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Edited Transcript of ECPG earnings conference call or presentation 27-Feb-19 10:00pm GMT

Q4 2018 Encore Capital Group Inc Earnings Call

San Diego Mar 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Encore Capital Group Inc earnings conference call or presentation Wednesday, February 27, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ashish Masih

Encore Capital Group, Inc. - President, CEO & Director

* Bruce Thomas

Encore Capital Group, Inc. - VP of IR

* Jonathan C. Clark

Encore Capital Group, Inc. - Executive VP, CFO & Treasurer

* Kenneth John Stannard

Encore Capital Group, Inc. - Head of European Businesses

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Conference Call Participants

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* Brian Dean Hogan

William Blair & Company L.L.C., Research Division - Associate

* David Michael Scharf

JMP Securities LLC, Research Division - MD and Senior Research Analyst

* Dominick Joseph Gabriele

Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst

* Eric J. Hagen

Keefe, Bruyette, & Woods, Inc., Research Division - Analyst

* Hugh Michael Miller

The Buckingham Research Group Incorporated - Director

* John J. Rowan

Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance

* Mark Douglas Hughes

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Robert James Dodd

Raymond James & Associates, Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to Encore's Fourth Quarter and Full Year 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Vice President of Investor Relations, Bruce Thomas. Mr. Thomas, you may begin.

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Bruce Thomas, Encore Capital Group, Inc. - VP of IR [2]

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Thank you, operator. Good afternoon, and welcome to Encore Capital Group's Fourth Quarter 2018 Earnings Call. With me on the call today are Ashish Masih, our President and Chief Executive Officer; Jonathan Clark, Executive Vice President and Chief Financial Officer; and by phone, Ken Stannard, the CEO of Cabot Credit Management, our subsidiary based in the U.K. Ashish and Jon will make prepared remarks today, and then we will be happy to take your questions.

Before we begin, we have a few housekeeping items. Unless otherwise noted, comparisons made on this conference call will be between the fourth quarter of 2018 and the fourth quarter of 2017 or between the full year 2018 and the full year 2017. 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 use rounding and abbreviations for the sake of brevity. We will also be discussing non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are included in our earnings presentation, which was filed on Form 8-K earlier today.

As a reminder, this conference call will also be made available for replay on the Investors section of our website, where we will also post our prepared remarks following the conclusion of this call.

With that, let me turn the call over to Ashish Masih, our President and Chief Executive Officer.

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [3]

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Thanks, Bruce, and good afternoon, everyone. Thank you for joining our conference call. Today, Encore announced financial results for the fourth quarter and for the full year. 2018 was a year of significant achievements for Encore, characterized by our accomplishment of key objectives and record results. This is a very good time for the debt-buying industry, particularly in the United States, and our improving performance reflects a strong position in key markets.

As the year began, strong forward flow commitment levels drove our expectation that the U.S. market would support an aggressive capital deployment plan with strong returns. In order to capitalize on this favorable purchasing environment, we deployed more in the United States in 2018 than in any prior year. Through our operational innovation and increased productivity, global collections and revenues increased to record levels. This performance helped generate record profitability and was key to delivering on our expectation of at least 20% growth in earnings per share for 2018.

In July, we completed our acquisition of the remaining interest in Cabot Credit Management. Accordingly, our fourth quarter financial performance includes 100% of the benefit of our full ownership of Cabot for the first time, contributing to our record results.

Turning now to our U.S. business. From an operations perspective, collections in the U.S. increased 11% or $123 million in 2018 to the highest level ever. For the quarter, collections in the U.S. grew by 15% compared to Q4 of 2017. Our consumer-centric approach to collections and improved productivity are driving a higher proportion of call center and digital collections compared to legal collections. As a result, U.S. call center and digital collections for the year were up 25% compared to 2017 and were also up 25% for the quarter versus Q4 of 2017.

Our investments in our digital collections platform continue to drive online collections growth. In addition, speech analytics and other technology-based initiatives provide opportunities to increase our productivity and make the best use of our scale.

2018 was a very good year for Encore from a capital deployment perspective. We increased deployments in the U.S. by 19% to $638 million, higher than in any other prior year, reflecting the favorable purchasing conditions and attractive returns. In anticipation of another strong year of investing in U.S. portfolios, we have already secured approximately $480 million in forward flow purchase commitments for 2019, and we expect to continue to grow deployments.

Fresh paper continues to dominate U.S. market supply and comprised virtually all of our purchases during the year.

The debt purchasing market in the U.S. has been favorable for some time now. Importantly, we believe that a much better market for buying portfolios is yet to come. In fact, the Federal Reserve recently released December 2018 figures. And revolving credit in the U.S., which is comprised largely of credit cards, has reached an all-time high of $1.04 trillion. Historically, there has been a strong correlation in the U.S. between the unemployment rate and the credit card charge-off rate. When more of the population are out of work, more people are susceptible to having trouble paying their credit card bills, thus leading to an increase in charge-off rates. However, over the last 2 years, charge-off rates have increased despite the fact that unemployment remains at historically low levels. We believe this charge-off growth has been driven not by unemployment, as is typical, but instead, by increased lending. We believe that the best purchasing opportunities are yet to come for this credit cycle in the U.S. When unemployment begins to rise, combined with the record level of revolving debt, we expect an increase in supply for our industry. Based on previous cycles, we expect this will lead to further rise in purchase price multiples and even more attractive purchasing opportunities for Encore.

Turning to the European market. In the fourth quarter, we saw an active marketplace with opportunities to win business at attractive returns. Due to continuing regulatory and supervisory pressure, banks across Europe continue to improve the balance sheets by selling the charged-off receivables. We are also seeing a growing pipeline of servicing opportunities as banks look to experienced servicers, such as Wescot, to outsource a more significant portion of their increasing credit management needs. Similar to the U.S., indebtedness in the U.K. has increased to record levels. And as a result, we anticipate a significant rise in consumer default rates in the future.

Cabot provides us a leading platform for long-term leadership and growth in Europe, particularly in the U.K. And we continue to focus on driving synergies from the transaction. Our U.S. and U.K. teams are collaborating in various key competencies, such as decision science and analytics, digital collections, speech analytics, collections platforms and consumer-focused call techniques. Our previously separate operations in Spain are now being managed as a single purchasing and servicing business under one leadership, leveraging the combined expertise in SME and consumer debt.

Turning now to annual results. We deployed $455 million in European portfolio purchases in 2018, buying the majority of this total in the U.K. Collections in 2018 from our European debt purchasing business were up 15% compared to 2017, continuing a strong multiyear growth trend. Overall European revenues, aided by the inclusion of Wescot servicing revenues for the year, were up 30% in 2018. Our growing servicing capabilities are providing us opportunities to work with a broad range of banks on BPO contracts as well as on pre- and post-charge-off servicing arrangements.

The acquisition of the remaining interest in Cabot allows us to step back and consider our deployment from a consolidated perspective, without having to take into account the previous minority interest. As a result of this change and after considering the differences in returns across our key markets, we plan on deploying a higher proportion of our capital in the more attractive U.S. market in 2019, while being more selective in purchasing portfolios in Europe. At the same time, we plan to grow our servicing cash flows and focus on operational efficiency. We expect all of these actions will contribute to reducing Cabot's leverage. We also expect that Encore's consolidated leverage will improve slightly in 2019 as a result of this plan.

Before I hand the call over to Jon, I'd like to spend a moment on Encore's other businesses. You may recall that over the past several years, when the U.S. market headwinds created pressure on volumes and returns, we made investments in a number of international markets. Those markets allowed us to deploy capital at higher returns. We closely monitor and evaluate the progress of all our businesses and R&D investments as these markets and our corporate priorities evolve. As a result, in December, we divested our interest in the Refinancia platform in Colombia and Peru. Although we developed a significant market share in this region, we believe that future growth of this business was limited. Furthermore, U.S. market conditions have recovered, making the U.S. market and its returns comparatively more attractive. Our reduced operational footprint after divesting Refinancia allows us to sharpen our focus on better returns in our core markets.

With that, I'd like to hand the call over to Jon for a more detailed review of our financial results.

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [4]

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Thank you, Ashish. Before I go into our financial results in detail, I would like to remind you that as required by U.S. GAAP, we are showing 100% of the results for Cabot, Baycorp and Refinancia in our financial statements. Where indicated, we will adjust the numbers to account for noncontrolling interests. Keep in mind that the Cabot transaction was completed in July, and therefore, we were only partial owners of Cabot for periods before the fourth quarter of 2018.

In the fourth quarter, Encore earned record GAAP net income from continuing operations of $47 million or $1.50 per share. This compares to $13 million or $0.48 per share in the fourth quarter of 2017. Adjusted income was also a record $45.5 million or $1.45 per share compared to $28 million or $1.05 per share for the fourth quarter a year ago.

I'm pleased to highlight Encore's continued strong cash generation. We believe adjusted EBITDA, when combined with collection applied to principal balance, is an important measure of the return of capital to the business. This cash generation enables a number of valuable activities, such as purchasing debt portfolios, reducing debt, expanding collections capacity and investing in innovation. Our increased level of adjusted EBITDA over the past year has given us the flexibility to achieve record deployments in the U.S. at the same time that we added collections capacity in the U.S. business and completed the Cabot transaction.

Global deployments totaled $247 million in the fourth quarter compared to $301 million in the fourth quarter of 2017. We deployed a total of $134 million in the U.S. during Q4, all of which represented fresh portfolios of charged-off credit card paper. This compares to $170 million in U.S. deployments in Q4 of 2017. European deployments totaled $106 million during the fourth quarter compared to $110 million in deployments in the same quarter a year ago. For the full year, deployments totaled $1.13 billion compared to $1.06 billion in 2017. We deployed a record total of $638 million in the U.S. during 2018, an increase of $102 million or 19% compared to $536 million of U.S. deployments in 2017. European deployments totaled $455 million in 2018 compared to $464 million in 2017.

Global collections grew 11% to $484 million in the fourth quarter compared to $438 million a year ago. Our domestic call center and digital collections were up 25% compared to Q4 of last year due to the benefits of our consumer-centric collections approach and improved account manager productivity. We also reported strong collections performance in Europe in the fourth quarter, growing 7% compared to the same period last year.

On a global basis, we collected a record $1.97 billion in 2018, up 11% compared to 2017 collections, which totaled $1.77 billion. European collections in 2018 grew 15% compared to the prior year, primarily as a result of better performance from liquidation improvement initiatives at Cabot.

Global revenues, adjusted by net allowances and allowance reversals, grew 10% in the fourth quarter to $349 million compared to $317 million in Q4 of 2017. U.S. revenues, adjusted by net allowances and allowance reversals, were $179 million in the fourth quarter, up 7% compared to the same quarter a year ago. In Europe, Q4 revenues, adjusted by net allowances and allowance reversals, were $144 million and grew primarily from the increase in collections, driven by our operational innovation as well as additional servicing revenue from Wescot.

Revenue for the full year of 2018 grew 15% to a record $1.36 billion compared to $1.19 billion of revenue in 2017 and primarily reflected our growth in European collections, driven by our operational improvements. Our ERC was $7.2 billion at the end of December, up $209 million compared to the end of December 2017.

In the fourth quarter, we recorded GAAP earnings from continuing operations of $1.50 per share. The pretax impact of the adjustments in the quarter totaled minus $0.01. After applying the income tax effect, we end up with $1.45 per fully diluted share, and our non-GAAP economic EPS was also $1.45. Our GAAP net income in the quarter was larger than our adjusted income, principally as a result of a favorable settlement related to Cabot's prior acquisition of dlc, which was included in our GAAP results, but not in our adjusted results. We did not exclude any shares from the calculation of our economic EPS in the fourth quarter.

For the year, we recorded GAAP earnings from continuing operations of $4.06 per fully diluted share. There are also certain items that affected our full year 2018 results. The majority of these adjustments were associated with the acquisition of the remaining interest in Cabot. After making all adjustments and applying the tax effect, Encore's adjusted income was $4.98 per fully diluted share and our non-GAAP economic EPS for 2018 was also $4.98. For clarity, we've included in our appendix the pertinent information about our share count that was used to calculate Encore's earnings per share throughout 2018.

With that, I'd like to turn it back over to Ashish.

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [5]

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Thank you, Jon. In summary, I'm very pleased with Encore's operational and financial performance and excited about our prospects. We reported record earnings for the fourth quarter as well as records for global cash collections, revenues and earnings for the year. In the U.S., the market for debt purchasing remains favorable, and we deployed a record amount of capital in 2018 to purchase portfolios to capitalize on this opportunity. In addition, call center and digital collections were up 25% for the year.

2018 was also a transformational year for Encore, during which we increased our ownership of Cabot to 100%, and we continue to focus on driving synergies from the transaction.

Collections from European debt purchasing grew 15% for the year, and revenues, which included a full year of Wescot results, grew 30% in 2018.

Looking forward, in Europe, we expect collections from debt purchasing to grow -- continue to grow in 2019, and we plan to further grow our capital-light servicing business. During 2019, we expect a higher proportion of our capital deployments to occur in the U.S. to take advantage of the current market's higher returns. Importantly, we are well positioned to purchase portfolios with even better returns once the growth in credit card charge-off rates begins to accelerate.

Now we'd be happy to answer any questions that you may have. Operator, please open up the lines for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Eric Hagen of KBW.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [2]

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A follow-up on the leverage that you mentioned in your opening comments as it relates to Cabot as well. Have you guys considered a restructuring of any sort of your debt that would make it more commingled with Cabot's in order to, I guess, generate what I would consider maybe a true shared capital model for the company?

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [3]

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Yes. Hi, Eric, it's Jon. We've actually been contemplating that even pre-closing of the acquisition of Cabot. As you can understand, it's quite complicated, and we have a team on it. And we're making some good progress, but it's too early to say how that will play out. But I think we're all in agreement that if there's a way to make that happen, I wouldn't -- well, I wouldn't phrase it as a restructuring. I think we would just evolve into more of a shared model with, if you will, kind of commingled ERC and borrowing bases. But that is certainly the hope, but I'm afraid I'm going to have to -- everyone's going to have to stay tuned and see how that plays out.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [4]

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Okay. Well, that's helpful color, nonetheless. The strength in acquisitions that you guys are expecting in the U.S. for the year, how do you expect the mix of legal versus call centers to shake out?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [5]

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Eric, this is Ashish. So the acquisitions that we've -- the portfolio that we're buying, they are mostly fresh portfolios in the U.S. And in terms of collections mix, as you notice over time, the share of call center and digital has been growing. And that's part of a concerted strategy to work to resolve debts through the call center with consumers and supplement it now with our investments in digital, which is -- which provides a multichannel approach. Now that said, legal is a very important channel still and will continue to be. But as we continue to invest in capacity and on the consumer-centric call model, we expect our call center and digital collections to continue to slowly increase in proportion. Now I would caveat that and just add to this comment, that depends -- that the mix depends a bit on other factors as well and can be impacted by, for example, the type of paper we buy, and if it's older or different balances, or if there are any books that are legal-only books that we purchase that we have done in the past, that would impact that number. But if nothing else changes, as we continue to push on call center approach and a digital approach, that mix should continue to tick up slowly over time.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [6]

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Got it. That's helpful. One last housekeeping item for me. Just how many shares has JC Flowers sold since it -- since the Cabot acquisition closed in July?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [7]

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We're not aware that they have sold any shares. Their lockup has expired as of sometime in early January. So it is their decision when they want to sell and what they want to do. And we are not aware of any sales to date at this point.

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Operator [8]

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And our next question comes from David Scharf of JMP Securities.

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David Michael Scharf, JMP Securities LLC, Research Division - MD and Senior Research Analyst [9]

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Ashish, I wanted to focus a little bit on the European market and Cabot. And first off, notwithstanding the commentary on available liquidity, I'm wondering, should we be thinking about the purchasing outlook in Europe lightening this year as more of a reflection of the potential returns you're seeing on portfolio bidding out there. Or is it more of a deliberate focus on deleveraging at Cabot?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [10]

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Thanks for the question, David. And by the way, just for the record, Ken Stannard is also on the phone from U.K, so I will let him jump in as appropriate to the call. So to your question, the returns in Europe are strong, and U.K., they're even stronger for us. Historically, at times, people characterize the returns as lower, but we see very strong returns in U.K. due to our differentiated platform. And we have done benchmarking studies against competitive data, and we are able to achieve, because of our scale in analytics and just operations, we are more than twice the size of the next player in the U.K., for example. And the legal scorecards and so forth, we're able to achieve much higher returns in the U.K. compared to others. So we see good returns, and we'll keep deploying capital in U.K. and other parts of Europe as well. You correctly characterized as it's more of a deliberate strategy to just change the balance slightly on the margin as part of deleveraging of Cabot and that some other players are also doing in Europe and U.K. at this time that you may have heard. And I'll let Jon jump in as well or Ken after that, if there's anything...

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [11]

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Yes. I think we believe that, today, the conditions in the London high-yield market, which I'm sure, as you're aware, David, is a way folks fund over there, have changed in such a way that Cabot and their peers will. I think you can expect to reduce leverage. One would assume that I think it's all a bit of a zero-sum game, in that I would expect, with that -- the industry as a whole, returns will likely improve because there will be less pressure, right? And Cabot, I want to emphasize, as opposed to some players, right, we have a large and growing capital-light servicing business in Wescot. And we're focusing on growing that and increasing our efficiencies in order to help improve our leverage. But I think we certainly do have a goal of reducing leverage in Cabot. And I'll turn it over to Ken, if you want to add anything, Ken?

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Kenneth John Stannard, Encore Capital Group, Inc. - Head of European Businesses [12]

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I think you've said it all. I don't think there's much to add there. We certainly intend to manage our leverage down gradually over time. And it's a combination of building the capital-light business, working on continuous efficiencies and deploying at higher returns.

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David Michael Scharf, JMP Securities LLC, Research Division - MD and Senior Research Analyst [13]

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Got it. And as we think about the pace of deleveraging in Cabot this year, combined with the expectation for collection growth in Europe on purchasing, Jonathan, should we be in kind of safe territory, assuming that the ERC in Europe would close out 2019 below where it closed out 2018?

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [14]

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That's a little hard to tell. I think we'll -- it's -- as you know, there's a lot that goes into that, what multiples you buy at, et cetera, et cetera, right? So I'm not sure I'm that good of a prognosticator.

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [15]

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We do expect our collections in Europe in 2019 to be higher than 2018. So that's in our plan and again, depends on purchasing and so forth. But that's what we expect for sure. And ERC will be a result of purchasing and our collections and so forth. So...

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Kenneth John Stannard, Encore Capital Group, Inc. - Head of European Businesses [16]

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And sorry, just on that, it's absolutely not required to reduce our ERC in order to delever. We can still moderately grow our ERC and still delever quite significantly.

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David Michael Scharf, JMP Securities LLC, Research Division - MD and Senior Research Analyst [17]

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Got it. Maybe one last question, shifting to the U.S. market. And I appreciate the commentary about kind of the forward look and speculation when this kind of 10-year recovery finally runs its course. I'm just curious about maybe some of the behavior among the large card issuers that you work with. Obviously, you highlighted the magnitude of the forward flow arrangements, which partially answers the question. But I'm curious, you compete indirectly with collection agencies with outsourcing, I mean, to the extent all the issuers have the opportunity to outsource for a fee versus to sell to you and a handful of others, is there any change -- are you aware of any change in the mix of how the card issuers are dealing with their fresh charge-offs, whether they're working more in-house, selling more or outsourcing more?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [18]

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David, nothing that would make a pattern, right? What we know for sure and we see is all issuers have some sort of capacity, which they call internal capacity, and it's largely in the post-charge-off world, in agencies and law firms, right? Generally, they don't have much internal employees working post-charge-off. And so they always have that, and they have asset sales, the debt sales of a channel. And over time, we see different issuers going through ebbs and flows in terms of the mix, and they're constantly looking at strategies, whether to sell right at charge-off or 6 to 12 months later and that keeps changing. And we characterize fresh as 0 to 6 months, for example. So there's no pattern I can tell you that's predominant at this time, except that each issuer keeps kind of evaluating. And if they try to, let's say, use agencies, but if they don't get their returns, they come back to sales. They have quarterly goals as well. So it's a mix of those things. And then, clearly, when you're working through agencies and law firms, you have an expense line that you have to bear, which is very different than when you have a portfolio sold to the debt sales channel that impacts your losses, right, in a very different way. So they keep evaluating those. I haven't seen any pattern that you can draw on as you look at this stage of the economic cycle and the credit cycle that we're in right now.

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David Michael Scharf, JMP Securities LLC, Research Division - MD and Senior Research Analyst [19]

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Got it. And I apologize, there is actually just one last one I wanted to get in there. A big topic this fourth quarter throughout earnings calls has obviously been all the news surrounding tax refund season, both the timing and the magnitude of refunds. Based on kind of what you're seeing since the U.S. collection industry is so seasonal, should we be thinking about a Q1 kind of collection rate or year-over-year collection growth that's maybe a little more on the conservative side, to the extent that refunds are coming in lighter than historically?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [20]

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Yes. That's a very pertinent question. So we started the year very strong in all our collections channels, call center, digital, legal, debt settlement agencies and whatnot. And just I would say in the last couple of weeks, you could -- we have observed, perhaps, a little bit of softness that's consistent with some of the reports that the federal agencies put out on tax refund rates. But again, it would be very minimal impact, if any, on our overall collections, maybe 1% or 2%. But I would also be -- I don't think I would be wrong to say that, that would be perhaps delayed collections. And this is, again, a first year of refunds after the big tax changes. So it's possible people were able to withhold more and reduce their withholdings. So it's still early to tell, but given you asked, I would say 2 weeks of slightly some softness in collections, but too early to make a trend. And overall, it can catch up as well as we found in the prior years.

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Operator [21]

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And our next question comes from Hugh Miller of Buckingham Research Group.

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Hugh Michael Miller, The Buckingham Research Group Incorporated - Director [22]

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I just had one, starting off on Europe. And it seems like you guys have -- have provided some color there, but that some of your peers have indicated, as well, a shift in their capital allocation plans for 2019. You know, being a bit more selective with deployment and also some of them maybe focusing a bit more on secured asset, which isn't as much of a focus for Cabot. Can you just give us a sense as to what your expectations are with regard to returns in Europe in 2019 relative to 2018? And given some of the shifts you're seeing, are you seeing issuers who are a bit more willing to issue forward flows in the U.K. and other parts of Europe?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [23]

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In terms of returns, we expect it to be somewhat similar, at least that's what we're planning. And it could get better. The impact of other players in the industry, the buyers in the industry, perhaps slowing down purchasing, hasn't been felt in terms of returns and multiples yet. But it takes a while, as we've seen that in the U.S. as well in the past. And at times, there are forward flows and things like that. And also, the banks have to kind of get used to the new reality. So I think that outcome is yet to be seen. And I would kind of let Ken also provide some color, given he sees that in every day and bidding and purchasing that happens out there in the market to provide any additional color so...

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Kenneth John Stannard, Encore Capital Group, Inc. - Head of European Businesses [24]

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Yes. Thank you, Ashish. Thanks, Hugh, for the question. The particular competitor I think you're alluding to that has the banking license is going to have to curtail its activity in the unsecured NPL acquisition space, which given they're a large competitor of ours in the U.K., is certainly going to mean that there's a reduction in demand in our competitive homeland in the U.K. That, I think, bodes very well for the future in terms of the balance of demand and supply and should be reflected in improved pricing or improved returns. We clearly haven't yet seen that in our results, but I can tell you that some early signals have been seen in some of the bidding activity. So hopefully, that will continue, and we'll be able to see that come through in the rest of the year. But as Ashish was saying, it's early days at this stage.

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Hugh Michael Miller, The Buckingham Research Group Incorporated - Director [25]

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Definitely helpful color there. Some of your peers have indicated in Europe sort of the leverage ratios that they're targeting to manage down to. Was wondering, obviously, you've indicated that you'd like to see Cabot delever over time. I certainly understand that you can still kind of maintain purchasing without being active on growth and still delever the balance sheet a bit. But is there a sense of magnitude that you can talk about in terms of where Cabot's leverage is now and kind of maybe over the course of the year where you think you might kind of try to get down to?

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [26]

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Yes. I think, at this point, we're not prepared to share any specific targets. But stay tuned.

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Hugh Michael Miller, The Buckingham Research Group Incorporated - Director [27]

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Okay. Certainly understandable. And then last for me. Just as we think about -- you talked about some of the forward flows that you've seen in the U.S. and the growth in revolving credit. But as you think about the capital deployment opportunities in the U.S. in 2019 relative to 2018 with where we stand now, do you have a rough sense of what you think about in terms of where your deployment may be relative to 2018 in terms of overall capital expenditures for the U.S. market in 2019?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [28]

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So as I said in my [opening] remarks, we do expect to shift proportionately more deployment in U.S. And at this point, I would expect 2019 to be higher than 2018. And we have given the number that you already have in terms of forward flows for the year, which is $480 million locked for the year. So...

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Operator [29]

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(Operator Instructions) Our next question comes from Mark Hughes of SunTrust.

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Mark Douglas Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [30]

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The tax rate outlook for 2019, can you give us any thoughts on that?

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [31]

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Yes. I would, Mark, I'd expect it'd be mid- to low 20s.

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Mark Douglas Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [32]

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Mid- to low 20s? Okay. And am I right on the adjusted number for the fourth quarter? It was roughly 17%, 18%. Is that right? What you disclosed, I think in...

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [33]

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Yes.

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Mark Douglas Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [34]

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Okay. The interest expense has been bouncing around a little bit, was down clearly sequentially this quarter. Is this a reasonable run rate, you think, on a go-forward basis?

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [35]

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Yes. If you had to pick a quarter to kind of normalize and use as a run rate, Q4 wouldn't be picked.

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Mark Douglas Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [36]

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Very good. And then likewise, the legal collections costs, any thoughts as we look at next year? You're clearly having success with the call centers and the digital. Are those costs going to be flat?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [37]

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As I said, we expect to slowly kind of keep changing the mix of -- away from legal, but it won't be anything material or major that would impact the costs. And we are very steady in our legal placements and processing, and we are continuing to grow internal legal. So we're pretty steady in terms of placement, and there's no lumpiness. Now that said, it can change, as I said, based on the purchasing mix. And we may buy certain portfolios that come to market that have a higher proportion of legal or low proportion of legal that can -- that has happened often in the past. And that could change things around. But otherwise, we expect it to be kind of fairly steady to what we've been doing last year or so. At this point, I'd be -- I don't think I can give you a legal collections expense outlook because it's not just the U.S. with a legal collections expenses. There's legal expenses in Europe, including U.K. and Continental Europe, and certain portfolios may incur higher legal expenses if we just -- if there's a different mix of portfolios that we end up buying. And we do buy a much wider range of types of asset classes in Europe than in the U.S.

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Mark Douglas Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [38]

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Very good. One follow-on question. The -- you hit your 20% earnings growth target or earnings per share growth target for 2018. You care to venture any thoughts about 2019 in terms of EPS growth rate?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [39]

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It's a good question, Mark. At this point, no. So let me just back up a little bit. As I look at the past, we delivered really solid results in 2018. And as I look ahead, Encore is in a very strong position as we look at our key markets. We had record deployments in U.S., and collections in U.S. and Europe are growing in a healthy manner. So we are demonstrating strong collections growth in both markets. When it comes to platforms, where we deploy a bulk of our capital, Cabot is differentiated, particularly in the U.K. where it outperforms other competitors. In U.S., we've improved liquidation through innovation, and we're leading in the fresh debt segment. So when I look at our platforms and what we've been able to deliver, and I look at 2019 in terms of deployment as I -- just to repeat, we expect to deploy more in U.S. compared to 2018. And in Europe, we expect to deploy less in 2019 compared to 2018. And overall, in terms of the impact in earnings, we typically don't provide guidance in rare situations, but there has been a lot of complexity, we have done that. But it's been rare, and we do not do that in normal course. At this point, we are not going to be able to provide any guidance on earnings for 2019.

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Mark Douglas Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [40]

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And then one final question. The -- I don't know if you addressed this, but as you think about the returns on the U.S. portfolios you bought in the fourth quarter, say, as compared to earlier in the year or at this time a year ago, are returns relatively steady but still attractive? Have they gotten more attractive?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [41]

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I would say steady and similar type of returns than earlier in the year.

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Operator [42]

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And our next question comes from Brian Hogan of William Blair & Company.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [43]

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First question is a follow-up on the interest expense question. To be stable, good run rate going forward, I guess, was there a refinancing in the quarter? Or what drove the sequential decline?

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [44]

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Well, if you're looking Q-on-Q, between '17 to '18, it's actually up, right?

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [45]

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Yes, and quarter-over-quarter, yes.

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [46]

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Quarter-to-quarter. Well, in that one, there was an extra $3 million in Q4 as a result of the -- some Cabot refinancing. Those costs associated with those are -- you may or may not be aware. We did -- we bought some remaining high-yield bonds and effectively exchanged them for longer-duration bonds. And so -- in that put and take, there were fees associated with that, which end up getting rolled up into interest expense.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [47]

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In 4Q. Yes.

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [48]

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In 4Q. Correct.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [49]

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All right. The capital light -- the growth of that business over in Europe, is that going to be more through organic relationship business? Or is that, like, involve acquisitions? Or what's the -- how do you expect to drive that growth?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [50]

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Ken, you want to take that question?

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Kenneth John Stannard, Encore Capital Group, Inc. - Head of European Businesses [51]

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Yes, sure. So the vast majority will be organic growth. So we're seeing quite a lot of additional demand and strong pipeline coming through across markets, but specifically, in the U.K. as both regulatory pressure encourages the banks to be looking to outsource some of their sensitive collections operations to the likes of Wescot who have industry-leading compliance capabilities. But also, in preparing for potential economic downsides means that the banks will want to have further outsourcing capabilities. So if they need to ramp up the collections capabilities, they can. So we're seeing a bit of an unprecedented demand at the moment for additional servicing opportunities, which sometimes take little time to roll out and to implement. And these things are done in phases, but certainly bodes well for growth in that business.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [52]

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And does that cannibalize your purchasing business?

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Kenneth John Stannard, Encore Capital Group, Inc. - Head of European Businesses [53]

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No, it doesn't. It's a really good question. But it doesn't because it's the early-stage collections. So this is really in the pre-charge-off space as opposed to post charge-off, which is where most of the debt gets sold.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [54]

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All right. The regulatory environment here in the United States, and you commented on broadly in Europe as well. Anything that concerns you? Any proposals? Any actions that's being taken that you're seeing?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [55]

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Brian, in the U.S., no material change. What we have is kind of I would say, as I've described in the past, a 3-part regulatory environment that we really care about. One is the OCC that guides the banks and regulates banks, asset sales and their agency relationships. And that has not changed at all. Banks still have very high standards they expect from the debt buyers. And they audit us on a very regular basis, and we pass all those audits. So that is still there. So the moat is deep and wide from that point of view. Secondly, on the CFPB front, as we have a new director, who's taken charge, so we're waiting to see. The CFPB back in August or September had outlined a time line, which said March 2019 is when they will start the proposed rule-making process. And as of 2 weeks ago, when their kind of semi-annual report was published, it was still mentioned that March is -- or at least that's the next time line -- deadline in terms of potential rule-making that may happen. So we're going to wait for that to happen. It's a month away and it's about almost there. That will take several quarters of comments and feedback and so forth before anything goes into effect. And let me just remind you, we think, at least based on the advanced notice that happened several years ago, the rules are second nature to us. We should be 60%, 70%, 80% if you would, things we do already because of a consent order. And things we would like to see different would actually help in terms of technology, texting, use of e-mails much more easily. So bringing debt collection rules in the United States much more into the 21st century. We're hoping for a positive movement on that side, but that's something that's going to happen. And on the third front, in U.S., TCPA, which is regulated by the FCC, and there was a kind of a split decision on categorization of kind of the technology we use for dialing -- predictive dialers being autodialer, which is supposed to dial random numbers. And the FCC has received comments. We provided those. Industries provided those. And we are hoping, at some point in the very near future, the FCC may provide guidance on it that will help our industry, and of course, Encore, being able to use that technology that's been in place that users' numbers that consumers already provide us so we have them from issuers to dial them. And we think that, that should come through. But again, we've been waiting for that for a while. And those are the 3 things that are big on the U.S. front. In the U.K. and European front. On Europe, the banks -- the European Central Bank and other regulatory authorities continue to push the banks to shed their NPLs and bad loans. And that's promoting a lot of sales. And as you know, in Europe, the asset classes where loans are sold is very broad: SME, consumer, mortgage, and we play in all of those categories. And in the U.K., the regulatory environment seems to be fairly stable, with FCA regulating the banks and our industry. And we are compliant, and we were the first large debt buyer to be licensed by the FCA a few years ago. But I'll let Ken jump in on anything on Europe or U.K. if there's anything new or different with any additional color.

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Kenneth John Stannard, Encore Capital Group, Inc. - Head of European Businesses [56]

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Yes. Just additional color really, Ashish. So what I'd say is on the first one, U.K. service on U.K. FCA compliance is customer conduct. Really, that is what is driving the pipeline increase on the service side. So the banks are wanting to outsource to us, as in Wescot, to solve some of their sort of conduct issues that they have or just to have us manage their operations so they don't have to worry about the conduct and they can rely on us. So that's what's helping the momentum in those businesses. We'd like to see more of that momentum outside of the U.K., but it's a slower story. But we're encouraging the regulators to get more active. It's in our interest as a leader in a customer conduct space for that to happen. So what we're really seeing from a banking regulator perspective in Europe, as Ashish was alluding to, is more impacting the balance sheets of their creditors, those organizations selling to us. The specific rule that is creating quite a lot of movement is the fact that 2 years after April 2018, banks across Europe need to be providing 100% for new and nonperforming loans in the unsecured space. So by April 2020, they're going have to take significant write-downs of those unsecured assets if they do not sell those assets. So that's why many banks are now considering selling assets where they haven't before. So that's creating good momentum on that sale side.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [57]

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All right. Staying in Europe there, your thoughts on the impact of Brexit? I mean, I wouldn't think there'd be any material impact on your business given the consumer you're dealing with, but just thought your -- what are your thoughts on Brexit?

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Kenneth John Stannard, Encore Capital Group, Inc. - Head of European Businesses [58]

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Very good question and insightful partial answer on your behalf. So the banks will obviously see a bigger impact from -- in the performing space, where you've got customers who are regularly paying the full amount. Those customers are going to potentially come under a lot more pressure in a no-deal Brexit scenario. But those of us who have impaired loans already paying very minimal payments, GBP 25 or less a month, will see a considerably reduced impact because those customers are already in their own form of recession already. Having said that, your guess is probably as good as mine as to the probability of no Brexit in the first place. Certainly feels at the moment as though the political environment is -- has got very little appetite to allow that to happen. I imagine that will be reflected amongst the European Union countries as well. So we'll see what happens.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [59]

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All right. And then one last one for me is your thoughts on the impact of CECL Accounting and your plans for implementation and progress there.

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [60]

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Yes. Well, the FASB actually met earlier today, in a meeting to discuss, among other things, the exposure draft for CECL. And we're still in the process of evaluating the information from that meeting. As we've noted before, we've established a project management team to address CECL. That team is evaluating CECL model and developing our accounting policy and planning implementation. But I really don't have anything else to share at this time at the -- exactly how CECL will impact our industry is still far from clear at this point.

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Operator [61]

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And our next question comes from Robert Dodd of Raymond James.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [62]

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Two clarification questions, actually, on -- you addressed U.S. tax seasonality, and obviously, I mean, the average refund so far through mid-February is down 17%. You said it's had very modest impact so far. Can you clarify, if the average refund stays down 17%, say for the whole tax season, would you still expect only that kind of 1% to 2% negative effect on collections? Or is that indicative of just the fact that we're relatively early in tax season at this point?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [63]

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Robert, I think you answered the question. We are very early in the tax season, especially even more early in this kind of recent trend, which is a week or 2 perhaps. So I'm not sure if it even makes a trend. But if it stays that way, we're still analyzing, and the team's initial analysis is maybe it's a couple of percentage points. We'll have to see. Because a lot of our payments -- people get money from other sources or -- and legal process. It may be garnishments and whatnot. And then, in the long term, we also expect liquidation may not be impacted anyway because you get it a little bit later. So way too early to give any impact of this really recent 1 or 2 weeks of slightly lower tax refund data that we are all seeing at the same time.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [64]

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Got it, got it. I appreciate that. And then the second one is actually a follow-up on Brexit, less on what it could do to the consumer obviously, but operationally, have you got any contingency plans or maybe you don't think, they're -- I mean, obviously, if the U.K. crashes out hard Brexit and drops out of the European Data Protection zone, for example, is there a plan in place to cope with that? Or are there other kind of operational issues that could be impacted rather than what it does to the consumer or doesn't do, depending on how it turns out?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [65]

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Ken, can you take that one?

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Kenneth John Stannard, Encore Capital Group, Inc. - Head of European Businesses [66]

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I can absolutely take that. So yes, good question. So the 2 things that we -- that you mentioned are exactly in our plan. So one is on the Data Protection. So at the moment, we do move some data across jurisdictions into central data warehouses. That would be -- we would be able to relatively quickly stop moving our personalized data across the new border, between the U.K. and Europe, if that was the eventuality. So we've already planned on how we would do that and how we'd do that rapidly. On the operational side, from a collections perspective, we have got plans for if we had additional call volume coming in, and we would expect to have exactly that, and we would expect to be able to cope with the additional volume that we've modeled. So good points, and we should be adequately prepared.

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Operator [67]

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And our next question comes from John Rowan of Janney Montgomery Scott.

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [68]

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The gain that you mentioned on the prior settlement for dlc, what line in the P&L is that from? Is that maybe a credit in G&A? And how much was it?

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [69]

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Give me 1 second. Just give us a second there, John.

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [70]

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Okay. I'll just go to my next second question then while Jon -- how much is left in the Cabot impairment reversal bucket?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [71]

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In the European impairment bucket, it's -- I'll let Jon refine that one as well. It's less than $10 million on the impairment -- European impairment -- Cabot impairment bucket, John.

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [72]

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That's left to be reversed, correct?

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [73]

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Yes, what's left today is approximately $10 million.

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [74]

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Reversed, but it is what's left as an allowance that was taken.

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [75]

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Okay. And then if you -- if I'm not mistaken, you said earlier in the call you divested Refinancia. Does that mean that -- I'm just trying to remember if that's the remaining piece that comes through noncontrolling interest and if that zeroes out going forward.

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [76]

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So that was coming through -- so the management company, not the portfolio, the management company was coming through noncontrolling interest. And that would go away. But we do have very small other platforms, for example, in France, that also is not 100% owned. So that will still come through noncontrolling interest. It's very small.

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [77]

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That number would be very, very small. And to answer your earlier question, John, it does come through G&A. And it was pretax and after-tax. There's no tax impact to it, $5.5 million.

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Operator [78]

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And our next question comes from Dominick Gabriele of Oppenheimer & Co.

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Dominick Joseph Gabriele, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [79]

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If we just talk about just the Brexit impact just maybe in a slightly different way. Is there a higher breakage rate now given the tough environment versus previously? And can you just talk about how that breakage rate has changed over time, pre-Brexit and now, versus your original expectations in your cash collections?

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [80]

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Ken?

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Kenneth John Stannard, Encore Capital Group, Inc. - Head of European Businesses [81]

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Yes. I can take that. So we have been running at very low breakage rates for some time now. And it's been unaffected by the uncertainty course over the last couple of years by the prospective Brexit. So, we -- and I think it's probably worth stepping back and just explaining just how stable this portfolio we have. We have over 800,000 customers who are regularly paying quite a small payment, so below GBP 25. That breakage rate, as in the number of those arrangements that break over a 3-month period, is in the order of 2%. So we have an extremely stable bank book. And it's very stable because the way we set those payments is designed to be very affordable and to have a buffer for each and every one of those customers set at an individual level based on an assessment of their income and expenditures. So if we go into a worsening scenario, and we have had this experience back in the crisis where unemployment jumped in the U.K. from 4% to 8%, we will monitor exactly what the impact is and respond accordingly. If you look back at 2007, 2008, we saw a very small impact from a doubling of unemployment in the U.K. because of the fact that those payments have been set at low levels and very affordable levels for a population of customers that are already in their own sort of mini recession. So it doesn't mean we don't anticipate some impact to our overall ERC from a no -- the worst-case scenario, a no-deal Brexit, but we think it's going to be very manageable. And it's going to be offset by the positives of additional flow into our Service business and higher returns from fresh debt sales.

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Dominick Joseph Gabriele, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [82]

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Great. And then just one more. Purchases of property and equipment was up a little more than it usually is versus the previous few quarters. Can you just talk about what drove that in the quarter? And do you expect this to revert back towards maybe 1/2 of the amount that it was in the current quarter for 2019 on a quarterly basis?

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Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [83]

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Yes, Dominick, it spiked up because we were investing in especially a lot of systems to help us with our collections. We also, as you're aware, expanding capacity over time, which meant we had to expand our facilities. So we had a CapEx level, and therefore, PP&E growth, which was higher than we would would've expected. And so now we're going to revert to not quite perhaps as low a CapEx as we were initially. But after another year or 2, I guarantee you, we'll get down to a CapEx level, which is more like we've experienced in the past. So you've seen, if you will, the -- and as you know, there's expenditure, and then there's depreciation out of it, right? But in terms of the CapEx part of it, we peaked.

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Operator [84]

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And I'm not showing any further questions at this time. I would now like to turn the call back over to Mr. Masih for any further remarks.

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Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [85]

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Thank you. That concludes the call for today. Thanks for taking the time to join us, and we look forward to providing our first quarter 2019 results in May. Thank you.

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Operator [86]

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Thank you, ladies and gentlemen. Thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a wonderful day.