Encore Capital Group, Inc. (ECPG) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2016 Encore Capital Group Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at this time. [Operator Instructions] As a reminder, today’s conference may be recorded. I would like to introduce your host for today’s conference, Mr. Bruce Thomas, Vice President of Investor Relations. Sir, please go ahead.

Thank you, operator. Good afternoon, and welcome to Encore Capital Group’s second quarter 2016 earnings call. With me on the call today are Ken Vecchione, our President and Chief Executive Officer; Jonathan Clark, Executive Vice President and Chief Financial Officer; Ashish Masih, Executive Vice President, U.S. Debt Purchasing and Operations and Paul Grinberg, Group Executive, International and Corporate Development. Ken and Jon will make prepared remarks today, and then we’ll be happy to take your questions. Before we begin, we have a few housekeeping items. Unless otherwise noted, all comparisons made on this conference call will be between the second quarter of 2016 and the second quarter of 2015. Today’s discussion will include forward-looking statements subject to risks and uncertainties. Actual results could differ materially from these forward-looking statements. Please refer to our SEC filings for a detailed discussion of potential risks and uncertainties. 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 earnings presentation, which was filed on Form 8-K earlier today. As a reminder, this conference call will also be made available for replay on the Investors section of our website, where we will also post our prepared remarks following the conclusion of this call. With that, let me turn the call over to Ken Vecchione, our President and Chief Executive Officer.

In the second quarter, we earned $1.29 in economic EPS, growing 7% compared to last year, assisted by higher revenues, strategic cost management initiatives and a lower tax rate driven by our capital allocation. This performance has led to an improvement in our return on invested capital on a year-over-year basis. Our returns in the U.S. market remain higher than last year’s returns and are driven by continued progress in our consumer-focused liquidation programs and modestly better pricing. Our international businesses helped drive revenues higher than a year ago, particularly in our contingency collections business. Our emphasis on strategic cost management in the U.S. contributed to a 70 basis point improvement in our overall cost-to-collect. Full-year commitment levels for our U.S. business continued to grow, and the domestic market continues to exhibit pricing discipline. In Europe, we had a strong deployment quarter as we solidified our presence in Spain. This led to an overall solid second quarter of purchases for Encore. I’d like to begin by reviewing Encore’s business on a regional basis for the second quarter. In the U.S., debt buyers have continued to exhibit discipline when bidding on portfolios, effectively reducing prices and enabling us to book business at higher returns when compared to a year ago. The market, which has been supply constrained due to the absence of sidelined issuers, is undergoing a transformation. We believe that pricing in the industry is declining as large and mid-tier debt purchasers seek higher returns for their invested capital. The pricing power in the market is shifting as issuers now compete for debt buyer capital. Encore’s consumer-centric liquidation programs also help to reinforce the favorable trend in improving returns as first-year liquidations and consumer satisfaction are both on the rise. Our earnings in the second quarter were supported by cost reductions. In our core U.S. business, we successfully removed $18 million of recurring expenses in the second quarter compared to last year, which offsets declines in revenue. Year-to-date recurring expenses are down $30 million. In Europe, Cabot has continued to deliver on its customer focus as a key business priority, which they validated by winning the coveted Treating Customers Fairly industry award for 2016. Customer treatment is a key focus area of regulators in the United Kingdom. Many of the key legislative requirements applicable to the industry, defined principally by the Consumer Credit Act, have been in place for many years. However, the transition of regulatory oversight of the industry from the Office of Fair Trading to the Financial Conduct Authority otherwise known as FCA in 2014 has more clearly defined the FCA’s principle-based expectations. As greater clarity has emerged, Cabot has been implementing changes in regulatory policy and practice for several years. This has enabled Cabot to affirm its leadership position in the UK by becoming the first large debt buyer to achieve FCA authorization. We have noted, however, the cumulative effect of these changes has gradually reshaped and extended Cabot’s collection curves beyond our original expectations. As an example of this evolution, one of the FCA’s Principles of Business requires that debt repayment plans must be proven as affordable to the consumer. This has resulted in more means-based evaluation of proposed repayments, with fewer discounted settlements upfront, replaced by affordable sums of money paid in installments over a longer period of time. The cumulative impact of these and other regulatory expectations has resulted in more consumers entering into long-term payment plans, foregoing short-term settlements, which we expect will extend and increase collections over a longer period. As a result, we expect Cabot’s gross collections to rise over time. Cabot has implemented and continues to evaluate operational strategies that are designed to increase collections and mitigate the effects of the shift of collections from near to long-term. As we have observed the cumulative impact of these changes, we’ve seen a recent and meaningful shift of near-term collections to longer-term sustainable collections. Collection curves are now extending to 15 years and beyond. This recent and meaningful shift has changed our outlook when compared to our original collections expectations. It is not yet possible for us to predict a precise impact that the changes in regulatory expectation will have on the ultimate timing and magnitude of collections at Cabot. While these changes are advantageous to the consumer, we expect the changes will result in increased collections over each pool’s life, and believe pools could provide a steady source of income for 15 years and possibly longer. Under the authoritative accounting guidance, gross collections are to be discounted over the life of the collection curve. Even if total collections rise, a change in the timing and shape of those collections may dictate whether an allowance charge is warranted. Further analysis is being undertaken to determine the longer-term impact of the cumulative changes on Cabot’s collection curves, which is expected to be completed by the end of the third quarter. With regard to second quarter purchasing; in the second quarter, our capital in Europe was deployed primarily in the UK, Spain, and for the first time in Portugal. At Cabot, just as we done in the U.S., we’re deploying many of the same innovative and consumer-focused liquidation programs in an effort to drive higher returns through the sharing of best practices with our U.S. business. In addition, as in our U.S. business, Cabot is implementing strategic cost management initiatives in order to support earnings, maintain returns, and offset the run-off of older portfolios with higher returns. As you all know, the British chose to leave the European Union in a referendum vote held in late June. We’ve been asked by many for our thoughts on what this will mean to the debt recovery space. I believe that it’s simply too early to predict with any accuracy what might happen in the future in the UK. What is clear is that the pathway for the UK to actually exit the EU will be a lengthy process that includes the renegotiation of treaties between countries, which some analysts say could take several years to complete. For now, it’s too early to tell what the impact of Brexit might be on our business, but so far since the vote, we see no significant impact to our consumers. We continue to be optimistic about our long-term prospects in Latin America, where expected returns are favorable. From a deployment standpoint, recent political and economic instability in Brazil has driven us to prioritize our business in Mexico for the time being. Returns from our Colombia-based Refinancia business continue to meet our expectations and we anticipate an improvement in market supply in the second half of the year. Characterized by higher IRRs and lower effective tax rates, we expect that our business in Latin America will be an important driver in moving our corporate ROIC higher in the long-term. We’ll turn our focus back to growth in the region when our comfort level regarding the macro political and economic conditions improve. Until then, we remain appropriately cautious and optimistic about our potential for expansion in Latin America. Together, the U.S., Europe and Latin America comprise the vast majority of our financial results today. However, we continue to expand our platforms in other regions as we look to the future. In India, we have worked diligently to establish our Encore Asset Reconstruction Company and we are now focused on operational readiness, while we await license approval from The Reserve Bank of India. The Indian NPL market continues to grow while banks there have been ordered by regulators to clean up a massive $120 billion in distressed paper. In Australia, we expect our 2016 deployments to exceed those of last year as Baycorp works through the early phase of a business transformation. On the next slide we provide our leverage statistics in a similar way to how our domestic lenders consider them, without Cabot. Our leverage ratio improved during the second quarter from 4.38 times to 4.26 times. Considering these ratios without Cabot, our debt-to-equity ratio is substantially lower, at 1.96 times. It is important to remember that we fully consolidate Cabot’s debt on our balance sheet because we have a 43% economic interest in Cabot and we control their Board. Nonetheless, Cabot’s debt has no recourse to Encore. Consequently, Encore is far less levered than a quick review of our financials would indicate. Last week the Consumer Financial Protection Bureau published an outline of proposed new industry rules as they prepare to convene the upcoming small business panel in August. This was an important milestone in the evolution of the rules for our industry. The document released last Thursday was an outline of proposed rules. We’ll continue to evaluate these proposals as they become further refined so that we can precisely identify the actions we’ll need to take in order to comply with the new expectations. We will also provide feedback and commentary on the rules to the CFPB. That being said, we’re pleased that in a number of instances, the proposed new rules were derived from our own best practices and recommendations. Many of the new proposed rules are already part of our current operations, however it is not yet possible to predict a precise impact any final rulemaking will have on our operational practices. Overall, we believe that the new rules will provide important clarity around key issues in our industry, remove uncertainty that was over-hanging the company and our industry, help raise industry standards to our high levels, and create a more level playing field for all industry participants, both large and small. I’ll now turn it over to Jon, who will go through the financial results in more detail. Jon?

Thank you, Ken. Before I go into our financial results in detail, I would like to remind you that, as required by U.S. GAAP, we are showing 100% of the results for Cabot, Grove, Refinancia and Baycorp in our financial statements. Where indicated, we will adjust the numbers to account for non-controlling interests. In the second quarter, Encore generated GAAP net income from continuing operations of $1.14 per share and economic EPS of $1.29, an increase of 7% over last year. This earnings growth was supported by revenues totaling $289 million, and strategic cost management, which contributed to a lower cost to collect. These quarterly results were impacted by a stronger dollar and a weaker pound, which distort the measurement of our year-over-year performance. Deployments totaling $233 million in the second quarter. In the United States, the majority of our $129 million of deployments represented charged-off credit card paper, nearly three quarters of which was comprised of fresh accounts. U.S. year-to-date purchases and commitments now total nearly $400 million for 2016. Projected returns from our 2016 deployments continue to exceed those from 2015. European deployments through Cabot and Grove totaled $86 million during the second quarter with the majority attributed to portfolio purchases in the UK and Spain. Cabot also purchased its first portfolio in Portugal during the second quarter. We deployed $18 million in other geographies in the second quarter, including purchases in Australia and Latin America. Worldwide collections declined 1% to $434 million in the second quarter. In constant currency terms, collections grew 2% in the quarter. An additional significant change to our collections on a year-over-year basis was from the addition of Baycorp, our subsidiary in Australia and New Zealand. The second quarter of each year tends to generate our second highest level of cash flows. The impact of our strategic cost management programs helped drive EBITDA levels higher. In Q2, we generated $279 million of adjusted EBITDA, an increase of 2% over the second quarter of 2015. In constant currency terms, adjusted EBITDA increased 5%. On a trailing twelve months basis, we generated adjusted EBITDA of $1.076 billion, which was up 5% compared to the same period of the prior year. Revenue in the quarter was $289 million, an increase of 2% over the second quarter of 2015. In constant currency terms, revenues grew 6% in the quarter. International revenues grew 24% in Q2 driven primarily by Cabot’s acquisition of dlc and Encore’s addition of Baycorp. Of particular note in the second quarter was a record proportion of revenues delivered by our international businesses, topping 42% for the first time in Encore’s history. We had no portfolio allowances in the quarter. We recorded $2 million of net portfolio allowance reversals in Q2, compared to $4 million in the same quarter a year-ago. In the second quarter, we increased domestic yields primarily in the 2010 vintage, and 2012 through 2015 vintages as a result of sustained overperformance by pools within those vintages. Turning to cost-to-collect, excluding acquisition-related and other costs, our overall cost-to-collect in our portfolio purchasing and recovering business for the second quarter was 36.9%, compared to 37.6% in the same quarter a year ago. This reduction of 70 basis points year-over-year reflects the impact of our strategic cost management efforts in the U.S., and a higher proportion of Cabot’s collections in our total. Cabot’s collection costs trend lower than our overall cost-to-collect because of the many consumers who are already on payment plans with Cabot, and who historically involve little litigation. We continue to be successful in developing stronger relationships with our consumers, resulting in scheduled payment plans with far less discounting than in the past. These payments over time are yielding a greater net return per invested dollar. Our estimated remaining collections, or ERC, at the end of the second quarter was $5.5 billion, a decrease of 3% compared to the end of June a year ago. In constant currency terms, our ERC grew 6% on a year-over-year basis. As a result of recent SEC interpretations, we’ve made some modifications to our non-GAAP disclosure. Most notable is that adjustments being made in the non-GAAP reconciliation of earnings and earnings per share will no longer be presented net of tax. In the second quarter, we recorded GAAP net income from continuing operations of $1.14 per share. Adjustments included $0.11 related to the non-cash interest and issuance costs associated with our convertible notes, $0.13 related to acquisition, integration and restructuring costs, $0.05 related to settlement fees and related administrative expenses, all followed by $0.02 for the amortization of certain acquired intangible assets related to our contingency collections business. After applying the income tax effect of the adjustments and adjusting for non-controlling interest, we end up with $1.29 per fully diluted share, and our non-GAAP economic EPS was also $1.29. Encore earned through a $0.04 foreign currency exchange headwind in the second quarter. Because our shares traded at an average price below the initial conversion prices of our convertible debt during the quarter, we did not exclude any shares from the calculation of our economic EPS. With that, I’d like to turn it back over to Ken.

Thanks, Jon. As I look into the rear view mirror for a moment, we’ve navigated through the uncertainty and volatility surrounding Brexit and the dramatic shifts in the value of the pound. We believe the outline of new proposed rules from the CFPB provides important clarity around key issues in our industry, removes uncertainty that was overhanging the company and our industry, helps raise industry standards to our high levels, and creates a more level playing field for all industry participants. We’re also seeing positive traction in the U.S. market relating to pricing and returns and I continue to be proud of our management team and Encore’s people located around the world for their hard work and dedication and the large degree of success we’re having in this complex industry. I’d be happy to answer any questions that you may have. Operator, would you please open up the line?

Thank you. [Operator Instructions] Our first question comes from the line of Bob Napoli with William Blair. Your line is open. Please go ahead.

Thank you and good afternoon.

Hello, Bob.

Just on the – to understand the efficiency improvement, $18 million of reduction in recurring expenses, that’s an annual number? And how did you – what drove that improvement?

Sure. The $18 million is year-over-year, and as we sit here today, it’s $30 million year-to-date compared to last year at this time. We drove this through just a series of different programs. Some was realigning our business. Some was just natural flow from the fresh paper that we continue to buy, which is more call center centric than being placed through the legal channel. And so, we see that expense improvement continuing to move forward because we see more fresh paper being sold in the industry. Ashish is sitting next to me, and he really should get a lot of credit for driving this. So, Ashish, do you want to give one or two other examples?

I think you highlighted one of the big ones on fresh paper. The other one is just continued efficiency in our operations in internal legal and legal collections and call centers as we’ve become more productive using our employees. We’re also getting better at managing our external service providers and vendors in terms of pricing we pay for them and the fees we pay to them. So those are the other couple of major examples.

Then a $30 million year-to-date annualizes the $60 million then?

I would say may be not that large number, but we’re doing a very good job chipping away and producing lower expenses, which I would expect in Midland, in the U.S. business, on a year-over-year basis to continue for Q3 and for Q4.

Then on Europe, just trying to understand within Cabot, two things. One, the extension of the collection term. The changes in regulation drove that? And the – you’re looking at whether or not you would take an impairment in the UK, which you will decide in the third quarter. And then just related to that, the purchase flow in Europe. And we hear from all of your competitors how ample the – your European competitors that are listed, how ample the flow is. And your purchases were okay, but as not as much as maybe you could have had.

Yes, so let me take the second question first on the purchase activity. Actually, I was pretty pleased with the purchase performance. And I would say to you, I think, we had a much stronger Q1 than our competitors. So year-to-date, I like where we’re at. I will say, there are several large pools in the UK that came up for bid. And at a certain point, we just found that we had better choices or uses for our capital, and we were not going to run after lower-performing investments. And we thought some of the large deals, which attract a lot of bidders, was getting to that level. So we’re fortunate that we could pivot into Spain, where we see some very good deals and very good returns. We made our first pivot into Portugal, and quite frankly, again, I’m happy with what we purchased. And I would say that it looks like a very good pipeline that’s materializing in Q3 for the industry. And so far, it’s early into Q3, but we’re off to a good start with Cabot in Q3. In terms of your comment about the Cabot collections, let me maybe give you a few bold points for you to think about. Starting first – let’s start with the customer. We think these rule – the clarity on the rules from the FCA is very good for the customer, okay. The cumulative changes from the FCA on their principle rule-based expectations, I should say, are changing the shape, timing and length of the curves. We do expect that we’ll collect more money over a longer period of time, all right. Also short-term collections will shift later on. But on a nominal basis, we believe cash collected would clearly exceed our cost base. Next, if we were just to take those vintages and put them all out to sale, the fair market value for each one of those vintages would also clearly exceed our cost basis. But what we have is a changing of cash moving from the near-term to the longer-term. And there, there are very specific rules for revenue recognition, which requires to look at our current performance, then look at our future collection expectations, discount that back into today’s terms. And we’re all math majors around the table and on the phone, and we all know a dollar that comes far later in year 15 is not worth a dollar that moves out of year one. So that’s what’s happening. And let me just take just maybe another step further. We’re seeing this with many of our older pool groups. So for example, the original Cabot acquisition has vintages in it that date back to pre-2002, that run from pre-2002 to 2013 when we purchased Cabot. A lot of those older pools are today out towards 15 years and some have already extended beyond 15 years. So, we’re seeing this change happen, and it’s a bit of change that’s been happening slowly and gradually. But now, the cumulative effect of that is becoming more obvious to us that our original collection expectations, when we booked the portfolio are not going to be met nearer-term. But again, as I said, longer-term, much more cash coming in. And, so I’ll leave it there for a moment. And I think that’s hopefully –

Is that an affordability factor where you have to reduce the payment to a certain income level? Is that what’s driving it?

Well, there are several things. So you asked a good question, and let me just take another second. This is where I was going to go. So the FCA talks about evidence of affordability. And the way you get there, at least, for us was to create an income and expenditure report. When we bought Cabot originally, there was no income and expenditure report. And further, Cabot was known for a, maintaining customers on payment plans and then also uplifting those payments over time. Now, with the I&E, the income and expenditure report, we put people on longer-term payment plans, which now means we are foregoing short-term settlements. And we had in our forecast back three years ago when we made the deal, a certain amount of short-term settlements that would happen, which have now turned into longer-term payments. In addition, the FCA gave a little bit more clarity around the number of accounts that are suitable for litigation, extension of pre-litigation periods, and the encouragement to place as many accounts as possible on long-term payment plans. So all these changes kept rolling in over time. And now, we’re beginning to see the cumulative effect of those, and we think that the curves are just going to be extended out. And in the sense we’re pleased with the fact that we see a longer-term – long-term collections extending, which means we’re going to have long-term revenue streams, which will be more of annuity than we originally purchased Cabot. The unfortunate piece here is the accounting convention is one that is penalizing what is actually good for the industry and good for the consumer. So that’s where we are, Bob.

Okay. I appreciate. Thank you.

Thank you. And our next question comes from the line of Hugh Miller with Macquarie. Your line is open. Please go ahead.

Hi, thanks for taking my questions.

Hey, Hugh.

So I guess and maybe in following up on the topic of Europe and the changes there, the shifts in the collection curve, I mean, I guess, at this point, would you be able to provide us with kind of a rough, maybe, range of the potential impairment charge that you could be looking at? And maybe you could give us some type of ballpark at how we should be thinking about things at this point?

We can’t. And the reforecasting of these curves is a very detailed, methodical exercise that cannot be rushed. We need to get it right. And there are just so many factors to consider. And let me just give you one as an example, which will show you the complexity of forecasting. Let’s go back to the initial Cabot pool group that we purchased. Again, I said, we have vintages that date before 2002 and then straight up to 2013. Well, each one of those vintages has their own characteristics that have to be forecasted and considered. In addition, we’re not going to sit here with our hands – we’re not going to sit on our hands, I should say. So we have a number of operational strategies, very much like the strategies Ashish has put in into Midland Credit, these consumer-centric programs, which are designed to accelerate or accentuate near-term cash, and we have to consider how those are going to be reflected upon the curves. So this is a job, and this is going to take sometime. We just thought – you heard me say this a lot Hugh, we try to be as transparent as we can and we try to be as early as we can. We just thought that this is something you guys ought to know, that we’re working on and that this trend is emerging.

Sure. Definitely I appreciate the insight. I guess, and heading back to the discussion you guys had about some of the benefits on the efficiency gains. Can you give us a sense as to maybe a rough ballpark of what is based off of the shift, fresh paper versus other types of improvements? Because I would assume that a portion of the benefit on the cost savings for fresh paper would be mitigated and offset by kind of a higher price point on that on a relative basis. So, some of that would be – wouldn’t drive all to the bottom line. Is that correct – is that the correct way to think about it?

I think we got a couple of things working here simultaneously. For the newer pools, and I’m talking – I’m sorry, the newer purchases, let’s talk about 2016. We are seeing, in certain segments, between a 10% and 15% price reduction. So, let’s check that off because that’s a good thing. And if that continues, which we expect it to, because I think issuers are finally understanding how precious capital is to us and how precious capital is to them if they want some of it. So we think pricing is going to continue to – continue down as we go forward. The impact of that, we’re just buying these pools now, you’ll see over longer terms. And they will – and they are creating longer-term IRRs, all right. The expense reductions that we’re seeing presently, I don’t have a number to say it’s 30% or 40%. I will say over time, it will become – the fact that we’re moving to fresh pools, it will become an increasingly amount – that amount that we save will be corresponded – corresponding to the amount of fresh paper we can continue to buy over time because remember, we’re going to put less through the legal channel right now. But currently in today’s operations, we’re still putting a lot through the legal channel because most of our paper, relatively speaking, is a little more seasoned than it is fresh. So this will continue to evolve over time, which is – which maybe is another way I should have said is that our current expense reduction programs are a combination of several things: one, price negotiations with vendor; two, doing things very, very smartly and differently. And here’s an easy example of one, which I think is just perfect. In an effort to drive down or improve our – in an effort to drive up our customer satisfaction, we found a way to drop our calling, ready for this, by two-thirds and yet maintain or increase our right party context. So think about that. We’ve gotten rid of a lot of expense by calling. We’re still talking to the people we want to talk to, may in fact, maybe even a little more. So, it has an expense reduction and it has a better customer satisfaction outcome as well. So these are the things that we’re trying to do on the cost side. Over time, we expect as we move forward with newer pools – or newer purchases towards the end of 2016, into 2017, our cost to collect, as you see us report, will come down. And in fact, it is coming down and will come down even more.

Great color. That’s very helpful. And then, just I guess, last for me. Given the year-to-date strength we’ve seen in credit card balance growth, I definitely appreciate the insight you’ve given us from a pricing perspective. But are you seeing more issuers that are willing to go out there and do forward flow agreements? Any changes in kind of the supply of forward flow that’s coming to market now just given that growth in credit card balances outstanding?

Roughly, on an industry basis, the industry should deploy about $1.1 billion thereabouts. We are hearing a lot of conversations that more supply is coming to the market with a few issuers. We have seen them auction more supply over a longer period of time, but it’s not yet at the level we’d like to see and it’s not yet at the level that we expect that’s going to come. Let me give you a fun fact, if you will. By the end of this year, there’ll be enough – the consumer debt outstanding will equal the consumer debt outstanding right before the great recession. At that level, when you start to assume charge-off levels rise from 3 to 4.5 or 3 to 5, you get pretty excited about the volume that will be coming your way. I can’t tell you that the volume is here today, but I can tell you I could smell it coming, okay. I can just begin to taste it. And so we’ll wait and see how it unfolds. But this will be another good thing as more supply comes to the market. Come back to what I tried to say in my prepared notes. There’s a transformation happening in the market from being supply constraint, where pricing was being driven higher to having capital discipline whereby the big guys and the mid-tier guys are being very judicious in how they want to deploy their capital and expecting better returns through lower pricing.

Great. Thank you very much.

Thank you. And our next question comes from the line of Mark Hughes with SunTrust. Your line is open. Please go ahead.

Yes, thank you. How much did Cabot contribute from an EPS perspective, just the Cabot operations?

About one-third.

It’s about one-third of EPS?

Yes.

You do you have a meaningful impairment in the UK.

I’m sorry, the guys corrected me. It will be precise 28%.

$0.28.

Sorry, sorry.

$0.28.

$0.28 in the quarter? So if you do have – let me ask this first. Is there a receivables amount – carrying value amount that you have got in mind that’s going to be evaluated as part of this process? The proportion of your total balance sheet, what are we talking here as the universe or the potential asset size that you’re evaluating?

We’re going to take a look at all the pools, all right. But I don’t think all of them are going to be subject to change because as we’ve learned and seeing what these new FCA expectations are, we’ve captured those in the most latest pools in 2015 and 2016. So, I think some of this is going to really apply more to the larger acquired pools that occurred in 2013 and 2014.

So 2013, 2014 UK vintages would be the ones we’d want to look at?

Yes.

Yes. So if you did $0.28 in the quarter from Cabot, and you – theoretically, you impaired 10% of the receivables, your yield is the same. Is your – so your revenue presumably would be reduced by 10%? Is your cost to collect going to be influenced? Do you think this is going to lead to margin compression when you implement these new collections procedures? With kind of an extended tail, does that make it more expensive to collect in the UK?

So I’m going to give you, Mark, a partial answer. I don’t want to be drawn in yet on a hypothetical scenario regarding what the impact to revenue can be. I just don’t want to go down that yet. We’re not ready to discuss that with any level of confidence. What I will say, the same type of strategic cost management programs that have been put in place in the U.S., at Midland Credit are being rolled out in Cabot as we speak. So, we are trying to manage the expense base of Cabot as well. And over time, as more collections come through a longer-term payment plans, the cost of collect should decline as we’re not spending as much money on legal expenses.

So, do I have this right? If you impaired 10% of the Cabot balances, since you’re maintaining the same yield, your revenue would be down by 10%. If you’re able to control the costs, your cost structure hold steady, then that’s a $0.03 quarterly impact? Is there anything wrong with that? I know it’s a hypothetical, but just sort of mathematically, is there anything wrong with that thinking?

It’s hard to conceptually, Mark, to make sure I have my head around all the variables. Conceptually, you’re right. If you take an allowance, you are reducing – your IRRs stayed constant and you’re reducing your basis, right? So, quite frankly I want to noodle on, on it a bit further to be confident, but yes.

And as long as your margins held, then the impact on ongoing EPS would be modest even if you had a meaningful non-cash charge in a given quarter?

And Mark, this stuff is very, very complicated. And as Ken said, we are working our way through the process. And I don’t want to encourage a lot of speculation as to what this might look like until we’ve done our work.

Great. But it’s probably also important to look at the ongoing EPS impact of what that sort of one-time impairment would be. And depending on the size of the allowance, it should have a proportional impact presumably on the EPS contribution. And so at least, that’s one way of thinking about it?

Yes.

Yes, thank you. I think that’s – any language you’d like to throw with the kind of the large issuers and their behavior or expected behavior? Anything that you’ve learned and are able to share with us?

These very large issuers, you mean…

The ones who have not been – who have been out of the market, the absent sellers.

No, Mark. All I can tell you is I am wrong in my predictions. I am certain that I’d be wrong again. That’s the only thing you can bet on that I would be wrong. We’ll just wait for them to come back. And as I’ve said a thousand times, we run the Company with the expectation they never come back. And if and when they do, it will be just a bigger benefit to us and to the overall market itself and the industry.

Has their behavior changed in terms of their dealings with you? Or any kind of regulatory activity that might be undertaking? Have they slowed down any kind of context – accelerated in the kind of context?

Each one of them has a different roadmap. And I couldn’t characterize them all as doing one thing or the other. So they all have their own timing and pace. It’s not necessarily about this market. It’s about a broader regulatory regime or framework for them and other things they do just besides selling consumer debt to us.

Great. Thank you very much.

Thank you.

Thanks, Mark.

Thank you. And our next question comes from the line of Michael Kaye with Citigroup. Your line is open. Please go ahead.

Just shifting gears for a little bit. I know it’s early, but with the CFP performance outlined, it just came out last week. But is there anything you saw so far that gives any sources of a concern, like in particular, some of the frequency of contact limitations?

Yes, you picked up on the one that has raised our eyebrows. And so we hope to do several things. One is to get the CFPB to adjust their limit. And the second thing is we’re understanding what operational strategies we could put in place to mitigate the limited amount of contacts. And there’s a – and there are other things embedded in the overall rules that could be a little bit more of a positive to us. So, we are evaluating it all now. As you said, it is early. There aren’t any big time bombs, that much I’ll say, and that’s good. And I have to come back and say we are just pleased that they finally published the rules. And they are mostly in line – a lot of it is in line with our consent decree, and that’s good as well. But there are a few things, few paragraphs that we need more clarity around. And I’ll give you, like for example, for the mere fact that they are posing a limit on contacts, they have given us a little bit that we can now leave messages. So there’s a little bad, there’s a little good. And we have to think through it yet. I kind of believe that this process is going to take sometime to play out still, and we’re probably not going to feel any impact of this stuff or know when the rules go into effect until probably close to the middle of 2017.

All right. That’s helpful. Just on another topic, with the Brexit vote coming in and the sharply lower British pound. Like how does this change – does this change your views on a potential acquisition of JC Flowers taking Cabot for the better or worse?

There are some prescribed guidelines as to when and how JCF and us will interact with each other. And I think I’d rather let that time frame unfold. And then, we’ll see where we are at that point as to what we’d want to do. We think we’ve got some optionality. We like our optionality. But we’ll wait to see – when the clock really begins to tick, we’ll wait to see what we’re going to do and what they’re going to do. I can’t say we have a good partnership with them. We like working with them, I think they like working with us. And overall, we have been creating a lot more value at Cabot together.

That’s great. Just one numbers question for Jon. You said – I noticed some – in other income a $3.1 million income. Just wondering is that some sort of like hedge gain like last quarter. And just what’s the impact to economic EPS, that’s onetime-ish?

Well. We did have – of the – in Q2, we did have a – what you’re looking at is a – there is – built in there a gain, which is done because that’s the way it has to be in GAAP. It’s pre-non-controlling interest. And so with the net impact on the hedge, if you’re trying to fish for what the impact of the hedge is, was actually a loss of about $0.01 this quarter in Q2.

There’s a hedge gain that offset the net loss from – so what was like the gross hedge gain in the $3.1 million?

It’s one of the interesting things of this accounting, and that you’ve focused in on, which is a – on a, if you will, a gross basis, it’s a $2 million gain. But then after you – there were some hedges at Encore and some hedges at Cabot. And after it sits to the bottom line, it was $0.01 loss due to minority interest. So in other words, a gain at Cabot, we only recognized our share at that rate.

Thank you. And this concludes our Q&A session for today. And I would like to turn the conference back over to Mr. Vecchione for any closing remarks.

Thank you all. Thanks for participating. We look forward to talking to you at the end of Q3. I know you’ve got a lot of questions about what’s the comment. We hope to have a very clear discussion about that towards the end of the quarter or at our next quarter call. Thanks again, everyone, for attending.

Ladies and gentlemen, thank you for participating on today’s conference. This does conclude the program, and you may all disconnect. Everyone have a great day.