Encore Capital Group, Inc. (ECPG) Q4 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Encore Capital Group's Q4 2016 Earnings Conference. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will host a question-and-answer session and our instructions will follow at that time. [Operator Instructions] As a reminder this conference is being recorded for replay purposes. It is now my pleasure to hand the conference over Mr. Bruce Thomas, Vice President of Investor Relations. Sir please proceed.

Thank you, Operator. Good afternoon, and welcome to Encore Capital Group's fourth 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, President of our Midland Credit Management; and Paul Grinberg, International Group Executive. 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 fourth quarter of 2016 and the fourth 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.

Thanks, Bruce, and good afternoon everyone. When looking back over the past year, the industry looks much different today than it did in the first half of 2016. At the beginning of last year, you may recall that pricing was stable although elevated at 2015 levels and supply was projected to remain flat or grow modestly year over year. As we approached mid-year, industry sentiment began to change course as pricing declined and supply improved. Toward the end of 2016, we could point to industry growth of greater than 15%, with corresponding 15% declines in pricing. These pricing and supply dynamics give confidence to projected higher returns in 2017. Reflecting on this past year and looking forward to the future, we believe industry volume will continue to improve as issuers have indicated in their recent earnings commentary that delinquencies and charge-offs are expected to rise. In a broad sense, we are an investment business with an operating platform and we conduct our business in cyclical markets. During the last several years we have reaped the benefits of purchasing high money multiple and IRR portfolios, particularly from the 2008 through 2011 vintages. Portfolio purchases made in 2014 and 2015 experienced the impact of elevated pricing and muted supply, which together pushed purchase price multiples down and along and IRRs. Starting in 2016 and continuing now into 2017, both returns and purchase price multiples have begun to rise again. Against this cyclical backdrop, we remain committed to our Connect with the Consumer programs, our analytical rigor, and pricing discipline. In the fourth quarter, Encore continued to see the favorable trend of lower pricing and higher volume in the US market. We believe the turn we’ve been seeing in the industry cycle continues to progress as pricing and supply are better than they were last year at this time. In addition, our consumer-centric liquidation programs continue to help drive better returns. As we look at the competitive landscape, we feel we are well positioned to take advantage of a number of emerging opportunities. We also feel that there are many characteristics in the current environment that will create barriers to entry to new or returning market participants. During today’s call, I’ll talk about how we’re positioning Encore to make the most of our current opportunities and take specific actions aimed at maximizing our return on capital. Let me begin by discussing Encore’s domestic business. Consistent with recent trends, we continue to see favorable buying conditions in the US market as pricing discipline persists. After several years of our market experiencing flat to modest growth, we estimate that the available market in the US grew greater than 15% in 2016 with the fresh segment growing at a greater pace than older seasoned paper. Based upon current industry trends and reported commentary from issuing banks, we expect the face value of charge-off balances to grow at a double-digit pace in 2017. Total outstanding credit cards just reached $1 trillion, and we are forecasting growth will continue over the longer term as issuers grow their loan portfolios and loss rates continue to rise. This pattern has traditionally been a leading indicator for future supply growth and improving purchasing opportunities. A number of factors are driving the increase in supply and corresponding higher returns. First, we believe the issuers are becoming capacity constrained, and therefore selling more. In fact, at a time in the cycle when we would expect issuers to be adding in-house collections capacity, we’re actually seeing some of them doing the opposite. We’ll be adding operational capacity in 2017 to take advantage of this opportunity. I’ll have more to say about the expenses involved with the capacity expansion shortly. In addition to the premium on collection capacity, there are fewer qualified buyers for the larger purchasing opportunities in the US. Because there have been more buying opportunities in the market, it appears that capital amongst some of our competitors is being consumed. This provides an advantage to those with capital to buy at a better price. In this regard, we believe that we are well-positioned. Injection of new capital in the market from new sources faces real challenges, due to the high cost of compliance, the persistent, demanding regulatory environment, and the significantly different collection techniques that are now required compared to those employed in the past. While all these trends are moving in a favorable manner, it will take time for us to move back to the higher returns that we saw in the pre-2011 vintages. But from where we sit today, it looks like the cycle has turned and we are headed in a favorable direction. We expect the evolution of this cycle to take time and to have favorable impact in coming years. We are increasingly taking advantage of larger buying opportunities in the market, already having committed more than $200 million towards forward flow commitments in 2017, with higher returns than last year. Better returns are being driven by lower pricing as well as continued improvements in our liquidations. Over time we’ve mentioned our multi-year initiative aimed at improving first-year liquidations by 50%. We remain on track to achieve this performance level before the end of 2017, despite the significant regulatory headwinds that the industry has weathered in recent years. Industry followers know that expenses precede liquidation. Starting in the back half of 2016, we found increased opportunities to deploy incremental capital at attractive returns. Some of these opportunities were in lower balanced portfolios that resulted in higher account volume. These portfolios contain more accounts per dollar deployed and generate increased expenses from account manager hiring, legal placements, and letter volumes. In 2017 you’ll see us hire additional account managers to address this volume increase and to build capacity for future opportunities. We expect account manager hiring and legal spend associated with this incremental account volume to add approximately $20 million of additional expenses in 2017, creating near-term earnings headwind. Our fundamental focus on IRRs is the right strategy to maximize long-term profitability and return on invested capital. In summary, in 2016, we deployed over $560 million in the US, up approximately $55 million from the prior year. We’re taking advantage of purchasing more volume at better returns and in investing early in the lifecycle to maximize our opportunity We are constructive on the US market as we expect to see higher delinquencies and more volume facing off against limited issuer collections capacity. Let’s now turn our focus to our International business now. As many of you know, by prior agreement, the window opens in July of this year for our Cabot investment partner J.CFlowers to begin an exit process for their ownership stake in Cabot. Over the joint ownership period, we believe we have created incremental equity value at Cabot through entering the new markets of Spain, France and Portugal, through market consolidation, and in maintaining our leading market share position in the UK. With that in mind, JCF and Encore have begun exploring an initial public offering of Cabot, which we believe will help crystallize the value creation of our European franchise. We are in the very early stages of this process, but we believe that it could be completed as early as the back end of 2017. We don’t expect to provide further comment for some time to allow the process to run its course. UK market is generally slow in the first quarter of the year. Nonetheless, we anticipate having a better-than-average quarter with respect to deployments in Europe. There has been much debate around the UK’s decision to exit the UK, we are monitoring this closely and so far we have not seen any impact on our collections performance. While the UK market is among the most sophisticated, we continue to leverage learnings from other markets to our benefit here. Elsewhere, we continue to invest in Latin America, monitoring our R&D investments in Brazil and Mexico as we pursue long-term growth opportunities. In India, after a lengthy period of preparation and regulatory review, Encore’s Asset Reconstruction Company otherwise known as EARC is positioned to begin operating during the first half of 2017. The India market shows great promise, and we believe being patient and working our way into the market is the prudent course of action. We plan to test into the market through the EARC, making smaller initial capital deployments as we invest in its infrastructure and work through the early challenges. As we learn, we will grow. We expect these additional costs will create an approximate $0.05 drag on earnings in 2017. Turning back to current events in the United States, the new administration has raised questions about the impact of federal regulations on the financial services industry. No matter how regulatory agendas take shape, we remain committed to the compliance and risk management principles we’ve advanced over several years. Sellers remain focused on managing reputational risk, and continue to push high levels of consistency in standards governing consumer interactions. Encore’s high levels of compliance and sophistication, as well as our culture of fair consumer treatment, provide sellers a clear path to achieving their goals This is a good and necessary emphasis for the continued long-term growth and maturity of the US market. At this time, I’ll turn it over to Jon, who will take you through the financial results.

Thank you, Ken. Before I go into our financial results in detail, I would like to remind you that, as required by US 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. Turning to Encore’s results in the fourth quarter, Encore earned GAAP net income from continuing operations of $22 million or $0.85 per share. Adjusted income was $19 million or $0.72 per share. Our GAAP net income was larger than our adjusted income in the fourth quarter after we reversed a reserve for an unrealized earn-out associated with one of our smaller acquisitions. Without the impact of foreign exchange headwinds in the quarter, our Economic EPS would have been $0.03 higher. Cash collections in the quarter were $397 million, compared to $417 million a year ago. And our ERC at year’s end was $5.8 billion. For the year, GAAP net income of $79 million or $3.05 per share was impacted by the allowance charges associated with our European business in the third quarter We collected nearly $1.7 billion in 2016, which was approximately the same as last year’s total, despite the historic movement in the value of the pound versus the dollar. Let’s now take a closer look at some of the underlying financial metrics. Deployments totaled $210 million in the fourth quarter. In the United States, the majority of our $148 million of deployments represented charged-off credit card paper, with nearly 85% comprised of fresh accounts. European deployments through Cabot and Grove totaled $42 million during the fourth quarter with the majority attributed to portfolio purchases in the UK and Spain. We deployed $20 million in other geographies in the fourth quarter, including purchases in Australia and Latin America. Overall in 2016, Midland deployed $562 million in the US, up 11% or $55 million, when compared to 2015, reflecting improved US market conditions. For the full year of 2016, Encore capital deployment reached $907 million. Worldwide collections were $397 million in the fourth quarter, compared to $417 million a year ago. In constant currency terms, collections grew 1% in the quarter. Encore’s collections declined in the US, primarily as a result of the delays we have been experiencing in legal collections mentioned a quarter ago. Although we had encountered delays through Q3 of 2016 in both collections and expenses, we have now ramped back up to a more typical legal collections run rate. We remain confident that the majority of legal collections delayed in 2016 will be shifted to 2017 with no material impact to revenue. Globally, we collected $1.69 billion in 2016, on par with the $1.7 billion we collected in 2015. In constant currency terms, collections grew 3% on a year-over-year basis. In 2016, collections from our international businesses comprised 36% of our total collections, compared to 31% of our total collections in 2015. Revenue in the fourth quarter was $271 million compared to $291 million a year ago. On a constant currency basis, revenue would have been $289 million in the fourth quarter, which would have been essentially flat compared to the prior year. Domestic revenues were down 4% compared to the same quarter last year, as we continue to see the impact of higher multiple portfolios rolling off our books. We recorded $3 million of domestic net portfolio allowance reversals in Q4. In the fourth quarter, we increased domestic yields primarily in the 2011 through 2014 vintages as a result of sustained over-performance by pools within those vintages. Encore generated $38 million of zero-basis revenue in Q4, compared to $32 million in the same period a year ago. Encore’s prudent accounting approach contributes to generating zero-basis revenues, which are highly predictable and provide Encore with a valuable long-term revenue stream. Revenue for the full year of 2016 was $1.03 billion, compared to $1.13 billion of revenue we generated in 2015, with the difference largely driven by the European portfolio allowance charge we took in the third quarter and the change in value of the pound versus the US dollar. In constant currency terms, revenues declined 6% year-over-year. Our Estimated Remaining Collections, or ERC, at December 31 was $5.8 billion, up $129 million, representing an increase of 2% compared to the end of 2015. In constant currency terms, our ERC grew 12% on a year-over-year basis. In the fourth quarter, we recorded GAAP earnings from continuing operations of $0.85 per share. In reconciling our GAAP earnings to our adjusted earnings, add-back adjustments totaled $0.43. In addition, we realized a $0.31 gain on reversing an earn-out reserve mentioned earlier. After applying the income tax effect of the adjustments and adjusting for non-controlling interest, we end up with $0.72 per fully diluted share, and our non-GAAP Economic EPS was also $0.72. 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. There were also certain items that affected our full-year 2016 results. After making all of the adjustments, we end up with adjusted income of $3.48 per fully diluted share, and our non-GAAP Economic EPS was also $3.48. Without the impact of foreign currency exchange rates, we would have earned one additional $0.01 of economic EPS in 2016. Our consolidated debt to equity ratio at December 31, 2016 was 4.65 times. Considering this ratio without Cabot, our debt to equity ratio was 2.27 times, which is less than half of the consolidated ratio. 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 our financials would indicate. Available capacity under Encore’s revolving credit facility, subject to borrowing base and applicable debt covenants, was $204 million as of December 31, 2016, not including the $250 million additional capacity provided by the facility’s accordion feature. I would also like to remind everyone that we amended and extended our domestic credit agreement in December, providing us with considerably more financial flexibility. With that, I’d like to turn it back over to Ken.

Okay Jon, thanks. To summarize, we believe supply in the US could outpace available industry capital, presenting a favorable purchasing environment. We’re adding call center capacity and increasing legal channel spend to accommodate recent purchases and to get ahead of demand. These early investments will drive near-term earnings pressure but will improve returns over the longer term. The US market for charged off receivables continues to be favorable for the few remaining qualified large debt buyers and our liquidation improvement programs are helping to drive higher returns. We believe Cabot’s equity value has grown since our purchase in 2013. Consequently, Encore and J.CFlowers have begun exploring an initial public offering for Cabot. Our EARC business in India will launch operations sometime in the first half of 2017. At this operator we are happy to open the lines and take questions.

[Operator Instructions] Our first question will come from the line of Mark Hughes with SunTrust. Please proceed.

When we think about the run rate earnings and we look at the fourth quarter results, you mentioned some puts and takes here in terms of investments. I wonder if you could maybe kind of walk us through what's recurring and nonrecurring in the quarter. Certainly the higher tax rate we assume will continue. When we think about the Q1 versus Q4, how should we think about legal spending, other operating expenses that might impact numbers.

One of the things that I’ll discuss is the tax rate. You’re right Mark, the tax rate is quite high in the current quarter. And I think all you guys expected that last quarter we talked about a large part of that which is the $10 million carry over if you will from the capital allowance charge in Q3. So in terms of expectations going forward on the tax side, I would say there are a number of changes, foreign tax law changes that work especially regarding the deductibility of interest in the UK. So we’re historically we have been pushing closer and closer to 30%. I would say for 2017 you should expect something closer to 40% in terms of tax rate.

So Mark, we're going to spend about $20 million more in operating expenses next year. And that's going to be split evenly between our call centers and I'll call that call centers and our lettering campaign and then legal expenses. Let me just take a half a step back and kind of explain why the 20 million is being spent. In the middle of this year we saw a real fundamental change in the way we price portfolios and the returns that we receive. And I think I can say that some of the large players and the mid-sized players began to really appreciate the capital they had preserve it. And by doing that pricing dropped. As pricing dropped, we purchased far more accounts than we normally purchase for the dollar spent. So we have a lot more volume coming our way in accounts. Accounts drive expenses in our company, right. So we spend 560 million in 2016 in deployable capital that compares to 505 million that we spend in 2015. So, one the volume is up in the dollar spent and then the amount if accounts were up as well. Those accounts are coming at far higher IRRs than we saw in the first half of 2016. For the back half of ’16, returns were far higher because pricing was lower as well as the programs we always talk about were also beginning to gain more and more leverage those are our consumer centric programs. So you have this account volume coming through into the company. That spend along with few dollars that we've said we were going to spend in 2017 from legal collections which we couldn't get to in 2016 because issuers needed to ramp up their back offices to give us all the documentation we needed to go out of the reasonable basis to sue or moving into 2017. And so I'll leave it there and see if that answered most of your questions.

That's very helpful. When you think about the cost of legal collections in the quarter, it was 43 million, down from the full year run rate 200 million or so. How should we think about that on a go forward basis, is the 43 million a good base to start with, the 200 million you know take a quarter of that, where should we start out.

I think about the spend for legal, I'll just say that I have just simply add a little more than $10 million plus year over year to our 2017 or to your 2017 numbers and really another $10 million for call center operations, so that’s the $20 million that I keep talking. That will pretty much come in relatively flattish equally throughout the four quarters.

And then the cost of legal collections if we look at that and I appreciate that marginal amount that 20 million. I got you there. How about the underlying cost of legal collections. If you're going to be ramping up again because you're going to start getting the documentation. Is that going to be higher as a percentage of the collections say in 2017 than it was in 2016.

Total legal expenses as a compared to what, Mark, is your denominator on that?

I’m thinking in terms of the margin, the legal collection ratio, the percentage of the legal collections costs relative to say either revenue or collections.

I would probably say that probably run about 25 percentish of total revenues as it relates to our Midland that's where this spend is really coming in. So I would say that's probably what we were tracked to and we tracked about nearly at almost a similar amount in 2016 as well. So while the spend is up, we also found other ways to find economies or cost savings in our legal line. But roughly I think you could think of it as about 25% of total revenues for our Midland business.

And we expect that Midland will be up, but we think the Cabot will be a bit down. So that cuts, dampens it somewhat.

And then, there were some speculation in the press about the potential valuation on Cabot, a billion pounds plus I think was the reference. Any early thoughts on that.

Yeah the early thought is we are very early into this process. So we have not picked bankers yet. And we will again meeting with them very very shortly and we'll hear what they have to say and you know how this works. This is a long process getting towards the back end of the year and as we get closer to the backend we'll have a better sense of what value is and I'll just leave it at that. I really don't want to speculate at this time on what the valuation is.

Our next question will come from line of Hugh Miller with Macquarie. Please proceed.

Thanks to my questions, I appreciate the insight you guys gave about the US market. Had a couple of questions just in terms of I guess Europe with the $42 million invested in fourth quarter, obviously Q4 tends to be the seasonally strong quarter and there were discussions about strong supply coming to market. I was wondering if you could just give a little color as to you know you guys being a little more selective with capital deployment in 4Q in Europe and how that breakout of the 42 million compared between deployment on UK versus Spain.

Let me kind of give you the maybe the big picture. We were judicious in how we deploy capital in the fourth quarter for European businesses. Generally going into 2017, Q1 are usually lighter and with more sales activity happening in the back half of the first half of the year in the second quarter. But we are actually off to a very strong start in Europe and with numbers that are already ahead of what we are reporting for Q4. And we are looking at smaller-ish deals that give us the types of returns that we want. We think towards the back half of the first half of the year, I should just say the second quarter, where there will be a lot - there will be a number of issuers, large issuers coming to the market with large deals. We've learned our lesson from the last year and the year before they get a lot of activity and people drive those prices way up and the returns way down. We tend not to win a lot of those because we just think capital is being deployed at levels of returns that we just don't think are warranted. So we've been moving to smaller deals. So we see again the first quarter being strong, maybe even front loading some stuff that we would have gotten in the second quarter into the first quarter but much better than the fourth quarter and we're pretty optimistic at this moment with Cabot and what we've done to date in the first six weeks of the year.

That's helpful. And I guess the breakout between UK and Spain in 4Q and did you see an uptick in supply in secondary portfolio sales from some financial buyers exiting the market in Spain during the quarter?

Spain remains a little choppy. Actually I know, Paul, you're on the line and you're over there now, maybe you want to give a little - touch more recent color than I'm about to give.

I think Ken you started it off correctly and that Spain is choppy but, Hugh, your market intelligence is correct, there were some deals from some of the financial players who has exited the market and there will be some of those this year as well. But supply still remains strong from issuers. We don't really go through and provide detailed breakout of how much we deployed in each geography, we've got many, many geographies there, but there is healthy supply in Spain, there's healthy supply in the UK and as a result of that we're just being very particular about where we're deploying our capital to make sure they're hitting our returns.

Yeah. And then, as I said, Paul touched on an important point which is a mere fact last year that we moved into Portugal, we moved into France gives us now five countries, including Ireland to deploy capital. So we get to move that capital around a little bit and so when we don't like particular returns in the UK, we have other places to deploy it.

That’s helpful. Thank you. And then there was some discussion that we heard a little bit about one of the sideline issuers that had started to do some more in terms of testing portfolios, maybe smaller portfolios that they were coming around for sale. I was wondering, is that something that's at accurate description, is that something you're seeing, maybe if you could just provide us an update on where things stand at this point with the sideline issuers?

So I really stopped giving commentary on the sidelines issuers. I’ve been here for years and I've been wrong every quarter for four years. So I have a perfect unimpeachable track record of being wrong. But I think where we have been right is that we've been predicting the supply to grow. Right. And I think this year -- sorry in 2016, we saw good growth north of 15%. And right now, we're projecting without the sideline issuers coming back that you'll see growth of low double digits without the sideline issuers coming back over 2016. Those are the numbers we focus on. And if and when the sideline issuers come back, it's just additional gravy. It's more volume out there and I think it just helps the pricing equation for the debt purchasers.

Great. Thank you. And then one last for me. I don't know if I heard you correctly Jonathan about the tax rate guidance. Were you suggesting that the tax rate should be 40% in 2017 or if you could just provide a little bit more insight on that and if so why that would be.

Yeah. I would expect it will be closer to 40%. One of the significant changes we are always dealing with tax law changes internationally, domestically, but we see a lot recently internationally and especially regarding the deductibility of interest in the UK with the way we're structured there, that creates an elevated tax rate, so that would probably be the single biggest driver.

Thank you. Our next question will come from the line of Michael Kaye with Citigroup. Please proceed.

I just wanted to ask a quick question on the Cabot situation, just trying to understand what this potential Cabot IPO signals. I mean did you start negotiations with J.C. Flowers depending on the terms, is really the reality that it’s tough for you to acquire J.C. Flowers stake just given your valuation level and could you still theoretically end up buying J.C. Flowers stake before an IPO happens or has that door closed by now?

So I'll start off by saying that J.C.F has been a great partner of ours and quite frankly, and I think I've said this publicly, I was a little cautious going into this whole relationship when you have a strategic and a financial partner together. Sometimes, the different timelines of returns would get in the way of making investment decisions, but that never happened. We've had a very, very good relationship with them. This is a liquidity event for J.C.F. We've been very clear that come the summer of 2017, J.C.F. had the right to have a liquidity event or start one. And we've been working with them towards that goal. There also will be a valuation event for the company as well as once we take the company public and anything we may do between now and then again falls under the heading of speculation and I just don't want to go there at this time.

Okay. That's fair enough to start changing topics. The outlook for capital deployment in both the US and international, you did 907 million this year and I think you said, US, I think the supply should be up low double digits. Should I expect your US capital deployment for instance to be low double digits as well?

So the way we approach this is not looking at a capital deployment number for the sake of just applying a number, but rather look at the returns that we want to achieve. And with greater supply, we have the opportunity to, for example, stay at the same level of deployment and get a better return. And so we're all about chasing the returns, but not chasing the supply dollars. So we don't have an anticipation that we're looking to hit a certain deployment number, which would be higher than what we did in 2016. I'd be happy if we did that same number. I'd be happy if we did less than that. It's really going to be all about the returns and that's what we've been focused on and we see returns on the forward flow paper that we've purchased today are off again versus ’16 and ’16 was up against ‘15. So we are in the very, very early stages if you want to talk about this in terms of a baseball game, I actually think we're just coming up to the plate and we've just taken a few practice swings and the pitcher hasn't even started to make his first pitch of the game yet. We think and we'll keep monitoring this and we'll keep talking about it as we go quarter to quarter, but we think we're in the beginning of that cycle that we’ve been waiting for you that you saw several years ago with more supply coming at a faster pace fairness, but what's different now than back then, there are less new people that can come into the market. That's one. Number two, issuers don't have the ability to absorb the additional supply. They don't have that capacity. We are trying to get ahead of that and we are building that capacity for the future as well as building it for the volume that we acquired towards the end of 2016. And the other thing that's interesting here too, which also has an impact on pricing, which has an impact on the amount of deployment is the pricing discipline that's coming that we see in the industry and we think is even going to further continue is because people are very judicious about how they want to deploy their capital. And if you wait, you'll get a better price, which means you’ll get a better return. So for us, we have not been chasing any deals and we wait to get our price and we put it in, someone wants to hit our bid, we’re happy to sell it, but we're not going out and trying to hit everyone's ass and we've been very, very disciplined and for the most part, I think some of the other players in the industry have been disciplined as well.

[Operator Instructions] Our next question will come from the line of John Rowan with Janney.

Good afternoon, guys. Has there been a change in the TCPA and if not, do you anticipate any changes affecting your cost to collect?

So we have our legal counsel here. I think this will be the first time he's been able to answer a question since I’ve been here. So we're going to throw it over to him.

So good question, John. This is Greg Call. There haven't been changes to the TCPA itself, but what you do have is you've got the FCC being the agency that's been assigned to interpret the TCPA and in years past, that agency has created a lot of confusion around how the statute should be interpreted. With the change in administrations, we're also seeing a change in the power structure and the commission that oversees the interpretation of the TCPA and it's definitely a shift that is biased more towards interpretations that we think are more reasonable and so there's positivity there at the agency level. There's also been already in the new administration talk about legislative reform of the TCPA. So no changes yet, but I guess cause for optimism in the near future.

And we have our Head of External Affairs, Regulatory Affairs also going out and meeting with the folks in Washington to try and influence that. So that's one of our key objectives this year is to influence that.

Okay. And then to go back to the Cabot IPO, if there were to be an IPO, what would be your primary uses of cash? Assuming that you are obviously selling your stock as well.

So that's headed into the speculation category and I’ll just say again that we've got ten months, eight months before anything happens and let's just wait. It's just not -- anything I say, I'm definitely no longer going to be wrong. And as we get closer to the date, we’ll have a better sense of what we're going to do, but I would say right now think of it as a valuation event for us and the liquidation event for J.C.F. and as we get closer to the IPO date, we'll let you guys know what our plans are going to be.

Okay. And then just for the fourth quarter, I remember you guys last quarter saying, that it was a $10 million expected unusual item, can you just -- was that the actual number for the fourth quarter for the tax group?

Yes. That was roughly the carryover of tax from Q3 to Q4. Correct.

Okay. And last question for me, I'm not sure I really understood the guidance around the $20 million additional expenses in ‘17. Can you just kind of go through it again? I know there is 10 million in call center, 10 million in legal, just kind of frame it up versus the fourth quarter. You probably went through this, but I didn’t get it all.

I don't know that we said much more than that. That 20 million overall is going to come in basically evenly spread throughout the year, maybe a little lighter in Q1 and it will build up slightly towards the back end of the year.

But is that relative to the full year number for those items or the fourth quarter?

Relative to the full year number.

Full year 2016 number.

Do you want to add anything, Ashish?

This is Ashish. So that 10 million in legal expenses and 10 million in call center is comparing to 2016 expenses that we expect we’ll spend additional in 2017 for the incremental accounts we purchased in late 2016 as well as the additional capacity we’ll be investing in.

Thank you. Our next question will come from the line of Leslie Vandegrift with Raymond James. Please proceed.

Good question. Quick clarification. I know you mentioned it in your commentary at the beginning, the fourth quarter loan and also talked about the 2013, 2014 vintages, slight change in the performance there, I think you said adjusted. Can you give a little breakdown of the allowance real quick for me?

Not sure, if I followed the question, Leslie. I think you're thinking, we talked about where we raised IRRs, predominantly in the 2011 through 2014 pool vintages, correct?

Got it. Okay. That’s what I was looking for. Okay. Yes. You have made a mention of you expect commitment activity to pick-up versus Cabot activity went down in the year coming, so is that mainly due to Cabot possibly looking at the IPO obviously the speculation, but is that the reason you see a slowdown or is it more on general European market right now?

I think what I said, first of all, for the US, we see a strong deployment year, assuming pricing stays where it is or drops and we get the returns that we want and I'll reiterate again, we're just not about deployment, we’re about the returns. But as we look to Europe, we're seeing a lot of activity in the beginning part of the year and we've captured a lot of that activity. We just -- but generally the first quarter is a slower quarter generally and we see a lot -- we see a number of larger issuers coming to market in the second half of the year. Those portfolios are generally well bid and the returns are a lot lower than we would like and we have stayed away from winning those portfolios or bidding for those portfolios, because it doesn't hit the returns that we'd like. But we think overall for the industry for the UK, they will be at the same level of deployment they had the industry this year or slightly greater than that. For us, we're just not about the UK anymore. There is France. There is Spain, there is Portugal and there's opportunity for us in Ireland. So we move our money, our euros, or pounds around in Cabot to those countries, through US customs.

Okay. All right. And my last question, you talked about testing the waters in India finally in the first half. I know you guys have been working towards that. How long does that typically take, are you guys going to see it start to really ramp obviously if the tests go obviously in second quarter or third quarter or is it pushed back a little bit later.

Yeah. So acknowledge and we want the folks to know that the India operation, sorry, the EARC, Encore Asset Reconstruction Company, I want to make sure that we differentiate that from the India operations, which is the call center and back office for MCM. That's going to cost us about a nickel this year. That's the cost of putting people and starting them up in the EARC, bringing in business development team, bringing in our people that do decision science, operators, what have you. So our goal there is to go very, very slow. Okay. India is the seventh largest and growing economy, in the US, we think the face value alone for the three markets that we want to play in, which is consumer, retail which is think of it as credit cards, mortgages and then SME, small to medium enterprises, we think that market in terms of face value of charge offs in 2016 was about $17 billion with just single digits of that being sold to other asset reconstruction companies. So for us, and I've said this many, many times, I'd rather be slow to this market. There's no reason to be first and to try to get a first mover advantage. For us, it's important to understand how the portfolios we buy in the market segments I just described react to our collection techniques, so that we have a better sense of how to bid and price this as we go forward. So what you're going to see from us is a portfolio purchases, but think of them all as R&D and I would not have any, we are not going to ramp up in India in 2017 for certain. We are just going to buy and test our way and as we have more confidence in what we are doing towards the end of ’17, we'll give you a viewpoint as what we're going to do in ‘18. Okay. And I should say that the India -- the Encore Asset Reconstruction Company is going to report into Ashish. So he'll be doing double duty here running Midland and then also overseeing the operations in India. We’ll have a whole team there as well obviously, but he’ll be ultimately responsible for that.

[Operator Instructions] Our next questions will come from the line of Mark Hughes with SunTrust. Please proceed.

The adjusted earnings in the quarter, the $0.72, did you use the tax rate kind of the low-30s tax rate or more like a 40% tax rate calculating that? Through the fourth quarter, the $0.72, what was the underlying tax rate you used on that?

So the underlying tax rate, I’m not sure what you mean by that. Effectively, it was a 73% tax rate.

Right. And so if I backed out the 10 million?

Well, if you backed it out, you start at a 35% tax rate, tax schedule to get there, that’s where you start right.

Right. And then aside from that $10 million item, the effective tax rate in the quarter would've been 35%?

It would have been. [indiscernible] the quarter you had with what you’re moving, it certainly wouldn’t have gone all the way down to the 35%. You had some other moving parts. So –

And I’m trying to take the $0.72 run rate presumably adding the $10 million higher tax rate?

Yeah. We had some other puts and takes, right. You always have this, right. We had some statute limitations playing out in some positions, we’re able to release some. We had a valuation allowance we put on, we had the earn-out that we discussed earlier. So there's always some puts and takes. So if you're trying to reconcile the rest of the puts and takes summed up to roughly $6 million to $7 million.

Right. And so if I’m thinking kind of run rate earnings, I'm just trying to make sure I understand the walk from the $0.72 to what might be a more normal run rate earnings going forward?

The important thing if you're trying to do it going forward, Mark, there's a lot of specific items that are replicated, which occurred in fourth quarter, which I just went through. If you look at 2017, the thing you really need to focus on I think is moving from where we may have been and the way the world used to be, which was 30% and the way we think the world is going to be, which is closer to 40%, which are driven by changes in foreign tax rates, the most significant of which is in the UK, the reduction of interest expense.

Hey, maybe I'll try to give you a broader answer and I think I know where you're going a little bit, but if you, I’m making this as simple as possible, but if you take the $0.72 that we earn, add back that $10 million adjustment, tax adjustment and start that as your fourth quarter earnings and then from there, put in the go forward tax rate and the incremental expenses that we're going to spend on a quarterly basis that we talked about, that’s the total of 20 million, that will give a sense of where, just as a beginning place, where you ought to begin doing your modeling.

Right. You’re reading my mind on that and that's why I was trying to make sure I understood where I was starting from as I'm going to the 40%, was at 35, was it 32. Essentially, how many more points of tax do I add off the $0.72 in order to get to 40? And Jonathan, should I assume this was sort of 31% tax rate?

It would be something in the order of the low-30s, the 31 is about right if you didn't have the dynamics which are now in place.

Right. So we go from low-30s to upper-30s, close to 40, we add the 10 million and that’s kind of run rate, but then we make the adjustments for the 20 million in spending that's going to come in relatively evenly through the year. Does that sound right?

Yeah. And remember if I’m trying to figure out I’m not sure you told me on board, exactly how you’re approaching this, but the real driver here right just to be clear, the real driver is what's happening outside of the US. Right. So in the past, we've been able to drive our tax rate down and because of some tax law changes, now it’ s working against us a bit and it's backing up some. So that's really what’s driving the shift to 40% from low-30s, right.

Right. Exactly. And I am very much on board with the logic behind it, I’m just trying to make sure I can do the math. So I think I’ve got it. Thank you.

Thank you. There are no further questions in queue. So now, at this time, I'd like to hand the conference back over to Mr. Ken Vecchione, Chief Executive Officer for closing comments and remarks. Sir?

Thank you all very much. We appreciate your participation. Bruce will be around for taking calls and questions after this. And we look forward to talking to you on our next call. Thanks again for your support.

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program and you may all disconnect. Everybody, have a wonderful day.