PRA Group, Inc. (PRAA) Earnings Call Transcript & Summary

Thank you. Hello, and thank you for joining us. I'm Mark Hammond, the High Yield Financials' analyst at BofA Securities. I'm pleased to have PRA Group with us today. From the company, we have Pete Graham, CFO; and Darby Schoenfeld, VP, Investor Relations. We have 30 minutes in total today. We will start with an introduction from Pete and Darby, move into some discussion between myself, Pete and Darby, and then wrap up with our participant -- question-and-answer session. [Operator Instructions] With that, I will turn it over to the company.

Great. Thanks, Mark, and we're glad to be here today virtually. Maybe I'll start just with a little bit of background on the company, PRA Group. We're a global leader in purchasing collection of nonperforming loans. The company was founded in 1996 and has been public since 2002. We're unique in our industry. In that, we've got 2 of the original founders still in leadership positions as the CEO and Chair of the Board, respectively. And we've got a very seasoned management team that's been through multiple economic cycles in our industry and a demonstrated strong track record of success. We are focused on steady growth through disciplined portfolio investment and disciplined use of leverage. We're geographically diversified with portfolio investments across 17 countries throughout Europe and the Americas and soon to be 18 with our expansion into Australia. Our estimated remaining collections, which is the cash that we expect to collect in the future as of the Q3 balance sheet date, was $6.3 billion with 50% in the Americas and 45% in Europe. Cash EBITDA generated by the business in the last 12 months ended September 30 was $1.3 billion. And a key leverage metric for our industry debt to adjusted EBITDA, we're at 1.9x as of September 30, 2020. And over that same sort of trailing 12-month period, we invested approximately $1 billion in portfolio during that time period. So just a quick sort of snapshot of the company. And I guess, Mark, I'd turn it back to you for Q&A.

Yes. Thanks, Pete. Could you just go over some recent performance of the company year-to-date, including the COVID impact on the business?

Yes, sure. This has been a pretty interesting year for us, I think, for a lot of companies. We came into this year feeling like we had some cyclical tailwinds in terms of charge-off levels and portfolio supply. And we were off to a pretty good start when COVID hit mid-March. We went into work from home immediately for the bulk of our corporate and support functions. But our call centers largely, in the U.S., have remained open as we met the criteria for essential business in a variety of different states where we operate. So we were fully functional. In Europe, we had kind of a mix of work from home, depending on geographic location. But the regulatory framework in Europe is much more amenable to work from home even for the collector workforce. So we -- even though we had a much higher percentage of the workforce working remotely, we were still able to remain pretty effective through sort of the depth of the lockdown period in the early summer. We expected to have some degradation in performance in cash collections as we went into this COVID time frame, and we took some adjustments in our first quarter results to reduce our expectations for cash in the future. And largely in Europe, we're pretty close to the mark in the second quarter with that. But the U.S., with a variety of things happening in the environment between stay-at-home orders, deferral programs early on, we had the direct-to-consumer stimulus. We had enhanced unemployment benefits and all these things contributing to increased liquidity for consumers in the U.S. drove much higher collections than we were expecting. And that continued second quarter and into third quarter. So that kind of through the end of the third quarter for the 9 months, we were in excess of $200 million above our expected collections for that time period. And we've cautiously assumed that, that's acceleration from collections that we would have gotten later in the curve, just given this unprecedented amount of liquidity that particularly the U.S. consumer has. And so we took adjustments to our future ERC to reduce that we took an NPV charge of about $180 million for that 9-month period. So on balance, net positive in terms of revenue, but really a unique thing that we've never experienced in our long history in this business through many cycles, really an unprecedented time for us.

Thanks, Pete. And another somewhat, maybe not unprecedented, but unusual bit that's happened in the past 2 quarters, is your cash efficiency ratio has improved. And I'd hope you'd be able to just talk a little bit about that also somewhat perverse in the environment. But nonetheless, I...

Yes. So there's -- there's a few things going on there: One, I'd say any of our metrics that are keyed off cash collections are skewed somewhat by this overperformance that we're experiencing. But also during this COVID environment, particularly in the second quarter, we had a dramatic reduction in expenses, which is the other piece of that equation. So our -- particularly in our legal collection channel, we -- in the U.S., we paused new placements into the legal channel in mid-March and did not reopen that channel for new placements until June. So that had a depressive effect on the amount of legal spend. We had been running at $30 million to $35 million a quarter in expenses there. And that was dramatically reduced in the second quarter. And then as we've come back out of the lockdown period and into the back half of the year, we've seen that again, and we attribute this to acceleration because of the liquidity in the consumer's pocket and the increased contactability and willingness to engage with us voluntarily, we believe a lot of this collections that we've experienced in excess of our expectations is a pull forward from further in the channel. And so our legal inventory right now is much lower -- or legal eligible inventory is much lower than what we would have otherwise thought it would be. So that's another thing we're pointing to there. And so that's going to result in kind of lower levels of legal costs than what we had been running at previously. At the margins, that was true also for Europe, we had closure of the court systems, the bail systems in Europe during the summertime. That's now largely reopened. And even though they're kind of sliding back into rolling lockdowns around Europe, it's a little more targeted, at least so far this time than last. And largely, our expectation is that the court systems and the bail systems that are key to collections in Europe will continue to function at kind of a normal pace. The other element that went into this, particularly in the second quarter, was furloughed employees and folks not hourly folks in the U.S., not showing up to work early in the pandemic. And so that had a depressive effect on our salary expense during that time period. It's largely normalized now. And we expect that kind of the run rate that we've been experiencing in the third quarter will largely hold as we move into fourth quarter and beyond.

Got it. Thanks, Pete. To switch topics a little bit to the upcoming federal administration changes. Would you be able to talk a bit about whether you see any policies or proposed policies from the administration -- new administration that might impact for better or for worse PRA?

Yes. Sure. I think with a lot of things -- a lot of things are hinging on what happens in the recount elections in Georgia for the Senate. But if it's sort of evenly-divided Senate or if it stays in Republican control, I think that's going to limit in some respects, some of the more maybe radical things that might be proposed by the new administration. So time will tell there. I think at any rate, the rule set that we've been operating under our consent order for many years, that originated in a Democrat control of the CFPB when it was originally constituted, we believe that the rules in our consent order are best practice for our industry, and we intend to continue following those even though the time period on that consent order has sunset this year. The new rules promulgated by the CFPB recently, we feel they are a good framework for our industry. And the unique thing and the good thing for PRA and I think for the industry in total is that it's a rule set that applies evenly to everyone in the industry, whereas the consent orders that we had been operating only applied to ourselves and our main competitor, Encore. So having a set of rules that's consistent for the entire industry, I think, is good for everybody. The CFPB has also said that they intend to release some additional rules in December that will largely focus around disclosure-related elements. And again, I think having a rule set that's consistent for the entire industry is good for everyone. And even if we get a change in administration at the CFPB, we think that having that regulator promulgate rules in a way that is standard practice for the regulators in the federal space, publishing rules, exposing them for comments, publishing final rules and then giving time to implement. I think that's the way that regulator is going to operate, whether there's a change in the top of the regulator or not. So I think that's good for the industry, having consistent rules that everybody understands what we're being held accountable for.

Yes. Got it. And on the regulatory front, if you could, in just a very brief way, for someone who may have not heard of PRA before, just the regulatory history of the last 5, 10 years and how it's changed the industry better, but I'll leave that to you.

Yes, sure. No, I think this industry went from one that was largely regulated by various state entities to one that has got a regulatory framework at the federal level. And so it's -- it really kind of falls into a couple of key parts. One, is the OCC regulation of the banks as to what they need to -- what things they need to do and rules they need to follow to engage in debt sale. And so in 2014, the OCC issued guidelines on our industry, in essence, from their position as the regulator of the selling banks. One of the key components in that set of rules or guidelines is the requirement that the selling banks need to assess the buyer's ability to comply with the rules and have fair customer treatment and an increased audit requirement around those aspects. And so that was the first kind of key piece of regulation around the debt sale space. And then separately and the close follow was the creation of the CFPB. And unfortunately, the way that the CFPB went around -- went about creating rules was to create rules by enforcement. And so for our -- they basically came to ourselves and Encore and institute of consent orders, which, we believe, are best practice for collections, practices and procedures. And we've built a compliance management system to comply with that rule set. So as I said before, even though our consent order sunset in September, our intention is to continue operating under the same sort of compliance management system that we built to comply with the consent order. And our hope and expectation is that as the CFPB continues its rule-making process that it will continue to codify and clarify some of the things that were already implied in the way that the consent orders were structured. It was our early belief that -- and I think perhaps the CFPB's belief that if they created these rule sets for the 2 largest players in the industry, all the others would sort of follow along with that. But as time went by, it became apparent that because there was not a rule set that was consistent for the entire industry, not everyone was following the rules, and there wasn't a level playing field. And we believe the new rules published by the CFPB and the ones that are potentially coming in December will create that level playing field for everyone in the industry.

Got it. Thanks for the recap on the regulation. To turn back to today, could you talk about the competing or the differing opinions in the market about the supply environment over the next year or so, whether it's going to come, it's going to be delayed, it won't come at all due to the higher level of unemployment in the tapering off of federal and state unemployment benefits?

Yes, sure. I think we've been pretty consistent in our commentary around supply. Our view is that it's not a question of if, but when. Certainly, the U.S. with the factors that I talked about in terms of our cash collections performance this year, I think all those factors are also impacting the originating issuers in terms of pay down of balances and reduce delinquencies. But if you look at the provisioning that those banks have done, and you listen to their commentary, and then I would include our commentary with issuers as well. I think they expect that at some point in 2021 that those delinquency metrics will start to tick up and that charge-offs will follow. We've seen -- and Kevin talked about it on our most recent earnings call, we've seen some analyst reports that sort of translate the provisioning to date into a forward-looking charge-off ratio, and it's a pretty significant move from where we are now. And so our expectation is for the U.S. in probably the second half of next year, we'll start to see elevated levels of delinquency and charge-off manifesting in the portfolio and translating into that sale. In Europe, there wasn't as much direct stimulus implemented. So I think that trajectory is probably going to be a little more "normal" from what we would expect in a credit cycle. The selling banks in Europe largely paused when the COVID crisis first started, but they started to reopen their debt sale processes beginning kind of June, July time frame. And as we said on the call, we feel like we've got a pretty good pipeline of portfolio activity in Europe. And we said in the second quarter, we thought that the lower level of investment in the second quarter would likely be a pause in come back to market, probably in the second half of the year, and we're seeing signs that, that's actually occurring. And so we expect that portfolio supply in Europe to be strong going into the first part of next year. So a little bit different sort of pattern than the U.S., but I think, ultimately, the U.S. will catch up as well.