Encore Capital Group, Inc. (ECPG) Q1 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Encore Capital Group's Q1 2020 Earnings Conference Call. At this time, all participant lines are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Bruce Thomas, Vice President of Investor Relations for Encore. Sir, you may begin.

Thank you, operator. Good afternoon and welcome to Encore Capital Group's first quarter 2020 earnings call. Joining me on the call today are Ashish Masih, our President and Chief Executive Officer; Jonathan Clark, Executive Vice President and Chief Financial Officer; Ryan Bell, President of Midland Credit Management, based in San Diego; and Craig Buick, CEO of Cabot Credit Management based in London. Ashish and Jon will make prepared remarks today and then we'll be happy to take your questions. We ask for your patience as consistent with social distancing best practices each of us from the company will be speaking from a different location. We'll do our best to mitigate any impact this may have on the execution of the call. Unless otherwise noted, comparisons made on the conference call will be between the first quarter of 2020 and the first quarter of 2019. In addition, 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 be using 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'll also post our prepared remarks following the conclusion of this call. With that, let me turn the call over to Ashish Masih, our President and Chief Executive Officer.

Thanks, Bruce, and good afternoon, everyone. Thank you for joining our earnings call. We are living in an unprecedented time due to the COVID-19 pandemic. It is impacting the health of our loved ones, the business we rely upon, the state of the global economy, and the way we live our daily lives. For those who are on the call, I hope that you and your families are safe, healthy and finding ways to stay connected under the current circumstances. Before we begin, I want to recognize those impacted directly by the coronavirus and their families and friends as well as the selfless heroes, the healthcare workers, first responders and law enforcement officers, who are tirelessly working with immense courage to help us all through this crisis. I would also like to thank our 7,000 plus employees around the world who have stepped up to the challenges of these unprecedented times. At Encore, we have been helping people recover from financial difficulty and turn toward a path of economic empowerment for years. It remains at the core of what we do and is even more relevant in current times. I'd now like to take a moment to provide an update on the impact of COVID-19 pandemic on our people, our business and our environment. First, the health and well-being of our people is our most important responsibility. Early on, we activated a business continuity plan designed to protect our people and our business. We created a cross-functional global task force that continues to manage our response to the evolving situation. Through a combination of social distancing and working from home, we have remained operational across all our jurisdictions. And I'm proud to say that our people adapted quickly to their changing work environments. In times of crisis, it is prudent to maintain a solid footing in ample financial resources. The improvements we have made in strengthening our balance sheet over the past two years has provided us with a solid liquidity position. This strong position increases our flexibility and will also enable us to capitalize on purchasing opportunities as we navigate our way through the coming months. As a leading player in the credit management services industry, Encore continues to treat our consumers with empathy, dignity and respect during this difficult time. Many of the hardships brought about by COVID-19 and the measures implemented to contain the spread of the virus are similar in nature to the hardships encountered by our consumers on a day-to-day basis. Our consumer-centric collections approach, which is a core competency of ours, is designed to specifically to work with consumers facing such hardships. At the same time, there are number of factors impacting our collections that are outside of our control, including restrictions within certain court systems and the various shutdowns impacting the broader business environment. We operate in a highly regulated industry, and across the globe, governments and regulators are adopting changes in order to provide relief to COVID impacted consumers. Adapting to changes such as these is a strength of ours, made possible by the expertise of our team, as well as through prudent investment in systems and compliance over the past several years. Finally, we have solid relationships with the banks and credit card issuers from whom we purchase portfolios, and to whom we provide credit management services. It is our aim to be strong partners for them and to be able to respond quickly as their needs evolve through these uncertain times. Turning now to Q1, today we announced financial results for the first quarter of 2020, during which we delivered another period of strong operating performance. Additionally, it should be noted that the impacts of COVID-19 outbreak did not occur until the quarter was nearly complete. While we delivered record collections of $527 million and record ERC of $8.5 billion, this strong performance was overshadowed by changes we made to our collections forecast caused by COVID-19. These forecast changes resulted in a non-cash charge of $109 million in the first quarter. As a result, we reported our first quarter GAAP net loss of $10 million or $0.33 per share with the non-cash charge reducing our earnings by $87 million after tax or $2.77 per share. Without the impact of revising our collections forecast in response to COVID-19, we would have established a new record level of quarterly earnings in the first quarter by a wide margin. The adjusted loss in Q1 was $6 million or $0.19 per share. The changes to our collections forecast had a significant impact on our financial results for Q1, as the large non-cash charge led to a loss in the first quarter. Importantly, these forecast changes are very much driven by anticipated delays in collections, and not by an expectation of permanently reduced collections. The COVID-19 pandemic has affected each of the world economies differently. Likewise, each of our businesses has also experienced different levels of impact. We are seeing that our business in Continental Europe has been impacted more than our business in the U.K. And our business in the U.S. has been impacted even less. Our forecast revisions in response to COVID-19 were based on delays in a portion of Q2, Q3 and Q4 2020 collections. In the U.S., we estimated the delays to range from 12 months to 21 months. In Europe, we estimated the delays to range over a number of years, due in part to the nature of lengthy payment plans in the U.K. Both in the U.S. and in the U.K., our history of success in purchasing portfolios with higher returns is a contributing factor to the relative size of our Q1 charge. As even a modest delay in collecting from a large pool group with a high return can generate a meaningful charge. Jon will provide more detail regarding this point in his prepared remarks. Although we normally don't provide partial quarter performance updates, we are pleased to share that our global collections in April were approximately 15% of our revised collections forecast. With the record collections in the first quarter, our business continues to generate significant amounts of cash as we collect on the portfolios we own. In fact, we set a new record in the first quarter for the combination of adjusted EBITDA added to collections applied to principal balance which is the industry benchmark for cash generation. Turning now to our business in the U.S., MCM collections in the first quarter were a record $375 million and were up 14% compared to Q1 of last year. MCM delivered a strong period of purchasing in Q1 with U.S. deployments totaling $185 million at an attractive purchase price multiple of 2.3 times. As I mentioned previously, we take pride in our strong relationships with the banks. And as the COVID-19 pandemic evolves, we continue to have constructive conversations with our partners with whom we have forward flow arrangements. Despite the addition, beginning in Q1 of 100% of court costs to operating expenses, we've succeeded in again reducing our cost-to-collect compared to the year-ago period. This is a strong reflection of our continued focus on expense management and operating efficiency. Turning to Cabot, the COVID-19 pandemic is having a substantial impact on much of Europe. Although the impact does differ from country to country, Cabot has adapted quickly to the varying conditions in each market, which reflects a deep understanding of our markets and years of experience in adapting to change. It is important to remember that Cabot like MCM has been helping customers who have been experiencing financial hardship for many years. This is what we do. As part of helping customers, we regularly provide forbearance to customers when it's the right thing to do. In the U.K., the FCA has provided industry guidance that cause the firms to offer forbearance when appropriate in hardship cases. Importantly, the proper respectful handling of hardship cases is already embedded in Cabot's collections approach. Within Cabot, the U.K. is our largest business, representing nearly 40% of Encore's overall ERC. During Q1, we saw consumer collections performing in line with expectations, and saw no material change in payment plan breakage rates. In the other parts of Europe, the impact from COVID-19 has been more profound. Emerging collections performance in late March and April indicates that the impact of COVID-19 on the Spanish market has been more significant than in the U.K. However, Spain represents less than 7% of Encore's overall ERC. Regarding the purchasing environment in Europe, since the viral outbreak began, banks have largely pause normal sales processes to focus more on addressing the near-term customer needs. As a result, we expect lower level of new portfolios coming to market in the near-term. However, over the medium-term, we anticipate that increased volumes of portfolios with strong returns will come to market as charge-offs are expected to rise meaningfully as a result of the COVID-19 pandemic. And I have more to say on this topic in a few moments. I'd now like to hand the call over to Jon for a more detailed look at our first quarter financial results.

Thank you, Ashish. As a reminder, we will sometimes refer to our U.S. business by its brand name Midland Credit Management or more simply MCM. We may also refer to our European business as Cabot. Global deployments totaled $214 million in the first quarter compared to $262 million in the first quarter of 2019. MCM deployed a total of $185 million in the U.S. during Q1, up 6% from the same period a year ago, when we deployed $174 million. European deployments totaled $29 million during the first quarter compared to $84 million in the same quarter a year ago. Deployments decreased in the first quarter of this year, primarily due to a relatively limited supply of portfolios coming to market in our core markets and as a result of our continued focus on returns. Global collections were a record $527 million in the first quarter and grew 3% compared to the same quarter a year ago, a period in which, Baycorp, a business we sold in August of 2019, generated $12 million of collections. In constant currency and after adjusting for the sale of Baycorp, global collections grew 6% compared to Q1 of 2019. MCM collections in the U.S. grew 14% in Q1 to a record $375 million. Collections from our debt purchasing business in Europe in the first quarter were $144 million, down 9% in constant currency. Global revenues reported for the first time under the new CECL accounting standard were $289 million in the first quarter. In the U.S., MCM revenues were $208 million in the first quarter. In Europe, Q1 revenues were $76 million. Under CECL, instead of allowances and allowance reversals, we will now report changes in expected recoveries, which consist of a current component and a future component. The current component is a measure of how much we collected in the quarter compared to expectations. This will be referred to in our filings as charges to expected current period recoveries - changes, sorry, changes to expected that current period recoveries, which in Q1 totaled $10 million. This means we collected $10 million more than we expected when the quarter began, another reflection of the strength of our underlying business. In conversation, we call these cash overs for collecting more than expected and cash unders for collecting less. As you might expect, the future component is labeled changes to expected future period recoveries. And under CECL, this number will reflect both positive and negative changes to the collections forecast. For Encore in Q1, that is the $109 million non-cash charge mentioned earlier. To be clear, three primary factors impact the calculation to determine this charge: how many collection dollars are expected to be delayed; how long the delay is expected to be; and the discount rate. Under CECL, the discount rate is our effective interest rate or EIR based on the purchase prices of the various portfolios contained within the pool group, and the expected future cash flows at the time of purchase. And for Encore, we've been booking portfolios at strong returns for quite some time. As a result, even a modest delay in collections for a large pool group with a high EIR causes a meaningful non-cash charge. As Ashish mentioned in his earlier comments regarding the effect of the viral outbreak on our earnings, with the impact of revising our - without the impact of revising our collection curves in response to COVID-19, we would have established a new record level of quarterly revenues in the first quarter by a wide margin. Before we leave this topic, I'd like to share my perspective on these COVID-related forecast changes. When we as an industry encounter something that impacts all players on a macroeconomic level like the COVID pandemic, the non-cash charges we incur are zero-sum game. The macro impacts will be largely universal, and will apply uniformly to all players within each geography. I believe those who had the best engines before the crisis will have the best engines during and after the crisis. I also believe that all of these charges will be self-correcting over the next few quarters through cash overs, cash unders and future forecast changes. If I know one thing, it is that none of us initially got it right, but as we move over time from projections to actual, the true economic impact will be consistent. There are a number of significant changes to our ERC since the end of December. As a result, we will not only compare our Q1 2020 ERC to the total from a year ago, but we'll also compare it to the total from a quarter ago to better explain the changes. Our global ERC total was a record $8.5 billion at the end of March, up $1.2 billion or 15% when compared to the end of Q1 2019. It is notable that our total from a year ago included $139 million of ERC associated with Baycorp, our former Australian subsidiary we sold in August of 2019. In constant currency and after adjusting for the sale of Baycorp, global ERC was up 21% compared to Q1 of 2019. Since the end of 2019, we have implemented the new CECL accounting standard, which resulted in two one-time transitional adjustments to ERC, which we mentioned during our previous earnings call. First, we are now including court cost recoveries in our collections forecast, which resulted in a $316 million increase. To remind you, this now makes us consistent with the rest of the industry in terms of court cost treatment. Second, we moved from a fixed duration forecast to a 15-year rolling forecast, which added $635 million to our ERC. Again, these two adjustments were associated with the transition to the standard and will not be repeated in the future. Typical updates to ERC comprise the balance of the changes, except for the impact of COVID-19 which resulted in an ERC reduction of only $31 million or less than four-tenths of 1% of our ERC. The small number reflects our belief that the vast majority of the impact of COVID-19 on our back-book is due to expected delayed collection and not an expected permanent loss of collections. In the first quarter, Encore recorded a GAAP loss of $0.33 per share. As Ashish mentioned earlier, this loss was a direct result of changes in our collections expectations caused by the COVID-19 pandemic. The impact to GAAP earnings in Q1 was $2.77 per share. After other non-cash and non-operating adjustments, our non-GAAP economic EPS was a loss of $0.19 per share in Q1. As Ashish mentioned earlier, in this challenging environment, it is prudent to maintain the solid footing and ample financial resources. The improvements we have made in strengthening our balance sheet over the past two years have provided us with a solid liquidity position and has created increased optionality as we navigate our way through the coming months. We have reduced our debt to equity ratio over the last two plus years from 5.9 times of 3.8 times with an uptick in this metric in Q1, primarily caused by the implementation of CECL and a foreign - and foreign currency effects in the first quarter. We have also reduced our ratio of net debt to adjusted EBITDA, a measure common in our industry. Over the past two years, we reduced this ratio from 3.2 times to 2.6 times, resulting in a level that is among the lowest in our industry. Encore's delevering has been driven by strong operational - operating performance and focused capital deployment, which have driven higher levels of efficiency and improved profitability. The combined available capacity under the revolving credit facilities for Encore in the U.S. and for Cabot was $581 million at the end of the first quarter, and we concluded Q1 with $169 million of non-client cash on the balance sheet. We adopted the new CECL accounting standard on January 1, and we would like to offer a brief recap of the key changes to our financial reporting being driven by the new standard. To begin, we now employ a rolling 15-year ERC forecast across our entire business as we typically continue to see collections on portfolios, up to 15 years and beyond. From a revenue recognition standpoint, the EIR of each pool group is now fixed for life from the time of purchase and both over and underperformance are recognized immediately in the period. We also changed our accounting for court costs. We now expense all court costs upfront when they are incurred. Because court cost recovery payments are now treated as collections, our reported purchase price multiples did increase by approximately a tenth of a turn making it easier to compare our multiples with those of our peers as they already account for court costs using this method. Even though we performed strongly enough in Q1 to reduce our cost-to-collect, the accounting change regarding court costs does put upward pressure on the cost-to-collect metric. Additionally, the change in our accounting with regard to court costs led to a one-time reduction in equity of $44 million. Finally as a reminder, the implementation of CECL has no impact on the strong cash flows that we generate. With that, I'd like to turn it back over to Ashish.

Thank you, Jon. The effects of COVID-19 on society are many, but one aspect that has become increasingly clear from government reports is that unemployment has risen dramatically in literally every major economy in the world. Historically, increases in unemployment have driven corresponding increases in credit card charge-off rates and in blank - bank loan delinquency rates. As the COVID-19 situation runs its course, we expect charge-off rates in the U.S. will react to the spike in unemployment, potentially driving a significant increase in the supply of receivables for our industry. As you know, we are focused on both the U.S. and U.K. markets, and we have the same expectation in the U.K., regarding the likely impact on charge-off rates in reaction to the spike in unemployment there. We expect both the U.S. and the U.K. markets are poised for substantial growth in the supply of charged-off receivables. For quite a while now, we have provided quarterly updates on our strategic priorities. We believe these three company-wide areas of steady focus are instrumental in building shareholder value. As a result of our emphasis on these priorities, we are well positioned for the unprecedented times caused by the COVID-19 pandemic. Our focus on the U.S. and U.K. markets has minimized the impact on our company related to those countries in Europe that have experienced deeper repercussions from COVID. In addition, we closed the sale of our Brazilian portfolios in April, allowing us to further concentrate our efforts on our key markets. Innovation and investments in technology, such as digital collections and speech analytics, have enhanced our competitive advantages in our core markets, and have also enabled us to quickly adapt to the varying operating conditions resulting from the pandemic. Perhaps the most important of these three priorities has been our heightened focus on strengthening our balance sheet, while delivering strong results quarter after quarter. As a result of this effort, we enter this period of uncertainty with a strong balance sheet and solid liquidity position. In summary, Q1 was a strong operating quarter for Encore in which we delivered record collections and record cash generation. In response to the COVID-19 outbreak, we implemented safety measures, social distancing and work-from-home strategies to protect our people and our operating capabilities. Additionally, had it not been for the non-cash accounting charge related to COVID, we would have reported record quarterly revenues and profits by a wide margin in Q1, an indication of our strong underlying performance and ability to generate considerable cash from our investments in high-return portfolios. Looking ahead, we have a solid liquidity position and believe the strength of our balance sheet, which we have improved over the last two years, will allow us to capture upcoming opportunities in our core markets, the U.S. and the U.K., which are poised for substantial growth. In closing, I believe that crises such as COVID-19 not only help build character, but also reveal it. I know that the current situation will reveal the strength of Encore's character, and I am confident that we will emerge stronger and more resilient than ever. As a company, we are well prepared. We are the experts in helping people who are facing financial difficulties. We are doing that now, and we will continue to do so in the future. Now we'd be happy to answer any questions that you may have. Operator, please open up the lines for questions.

Thank you. [Operator Instructions] And our first question comes from Mark Hughes from SunTrust. Your line is now open.

Yes. Thank you very much. I appreciate that. Thank you. Jonathan, can you say...

Hi, Mark.

I think, Ashish, you might have said that the people collections were 15% above your global revise collections. Any detail you might provide relative to prior expectations in the U.S. or Europe?

I think the - I'm not ready to provide any - anymore detail other than the fact that obviously, Mark, when you get the - go through the Q, you have a good sense of what the new curves are. And so you'll be able to get a good sense of what that meant in terms of what we collected in April.

In the - when we think about the financial impact, say, for 2Q of the adjustment, is it fair to say that your account balances are roughly 3% lower, so therefore we're going to apply similar yield, but just to a slightly smaller account balance. And of course, it's going to be influenced by purchases and run-off of the existing portfolios. But is that a fair way to look at it?

Yes, Mark, if I followed you. The EIR is fixed. So to the extent, all these - this charge reduced the basis, and so you have that same EIR that's applied against a smaller basis. But as you pointed out, we continue to purchase so - and continue to collect, and so you have those pushes and pulls.

And then, finally, anything about the pricing in supply in the U.S. under these circumstances?

Mark, this is Ashish. The U.S. market is heavily forward flow based and we actively are engaged in that market and in conversations with our issuer partners, so issuers continue to sell, and there has been no change on that front. And as you can imagine, many of them are potentially expecting increased supply at some point in the future, depending on how those delinquencies move through charge-off, but the market is healthy and all the sales are continuing to happen.

Thank you.

Thank you. And our next question comes from David Scharf from JMP Securities. Your line is now open.

Hi, good afternoon. Thanks for taking my question.

Hey, David.

Hi. Hope everybody is safe and healthy. Hey, Ashish, I'm wondering, obviously there are so many unknowns at this point. But as we think about the legal collection channel, can you maybe provide a little bit of incremental color on not just how many courts are open or handling cases on a virtual basis versus in person, but just strategically, how you're thinking about the backlog of potential legal claims if you plan on pursuing filing cases currently? And just maybe give us a little - little texture on how to think about maybe how the pace of legal collections may unfold this year just given some of the anomalies around court closures and public relations and so forth?

Yes. So there are few things embedded in your questions, David. So one is legal, something that we are reducing over time, and we take as a last resort after trying to engage consumers and only use that for very small subset of our consumers. And in a time like this, we've been extremely careful with hardship policies and so forth, and delaying some of our legal processes. Overall, let's say, I'll answer for MCM for U.S., not just legal, our collections as Jon mentioned, it's mostly a delay, and we expect at least based on our belief right now and things change every week literally that some collections for Q2 to Q4 2020 would get delayed by about 12 months to 21 months. And that's what the delay we assume and causes the charge that we took in Q1. Now the delay implies that eventually the court processes will start working. Now U.S. is a very large country with varying levels of court systems and with what are open, and it's not a zero or one. There's different stages in the legal process that happen. So states are operating and cities are operating at different levels of kind of open - opening and what functionalities. And we are watching it very carefully and taking it into account as we project our collections. And our best guess is there is going to be a delay, not a permanent loss only perhaps about a 10% loss of the collections that we just mentioned is going to be permanent, and you could attribute that to some to legal, some to call center, but eventually we hope to recoup about 90% of collections over time.

Yes, I understood. That's helpful. And maybe just to help us put things into context, especially since you under CECL are now expensing upfront the court filing fees and other legal collection costs. To the extent that you may be holding off on filing new cases, in the very near term for a variety of reasons, should we be thinking about a pretty material reduction to that $66 million of legal collection costs in the first quarter as we think about Q2, Q3?

That is correct. There will be a reduction in legal expenses, both from court costs, but also any reduction in legal collections that comes from our law firms. So there is less commissions to be paid. That is correct. And it will largely reflect in some ways the delays, I mentioned, although the curve for cost is a bit different than the collections.

Got it. And maybe one other follow-up question, and this is much more broad. But trying to understand, maybe some of the underlying macro assumptions that were kind of made at March 31 to sort of book that $109 million, ultimately the present value reduction. We've had some consumer lenders during this reporting season sort of lay out a trajectory of where they think unemployment will be near term ending the calendar year and settling in next year. As you mapped out that initial guess and we realize the constraints and uncertainties, are there any broad assumptions on unemployment that you were making that under laid that reduction?

That's a great question, David. So let me walk you through our kind of overall approach and thinking about the delays. So we - at that time and little later, we had to make kind of a belief on what the future would unfold, and this situation is a bit different. So there is two levels there. One is consumers, and you correctly point out, unemployment rate, but you also have to realize that in our business, our consumers are already in their own personal recession, if you would. So, unemployment rate has less of an impact on our ability to collect different topic, but it has a huge effect on the supply of charge-offs. This time, there is another factor which is working conditions, which is a broader business environment of courts, process servers, business openings and so forth that impacted, and we have a point of view - we had a point of view about what the future might be, and this change to collections forecast is our best estimate of how and when our collections will respond to such evolving situation, and it is continuously evolving. And as Jon mentioned, the vast majority of our collections changes reflect delays, not permanent reductions. And let me just give you a bit of color. The total ERC reduction, as you mentioned, is about $31 million, which is about 24% of total ERC. For MCM, we assumed between Q2 and Q4 of this year about approximated delay - approximate delays of about 12 months to 21 months. For Cabot, we assume for Q2 to Q3 this year delays award longer term in part because of the payment plans that are a staple of the U.K. business and that takes much longer to come back. And the last part that may not be intuitive as CECL has come into play at times is the size of the non-cash charge is the net present value of these changes. And as you can - against the discount rate has a huge impact on it. It's determined by what Jon described and defined as the EIR, effective interest rate, of each pool group. And we've been booking portfolios at very strong returns for some time. And if you do the math, even a very modest delay for a large but high EIR portfolio causes a non-cash charge, that's significant. So that's how we thought about what the future might unfold. Again, it will be different than what we expected at that time. And we continue to watch and adapt our operations and our practices to kind of what's unfolding right in front of us.

Got it. That's helpful. And maybe just the flip side of that and then I'll get back in queue. As you were contemplating the delays, and particularly the delays in this year pushing outward, did you factor in the combination of state unemployment, federal stimulus, both unemployment and the 1,200 and the 500 deductible, and did you notice any almost real-time impact to April collection patterns when stimulus check started to arrive?

So, as I said earlier, the factoring in was kind of broader assumptions about the business environment, codes and other things, of course, some of the macroeconomic as well. I cannot point out exactly how any stimulus or other things might be incorporated. We did see some effect in April, but we cannot point out to that. We definitely are not garnishing any bank accounts or anything like that. We stopped that well early in March for example, in the U.S. So people are making their decisions based on the funds they're getting. As I mentioned earlier, we are very consumer-focused and our consumers are already in their personal recession, and they make the best decisions and how they want to recover from the financial difficulty they are in. So, perhaps that played a factor in how they were making those decisions. We cannot exactly point out how that played out.

Got it. Thank you very much.

Sure.

Thank you. And our next question comes from Eric Hagen from KBW. Your line is now open.

Hey, thanks. Good afternoon, and hope all is well. Another follow-up on expenses. Just In addition to legal, which I think you just addressed, how does the rest of the operating cost structure responding to COVID? And then on the interest rate exposure side, just given how much of your debt is revolving, any benefit on the interest expense side that we should see in response to lower rates?

Yes, let me take a stab on the expenses, and Jon can add color to it but also address the interest rate question. So as you can imagine, and you've seen in the past well before that we've been trending our cost-to-collect and expenses down pretty steadily over the last couple of years. We continue to do that, but of course in this time, we put a sharper pencil on the expenses in terms of direct collections expenses, but also other expenses, the intensity and the focus has been much higher. So we expect expenses to continue to trend well, and in Q2, especially the legal expenses for the U.S. and U.K. as well will trend down, and perhaps pick back up again. But overall, we are managing the expenses with a heightened sense of focus as you can imagine in this time. Jon, I'll let you to chime in with anything on expenses and also the interest rate.

Yes. In terms of expenses, yes, I think Ashish, you have a good summer. I mean there are - in general, we've been obviously as you're aware, focused on this for quite some time. Remember that many of our - as we move forward here, many of our costs are variable costs. So if you collect more, your variable costs obviously will go up; if you collect less, it will go down. But there's also been things like reductions and things like consulting and infrastructure, because we've had big spend historically. And also remember some of our SG&A, as an example, is helped by the removal of Baycorp. So there are a number of moving parts, but the emphasis continues to be on controlling costs. And in terms of our interest, as you're probably aware, we try to be very prudent in managing our interest rate risk. And so at this point, we have in terms on a consolidated basis, 82% of our debt is either fixed or hedged. So at the margin, we do pick up something on the variable side as rates move down here some, but we have inherently fixed rate assets so we try to do our best to match our liabilities to those.

Great. That was helpful. Thank you. And I guess we'll see it in the Q, I think maybe it just came out, but can you shed some light on the breakdown of allowance between the U.S. and Europe, and even among vintages, if you were able to - and historically as you've seen subsequent improvements in cash collections. Any - can you kind of lead us to where those show up first, are they in older vintages or new, or what's the profile of receivable that typically outperforms your estimates? Thanks.

Yes. In terms of the charge roughly two-thirds of it was in Cabot and a third of it was in MCM. I'll often scold you for using allowance where we're trying to get away from that. So - but of the charge, it is about a two-third, one-third split. And in terms of, I don't think I'm prepared to go into a lot more detail in terms of vintage, et cetera, in terms of you referring to how things have gone in April was that you're [indiscernible].

Well, it would be great if you could - yes, I mean, if you could - it would great if you could address that. I mean, my question was maybe a little bit more broad or intended to be a little bit more broad, just as historically as vintages have outperformed your initial estimates, where those typically show up? Are they - just give us a sense for the profile of the receivable that typically outperforms your estimates? Are they older, are they newer, are they - are they some of the type of receivable that typically outperforms?

Yes, I think it's relatively broad based. I wouldn't say there's any bias on one or another. You can obviously go to our Q, and pull out for Q1, how it's been performing by vintage, but you won't have access obviously to April yet.

Okay. And did you guys say the supply of charge-offs coming to market over the near-term will be lower, but higher over the longer term. Is that just a reflection of COVID or was there something else in there to be aware of?

On that just want - yes, Eric, this is Ashish. To clarify what we said was in U.S., the market has been steady and still selling and so forth. And of course as we showed the potential that correlate - the correlation between an unemployment rate and charge-offs, you can predict what may happen. What I meant therefore was Europe especially U.K. is bit of a pause there from insurers and banks as they work to address their customer needs and the volume will come later in the year. I'll let Craig chime in as well on the supply dynamic in Europe. That's what we had bent [ph] at for Europe more than U.S. on that comment.

Yes. Eric, it's Craig here. Ashish, you're spot on, based on the discussions we've been having with our clients here, particularly in the U.K. They are very much focused on what they need to do to help to customers right now. We're not anticipating any material portfolios coming to sale in the near term. Things will need to stabilize a little bit. So it will be towards the latter parts of the year before we expect to see the volumes starting to pick up at this point.

But for U.S. just to make sure I was clear, Eric, that most of the large issuer sell on flows. So as the delinquencies are rising and the volumes are expected to rise much more quickly, and in the near term, I would think, and the supply will increase throughout the year in the U.S. Ryan, do you want to jump in, anything you're hearing something different there.

No, I think supply - current supply is consistent from what we see in the past, and obviously there are some upside potential in the back half of the year.

Great. Thank you very much for taking my question.

Perfect, Eric. Thanks.

Thanks. And our next question comes from Dominick Gabriel from Oppenheimer. Your line is now open.

Hey, thanks for taking my question and hope you guys are doing well. So can we just talk a little bit about how your expectations for delays in collections on payment plans versus the traditional collection strategies are impacted? Given you did discuss some of the delays associated with years versus bonds [ph], you did touch on this on some of the other previous questions, but given your mix between payment plans of your total book, how does this dynamic play through the delays in collections versus kind of what you saw in the great financial crisis? And how does this play kind of on the legal versus call center side? Thanks.

Sure, Dominick. Let me take a stab, and then I'll let Craig jump in. Now, I just want to be clear, the payment plans - we have lot of payment plans in the U.S. as well and that's increased, although the payment plans in U.S. are way shorter, significantly shorter than the U.K. ones. So for U.S. what I said earlier is, we expect the three quarters of - whatever the delay is for the three quarters of 2020, we will recoup within 12 months to 21 months. Most of it - vast majority of it in 2021. And even if its payment plans because the plans are much shorter. In U.K., the dynamic is fairly different. Some of the plans are very stable, but they are smaller monthly payments. And that's where it may take a longer time, a few years at times for those payment plans to come back to the levels, although we expect that again vast majority to come back, and it just takes much longer because the monthly payment sizes are smaller. So Craig, if you want to just chime in there as well.

Yes, Dominick. So the way to think about it is in the near term, we expect some of our customers are going to want to put their existing plans on hold where they sort of look at the world around and then understand what is going on. We expect we may then restart those payment plans if they're paying us, let's call it GBP25 a month in the U.K previously, they're going to go back to paying us GBP25 a month, but the two or three months of payments that they might have missed because there are a lot of things to focus on. Well, they're likely to pay them off at the end of their plan. So if their plan was originally 10 years; now it's 10 years and three months. So you need to think about that time, value of money, back to Jonathan's point, two of the three payments miss now when you discount it back, well out into the future, you end up with this accounting non-cash charge needing to be recognized at this point in time. We recognize as collections come down, we may get to the other side. Most of our consumers, who, as we said, are already in their own form of personal economic crisis. I'm not going to have materially better financial means on the other side, so we're expecting now to get back to what they were paying previously. Hence quite a long delay in terms of the recovery of those loss collections. Hopefully, that makes sense, Dominick.

Yes. That's really helpful.

Yes, sorry, Dominick. If I guess just - this is Ashish again. Again, we are all in different locations, so I appreciate you all bearing with us as we jump back and forth. There is a nuance I think you had a question around how is this different from previous crisis of the economic downturn. For the U.S. business MCM, it's actually quite different. Very significant part of our collections from call center come from payment plans. Now, as I said, these are shorter plans and much larger payment sizes. So they are very sticky. So the impact from any kind of economic downturn is much less on payment plans than on our ability to generate new payers. 10 years ago, we were pretty much all dependent on generating new players of settlements if we would, now a vast majority of very significant over 50% is coming from payment plans, which are very sticky. And so the impact is actually muted. And that's why we feel very comfortable that the delay is pretty short year to year and a half or so on the U.S. side.

So just really quick, I mean, CECL we know - just to add to this piece of the conversation, CECL we know on the bank side, it's all about the average loan loss and how long are the average life of loan. So is this really based as the two-thirds, one-third in Europe versus U.S. are the borrowers, they're paying ability dynamic significantly different? Or is it literally just the fact that on average, they're twice as long of the payment plans. And so because of CECL you have to take a bigger hit as you guys were almost explaining. Is that really more of what it is or is that payment ability is so much different? Thanks.

So, yes, sure. I think that might be oversimplifying it a bit. We have in Europe - we have Spain and U.K. are the larger ones. Of course, U.K. is the largest. So I wouldn't make that as simple conclusion. The delay is what causes it. So there is macro changes whether it's court systems, broader changes in process servers and other things that we took into - incorporated into our revised collection curves. So what the charge difference shows is how the ERC changes and over what time. Again if you have high effective interest rates the delay causes to the charge to be larger. So it's just a longer delay on the European side versus the U.S. side. That's the bigger one. I wouldn't jump that far that it's - one is twice the other in terms of the consumer behavior because the curves depend on consumer behavior, types of collections, legal versus call center, payment plans as well as the court systems and other environmental factors.

Okay, great. And then, just one more, if I could. The collection agency commissions, I think because of the sale on the geography that your expenses, they kind of changed a little bit in the fourth quarter because of the sale of refinance here. And then it looks like they almost reverted back with a very small collection agency commission, dollar expense amount and then a higher versus the fourth quarter, I'm saying kind of just total other expense G&A and other expense categories. Did something flip back where the geography of your expenses, we should expect that $13 million - roughly $13 million to be back down or should it be back up towards that $37 million we saw in the four things [ph]?

I wouldn't - yes, go ahead, Jon. Sorry, go ahead. Yes.

Were there something else going on? Thanks.

Yes, no. It's the - what's going on is couple of things, right. One, as you are probably aware, this is heavily non-U.S. function. So there is FX that gets in play here, and that impacted this. Also just - there was globally lower third-party collections. So the combination of the two drove lower number. Now what will it be going forward? Well, much of that is determined by things like if you buy, as an example, a paying book at Cabot, and you - and it's already with a servicer you don't necessarily turn it right around and try to move that because of breakage, right. So the more of those you buy that pushes it up, FX obviously will move it around too.

Okay. Thanks, everybody. Appreciate it.

Sure.

Thank you. And our next question comes from Robert Dodd from Raymond James.

Hi, guys. On the April data, you said plus 15% on global, separately you also told us, obviously, the U.S. in spite doing better than the U.K., and the U.K. is doing better than Continental Europe. So can you bridge, does that relate also to what's going on in April or is that just a general reference to how you shifted the curves that - in terms of duration that continental Europe stretch further, U.S. stretch less. Or does that tie into also how things are performing in April. And if that's the case, is there anything that you can kind of lay at the door with why that's going on?

Yes, Robert, that is correct. April is also reflecting that kind of performance differential across geographies. Again different countries have been impacted differently by different factors. One is level of locked down, level of government support, and kind of just ability to contact consumers and whatnot or do some of the other collections tools that we have. So it is largely reflective that U.S. performed better than our new April expectations better than that 15%, and Europe was a little bit less than 15%.

Okay, thank you. On kind of [indiscernible] or if you can - do you have any data you can share, is it about productivity versus say in a shutdown geography versus year-over-year or however you want tell [ph] how much - where people are still working, but maybe not in the call center, or lower density or how exactly you're managing that? What's been the impact on productivity, and how much of that is responsible for the changes to the curves versus just a simple duration function as well?

I'm sure. So I think our internal productivity has been very high. Now clearly it was impacted and our teams did an amazing job from using social distancing, work from home and other things to get us to almost full capacity. And I would say the collections changes that our future looking are more about consumers, as well as the broader environment such as courts and the pace of courts opening, our processor was working. It's more of that than productivity. And as you can imagine, we can - we are very analytic in our approach. We can make sure we are working on the most valuable accounts of portfolios with the people we have. And whatever margin loss and productivity we have had over time and that's continuing to reduce has not really been the biggest driver of our future expectation changes.

Okay, got it. Thank you.

Sure.

Thank you. And our next question comes from Mark Hughes from SunTrust. Your line is now open.

Thank you. You've mentioned a few times how the higher discount rate that EIR influences, the NPV calculations. And so I assume it's not an economic discount rate like you might normally think about, but rather a function of the yields on the relevant portfolios. Can you say what the aggregate yield was for the calculation?

I'm going to let Jon take this. This is something we've thought about quite a bit and that's why we alluded to it, and it's an important one to understand. So, Jon, you want to walk us through this.

Yes. There is a couple of different ways to look at this. You obviously can go to the Q mark and get the EIR for each vintage, right. But thinking about it from a big picture perspective, you have your cash flow or your original projections, let's take a random pool group, and say that you've got [indiscernible] as an example, thinking about the 2018 vintage. Now the 2018 vintage, you know, there's roughly - you had the last three quarters of this year, you then push out to the last three quarters of next year. That's basically the way it works, right. And so that if you think about it, you just take in and somewhat it on a pro rata basis with a modest haircut, and say you collect 90% in that period. So when you think about a period on period, you're kind of rolling everything 12 months out, right. And that small move at that EIR, right, and if you think about it, when you get up to - I'll remind you EIR stated as a monthly basis. So that's a - translates an annual basis to something like 56% for that vintage, right. So think about that, right. A 56% annual discount rate and you pushed out several million dollars by 12 months. And you get a charge for that movement in excess of $10 million, right. So it doesn't take much with these kind of IRRs to move them out and have a profound impact on kind of I think what people lose sight of is EIR is a monthly metric, and so these are actually very, very high EIRs, right.

If you changed that analysis and did a discount - did a calculation [indiscernible] normal discount rate 8% or 10%, the NPV of that would be much lower that they were looking...

Much lower. And to remind for those who aren't as familiar as you are with how this works, right, these calculations are done on a gross basis. So it doesn't mean that this has a net IRR of that kind of level, right. What it means is just gross cash flows that we paid out and gross cash flows that we're getting back and does not account for expenses, but that's the way the revenue calculation works.

Very good. Thank you.

Sure.

Thank you. And our next question comes from John Rowan from Janney.

Good afternoon, guys. I just wanted to make sure that I understood previous comment correctly. So the collection agency commissions going down sequentially. That was a function of FX. And so I'm assuming then there was some type of FX gain in the quarter. And that's how I interpreted what you said. I just want to make sure that I've heard it correctly.

No. What I meant to say, to be - try to be as clear as possible, when you compare Q-on-Q, so 2020 of - first quarter of 2020 to first quarter of 2019; that difference - that reduction was caused by - remember this is an expense. It was caused by the pound weakening relative to the dollar and lower collections from third parties.

Okay. All right. Thank you.

Yes.

Thank you. And I am showing no further questions. I would now like to - actually we have one follow-up from Mark Hughes from SunTrust.

Okay. Mark, go ahead.

Sorry about that.

No problem.

The other expense - other income, other expense, it's a volatile line item. It was slightly positive this quarter. Directionally, how should we think about that?

I'm sorry, Mark, you were talking about the other income, other expense on the P&L?

Yes, that's right.

Yes. From where I sit, Mark, if I were you, I'd model that as zero, right. Sometimes it's higher, sometimes it's lower, so zero it out.

Okay. Thank you.

Thank you. And I'm showing no further questions. I would now like to turn the call back to Ashish Masih, the CEO. You may go ahead, sir.

Thank you. So that concludes the call for today. Thank you all for taking the time to join us. And we look forward to providing our second quarter 2020 results in August. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.