ECPG - NASDAQ

Good day and thank you for standing by. Welcome to the Encore Capital Group’s Third Quarter 2024 Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your first speaker today, Bruce Thomas, Vice President of Global Investor Relations for Encore. Bruce, please go ahead.

Thank you, operator. Good afternoon, and welcome to Encore Capital Group’s third quarter 2024 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 Tomas Hernanz, Chief Financial Officer of Cabot Credit Management. As you may recall, Tomas will succeed Jonathan as Encore’s CFO when Jon retires at the end of March 2025. Ashish and Jon will make prepared remarks today, and then we will be happy to take your questions. Unless otherwise noted, comparisons on this conference call will be made between the third quarter of 2024 and the third quarter of 2023. In addition, today’s discussion will include forward-looking statements that are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially from our expectations. Please refer to our SEC filings for a detailed discussion of potential risks and uncertainties. We undertake no obligation to update any forward-looking statement. 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 investor presentation, which is available on the Investors section of our website. As a reminder, following the conclusion of this call, a replay of this conference call, along with our prepared remarks will also be available on the Investors section of our website.

Thanks, Bruce, and good afternoon, everyone. Thank you for joining us. I’ll begin today’s call with key highlights from the third quarter. Encore’s strong third quarter performance was largely driven by MCM in the U.S., our largest business. Record portfolio supply in the U.S. is being driven by the highest charge-off rate in more than 10 years, coupled with growth in lending. Amid these favorable market conditions, MCM continues to deliver on this robust opportunity with portfolio purchases up 28% compared to the year ago quarter, while collections in the quarter were up 22% to the highest level since 2021. In Europe, the portfolio purchasing market continues to show signs of improvement but remains competitive. Although we see examples of improved pricing, we believe European portfolio pricing still does not consistently reflect the higher cost of capital caused by higher interest rates. We are maintaining that discipline and continue to be selective, which has led to reduced Cabot portfolio purchases. At the same time, we are managing Cabot’s cost structure accordingly. Overall, our year-to-date performance is ahead of expectations we revised upward a quarter ago, driven by continued growth in portfolio purchasing and collections resulting in higher cash generation. I believe it’s helpful to remind investors of the critical role we play in the consumer credit ecosystem by assisting in the resolution of unpaid debts. These unpaid debts are unexpected and necessary outcome of the lending business model, although the levels may vary depending on the stage of the macroeconomic cycle. Regardless of where we are in the cycle, our mission is to create pathways to economic freedom for the consumers we serve by helping them resolve their past due debts. We achieved this by engaging consumers in honest, empathetic and respectful conversations. Our business is to purchase portfolios of nonperforming 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 and ensuring the highest level of compliance and consumer focus. We achieved these objectives through our 3-pillar strategy. This strategy enables us to deliver strong financial performance while positioning us well to capitalize on portfolio purchasing 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 U.S. The U.S. Federal Reserve has been reporting that revolving credit in the U.S. has been steadily rising since early 2021. At the same time, since bottoming out in late 2021, the credit card charge-off rate in the U.S. has also been steadily rising and is now at its highest level in more than 10 years. The combination of higher lending and growth in charge-off rate is driving record portfolio supply in the U.S. Similarly, U.S. consumer credit card delinquencies, which are a leading indicator of future charge-offs, also continue to rise. With both lending and the charge-off rate growing simultaneously, purchasing conditions in the U.S. market remain highly favorable. We are observing not only continued strong growth in U.S. market supply but attractive pricing as well. This data supports our expectation that 2024 will be another year of record portfolio sales by U.S. banks and credit card issuers. With portfolio supply in the U.S. surging to its highest level in over 10 years, Q3 was another strong quarter of portfolio purchasing for our MCM business. U.S. deployments of $230 million were up 28% compared to Q3 2023 at strong returns. Collections in the U.S. in the third quarter were $402 million, up 22% compared to the third quarter of 2023, resulting in MCM’s highest collection quarter since 2021. This is an especially strong performance considering that in a typical calendar year, Q3 is usually a seasonally lower collections quarter than Q2. Consumer payment behavior remained stable throughout the quarter. We continue to purchase significantly more volume than we ever have in the U.S. Given current and expected market conditions as well as our forward flow commitments already in hand, we anticipate 2024 to be another record year of portfolio purchasing for our MCM business in the U.S. In contrast to the U.S., supply in the U.K. has been growing much more slowly. Credit card outstandings just recently returned to pre-pandemic levels as banks in the U.K., unlike those in the U.S., have not been meaningfully increasing consumer lending. In addition, U.K. charge-offs remain at low levels. Cabot collections in Q3 were $148 million, up 10% compared to the third quarter a year ago. We continue to be selective with Cabot’s portfolio purchases, which were $52 million in the third quarter. Although portfolio pricing continues to improve, we believe it still does not yet consistently reflect higher funding costs. Accordingly, we expect to continue to deploy at modest levels until the returns in Cabot’s markets become more attractive. We are currently choosing to allocate significantly more capital to the U.S. market, which has higher returns, consistent with our well-established strategic focus. During the third quarter, we exited the secured NPL market in Spain by selling related portfolios, resulting in a pretax loss of $8 million. It is important to note that secured NPL was a small niche portion of our Spanish business, where our primary focus has been and will continue to be unsecured consumer and SME portfolios. We also continue to prudently manage the Cabot cost structure given the reduced level of portfolio purchases in recent quarters. I would now like to highlight Encore’s third quarter performance in terms of two key metrics, starting with portfolio purchasing. Encore’s global portfolio purchases increased 23% compared to Q3 a year ago to $282 million, driven primarily by continued strong U.S. deployments in our largest business, MCM. This increased level of portfolio purchasing will help drive Encore’s collections growth over the next few years. The fact that the vast majority of our global deployment in the third quarter was in the U.S. is a reminder of the flexibility that our global funding structure provides to us. This structure enables us to allocate capital to the opportunities in the markets with the highest returns. Global collections in the third quarter were $550 million and up 18% compared to Q3 a year ago. The past several quarters of higher portfolio purchases, particularly in the U.S., has led to meaningful growth in collections, a trend we expect to continue. I’d now like to hand the call over to Jon for a more detailed look at our financial results.

Thank you, Ashish. The third quarter was another period of strong purchasing for our U.S. business at attractive returns. Collections were higher than our forecast for the quarter, and we made minor adjustments to our ERC forecast, which together resulted in a positive impact to earnings. I would also like to reiterate that the sale of portfolios related to our exit from the secured NPL market in Spain reduced our third quarter earnings by $8 million or $0.27 in earnings per share. In addition, I’d like to highlight a few items. Q3 collections of $550 million were up 18% compared to the third quarter last year. ERC at the end of the quarter was $8.65 billion, up 10% compared to a year ago. Operating expenses remain well controlled and were up 11% compared to Q3 last year as we continue to realize operating leverage and the scale benefits of collections growth in our business. As a result, our cash efficiency margin increased from 51% a year ago to 53.6% in the current quarter. GAAP net income of $31 million and GAAP EPS of $1.26 in the third quarter were up 58% and 59%, respectively, compared to the third quarter of 2023. We believe that our ability to generate significant cash provides us with an important competitive advantage, which is also a key component of our three-pillar strategy. Similar to the dynamic Ashish mentioned earlier, higher portfolio purchases at strong returns over the past several years have also led to meaningful growth in cash generation, a trend we expect to continue. Our cash generation in the third quarter was up 22% compared to Q3 of 2023. As a third pillar of our strategy, balance sheet strength is a constant priority. Our unified global funding structure provides us with financial flexibility, diversified sources of financing and extended maturities. It also underpins one of the best balance sheets in our industry with comparatively attractive leverage. Importantly, even as we remain on a record pace for portfolio purchases in the U.S. this year, our leverage declined again during the third quarter given our strong cash generation, just as we expected it would. This cash generation is driven by our increased volume of purchases over the last several quarters, the higher returns associated with those purchases and continued strong collections. Our leverage ratio of 2.7x at the end of the third quarter remains well within our target range and is down from 2.9x at the end of 2023. We believe our balance sheet provides us very competitive funding costs when compared to our peers. Our funding structure also provides us financial flexibility and diversified funding sources to compete effectively in this growing supply environment. In the third quarter, we again made good use of our diversified funding structure to proactively manage our debt maturities. In September, we amended and extended our U.S. facility to, among other things, increase its capacity to $300 million from $175 million and extend its maturity by 1 year to October 2027. You may recall, we issued a total of $1 billion of senior secured notes in the first half of 2024, comprised of two $500 million offerings. These two bonds expanded our options for future financing, establishing our access to the broad and deep U.S. high-yield market. While we initially used the proceeds from these bonds to pay down our revolving credit facility, we subsequently used the same facility to redeem our 2025 euro notes at par in October, and we plan to redeem our 2026 sterling notes at par in mid-November. As a result, we now effectively have no material maturities until 2027. In addition, we amended and extended our revolving credit facility in October. We increased its capacity by $92 million to $1.295 billion, reduced the interest margin by 25 basis points and extended its maturity by 1 year to September 2028. With that, I’d like to turn it back over to Ashish.

Thanks, Jon. Now I would like to address a change to our capital allocation priorities. We strongly believe that the prospects for our business exceed those of our competitors by a wide margin. A strong position in the valuable U.S. market, our investing discipline, operational performance and financial flexibility are all factors that provide us a consistent advantage over our competition. And so when we look at today’s market, buying portfolios, particularly in the U.S., offers the best opportunity to create long-term shareholder value by deploying capital at attractive returns, which is exactly what we are doing as highlighted by our recent purchasing history. Now as we look at the market and ongoing industry challenges, we are not seeing opportunities for value-creating strategic M&A. As a consequence, we are far more likely to repurchase our own stock than acquire another firm. Although this has been implicit in our capital allocation and demonstrated by our track record over the past several years, we now want to be more explicit by clearly prioritizing the return of capital over strategic M&A. Having said that, maintaining a strong and flexible balance sheet, including a strong BB debt rating as well as operating within our target leverage range of 2x to 3x remain critical objectives. As we work through the current cycle and continue purchasing portfolios at current or even growing levels, we anticipate that our leverage will continue to decline. When leverage nears the midpoint of our target range, we expect to resume stock repurchases subject to balance sheet considerations and market conditions. Furthermore, as leverage approaches the low end of our target range, you can also expect to see an increase in the pace of share repurchases. I’d now like to recap how we are differentiated from others in our industry, especially during a time when a number of our competitors are dealing with their own challenges. First, we are the largest player in the attractive U.S. debt purchasing market. Second, we believe our ability to collect on the portfolios we buy and a corresponding purchase price multiples lead to collecting more over a vintage’s lifetime, which in turn generates more cash, more earnings and ultimately higher returns. And third, our well-diversified global balance sheet allows us to allocate capital to opportunities with the highest returns. This flexibility is vital as demonstrated by our current allocation of the vast majority of our capital to our MCM business in the U.S. Our balance sheet also provides us the flexibility to fund our business in a myriad of ways. This provides a significant advantage in times when traditional markets become less certain and more expensive. In closing, I’d like to quickly summarize our third quarter performance. Portfolio supply in the U.S. market continues to grow to record levels, which is where we are currently focusing the majority of our capital deployment. Against this highly favorable backdrop, we deployed $230 million in the U.S. in Q3 at strong returns. In the UK and Europe, we are maintaining our discipline and continue to be very selective in our purchases until returns become more attractive. We are also rightsizing the business to reflect Cabot’s current purchasing levels. Our overall performance through Q3 is ahead of the expectations we last raised in August, driven by strong portfolio purchasing and collections. As a result, we are raising our guidance again. We now anticipate our global portfolio purchasing this year to be approximately $1.25 billion, an increase of $175 million when compared to 2023. This implies our Q4 purchasing to be approximately $400 million and is driven by continued strong purchasing at MCM as well as a large spot purchase at Cabot. In addition, we now expect our year-over-year collections growth to be approximately 15% to over $2.125 billion, an increase of over $250 million when compared to 2023. Now we’d be happy to answer any questions that you may have. Operator, please open up the lines for questions.

Thank you. [Operator Instructions] Our first question comes from Mark Hughes with Truist Securities. Please go ahead.

Yes. Thank you. Good afternoon.

Hi, Mark.

Ashish, you started off the call and you got some great slides on the supply increasing meaningfully in the U.S. and you’re investing a lot of money. And then at the end, you refer to capital allocation strategies. It seems a little at odds. How should we think about that? Is this kind of an indication that you think the charge-offs may be topping or rate of increase may be slowing and therefore, you’re preparing for the next stage? How should we think about it?

Mark, from – it’s in no way indication of any change in the U.S. market or globally the opportunities we have. So as I said in my remarks, let me recap. The most important thing and the first thing I said was we believe we have an advantage in terms of our competitors, whether it’s our collections operation and investing discipline and so forth. So the most important thing and the highest priority continues to be buying portfolios at strong returns. So no change there and particularly in the U.S., which is where we are continuing to buy portfolios at a healthy clip and as demonstrated by our track record. So no change on that front in terms of a belief in the market, which continues to be very favorable. ‘24 is going to be a record after ‘23 was a record, and we see continued growth in lending and growth in charge-offs, even if it’s somewhat plateauing at a higher level at a normalized level. So supply continues to be very strong. So our capital allocation priority change is along the next level that we indicate on that page. And there’s two parts to the change as we think about opportunities looking ahead. So first one is, as we’ve been observing the market and industry challenges, particularly some of our peers, as we’re often asked, we actually do not see opportunities for value-creating kind of strategic M&A at this point. And when time comes, we are far more likely to repurchase our own stock than acquire another firm. So that’s been implicit pretty much in our capital allocation priority and even more important, demonstrated in our track record over the years. So this time, we thought it would be helpful to our investors to be more explicit about this as opposed to being implied. And that’s why we chose to highlight that. The second separate element of our capital allocation, we did want to add kind of a color to it and our thinking and provide some of our thinking to the investors. And there, that’s about our balance sheet. And as we have stated many times, strong balance sheet – maintaining a strong balance sheet and flexibility is critical. And that includes a strong BB debt rating, operating within our target leverage range of 2 to 3. None of that changes. But as you’ve observed, and we wanted to comment and provide a color on it is even if we continue purchasing at strong levels or growing levels, our leverage will steadily decline. And therefore, what we are saying is, as it approaches the midpoint, we are more likely – we are likely to resume stock purchases – repurchases at that time, of course, always subject to balance sheet considerations and market conditions. And finally, as it approaches the lower end of the range, that pace should accelerate. Again, so there are two separate elements, and hopefully, this provides color kind of what we’re trying to do here, and it’s nothing to do about opportunity in the U.S. market chaning.

Appreciate that detail. Can you share the collections multiples as they sit for the U.S. core paper and the Cabot paper? I think the Q maybe is not out yet, but what collections multiple will we see on the 2024 vintages?

Yes. On the 2024 vintage for U.S., you will see a 2.3 multiple. And for our Cabot business, you will see a 2.3 multiple as well on vintage in the Q.

Okay. And then the – you mentioned a large spot purchase for Cabot in the fourth quarter. Did I hear that properly? And your large competitor also had some strong European purchasing. Is there something going on? Is that part of a broader trend or both of you happen to hit on the large opportunity at the same time in Europe?

Yes. So, I can comment about kind of our view. So, you have heard it correctly, Mark, that in Q4, we are expecting around $400 million in purchases. Now, that’s based on two things. Continued strong MCM purchasing in the U.S. as well as kind of normal Cabot purchasing, but there is one larger spot purchase that we got an opportunity. As you know, in UK and Europe, purchasing can be quite lumpy quarter-to-quarter, and that’s because there is more – there is a higher prevalence of spot deals in Europe and UK. And sometimes you win those, so that’s what happened. In terms of market overall environment to your other second part of the question, kind of over time, it’s steadily improving, but it’s not there yet in terms of fully reflecting the cost of capital, so still competitive. It has been improving over the last year or 2 years or maybe 18 months. So, it’s clearly a good trend. And therefore, we were able to get this one spot opportunity, and we wanted to provide that in advance as we have given the full year purchasing over to you.

And then just one more, with the strong cash flow, strong collections, a lot of purchasing, how should we think about the cost picture, the cash efficiency, is there prospects for leverage there, or are you going to continue to work those portfolios aggressively and so it should be relatively stable?

I think you hit on an important point. I mean our collections are growing faster than expenses. So, we are continuing to improve our operations, drive technology investments and whatnot. But overall, you are seeing scale effect and operating leverage. So, our collections efficiency margin improved from 51% to 53.6% in the current quarter. And I would expect that trend to continue in a steady way, just typical scale effect that one should see.

Thank you very much.

Thank you. And our next question comes from Mike Grondahl with Northland. Please go ahead.

Hey guys. Did you disclose collections kind of as a percent of expectations for both the U.S. and Cabot? Do you have those numbers?

Yes, Mike. So, in our slide presentation, we do disclose that in a footnote. So, this is just to clarify, versus expectations as of December 31, 2023. For Encore, that percent is 103%, for MCM in the U.S., it’s 105% and Cabot is 97%.

Okay. Great. And Ashish, do you think it’s fair your repurchase kind of reallocation or increasing the emphasis on that, is it fair to think about that as it kind of adds discipline to the process, especially at this stage? I mean if you can buy $282 million of paper, it doesn’t seem like it’s a wild stretch to buy $10 million or $20 million of stock in the quarter and that $280 million sort of pro forma would just be a little bit lower. Is that a fair way of thinking about the increased priority of a buyback?

I would anchor back to what we have said in our remarks, Mike, which is, so the first priority is buying portfolios at strong returns which we continue to do. Now, what’s happening is even if you buy at strong levels that we are, high levels and growing even, given our multiples and strong collections, we continue to de-lever. We can do both at the same time. And therefore, we wanted to clarify kind of if that continues, and we are not seeing strategic M&A as an opportunity. Once you come to the midpoint of that leverage range, we can resume stock repurchases. Now balance sheet strength and all of those considerations are paramount. So, that’s something we will always be focusing on. But that’s how we want to think about it at the midpoint of the range. Before that, buying portfolio is the number one priority given the opportunity we continue to see. And again, we expect to continue to de-lever while buying at very strong levels or even growing levels.

Got it. And do you have an active buyback in place? And how much is left on it?

Yes. There is an active buyback authorization. About $92 million is remaining on that.

Okay. And then Jonathan, a little bit ago, the Fed cut rates, 50 bps. If I recall right, about 25% of your debt float. Any rule of thumb you can give us sort of how to think about the Fed going down 50 bps or 25 bps and how that will translate for you guys?

Yes, great question. And just to level set you on what’s fixed and floating today. If you look at our – what’s fixed and hedged, we are actually about – as of September 30th, we were 99% fixed. So, I could tell you as of September 30th, there would be little to no impact. But as you could – when you think about it, as we use our RCF to continue retiring the bonds that we refinanced early in the year, we will be back up to a 20% to 25% range of floating, and that, I guess…

Is that by year-end?

That would be by year-end, yes.

Okay, 20…

We have already done one, and we will do the second this month.

Got it. Okay. Thanks guys.

Thank you. Our next question comes from Robert Dodd with Raymond James. Please go ahead.

Hi guys. Thank you for the clarity, very clear presentation on capital allocation priorities. So, the question I have is on legal. Obviously, I mean legal expense is up pretty significantly in the quarter year-over-year sequentially. Not surprisingly, given all the purchasing. But is this – should we expect that to continue? I mean obviously you had very strong purchases in purchase growth in ‘22, ‘23, and ‘24. And those are all, I would assume, start flowing into the legal process now. So, I mean is this new level, not a level set, but the beginning of a maybe slower, but a continued ramp as the last couple of years purchases flow through that kind of process?

Yes, Robert, so as we are buying increasing levels, they start going through the legal process. Now, we continue to be very consumer-focused and try to resolve as many accounts prior to legal process. But as the volume of purchasing is rising, you can expect the legal expenses to kind of steadily rise. Now overall, I would repeat the point that we expect to continue to see improved operating leverage, which is collections efficiency margin in terms of the overall cost structure.

Got it. Thank you.

[Operator Instructions] I am showing no further questions at this time. I would now like to turn it back to Mr. Masih for closing remarks.

Thanks for taking the time to join us today and we look forward to providing our fourth quarter and full year results in February.