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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good afternoon and welcome to the PRA Group's Second Quarter 2023 Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Mr. Najim Mostamand, Vice President of Investor Relations for PRA Group. Please go ahead.
Thank you, operator. Good evening, everyone, and thank you for joining us. With me today are Vik Atal, President and Chief Executive Officer; and Pete Graham, Executive Vice President and Chief Financial Officer.
We will make forward-looking statements during the call, which are based on management's current beliefs, projections, assumptions and expectations. We assume no obligation to revise or update these statements. We caution listeners that these forward-looking statements are subject to risks, uncertainties, assumptions and other factors that could cause our actual results to differ materially from our expectations.
Please refer to the earnings press release and our SEC filings for a detailed discussion of these factors. The earnings release, the slide presentation that we will use during today's call and our SEC filings can all be found in the Investor Relations section of our website at www.pragroup.com.
Additionally, a replay of this call will be available shortly after its conclusion, and the replay dial-in information is included in the earnings press release. All comparisons mentioned today will be between Q2 2023 and Q2 2022, unless otherwise noted, and our Americas results include Australia.
During our call, we will discuss adjusted EBITDA and debt-to-adjusted EBITDA for the 12 months ended June 30th, 2023, and December 31st, 2022. Please refer to today's earnings release and the appendix of the slide presentation used during this call for a reconciliation of the most directly comparable US GAAP financial measures to these non-GAAP financial measures.
And with that, I'd now like to turn the call over to Vik Atal, our President and Chief Executive Officer.
Thank you, Najim, and thank you, everyone, for joining us this evening. It has been a pleasure these past few months connecting with many of you at the various conferences and meetings we attended and I have been looking forward to sharing an update on our recent performance and business outlook.
Having completed the first 100 days of my tenure, it is appropriate that I spend a few minutes reflecting on the perspective I have gathered during this period, prior to discussing our financial results for the quarter. My remarks are grouped into five broad themes.
First, our people. It may be viewed as a cliche to have an incoming CEO, extol the virtues of his team, but I do so nonetheless and in full sincerity based on my assessment of their capabilities and strength.
Most of you are familiar with our long standing CFO, Pete Graham, and the team that he leads. However, our talent extends beyond Pete to encompass individuals in every function and geography and across all levels of the organization.
I believe that their intellect, domain knowledge and pride in their work are second to none, and I have full confidence in their ability to drive PRA's success. Next our European business. This past month I visited our European operations and not only had the opportunity to connect with our team, but also engage with banks and top sellers in meaningful conversations about our business.
Europe now represents over 50% of our ERC. And while the UK remains our largest market presence in the region, we have established broad diversification across the continent. Over the years, we have invested considerable effort to build relationships with sellers and other stakeholders, along with a focus on enhancing core capabilities such as digital.
These efforts have paid off with broad investment opportunity across the region and a compelling track record on revenue growth and expense efficiency. Furthermore, we exercise significant restraint in recent years as pricing became irrational in certain markets.
We believe the diversification provided through our European business is a key differentiator for us versus most industry peers and we will be looking to build on this success while maintaining operational and pricing discipline. Third, the growing portfolio of supply. Consistent with the messaging from consumer lenders and credit card industry statistics, we are seeing increased inventory being made available for sale in the US.
Global portfolio purchases are up 47% for the first six months of 2023 versus the year ago period. While we continue to anticipate seeing increased supply, we don't expect this level of year-over-year growth to sustain. Of note within the US we are not only benefiting from the increases in market supply, but are also anticipating opportunities to extend the set of seller relationships to supplement baseline trends.
In contrast to recent trends, pricing is also improving across all of our markets as we renew forward flows and enter into spot transactions. We believe we have now entered an inflection point in the cycle that is translating to portfolios being purchased at higher returns. Fourth, our US business. It is undeniable that it is not performing to our expectations.
Notwithstanding the references we made in previous quarters of our collection shortfalls on recent vintages, our track record on underwriting purchases extends back over two decades and is excellent. We have, however, underinvested in the processes and capabilities required to optimise cash generation from the portfolios we own.
Over time, this gap has expanded and coupled with the lower volume of available supply in recent years, contributed to the reduced levels of profitability in this portion of our overall business. Optimizing our US business is therefore key to our success both in the long and the short-term.
I shared a slide similar to this at the William Blair conference earlier this summer, and I now wanted to briefly provide an update on this important initiative. It is essential that we generate more cash from our existing portfolio. To accomplish this, we are examining our end-to-end core processes with the goal of enhancing efficiencies, driving revenues and optimizing results. This work is already underway.
And, as examples, we are in advanced discussions with select third parties to expand our outsourcing and offshoring capabilities. We are also beginning to rationalize the capacity of our US collection sites with the announced closure of one of our sites last month.
These developments in and of themselves are not yet at a scale to impact the business results. But I mention them here as an indication of the speed, decisiveness and open ended approach we are taking to address the underlying issues.
In parallel we are optimizing a range of customer interactions and revenue generating activities, including legal processes. This brings me to the fifth and final theme of my opening remarks, which is creating shareholder value.
It is important to note that while the changes and initiatives referred to above are being implemented with urgency. We anticipate that it will take at least several quarters for their effect to flow through and influence our results. Ultimately, we believe the steps we are taking today are laying the foundation for a stronger, profitable and higher performing PRA.
And with that, I'd now like to turn things over to Pete to go through investments and the financial results in more detail.
Thanks, Vik. Looking at our investments this quarter, we purchased $328 million of portfolios, which represents a record for a second quarter in company history and is the highest quarterly investment since the third quarter of 2021.
Up 42% year over year, this level of investment was driven by building flow volumes and a number of large spot transactions in the US and Europe. Importantly, this record level of investment was achieved even as pricing improved. I'll talk more about that in a minute.
In the Americas, we invested $184 million, which represented a sequential increase in purchases for the fifth consecutive quarter. The underlying US market is improving steadily. Volumes and pricing continued to improve during the quarter as we increased our US investment level for the third consecutive quarter.
The significant driver of this was the increased number and size of spot transactions we were able to close during the quarter. While the US is predominantly a forward flow market, we experienced a higher proportion of spot transactions than usual in the second quarter.
Historically we've seen this happen when charge off volume is increasing as sellers experience volumes that exceed committed flows, they will bring spot transactions to market. In our existing forward flows of fresh paper, we once again experienced a sequential increase in volume from the prior quarter. Looking at publicly available economic data that we regularly share, active credit card balances, delinquency rates and charge off rates are all continuing to climb.
And based on this data and our experience, we believe that these metrics will trend even higher. Given our stellar interactions and the data sources we track, we expect increasing supply with pricing and returns continuing to improve as we move through the rest of this year and into 2024.
The European market remains robust and continues to provide healthy investment volumes. During the quarter, we invested $144 million across eight markets with meaningful purchases in Northern Europe, demonstrating the continued strength and diversity of our European operations.
As a reminder, the second and fourth quarters have historically been our strongest purchasing quarters in Europe. The rising cost of capital is clearly impacting the market. Pricing has improved and has been more consistent across markets. And in contrast to last quarter when sellers were pulling deals for low pricing, it appears they are now starting to accept the lower prices.
Some European competitors are continuing to struggle with high debt balances and increased funding costs and are reducing portfolio investment and attempting to sell parts of their book in order to deliver. As supply builds, especially in the US, we will continue to practice prudent capital deployment with a firm discipline on pricing. Moving onto the financials. Total revenues were $209 million for the quarter.
Total portfolio revenue was $205 million with portfolio income of $184 million and changes in expected recoveries of $21 million. During the quarter, we collected $25 million in excess of our expected recoveries, exceeding our expectations on a consolidated level by 6%, with the Americas overperforming by 2% and Europe overperforming by 11%.
The overperformance in Europe was mainly due to larger than expected one time payments and a catch up in legal collections due to the resolution of the court strikes in Spain. Operating expenses for the second quarter were $164 million, an $11 million decrease, driven primarily by lower compensation and employee services and lower outside fees and services. The decrease in compensation and employee services was due to lower compensation accruals and health care expenses compared to the prior year.
After normalizing for recent volatility in anticipating an increase in variable costs associated with higher investment levels, we expect the compensation expense in the third quarter to be in the mid $70 million range.
Our legal collection costs were $22 million for the quarter with the year-over-year increase being driven by a higher volume of accounts placed into the legal channel. As a reminder, there's a timing lag when we invest in our legal channel.
Typically, there's an upfront cost paid to the courts when a lawsuit is filed, which is then followed several months later by cash collections starting to build. We expect legal collection costs for the third quarter to remain consistent with the second quarter and approached the mid $20 million range by Q4.
Outside fees and services were down $9 million for the quarter, primarily due to the higher corporate legal expenses in the second quarter of last year. Net interest expense for the second quarter was $43 million, an increase of $11 million, primarily reflecting increased interest rates and higher debt balances.
It should be noted that our net interest expense in the quarter was reduced by $4 million in interest income. The majority of which came from investments in cash held to retire our convertible notes on June 1st, which will not recur in the future.
For the third quarter, we expect our interest expense will approach $50 million. Our effective tax rate for the quarter was 58%, with the increase primarily due to timing of discrete items. However, looking at the full year, we expect an effective tax rate in the mid 20% range. Net loss attributable to PRA was $4 million or negative $0.10 in diluted earnings per share.
Cash collections for the quarter were $419 million compared to $444 million in the second quarter of 2022. Lower collections in the Americas were partially offset by higher collections in Europe.
For the six months ended June 30th, we are 1% above our ERC projections made last December with 5% over performance in Europe and 2% underperformance in the Americas. For the quarter, America's cash collections were $247 million, a decrease of $31 million or $30 million on a currency adjusted basis, driven primarily by the impact of lower levels of portfolio purchasing in the US over the last few years.
Despite this, collections in the Americas modestly exceeded our internal expectations for the quarter. European cash collections for the quarter increased 4% or 5% on a currency adjusted basis. This represents overperformance of approximately 11% compared to our internal expectations.Our cash efficiency ratio was 61.2% for the second quarter, which is consistent with the prior year period.
The second quarter generally has a higher cash efficiency ratio because of favorable cash collection seasonality and European countries where we have a lower cost to collect. We still expect to achieve a cash efficiency ratio approaching 60% on a quarterly run rate basis by the fourth quarter of 2023.
ERC at June 30th was $5.9 billion, with 54% in Europe and 36% in the US. This represents an increase of more than $200 million compared to the prior quarter, as our strong purchasing in the quarter helped us grow ERC. We expect to collect $1.5 billion of our ERC balance during the next 12 months. It's important to note that this number only reflects the amount we expect to collect on our existing portfolio
It does not include the cash we expect to collect from new purchases made. Based on the average purchase price multiples we've recorded in 2023, we would need to invest approximately $843 million globally over the same time frame to replace this runoff and maintain current ERC levels.
With the continued build in US supply and improved pricing, we anticipate we will exceed this level of investment and grow ERC further as we close this year and move into 2024. We have a strong and conservative capital structure with ample capacity in the markets where we invest.
At the end of the quarter, we had $1.4 billion of undrawn capacity committed under our credit facilities, $332 million of which was available to borrow after considering borrowing base restrictions. Additionally, in the last 12 months, we generated $1 billion of adjusted EBITDA.
Now, I'll turn things back to Vik.
Thanks, Pete. Quarter two was an important and positive step in the right direction as we look to return to profitability and further capitalize on the consumer credit cycle. I am especially encouraged to see strong purchasing and ERC growing again, but I also recognize that our work has just begun. We have plenty of opportunities to build on our strong foundation and we remain focused on the strategic objectives and initiatives I shared earlier, especially as it relates to optimizing business processes and our cash generation potential.
The early signs of progress are here and we look forward to driving organic growth, stronger returns and increasing shareholder value over time. It won't happen overnight and it may not always unfold in a straight line, but I am more than encouraged by where we are heading and the opportunities that lie ahead.
Thank you again for joining us and for your continued support of PRA. Operator, we are now ready for questions.
We will now begin the question-and-answer session. [Operator Instructions] The first question today comes from David Scharf with JMP Securities. Please go ahead.
Hi. Good afternoon. Thanks for taking my questions. You know, Vik, I'll let others kind of dig into the numbers and questions about the collection environment. But I was curious, I wanted to ask you to follow up a little bit on a couple of things you mentioned in your opening remarks. And the first related to expanding seller relationships. Are you primarily talking about adding more card issuing banks in the US or banks in Europe? Or are you, you know, for credit card receivables or are you envisioning expanding the number of asset classes the PRA is involved in?
At this point in time, david, we are focused on our core business and we're expanding or looking to expand our market access within our core business without expanding into new asset classes.
Got it. And within the US, I know it's been over a decade now since some of the largest card issuers have exited the debt sale market is implied by that comment that your understanding is that they may be looking to re-enter.
My sense is that those that have stayed away from the market for a decade are unlikely to be re-entering the market in the near term. That's our sense of the market, but it's -- I'm not in a position to know what their thoughts might be on that topic, right.
Got it. Yeah, our understanding as well. So it sounds like your comments about expanding seller relationships relate to other existing issuers. And then as a follow up, can you just clarify I know you've mentioned it in the past, but I apologize for asking again. You know, your references to outsourcing and offshoring are -- is that a reference to actual collection activities, working with collection agencies, third-party agencies, or is this a broad commentary about expenses throughout the organization?
It's a -- I don't want to get ahead of myself because we're in discussions with a lot of different parties, David, on different processes. But it's a broad commentary, as I mentioned. And I just want to reemphasize, you know, we're looking at our end-to-end processes and I've defined processes broadly to explore, you know, what opportunities across the entire envelope there would be for us to leverage capabilities, flexibility, including costs.
Got it. Great. Thanks very much.
Thank you.
The next question comes from Bob Napoli with William Blair. Please go ahead.
Thank you. Good afternoon, Vikram and Pete. So I guess maybe just -- I know there's a lot to dig into on the numbers. Just the change in expected recoveries, the 2021 pool was like where there's a lot of focus, obviously. And I think that year is underperforming, not just for you, but for others as well, but maybe more so for PRA. The change in expected recovery to change was a negative $15 million this quarter, negative $37 million last quarter. Is that pool is it to the point where you're turning the corner on that book of business, if you would, such that, and I think maybe a bigger picture, would you expect to be able to return to profitability on a sustained basis in the back half of this year?
Yes, I would say, with regard to 2021 vintage, we've implemented some additional strategies around the underperformance we've seen in that vintage, but things like legal will take some period of time before they start to manifest themselves. So I'd say we're early in the cycle on clawing back cash on the '21 vintage.
And on the return to profitability?
Again, we're on a glidepath here. We took some pretty significant adjustments to the curves in the first quarter, less so this quarter and we'll see where we go from here. We do our best each quarter to get the curves right and that's about all I can say at this point in terms of forward-looking guidance.
Okay. And just may be for Vikram and this is like a big picture question as well. What should be the right return levels for -- I don't know if you think about it in return on equity over the long term, where should this company be earning? Where would you want to get it to?
I don't believe, Bob, that we've sort of discussed or shared that information with the Street, right. So I wouldn't want to be going there on this conversation now. Clearly, we're not where we need to be when we're not delivering profitability, so that's my primary focus, at this point in time, is to get us back to a profitable situation.
Thank you. Maybe this just question. You talked about European competitors looking to sell books. I would imagine that you're looking at those. Are there opportunities that you expect to execute on in Europe in the back half of this year as it relates to other companies selling their current portfolios?
Yes, that wasn't necessarily intended to signal any pending transactions by us, but just more an indication of stress in the marketplace in Europe. And that's having more of an impact on pricing of deals, less aggressive behavior by some competitors. And market pricing adjusting to reflect increased cost of funds for everybody.
Thank you.
The next question comes from Mark Hughes with Truist. Please go ahead.
Thank you. Good afternoon. Does the forward curve assume some improvement in your US processes? Do you need some outsourcing or offshoring in order to hit the curves or will that be upside if you're successful?
In terms of the offshoring/outsourcing commentary, that's really more cost thing at this point than overall cash generation. We do have some assumption in our curves of the initiatives that we've taken to start recouping value in that particular vintage occurring in the future.
How much was the -- your 11% overperformance in Europe, can you say how much of that was the court system in Spain and is that a kind of onetime thing or will that flow through subsequent quarters?
I think largely the Spanish thing was a catch-up. It's probably the smaller piece of the overperformance versus some seasonality and onetime large payments in the Nordics and Poland.
I think, Vik, you had alluded to the fact that we're not going to see this level of increase in coming quarters on purchasing. Would it make sense to hold off, wait till the supply-demand imbalance becomes presumably even more favorable in subsequent quarters? What was the thinking in terms of kind of pushing ahead this quarter when it sounds like you think things should be getting better?
We see a lot of transactions. We're evaluating transactions almost on a daily basis with the volume we're seeing now. And we're being very disciplined about what pricing would be acceptable to us to ensure that it covers all of our costs and the potential increases in interest rates, et cetera. So we'll keep looking at it. We were just trying to signal in that commentary not to do the simple math and necessarily assume that we're going to be up around 50% from last year. But time will tell as to exactly where the business ends up for this year.
And I'd say also, Mark, you've covered us for a long time. You know that pricing and price discovery is important for us. So we'll continue to use the same discipline that we always do to sort of test into pricing as the market continues to evolve. We're doing that on bids every week, every month as we move through this part of the cycle.
I guess you've discovered you're winning more than you might have thought perhaps.
Yes, we don't want to win every bid, that's for certain, in this type of an environment.
And final question in Europe in the core, it looks like the collections multiple for the six month is down a little bit at 165%. I think it's down few basis points sequentially. Anything going on there?
That's just mix of different price multiple or gross purchase price multiples and different countries and different costs to collect of the business there. It's a normal sort of dynamic in Europe.
Would you say the pricing is better in 2Q than in 1Q?
Yes.
Yes, okay. Thank you very much.
[Operator Instructions] The next question comes from Robert Dodd with Raymond James. Please go ahead.
Hi, everybody. On the outsourcing and offshoring, again, I think you mentioned its more efforts on costs and efficiency, but obviously, with some of the bank relationships in the past, there's been some resistance to outsourcing or offshoring, particularly, in some relationships, not necessarily yours. Have you approached any of your bigger clients and had any preliminary discussions about whether they'd actually be open to offshoring as a component of the collection process rather than just the efficiency process, let's say, or is that just not something that you're going to leave up to them or discuss with them in advance?
Anything we're doing is, obviously, any action we're taking is completely in conformity with our existing contractual processes and connections with them. And I think just to reiterate, this whole notion of offshoring and outsourcing is not just on collections and voice, but we have enormous amounts, as a company, right, enormous amounts of data management that we need to do at every level of our processes, from the starting of the relationship to executing it. So we're looking at, as I just told you, we're looking at voice, we're looking at data, we're looking at all of the optionality that we have, and over the next several months, we hope to be able to make decisions around that, that would be helpful, but all of it would be in conformity with our contracts, and we don't believe at this time that we need to open up conversations with our seller relationships to get any variance from them on their existing protocols.
Got it. Thank you. And I scribbled something out. On the comp for Q3, did you say kind of mid-70s up from like mid-60s? Or did I write that down wrong? And if that is the case, can you give us any color on the big driver. Obviously mid-70s isn't particularly high compared to where it was last year, but it would be a big change from Q2?
Yes. Again, you heard me right. I signaled that mid-70s for compensation for the third quarter. Again, we've had some volatility in that line item over last quarter and this quarter, some onetime things in terms of timing of different accruals and the like. And as well as healthcare expenses, which can move around from quarter-to-quarter based on claim experience. So that mid-70s is our best view of what third quarter is going to look like.
Got it. Thank you.
The next question comes from Bob Napoli with William Blair. Please go ahead.
Thank you for the follow-up. Just can you give some color on the mix of forward flows that may be at historical higher prices versus the better pricing, the higher IRRs that you're getting in today's market?
Just broadly, as we go through this year, because of the way that forward flows are staggered in terms of their renewal dates, we will gradually blend into the more current pricing environment and the older flow bids will roll off. We've also begun to look at optionality on some of those existing flows where returns might not be commensurate with current market pricing and evaluating options for what to do there as well.
Great. Thank you. And then, Vik, just from an operating perspective, I know you've talked about areas of underinvestment and I know we've talked about that before. Can you maybe just give an update on versus not just insourcing, outsourcing, but just overall where the underinvestment has been and where you see the biggest opportunities to make improvements?
Look, I think, I look at it similar to what we've all experienced as consumers, Bob, where the world has changed and over the last 10 or 15 years in terms of the infrastructure, the capabilities that exist outside. How do we bring that level of thinking and investment into the company, right? So we're looking at our core operating platforms. We're looking at the supporting infrastructure. We're looking at the efficient management of data. We're looking at policies and procedures that are updated or reflect both customer needs and customer expectations. And this is a sort of broad exercise that, for a variety of reasons, the company did not fully do over the last several years. They were running a lot of other things really well. Like I mentioned, our underwriting processes are terrific, right, really exceptional. But there were other things that might have been done in years past that were not. And so we're looking at all of that. And we will -- overtime time will determine the value that we can create from that. But we're encouraged by the early start.
Thank you.
The next question comes from David Scharf with JMP Securities. Please go ahead.
Hi. Thanks for allowing the follow-ups. Taking a step back, I'm wondering, last quarter there seemed to be more discussion about just the state of the US consumer, the macro backdrop, a weaker tax refund season, and so forth. I mean setting aside the variances to forecast, are you telegraphing any different near-term outlook on collectability in the collection environment or the comments from last quarter pretty much hold steady?
No, I think we had done a lot of communication around our interpretation of the various data publications by the Fed and others just trying to broadcast kind of where we thought we were in the cycle. I think that data, nothing's really changed there, and I think we continue to see the migration in delinquency and charge-off metrics. And on balance that's a good thing for us in terms of increased supply and more favorable pricing dynamic. So the fact that we didn't go into lots of detail on more economic statistics isn't an indicator of anything other than we thought we had made that point in prior quarters and didn't need to keep beating that drum.
Got it. Appreciate it. And maybe one last question. And this isn't meant to pin you down in any kind of forward guidance, but within the -- I'm trying to understand sort of the margin structure that ultimately you hope to achieve with a lot of the cost efficiencies, outsourcing, rationalization. I mean if we think about your guidance of exiting the year at about a 60% cash efficiency ratio, and then looking at the abnormal 2021 pandemic stimulus-driven 65% ratio as maybe a ceiling, I mean do you ultimately after all of these operational moves, do you think that this is a business that could operate closer to that 65% in a normal environment or is this all kind of meant to sort of stabilize things at a predictable 60%, 61% level?
No, I think our goal is to be 65% and potentially beyond that in years to come. And I think given the focus that we have on efficiency and the impact that some of these opportunities could present for us, I think that's eminently doable.
Got it. Very helpful. Thanks, Pete.
This concludes our question-and-answer session. I would like to turn the conference back over to Vik Atal for any closing remarks.
Thank you, everybody, for joining us today and really, truly appreciate your support of PRA. Thank you.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.