On Wednesday, November 9th Encore Capital Group (ECPG), reported its financial results for the third quarter of 2016, reporting a loss of $1.5 million in its third quarter. On a per-share basis, the San Diego-based company said it had a loss of 6 cents.

The company also hosted a conference call to discuss the results. ECPG is an international specialty finance company with operations in eight countries that provides debt recovery solutions for consumers across a broad range of assets.

Highlights for the Second Quarter of 2016:

  • Investment in receivable portfolios was $206 million, including $142 million in the U.S., compared to $187 million deployed overall in the same period a year ago.
  • Gross collections declined 4% to $407 million, compared to $422 million in the same period of the prior year.
  • Total revenues were $179 million, compared to $279 million in the third quarter of 2015, with the difference primarily driven by a $94 million gross consolidated portfolio allowance charge.
  • Total operating expenses decreased 19% to $201 million, compared to $248 million in the same period of the prior year, primarily reflecting the benefits of strategic cost management programs and the impact of the CFPB settlement in the third quarter of 2015. Adjusted operating expenses increased 1% to $167 million, compared to $165 million in the same period of the prior year.
  • Adjusted EBITDA decreased 7% to $245 million, compared to $264 million in the same period a year ago, reflecting the adjustment to deferred court costs.
  • Total interest expense increased to $48.6 million, as compared to $47.8 million in the same period of the prior year, reflecting the financing of recent acquisitions and portfolio purchases.
  • GAAP loss from continuing operations attributable to Encore was $1.5 million, or $0.06 per fully diluted share, as compared to a loss of $13.2 million, or $0.52 per fully diluted share in the same period a year ago, reflecting the allowance charges for certain European pool groups in the third quarter of 2016 and the impact of the CFPB settlement in the third quarter of 2015.
  • Adjusted income from continuing operations attributable to Encore was $3.6 million, compared to $32.2 million in the third quarter of 2015, with the decline mainly attributed to the portfolio allowance charges for certain European pool groups.
  • Adjusted income from continuing operations attributable to Encore per share (also referred to as Economic EPS) was $0.14, compared to $1.25 in the same period of the prior year. In the third quarter of 2016, Economic EPS was not adjusted for shares associated with Encore’s convertible notes. In calculating Economic EPS for the third quarter of 2015, 0.8 million shares associated with convertible notes that will not be issued but are reflected in the fully diluted share count were excluded for accounting purposes.
  • Estimated Remaining Collections (ERC) increased 1% to $5.73 billion, compared to $5.65 billion at September 30, 2015.
  • Available capacity under Encore’s revolving credit facility, subject to borrowing base and applicable debt covenants, was $176 million as of September 30, 2016, and total debt on a consolidated basis was $2.8 billion.

insideARM perspective

We have commented before that ECPG and Portfolio Recovery Associates (PRAA) quarterly reporting provides an excellent overview of the debt-buying industry. We also suggest the reports should be viewed together. (Editor’s note: PRAA reported their second quarter earnings on November 7th. insideARM will also report on that announcement today.)

As usual, the earnings conference call is always more interesting than the raw numbers.  Five items stood out.

First, during the earnings call, Kenneth A. Vecchione, ECPG President and Chief Executive Officer discussed pricing and supply:

“We believe we are seeing a turn in our industry cycle in which pricing and supply are improving. The U.S. market for charged-off receivables is becoming an increasingly attractive market for us and continues to show signs of improvement. Supply in the U.S. is on track to rise 15% in 2016, accompanied by meaningful declines in price from last year. Newly committed forward flows are being booked at higher returns for 2017 than they were for 2016, a continuation of the trend we have been seeing for approximately the last 12 months.”

Second, Vecchione also discussed the litigation process on domestic accounts:

“In the domestic market, issuers have now caught up with our documentation requests to support our legal collection efforts. We do not see this as a problem going forward, and indeed the improved documentation is enhancing our legal collections.

Although we have encountered delays in both collection and expenses, we are beginning to ramp back up to a more typical collection run rate, and expect to be fully ramped as we enter 2017. Legal collections delayed in 2016 will be shifted to 2017, with no material impact to revenue.”

Third, Vecchione commented on the CFPB debt collection rule making:

“I would like to remind everyone that we are entering one of the last phases of the CFPB's formal rule-making process. When we spoke about this a quarter ago we acknowledged that the new rules were going to create a level playing field for participants in the US market, that the outline of proposed rules aligns well with Encore's current practices, and that we were pleased that many of the proposed rules were consistent with our own recommendations or current practices. Because of this alignment, we believe we are well positioned and, in fact, far ahead of others in the industry as these new rules are rolled out.

The substantial investments of time and resources we have made over the last several years have developed our compliance pedigree and given us a competitive advantage. I'd like to add that we continue to have thoughtful dialogue with the CFPB on several areas of the proposed new rules where we suspect that a small subset of the current proposals may lead to unintended consequences for consumers.”

Fourth, an analyst asked about the dispute process and its impact on collections and expenses. Ashish Masih, Encore Capital Group, Inc. - President, Midland Credit Management responded:

“As you can imagine, due to the nature of a collections business, there are always some consumers who will dispute the debt, including in our call centers when they speak to our account managers.

Now through training, we have been able to ensure that consumers truly understand the origin of their debt and not dispute it. We have found dispute volumes in our call centers very much in control since the consent order went into effect earlier this year.

Now that said, there are some consumers who still feel the need to dispute, and we have a process -- we have always had a process, actually -- to pause collections temporarily while we investigate the dispute reasons. And this temporary pause is not a new process for us. We have always had this.

What is new -- to your question -- is that since the consent order, when consumers dispute, we are now required to send the documentation to the consumer. What we have found is over the last several months, about half our disputed accounts, or cases, we have the documentation ready and we are able to respond to the consumer within two or three days, in a very timely manner, and put the account back into collections. So there is no delay.

For the remainder, we are able to go back to the issuers and sellers, and in majority of cases, obtain the documentation. It takes a month or two. But for the majority, we are able to do that. Now, just keep in mind, for more recent purchases and for all future purchases, we receive full documentation on all accounts in a portfolio, so over time, this minor issue will become even smaller over time.

And in terms of collections impact, we have actually not seen any negative impact of these disputes on our collections. We also have staffed up well in advance of the March deadline -- implementation deadline that we had, so our current expenses also fully reflect on that staffing, as well.”

Finally, a financial analyst asked management a very good question – “If pricing continues to improve like it is now, is there any risk that some issuers could pull back from selling, maybe perhaps off to keep some more and just use third-party agencies instead of selling to third-party debt buyers?”

Vecchione’s response was interesting and somewhat negative to the traditional third party ARM community. Vecchione commented:

“I think that's a well-thought-out question. And we wrestled with that, as well, but I will tell you where I think the market's going. The proposed CFPB rules, which has in there contacting consumers six times a week. We believe that agencies will not be able to figure out that puzzle. We are well on our way to figuring it out, and I think our decision science support is world-class.

So if the larger issuers are going to move money over to the agencies, I don't think the agencies are going to fulfill their expectations -- that's one. But the other story is capacity. We do not believe that some of the larger issuers have the ability to ramp up their capacity. We don't believe that the agencies can ramp up their capacity in a way that will be effective, given where the new proposed CFPB rules wind up.

Even if those new rules go from six times a week to a greater number, we still don't think that they're going to be as effective. And I think that's why we're comfortable that debt sales will continue to occur at the pace that they have been occurring at.”

Per Zacks Equity Research, both PRAA and ECPG missed analysts estimates revenue and net income for the quarter. PRAA missed Consensus Estimates by less than 5%.  ECPG missed Consensus Estimates by 88%.

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