders were there for the celebration along with several banking institutions and consumer assistance charities, creating a great atmosphere that reinforced our values of working together and making a positive impact. To provide more color on the Halo Building, it's the new center of our U.K. business, which is our second largest market globally. This not only demonstrates our commitment to Humenik, where we are one of the largest employers, but also our commitment to the environment and ESG, all while providing our employees a cutting-edge facility to be excited about coming to each day. Along with the grand opening of Halo, we continue our long-standing tradition of charitable giving. Since our founding in 1996, we have made it a priority to invest in communities where we work and live. 2021 was a record year for us in terms of charitable giving, and we are making impactful contributions in 2022, despite the challenging global context. Shifting now to Q2, we had another solid quarter led by the performance of our European operations. Please keep in mind, though, that as last quarter indicated, prior year comparisons will be skewed given the global excess consumer liquidity experienced in 2021. This excess liquidity contributed to record collections for us in that year. In Q2, total cash collections were $444 million globally, an 18% decrease year-over-year. However, it's important to note that we beat our expectations, which Pete will cover in more detail later. The U.S. was responsible for most of the decline, but this was largely driven by the normalization from last year’s excess consumer liquidity, a topic I have been discussing since mid-2020. COVID-related government actions such as lockdowns and restrictions led to excess consumer liquidity and savings, which lowered loan balances and delinquency rates. For PRA, this resulted in cash collections grossly exceeding our expectations during 2020 and 2021, but it also resulted in reduced levels of supply, lower portfolio investments, and fewer accounts to collect upon in 2022. As we review the market today, however, most economic indicators point towards a coming increase in supply, which I'll discuss in detail later. Our European cash collections increased on a currency-adjusted basis while decreasing on a GAAP or U.S. dollar basis. Specifically, European cash collections decreased approximately 9% on a U.S. dollar basis, including the negative effects of the strengthening dollar seen in Q2. Excluding currency impact, European cash collections increased by 2%. This growth was driven by our strong investments in Europe, particularly in Northern Europe. The dramatic strengthening of the U.S. dollar against European currencies had a significant impact, creating a headwind of nearly $20 million during the quarter. Again, Pete will provide more details on foreign exchange effects later. Net income attributable to PRA Group for the quarter stood at a robust $36 million, albeit down from last year due to the same factors affecting cash collections year-over-year. Quarterly portfolio purchases totaled $231 million, with 54% in Europe, including a sizable purchase in a Northern European market that we had not purchased in since 2020. We also repurchased nearly $35 million of our common stock, reducing our total common shares outstanding by 14% since we began share repurchases last year. These share buybacks are an important component of our capital allocation strategy. From an operational perspective, we had another strong quarter as we continue to drive new efficiencies, benefiting from gains made over the past few years. Given that prior year comparisons are distorted by pandemic effects, we benchmark our internal performance to 2019 to negate that impact. When comparing our results to Q2 2019, our cash efficiency ratio has improved by 90 basis points thanks to our innovation emphasis through investments in digital, data analytics, and operational health. We're consistently seeking new methods to enhance our predictive scoring models and improve our strategies, particularly in legal and outbound collections. Several specific factors contributed to our overall cash efficiency improvements, including our growing digital platforms and increasing domestic call center productivity in the U.S. In Europe, we've also invested extensively in technology, including digital innovations, cloud-based dialers, robotic process automation, and integration into supporting systems. We firmly believe that these efficiency gains position us favorably to capitalize on the increased supply we expect in the coming months. Regarding cash collection and inflation, we noted in the last quarter that we have not observed any negative effects of inflation on our cash collections. Anecdotally, we have heard from customers expressing concerns over inflation. However, based on our historical data, we do not foresee inflation having a material impact on our cash collections moving forward. Our experience with varying inflation levels in past cycles supports that belief. It is also important to discuss how this has historically connected to our buying. As a reminder, from a cash collection perspective, we analyze 10 to 15-year curves, and across our 25 years of operations, forecasting that total area has been one of our strengths, navigating variations in timing driven by factors such as inflation. When tying this to the purchasing side of the equation, banks tend to experience charge-offs more frequently during economic downturns, as they do not have the same time horizon driving those charge-offs like we do. This leads to increased charge-offs and, in turn, higher portfolio purchases. We will continue to monitor inflation in all of our markets and will provide updates as necessary. Briefly discussing Australia, we see it as a significant and growing market for us. Since entering the market in 2020, we are pleased with our team's development, now at 50 full-time employees, with infrastructure in place to scale further as we increase market share. We are committed to the Australian market and focus on the customer journey. Overall, we are satisfied with our positioning in Australia and look forward to providing more details as they evolve. From an investment standpoint, we deployed approximately $231 million in Q2, showcasing our strong balance sheet and competitive advantage in our expansive global footprint. Particularly notable was our sizable purchase in Northern Europe, where we had not invested since 2020. In the Americas, we invested $106 million, although conditions remain unchanged on the supply front. We've seen similar volumes of marketed deals compared to last quarter and the previous year, down from pre-pandemic levels. The competitive landscape also remains consistent, and while we anticipate more supply becoming available, I will elaborate on that shortly. In Europe, we invested $125 million in Q2, marking the second-largest investment made in Europe during a second quarter. Supplies in Europe remain healthy, and competition trends are consistent with Q1. Looking ahead, economic indicators suggest an increase in supply is imminent. Rising inflation is putting pressure on the average consumer, who battles increasing food costs, energy prices, and interest rates. Spending is rising, leading to higher credit card balances, not only due to inflation but also because government actions that previously reduced these balances have been reversed. Consequently, lower savings rates and higher credit card balances are likely to result in more delinquency rates for some issuers. Although high delinquency rates have not yet led to increased charge-off rates, historical patterns indicate higher charge-offs could be on the horizon. I am not an economist, but from my extensive experience in the industry, it appears that these trends will culminate in increased supply and portfolios for purchase as more consumers default on obligations and debt sellers offload portfolios. Across multiple credit cycles, we have witnessed similar patterns develop, and we anticipate a similar scenario in the upcoming months. Additionally, we're observing data from the U.K., where the impact of the Russian invasion of Ukraine has materialized through rising global fuel and food prices. The U.K.'s Office for National Statistics reported that household disposable income fell in real terms for four consecutive quarters—the longest such trend recorded. As a result, more individuals are relying on credit, with credit card borrowing in June rising at the fastest annual rate since 2005. Ultimately, we remain disciplined in capital deployment, focusing on markets and portfolios that promise profitable returns. As we approach our third decade in business, with November marking our 20th year of being publicly traded, we recognize cycles will come and go. While supply is currently not where we need it, we believe a return of supply is not a matter of if, but rather when. Now, I'll turn things over to Pete for a breakdown of the financial results.

Thanks, Kevin. Again, this quarter, the prior year comparisons are challenging, but we are performing in line with our expectations. Total revenues reached $258 million for the quarter. Total portfolio revenue was $251 million, consisting of portfolio income at $194 million and changes in expected recoveries of $57 million. During this quarter, we collected $36 million in excess of our expected recoveries, equating to a consolidated overperformance of 7%, with the Americas overperforming by 4% and Europe by 12%. We have observed several quarters of more normalized collections, with sustained overperformance in certain older vintages. This has granted us the confidence to modestly increase our ERC forecast for those vintages, leading to a positive change in estimate of $21 million. Our operating expenses were $175 million, reflecting a $7 million decrease driven primarily by reductions in compensation, employee services, and legal collection fees, alongside the strengthening of the U.S. dollar against European currencies. Our effective tax rate for the second quarter was 26.6%, bringing the year-to-date tax rate to 20.3%, with full year expectations remaining in the low 20% range. Net income stood at $36 million, generating $0.91 in diluted earnings per share. Cash collections totaled $444 million compared to $544 million in Q2 2021, impacted negatively by $19 million from the stronger U.S. dollar. Collections in the Americas were $279 million, down $84 million, driven by the excess consumer liquidity environment last year and the lower levels of portfolio purchases in the U.S. European cash collections decreased by 9%, though they grew by 2% on a currency-adjusted basis, showcasing the growth we are achieving in our European business due to past investments, notably in Northern Europe. Our cash efficiency ratio was 61.3% this quarter, down from last year's 66.8%, yet reflecting a 90 basis point improvement compared to Q2 2019. The operating efficiency enhancements we have introduced over the last few years are credited for this increase. We project our full-year cash efficiency ratio to be around 62%. By the end of the quarter, our ERC stood at $5.6 billion, with 41% in the U.S. and 52% in Europe. The decline from Q2 2021 is attributable to lower buying activities and currency translation impacts that weakened our ERC balance due to a strengthening U.S. dollar by nearly $300 million during the second quarter. Should this translation impact not have occurred, our ERC would have increased from the first quarter for the first time since last year’s third quarter. We expect to collect $1.5 billion from our ERC balance over the next year, and to maintain current ERC levels, we would need to invest approximately $870 million globally, contingent on the normalization of the U.S. market expected later this year and into next year. Our capital position remains robust with leverage ratios at the low end of our long-term target of 2x to 3x debt to adjusted EBITDA. As of the quarter's end, we had $1.6 billion available under our credit facilities, with $453 million of that available to borrow after accounting for borrowing base restrictions. Furthermore, we generated $1.2 billion of adjusted EBITDA over the last 12 months. With rising interest rates being a point of focus in the news, I would like to comment on our interest rate hedging program to manage the related risks. On a consolidated basis, we are 66% hedged. By currency, we're nearly 100% hedged in U.S. dollars, over 50% hedged in Sterling, and less hedged in other European currencies. We believe this allocation effectively balances the cost of hedging with our exposure to interest rate increases. In this quarter, we repurchased $35 million, or approximately 808,000 shares of our common stock, leaving us with around $93 million of share repurchase authorization remaining. Our strong capital position, financial performance, and conservative capital structure afford us considerable flexibility to fund the higher levels of portfolio investments we expect to see in the near future. It's only a matter of time before we will engage in these investments, and until then, we will evaluate all opportunities to drive significant growth and enhance value for our shareholders. Now, I'll turn it back to Kevin.

Thanks, Pete. We appreciate all of you attending this call and receiving our latest updates. We recognize there was a lot to cover this quarter, and we believe the takeaways are clear. Firstly, Q3 was another great quarter for the company, somewhat masked by challenging comparisons against 2021 and the FX headwinds largely beyond our control. Secondly, economic indicators suggest that more NPL purchase volumes are coming. To conclude, I want to provide some insight on how our business is positioned to perform during a potential recession, an increasingly discussed topic. Generally, economic recessions lead to increased charge-offs and more supply for us to acquire. A common misconception is that collections will suffer significantly during these times; however, history shows that our paying customers often already face personal financial challenges unrelated to broader economic conditions. These customers typically continue to honor their payment agreements, meaning collections remain more stable than expected. What is impacted by recessions is the number of new charge-offs as a fresh batch of consumers undergo financial hardships. This inevitably results in higher charge-offs and increased portfolios for acquisition. This trend is consistent with our experiences following previous economic downturns. As I mentioned earlier, most of the economic data indicates that more supply is on the horizon, and we are prepared for it. We have built a high-performing, well-capitalized, and profitable business model that is eager for new portfolios. We will always exercise discipline in our capital allocation, yet we are optimistic about increased purchasing activities this quarter. Overall, we are excited about our current standing within the company, and we look forward to connecting with all of you as we continue demonstrating the value of investing in PRA. Thank you once again for listening and for placing your trust in us. Operator, we are now prepared for questions.

The first question today comes from Bob Napoli with William Blair.

Thank you and good afternoon. So just a question on supply in Europe. Kevin, you certainly highlighted a strong quarter, but it can be somewhat lumpy. Are you seeing a consistent uptick in supply in Europe that is sustainable, or was this quarter affected by one-off larger purchases?

No, overall, the supply has been as expected. It's been strong. But don't get confused; it's definitely lumpy. The deals are bigger than they are in the United States. Overall, I'd say it's consistent and as we expected.

Then the cash efficiency ratio at 60.7% this quarter. What is your view on the sustainable level of cash efficiency ratio as consumer cash collections have normalized?

Again, I stated in the prepared remarks, Bob, that I believe we will be around 62% for the full year. There may be some seasonal variations each quarter, but I think 62% is a solid benchmark for the full year. I believe that's likely where we'll be moving forward. We continue to seek improved operational efficiencies, which we believe provide a competitive edge as we increase the portfolio.

Great. And then one last question for me. Kevin, you seemed a bit more enthusiastic in the last call regarding M&A potential. Do you have updated thoughts on what you're looking for, or if you've built a pipeline?

Yes, I appreciate that. I remain excited about the M&A prospects. I might have mentioned in the last quarter that now is an excellent time for us in our evolution as we have a fantastic new hire on board reporting to Pete Graham. We are actively exploring options that align with our strategy, whether they are tangentially related businesses or complementary investments. I'll leave it at that, but Pete may want to share additional insights.

No, I think we're proceeding methodically with our approach. When we have substantial updates, we'll certainly share them with you.

Pete, Kevin, appreciate it. Thanks.

The next question comes from Mark Hughes with Truist.

Thanks. It appears that there was a significant increase in the forward flow numbers, particularly in Europe. Is that accurate? Can you elaborate?

Yes, we regularly update based on our most recent contractual obligations. You've probably noted our discussion last year about a multi-year flow that we secured. The primary driver of the increase reflects our commitments looking out over the next year.

How much of that volume do you expect within 12 months?

That's likely to be observed within 12 months. Though, it's important to note this is a contractual commitments disclosure, indicating maximum contributor volumes over the entire contract period, not our best estimate of probable flows.

Understood. You reported a $7 million decline in costs while your collections experienced a $100 million downturn. How do we evaluate variable versus fixed costs currently?

A lot of that decline is tied to the top-lining liquidity we experienced during 2020 and 2021. On a cash efficiency basis, we compare our performance to 2019 to control for that top-line liquidity. Presently, we have reached a plateau in overall expense levels and are confident regarding our collector numbers in the U.S. We likely possess some excess capacity to scale as additional portfolios enter the market without substantial cost increases. Therefore, our total operating expense this quarter seems to level off aligned with trends we’ll likely see in the coming quarters, albeit with some fluctuation among categories.

Would your appetite for share buybacks remain strong if supply increases?

We may moderate buybacks as portfolio opportunities emerge, but this strategy will remain a key component of our toolkit. We still have $93 million available under our authorization as of the end of the quarter.

Regarding the sizable purchase in Northern Europe, how do you assess your visibility into the collections performance for that portfolio since you hadn't made purchases there since 2020?

It's a unique market, and we have substantial data from our time there. Although older, the market operates based on a distinct legal framework for collections. We've been active in this market for a long time, so we are confident about this purchase, and we're performing well with the 2020 acquisition.

What prompted this change? Did you simply hit a bid that you had been pursuing, or did a competitor back out?

No, it wasn't due to a competitor backing out, which has happened previously. We merely succeeded in this particular deal.

The next question comes from Robert Dodd with Raymond James.

Regarding OpEx, following up somewhat on Mark's line of inquiry, there was a notable increase in outside fees and expenses this quarter, particularly indicated by higher corporate legal fees. Is this represented by a one-time situation, or should we anticipate a sustaining level?

We evaluate a multitude of cases quarterly, adjusting our accruals as necessary. This line is a bit elevated this quarter, but we maintain that our total OpEx is currently at an appropriate level. Further, there will likely be some spending variations across different categories in the near term.

Understood. What is your outlook for the U.K.? There seems to be significantly more strain on the average U.K. consumer than on U.S. consumers presently. As we approach the latter part of the year, European energy costs are escalating sharply.

Thanks for your inquiry. Indeed, as energy costs rise and cold weather approaches, the situation becomes dire for many U.K. consumers. We continue to purchase portfolios in the U.K., where we have long-standing relationships and strong performance. Our data supports this as well. We remain mindful of the factors you pointed out, including energy costs. We are consistently involved in large forward flows, not restricted to a single contract. We are one of the top players in the U.K. market, and our historical data is reinforcing our strategies.

We approach each quarter with caution, making projections not only for the short term but over longer forecast periods. U.K. performance largely hinges on the types of portfolios we have historically bought, which often consist of long-term payment plans. We conduct a thorough evaluation of each customer's capability to sustain these payment plans, which tend to be quite resilient even when consumers experience hardship.

Thank you for the clarification. One more question on the digital investments you've referenced previously. You have shared notable progress over the last two years but did not speak to it this quarter. Is the investment still performing beyond your initial expectations, or has it settled into a more predictable pattern?

That's an excellent question. Columbia Digital indeed performed significantly above our expectations during 2020 and 2021. Reflecting on when we initiated the process of investing in digital, it began as a minor aspect of our business. Our internal goal seemed almost unattainable at that time, yet we are nearing that target despite moving beyond excess liquidity timeframe. This quarter, we are working towards establishing new, ambitious goals. Productivity indicators, such as our current collector headcount not being this low since about 2007, reinforce the journey we’ve taken. We are accruing a higher volume of collections in a quarter than we previously did annually back then, with the same number of collectors. Our advancements in digital techniques, scoring models, and improved access to legal resources reflect this progress. My silence on the subject this quarter shouldn't be misconstrued as a lack of enthusiasm.

The next question comes from David Scharf with JMP Securities.

Thanks for including me. I apologize if some of these questions have already been posed. A few quick inquiries, if possible. Kineret, regarding the footnote about forward flow and maximum volumes, are there guaranteed minimums, or does the disclosure only provide maximum limits?

The flow contracts generally do include both minimums and maximums. However, our disclosures primarily highlight maximum commitments due to regulatory requirements.

Are you restricted from disclosing the minimum metrics?

We have the ability to disclose minimums; we simply choose not to.

Understood. As credit normalizes alongside macro factors, have sellers begun raising their provisions? How do they typically approach channel preferences when losses start to compound? For instance, do they usually utilize third-party collections before engaging with you, or does it vary by lender?

It largely depends on the seller's strategy. Some may stick to their traditional methods when managing rolling charge-offs, while banks may sell earlier during economic downturns—especially reminiscent of the 2008 financial crisis. Because strategies can vary by institution, it's difficult to generalize across the board.

That makes sense. Lastly, I want to address the recent collection performance. It seems like we should cautiously model for a decline based on macro factors and consumer payments, particularly as you witness increasing caution from consumer lenders. Should we expect this figure to trend lower moving forward?

As I have previously mentioned, we must assess our performance holistically. Our model indicates that changes in estimates are linked to our existing yield component. We ideally view changes in estimates positively, as we typically observe upward movement in estimates over time. I believe this dynamic will consistently apply going forward. To clarify, our industry operates differently—we work with distressed consumers who have deep-rooted issues. Unlike traditional lenders, we're focused on those who are already undergoing financial hardships, encountering perhaps their own personal recessions already, which ties back to our cash collections.

In sum, we are continuously monitoring and engaging with trends and patterns. Historical data shows consistency in how collections perform under varying conditions, and we often see our estimates expanding rather than contracting. The upcoming macroeconomic environment has its uncertainties, but we will be able to navigate it and deliver value to our stakeholders.

This concludes our question-and-answer session. I would like to turn the conference back over to Kevin Stevenson for any closing remarks.

Thank you very much. Again, it's a great time to be at PRA. We're grateful for everyone's participation today. We look forward to providing updates next quarter. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.