PRA Group, Inc. (PRAA) Q3 2020 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the PRA Group Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Ms. Darby Schoenfeld, Vice President of Investor Relations for PRA Group. Please go ahead.

Thank you. Good afternoon, everyone, and thank you for joining us. With me today are Kevin Stevenson, President and Chief Executive Officer; and Pete Graham, Executive Vice President and Chief Financial Officer. We will make forward-looking statements during the call, which are based on management’s current beliefs, projections, assumptions and expectations. We assume no obligation to revise or update these statements. We caution listeners that these forward-looking statements are subject to risks, uncertainties, assumptions and other factors that could cause our actual results to differ materially from our expectations. Please refer to the earnings press release and our SEC filings for a detailed discussion of these factors. The earnings release, the slide presentation that we will use during today’s call and our SEC filings can be found on the Investor Relations section of our website at www.pragroup.com. Additionally, a replay of this call will be available shortly after its conclusion, and the information needed to listen is in the earnings press release. All comparisons mentioned today will be between the third quarter of 2020 and the third quarter of 2019, unless otherwise noted. During our call, we will discuss total revenues for the third quarter of 2019 on an adjusted basis as well as debt to adjusted EBITDA for the 12 months ended September 30, 2020. Please refer to the appendix of the slide presentation used during this call for a reconciliation of these non-GAAP financial measures to the most directly comparable U.S. GAAP financial measure. The slide presentation, including the U.S. GAAP reconciliation can be found on the Investor Relations section of our website. I’d now like to turn the call over to Kevin Stevenson, our President and Chief Executive Officer.

Well, thank you, Darby, and good evening, everyone. I’d like to begin this evening, as I did in the first and second quarter, by acknowledging that this pandemic is a human tragedy, the likes of which the world has not seen in a very long time. As a company, we started to do the right things for the right reasons. We’re extremely sensitive to the impact this is having on everyone globally, and our thoughts go out to all of those affected. I’m very proud of the hard work and dedication our employees have shown in 2020 as well as their commitment to treating our customers, respectfully, fairly and with empathy as we continue to work with those who have been impacted directly by COVID-19 or indirectly through its impact in our economies. These are unprecedented times and our employees' willingness to hold to our founding principles and core values is what makes PRA a leader in this industry. Before we discuss third quarter results, I want to share with you some thoughts on the final rules implementing the FDCPA or Fair Debt Collection Practices Act that the CFPB issued on Friday. The rules will become effective one year after the publication in the Federal Register. After our preliminary review, it’s our opinion that the rules provide much needed clarity around existing provisions of the FDCPA. Given that our focus has long been on the fair treatment of consumers, we don’t believe that major operational changes will be required to comply with the rules. So for example, call limits. The FDCPA has long prohibited harassing or oppressive or abusive conduct. But the new rule is defined and clarify that calling a person in connection with collection of a particular debt more than seven times in seven days will be deemed harassing, oppressive and/or abusive conduct. Call restrictions such as these are already part of our operations. The rules also include certain guidelines around the use and/or expansion of modern technology in communicating with consumers, namely e-mail and/or text messages. We continue to review these rules in conjunction with other laws and guidelines, including the TCPA, the Telephone Consumer Protection Act, as well as individual state requirements in order to determine the best pathway to expand usage of these channels. There’s a lot more to these rules than the limited examples that I spoke of, but in general, we applaud the CFPB’s efforts here and are pleased that the rules appear to be fair and balanced and will be applied to the collection industry as a whole, helping to level the playing field amongst all companies in this industry. The Bureau has also indicated it intends to publish additional rules around in the December time frame that will be more focused on required disclosures and/or related consumer protections. And again, we applaud the CFPB’s direction. We encourage these efforts. We all need to stay focused on leveling the playing field and bringing the entire industry uniformly in line with best practices. Moving on to the third quarter. For the third straight quarter, we set a new global cash collection record. In Q3, we collected $519 million beating our Q2 2020 record results, which is driven by significant growth in U.S. core non-legal collections as well as Europe cash collections. Quarterly portfolio purchases were $178 million with improving price multiples – so purchase price multiples and no significant change in the type of portfolios that we’re purchasing. We’ve also started to see some of the volumes, that were paused in Europe, make their way to the market, and we are maintaining close working relationships with sellers. And then rounding out the quarterly highlights, estimated remaining collections or ERC ended the quarter at $6.3 billion. In the Americas, our cash collections were $374 million. In the U.S., the trends we saw in the first half continued into the third quarter. And as we discussed in prior conference calls, it’s our continued belief that large scale work from home, decreased opportunity to spend money on travel and entertainment, and continuing forbearance programs, have provided U.S. consumers with excess net funds at their disposal. And this has been a key driver of cash collections this year. This phenomenon is also evident in many areas of our economy outside our industry, and I trust most of you have seen that. Generally high – generationally high savings rates, strong demand for goods such as boats and campers and, of course, strong demand for home improvement goods and supplies. We believe this has contributed to a shift in payment channels from legal to call center as well as digital. And we prefer this shift because the legal channel is generally are our last option. It’s typically employed when our other collection efforts are unsuccessful. Our operational capacity in the U.S. is strong. Because of our decision to maintain excess space in our call centers, we have plenty of room to maintain social distancing standards that are required to keep our offices open and productive. As a result, our U.S. business is operating at full capacity, and our call centers are open and generating productivity metrics that are record-setting. Our support staff, on the other hand, remains in a work-from-home status as I’m sure most of you on this call are experiencing, and their level of effectiveness is largely increased. Total portfolio purchases in Americas during the quarter were $98 million, and this was slightly depressed during the quarter due to the impacts I just mentioned in the U.S., which resulted in charge-off rates – lower charge-off rates and bankruptcy filings. However, based on loan loss provisioning and commentary from issuers, we believe this decrease is temporary and that supply will increase by mid-2021. Portfolio sales in South America have been quieter than normal as the pandemic has delayed sales volumes there, similar to what we saw in Europe. Moving on to Europe. Total cash collections in the quarter were a record $146 million. Cash collections in the quarter were driven primarily by a combination of record portfolio purchases in 2019 and the easing of COVID-related restrictions, which allowed payment channels such as legal to improve. Our European business is still operating at normal capacity but remains in various stages of work-from-home and in-office statuses with very little impact to productivity. Portfolio purchases in the quarter were $79 million, which makes this the third highest Q3 in terms of portfolio purchased in our history. But because of improving returns, it’s the second highest Q3 in terms of estimated revenue purchased. So we’re very pleased with this level of investment, which is – in what is typically a seasonally slower quarter. And we are starting to see the sale of portfolios that were delayed earlier this year, and that contributed to our results this quarter, and it’s also leading to a very strong pipeline in the fourth quarter. I’d like now to turn things over to Pete to go through our financial results.

Thanks, Kevin. During the third quarter, we continued the strong cash collections performance we saw during the first half of the year. Global cash collections were a record $519 million, increasing $66 million or 15%. This led to total revenues of $268 million, an increase of $22 million or 9%, primarily due to significant overperformance versus expected collections during the quarter. Recall that under CECL, revenue has two components. First is portfolio income, the yield component, which was $240 million. Second is changes in expected recoveries, which has two parts. First is cash that we collected in the quarter compared to expected recoveries. This amounted to $89 million in excess of expectations, driven by significant overperformance globally. The second part is the present value impact of any changes in ERC. This quarter, that netted to a negative $64 million. We’ve again assumed that the majority of the overperformance in the U.S. is timing acceleration of collections rather than an increase to total expected collections. We believe this is still an appropriate assumption given the current environment. However, if we see sustained performance over time, supporting an increase in our expected total collections, it should drive additional revenue in the future. Operating expenses were $179 million, a $2 million decrease from the third quarter of 2019. Our operating expenses were reduced in the third quarter due primarily to lower legal collections costs and compensation expenses. Net income was $42 million, which generated $0.92 in diluted earnings per share. Driving the quarterly record, cash collections in the Americas increased $48 million or 15%. This was driven by a 37% increase in U.S. non-legal collections, which again included a significant increase in digital collections. Americas collections are outside the U.S. grew $6 million or 21%, led by Brazil. These increases were partially offset by a 6% decrease in U.S. legal cash collections and an 18% decrease in Americas insolvency collections. Europe cash collections during the quarter grew $18 million or 14%. The biggest driver of this growth was the record portfolio purchasing we did in 2019. Our cash efficiency ratio was 65.6% for the quarter, bringing the year-to-date ratio to 65.3%, a continued improvement compared to last year. Legal collections costs were the largest contributor to the decrease in operating expenses when compared to the third quarter of 2019. As Kevin indicated, we’ve seen an increasing number of payments coming in through the call centers and digital channels. Our data indicates that some of the accounts paying us today would have historically been pursued through the legal channel later in the cash collections curve. This is one of the reasons we’re cautiously treating the overperformance in cash collections as acceleration versus improvement in total expected collections. This is a benefit to us from a timing perspective, as receiving cash earlier in the curve is always preferable. However, this also decreased the inventory of accounts in the legal channel during the quarter and will continue for the foreseeable future, thus reducing legal collections costs as well. During the fourth quarter, we expect legal collections costs to be in line with this quarter. As indicated last quarter, we expected compensation expenses to sustain improvement over 2019 levels, and they came in just over 4% lower than the third quarter of 2019. We believe the fourth quarter will be materially the same. This quarter’s results contribute to an increase in expectation for the cash efficiency ratio to around 64% for the full year of 2020. Our ERC at the end of the third quarter was $6.3 billion, with 50% in the U.S. and 45% in Europe. ERC decreased slightly from the third quarter of 2019 and was essentially unchanged from last quarter. We achieved a significant milestone during the quarter, completing the first unsecured notes offering in the U.S. for our sector. As part of this process, we obtained best in sector ratings of Ba1, BB+ from Moody’s and Fitch. Additionally, we retired $288 million of convertible notes that matured in August, and we amended and extended our North American credit facility. Our funding position is in great shape, and we have no significant maturities until 2023. Our recent strong cash and financial performance has driven significant improvement in our leverage position. For the 12 months ended September 30, we generated $1.3 billion of adjusted EBITDA, an increase of over $200 million when compared to the full year of 2019. As a result, we ended the quarter with a debt to trailing 12-month adjusted EBITDA ratio of 1.9 times compared to just over 2.5 times at the end of 2019. Our capital position is strong with over $1 billion available for portfolio investment, and we’re well prepared for higher levels of purchasing volume we anticipate coming in 2021. Now I’d like to turn things back to Kevin.

Thanks, Pete. There are many different things to consider as we think about what the next 18 months holds, particularly in terms of the supply of non-performing loans. If you consider the loan loss provisioning that the banks across the globe took in the first nine months of 2020, there will be significant increase in charge-off rates. We’ve seen industry analysis that suggests a doubling or more from the current levels. The actions of governments everywhere seems to have slowed the realization of that. But especially in the U.S., the bank’s implementation of CECL required those losses to be financially recognized now. As such, it’s our belief, it’s only a matter of time before those provisions are realized with increased charge-off volume. Interestingly, it’s our experience that during the global financial crisis that a quick increase in charge-off rates brought non-selling banks to the sales market. If that happens, in addition to the increased supply from current selling banks, you could see a very large increase in portfolio sales. We also saw evidence during the third quarter that portfolio sales that were paused in Europe are now returning to market. The pipeline indicates that this will likely impact the fourth quarter, and we believe the supply in Europe will increase sooner than in the U.S. As a result, thus far, in the fourth quarter, on a global basis, we’ve already won more volume than we recorded in Q3. As one of our founding principles is to maintain a capital and operational structure and that allows us to be ready no matter what environment may deliver. If you examine the position we’ve built over the last few years, I believe we’ve done that. We have built sustainable, efficient operating capacity and the ability to leverage that over additional portfolios. With record portfolio purchases we made in 2019, we have very recent data with somewhere between 12 and 24 months of experience data in pricing and determining collection activity. We’re at a strong capital position. In addition to the over $1 billion of adjusted EBITDA that we are consistently generating on an annual basis, we also have another $1 billion of additional committed credit capacity ready to invest in NPLs globally. And with our best-in-sector credit rating and a conservative capital structure, we believe we have the flexibility and capacity to raise additional capital, should that be needed. That all leads me to this. I believe PRA is in an excellent position. This is the result of planning and execution on our strategy, our commitment to our long-standing values. I continue to be impressed by things our employees are able to accomplish, and I want to thank each of them for everything they do every day. And with that, operator, we are ready to take questions.

[Operator Instructions] And the first question comes from David Scharf with JMP.

Good afternoon, everyone. Thanks for taking my questions. A couple of things, Kevin. For the most part, it sounds like the overall commentary on the environment is similar to three months ago, except in Europe. And I just wanted to get a sense for if you feel like the resurgence of some volumes there is maybe just sort of a little bit of a catch-up, some pent-up demand. You noted some pausing of sales earlier in the year. Or if you feel like you have a little better visibility internally into how much capital you can deploy there over the next 12 to 18 months?

Well, the first part of your question, I do think that a lot of what we saw in Q3 was some of those portfolios that were paused in Q2. So I think that, that’s fair, and I think I addressed that in my prepared comments. As far as volumes in 2021, again, we’ve got a lot of capital. I think – I focused on the U.S. banks, because CECL is so new for the folks in the U.S. environment. But the methodology is pretty similar in Europe, and it has been for a while, where they recognize that allowance, I’ll say, or that provisioning way in advance of seeing the delinquency rate. So I think that we are going to see really strong volumes in both the United States and Europe in 2021.

Got it. Yes. Yes. No. I mean, clearly, it seems like more of a not if, but when situation now. I’m just curious, obviously, I mean, a lot of lenders, card, auto, everything on the consumer side sort of over-reserved in the early days, weeks of the pandemic, given how unprecedented it was, and we’ve seen reversals since then. Same with you as you’re recording more collection upside. When you gauge sort of the pipeline, whether it’s the Europe or the U.S., does it include any kind of real-time qualitative chatter and feedback from your sellers? Or is it based entirely on just kind of looking at the same quantitative reserving figures that we can see for public sellers?

That’s a great question, David, so I’ll be measured in my response. So one of the great things about – well, about people’s willingness to get on Webex and Zoom calls is that they’re willing to get on Webex and Zoom calls. And so I have personally talked to not only a lot more employees than I normally do but also lawmakers and, I would say, selling and non-selling banks, and so – again, across the United States and Europe. And so I would say that the qualitative commentary is that they’re all expecting significant charge-off increases. And I would add to that, I think that even to some degree, some are trying to figure out themselves when that’s going to come. And even to the extent I would say, trying to time their sales so that maybe they can get in front of some of the wave. So that’s probably as far as I can go with a qualitative view on that, but I’ll let you digest that and ask another question.

Fair enough. Yes. Listen, enough. Yes. Listen, just one more, switching to the expense side. Looking at my notes from a quarter ago, at that point, I believed that you had anticipated legal expenses would kind of return to more normalized levels in the second half. They came in lower in Q3. You guided to kind of flat sequentially in Q4. I know Pete discussed some of the dynamics there. But I’m just trying to get a sense for how to think about maybe the medium-term efficiency ratio if you’re thinking about the collection mix just structurally a little differently longer term? Or is this a very kind of near-term just disruption from the pandemic that you’re not able to pursue as many legal recoveries?

Yes. Again, what I was trying to highlight in my prepared remarks was this concept of acceleration, right? So we’ve had really outstanding performance in the voluntary arena, call center, digital. And as a result, we believe that, that’s having an impact on the inventory of accounts that are eligible for our legal collections. And so at least for the near term, our anticipation is that, that’s going to result in fewer accounts being sort of put into process there and, as a result, lower expenses. I mean I wouldn’t say that’s a forever thing. But it’s kind of the inverse of where we found ourselves in 2018 when people were being non-responsive because of the robocalling and everything else, and we ramped up legal at that point. So it depends on what we buy. And if responsiveness in the call centers and digital continues at the same pace, then maybe that does become a more permanent level.

And the next question comes from Mark Hughes with Truist.

Look, you touched on earlier in the call, but the collections trajectory through the quarter, did you notice any changes as you progressed through the month?

Well, yes, things like – let’s take contact rates, for example. As you enter Q2 and Q3, they tend to be seasonally weaker collection periods and contact periods. So I would say we did see some, I would say, expected degradation along with the seasonality, certainly significantly higher than last than a year ago and last year. But that would be the color I’d provide.

So just normal seasonality, albeit at a higher level to begin with. Is that fair?

Yes. Yes, that’s fair.

And then I think you were just touching on this, but the view that you’re pulling forward the collections that has been acceleration rather than a betterment, what influences your view on that? Is it – I mean is this something kind of tangible in what you’re seeing in the nature of the collections that looks like acceleration rather than betterment? Or is that always mostly judgment?

I mean it’s always down to judgment. Part of the issue we’ve had this year is we’ve never had a collection profile during the year that we’ve had this year, right? Like usually March is the peak, and we kind of float down through the remainder of the year. We had consecutive month after month build of collections above that March peak this year. And we don’t – we’ve never experienced that before in company history, and we’re just cautious that we don’t know what we don’t know at this point. I think the only thing tangible we could probably point to is what I said around the legal collections channel in terms of data that would say we’ve collected things earlier through a voluntary channel. But yes, we’re cautiously looking at how we set the forward curves.

And then I don’t know if you commented on the – any international disruption from COVID reacceleration. Anything we ought to think about there?

Yes. The only comment I made was in my prepared remarks. I talked about the record had a – Europe had a record-setting quarter, and some of that was due to some of the easing of restrictions. And so any shortfall we may have had, say, in the legal channel, for example, in Europe, got caught back up. And that’s a significant finding, I think, from Europe. What do you say, Pete? You have anything else you had observed?

No, no, that’s right. And we’ll kind of monitor what happens as they seem to be instituting some newer restrictions. But so far, it doesn’t seem like they’re as onerous as before. So we’re expecting to continue to operate pretty well.

On the fee and other income, fourth quarter last couple of years has been a pretty big quarter. Is there some reason to think that stronger seasonality should repeat or that it should not repeat?

Yes, yes. It’s a little bit lumpy, and it depends on timing of deals. But I don’t really have any other guidance for it.

And the next question comes from Dominick Gabriele with Oppenheimer.

When we just think about the dynamics that are happening between the U.S. and Europe and obviously, kind of looking and waiting for that bell curve to materialize in gross charge-offs at the banks. Can you talk about what could cause a delay in Europe realization of that bell curve and the ramp in charge-offs versus the U.S.? Why you would think that would occur or not occur? It seems like you had a nice catch-up, like you said, bought a lot in Europe. And then maybe if you could talk about your allocation of the capital that you have, like you said, it’s just a tremendous amount of cash you guys stood off. And if the environment stays subdued, I mean, could you – would you ever purchase some – another partner or to go into a JV with a partner over in Europe or something along those lines if you see the opportunity in that way?

Absolutely. I had to jot these down real quick. So the first part of the question being about Europe NPL flow or charge-off increases, I would drive from that. I don’t – I can’t come up with an idea of why that would be delayed. I think that I talked about in my script about how I think there’s going to be a sooner recognition that in Europe even versus the United States, because there’s a lot of things that happen in the United States that could potentially delay like some significant stimulus package or something like that. But I don’t see that Europe. And there’s also some structural things around bank regulation. I think, could also drive volume in Europe as well. So I’m pretty optimistic about – well, I’m optimistic about both markets, frankly. But certainly, to your question specifically, I can’t think of a reason that would be delayed. So that’s that. On the idea of using this capital to purchase another company, we’ll do that first. The problem with purchasing a company is generally you got to pay for a platform. And so you take, for instance, our acquisition of Aktiv Kapital. That was fantastic, and I’m really pleased with that. And it’s worked out so well for us on so many fronts. But we needed a platform over there, and it was worth putting some goodwill intangible assets on your books. At this point, we are in a lot of places. We’re in the places we want to be, and I don’t see us needing a platform somewhere. If you could pick up NPLs off someone’s books for a reasonable price, that’s a possibility. But it would have to be something I’m not thinking about right now in terms of acquiring a platform. And I’ll just tell you, rating agencies, they’re not big fans of negative tangible common equity ratios and all that. So I’m very cautious on that matter. And then lastly is a joint venture. I think we might have been asked that question in Q1 some time ago. And one of the things I have – an issue with joint ventures is we’ve got a lot of capital. And I think the most precious thing we have is our relationship with our sellers. And if you own a JV, you’re kind of giving some of that secret sauce away. So then the only time I would think about something like that is somehow if somebody brought a unique relationship we didn’t have, and they kind of demanded to be part of that equation. I might consider that. But that’s just off the top of my head. And Pete, do you want to say something as well?

Yes. The other – I think the other part of your question was around capital allocation. And I’d just highlight that with some of the changes we made in the quarter with doing the unsecured bond issuance and the amendments to our facilities, we have an ability to move capital much more freely than we did prior to making those amendments. So we’re ready for the portfolio as and where it comes at this point.

Okay great, thank you. And then just maybe one more. If you think about the legal collections expense again in the third-party fees, if you kind of think about the dynamics between the two and how different they are versus what perhaps some may have expected just in the performance of the consumer, honestly. Is it maybe a better idea for someone on the outside that frankly add these two expenses together and let them lie where they may be over the next few quarters as we think about modeling out of those expense lines?

Sorry, was your question about legal costs and legal fees? Or I might have missed the question. Sorry.

Sorry. So let me – I’ll be a little more specific, sorry about that. So legal collection expenses plus the agency plus the outside fees, so basically, total fees ex compensation…

They’re really kind of different animals. So the legal collection costs really, as I was talking before about inventory, that’s really around the cost for placing those accounts through the legal channel. The legal fees are the sort of the commissions to external legal providers. And so those will move in tandem with our legal cash collections from third parties. The agency fees are really driven by where we’re using third parties for collections. to:

Thank you so much.

And the next question comes from Robert Dodd with Raymond James.

On – in your prepared remarks, Kevin, I think you mentioned obviously that a material increase in charge-offs if – when that happens could draw out some sideline sellers. I mean I just – is that based on any of your – any of those Zoom and Webex calls you’ve had with those banks? Or is that more of a hypothetical? It would make sense if it happened but more an assessment of whether it makes rational economic sense or based on conversations you’ve had?

No, no. I would say that it doesn’t come out of the Webex calls. It really comes out of just our experience in the global financial crisis. And we saw it happen there to varying degrees back then. And so it’s just one of those things, right? It’s one of those things that just give people that extra kick over the finish line. And if you think about it, Robert, you’ve been around long enough probably to remember that those guys left the market back in what, around 2015, somewhere around there because of a client’s problem. And the world is so changed. I mean it’s a whole – it’s post-CFPB world and it’s – the requirements are it’s – again, it’s just a whole different world. So I think you’ve got a lot of distance between those original compliance concerns back in seven years ago. You’ve got – if you get a kick in the pants a little bit for charge-off rates and goodness, if some of the analysis we’ve seen, if they do indeed double, that’s a pretty strong kick. So it’s just a hope, and it’s just something we saw in the GFC. So that’s why I mentioned it.

Yes. Absolutely. I mean, it makes sense. It does make sense. And then on the question of the curves, Pete, you’ve addressed it, obviously. Right now, you’re pulling things forward. How long would this kind of outperformance need to continue before you would conclude that may – it can’t – I guess it can be just put forward for effort, but how – what’s the metric? And how long would this need to continue before maybe you’d make the adjustment to say that it’s not just a pull-forward that it is a rise in the gross amount of collections you’re going to get from those accounts?

Yes. I think that’s going to depend on a variety of things. One is how do we see and observe a return to our expected sort of seasonality, particularly in the U.S. business. And I think also it’s going to depend on, in some respect on sort of how long have the vintages been on book. So to the extent something has been on book for a longer period of time, and we see kind of a return to normal patterns, we might do different things with different vintages depending on just how new they are. Because again, these are – particularly if you think about like 2019 or even 2018 vintages, we haven’t – we’re in the front part of that curve. These are 10-year curves that we’re pricing to. And it’s – we’ve never seen anything like this ever before in company history. So we’re – we’ll take some time to evaluate exactly before we know whether it’s a betterment or not.

And that concludes our question-and-answer session as well as the call itself. Thank you so much for attending today’s presentation. You may now disconnect your lines.