Encore Capital Group, Inc. (ECPG) Earnings Call Transcript & Summary

So hello, again, everyone. I'm Moshe Orenbuch from the specialty finance sector here at Crédit Suisse, and I'm very pleased to have with us Encore Capital today. We've got Encore -- we've got Encore's CEO, Ashish Masih; as well as CFO, Jon Clark, with us; and Bruce Thomas from Investor Relations. We're very pleased to have them. And the company is going to make a brief presentation, after which, we'll do a fireside chat with questions. So Ashish, over to you and your team.

Thank you, Moshe. And we will be sharing our presentation, a short presentation that we have posted and we'll only present some of the key slides from it. So Bruce Thomas is helping me do that. Bruce, if you could go to Slide 3. And I just wanted to take a moment to introduce Encore Capital Group to you all. And as the slide says, our focus has been on our 2 main markets, U.S. and U.K. And in these 2 markets, we are #1 in terms of dollars collected or pounds collected. And U.S., we are the largest debt purchaser. And in U.K., also, we are one of the largest debt purchasers, but we also have a servicing business that goes under the Westcot and a few other brands, and we are one of the largest servicing entity in U.K. as well that works with banks. And in servicing, we work in BPO or our fee-for-service basis. And as you can see, our estimated remaining collections, which is our future collections over the next several years based on our purchases to date, is $8.5 billion. And we operate in 8 countries. We have operations of our own in 8 countries with 7,700 employees globally. And with that brief introduction, I'll move to the next slide which talks about a bit our role in the consumer credit ecosystem. And it's a pretty important role. As you see from the picture, when issuers of consumer credit, whether it's banks or pure-play credit card issuers, they have delinquencies and when the consumer's charged off, they have a couple of options. They could service it internally, which is generally quite low in U.S. case. They do not have too many large internal operations. They can outsource or they can sell the debt. And that debt is sold to players like Encore. And we then buy it, and we hold it for life. We don't resell in U.S. any of our portfolios. And in U.K., as well, it's pretty rare to resell. So we hold on to the portfolios and take a very long-term view on the consumer and their situation, financial situation. We have a consumer-focused way to collect. We apply a lot of analytics. I'll talk about them. And then in the green box, as you'll notice, in 4 European countries, we do provide servicing to the banking clients in terms of third-party collections. All of this leads to returning capital to the banks and credit card issuers. And in our annual report we posted 2 days ago, we have a funnel picture in there, which can describe how much capital was returned by debt buyers. And in 2019, kind of last stable year, if you would, about $2 billion was returned by debt buyers to the banks; and in U.K., about $1 billion. And out of that, Encore had a very significant share, about 30% share in U.S.; and in U.K., a little bit less between 20%, 25% share. So that's the capital we returned back to the banks, and that's the role we play in the consumer credit ecosystem. So moving on to the next page. What's pretty unique about us is our scale and our focus on analytics. We have acquired over the 25-plus years in existence over 120 million accounts in these 2 markets. And we have a lot of data we've collected on consumers and accounts in terms of who pays; how much do they pay; when do they pay; do they start a payment plan, whether or nor they stop it. And that is proprietary data that you cannot buy from outside. So we use it in combination with data that a bank provides us when they're ready to sell a portfolio. We also supplement with external data such as credit bureau and telephone number and addresses and other things. And we use it. We have used it to build statistical models. We have large teams of data scientists and statisticians. And we have account level prediction models, which is what we use to underwrite a portfolio. And in that case, we predict an NPV of an account at an account level, kind of what's the likelihood of payment, how much will they pay, through which channel. And therefore, we are able to price the risk accurately for our portfolio. Now that's first stage. The second stage is to use those for actual servicing optimization. I'll give you a simple example. On the right, you will see the various channels. On the digital channel on a marginal basis, cost to collect would be close to 0 or very low. On legal, there's much significant cost. So what we use our models is to predict how much an account would pay in various channels, and we know the cost, and we make the best decision. And that decision is not static. Over time, as we learn about the consumer and the behavior or through the conversations or activity on our website, for example, we are able to recycle it back to continuous decision-making on those accounts that we own it for rest of life. And we also recycle back or kind of cycle back that feedback into improving the models for pricing as well as for servicing. So again, the scale is pretty unique that we bring to table. And it's unparalleled in terms of our ability to price risk and work their accounts. Moving on to the next part of the presentation. As I described, the role in consumer credit ecosystem is pretty straightforward, and our business, therefore, is pretty straightforward in some ways. We look to buy portfolios at attractive cash returns. So that's our decision-making cash-on-cash IRRs. We are very consumer and compliance focused, and I'll come back to that in a couple of slides. And we keep that focus in mind because we are in it for the long term, and we own the consumers account for many years. And we're looking to meet or exceed the collection targets we set at pricing stage. And we do it with low cost. We have large-scale presence as well as in countries where we can get cost advantages. And of course, we want to fund our purchases, and we'll talk about that again in a few minutes at the lowest cost of funding. How that plays into how we make money and how we succeed is pretty straightforward. We want to choose the best markets. So our focus is on the best markets. And in those markets, we want to be most competitive and continuously innovate to keep our competitive position. And then fund our purchases using a strong balance sheet and maintain a strong balance sheet as the market can be quite cyclical. And there are times when you need to really double down on purchases, for example, and a strong balance sheet helps us do that. So moving on to each one of these very quickly. In terms of market focus, there are certain attributes, we believe, are critical to -- for a market to be good. And U.S. and U.K. passed that criteria right now, which is consistent flow of opportunities from banks selling. Regulatory framework. We actually like good regulation, and that's focused on the consumers because that plays to our advantage. It also creates a deep and a wide moat around certain markets. In U.S., there's state-level regulation, there's federal regulation from the CFPB. And it creates barriers to entry for players who do not have access to large scale or capital. The other one is just sophistication and data availability. In certain markets, banks are very comfortable selling directly through forward flows. They have large teams in place that go and certify and audit the debt buyers. They have teams that sell as opposed to just depending on brokers, for example. The U.S. and U.K. are the most sophisticated. And their other markets are emerging. There's more mix of portfolios in those markets, SME, consumer and secured as well. And we have presence in Spain, France, Portugal and Ireland that we're looking to strengthen and gain even more scale than we have right now. And the last element is these markets are not dependent on just single events or big macro downturns. Although that increases the supply in the main markets, the sales happen on a regular basis quarter-over-quarter and year-over-year. So that's how we decide the best markets. And in the 2 that we have chosen, we are the leader. Moving on to the second pillar, maintaining competitive advantage. I already highlighted our scale and data advantages and modeling advantages. That helps us price risk, but regulation is also important. Good regulation, whether it's a CFPB or the FCA in U.K., creates predictable regulatory environment, which makes it hard for new players to come in. And it makes our life easy as we are very focused on the consumer and compliance. I'll give you an example. 10 years ago, we issued our first consumer bill of rights in U.S. We were the first one in the industry. In U.K., we have an institute for customer service that actually rates customer satisfaction across sectors in the economy, banks included. And in the bank's sector, financial services sector, our customer satisfaction scores, and these are public, are actually higher than all the high street banks. Believe it or not, in a collections business, you can achieve that. So that's a testament to the team in the U.K. And that is able to focus on consumer and still be able to collect and set them up on a payment plan that's very affordable, that's manageable for them, and they feel like they have been treated with fairness and respect. And all of that is enabled by technology and our efficient platform as well as now, increasingly so, digital capabilities. So a lot of consumers as they are very comfortable using digital when they are using their credit card and managing their accounts with the banks, that's what they seek when they deal with a collection company as well. And that channel is growing very rapidly for us. Moving to the next one, our third pillar. Balance sheet strength. It is something we've been focused on for the last 4, 5 years. Our leverage has come down very consistently over the years, whether it's debt-to-equity or debt-to-adjusted EBITDA, a measure that's more common in our industry. And most recently, Tomas Hernanz, who's on the call here, led the effort to really create a world-class financing structure for us. We combined our European and U.S. balance sheets into a well-diversified funding service that has a bank facility, bonds, convertible debt and a couple of other sources to create a low-cost funding structure that's very flexible. And that's going to be very important for us going forward in 2 ways. First, we have ample liquidity and dry powder when charge-offs will increase to buy as much portfolio as we want to. We are not restricted. Secondly, we do not have any restrictions in terms of which country to be deploying in. So whether -- whichever part of Europe or in the U.S., we have opportunities, we can deploy capital to buy the portfolios, which is our primary business. So to close out this section, 2 days ago, in our earnings presentation, we laid out our financial priorities. We mentioned return on invested capital as a way to measure our success and returns. And our goal is to deliver, and we have been, over time, delivering strong ROIC. We believe we have one of the best-in-class ROIC in our peer group in U.S. and in Europe. And we do it through the credit cycle, not just in peaks and valleys. Yes, it could go up or down a little bit, but our goal is and our track record is to deliver it through the credit cycle. We do it by maintaining a strong balance sheet. We have declared our target for leverage, between 2 and 3. We are at 2.4 currently. And our rating target as well. And that leads us to our capital allocation priorities, which is, obviously, buying portfolios at good returns, that is our primary goal. And we are always open to opportunistic M&A that may help build some skills, bring capabilities or allow for consolidation in the sector in U.S. and Europe. In U.K., we have done consolidation at -- and very successfully. When certain players look to exit, we got capabilities. As well as their back books, that have performed really well. And then share repurchase is also a key priority for us as we look to enhance shareholder value and keep creating shareholder value going forward. So those are our key financial priorities as we look at capital allocation, and we walked you through our kind of business model as well as what markets we choose, which ones we have chosen and how we compete on those. So thank you for the time to make this brief presentation, and I will now pause for any questions that might be out there.

So thanks, Ashish. [Operator Instructions] So maybe I'll kick it off. And I was hoping, Ashish, you could talk a little bit about -- you talked about the various markets. And maybe just talk a little -- in a little more detail about the ability to allocate the capital across those markets and what that does for Encore, what that allows you to do?

Yes, Moshe. So previously, we had 2 interesting balance sheets in U.S. -- one in U.S. and one in Europe. And given some of the concerns in the industry sector on leverage, Cabot, our European business, was a bit constrained in how much capital they could deploy. Since we have done this last September in 2020, now we can -- we have freedom and flexibility to deploy capital across the geographies. So our leverage targets and commitments to the banks and all that is on a global basis as opposed to by region or country. So we do not have any constraints on that front. I hope that addresses your question. I think I got it, but...

Yes. Yes. And when you think about like how different are the returns or investment opportunities in your major geographies right now. So -- yes.

Yes. So the opportunities right now are a bit in flux. When the COVID crisis started about a year ago, banks at that point took on -- increased their allowances very significantly in Q1 and Q2, expecting losses to happen within a few months. And consumer behavior has been anything but normal through 2020 as most of the CEOs and the earnings calls, you can hear kind of scratching their heads on, there is a downturn, there's like unemployment spike. But consumers are saving money and they're paying down their revolving debt as well as they paid us. So our collections have been strong as a result as well. They do expect, all of them, at some point, that will change. And unemployment is normally the most correlated or -- charge-offs are correlated mostly with unemployment rate, and that has not happened yet. And in the U.K., for example, there's extensive forbearance programs and furloughs that have suppressed unemployment rate. So unemployment in the U.K. has gone from 4 to 5, but there's a large number of people who are just being paid by the government. And when those fees end, there's going to be an increase and, therefore, impact on delinquencies and charge-offs. So what banks are saying right now, what we're hearing from them is some expect potentially by end of '21 supply to increase and others will expect in 2022, and that's true for both U.S. and U.K. In Europe, there's a bit more steady sales activity continuing because there's more secured, there's more mix of portfolios there, whether it's SME, consumer and secured as well as leftovers from the last Great Recession in some ways that banks are still continuing to sell or some funds who bought them and they resell the portfolio. So there's a bit more activity in Europe. And U.S., it's -- all the banks who sell are continuing to sell. There's been no pause. It's just the volumes in the contractual range are at the lower end of the range right now. That's what we are seeing.

Got it. So as long as they continue to be willing to sell, I think that's the key from your business. The other thing that you had mentioned at the very beginning of your presentation was your different collection strategies. Can you talk about how much of an impact on your returns can that optimization give you from where we are today or where we were in 2020? Like how do you think about the ability -- that ability to optimize? Is there a way to express that?

Yes. There is, I would say, at least we can qualitatively try to address. So one of the things we disclosed is the purchase price multiple, right? So in 2020, we bought a 2.5 multiple. For $100 million, you would expect $250 million over the life to collect. 10 years ago, our cost to collect was 1,000 basis points higher. So the same multiple now, it generates much higher returns over time. So we have become much more efficient in terms of our cost to collect. And we are booking at very strong multiples. Now typically, when supply will rise, multiples tend to improve as well because pricing should fall, but we are in a pretty comfortable place in terms of returns. We are achieving good returns. And our cost to collect trend over the long-term has been downwards. One of the biggest things that has been a consumer focus is -- consumer trend and our focus is digital. For example, in U.S., we continue to collect through digital as well as call centers much more. So 5 years ago, the breakup between legal and nonlegal was 50-50. Right now, it's close to 2/3 is coming from nonlegal, whether it's call center, digital channels. And they have very different cost to collect. So we are earning more for the same collections if we would even -- as we look ahead.

And that's a process that actually is iterative. In other words, it should continue to improve or at least be more optimal over time.

That is correct. I mean we saw a sudden increase in digital, a kind of a spike, but it is a long-term trend that's been going on and a constant push there. I'm sorry, I interrupted you. I think you had a question.

No. No. No, not at all. The next thing I want to talk about a little bit is you mentioned that you believe both from a scale and kind of expertise standpoint, you have advantages vis-à-vis competition. And so at any level of purchasing, can you talk about how that would benefit Encore both at today's kind of reduced levels of supply and at higher levels of supply as well?

So our scale allows us to price risk more accurately. So at times, you may find a small or midsized buyer comes in and takes down a flow perhaps, but that's it for them for the year. We can optimize purchasing throughout the year. And scale helps in 2 ways. We are collecting more. So our liquidation has improved, as we've shown in the past in some earnings presentations. Over time, we collect more for the same face value debt. And then our cost to collect is improving. So both dimensions continue to improve, and we're able to leverage our scale to kind of win portfolios that we want. And in U.S., especially many of the portfolios are long-forward flows. So once you win, 3 months, 6 months, sometimes 12 and occasionally a longer-term portfolio, that you can keep that advantage for a long time.

Got it. Got it. Can you talk a little bit about the competitive dynamic, if you would, in your 2 or 3 major markets at this point?

Yes. So the U.S. market has 2 large players, PRA Group and Encore, and there's a few midsized and smaller players. And that's been fairly stable over the last decade or so. There's been some consolidation. We bought 2 of our competitors, Asset Acceptance and Atlantic, in 2013 and '14. But largely over that time frame, it's been stable. And it's a very rational market. Banks are comfortable selling in. They're getting the capital and cash that they expect for the portfolios in terms of their recovery strategy that complements agencies and law firms. And players are rational as well. So we have not seen any, despite the up and down of the market in 2020, irrational behavior. Now occasionally, you'll find a portfolio here and there can go for -- that you scratch your head once in a while. But in general, it's a rational market. In U.K. as well, we've found market to be quite rational, although the competition level is a bit higher than U.S. There are a few more players. But FCA regulation still requires licensing and pretty stringent regulatory expectations and compliance expectations for only main -- kind of mainstream players to be able to buy. In Europe, you have a bit of a different dynamic. At times, you have certain funds that can go in and purchase portfolios, and they can use services to mark -- can service the portfolio. So you have a bit more competition. Now many of those funds often buy. And then 2 years later, they exit so that those resales are pretty common in Europe as well. And in Spain, for example, and we are able to buy some of those portfolios there as well.

Got it. As you kind of think about the competitive dynamic in a lower-supply environment for at least a period of time, and that may change later in 2021 or sometime in 2022. But do you see any situations potentially emerging where some of those competitors would want to combine? Is that something that you think is likely as a way to use some of your capital? Or is that because of the fact that they've consolidated some already? Are there opportunities or not I guess is the question.

Yes. Yes. I mean these things come up off and on, and we hear about all of them. I think that could -- I would say in the last cycle when supply started shrinking in 2013, '14, we bought 2 of the companies and others were consolidated as well. So I think some of those opportunities may happen. And it's possible for some of the smaller ones who may just decide they may not be able to survive because of their liquidity or whatever capital constraints they may have. And we'd be very willing to entertain and look at those because historically, we've done very well with those consolidation opportunities. And it's possible that in Europe, as well, something may happen. We haven't heard anything in particular. But I think if the pressure stays on for a bit, that could create some very interesting opportunities, and we'll be ready -- we'll be looking at it very fiercely, yes.

We've got a couple of questions in from the audience, which is always nice and a treat for us. I would say the first one was -- is, what do you estimate your free cash flow over the last 12 months after ERC replenishment? So how do you think about what that was over the last 12 months?