Encore Capital Group, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Encore purchases and services defaulted consumer receivables, primarily through its U.S. MCM and European Cabot operations. All amounts below are U.S. dollars; financial statements are unaudited.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Total revenue | $403.7M | $355.9M* | $1,118.8M | $1,049.9M* |
| Operating income | $142.5M | $108.3M | $409.3M | $333.1M |
| Net income attributable to Encore | $54.7M | $38.9M | $174.5M | $124.8M |
| Diluted EPS | $1.72 | $1.23 | $5.51 | $3.97 |
| Operating margin | 35.3% | 30.4% | 36.5% | 31.7% |
*2019 comparison is revenue adjusted for net portfolio allowance reversals. Encore adopted CECL on January 1, 2020 and did not restate prior periods, so revenue comparisons are not fully like-for-like. Q3 revenue growth versus the adjusted 2019 comparison was 16.2%; nine-month growth was 7.8%.
- Cash flow: Nine-month operating cash flow was $250.0M, versus $196.9M a year earlier. Investing cash flow was positive $7.6M, compared with negative $198.0M, mainly reflecting lower portfolio purchases. Financing cash flow was negative $267.9M.
- Liquidity: Cash and equivalents were $170.0M at September 30, 2020, including $20.4M held for clients. The company reported $464.8M available under its $1.05B Global Senior Facility and said it expected sufficient liquidity for at least 12 months.
- Debt: Balance-sheet borrowings were $3.252B, net of $106.5M in debt discounts and issuance costs; gross borrowings before those deductions were $3.359B. Total assets were $4.732B and equity was $1.127B. The company reported compliance in all material respects with debt covenants.
- Portfolio collections and purchases: Nine-month collections rose 3.1% to $1.575B. Portfolio purchases fell 30.4% to $532.2M; Q3 purchases fell 34.6% to $170.1M. Cost per dollar collected improved to 34.5% for the nine months from 36.8%, though the accounting change for court costs affects comparison.
Material changes and unusual items
- CECL adoption changed portfolio accounting and court-cost treatment. Encore now expenses court costs as incurred and records expected recoveries on a discounted basis. The transition reduced opening retained earnings by $44.2M. The change makes reported revenue and expenses less directly comparable with 2019.
- Q3 portfolio collections exceeded forecasts, which management attributed partly to forecasts reduced earlier in the pandemic and to collection improvements. Revised lifetime recovery estimates nevertheless reduced expected remaining collections, producing a $47.8M provision in Q3 and $199.4M for the nine months.
- Operating expenses rose 5.5% in Q3, including higher court-cost expense and a $15.0M CFPB settlement charge. Q3 interest expense increased 25.0%, including refinancing-related write-offs and a $10.4M make-whole payment. The September financing transactions generated approximately $24.6M of pretax expense overall.
- Q3 effective tax rate was 26.4%, compared with 7.1% in 2019; the nine-month rates were 25.5% and 12.8%, respectively. Management used the discrete tax method because pandemic uncertainty made annual earnings estimates less reliable.
Outlook, risks, and contingencies
- No specific earnings guidance was provided. Management said U.S. portfolio supply had declined amid lower charge-off rates and expected an increase in the second half of 2021. European banks had reduced near-term portfolio sales, and the company expected lower near-term supply there.
- Management said pandemic-related operational disruption had been addressed through remote work and social distancing, but macroeconomic consumer distress remained and could affect collections. It anticipated that a material portion of reduced European collections in 2020 could be recovered in future years; timing and extent remain uncertain.
- On October 15, 2020, Encore settled a CFPB lawsuit alleging violations of its 2015 consent order. The settlement requires a $15.0M civil penalty, approximately $9,000 of redress to 14 consumers, and continued adherence to a limited set of operational requirements. Encore neither admitted nor denied the allegations; the prior consent order was terminated.
- Other key exposures include ongoing consumer-protection litigation and regulatory scrutiny, possible changes to collection rules, uncertainty in recovery estimates, reduced portfolio supply, foreign exchange and interest-rate movements, and debt covenant restrictions. Management reported no material goodwill impairment indicators at quarter-end.
Investor verification points
- Assess the effect of CECL and court-cost accounting on reported revenue, expenses, margins, and the comparability of results with 2019.
- Track actual collections against management’s revised recovery forecasts, especially the $47.8M Q3 and $199.4M year-to-date reductions in expected recoveries.
- Verify whether portfolio supply and purchases recover as anticipated, and whether collections growth is sustainable across the U.S. and Europe.
- Review the full terms and ongoing compliance requirements of the CFPB stipulated judgment, along with subsequent regulatory developments.
- Monitor liquidity, debt maturities, financing costs, covenant headroom, and the ability to fund portfolio purchases while servicing debt.