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Edited Transcript of ECPG.OQ earnings conference call or presentation 2-Nov-20 10:00pm GMT

·42 min read

Q3 2020 Encore Capital Group Inc Earnings Call San Diego Nov 3, 2020 (Thomson StreetEvents) -- Edited Transcript of Encore Capital Group Inc earnings conference call or presentation Monday, November 2, 2020 at 10:00:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Ashish Masih Encore Capital Group, Inc. - President, CEO & Director * Bruce Thomas Encore Capital Group, Inc. - VP of IR * Craig Anthony Buick Encore Capital Group, Inc. - CEO & Director of Cabot Credit Management Group * Jonathan C. Clark Encore Capital Group, Inc. - Executive VP, CFO & Treasurer * Ryan B. Bell Encore Capital Group, Inc. - President of Midland Credit Management ================================================================================ Conference Call Participants ================================================================================ * David Michael Scharf JMP Securities LLC, Research Division - MD and Equity Research Analyst * Dominick Joseph Gabriele Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst * Mark Douglas Hughes Truist Securities, Inc., Research Division - MD * Michael John Grondahl Northland Capital Markets, Research Division - Senior Research Analyst & Head of Equity Research * Robert James Dodd Raymond James & Associates, Inc., Research Division - Research Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Good day ladies and gentlemen, and welcome to the Encore Capital Group's Q3 2020 Earnings Conference Call. (Operator Instructions) And as a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Bruce Thomas from Encore Capital. -------------------------------------------------------------------------------- Bruce Thomas, Encore Capital Group, Inc. - VP of IR [2] -------------------------------------------------------------------------------- Thank you, operator. Good afternoon, and welcome to Encore Capital Group's Third Quarter 2020 Earnings Call. Joining me on the call today are Ashish Masih, our President and Chief Executive Officer; Jonathan Clark, Executive Vice President and Chief Financial Officer; Ryan Bell, President of Midland Credit Management; and Craig Buick, CEO of Cabot Credit Management. Ashish and Jon will make prepared remarks today, and then we'll be happy to take your questions. Unless otherwise noted, comparisons made on this conference call will be between the third quarter of 2020 and the third quarter of 2019. In addition, today's discussion will include forward-looking 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. -------------------------------------------------------------------------------- Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [3] -------------------------------------------------------------------------------- Thanks, Bruce, and good afternoon, everyone. Thank you for joining our earnings call. With the COVID-19 pandemic persisting, we hope that each of you and your families remain safe and healthy while adapting to the realities of your current circumstances. At Encore, through a combination of working from home and the creation of safe workplaces, we continue to prioritize the welfare of our employees, and we remain fully operational in all the markets we serve. Working through the changing dynamics of the pandemic around the world, our team continues to perform at or above the high level of productivity we exhibited before the pandemic. The consumer dynamics we discussed a quarter ago continued into the third quarter. Our consumers are reaching out to us for assistance with their financial recovery. We deal with consumers and financial hardship every day and have been able to extend relief when appropriate while we help increasing numbers of consumers resolve their debts. As expected this past Friday, the CFPB released new rules for our industry in the U.S. These rules provide much-needed clarity and create uniformity in the fair treatment of consumers and debt collection. They also provide opportunities for us to communicate with consumers through more modern means, consistent with the way consumers prefer to interact with us. The new rules are largely consistent with those proposed 18 months ago. And as a result, we are well prepared to fully implement them with no significant incremental operational changes. Through these new rules, we remain very much aligned with the CFPB's goal of making consumer financial markets work for consumers, responsible providers and the economy as a whole. The third quarter was a period of great achievement for Encore. The steady improvement of our balance sheet has been a strategic priority of ours for some time. As part of this effort, we had a goal of combining the strength of our U.S. and European balance sheet into one unified global funding structure. We accomplished this goal in September through a series of actions that now maximizes our financial flexibility. More specifically, the benefits include enhanced access to capital markets, improved ability to deploy capital in the markets with the best returns and a line of sight to reducing our funding costs. Jon will recap the highlights of our new funding structure in a few moments. It was also an outstanding quarter operationally for Encore, in which we delivered strong results. Global collections for the third quarter were a record $540 million and came in better than expected for both MCM and Cabot. Revenues of $404 million were up 13% compared to the third quarter a year ago. Our ERC was a record $8.5 billion and was up 15% compared to Q3 last year. As a result of our strong collections performance, we delivered GAAP net income of $55 million or $1.72 per share, which was up more than 40% to Q3 last year. Non-GAAP adjusted income was $74 million or $2.31 per share. In addition to these results, a clear indication of our performance can be found in the higher level of returns in our business. Our return on equity reached 21.3% on a trailing 12-month basis in Q3 as we continue to operate efficiently and deploy capital at solid returns. The result demonstrates our ability to deliver strong returns under current market conditions as well as over time. We believe it is difficult to find such attractive returns at other companies in or around our industry. Our consistent growth in cash generation demonstrates the steady improvement in the business over the past several years. In fact, in the third quarter, we again set a new record for adjusted EBITDA plus collections applied to principal, which is the industry benchmark for cash generation. We continue to operate efficiently and purchase portfolios at attractive multiples. Even after subtracting cash taxes, cash interest, and CapEx, we continue to generate substantial cash each quarter. Turning now to our U.S. business. MCM collections in Q3 were a record $391 million, up 18% compared to the third quarter of last year. Our MCM performance continues to benefit from our efforts to direct a larger proportion of our collections towards the call center and digital channel. We continue to see strong demand from our consumer base to engage with us through our digital platform. As a result, Q3 collections in the call center and digital channel were up 32% compared to the same quarter last year. MCM deployments in the third quarter were $141 million. Our cost to collect continues to improve when compared to the year ago period, which is a strong reflection of our continued focus on expense management, our operating efficiency and the resulting operating leverage we have created in our business. Due to COVID-related impacts and constraints, MCM's expenses in the third quarter were somewhat lower than we would have incurred otherwise. These constraints are expected to diminish going forward. And as I mentioned a moment ago, we believe the new rules released by the CFPB last week provide clarity and create uniformity in how consumers should be treated across the industry. In addition, MCM requires no significant incremental operational changes to achieve compliance with the new rules as they are largely consistent with the CFPB's proposed rules that were issued 18 months ago, giving us time to prepare. Turning to Cabot. In the U.K. and in Continental Europe, our collections in the third quarter showed continued signs of recovery and were down only 6% compared to Q3 a year ago. In Europe, government measures resulting from COVID pandemic continue to impact the litigation-related collection practices. At the same time, collections in our call center and digital channel in Q3 were broadly in line with last year as we continue to see no material change in payment plan breakage rates. Cabot's management throughout the pandemic has enabled continued solid profitability. The subdued purchasing environment in the U.K. and in Continental Europe continued into Q3, and we expect this lower level of supply to persist through the end of 2020. However, we are seeing a stronger pipeline of servicing opportunities forming in the U.K. We anticipate an increase in purchasing opportunities as charge-offs are expected to rise meaningfully after government assistance programs subside. Looking forward, our new global funding structure removes the prior constraints related to Cabot's stand-alone leverage and thus provides us an enhanced ability to deploy capital at attractive returns. I'd now like to hand the call over to Jon for a more detailed look at our third quarter financial results. -------------------------------------------------------------------------------- Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [4] -------------------------------------------------------------------------------- Thank you, Ashish. As a reminder, we will sometimes refer to our U.S. business by its brand name, Midland Credit Management or more simply MCM. We may also refer to our European business as Cabot. Global deployments were $170 million in the third quarter compared to $260 million in the third quarter of 2019. MCM deployed $141 million in the U.S. during Q3, down from $173 million in the same period a year ago due to better pricing, coupled with somewhat lower supply. European deployments totaled $29 million during the third quarter compared to $85 million in the same quarter a year ago. The decrease in Q3 and was primarily due to limited supply of portfolios coming to market as a result of the COVID pandemic. Global collections were a record $540 million in the third quarter, up 8% compared to the same quarter a year ago. MCM collections grew 18% in Q3 to a record $391 million. Within that total, MCM's call center and digital collections grew 32% compared to Q3 of last year. Cabot's collections from our debt purchasing business in Europe in the third quarter were $141 million, down 6% compared to Q3 last year. Overall, Encore's global collections through the first 3 quarters of 2020 were at 100% of our ERC as of December 31, 2019. Global revenues in the third quarter were up 13% to $404 million compared to $356 million in Q3 a year ago. In the U.S., revenues were $256 million in the third quarter. In Europe, Q3 revenues were $142 million. Higher-than-expected collections drove an incremental $30 million of revenue in the third quarter. This is reflected in our income statement under changes in expected current and future recoveries. We believe the majority of our overperformance in the third quarter reflected overcollections against the forecast reductions made at the onset of the COVID-19 pandemic. Our global ERC was $8.5 billion at the end of September, up 15% when compared to the end of Q3 last year. In the third quarter, we reported GAAP earnings of $1.72 per share compared to $1.23 per share in Q3 of last year. After making noncash and nonoperating adjustments and accounting for the tax effects of these adjustments, our non-GAAP economic EPS was $2.31 per share in the third quarter. This compares to $1.64 per share of economic EPS in Q3 of last year. There are 2 items that I would like to highlight. First, our GAAP EPS in Q3 this year is net of the impact of a $15 million payment we made to the CFPB to settle a complaint they filed in September, which translates to $0.47 per share. Second, both our GAAP and economic EPS in Q3 are net of a $0.59 per share impact from expenses associated with establishing our new global funding structure, which totaled $19 million after tax. As Ashish mentioned in his opening remarks, we successfully implemented our new global funding structure in September, which effectively combined the balance sheets of our MCM and Cabot businesses and allows us to fully leverage their combined scale. Among the many benefits of this new structure, we have maximized our future flexibility, allowing us to better leverage our global borrowing base and enhancing our access to capital markets. We have extended our debt maturities. We have removed the prior leverage constraints that were specific to Cabot, providing us with an enhanced ability to allocate capital to the markets with the best returns, and we now have a line of sight to reduce funding costs. As a result of our new funding structure and the strengthening of our balance sheet over the past 2-plus years, we have put ourselves in a strong position to capitalize on the attractive opportunities that lie ahead. Since the beginning of 2018, we have reduced our debt-to-equity ratio from 5.9x to 2.9x. We've also reduced our ratio of net debt to adjusted EBITDA plus collections applied to principal, a measure common in our industry. We have reduced this ratio from 3.2x to 2.4x, resulting in a level that is among the lowest in our peer group. Encore's delevering has been driven by strong operating performance and focused capital deployment, which have, in turn, driven higher levels of efficiency and cash flow. Available capacity under our new global RCF was $465 million at the end of the third quarter, and we concluded Q3 with $150 million of non-client cash on the balance sheet. We also paid off $89 million of convertible notes that matured in July, which reduced the size of our convertible complex by 13%. If you follow us closely, you will recall that we're in the midst of a concerted effort to reduce the level of convertible debt in our capital stack. With that, I'd like to turn it back over to Ashish. -------------------------------------------------------------------------------- Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [5] -------------------------------------------------------------------------------- Thank you, Jon. As I have mentioned in the past, we believe our 3 strategic priorities continue to be instrumental in building shareholder value and driving strong results. The 3 priorities include: focusing on the U.S. and U.K., the 2 largest and most valuable markets; innovating to maintain and enhance our competitive edge; and continuing to strengthen our balance sheet while delivering strong results. With our steady emphasis on these priorities, we continue to deliver solid operating performance each quarter and remain well positioned for the attractive opportunities expected in our markets. In summary, Q3 was an outstanding quarter for Encore, in which we achieved record collections, ERC and cash generation. Our results in the third quarter are a continuation of significant growth in our GAAP earnings over the past 5 years. Our strong return on equity reflects Encore's solid performance over time. We are pleased to see the finalization of the rules for our industry in the U.S. The new rules issued by the CFPB will provide clarity and create uniformity in how consumers are treated across the industry. And finally, in addition to our new global funding structure, the quality of our balance sheet and our liquidity have us well positioned to capitalize on the significant increase in charge-offs expected in 2021 and beyond. Now we'd be happy to answer any questions that you may have. Operator, please open up the lines for questions. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) As your first question is from Mark Hughes from Truist. -------------------------------------------------------------------------------- Mark Douglas Hughes, Truist Securities, Inc., Research Division - MD [2] -------------------------------------------------------------------------------- Jonathan, does the economic EPS include the $15 million in CFPB settlement? -------------------------------------------------------------------------------- Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [3] -------------------------------------------------------------------------------- No, that only impacted GAAP. The one that impacted both was the charges related to the new global funding structure. -------------------------------------------------------------------------------- Mark Douglas Hughes, Truist Securities, Inc., Research Division - MD [4] -------------------------------------------------------------------------------- Okay. So the economic EPS excludes both the funding structure and the CFPB charge, is that correct? -------------------------------------------------------------------------------- Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [5] -------------------------------------------------------------------------------- Yes. No, no, sorry. What I was trying to say is that the global funding structure, the $0.59 that I referred to before, that was netted out of both. So both GAAP and economic are lower by that amount for the global funding structure. Economic EPS is not lowered by the settlement with the CFPB. -------------------------------------------------------------------------------- Mark Douglas Hughes, Truist Securities, Inc., Research Division - MD [6] -------------------------------------------------------------------------------- Okay. So if one were to do an operating EPS, excluding the CFPB settlement, one would add back the $0.47. Is that correct? -------------------------------------------------------------------------------- Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [7] -------------------------------------------------------------------------------- Well, yes, you can -- from our perspective, we incur these kinds of financing costs and refinancing bonds and from time to time with our bank facilities, and this one just happens to be bigger, of course. But we have absorbed similar costs in the past, just so you're aware. -------------------------------------------------------------------------------- Mark Douglas Hughes, Truist Securities, Inc., Research Division - MD [8] -------------------------------------------------------------------------------- Okay. Understood. -------------------------------------------------------------------------------- Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [9] -------------------------------------------------------------------------------- And Mark, this is Ashish, if I could jump in on kind of the comments you made on kind of thinking about operating earnings. So as I think about kind of Q3, there were 3 things out of norm. Jon mentioned 2 of them, so the $0.59 reduced it because of the global funding structure. The 2 other elements that might be worth noting, as you know, we are performing really well on collections, and we continue to do well. But the forecast that we are performing and comparing against was done in Q1 in the very early stages of the COVID pandemic, and we continue to gain benefit from that. And in this quarter, you would -- you could essentially assume about $30 million in revenues shifted from Q1 to Q3. So that $0.75 benefit that we had in Q3. And the other one is, I mentioned in my comments, expenses. So we continue to see lower expenses, but in particular, MCM collections expenses relating to legal and other activities have been running lower. And we -- that's about, I would say, $10 million a quarter approximately. So going forward, Q4 onwards, over the quarters, I expect that to normalize. So those are the 3 out-of-norm elements in our earnings -- economic earnings in Q3. -------------------------------------------------------------------------------- Mark Douglas Hughes, Truist Securities, Inc., Research Division - MD [10] -------------------------------------------------------------------------------- That's very helpful. What is the trajectory on the lead spending? It will normalize, but how long is it going to take to get back to that extra $10 million pace? -------------------------------------------------------------------------------- Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [11] -------------------------------------------------------------------------------- I think you start getting there pretty quickly. Some of it is legal, some of it is other collections expenses. So we start seeing in Q4 and then it will build up early in the year and going forward on a quarterly basis. -------------------------------------------------------------------------------- Mark Douglas Hughes, Truist Securities, Inc., Research Division - MD [12] -------------------------------------------------------------------------------- On the U.S. supply, the card companies have certainly made large provisions for expected losses, but credit card charge-offs continue to be low. How do you see that playing out over the next 12 months? -------------------------------------------------------------------------------- Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [13] -------------------------------------------------------------------------------- Yes. So we are watching very closely, and we're also talking to all our bank and issuer partners in the U.S. You have, I'm sure, followed all the bank earnings reports. So it's been an unusual time for the lending industry. Maturing credit cards banks are continuing to see -- despite an economic hardship and a macro environment that has higher unemployment rate, but it's an odd one. Banks are continuing to see delinquencies lower than normal and charge-offs lower than normal. They have reserved a lot in terms of the increased allowances, of course. So they expect those losses to come through. What many of them said and what we are hearing consistently is that second half 2021 is when they expect the charge-offs to start rising again. So we are seeing all the U.S. banks are continuing to sell rather than ones who normally sell our selling. And just we are seeing volumes at the lower end of their contractual amounts and their flows. And that, I think, will continue through the end of this year and most likely into the new year, but this has been an interesting and a strange economic environment in so many ways, so things could change. But that's what we're hearing from the banks right now, and we are preparing for. -------------------------------------------------------------------------------- Operator [14] -------------------------------------------------------------------------------- And our next question is from David Scharf of JMP Securities. . -------------------------------------------------------------------------------- David Michael Scharf, JMP Securities LLC, Research Division - MD and Equity Research Analyst [15] -------------------------------------------------------------------------------- So I'm wondering a couple of things. On the CFPB side, with the -- we hear you kind of loud and clear about the minimal operational changes. I'm just curious, do you either have a gut feeling? Or do you hear any chatter from your bank partners that the formalization of the new rules might negatively impact some of their outsourcing partners? I mean, ultimately, you compete with the third-party contingency guys as well because the bank can either keep it in-house, outsource it or sell it. Do you think that these new rules are going to improve your competitive standing at all? Or should we just kind of view this as just a formalization of stuff you've been doing, and it's not going to change the competitive landscape much? -------------------------------------------------------------------------------- Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [16] -------------------------------------------------------------------------------- So David, a couple of things you had in there, so let me try to address. So one is -- I meant no significant incremental operational changes. So there are things that are very positive in there on digital, technology, voice, texting, e-mails and so forth. There are things on calling that we'll have to adapt, for example. But overall, it should be a net benefit. Now we have been -- we have seen their draft rules for 18 months, so we've had a lot of time to think about it and adapt or at least plan for it. And the rules won't be in effect for another year, so we have time to implement. On your question about chatter from the banks, the rules are very fresh in terms of issuance, so they just came out on Friday. So as of now, we have not heard anything directly from the banks. But I would tend to have a point of view that you articulated, which is some of the agencies and smaller-scale players may have to invest a lot more in complying with the rules. If you want to do digital, it takes a lot of fixed cost, and we've been investing in digital for many years. So I would think it creates a benefit for people who are consumer-focused or people who are investing in these technologies and not waiting and are going to be able to leverage those investments much more. And that's what the consumers want, actually. So consumers are used to working digitally with their bank and ensure just before charge-off, and things shouldn't change dramatically. So now we'll be meeting the consumers with their preferences, and I would expect -- again, I have no data to support this at this point that people with technology and scale like Encore should benefit from this long term. -------------------------------------------------------------------------------- David Michael Scharf, JMP Securities LLC, Research Division - MD and Equity Research Analyst [17] -------------------------------------------------------------------------------- Got it. Got it. No, that's helpful, I would imagine. That's going to be the case. On the digital front, can you just clarify, when you refer to digital within the context of digital and call center collections, is that just referring to inbound payments such as digital, meaning like a payment portal that a consumer is going to? Or does digital also refer to outbound kind of outreach that -- like texting and so forth? -------------------------------------------------------------------------------- Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [18] -------------------------------------------------------------------------------- Yes, it refers to all of them because it is a multichannel, omnichannel kind of approach, if you would. So sometimes a call may lead a consumer to pay online or on the app, or an e-mail may trigger them to talk to us. So it's tough to ping. So when we have combined digital and call center into one channel, and that's what we refer to when we mention digital -- call center and digital channel. And again, back to your earlier question on CFPB, I think call caps of 7 calls per account in a week is also going to be something that shops that are very outbound focused will have to adapt and may suffer some collections. So that should be another factor as I just thought about it. And as you know, we've mentioned the last few quarters, our inbound both call center and digital continues to grow very significantly. So consumers are reaching in calling us and engaging digitally. So that's another factor that should help the trend that we've been driving for a while. -------------------------------------------------------------------------------- David Michael Scharf, JMP Securities LLC, Research Division - MD and Equity Research Analyst [19] -------------------------------------------------------------------------------- Got it. Got it. Just one final question, I guess for Jonathan. I don't know if it's just a coincidence, but obviously, the CECL-related allowance. The outperformance in Q2 plus Q3 is almost dollar for dollar, the COVID negative mark you took in Q1. Is that a coincidence? Or we should kind of view Q3 as sort of cleaning up the initial underperformance from Q1, and we kind of have more of a fresh start now? -------------------------------------------------------------------------------- Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [20] -------------------------------------------------------------------------------- Yes. It's a great question, David. You hate to -- I don't want to sound too cute and try to get too cute here on because, as you know, these are complicated calculations with various discount rates and obviously cash overs or how you exceed in the current quarter is obviously not discounted at all. Having said that, you're absolutely right. By the time you get to year-to-date, we're basically washed. So I think directionally, you're correct that we have now, on a go-forward basis, we've caught up on a significant percentage of what we had delayed in the past. And remember, there's difference in, as we've discussed in the past, in terms of recoveries in the U.S. versus the U.K. and so they're moving at different speeds, U.K. and Europe, given what's going on there, right, with those markets. But yes, generically, you're correct. -------------------------------------------------------------------------------- Operator [21] -------------------------------------------------------------------------------- (Operator Instructions) Your next question is from Mike Grondahl of Northland Securities. -------------------------------------------------------------------------------- Michael John Grondahl, Northland Capital Markets, Research Division - Senior Research Analyst & Head of Equity Research [22] -------------------------------------------------------------------------------- Congratulations on another good quarter. Digital collections, it looks like they're now 63% call center and digital in the U.S., growing 32% year-over-year. Can you kind of just get a little bit more granular there? What's working? Do you think you can -- driving those -- because the cost associated with them is definitely showing up. They seem to be doing well for you. Can you just give us a little bit more color? -------------------------------------------------------------------------------- Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [23] -------------------------------------------------------------------------------- Absolutely, Mike. So very good observation, indeed. But as I look at -- for many years back, you have a chart here of back to 2015 almost, the share of call center and digital has been growing steadily. So that's been part of an effort as we've enhanced our call model, hired call center account managers and really focused on a consumer-focused call model and analytics to help segment accounts into legal versus call center. That trend was very steady increase, not dramatic within a year-over-year. But over years, from 2015 onwards, it had increased the call center portion very significantly until the end of 2019. Now what we did find is the pandemic environment in which perhaps consumers are behaving differently as banks are also finding out in terms of how they're paying off their debts or savings rates, they are home more, they're perhaps opening mail more and responding to e-mails. There has been a marked shift in increase of calling into us, speaking to our account managers as well as engaging digitally. Now how much of that will sustain as a onetime or at least now a 2-quarter bump and continue? I cannot quite say, but I can say consumers are getting very comfortable digitally, and it's growing. And maybe the rate of growth will slow down, and we'll be on a steady uptick the way we were. Now I would also add, which is not immediate but a year from now when the rules go into effect, use of outbound e-mail, texting and voice mails and all of those things that consumers prefer to interact with by will also help increasing that channel use. So you're absolutely right. The impact is better outcome for the consumer as well as a very clear improvement in our overall cost to collect, and the impact falls straight to the bottom line. -------------------------------------------------------------------------------- Michael John Grondahl, Northland Capital Markets, Research Division - Senior Research Analyst & Head of Equity Research [24] -------------------------------------------------------------------------------- Got it. Secondly, if the U.S. gets a second stimulus at some point. How do you think about that in terms of your business, i.e., is there a trade-off, better collections, but a little bit softer supply? How should we think through a second stimulus if we get one? -------------------------------------------------------------------------------- Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [25] -------------------------------------------------------------------------------- So let me take a stab at it, and I'll just -- we are in different locations so I'm trying to jump in if he has additional points after this. So we do not target stimulus money per se. We're dealing with consumers and financial hardship on an ongoing basis. That's our business. For a bank, a small portion of consumers are in hardship, but we are always dealing with, and we're giving them delays in payment, lowering the payment plan, hardship -- temporary hardship collections stop and so forth. So we're not targeting stimulus money. But clearly, something is happening on the consumer front, whether it's stimulus or much lower expenses. The savings rate in the country and across the world in many ways has gone up. So -- and banks are finding out that banks -- their consumers are taking care of their debts at a higher rate. So delinquencies are down, charge-offs are down. I don't know which specific driver. Is it stimulus or just expenses or not traveling and other spending that's happening? And it may vary as the economy opens up. So over time, I would think the impact will be different. The other impact on lower delinquencies and supply and lower charge-offs is forbearance, right, whether in U.K. and in U.S. And forbearance programs, if you look at some of the bank presentations, are pretty close to low single digits, if not getting close to 0. So that use was significant in U.S. in the early stages of pandemic. That was impacting the delinquency and kind of roll rates and charge-off rates. That will probably go away, is at least what the banks are saying. Forbearance, maybe a bit more prevalent in U.K., so they might be longer. So stimulus comes in many ways. It's support in terms of direct cash, but also the support for consumers from forbearance will end. So we'll have to see how this plays out, but I have to believe what banks are saying and telling us that they'll expect delinquencies and charge-offs to eventually rise, and stimulus may impact some collections, perhaps delinquencies a bit here and there, but I don't -- nobody has really pinpointed the exact driver there. So Ryan, did you have anything else you're observing in operations on the MCM side? -------------------------------------------------------------------------------- Ryan B. Bell, Encore Capital Group, Inc. - President of Midland Credit Management [26] -------------------------------------------------------------------------------- I think you covered it well, Ashish. I think one thing I'd reiterate is I think a lot of things that go into the individual economic situation as a consumer, I think savings rate is an important metric to keep track of. I think people look at stimulus and other aspects. But just the overall health of the consumer determines their ability to pay. So as we track savings rates, we see that does correlate well with the ability for the consumer to pay their debt. -------------------------------------------------------------------------------- Operator [27] -------------------------------------------------------------------------------- And your next question is from Dominick Gabriele of Oppenheimer. -------------------------------------------------------------------------------- Dominick Joseph Gabriele, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [28] -------------------------------------------------------------------------------- So if we just look at the $540 million of gross collections and then we kind of look at that versus the yield on those collections, the revenue recognition rate to some extent, it's -- the revenue recognition rate is actually pretty flat versus the last year, where we've been seeing some kind of improvements to the first and second quarter. So I'm wondering if -- were there a bunch of balances that were basically collected that perhaps didn't have the time to either -- I don't know how to say this properly, but maybe not make as much money off of or came on at lower profitability or something along those lines just because, first, as your gross collections beat me by like, let's say, $50 million but the revenues were right in line so the multiple seems lower. And then I just have a few more if that's okay. Maybe just if you could explain some of the dynamics you're seeing there. -------------------------------------------------------------------------------- Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [29] -------------------------------------------------------------------------------- So I think revenue is now under the CECL. There's this first-line and second-line impacts also weigh in that could impact that. So I see your point on revenue recognition as a percent of collection, 63.3% to 63.5%, but there's this impact that we get from a CECL approach now that may be impacting it. I can't think of anything else unique that's happening. Jon, do you want to chime in? -------------------------------------------------------------------------------- Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [30] -------------------------------------------------------------------------------- Yes. Our -- we see -- as you can see from our multiples, we're booking better multiples. And we're -- and we have -- CECL did change our ERC, as you know, right, and made it comparable to everybody else and it caused some growth. But if you -- your Q-on-Q or period-on-period, I continue to expect certainly to maintain or perhaps improve on the revenue recognition rate. But I think part of this is what part of what Ashish was alluding to, right? There are a number of moving parts caused by CECL. So I wouldn't read too much into it. I think the important takeaways is that our IRRs have gone up or you can see it in the multiples, and there is a little bit of noise caused by CECL. -------------------------------------------------------------------------------- Dominick Joseph Gabriele, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [31] -------------------------------------------------------------------------------- Okay. Great. And then if you back out the -- it looks like $7 million, just -- this is just a silly modeling question. But if you -- the $7 million is in the operating expense, it says. And then I'm guessing the rest of that was probably captured in interest expense itself, which is why interest expense was so much higher, maybe 68%, something like -- was it 68-ish? -------------------------------------------------------------------------------- Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [32] -------------------------------------------------------------------------------- Yes, yes. I'm sorry, are you talk -- Dominick, you're referring to the global implementation of the global funding structure? -------------------------------------------------------------------------------- Dominick Joseph Gabriele, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [33] -------------------------------------------------------------------------------- Exactly. -------------------------------------------------------------------------------- Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [34] -------------------------------------------------------------------------------- Okay. -------------------------------------------------------------------------------- Dominick Joseph Gabriele, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [35] -------------------------------------------------------------------------------- Yes. So I guess if I add that going forward, maybe more like 50%, 51%, back at the normal levels, given all you've done and accomplished because that was obviously a big accomplishment and trying to keep these expenses down going forward. So are you guys thinking more along the lines of second quarter's interest expense on a core basis? -------------------------------------------------------------------------------- Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [36] -------------------------------------------------------------------------------- The -- I would say, generically, you're right. And the reason I say generically is I just want to caution you a little bit to the extent that we -- just like with the global funding structure, to the extent that we refinance some high-coupon debt, right, and put -- replace it with some lower-coupon debt, which we may conclude economically is the right thing to do in that period. You could see elevated interest expense again because of costs related to doing that. But if you were to ignore that, you would be -- I believe you'd be right. We'd be back in that low 50s range. -------------------------------------------------------------------------------- Dominick Joseph Gabriele, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [37] -------------------------------------------------------------------------------- Okay. Great. And then on the legal collections, I really appreciate all the color there. I just want to make sure I know which direction we're going. So there is about $60 million or so, and I believe the comment was around $10 million lower than you maybe otherwise would have seen. But I remember there was some kind of push and pull from the second quarter into the third quarter and across perhaps the next few quarters. If you wouldn't mind just touching on that. And are you kind of suggesting that legal collection is going to be a bigger portion of collections on a go-forward basis for any particular reason where it could hit more like $70 million? Or did I maybe just hear you wrong? -------------------------------------------------------------------------------- Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [38] -------------------------------------------------------------------------------- You're largely right as what we are saying roughly, whether it all shows up in legal collections expense or some other operating expense because there are some other collections-related expenses, whether it's mailing costs and other things that might be. But for MCM, what I did want to highlight is a roughly $10 million expense benefit that we saw in Q3 that we expect to start diminishing and not be there going forward. So that's -- it will probably be mostly in legal, but it'll -- it could be in other parts, too. -------------------------------------------------------------------------------- Operator [39] -------------------------------------------------------------------------------- And your next question is from Robert Dodd of Raymond James. -------------------------------------------------------------------------------- Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [40] -------------------------------------------------------------------------------- Congratulations on the quarter. Question more about Cabot or really the U.K. I mean, Ashish, in your prepared remarks, you said, obviously, not surprising, right, COVID had impacted litigation in the European market. I think you probably meant the U.K. there. So 2 questions. I mean, obviously, the U.K. has just gone down into another shutdown for the rest of November. So how does that impact anything going on there, either on the operational front or the expense front? And then also tied to that, obviously, we're now 9 weeks out from the end of the year. In the U.K., that means Brexit, no deal, deal, et cetera. Can you give us an idea of what your plans are around that, if you've got any ideas about how that could play out and whether there would be any need to make an adjustment on that basis? -------------------------------------------------------------------------------- Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [41] -------------------------------------------------------------------------------- So I'll do a very short response, and then I will let Craig respond. He's on the line as well from U.K. So you mentioned U.K. primarily. That is largely true, but we also have, from a legal collections point of view, other countries in Europe where we are active, especially Spain, where we have portfolios in SME and secured, which are even more impacted by any kind of legal or court shutdowns or legal processes not working at kind of full 100% level. So it does get impacted in other places, but I'm going to let Craig jump in on your couple of questions that you had there. -------------------------------------------------------------------------------- Craig Anthony Buick, Encore Capital Group, Inc. - CEO & Director of Cabot Credit Management Group [42] -------------------------------------------------------------------------------- Yes. Thanks, Ashish. Robert, it's certainly timely at this point in time with everything that happened over the weekend. And look, operationally, moving into another lockdown here in the U.K. is not going to impact us at this particular point in time. There's a lot that we've invested in over the years on technology and process that allowed us to move very quickly when the first lockdown came upon us with limited notice. We've managed to maintain our operational capacity through this period, which has allowed us to continue to meet our clients and our customers' needs at this particular point in time. The second lockdown will not be impacting on our operational capabilities. We still believe that we can continue to do what we are. It's slightly different to the first lockdown. A lot of the courts and a lot of the public services are remaining open this time. They were closed down the first time around. There's a lot that is still moving. So we're still paying close attention to this. But as I sit here today, I think we can continue with our operational capabilities. We did pull back from our litigation activity when the first lockdown kicked in. We have reinitiated those litigation activities, albeit in a very controlled and measured manner because we take very seriously our responsibilities to ensure that we are doing the right things by our customers, but those activities are underway. In terms of Brexit, as if COVID wasn't enough with Brexit on the horizon as well, it's drifted into the background in terms of the commentary, but it does remain out there. We have left Europe now. What we haven't got is the trade deal that's going to take place at the end of the year. That should not impact on us operationally, the way we are set up within Europe. We have separate operating entities within each of the jurisdictions. So even in a no-trade deal, we still will be able to undertake our activities as we are today in our various jurisdictions. So it shouldn't impact on our operational capabilities. We spent a lot of time looking at this, particularly around probably one of the main impacts is around GDPR and data sharing, where we've been putting a lot of work into that to make sure we understand the implications. Again, we don't believe that's having a material impact on the way we do business today, but we continue to monitor what's going on in those government discussions. We don't think it's going to impact on us from an operational perspective, but there's a lot of time between here and the end of the year, and we'll continue to monitor it. Hopefully, Robert, that helps give a little bit of color. -------------------------------------------------------------------------------- Operator [43] -------------------------------------------------------------------------------- And we have a question from Mark Hughes from Truist. -------------------------------------------------------------------------------- Mark Douglas Hughes, Truist Securities, Inc., Research Division - MD [44] -------------------------------------------------------------------------------- Jon, I think you've touched on some of this, I think, when you talked about the line of sight to reduce funding costs. Any specifics you'd care to share or just kind of the road map as you see how those costs will evolve? -------------------------------------------------------------------------------- Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [45] -------------------------------------------------------------------------------- Sure. If you look at our debt stack, you'll see a couple of relatively -- on a relative basis, expensive pieces of debt, which are the currently outstanding Cabot bonds that have been reconfigured to fit, if you will, within our global structure now. And when appropriate, I could see those being refinanced, and I think you can do some quick math and come up with round numbers, you're talking about $1 billion. And if you save a couple of hundred basis points, that adds up to real money for the -- for any given year, right? So that's the step 1, if you will. And then I just think -- I do expect that as we continue to move forward, we will get better and better execution as we continue to develop this structure. But I think the big near-term pops will be as the opportunities present themselves for those 2 bonds. -------------------------------------------------------------------------------- Mark Douglas Hughes, Truist Securities, Inc., Research Division - MD [46] -------------------------------------------------------------------------------- And is there some sort of call protection that makes it obviously uneconomic. When does that become more palatable? -------------------------------------------------------------------------------- Jonathan C. Clark, Encore Capital Group, Inc. - Executive VP, CFO & Treasurer [47] -------------------------------------------------------------------------------- Well, it's -- they're both callable today. They're at some pretty -- one in particular is a pretty steep premium, but that doesn't mean that if we see something compelling that we wouldn't be willing to pay that premium to do it, right? It all comes down to economics at the end of the day. -------------------------------------------------------------------------------- Operator [48] -------------------------------------------------------------------------------- And your last question is from Dominick Gabriele of Oppenheimer. -------------------------------------------------------------------------------- Dominick Joseph Gabriele, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [49] -------------------------------------------------------------------------------- Sorry. Do you think that the -- I just want to ask a bigger question since we have all of you here. Do you think that the quarter-over-quarter change in the U.S. purchases, in particular, that actually improved? And I remember you saying people were really reluctant to sell at one point. Are they opening back up? And then also, have you seen any slowdown in the inbound activity as you worked your way through the second and third quarter perhaps as, I don't know, maybe stimulus was weighing thinner and thinner post those infusions from the government? -------------------------------------------------------------------------------- Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [50] -------------------------------------------------------------------------------- Okay. Dominick, I'll take on the first one. And then second, not sure if we have seen any kind of real observable impact, but I'll let Ryan jump in because I think your question is for U.S.. On the selling, so I just wanted to clarify, all U.S. banks who have been selling into this market before COVID pandemic have continued to sell. They continue to sell-through some spot sales, but heavily through the forward flows. So there has been no change in selling patterns. What is now changing is the volumes of delinquencies and therefore, charge-offs have reduced. So that's what's impacting. I don't think anybody was holding back, I would say, and the volumes are coming down. In U.K. and Europe, there clearly has been a bit more of a pause, although we've seen deals and we participate in them. But the activity level of the banks, particularly in U.K., has slowed down to take care of the consumers, whether it's delinquency or forbearance programs and other things. So eventually, the supply will still come. It might be a bit lagged from the U.S. because the forbearance programs, maybe lasting a bit longer in U.K. than in U.S.. As I said, in U.S., from what I could see from the bank's presentations, they are down to very small proportions of their portfolios. But again, all the banks have continued to sell in U.S., has been no change. The volumes are down. And in Europe, which is less dependent on forward flows. There has been much more of a pause than we expect as volumes will come through their delinquencies and charge-offs rise, they'll be back in the market as well. It's probably in the later part of '21. So the slow rate that we expect for rest of the year may likely continue early in the year -- early part of the year for U.K. On the inbound call volumes, I'm going to let Ryan jump in if there's been any observable impact that we are able to share with you. -------------------------------------------------------------------------------- Ryan B. Bell, Encore Capital Group, Inc. - President of Midland Credit Management [51] -------------------------------------------------------------------------------- Yes. Thanks, Dominick. No observable impact. So we always see changes into inbound both from our call center and to our website and our digital side. So no ups and downs with seasonality. But I think across Q2 and Q3, no material change in any of our key metrics that we have observed that would let you believe you're seeing any change in consumer behavior. So no observations there at all. -------------------------------------------------------------------------------- Operator [52] -------------------------------------------------------------------------------- And there are no further questions at this time. I will turn the call over back to Mr. Masih for his closing remarks. -------------------------------------------------------------------------------- Ashish Masih, Encore Capital Group, Inc. - President, CEO & Director [53] -------------------------------------------------------------------------------- Thank you. That concludes the call for today. Thanks for taking the time to join us, and we will -- and we look forward to providing our fourth quarter 2020 results in February. Thank you. -------------------------------------------------------------------------------- Operator [54] -------------------------------------------------------------------------------- And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.