Encore Capital Group, Inc. (NASDAQ:ECPG) Q1 2024 Earnings Call Transcript

Encore Capital Group, Inc. (NASDAQ:ECPG) Q1 2024 Earnings Call Transcript May 8, 2024

Encore Capital Group, Inc. beats earnings expectations. Reported EPS is $0.95, expectations were $0.94. Encore Capital Group, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

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

Bruce Thomas: Thank you, operator. Good afternoon, and welcome to Encore Capital Group’s First Quarter 2023 Earnings Call. Joining me on the call today are Ashish Masih, our President and Chief Executive Officer; Jonathan Clark, Executive Vice President and Chief Financial Officer; and Ryan Bell, President of Midland Credit Management. Ashish and 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 first quarter of 2024 and the first 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 made available on the Investors section of our website. With that, let me turn the call over to Ashish Masih, our President and Chief Executive Officer.

Ashish Masih: Thanks, Bruce, and good afternoon, everyone. Thank you for joining us. I’ll begin today’s call with key highlights from the first quarter. Encore’s solid first quarter performance was driven by strong portfolio purchasing in the U.S. and double-digit collections growth on a global basis. Continued growth in U.S. portfolio supply, driven by both credit card lending growth and charge off rate at a 10-year high has led to very attractive pricing and returns. As a result, we continue to allocate the vast majority of our capital to the U.S. market, deploying a record $237 million in the U.S. in the first quarter. In Europe, the portfolio purchasing market remains very competitive. Although we continue to see some examples of improved pricing, we believe European portfolio pricing still does not consistently reflect the higher cost of capital caused by higher interest rates.

As a result, we continue to be very selective, which has led to reduced Cabot portfolio purchases. Overall, our performance in the first quarter was well aligned with expectations as portfolio purchasing, collections and cash generation are all off to a strong start in 2024. 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 an expected 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 macroeconomic 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 non-performing loans at attractive returns while minimizing funding costs. For each portfolio that we own, we strive to exceed our collection expectations while maintaining an efficient cost structure as well as ensuring the highest level of compliance and consumer focus. We 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 2 largest markets, beginning with the U.S. U.S. revolving credit has been steadily rising since early 2021. Each month for the last 2 years, the U.S. Federal Reserve has reported a new record level of outstandings. 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 a 10-year high. Similarly, U.S. consumer credit card delinquencies, 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, with continued strong growth in U.S. market supply and attractive pricing. The most recent delinquency data supports our expectation that 2024 will be another year of record portfolio sales by U.S. banks and credit card issuers.

With this environment in the U.S. as a backdrop, Q1 was another strong quarter of portfolio purchasing for our MCM business. We deployed a record $237 million in the U.S. at strong returns, the result of our disciplined purchasing approach amid an attractive pricing environment. MCM collections in the first quarter were $369 million, up 12% compared to the first quarter of 2023. In addition, throughout the quarter, consumer payment behavior remains stable. After expanding MCM’s internal collections capacity last year through the addition of approximately 500 account managers, we believe we are appropriately staffed to accommodate our higher recent purchase volumes. We expect the benefits from expanding our operations headcount will increase over time as these newer account managers gain experience and drive increased efficiencies and scale in our MCM collections operation.

In contrast to the U.S., supply in the U.K. has been growing much more slowly. Credit card outstandings are still not yet back to pre-pandemic levels as banks in the U.K., unlike those in the U.S., have not meaningfully increased lending since the pandemic. In addition, U.K. charge offs remain at low levels. Cabot’s collections in Q1 were $141 million, up 6% compared to the first quarter a year ago. Given the current state of the U.K. economy, we believe ongoing weakness in consumer confidence is marginally impacting one-time settlements while existing payment plan performance remains stable. We continue to be selective with Cabot’s portfolio purchases, which were $59 million in the first quarter. We have maintained a purchasing discipline in the face of portfolio pricing in Europe that we believe still does not yet consistently reflect higher funding costs.

We expect to continue to deploy at current low 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. 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 first quarter performance in terms of several key metrics, starting with portfolio purchasing. Encore’s global portfolio purchases increased 7% in Q1 to $296 million with record U.S. deployments in our largest business, MCM. This increased portfolio purchasing will help drive Encore’s collections growth over the next few years.

The fact that 80% of our global deployment in the first 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 toward our highest return opportunities. As market supply remains elevated in the U.S. and the pricing environment remains attractive, MCM’s ERC as well as our global total ERC continues to grow. The significant amount of ERC we are adding reflects the efficiency of our global capital deployment and is reflected in a higher purchase price multiples. This current highly favorable purchasing environment in the U.S. is allowing MCM to purchase portfolios at strong returns, which adds future cash flows and profitability to the business. Global collections in the first quarter were $511 million and were up 10% compared to Q1 a year ago.

The past several quarters of higher portfolio purchases, particularly in the U.S., has led to meaningful growth in collections. I’d now like to hand the call over to Jon for a more detailed look at our financial results.

Jonathan Clark: Thank you, Ashish. The first quarter was another period of strong purchasing for our U.S. business at attractive returns, while our collections grew in each of our key markets. Collections were in line with expectations for the quarter and we had small adjustments to our ERC which impacted earnings in a negative way. I’d like to highlight a few items and provide more detail. Q1 collections of $511 million was approximately $1 million above forecast. Small adjustments to our ERC resulted in negative changes in expected future recoveries, totaling $13 million, which reduced Q1 EPS by $0.46. ERC at the end of the quarter was $8.3 billion, up 7% compared to a year ago. Operating expenses remain well controlled and were up only 1% compared to Q1 last year as we begin to realize operating leverage and scale benefits of collections growth in our business, as well as the cost efficiencies that accompany a higher proportion of digital collections.

GAAP net income of $23 million and GAAP EPS of $0.95 in the first quarter were up 25% and 27%, respectively, compared to the first 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 3-pillar strategy. Similar to the dynamic Ashish mentioned earlier, higher portfolio purchases at strong returns over the past several quarters have also led to meaningful growth in cash generation, a trend we expect will continue. Our cash generation in Q1 was up 14% compared to Q1 of 2023. The third pillar of our strategy ensures that the strength of our balance sheet 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 though we continue to purchase at higher levels, our leverage declined slightly during the quarter given our strong cash generation. As we have discussed, this cash generation is driven by both the increased volume of purchases over the last several quarters and the higher returns associated with those purchases. Our leverage ratio of 2.8x at the end of the first quarter remains within our target range and is down from 2.9x at the end of 2023. With elevated interest rates and evolving conditions in the bond markets, I’d like to emphasize the importance of our global funding structure. 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 first quarter, you may recall that we issued $500 million of 2029 senior secured notes as a first-time issuer in the U.S. This offering expanded our options for future financing, establishing our access to the broad and deep U.S. high yield bond market. While we initially used the proceeds to pay down a revolver, we plan to eventually use the proceeds to redeem our 2026 sterling senior secured notes at par in November 2024. I’d like to provide some additional context for this transaction. It is the case that the coupon associated with the new bond is higher than the sterling bond it will replace.

Importantly, we’ve been building this kind of higher coupon into our bidding strategy since rates started to rise over a year ago. This is precisely why we have been emphasizing that pricing in the UK and Europe has not consistently adjusted to the currently higher cost of funding. In the U.S., however, market pricing has indeed adjusted to this higher cost of funding. I would also like to point out that our weighted average cost of debt on a pro forma basis after issuing the bonds and paying down the 2026 sterling notes is slightly below 6.5%. We also estimate this issuance and other recent movements will result in approximately $10 million to $15 million of additional interest expense through the end of 2024. Remember, if the current interest rate environment persists, then just as our cost of debt may increase over time, so will the positive impact of our investments in portfolios with higher returns.

With that, I’d like to turn it back over to Ashish.

Ashish Masih: Before I close, I’d like to remind everyone of our commitment to a consistent set of financial priorities that we established long ago. The importance of a strong, diversified balance sheet in our industry cannot be overstated, especially in the midst of the highly anticipated growth in U.S. market supply. We will continue to be good stewards of your capital by always taking the long view and prioritizing portfolio purchases at attractive returns in order to build long-term shareholder value. I’d now like to describe 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 our 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. 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 allocation of the vast majority of our capital to our MCM business in the U.S. in order to maximize overall returns. 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. And finally, our $8-plus billion of ERC represents our enormous capacity to generate cash.

In closing, I’d like to quickly summarize our first quarter performance. Portfolio supply in the U.S. market, where we are currently focusing our capital continues to grow to record levels. Against this favorable backdrop, we deployed a record $237 million in the U.S. in Q1 at strong returns. In the U.K. and Europe, we are maintaining our discipline, being very selective in our purchases, and constraining our capital deployment until returns become more attractive. Our overall performance in Q1 was well aligned with expectations and 2024 is off to a strong start. Driven by a strong first quarter performance and the disciplined execution of our strategy, we remain on track to deliver on our 2024 guidance provided in February. This guidance called for portfolio purchasing this year to exceed our 2023 total and for our collections to grow approximately 8% to over $2 billion.

Now, we’d be happy to answer any questions that you may have. Operator, please open up the lines for questions.

Operator: [Operator Instructions] Our first question comes from John Rowan of Janney Montgomery Scott.

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Q&A Session

Ashish Masih: John?

Jonathan Clark: Hey, John, we can’t hear you.

John Rowan: Sorry, my phone was on mute. Can you hear me now?

Ashish Masih: Yes.

John Rowan: Okay. So, I guess, Jon, just to unpack kind of the commentary around interest expense, you said 6.5% is kind of the current weighted average cost. You said $10 million to $15 million of additional interest expense by the end of the year, if I wrote that down correctly. I guess, I’m just trying to understand, is that a run rate per quarter? Or maybe if you could just give us what the weighted average cost of your interest will be once you do refinance those notes in November?

Jonathan Clark: No, that’s — John, that’s the — that’s a good question. To make it clear, that’s what the 6.5% is, right? And it is assuming that we refi the bonds. So it’s not that we pay down the bonds. So this is the full round trip, if you will, right? It’s not just raising money and paying down a revolver. It is then taking the money, the capacity from the revolver and paying down the sterling bonds. That’s [indiscernible] the 6.5%.

John Rowan: Okay. How much would that raise your — I mean, I guess raise your cost of funds in general? Maybe like what is the $10 million to $15 million? Is that just for the fourth quarter? I’m just trying to make sure I get the guidance correct.

Jonathan Clark: Yes, $10 million to $15 million is for the balance of the year.

John Rowan: But that’s only — but if you’re doing that in November, so that’s only for November and December, then?

Jonathan Clark: No, this is assuming everything happens in November and assuming it all plays out as we just talked about. From a modeling perspective, we can assume $10 million to $15 million between now and the end of the year.

John Rowan: Okay. So over — so that would be in addition to the kind of the 1Q run rate of $50 million, $56 million?

Jonathan Clark: That would be in addition to the $235 million that we gave as guidance, soft guidance kind of prior, right? We told people what we thought would be a quarter ago.

John Rowan: Okay, so $235 million plus $10 million to $15 million would get you to like $245 million to $250 million for the year of interest expense?

Jonathan Clark: Correct.

John Rowan: Okay. All right. Perfect. I guess — and just while I have you, can you remind us what the $2.7 million of other income was?

Ashish Masih: Usually in the — what is contained in other income is derivative impacts and things like interest income, which we — we do have a few pockets around the world where we have funds, where they earn interest. It’s not what we normally do with funds, but when you have interest income such as that, that’s where they fall. So interest income, if you look at the 3 months ended March 31, ’24 versus year end or prior year, the difference there would just be some increase in interest income and some increase in gains and derivatives.

John Rowan: Okay. And then just last question for me. Obviously, you had $13 million of negative forecast revisions, but $1 million of cash over collections. Can you remind me if there’s been a quarter where you’ve over-collected but impaired forecast revisions? Obviously, I guess, I’m trying to get to any sort of — I don’t want to say guidance, but an understanding of if we’re close to the cycle where you’re done kind of revising forecasts down. Obviously, if you’re over-collecting your forecasts, it seems kind of antithetical to also reduce forecasts as well. I realize one’s longer dated than the other, but I’m just trying to understand the relationship, if any, between those 2?

Ashish Masih: Yes, it’s a very good question, and I’ll try to keep this very high level because we can get the weeds very quickly. They are separate and distinct things. One is obviously a current cash impact and the other one is a change in expectations. But they — as you alluded to, they are also interrelated. So as an example, you may have a significant over-collections in the current period, but then have a negative revision to your forecast, which is solely means you decided that over-collections was a pull forward, not a betterment on your curves. So they are interrelated. And you have to remember a lot of moving parts underneath. Not all portfolios are moving in the same way in both how we collect it or expectations, and this is just the summation of how they landed. Does that make sense to you?

John Rowan: Yes. Okay. The pull forward makes sense. I appreciate it.

Operator: [Operator Instructions] Our next question comes from Mark Hughes of Truist Securities.

Mark Hughes: Jonathan, I’m going to ask that same question. You gave the $235 million soft guidance, an extra $10 million to $15 million. If you’re doing that transaction in November, is there going to be incremental interest expense prior to that or is that — yes?

Jonathan Clark: Remember, Mark, it’s short term. What we’re doing is we’re paying down a revolver at x rate and have created new funding at y rate, so there’s that delta as well, right?

Mark Hughes: And when does that transaction take place? If you could…

Jonathan Clark: Well, no, the first step….

Mark Hughes: If you look at the $10 million to $15 million. Yes.

Jonathan Clark: I’m referring to the first step, which has already taken place, right? So we already have the U.S. dollar bond and then we pay down revolver, but revolver attracts a lower rate than the bond, right? So that’s — if that’s — if you’re searching for what’s the incremental drag, if you will, that’s where it comes from. Does it make sense?

Mark Hughes: Right. And that would be — it does. That would be spread out evenly between now and the year-end.

Jonathan Clark: Now until November, correct?

Mark Hughes: Okay. And then there’s a more substantial impact post November.

Jonathan Clark: Well, just, no. There’s — when you — if you think about it, all we’re doing, we have this negative carry if you will, because of the transaction we did. And then we’re unwinding that, if you will, right? So our revolver will go up and we’ll still have — and our older, lower cost bond, if you will, will go away, the sterling bond will go away. So I wouldn’t get hung up on. There’s just some puts and takes, but the rest of the transaction will happen in November.

Mark Hughes: Thank you for that. And then the — did you, on the call, mention the collections multiple on the 2024 paper? I assume it’s in the queue. I haven’t taken the opportunity to look at it. But how did that multiple come in relative to the 2023? I don’t know, maybe for U.S. or the U.K. — and the U.K.

Ashish Masih: We did not provide that multiple, but it’s 2.4. This is Ashish, Mark, so it’s 2.4 for us in 2024. And Yes, so overall, just to step back, supply is still very strong, pricing remains very favorable, the way it’s been recently. So we continue to feel very good about how pricing is going and how multiples are going. Just remember, multiple is one element of a return, the shape of the curve cost to collects at times. We have portfolios, we buy that are lower multiple and much lower cost to collect. So that mix effect also plays out on a quarter-to-quarter basis, just to keep that in mind. But overall, supply and return picture looks very similar and very favorable and we booked a very good multiple for U.S. this quarter.