PRA Group, Inc. (NASDAQ:PRAA) Q3 2023 Earnings Call Transcript

PRA Group, Inc. (NASDAQ:PRAA) Q3 2023 Earnings Call Transcript November 6, 2023

PRA Group, Inc. beats earnings expectations. Reported EPS is $-0.31, expectations were $-0.39.

Operator: Good afternoon and welcome to the PRA Group’s Third Quarter 2023 Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Najim Mostamand, Vice President of Investor Relations for PRA Group. Please go ahead.

Najim Mostamand: All right. Thank you. Good evening, everyone, and thank you for joining us. With me today are Vik Atal, President and Chief Executive Officer; and Rakesh Sehgal, Executive Vice President. 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 in the Investor Relations section of our website at www.pragroup.com.

Additionally, a replay of this call will be available shortly after its conclusion, and the replay dial-in information is included in the earnings press release. All comparisons mentioned today will be between Q3 2023 and Q3 2022, 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 September 30th, 2023, and December 31st, 2022. Please refer to today’s earnings release and the appendix of the slide presentation used during this call for a reconciliation of the most directly comparable US GAAP financial measures to these non-GAAP financial measures. And with that, I’d now like to turn the call over to Vik Atal, our President and Chief Executive Officer.

Vikram Atal : Thank you, Najim, and thank you for everyone for joining us this evening. In a few minutes, I will pass the baton to Rakesh to cover the financial section of our third quarter results. Prior to doing so, however, I feel that it is important for me to provide a link between the results we are reporting today, which closely parallel our prior expectations, and the confidence I have in the results we expect to realize over the next 12 to 18 months. We believe these future results will be driven by a combination of portfolio supply, pricing, operational effectiveness, and efficiency. First, portfolio supply and pricing. The chart on the upper left profiles our quarterly investments in Europe stretching back three years.

As you can see, purchasing levels vary throughout the year. This is due to the mix of spot transactions versus forward flows in the region, but the overall picture indicates relatively stable averages continuing into this year. Despite the competition in Europe, we continue to benefit from our deep relationships with sellers to maintain investment levels and renew important forward flow agreements. Moving across to the chart on the right, the US picture shows the correlation between the overall industry credit card charge-off operate and our portfolio purchases. We believe these recent trends will continue into 2024, providing clear opportunities for us to benefit from this important tailwind. It is worth pointing out that along with the growth in volumes, the return on our new purchases have improved over recent quarters and a substantial majority of our forward flows are now priced to reflect the current macroeconomic conditions and funding environment.

Because these increased volumes and return profiles are fairly recent developments, they have not yet flowed through our current results to any meaningful extent. We expect for this dynamic to positively influence cash collections and revenues through 2024 and beyond. Next, operational effectiveness. As I have referenced on previous calls, it is essential for us to not only focus on the front end of our business, purchasing portfolios at attractive returns, but also to optimize the value from our back book. Therefore, from my very first week as CEO, I have encouraged and challenged our team to re-evaluate and enhance our operational effectiveness. They have responded superbly. Over the past six months, we have identified, tested, and begun rolling out a wide range of cash generating initiatives, both large and small to address our performance in the US.

Some of these initiatives include enhancements to our legal collection activities where we are identifying new information sources to optimize the value and decision-making processes across this important channel. We are also leveraging additional third-party resources to bolster and accelerate our post-judgment customer interactions. Both sets of initiatives have identified significant opportunities that are now migrating into execution mode. Similar efforts have been made within our US call center operations with correspondingly encouraging opportunities. We implemented a wide range of operational strategy enhancements starting in the second quarter, expanded these in the third quarter, and are rolling out further initiatives this quarter.

These changes are driving increased customer contact rates and more effective customer interactions leading to a growth in payment plans and US cash collections performance that has modestly outperformed our internal expectations over the past six months. Due to the timeline between the actions being taken and the impact on cash generation, particularly within the legal channel, but also extending into the call center, the effect of these initiatives and enhancements are only minimally reflected in our year-to-date results. Finally, efficiency. Our relative underinvestment in platform and system upgrades will be a focus of ours in the time to come. Meanwhile, in the near term, there are tangible opportunities for us to improve our efficiency that don’t require complex changes to our core architecture.

Over the past six months, we have instituted initiatives that are improving call center productivity and optimizing our site footprint in the US. We have also piloted multiple programs with third parties to leverage lower cost locations to support both voice and data processes. The rollout of these programs has commenced in the current quarter with an expectation that we will expand these over the next 12 to 18 months. While growth in account volumes and expanded legal processes suggest a corresponding increase in expenses, we believe these anticipated higher expenses will be largely offset by the efficiency initiatives underway. In other words, growth in cash collections is expected to outpace our growth in operating expenses over the near term.

This should position us to march towards an improved cash efficiency ratio into the low 60s level. With growing portfolio supply, improved pricing, increased operational effectiveness in the U.S. and robust efficiency measures, we believe we have clear line of sight to deliver significantly improved financial performance in 2024 and beyond. The speed, scope, and impact of the effort underway have far exceeded my initial expectations. We recognize the need to deliver results for our shareholders, and we will not let off the pace at which we are working to achieve this. With that, it’s over to Rakesh for a review of our quarterly results.

Rakesh Sehgal: Thanks, Vik. Looking at our investments this quarter, we purchased $311 million of portfolios, up 70% year-over-year, this level of investment was driven by increased forward-flow volumes, purchases from new sellers for PRA, and a few spot transactions that were higher than anticipated. Given the strong investment levels to date, our diverse geographic footprint across Americas and Europe, and the healthy pipeline of portfolios for sale, we are well on track to achieve over $1 billion in portfolio investments in 2023, a feat we haven’t achieved since 2019. This demonstrates our ability to capitalize on industry tailwinds as credit normalizes. We are especially pleased that these recent investments are being achieved at improved prices and returns compared to the 2020 to 2022 time period.

In the Americas, we invested $232 million in the quarter, which represented the highest quarterly level of purchasing since 2017. We are highly encouraged by the U.S. market with investment levels increasing for the fourth consecutive quarter, as volumes and pricing continues to increase, this should have a positive impact on portfolio income, which demonstrates the significant opportunity ahead of us as we move further into the credit cycle. You can see prices improving by the purchase price multiple expansion in our 2023 Americas core vintage, which was initially recorded at 1.75x at the end of the first quarter, but has since grown to 1.9x year-to-date at the end of the third quarter. In our existing US overflows of fresh paper, we once again experienced a sequential increase in volume from the prior quarter.

A close-up of a senior executive in a suit, typing away on a laptop to complete the latest investments in debt securities and equity interests.

As mentioned earlier, our forward flow agreements now largely reflect the higher interest rate environment and should generate returns exceeding recent vintages ventures. At a macro level, active credit card balances in the US have exceeded $1 trillion, up from roughly $850 billion pre-pandemic. Charge-off rates are also trending higher, reaching 3.2% with signs of continued credit normalization from pandemic era lows, suggesting a continued tailwind. Moving to Europe. Our European business continues to capitalize on stable investment volumes. As many of you know, Europe is more of a spot-driven market and generally experiences lower volumes of supply in Q3, which is reflected in this quarter’s investment of $79 million. In the markets where we do have forward flows, the volumes remain stable and have yet to show an increase.

The European market continues to be competitive. And as we have done in the past, we are being very disciplined, ensuring that returns are appropriate. For example, we are observing that price discovery is in process in certain countries. We saw portfolios brought to market earlier this year that did not meet the seller’s internal pricing thresholds and were pulled. Some of these portfolios have since come back to market, and we have purchased them at improved levels of return. Moving on to financials. Total revenues were $216 million for the quarter. Total portfolio revenue was $212 million, with portfolio income of $119 million, and changes in expected recoveries of $22 million. Following a period of declines, portfolio income has been stable for the past several quarters.

And we now believe we are positioned for growth based on expanding volumes and improved pricing. During the quarter, we collected $18 million in excess of our expected recoveries, exceeding our expectations on a consolidated basis by 4%, with the Americas overperforming by 3%, and Europe overperforming by 6%. Operating expenses for the third quarter were $173 million, which were consistent with the prior year period. Of note, this number includes a non-cash impairment charge of $5 million related to our previously announced decision to cease call center operations at one of our owned regional facilities in the U.S. Agency fees were up $4 million this quarter, primarily due to higher cash collections in Brazil. Our legal collection costs were $21 million for the quarter, which were down $3 million from the prior year period.

We would like to reiterate our expectation for legal collection costs to be in the low to mid $20 million range in Q4. Our cash efficiency ratio was 58.9% for the third quarter, which was up slightly from the prior year period. We expect the cash efficiency ratio to remain relatively stable for the fourth quarter. Net interest expense for the third quarter was $49 million, an increase of $17 million, primarily reflecting higher debt balance and increased interest rates. We expect net interest expense to be in the low $50 million range for the fourth quarter. Our effective tax rate for the quarter was negative 28%. Looking at the full year, we expect an effective tax rate in the low 20% range. Net loss attributable to PRA was $12 million on negative $0.31 in diluted earnings per share.

This includes a $0.10 per share impact from the non-cash impairment I mentioned earlier. Cash collections for the quarter were $420 million, compared to $412 million in the third quarter of 2022. The 2% increase or 1% decrease on a constant currency basis was primarily due to higher collections in Brazil and Europe which were partially offset by lower collections in the U.S. During 2022, we were witnessing year-over-year declines compared to 2021 due to excess consumer liquidity during the pandemic era. The year-over-year decline has now stabilized and we expect this positive momentum to continue to build into 2024. For the quarter, Americas cash collection decreased 2% or 3% on a constant currency basis driven primarily by the impact of lower levels of portfolio purchases in the U.S. over the last few years.

Americas cash collections modestly exceeded our internal expectations for the quarter. European cash collections for the quarter increased 9% or 2% on a constant currency basis. Our year-to-date cash performance versus our expectations at December 31st, 2022 has experienced 5% overperformance in Europe and 3% underperformance in the Americas or 1% overperformance on a consolidated basis. Let me give you a little more color on what we’re seeing with our customers. There has been a lot of discussion in the news lately regarding pressure on the consumer. We have seen limited evidence to date that such pressure is impacting our US customers. Year-to-date, we’ve exceeded our cash collection expectations, particularly in our older vintages. In Europe, we have seen that the cost of living is having some impact on consumers in a few of our markets.

In these markets, we have observed fewer large one-time payments. However, the proportion of customers paying us has remained stable, so we think that this will cause a timing delay instead of an overall reduction in cash collections. It’s worth noting that the other markets are still performing well and that Europe as a whole has consistently exceeded our internal expectations. In both markets, it is our experience that economic downturns and increased pressure on the consumer have historically led to a more charge-offs and portfolio supply that more than offset the impact to cash collections. ERC at September 30th was $6 billion, which was up 12% compared to $5.3 billion at September 30th last year. On a sequential basis, ERC increased more than $70 million compared to the prior quarter, with ERC in the U.S. increasing by $135 million.

ERC liquidates over a shorter timeframe in the U.S., so it is encouraging to see our U.S. ERC increasing. We expect to collect $1.5 billion of our ERC balance during the next 12 months. It’s important to note that this number only reflects the amount we expect to collect on our existing portfolio. It does not include the cash we expect to collect from new purchases made over the next 12 months. Based on the average purchase price multiples we have recorded in 2023, we would need to invest approximately $841 million globally over the same timeframe to replace this runoff and maintain current ERC levels. With the continued build in U.S. supply, we anticipate that we will exceed this level of investment and grow ERC further as we close this year and move into 2024.

We have a strong capital structure with a debt to adjusted EBITDA leverage ratio of 2.8x at September 30. We expect leverage to increase slightly as we continue to deploy capital at favorable returns. However, our long-term goal is to have our leverage be in the 2x to 3x range. In all three of our credit facilities, we have deep banking relationships, many of which stretch back over a decade. In terms of funding capacity, we have $3.1 billion in total committed capital to draw under our credit facilities. Our bank lines have margins ranging from 235 to 380 basis points over benchmark that provide an attractive cost of capital in this market and give us an advantage. As of September 30, we have total availability of $1.3 billion, comprised of $278 million based on our current ERC and $1.1 billion of additional availability that we can draw from subject to debt covenants, including advance rates.

Given the build-in supply we are expecting, we believe the capital available under our credit facilities, the cash generated from our business, including the initiatives Vik mentioned, and access to capital markets in both the U.S. and Europe should position us well to take advantage of where we are in the cycle. It’s also worth noting that we do not have debt maturing until September 2025. Looking ahead, our capital allocation strategy remains focused on purchasing portfolios at favorable prices. We have recalibrated our net return thresholds in light of their higher interest rate environment, and we expect to see the positive impact of this in our financial results as we move through 2024. That being said, I am very encouraged by the early signs of financial and operational progress in our business, and the path that we have laid forward to create shareholder value.

Now I’ll turn it back to Vik.

Vikram Atal : Thanks, Rakesh. Building on the strong progress we made in the second quarter; the third quarter was another step in the right direction as we continue to capitalize on the growing portfolio supply in the US and execute on our initiatives. As far as the next few months and quarters are concerned, we are encouraged by where the business is heading. Do recap. One, portfolio purchases and pricing are improving, supported by the tailwind of increasing portfolio supply in the US and our strong and diversified positioning across Europe. Second, operational effectiveness initiatives are in motion and should generate appreciably more cash. And finally, expenses remain carefully controlled. These developments provide a strong framework to deliver significantly improved results in 2024. And with that, we are now ready for questions.

Operator: [Operator Instructions] And our first question will come from David Scharf of JMP Securities.

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Q&A Session

David Scharf: Hi, good afternoon and thanks for taking my questions. And welcome aboard, Rakesh, for I guess your first earnings call. So I guess a couple things, I first wanted to maybe drill down into kind of the purchasing environment and maybe the timing of how this is, you expect this to unfold with respect to your portfolio returns because obviously big question for investors is when we see sort of a return to consistent gap profitability. I believe you had mention that the overall collection multiple and therefore the yield, I guess it improved closer to 1.9x cumulatively from 1.7x earlier in the year. Can you give us a sense for when the weighted average yield on your portfolio is specifically the North American Core?

How long it takes at current pricing levels? How long does it take for the weighted average yield to return to 2019 levels? Because it seems like North American Core was sort of yielding mid to high 40% returns on a gross basis forever until 2020. Then it dropped about 10 percentage points into kind of gap loss territory. And it feels like it needs to get back to that mid to high 40% range, which corresponds to maybe anywhere from a 2.1 to a 2.4 multiple. Like, can you walk us through just the timing based on your expectations of purchase volumes and how long it takes kind of the old stuff to run off?

Rakesh Sehgal: Yes, so, sure, that’s a great question. So look, the way to think about it, and I’m glad you’re bifurcating the US versus Europe, because the way the cash comes in from a timing perspective in the US, it’s over a much shorter time period. I would say that most of the cash comes in, in the first, called it, four years. And so that’s why what you’re seeing is we’re very encouraged by the multiples we’re seeing in 2023. And between the volumes and the pricing that we’re seeing in 2023, what we’re going to see is that’s going to offset some of the lower volumes and the lower multiples that we saw in the 2021-2022 vintage.

David Scharf: Right. And I guess, Rakesh, just in terms of expectations for purchase volumes, I mean, is it mid-24, mid-2025? Just once again, trying to get a sense for how you see this transformation taking place, whereby the blended yield on your portfolio, which is what reaches sort of pre-2020 levels because that seems to be sort of the high almost the magical level to return to being a consistent gap earner.

Rakesh Sehgal: Yes, so a couple of things, right? So one is in terms of the purchase multiples that you mentioned. So remember that this is happening in the latest vintage. This is happening with respect to a different environment with the interest rates. And if we are blending towards the 190, you do the math as to when we started the year at 175. So we are obviously writing business at multiples that’s higher. And then second is you need to think about some of the initiatives that Vik mentioned. So what we’re doing in the short term here over the next 12 to 18 months where you’re going to see the fruition is the investment that we’re making with respect to how we run the business, whether it is internally or leveraging external bodies whether that is data, whether that is from efficiency or a cost effectiveness perspective.

And the combination of the two, our expectation is that that’s going to drive meaningfully higher numbers on the multiples in the next call it 24-month timeframe. And so between the offset of the existing book of the last two years, David, and the new initiatives, our expectation, and that’s what we’re focused on, our expectation is that we’re going to create significantly enhanced value on our cash collections.

David Scharf: Got it. Understood. And I appreciate the color. Maybe as a follow-up on that operational side, I know you referenced the US collection center being wound down. Are there efforts underway, I mean, are offshore collection capabilities being explored, either PRA zone or leveraging third party?