Encore Capital Group Inc (ECPG) 2012 Q1 法說會逐字稿

Good day and welcome to the Encore Capital Group first quarter 2012 earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time.

If you should require audio assistance during this conference call please press * then zero to speak with an audio operator. As a reminder, this conference call is being recorded.

I would now like to turn the conference over to our host today, Mr. Adam Sragovicz, Director of Finance and Treasury. Please go ahead.

Thank you Carolina. Good afternoon and thank you for joining Encore Capital Group's first quarter 2012 earnings call.

As a reminder, in order to see the slides we are presenting this afternoon please be sure to log into the webcast on the Investor section of our website, www.EncoreCapital.com.

With me on the call today are Brandon Black, our President and Chief Executive Officer and Paul Grinberg, our Chief Financial Officer. We will begin with prepared remarks together with the slide presentation and then follow with a question and answer period.

Given the significant number of new items we decided to utilize the slide presentation as part of this quarter's call which will also be available on our website following the call.

Please also note that all spoken references to first quarter or Q1 refer to the first quarter of 2012 unless otherwise stated. Before we begin we have a few housekeeping items to take care of.

Throughout this conference call we will use forward-looking statements including predictions, expectations, estimates or other information that might be considered forward-looking. While these forward-looking statements represent our current judgment, these statements are also subject to risks and uncertainties that may cause actual results to differ materially from statements being made today. As a result we caution you against placing undue reliance on these forward-looking statements which speak only as of the date they are made.

We will also use rounding and abbreviations in our conference call for the sake of brevity. For more detailed numbers and explanations please refer to our Form 10-Q that was filed today with the SEC.

We will also be referencing both GAAP and non-GAAP financial results. We believe certain non-GAAP financial measures provide useful information about our business. However, the presentation of this additional information should not be considered an alternative to, or more meaningful than, our results prepared in accordance with GAAP.

Management utilizes adjusted EBITDA which is similar to a financial measure contained in covenants used in our credit agreement in the evaluation of our operation and believes this measure is a useful indicator of our ability to generate cash collection in excess of operating expenses through the liquidation of our receivable portfolio.

We included information concerning adjusted operating expenses excluding stock based compensation expense and bankruptcy servicing operating expenses in order to facilitate a comparison of approximate cash cost to cash collections for the debt purchasing business in the period presented.

Once again, please be sure to see our 10-K, 10-Q and other SEC filings including a press release issued as an exhibit to our current report on Form 8-K filed today for a more complete discussion of these factors and other risks.

As a reminder, this conference call will also be available for replay on the Investor Relations section of our website and we also plan to post the prepared remarks following the conclusion of this call.

With that, let me turn the call over to Brandon Black, our Chief Executive Officer.

Thank you Adam and good afternoon. I appreciate your joining us today to discuss Encore's first quarter results and review some meaningful corporate developments. It's my hope that you'll take away three key points from this call.

First, Encore delivered strong financial performance and record results in the quarter. Second, we continued to improve and evolve our operating model to maximize returns and adjust to the constantly changing regulatory environment. And third, the meaningful corporate developments that we are announcing today are a testament to our commitment to expanding our business by leveraging our core competencies to drive future growth and shareholder value.

I'm speaking to you today from the headquarters of Propel in San Antonio, Texas and I'm thrilled to welcome the Propel employees to the Encore team. Paul is in our headquarters in San Diego so please excuse any pauses during the question and answer period.

This had been an important period and time for our Company and before getting started I want to recognize and express my appreciation for our 2,600 employees around the world whose dedication, hard work, and perseverance helped make this quarter so successful.

Our core business delivered strong results in the quarter. Collections reached an all time high of $231 million which is a 21% increase over the first quarter of 2011. We were able to produce these collections while continuing to expand our operating margin.

During the quarter our overall cost to collect decreased 160 basis points to 38.4%. This is a significant accomplishment because these results include the continued investments that we are making in our internal legal initiative and our new operating site in Costa Rica.

The growth in collections and improvement in cost to collect led to earnings per share of $0.69 when adjusted for the non-cash charges related to Ascension. Adjusted EBITDA was $143 million up from $116 million in the same period of 2011.

During the quarter we successfully deployed $130 million on new portfolios which was a $40 million or 44% increase compared to the prior year. It was a record first quarter for purchases and we completed 64 transactions from 12 different sellers.

Our analytical discipline, increasing cost advantage and strong capital position drove our purchasing success. Over the past two years you have heard us discuss the possibility of industry consolidation and in the fourth quarter we started to see an increase in portfolio purchase opportunities from competitors. In fact, we spent almost $50 million on these types of transactions in the fourth quarter. It's our belief that a key factor in a competitor's decision to sell is the challenge of competing with companies with meaningful operating and cost advantages.

We are positioned to acquire these secondary market portfolios for three primary reasons. First, we have significant experience purchasing accounts in the secondary market. Our largest single purchase was from a competitor and we have been a major proven player in the resale market throughout history.

Second, our consumer-centric model allows us to accurately value portfolios independent of the owner or originator of the portfolio. Third, as I mentioned before, Encore enjoys important cost and cost of capital advantages.

These secondary market opportunities have continued into 2012. Specifically, we were the successful bidder on nine separate portfolios of consumer loan and credit card receivables from one seller. The total face value is $3.3 billion and we expect to close these transactions in mid May at a combined price greater than $100 million.

Some of you may have seen an FTC announcement earlier today granting early termination to Encore. That announcement was related to the purchase of these portfolios. When added to other purchasing commitments in place, this large acquisition will push our second quarter purchases to over $200 million. That means our combined purchases for the fourth quarter of 2011 and the first two quarters of 2012 will approach $500 million.

Successfully negotiating and integrating these large complicated deals is no simple task. Each part of our organization has to pull together to ensure success and I want to thank those individuals and teams who have worked so hard to make it happen, from analyzing and evaluating millions of accounts to onboarding dozens of new agencies and partners, our deep and talented teams have proven once again how truly capable they are.

To be successful in our business several key components are necessary. These include a robust consumer level evaluation process and servicing platform, cost efficient, highly effective operating sites, access to reasonably priced capital, and the ability to navigate through a complex and changing regulatory environment. We believe that an increasing number of our competitors will find it difficult to effectively compete across all of these dimensions and will ultimately exit the business, providing new opportunities for Encore.

While our core business has flourished, our Ascension bankruptcy servicing business has faced significant headwinds. Bankruptcy volumes have dropped year over year which has led to a decline in the subsidiary's profitability.

Also, in the first quarter Ascension's largest client put their business out for bid and received significantly lower quotes than what we could reasonably offer. Given that we decided to seek strategic alternatives for the business. In February we began exclusive negotiations with a company that has deep experience in the bankruptcy space and we have reached an agreement in principal to sell the business to them. There is no question this is the best solution for Ascension's clients and employees who will now have the opportunity to flourish in a new environment. Paul will discuss the details of this transaction and its impact on current and future periods.

For some time now we have been focused on identifying complimentary opportunities to our core business. In fact, over the past 24 months we've explored both geographic and asset class diversification including dozens of potential acquisitions. We have been focused on identifying an opportunity where we could add value to our analytical expertise, cost effective operating platform and knowledge and understanding of the distressed consumer. These broad and patient efforts enable us to form a deep knowledge of many adjacent industries and geographies and ultimately we decided to pursue an acquisition in the tax lien industry.

This asset class is a natural extension of our core business where success is driven by analytical rigor and efficient operating platform and consumer level underwriting and marketing. It gives us the flexibility to deploy significant amounts of capital and very strong risk adjusted returns. Our estimate of the total size of the tax lien market is between $7 billion and $10 billion of capital deployment on an annual basis.

Yesterday we closed on the acquisition of Propel Financial Services, the company we approached towards the end of 2011. Propel helps homeowners who are delinquent on their property taxes. On behalf of the consumer they purchase the obligation from the municipality at par and work with the homeowner to create a payment plan that allows them to pay off the balance on reasonable terms.

In this industry which is presently unique to Texas, the transaction is referred to a tax lien transfer. With the tax lien transfer model, homeowners opt in and engage with companies like Propel to help them pay off the delinquent taxes. This is a win for municipalities because they receive the funds they need during a difficult economic time for their budgets and it's a win for consumers because they can satisfy their obligations over time at a lower interest rate and fee structure than what the government charges. As the market leader Propel is a strong brand and enjoys very high customer satisfaction.

Propel has grown significantly over the last few years and we believe that we can accelerate its growth in 2012 and beyond by leveraging Encore's analytical, operational, and marketing resource.

The acquisition will be accretive to earnings in 2012, will strengthen our position as the leading consumer debt management platform and will create meaningful shareholder value. Paul will give you more information on the transaction and we will talk about Propel and the tax lien space in more detail at our annual Investor Day in New York on June 6. We are thrilled to be associated with such a high quality group of management employees and look forward to working with the Propel team to drive significant results in the coming years.

Before turning the call over to Paul I want to highlight some of the things we are seeing on the regulatory front.

While the industry continues to receive a significant amount of attention, we have become more adept at helping legislators and regulators understand both our Company and our industry. Unfortunately, there is a significant amount of misinformation or information that is taken out of context.

For example, there has been a lot written about the number of complaints that are made about the collection industry. Unfortunately, the wrong numbers are never put into context. When we have the opportunity we are able to show that the vast majority of consumers actually do not have a problem with the collection process. In fact, only one-half of 1% of consumers ever registers a concern about their treatment.

The industry has recently been provided access to the underlying Federal Trade Commission 2011 complaint data and, despite our size, complaints directed at Midland and Encore represent less than 1% of the total complaints collected. That number represents a remarkably small fraction when measured against the tens of millions of consumer interactions we had during the relevant period and that makes sense given the emphasis we place on treating consumers honestly and with respect.

These and other facts are regularly used when we speak with legislators and generally has a positive impact on the dialog. In the first quarter we engaged with legislators in several states and were able to work with them to modify legislation in a way that makes sense for consumers and the industry or in some cases, see the bills pulled or defeated altogether.

At the federal level we have continued to dialog with the CFPB and expect that to continue as they define their engagement level with the collections industry.

Finally, we have proactively reached out to a group of Attorneys General and are working closely with them to address any remaining concerns. These conversations have been very constructive and we hope it sets the stage for a positive resolution.

Overall, our legislative and regulatory efforts are becoming more comprehensive, more sophisticated, and more strategic to Encore. We believe that they will position us well, an ethical, responsible Company, in the distressed consumer receivables space and allow us to stay engaged in an evolving legislative and regulatory landscape.

With that, I will turn the call over to Paul who will discuss our financial results in more detail. Paul?

Thank you Brandon. As Brandon discussed we had a very strong first quarter. Rather than going through the results in as much detail as I normally do I will just focus on some of the highlights for the quarter and take the rest of the time to provide more detail about the three transactions which Brandon mentioned.

In this section, any reference to the prior year should be construed as a quarter to quarter comparison unless I mention otherwise.

Collections grew 21% to $231 million. Adjusted EBITDA grew 23% to $143 and earnings per share excluding the impact of the Ascension transaction grew 28% to a record $0.69.

On the operations front, despite the continued investment in initiatives like internal legal and our new site in Costa Rica, our cost to collect was the lowest in the Company's history at 38.4% down from 40%. We are excited about the increased leverage but I want to reiterate that our goal is to maximize dollars collected less dollars spent not the ratio of dollars spent to dollars collected. As such, where we can generate incremental collections we will do so even when it may entail a higher average cost to collect.

I also want to mention that as a result of the seasonality of our business our cost to collect is generally the lowest during the first quarter and highest in the fourth quarter.

The quarter's strong cash generation enabled us to deploy $130 million for purchases while only increasing our debt by $9 million. After reflecting the impact of the recent amendments to our credit facility, at the end of the quarter we had nearly $180 million of available borrowing capacity. This availability enabled us to complete the Propel acquisition and will facilitate the large portfolio purchases that Brandon mentioned without the need to raise expensive equity or other debt financing.

One of the metrics we monitor closely is our estimated remaining collections, or ERC. At March 31, ERC was just over $1.7 billion. We believe that our ERC which reflects the estimated remaining value of our existing portfolio is conservatively stated because of our cautious approach to setting initial curves and our practice of only increasing future expectations after a sustained period of over performance.

Taking a closer look at our collections by channel our call centers contributed 47.6% of total collections or $110 million for the quarter as compared to $88.5 million in 2011. Legal channel collections grew to $110 million in the quarter compared to $88.5 million last year and accounted for 47.4% of total collections. The remaining 5% of collections came primarily from collection agencies.

Direct costs per dollar collected in our call centers declined to 5.9% for the quarter from 7.6% in 2011. This improvement is largely the result of collections growth from our operations center in India which increased 40.7% from $42.3 million in 2011 to $59.5 million in 2012. India represented 54.2% of total call center collections during the quarter. Cost to collect in the legal channel in 2012 was 35.3% down meaningfully from 41.3% in 2011. The decline was largely attributable to the continued refinement of our analytic capabilities and increased ability to predict consumer behavior which has allowed us to become more precise about when to use this strategy.

Moving on, revenue from receivable portfolios in the quarter was $126.4 million, an increase of 20% over the $105.3 million in 2011. As a percentage of collections and excluding the effects of allowances the revenue recognition rate was 54.9% in the first quarter, slightly lower than the 58% in the first quarter of 2011.

During the quarter we expensed $373,000 in net allowance charges compared to $5.5 million in 2011. Looking at the breakdown by pool we had $1.1 million of allowances in the 2006 vintage, $78,000 of allowances in the 2005 vintage and $209,000 in the 2007 vintage. These allowances were offset by $1 million in reversals. We had no allowance charges for the 2009, '10, '11, or '12 vintages in the quarter as has been the case since we acquired these portfolios.

This quarter we outperformed our forecasted collection curves by 20%. The income tax provision in the first quarter was $7.3 million reflecting an overall tax rate of 39.2% as compared to 38.6% in the same period in 2011.

Turing to our Ascension, our fee based bankruptcy servicing business, revenue fell by 29% from $4.9 million in the prior year to $3.8 million and cash operating costs were $4.5 million compared to $4.3 million in the prior year.

Earnings per share for the quarter was impacted by our decision to transition Ascension to new owners. During the first quarter we recorded a one time, non-cash impairment charge of $10.3 million associated with Ascension's goodwill and intangible assets. This reduced after tax earnings by $0.25. Earnings per share were also impacted by Ascension's loss during the quarter and by the transaction costs associated with the Propel acquisition.

We have an agreement in principal with the new owner and expect the transaction to be completed by the end of May. As part of the transition, Ascension's new owner will invest in new technology and apply the bankruptcy servicing expertise necessary for Ascension to compete more effectively and we have agreed to cover normal operating losses in the first year of ownership. If the business grows and becomes profitable we will be paid an earn-out equal to 30% to 40% of Ascension's EBITDA for the first five years after closing.

In the second quarter we expect to accrue an estimate for Ascension's loss sharing and related matters of approximately $0.10 per share and incur approximately $0.12 per share in Propel yield costs which are expensed in accordance with GAAP. Beginning in the second quarter we will treat Ascension as a discontinued operation.

Turning to the acquisition of Propel and the large acquisition of nine portfolios, we will fund these transactions through availability on our existing credit facility, cash on hand, and a new $160 million syndicated loan facility led by Texas Capital Bank which will be maintained at the Propel subsidiary level. This new three year revolving credit facility bears interest at Libor plus a spread that ranges from 300 to 375 basis points, has a $40 million accordion feature, and had $122 million drawn at closing. We welcome our new financing partners to Encore and look forward to working with them to grow our tax lien transfer business.

Over the last few years we focused our business on developing more insights into the financially stressed consumer, improving our marketing efforts and operational models through analytical rigor and building a superior cost effective operating platform. These have all led to record cash flows, strengthened our balance sheet with record low leverage and as I mentioned earlier, allowed us to build up a reservoir of value reflected in ERC. Together with a new Propel revolving credit facility this enabled us to fund the Propel acquisition and will allow us to fund the nine portfolio acquisitions without the need for raising more expensive debt financing or equity.

The purchase price for Propel of $187 million will largely be allocated to Propel's tax lien transfer portfolio with the balance going to goodwill and other intangibles subject to a formal valuation analysis.

A recurring question we've had on our earnings calls has been whether we would deploy the excess capital we've been building to buy back stock or pay a dividend. We've maintained that we believed we could use that capital both in our core business and to diversify into other asset classes or geographies and that those types of investments would yield a better return to our shareholders than a buyback or dividend. We believe that the two transactions we announced today demonstrate our ability to deploy our capital in a prudent manner and in ways which will provide sustainable growth for our Company and create shareholder value.

In anticipation of these transactions we've made some changes to our credit facility. In anticipation of these transactions we've made some changes to our credit facility. The most substantive of these changes included increasing the size of the facility from $410 million to $555 million and reloading the accordion to $100 million bringing the total facility to $655 million. We also increased our advance rate from 30% of ERC to 33% of ERC reflecting the significant reduction in our cost to collect since we put the facility in place.

Despite the increased leverage resulting from these transactions we are still well within the financial covenants established in our credit facility. While our leverage ratio has increased it is still more than $315 million below our maximum threshold and we believe that using excess capacity to fund strong growth opportunities like Propel will improve return on equity.

As we continue to generate strong cash collections from our core business we expect our leverage will decline. Also, as a result of the nine portfolio purchases which we will close later this month we expect that purchases in Q3 will be significantly lower than historical purchase levels. This will also serve to reduce our leverage.

As Brandon mentioned, excluding deal costs we expect the Propel acquisition to be immediately accretive and expect solid performance from the large portfolio purchases. However, we will be making investments in Propel that will drive future growth in profitability and we'll also be making investments in legal operations as part of the portfolio acquisitions. Accordingly, we will be providing additional information and guidance at our Investor Day on June 6 to assist you in updating your financial models for Encore.

With that, I will turn it over briefly to Brandon before opening up the call for questions. Brandon?

Thanks Paul. Encore's first quarter performance demonstrates that we are uniquely able to succeed in an ever changing business, economic and regulatory environment. Our continued focus on our core expertise around distressed consumers, strong operational capacity, and legislative and regulatory expertise will help us drive future success.

We are pleased to have found an opportunity to further leverage our analytics and experience with the distressed consumer in our acquisition of Propel. Our strong team, disciplined approach, and growing capital availability are all great news for Encore employees and shareholders.

We thank your for listening and look forward to seeing you on our Investor Day in June. Operator, please open up the line for questions.

Thank you. (Operator Instructions) And we have a question from the line of David Scharf with JMP Securities. Please go ahead.

A few things, just starting on the purchase environment. I know you provided a little commentary on Q3 being below normal. Just kind of wondering, are there any unique staffing issues related to the amount of paper you're taking on in just a five month period? Should there be any kind of unusual spin-up costs that might kind of depress margins a little bit in the next couple quarters or is this all in kind of the regular course of business?

David, in anticipation of this transaction we started expanding our staffing notably in India and had the good fortune of being able to adjust the work efforts for some of our employees there from lower yielding accounts onto these new portfolios so we don't actually expect there to be a significant change although there was certainly some staffing requirements. We also have the ability to work with the seller who has generally had an outsourced model to allow accounts from other agencies for a period of time until we recall them but again, that's what I think we do well and I think our team is poised to bring on this large set of portfolios on top of the prior two quarters in an expeditious fashion without any meaningful disruption.

Okay, that's helpful and then turning to productivity, particularly legal, it was a dramatic decline especially given the investments you're making. Should we interpret the, setting aside seasonality, should we interpret this big decline in cost to collect to any macro or consumer driven factors or would you attribute this all to just operational improvement efficiencies?

If you go back, we made the decision five or six years to really ramp up the investment in legal on those consumers who we thought could pay but weren't engaging with us and back then it was more expensive but as time has gone on we've been able to build models that allow us to refine that process over and over and so we think it's just five or six years of learning and each time that we go around, annual process, we just get better and better at what we do so we don't think it's a macro effect. It's just really this long embedded duration of significant investment that has allowed us to bring the cost down.

Okay so no need to jump the gun on concluding anything about the consumer.

David, just I want to clarify that the internal legal costs are not included in the cost to collect for the legal operations. They're separated. They're disclosed in the Q separately but they're not part of that cost to collect.

Right, right, okay and then lastly and then I'll get back in queue, can you give us a little better feel for, I know you're going to discuss Propel in more detail on the Investor Day but just how these tax liens ultimately liquidate, how we ought to think about the average life of the collections on these or the workout schedule, how it relates to your core credit card receivables and what kind of typical purchase prices they're acquired at.

I'll handle part of it and let Paul start with the accounting differences but generally the assets are acquired at par so unlike our core business where you're paying cents on a dollar you're paying largely 100 cents on the dollar and that's because ultimately these liens are sort of super secured meaning that if you think about that waterfall of who gets paid first, these liens go above even the first mortgage holder. It's highly liquid and also highly secured and the way they're originated is you buy them at par from the municipality and then ultimately get their right as a tax lien holder. The duration, Paul, correct me if I'm wrong, is around three years and the accounting is slightly different. I'll let Paul work through that.

That's right. It's about between three and four years and effectively, they're acquired at par and then accrue an interest rate and so the earnings are the interest that's accrued on the investment and so the curves are flatter than our typical curves are in the core business because we're acquiring it at par and just generating a return on that investment.

Okay that's helpful. I'll get back in queue.

Thank you and our next question is from the line of Bob Napoli with William Blair. Please go ahead.

Question I guess first on what was the size of the nine portfolios, the dollar amount? Did you give that? I know you said over $100 million but how much over $100 million?

We did not give a number so we're just going to go with over $100 million.

Okay, obviously that transaction was well publicized and there was discussion about very aggressive price expectations from the seller. Can you, how can you give us comfort that the multiple you paid, the pricing you paid was reasonable? It's a big chunk of business to take on so it's a concentration of risk from one seller so how did you go through the pricing and the discussion of pricing in the market, was that right or wrong or maybe give some color on that and the returns you expect on that business because obviously it was very competitive.

I don't know how competitive it was or wasn't. What I can say is the whole portfolio wasn't sold and so what we're buying is a portion of the portfolio that meets our return thresholds. I don't know what the other parts of the portfolio did or didn't trade for. What I do know is that as I mentioned in the call, our underwriting model is perfectly suited for this kind of opportunity. Our ability to evaluate the collectability at the individual consumer level allows us to look at portfolios that come from issuers in the resale market because ultimately we don't care who owned it right before us or who underwrote it. We care whether that individual consumer can recover and repay us over time and the greatest testament to that I think is if you look at our history in being profitable in 95% of your deals, I'm not sure there is a better answer than that one but you take our operating model, our history and the fact that we only bought the portion of the portfolio that met our return thresholds should give you the confidence and I won't comment on what other people think about it.

Do you expect similar returns on this paper as any other paper you've been buying in the market?

Absolutely.

Okay and then on the acquisition of Propel, interesting business. I looked at tax lien businesses off and on for a long time and typically there has been a decent amount of regulatory risk that has been associated with the tax lien industry at least in some markets at some times. How did you get comfortable with this business from that perspective? It's in one state. Did you have discussions with regulators in the State of Texas or how did you get comfortable with the acquisition of Propel and was it a competitive bid?

It was not a competitive bid. It was a company that we approached and quite frankly, we view it as having very little regulatory risk in the sense that this is a government debt and so unless they have a challenge with their own math, you don't run it yourself and the issue of kind of is the underlying data good?

In this particular product the consumer chooses the option so it's an opt-in process and the consumer gets better terms and conditions than they'd get otherwise. The industry in Texas was legislated into existence about 70 years. It was amended about 20 years ago with some different changes so we actually believe this model is the absolute right model for consumers. We think it comes with very little regulatory or headline risk certainly compared to our core business and we spent a lot of time getting comfortable with that but we really think that it's an excellent product and one that consumers need.

Okay and then the purchase price, was there book value? What was the book value of Propel or is the $187 million, is that all intangible?

It's not all intangible. As I mentioned, a large portion of that will be allocated to the portfolio and the rest will be goodwill and intangibles and obviously over time we'll be disclosing more details on what that is.

Thanks and just last question, what is the yield on that? What kind of yield do you get on the tax lien business? What's the interest rate on the loan to the consumer?

We're not giving exact amount but you can think about it in sort of the mid teens.

Thank you and our next question is from the line of Mark Hughes with SunTrust. Please go ahead.

What does the revenue and margin and cash collection profile of the Propel business look like if you take a current run rate or last 12 months or something, just so we can get a sense of how will it look on your income statement?

Mark, we'll be providing more information about the detailed specifics on Propel, some historical data, when we do our 8-K filing which will include 2011 financial data for Propel so we'll be filing our 8-K within 75 days or so of the closing of the acquisitions so we'll provide more information then and obviously as we close out our Q2 earnings and as part of that we'll be providing additional data then.

How applicable is this business to other markets? It's obviously in Texas. It sounds like it's pretty idiosyncratic for that state. Is it legal elsewhere? Is the hope to make legislative changes so it is something you can spread to other states?

We actually think about this acquisition as the entry into the tax lien market. We're doing it through what we think is one of the best platforms you could find. The actual product they work on today is exclusive to Texas although we believe that it's got the opportunity to go more broadly but as a Company we think about this as a 28 state, $10 billion market that we're sort of starting and getting a toehold in Texas but we expect that over time to grow either by expansion of this product or by outright tax lien acquisitions over the next few years.

Were they capital constrained in Texas? Were there still attractive investments they could have made if they'd have had more capital?

What I will tell you is the combined penetration of all the participants in the space is less than 20% so we think there is a significant amount of opportunity to penetrate this consumer base because quite frankly, there isn't anybody who has a delinquent tax lien that shouldn't take this product given the rate and fee structure of what they'd get through the governmental entities. Our job is to help them with the analytics and the marketing to really grow and penetrate the other 80% but we think there is significant growth opportunity just in Texas.

Paul, you've mentioned some good puts and takes here in terms of outlook. We've obviously got accretion from Propel and selling off Ascension and these portfolio purchases. You also mentioned investments in legal. Can you give us some body language on how does that shake out relative to you know, you've been going along at a pretty good clip in terms of growth. EPS in the last year in the low 20s, this was obviously better than that. What can you tell us about how this all impacts the bottom line?

I think we've always said that our goal is to continue growing the business at rates where we've been growing it historically and I think this will be one of the things that will be part of that growth.

Right, now you're putting a lot of capital to work. One would hope if you do put that amount of capital that it would make the business grow faster. Would that be too optimistic?

Since we've said this will be accretive to earnings so we'll clearly grow faster than had we not done it.

Good, that's helpful. Thank you.

(Operator Instructions)

And our next question is from the line of Adam Letson with Piper Jaffray. Please go ahead.

Just quickly to make sure I heard correctly, the Propel deal closed yesterday and then Paul, if you could walk through just the deal charges again and then potentially kind of what you think the magnitude of accretion is.

We haven't shared what the magnitude of accretion is so there is nothing there. In this quarter there was about a penny of deal costs which I didn't mention but there is about a penny of deal cost in Q1. For Q2 we expect to have about $0.12 in deal cost.

And it did close yesterday.

Just one quick follow up on the pricing environment. Clearly, the purchases you made this quarter were a bit more expensive than last year. Purchasing the large portfolio, next quarter is there -- if you can just give a little bit more color as to kind of how the pricing is working out relative to this quarter that would be helpful.

It's our belief that the pricing continues to go up slightly quarter to quarter although the advancements in pricing have slowed down pretty meaningfully from what was occurring in 2011 so we see pricing going up a little bit. I just think our ability to purchase is a function of both the gross liquidation we're able to give which we think is industry leading but now with our costs down where they are it just allows us to be significantly more competitive than many of the people we compete with and that's what we built the Company for so while we see a little bit of price increase we've been able to moderate that with improvements in our operating platform.

And our next question is from the line of Hugh Miller with Sidoti. Please go ahead.

You guys had referenced kind of a mid teens interest rate for the Propel business. I was wondering was that the rate that the government is charging or that is the rate that you guys would be receiving after you're taking on the business?

The government actually charges a higher rate than that so that would be our rate.

And as you look at that business and the returns on invested capital relative to the debt buying business, how do they compare?

On a risk adjusted basis we think they compare very favorably with our core business.

Okay so one could say though that you view the Propel business as a lower risk business, correct?

That is correct.

Okay so risk adjusted, they're the same. Alright, that makes sense. And as I look at the productivity, you guys reference obviously some of the improvements you've made in productivity on the legal side but it also looked like cash collections per hour paid was up materially on a year over year basis as well, north of 20%. I was wondering if you could talk about the drivers of that and if it's primarily seasoning of some of the collectors or have you noticed any difference in average payment size on a year over year basis?

We think a big part of it is the seasoning of the account managers especially in India. As we highlighted going back a couple years now as we bring on a significant number of new employees it takes them about a year to get up the curve and (inaudible) and his team over there have just done a fantastic job of growing that workforce and that's a big part of it. I also think we're getting better on the marketing direct mail side which drove significant returns in the quarter so it's a combination of those two.

Okay and any color you can provide on the average payment size? Any trends that you're noticing there relative to last year in the first quarter?

We've seen a pretty flat average payment size for the last few years and no discernable trends in the first quarter.

Okay and you guys also referenced in the third quarter that you'd anticipate seeing kind of less than normal buying activity for you guys to swallow the deal activity in the first half of the year. Can you give us a sense on how meaningful that reduction is probably likely to be?

What we've done every year is on our Investor Day we've shared the details on our forecast for purchasing during the year so we're likely to do that again this year so stay tuned for another, I guess it's four weeks from today and we'll give you the details on our forecast for purchasing for the year.

Okay, I appreciate the insight. Thank you.

And our next question is from the line of Mark Hughes with SunTrust. Please go ahead.

Just so I understand, could you walk me through how the cash flow works on you know, you make an investment, say, of $100.00 in the tax lien business. It sounds like you're buying it at par. You're than charging the consumer a 15% interest rate. I presume you're recognizing that as revenue. Could you give me just a little more detail? You spend $100.00. How does it come back to you with a good return?

Through Propel we would enter into something similar to an amortizing loan with a consumer where if we lent $100.00 and it paid as the example you gave, 15%, and it was a five year term there would be a monthly payment that they would pay every month which includes both principal and interest and it would amortize that loan in the example over that five years and there are no prepayment penalties so while the terms are typically longer, the average life is three to four years because there are prepayments.

And do you always buy it at par?

Yes.

And so whatever the losses may be are just factored into the interest rate that you charge?

Historically there have been no losses.

Right, so everybody pays?

That's correct.

It's the Big Daddy Gov is backing you up, right? Okay, well that's -- can you say what Propel, their revenue growth in 2011, what it was over 2010, historically what kind of cyclical impact of this business? Are cities more likely to, I don't know whether they persuade or are happier to have you step in or more consumers are delinquent in bad economies and so therefore if we do get in a recovery that that could have some influence on the business. Again, what was the growth last year and what kind of cyclicality does the business have?

I'll address the cyclicality. I actually believe this has been a growing market. If you look back through time we think any reduction in any one geography will be offset by growth in the new geographies so it's our belief we'll continue to do that.

We also think that this consumer friendly product of having the consumer ultimately choose it rather than have it imposed on them is a better solution and we think more and more localities will come around to believing this is a better product than either holding on themselves or selling it in some way. If you think about what funds most municipal budgets it's the taxes on real estate and so we think if anything there will be more people selling given the shortfall in any budget, not fewer.

How do your analytics help in this case? Is it determining whether you accept the consumers if they choose this? Is it an underwriting process where you accept or reject or your interest rate adjusts depending on the individual? How does that work?

I think you described it largely. I think it's understanding the population of consumers who are eligible. It's a defined set of people and creating offers and opportunities for them at the individual level and when we bring to the table the ability to really understand and analyze that consumer rather than just the property and so we think the combination of consumer level analytics and the real estate knowledge that Propel has is one advantage.

The second is our deep ability to think about how do you market to these consumers and then we think our servicing platform will be able to help them in building other avenues in areas like telemarketing where not much is done today.

So there are a broad number of areas and we'll go through all of the synergies as we seem them when we get to the June meeting.

And we have a follow up question from the line of Bob Napoli with William Blair. Please go ahead.

Hey guys. On the legal side, the reduction in the fees that you pay to the attorneys, is that sustainable? I mean, you had a pretty big drop in legal cost. The cost that we see this quarter as a percentage of the legal collections, is that sustainable? It's a pretty big drop percentage-wise and I'm just trying to understand how that happened and if it's sustainable.

A lot of it happened because of what Brandon described which is being more sophisticated around which consumers we use this strategy with and so it is sustainable but I'll say one thing though that if we're able to identify in another group of consumers where we can spend a little more and generate incremental collection dollars we will do that so our goal isn't to minimize the cost per dollar collected. It's to maximize the dollars collected less dollars spent so based upon the pool that we collected from this quarter, clearly it's sustainable but we keep identifying new pools of consumers so there may be increases in the future depending upon whether we can generate incremental dollars or not.

A decrease in the commission rate, is that happening across the industry or is it because you're giving so much volume to the attorneys?

This is less about the actual commission rate. It's more around, our costs are both the commissions we pay the law firms as well as the unsuccessful use of court costs and we see here is a meaningful reduction in the, I'll call them wasted court costs over time.

Okay, interesting and then in portfolio purchases I kind of missed what you said about third quarter purchases.

I said that they would be lower than our, significantly lower than what we typically spend in the third quarter as we digest the significant volume of purchases we've had in Q4, 1, and what we're anticipating in Q2.

Are you seeing less -- I mean, obviously a significant competitor is selling their portfolio. You're buying a part of it. Are you seeing any new players, private equity backed players or anything? There has been pretty big merger of the industry into a handful of larger players. Are there new players coming up? Are there less bidders now for portfolios than you've seen over the last ten years?

We're seeing meaningfully fewer bidders when you contrast over history. In the near term I think what you're seeing is it's getting harder and harder and harder for the small and medium sized companies to compete just because they don't have the access to capital or the operating platform or the analytics or the technology. It's our belief that over time the industry will consolidate into a few significant, meaningful players and it will be hard for a private equity-like firm to come into the business and make it work.

And then just last question on the tax lien business, it sounds like the metrics that you put out, it sounds awful attractive -- zero losses, mid teens yields and it improves a lot of the consumer. It sounds like a great business but what is the competitive environment like? It seems like a kind of business that would attract a lot of competition. What is the barrier to entry? What does your company do that builds a barrier to competition? What is unique about Propel?

It's unique in many ways. One is it's clearly the market leader and it's one that has sort of branched in a couple different directions. It's got one set of offices that have storefronts that address populations, maybe more face to face interaction. It's got a direct marketing arm. Now they have five years worth of history. This isn't just something you come in and just start sending letters around to people. I think getting access to capital is challenging as well. We think the history that they have, the fact that they've been able to build multiple distribution channels for the product, the fact that they've been dedicated to thinking about it in analytical lens and then our access to capital is what's going to keep it from having a lot of people come in. There are competitors in the space. There are more than a handful but Propel has just driven a better model and that's why we approached them late last year. We felt like they were the best in class and we'd be able to really take advantage of it.

And then we have a follow up from the line of David Scharf with JMP Securities. Please go ahead.

Two things, one on the purchasing side. Obviously, we heard about the Q3 reduction as you front end loaded so much buying with these large acquisitions. I don't know if you purposefully omitted Q4 but should we see a return to normalcy by the end of the year or do we kind of consider this to be sort of 2012's budget pretty much nailed down by June?

As Paul alluded to we'll give more distinct guidance but we expect the majority of the pause could be through the third quarter and then a higher level of purchasing in the fourth quarter. We'll try to give you more specific detail in June.

Okay that's actually helpful. And then just a couple follow-ons, on the tax lien, I heard you mention no losses. Is there, it's a super secured lien. Is there actually a foreclosure element to this type of product that you have to outsource? I'm still kind of a little bit at a loss to grasp the concept of zero percent losses on these assets.

It starts with positive selection from the consumer. Again, the consumer opts in so you are able to segment the whole universe of people to those who positively select in versus not. Ultimately, if it's not paid by the consumer the next likely target to pay it is the first mortgage holder who oftentimes, the vast majority of times will pay off the delinquent tax liens and roll it into their obligation. In about 1% of the cases there is a foreclosure element to it.

It's less than half of a percent of foreclosure instance.

And we have a follow up question from the line of Hugh Miller with Sidoti. Please go ahead.

Actually, you guys delved into the questions I had about the competitive environment and the differentiations between Propel and other companies. Just I guess two quick follow ups, one, you talked about how the penetration rate in Texas is extremely low at this point but is it still somewhat competitive that everyone is kind of chasing after the same pool group of assets, consumers to do business with?

And the other question is just you talked about expansion into other states as a possibility. Would that be done via an acquisition of another firm or do you feel as though the knowledge that Propel has here could then be used organically to grow into other states?

The first question, the universe of people that you can market this product to is finite. It's published by the state and so you do have, each group deciding of that population who they're willing to target based on their risk tolerance. We think we're able to broaden that universe given our consumer level analytics.

And then we think a lot of it is education and the marketing angle and that's what we're going to focus on but we think that there is a finite number. We can't create an [increment] of people. Our job is going to be to figure out how to partner with the team down here to penetrate that 80% that's not being penetrated.

In terms of our growth strategy we think about the team down here as being the team we will use to drive into other geographies. It doesn't mean we won't add industry expertise or geographic expertise but our platform will be the Propel platform.

And our next question is a follow up from the line of Mark Hughes with SunTrust. Please go ahead.

The company has been in business for five years. Is there any potential for some kind of tail risk? Are there still some early loans that are still on the books that haven't been repaid? Again, that zero loss number is a very good number. Is there some reason to think that the decent life but not too long of a life of the company might not reflect some additional risk?

We believe the answer, we believe is no and part of the reason why and we haven't talked about it thus far, we hope to get into many of these details in the June 6 meeting but appreciate the questions. The LTV of many of these loans, you want to think about it that way, is underwriting is about 5% so you're talking about just a dramatic difference between the value of the property and the actual lien amount and so even the older vintages we think are the most valuable ones because those are the consumers who have been paying for five years so in the sense that when you get late in the tail you're talking about who is the most committed? You're probably most at risk early on when somebody takes on the transfer but ultimately doesn't start paying right out of the gate. We don't believe there is any tail risk.

Thank you. This concludes the Q&A portion of today's conference call. Thank you for your participation in the Encore Capital Group first quarter 2012 earnings conference call. This does conclude the program and you may now disconnect. Thank you and have a wonderful day.