Encore Capital Group, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Encore is a specialty finance company that buys defaulted consumer receivables and provides debt collection and servicing, principally in the United States and Europe. Results are unaudited. Unless stated otherwise, financial amounts below are in millions of dollars.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Total revenue | $426.0 | $344.8 | $715.1 | $690.5 |
| Operating income | $219.7 | $113.7 | $266.9 | $224.8 |
| Net income | $130.8 | $36.8 | $120.2 | $86.3 |
| Net income attributable to Encore | $130.3 | $36.7 | $119.9 | $85.9 |
| Diluted EPS | $4.13 | $1.17 | $3.79 | $2.74 |
| Operating margin | 51.6% | 32.8% | 37.3% | 32.4% |
Q2 revenue rose 23.6%; six-month revenue increased 3.6%. Comparisons are affected by adoption of the new CECL credit-loss standard in 2020, which changed portfolio revenue accounting; prior-period figures were not restated. Q2 revenue included a net $66.0 million benefit from changes in expected recoveries: $108.6 million of collection outperformance, partly offset by a $42.6 million reduction in estimated future recoveries. For the first half, changes in expected recoveries reduced revenue by $32.7 million.
Q2 receivable-portfolio revenue was $335.3 million, up 7.3%; servicing revenue fell 25.9% to $24.0 million. Six-month portfolio revenue increased 11.1% to $692.7 million, while servicing revenue declined 20.7% to $52.6 million. Lower servicing revenue partly reflected the 2019 Baycorp sale, COVID-19 effects, and foreign-exchange movements.
Q2 operating expenses fell 11.5% to $206.3 million, including lower legal collection costs and reduced general and administrative expense. First-half expenses declined 4.5% to $448.2 million, although legal collection costs rose 3.1%, partly because court costs are now expensed as incurred. Interest expense decreased 21.3% in Q2 and 11.7% for the first half, reflecting lower rates and certain prior-year refinancing costs, among other factors.
Cash flow, debt and liquidity
- Six-month operating cash flow was $209.7 million, versus $108.8 million in 2019. Investing cash use was $11.0 million, compared with $115.7 million; financing cash use was $87.6 million, versus $27.6 million of financing inflow.
- Cash and equivalents totaled $293.8 million at June 30, 2020, up from $192.3 million at year-end 2019. The balance included $21.1 million collected for third-party clients; $126.2 million was held by foreign entities, most of which was considered indefinitely reinvested.
- Total borrowings were $3.354 billion, down from $3.513 billion at December 31, 2019. Total liabilities were $3.698 billion and total equity was $1.042 billion. Investment in receivable portfolios was $3.201 billion.
- Encore reported $356.2 million of available capacity under its revolving credit facility, after borrowing-base and covenant limits; Cabot reported approximately $261.6 million available under its revolving facility. Management said it expected sufficient liquidity for at least the next 12 months and reported material compliance with financing covenants.
- On July 1, the company repaid $89.4 million of 2020 Convertible Notes at maturity using cash. A July 9 credit amendment increased revolving commitments to $1.127 billion and the term loan balance to $188.8 million, extended most facility maturities to July 2023, and added an accordion feature for up to $250 million. Some commitments and term loans remain due in December 2021.
Material changes, outlook and risks
- CECL adoption on January 1, 2020 changed portfolio impairment and revenue accounting and ended capitalization of court costs. The transition reduced retained earnings by $44.2 million, eliminated $100.2 million of deferred court costs, and added $44.2 million to receivable portfolios before other transition accounting effects.
- Management initially recorded a $109.0 million credit-loss adjustment in Q1 based on expected COVID-19-related collection delays. Q2 collections exceeded that reduced forecast; management judged most of the outperformance to be a pull-forward of future collections, not higher lifetime recoveries. Future estimates remain uncertain.
- Q2 gross collections from purchased portfolios were $508.2 million, down 1.3% year over year; first-half collections were $1.035 billion, up 0.7%. U.S. collections increased, while European collections declined amid pandemic effects and unfavorable currency translation.
- Portfolio purchases were $147.9 million in Q2, down 39.1%, and $362.1 million for the first half, down 28.3%. The filing cites cautious purchasing, limited European supply and greater uncertainty. It states that banks had reduced European portfolio sales and management expected near-term supply to remain lower.
- The filing provides no specific earnings or revenue guidance. Management described its long-term focus as investing in the U.S. and U.K. portfolio businesses and developing operations elsewhere in Europe. COVID-19 duration, government responses, court closures, collection timing, portfolio supply and economic forecasts could affect results and recovery estimates.
- Other items to note: the company sold its Brazil investment in April 2020 and recorded a $4.8 million loss; foreign-currency translation reduced first-half comprehensive income by $60.4 million. No goodwill impairment indicators were identified at June 30, but management warned adverse conditions could lead to future impairment. The company disclosed routine collection-related litigation and regulatory matters, with no material legal reserves; it had $2.3 billion face value of portfolio purchase commitments for approximately $276.3 million.
Key investor verification points
- Reconcile the reported earnings increase with the $66.0 million Q2 net recovery estimate benefit, CECL adoption, and the non-comparable prior-period accounting.
- Track whether Q2 collection outperformance persists or represents collections pulled forward, and whether estimated remaining collections and portfolio values are revised.
- Monitor COVID-19 impacts on European and legal-channel collections, court operations, portfolio availability, and cost to collect.
- Review liquidity and refinancing needs against the debt maturities, including the remaining December 2021 credit-facility amounts, and the cash repayment of the 2020 notes.
- Assess portfolio purchase returns and future collection assumptions alongside the $2.3 billion face-value purchase commitments and management’s lower near-term supply expectations.