Encore Capital Group Inc (ECPG) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Encore Capital Group's third-quarter 2016 earnings conference.

(Operator Instructions)

As a reminder, this conference is being recorded. Now I would like to welcome your host for today's conference, Mr. Bruce Thomas. Please go ahead.

Thank you, operator. Good afternoon, and welcome to Encore Capital Group's third-quarter 2016 earnings call. With me on the call today are Ken Vecchione, our President and Chief Executive Officer; Jonathan Clark, Executive Vice President and Chief Financial Officer; Ashish Masih, President of our Midland Credit Management business; and Paul Grinberg, Group Executive, International and Corporate Development. Ken and Jon will make prepared remarks today, and then we'll be happy to take your questions.

Before we begin, we have a few housekeeping items. Unless otherwise noted, all comparisons made on this conference call will be between the third quarter of 2016 and the third quarter of 2015.

Today's discussion will include forward-looking statements subject to risks and uncertainties. Actual results could differ materially from these forward-looking statements. Please refer to our SEC filings for a detailed discussion of potential risks and uncertainties.

During this call we will use rounding and abbreviations for the sake of brevity. We will also be discussing non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are included in our earnings presentation, which was filed on Form 8-K earlier today.

As a reminder, this conference call will also be made available for replay on the Investor 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 Ken Vecchione, our President and Chief Executive Officer.

Thanks, Bruce, and good afternoon, everyone. In the third quarter Encore enjoyed another solid quarter of capital deployment in an increasingly favorable domestic environment. We believe we are seeing a turn in our industry cycle in which pricing and supply are improving. In addition, our consumer-centric liquidation programs are contributing to better returns.

Our financial results for the quarter are clouded by non-cash charges associated with our thorough review of all of our European pool groups. Unlike typical allowances, which are driven by reduced expectations of collections, our revised collection curves resulting from our review are forecasting more expected collections, but the timing of the collections is delayed due to factors I will describe in a moment. It is important that we provide a clear picture of the events that led up to the charges and why we are confident that we've resolve the issues with the actions we took in Q3.

In addition to covering the highlights from our business in the third quarter, some investors and analysts have also asked us to discuss and outline the new proposed rules of the CFPB, and we have a bit more detail to add on that topic. So, let me start with the domestic business.

The US market for charged-off receivables is becoming an increasingly attractive market for us and continues to show signs of improvement. Supply in the US is on track to rise 15% in 2016, accompanied by meaningful declines in price from last year.

Our consumer-centric liquidation improvement programs continue to improve our collections performance, while simultaneously increasing consumer satisfaction. Newly committed forward flows are being booked at higher returns for 2017 than they were for 2016, a continuation of the trend we have been seeing for approximately the last 12 months.

Encores is well positioned in this market, as we judiciously deploy capital along with other debt -- large debt purchasers. Our liquidation improvement programs are generating strong results and our strategic cost management initiatives continue to lower our cost to collect. All of these actions contribute to the rise in the current and future returns.

Incremental capital is being deployed at higher money multiples and higher IRRs for the last few years. IRRs for our 2016 vintage are nearly 40% higher than in 2015. As capital allocators, nearly 90% of Encore shareholder capital is designated for deployment in the US market, excluding our subsidiaries, Cabot and Baycorp, which are self-funding.

Our expectations for the coming domestic cycle are different than for prior cycles. Capital inflows by opportunistic outside participants are limited by the regulatory environment, the need for substantial compliance investments, and the absence of sophisticated operating platforms. We believe investments in compliance and operations have ensured that the moat that protects our business continues to get wider and deeper.

In the domestic market, issuers have now caught up with our documentation requests to support our legal collection efforts. We do not see this as a problem going forward, and indeed the improved documentation is enhancing our legal collections.

Although we have encountered delays in both collection and expenses, we are beginning to ramp back up to a more typical collection run rate, and expect to be fully ramped as we enter 2017. Legal collections delayed in 2016 will be shifted to 2017, with no material impact to revenue.

Strategic cost management initiatives implemented at the beginning of this year have produced very strong results, as operating expenses declined by $23 million in Q3 and $53 million year to date. Of these totals, we reduced expenses due to documentation delays by $5 million in Q3, and $8 million year to date. Some of these expenses will be shifted into next year as we ramp up legal collection efforts in 2017. Higher deployments in the US market, combined with our continued focus on expense reduction should result in lower cost to collect over time.

The rising consumer receivables to pre-2008 recessionary levels should support the current pricing and supply environment. In addition to improved pricing in the US market, several recent indicators of credit growth lead us to conclude that supply is poised to increase further.

Consumers are increasingly taking on higher debt load is one item. We heard from several large CEOs who are including in their earnings commentary that delinquencies are expected to rise, followed by charge-offs and higher recoveries, including debt sales, which will help mitigate the rise in charge-off rates. Outstandings have grown to pre-recession levels. Average household credit card debt has also grown to pre-recession levels.

The improved returns we're seeing from our US business will take some time to offset the lower returns from portfolios purchased in 2014 and 2015. Consequently, their full impact will not be realized immediately; however, as we approach this crossover point, we will continue to aggressively invest in the improving US market and to opportunistically deploy capital at attractive returns in other regions.

Let's turn our attention to Cabot now. The largest of our international businesses is Cabot Credit Management, headquartered in the United Kingdom, with a long history of solid collection performance in over 1400 unique portfolios among their assets. Cabot has become the largest debt buyer in Europe, with a sizable advantage in estimated remaining collections over their next largest competitor.

Cabot continues to build upon its leading market positions in the UK and Ireland, and has expanded into businesses in Spain, France and Portugal. These markets offer attractive returns on capital deployment.

Cabot buys and services secured and unsecured debt. They also continue to expand the capabilities of their servicing and BPO businesses. Cabot's long collection curve is driven by a high concentration of payment plans and low affordable payment amounts provide steady collections and long-term sustainable revenue streams.

In October Cabot redeemed it's GBP265 million senior secured notes, due 2019, and replaced them with a new GBP350 million senior secured offering, due 2023, with a reduced coupon. In addition, Cabot increased the size of its revolving credit facility from GBP200 million to GBP250 million and extended its maturity at a reduced interest margin. After these actions, Cabot's liquidity stood at approximately GBP250 million, reinforcing our expectation that Cabot has the appropriate liquidity and capital to continue its growth.

Before we turn our attention to the European allowance charge, I would like to take a moment to touch upon our accounting practices. Since 2008 Encore has consistently applied a prudent approach to revenue recognition.

Over this period of time, Encore has not taken any portfolio allowance charges for portfolios purchased after 2008, other than the single charge related to the CFPB consent order. Because of our approach, it will take a fairly unusual event, such as a significant regulatory change, or an isolated issue related to a single portfolio to trigger a material allowance charge.

Given our long history of consistently applying this approach to our purchases, we have strong confidence in our reported ERC. During our last earnings call we announced that Encore and Cabot teams are undertaking a thorough examination of our European pool groups. After completing this exhaustive study and calculating revised curves, based upon our analysis we have recorded a gross consolidated allowance charge of $94 million, of which $37 million represents Encore's share after taxes.

The allowance charge was the result of two factors. First, on certain pool groups, we had increased our expectations and raised IRRs under US GAAP based upon collections overperformance and expected uplift from operational initiatives. Second, these uplifts were delayed and tempered, primarily due to revised regulatory requirements and operational initiatives, which did not fully materialize.

The size of this allowance charge was driven mainly by the largest pool group in Encore's European (inaudible), the Cabot Acquisition Pool Group. This pool group is approximately 10 times larger than a more typical pool for Cabot, and contains all the historical Cabot pool groups from pre-2002 up through 2013, when we acquired Cabot.

The ERC associated with our 2013 European Vintage, which contains this pool group, is more than $900 million. In reforecasting these pool groups, we have revisited our expectations going forward to a methodical analysis, and now have full confidence that we have comprehensively concluded the review of all of our European pool groups.

Unlike more typical allowances, the charges we have taken today are largely the result of delayed collections, not reduced collections. And, in fact, we expect to collect more from these pools over time. We now expect to generate greater collections in a more consumer-friendly fashion, but have incurred an allowance charge due to the timing of these collections.

Regulatory changes in recent years drove changes in business practices, which Cabot incorporated into their collection practices over time. The cumulative impact of revised regulatory expectations eventually offset some of the upside we were anticipating in the near term, ultimately delaying, but increasing collections over time. In the face of these influences, planned liquidation initiatives were not as effective in generating near-term collections as we had predicted.

Pursuant to Cabot's policy under IFRS, Cabot's ERC as reported is a rolling snapshot of expected collections over the next 10 years. Pursuant to Encore's policy under US GAAP, Encore's ERC as reported was derived from a static ten-year window, with its beginning fixed at the time of purchase for international portfolios.

Beginning in Q3 2016, Encore lent in Cabot's ERC, as calculated under US GAAP, to 15 years, in order to reflect the longer duration of these curves and better capture the total collections expected over time. We believe this change will improve the accuracy of the ERC by accounting for years 11 through 15, which now comprise a meaningful portion of the total expected collections.

Both accounting policies have as its starting point, forecasts that originate at Cabot. Based upon our ownership share and applying the appropriate UK tax rate, the reduction in the basis resulting from the portfolio allowance charge reduced quarterly earnings in the third quarter by approximately $0.11 per share after tax.

In connection with our review of all European pool groups, we also undertook a thorough review of Cabot's deferred court costs, which represent the portion of incurred costs we expect to recover through litigation. This review caused us to re-examine the timing and estimate of Cabot court cost recoveries. The cumulative impact of regulatory changes also had a negative impact on our recoveries from litigation efforts.

When combined with changes in the types of assets were litigating, we reduced our expectation for recovering court costs. As a result, we made an $11 million adjustment to Cabot's deferred court costs. After accounting for non-controlling interest, the non-cash deferred court cost adjustment for Encore was $4 million after tax.

Before I hand the call over to Jon, I would like to remind everyone that we are entering one of the last phases of the CFPB's formal rule-making process. When we spoke about this a quarter ago we acknowledged that the new rules were going to create a level playing field for participants in the US market, that the outline of proposed rules aligns well with Encore's current practices, and that we were pleased that many of the proposed rules were consistent with our own recommendations or current practices. Because of this alignment, we believe we are well positioned and, in fact, far ahead of others in the industry as these new rules are rolled out.

The substantial investments of time and resources we have made over the last several years have developed our compliance pedigree and given us a competitive advantage. I'd like to add that we continue to have thoughtful dialogue with the CFPB on several areas of the proposed new rules where we suspect that a small subset of the current proposals may lead to unintended consequences for consumers.

We continue to cooperate with the CFPB in this way, and are providing statistical support to the issuers we believe that have the most -- to have the most important -- I'm sorry, excuse me -- statistical support to the issuers we believe to be the most important to the industry as we navigate our way to expected new rule implementation sometime in 2018. Once these rules are finalized, we can measure their intended and unintended impact on the consumer and on our US business. At this time, I will turn it over to Jon, who will go through the financial results in more detail.

Thank you, Ken. Before I go into our financial results in detail, I would like to remind you that as required by US GAAP, we are showing 100% of the results for Cabot, Grove, Refinancia and Baycorp in our financial statements. Where indicated, we will adjust the numbers to account for noncontrolling interest.

The non-cash portfolio allowance and the adjustment of our deferred court costs reduced Encore's revenue by $94 million and increased operating expenses by $11 million in the third quarter. GAAP net income and EPS declined $41 million and $1.57, respectively, while ERC rose $296 million. Due to the timing of collections, an allowance charges is warranted when future collections are discounted at current monthly IRRs, even though the total ERC increased.

Turning to Encore's results in the third quarter, Encore incurred a GAAP loss from continuing operations of approximately $1.5 million, or $0.06 per share, with the results heavily impacted by the $41 million non-cash allowance charge in the quarter. Adjusted income was approximately $3.6 million, or $0.14 per share.

Deployment totalled $206 million in the third quarter. In the United States the majority of our $142 million of deployments represented charged-off credit card paper, over 80% of which was comprised of fresh accounts. And, as Ken mentioned earlier, excluding self-funding subsidiaries, nearing 90% of Encore's shareholder capital deployed in Q3 was invested in the US market, reflecting our commitment to capturing the improving returns available in the United States.

US year-to-date purchases and commitments now total over $530 million for 2016. With pricing having peaked in 2015, projected returns from our 2016 deployments continue to exceed those from last year.

European deployments for Cabot and Grove totaled $43 million during the third quarter, with the majority attributed to portfolio purchases in the UK and Spain. We deployed $22 million in other geographies in the third quarter, including purchases in Australia and, to a lesser extent, Latin America.

Worldwide collections declined 4% to $407 million in the third quarter. In constant currency terms, collections grew 1% in the quarter.

Our collections this quarter represent the most geographically diversified stream of collections in the Company's history. Encore's international collections received benefit in the year-over-year comparison from the addition of Baycorp, our subsidiary in Australia and New Zealand.

In the third quarter we generated $245 million of adjusted EBITDA, a decrease of the 7% compared to the third quarter of 2015, primarily due to the $11 million adjustment we made to our deferred court costs. In constant currency terms, adjusted EBITDA decreased 2%.

On a trailing 12-month basis, we generated adjusted EBITDA of $1.057 billion, which was up 2% compared to the same period a year ago. Revenue in the quarter was $179 million, net of the $94 million portfolio allowance charge.

Domestic revenues were down 2% compared to the same quarter a year ago, as we continue to see the impact of higher multiple portfolios rolling off our books. International revenues, outside of Europe, grew compared to the third quarter last year, due to Encore's addition of Baycorp in Q4 of 2015.

We recorded $3 million of domestic net portfolio allowance reversals in Q3. In the third quarter we increased domestic yields, primarily in the 2012 and 2013 Vintages, as a result of sustained overperformance by pools within those Vintages.

In the third quarter Encore generated $38 million of zero-based revenue compared to $29 million in the same period a year ago. Encore's prudent accounting approach can generate zero-basis revenues. Zero basis revenues are highly predictable and provide Encore with a valuable long-term collection stream.

Turning to cost to collect. Excluding acquisition-related and other costs, our overall cost to collect in the third quarter was 41.1% compared to 39.2% in the same quarter a year ago.

This increase of 190 basis points year over year reflects the impact of the adjustment to Cabot's deferred court costs and was partially offset by improved cost to collect in the United States, which benefited from our strategic cost management program. Without the adjustment to Cabot's court cost reserve, our European cost to collect would have been approximately 31%, and our overall cost to collect would have been approximately 38.3%. We expect our European cost to collect to return to its normal run rate, closer to 30% in Q4.

Our estimated remaining collections, or ERC, at the end of the third quarter was $5.7 billion, an increase of 1% compared to the end of September a year ago. In constant currency terms, our ERC grew 9% on a year-over-year basis.

It is important to understand that Encore and Cabot account for ERC differently. In accordance with US GAAP principles, Encore's ERC represents our best estimate of future collections. And as Ken mentioned, we are now migrating to a 180-month ERC for Cabot pool groups, beginning at the time of acquisition.

Cabot's ERC is reported as revised for each pool group each quarter. Cabot adjusts ERC based on collections for the most recently completed quarter, either up or down, and it is done in a formulaic basis.

Unlike Encore, Cabot's ERC is based on a 120-month window -- a rolling 120-month window. Because of these differences and because Encore's European Vintages and Cabot's Vintages are constructed from different combinations of pool groups, Encore's ERC is not directly comparable to Cabot's ERC for any given Vintage.

Additionally, all collection curves and forecasts for Cabot's pool group originate at Cabot. The projected ERC always starts with Cabot and Cabot management. Importantly, we believe the reported ERC in both Encore's and Cabot's financial disclosures, though different, is correctly represented, given each company's respective accounting policy.

In the third quarter we recorded a GAAP net loss from continuing operations of $0.06 per share, which resulted largely from a European allowance charge, partially offset by a tax adjustment. In reconciling our GAAP net loss to our adjusted net loss, adjustments included $0.15 related to acquisition integration and restructuring costs, $0.12 related to the non-cash interest and issuance costs associated with our convertible notes, $0.10 related to settlement fees and related administrative expenses, followed by $0.02 for the amortization of certain acquired intangible assets related to our contingency collections business.

After applying the income tax effect of the adjustments and adjusting for noncontrolling interest, we end up with $0.14 per fully diluted share, and our non-GAAP economic EPS was also $0.14. Because our shares traded at an average price below the initial conversion price of our convertible debt during the quarter, we did not exclude any shares from our calculation of our economic EPS.

I would like to mention here an important point about our tax provisions for the third and fourth quarters, which are explained in more detail in the income tax footnote in our Form 10-Q. The large disparity in tax rates between the US and Europe normally reduces our effective tax rate, but because of the Q3 loss centered in European operations this quarter, it instead increased our effective tax rate. Since the effective tax rate expected for the year will also be much higher due to the same factors, our tax expense for the fourth quarter is expected to be approximately $10 million higher than our normalized rate.

Our consolidated debt-to-equity ratio in the third quarter was 4.56 times. Considering this ratio without Cabot, our debt-to-equity ratio is 2.18 times, which is less than half of the consolidated ratio. It is important to remember that we fully consolidate Cabot's debt on our balance sheet because we have a 43% economic interest in Cabot, and we control their Board.

Nonetheless, Cabot's debt has no recourse to Encore. Constantly, Encore is far less leveraged than a quick review of our financials would indicate. Available capacity under Encore's revolving credit facilities, subject to borrowing base and applicable debt covenants, was $188 million as of yesterday, not including the $195 million additional capacity provided by the facility's accordion feature.

With that, I would like to turn it back over to Ken.

Thanks, Jon. To summarize, the US market for charged-off receivables continues to be favorable, with a few remaining qualified large debt buyers. Pricing leverage is shifting from sellers to buyers and we believe, based upon year-to-date performance, we are approaching a positive turn in the market. We expect [inter-debt sales] to continue at these lower prices.

Add to this increasing supply and the benefits we're seeing from our consumer-centric liquidation program, and it is clear that returns are rising for the US -- for us in the US. The Encore team is also driving improved returns by reducing costs through our emphasis on cost-management initiatives around our global operations.

With a comprehensive review of our European pool groups, we are highly confident in our ERC and the accounting curves that support them. We continue to be focused on improving shareholder value by judiciously deploying capital, improving liquidity and managing our costs.

At this time, operator, we are happy to take some questions.

Thank you.

(Operator Instructions)

David Scharf, JMP Securities.

Good afternoon. Thanks for taking my call. Maybe two things. One, just focusing on your commentary on the US market, Ken.

Yes.

Just curious, a topic that came up earlier in the week regarding one of your competitors was the concept of changes to some of the rules regarding consumers disputing claims and some of the documentation that has to be produced for that. They had commented that it both elongates the recovery process and in some cases, it may impair the value. Are you seeing an impact from any of the changed rules regarding disputes?

I'm going to toss that over to Ashish, who is sitting here, who runs that operation. Go ahead, Ashish.

Okay. Thanks, Ken. It is a good question. It did come up earlier.

It will help to just step back and let me give a little context and give a comprehensive picture on what the change was in the rules and what's happening. As you can imagine, due to the nature of a collections business, there are always some consumers who will dispute the debt, including in our call centers when they speak to our account managers.

Now through training, we have been able to ensure that consumers truly understand the origin of their debt and not dispute it. We have found dispute volumes in our call centers very much in control since the consent order went into effect earlier this year.

Now that said, there are some consumers who still feel the need to dispute, and we have a process -- we have always had a process, actually -- to pause collections temporarily while we investigate the dispute reasons. And this temporary pause is not a new process for us. We have always had this.

What is new -- to your question -- is that since the consent order, when consumers dispute, we are now required to send the documentation to the consumer. What we have found is over the last several months, about half our disputed accounts, or cases, we have the documentation ready and we are able to respond to the consumer within two or three days, in a very timely manner, and put the account back into collections. So there is no delay.

For the remainder, we are able to go back to the issuers and sellers, and in majority of cases, obtain the documentation. It takes a month or two. But for the majority, we are able to do that. Now, just keep in mind, for more recent purchases and for all future purchases, we receive full documentation on all accounts in a portfolio, so over time, this minor issue will become even smaller over time.

And in terms of collections impact, we have actually not seen any negative impact of these disputes on our collections. We also have staffed up well in advance of the March deadline -- implementation deadline that we had, so our current expenses also fully reflect on that staffing, as well. Hope that answers the question in a somewhat comprehensive way.

Yes. No, that does. It is very helpful. Maybe I'll just finish up with some questions on the allowance. I know others are probably going to have some, as well.

A couple things. First of all, in terms of this concept of a 15-year life, or average collection lifetime, how much of the increase in ERC just sequentially was related to your purchase activity, less collections, in the quarter versus adding five more years to the life of these European assets?

Try that question again, David, for me.

I am trying to understand -- my understanding is that you raise -- that some of the increase in your ERC is related to increasing the life -- the collection life of those Cabot assets to 15 years. Did I hear that correctly?

Correct. We shifted out a year and pushed more into years 2011 through 2015.

Right. So what I was trying to understand is, when I look at how your ERC improved from Q2 to Q3, how much of that was related to your purchasing activity in the quarter versus how much of it was related to lengthening the life of those existing assets to 15 years?

The improvement, when we went through the study on the European pool groups, added $300 million in the longer term, so $296 million, thereabouts, $300 million was added. You don't fully see it recognized in the total ERC because of the exchange rates, but if you would have normalized for exchange rates, you would've seen our ERC be about $6.1 billion and change. And that is where you would've seen the total ERC rise. But the exchange rates tempered some of the rise that we saw when we did our study on the European pool groups.

Got it. And Ken, was the $94 million, was that entirely on the 2013 Vintage at Cabot?

No. Basically, three Vintages -- 2013, 2014 and there was just a little bit in 2015. Most of it is in 2013.

Yes. The vast majority. (multiple speakers)

David, I'm sorry -- David, I was going to say, about $76 million in 2013, $13 million in the 2014 Vintage, and under $5 million for the 2015 Vintage.

I apologize because I don't have the Q in front of me. But the unamortized balances -- of those three Vintages combined, what percent of a breakdown is this, in effect, the $94 million?

About 10%.

10%.

A little less than 10%. Yes.

Okay. Am I calculating -- just trying to get a feel -- the $37 million, which is your 46% after-tax impact. If I just -- that's an after-tax.

If I just divided that by your share count -- I'm trying to get a sense for how to think about run rate, quarterly run rate earnings. Is there a way X the allowance charge after tax? Is a way to think of it as at $14 million adjusted EPS plus?

Yes, David. In the slide deck we have, it is on page 11. But the quick answer for you, is it is $0.11 per share for the allowance charge going forward.

Got it. Okay, thank you.

Okay.

Mark Hughes, SunTrust

Thank you. Just to make sure I understand your last point -- the earnings in the quarter, if we take your $0.14 economic EPS, do we simply add back if we wanted to do this adjusted for the allowance charge? Do we just add back the $37 million divided by the number of shares? Is that -- ?

There are a few different add-backs I would direct you to. But first is the add-back of about $1.52 for the allowance charge. I would add back about $0.16 for the deferred or cost receivable reserve adjustment.

$0.09 for different compensation issues that related to this charge, and then the tax impact was about $0.40. When you reverse engineer it, which is where you were going, had we not had the allowance charge, our earnings would have been about $1.33. Not about -- our earnings would have been $1.33.

Okay. On a go-forward basis, would that $1.33 be reduced by the $0.11, or is that already incorporated in the $1.33?

No, it would be reduced by the $0.11.

That would be -- $1.22 would be the run rate.

Yes I am throwing an extra $0.01 for the core costs receivable adjustment, so it is about $0.12 EPS going forward.

Right, okay. $0.11, and you would add another $0.01 of headwind, so to speak, for the court cost adjustment, is that what you're saying?

Yes, that is correct.

Okay. You had given a number of 40% increase in IRR. Was your comparison period 2015 to 2017?

No. The comparison period is 2015 to 2016. So 2016, on average, our IRRs were lifted -- are being lifted by 40%. And what you're seeing -- I'll just add a touch more color on that -- but what you're seeing is a combination of three things actually coming together.

Really, there are three general levers you can pull to improve IRRs -- liquidation programs. Since the beginning of 2014, we have been talking about how we're on this journey to improve our first year liquidation by 50%. That was a very large, audacious number, and we continue to track against that goal, which we should hopefully accomplish by the middle of 2017.

One, we've controlled some of our liquidation improvement by the programs we put in place. Two, we've worked on our cost structure, which you have heard us talk about and you see that our CTC has also declined.

And then the third, which we don't necessarily have full control of, but you can see the marketplace is responding to higher supply. But the debt purchaser, certainly the large ones, are distributing or using their capital in a more judicious way, which is forcing pricing to come down, because people are being disciplined.

I think those three things together for us have led to this increase year over year in IRRs. What I am also saying, is based upon our forward flow as we sit here today going into 2017, the 2017 returns will be higher at this moment than the 2016 that we are booking.

Mark, when Ken refers to the 40% improvement, he is referring to new investments, obviously, flows that were entered into in 2015 that continue into 2016 at the same return. The new investments, though, are 40% higher.

Okay. And then your point about your projections is that the projections start with Cabot. Are your projections now the same as Cabot, other than you're using different pools and maybe different periods, but are they -- the underlying projections essentially the same?

I would say that everything starts with the same collection assumptions, and they all are generated by the Cabot management team. Because Encore and Cabot operate under two different accounting policies, they produce two different estimated remaining collection expectations, okay?

One, Cabot just uses a 120-month rolling ERC projection. Encore, as we just told you, uses a 15-year fixed time period.

Encore looks forward and relies on judgmental approach when forecasting estimated remaining collections. Cabot uses a formulaic accounting approach, whereby whatever the improvement in current performance is for that quarter, they extrapolate that to their ERC. So, if performance was better by 2%, they would extrapolate that all the way out, so total ERC would be better by 2%.

So, yes, we both start with the same assumptions, but the accounting policies and the approaches to the accounting get us to two different numbers. That's why it's very possible -- not possible -- that is why we, as we increased our -- we being Encore -- as we increased our expectations, we are now taking an allowance charge against an increased expectation, while Cabot is achieving their expectations, because they did not have to put in those estimated judgmental improvements to the operating initiatives that I alluded to before. Does that make sense to you?

It did. I was thinking it would be great to see a written down, maybe the accounting language, one versus another. It is a complicated topic and probably hard to absorb it at one setting. I think I understand the general idea, but I could certainly use some additional detail, if that were possible. And we can do that off-line, certainly.

We will get you an example. An example would work best.

Yes, that would be appreciated. One final question. The legal collections impact, you had suggested you have had some impact from that that you're getting back up to full speed now. Can you speculate as to what that might have been, say in the third quarter, what headwind from legal related to the new processes?

I will phrase it this way -- I think all in, we are moving about $40 million of collections out of 2016 into 2017 that we'll pick up in round numbers, okay? But as I said, it won't impact our revenue recognition.

And that would have been $40 million over the Q2, Q3 and Q4?

Yes, primarily. Yes.

Okay, thank you.

Robert Dodd, Raymond James & Associates, Inc.

Hi, guys. Just want to clarify, on the allowance charge in Europe and, obviously, the UK -- the regulatory mention that you made in related to that -- does that relate to the process with the FCA in getting certified over there, or is there still something separate going on on that front?

The result is the cumulative effect of a lot of regulatory changes that have taken place over the last few years, as Ken described in his prepared remarks. Those -- we increased the expectations from certain operational initiatives that we had, and over time, the impact of the regulatory initiatives resulted in those initiatives -- the collections from those initiatives getting delayed over a longer period of time, which resulted in the extension of the curve of the ERC coming in at a later point in time.

It was not specifically a one point in time approval of the FCA; it was a cumulative impact of a lot of different changes over the course of time, primarily in the UK.

Right Got it. Then just on the competitive front. Obviously, the US seemingly much improved with IRRs up substantially. You are talking about forward flow agreements also coming in.

Are you seeing a greater and greater reliance on forward flow? Obviously, we certainly saw that from 2015 to 2016 in terms of you coming into the beginning of this year with a lot more volume locked up in forward flow already. Do you expect that to continue shifting? Is that going to be a continuing trend, given the consolidation in the US, obviously, as we go forward and have even greater visibility in earnings as you get into -- as you lock up these longer-term deals?

A lot of that is driven by the issuers, and a lot of that is driven by their own level of defaulted debt charge-offs and how they want to manage their earnings. We have a fair amount that comes through forward flows. We've got a fair amount that some issuers, just want to get debt sold in bulk sales on a particular quarter.

We are happy to accommodate both. We stand at the ready to accommodate both. Right now, obviously, what we have going into 2017 is all forward flow-related, but we see a mix of both the forward flows and the bulk deals.

Got it. One last one, if I can. A fairly obvious question -- in the UK, and you may have mentioned it, but I have missed it, if you did. Have you seen any shift in the competitive landscape and the IRRs that you're getting in the UK markets?

Yes. In the UK I'd say UK is looking a little bit like the US was about 18 months ago, still elevated pricing returns are down a touch. There are some competitors that we clearly don't understand their pricing.

So we at Cabot, we've shifted to trying to do smaller, off-market deals in the UK to circumvent large, competitive pricing transactions. And that's why we have also moved into Spain, France and Portugal, where we see returns in excess of those in the UK. We look at our credit facility that Jon alluded to over there allows us to go seamlessly between the countries.

We're just reallocating capital away from the UK into Spain, Ireland, I should say as well, France, Portugal -- France and Portugal, period. We will wait for the UK to come a little bit back to more reasonable returns or more reasonable pricing.

Our approach in Cabot is the same as in Encore, which is if we can't usually figure out how to make it work, there is one thing if we lose a deal by 5 or 10 basis points, but we've lost some deals by hundreds of basis points, and we can see how those deals work. And over time, it's our projection that those buyers will have to pay the price for paying such a high price in buying the debt.

Okay. Appreciate it. Thank you.

Michael Kaye, Citigroup

Hi. Thanks for taking my questions. Pricing -- in the US, pricing supply is clearly improving. But I just wanted to get your thoughts -- if pricing continues to improve like it is now, is there any risk that some issuers could pull back from selling, maybe perhaps off to keep some more and just use third-party agencies instead of selling to third-party debt buyers?

I think that's a well-thought-out question. And we wrestled with that, as well, but I will tell you where I think the market's going. The proposed CFPB rules, which has in there contacting consumers six times a week. We believe that agencies will not be able to figure out that puzzle. We are well on our way to figuring it out, and I think our decision science support is world-class.

So if the larger issuers are going to move money over to the agencies, I don't think the agencies are going to fulfill their expectations -- that's one. Number two, the issuers are attached to this earnings stream. So they may be getting a little less than what they previously got as the high, but they do like those returns -- I'm sorry, the sales -- because they do lower the charge-off rates as their recovery rates go up.

I don't think they're going to be able to move. And what I'm saying here is really, this is a different story here as we talk about there's capital that is being deployed in a constructive way by the debt purchaser.

But the other story is capacity. And we do not believe that some of the larger issuers have the ability to ramp up their capacity. We don't believe that the agencies can ramp up their capacity in a way that will be effective, given where the new proposed CFPB rules wind up.

Even if those new rules go from six times a week to a greater number, we still don't think that they're going to be as effective. And I think that's why we're comfortable that debt sales will continue to occur at the pace that they have been occurring at.

Our significant returns are driven by our improvements to our liquidation. So it's not just pricing that's driving our returns; a material part of the return is driven by all of the effort we've had in improving how we collect in a consumer friendly manner

Paul makes a very good point here. Let me just say that to date, the majority of our returns are more our liquidation programs, when they have been in price reductions. So as price reductions continue with a higher set of liquidation expectations, our returns should rise overall.

Okay. That's a great answer. I really appreciate that.

I just want to talk a little bit about any of your capital here. I know you have (inaudible) in some convertible notes that's due next November. I just wanted to understand your plan with that. Do you plan to refinance that? Do you plan to be able to just pay it off somehow?

Yes, it's a good question. We've -- it is12 months off. We have given this a lot of thought.

We have a number of alternatives available to us. You can either do something in the convert market or other markets to generate cash. I think we have a number of alternatives, and we're just going to select the one at the end of the day that is the most cost-effective. But I don't lose a whole lot of sleep over that one.

It sounds like the supply environments are doing much better and you're very well positioned. But how do you feel -- let's say the large issuers come back, hypothetically, and (inaudible) supply continues to improve, do you have enough capital to really take advantage of these opportunities?

Sure. We've got -- today, in the US we've got almost $190 million of availability, right? That's just standing still, not exercising an accordion. And then internationally, we've got now GBP250 million, so we've got plenty of liquidity.

That $190 million, could you actually -- is that really available for you to pull now, or is that subject to conditions? Is that real -- ?

Technically, subject to conditions, but the way we define it here is, can I write a check for that today? And the answer is yes.

Okay, perfect. That's it. I really appreciate the answers. Thank you.

Bob Napoli, William Blair & Company.

Any thoughts on the election and what that might mean for your business and the CFPB and regulations and things like that?

Yes. I think the Trump presidency is not 24 hours yet, but at least the news -- that's 24 hours old. But I would say, in a general sense, his stance on taxes are favorable for us. That's one.

He has said that he wants to see less regulation, so for every rule that is written, he wants two rules to be removed. That would be favorable for us. I think you know there has been regulation out there for the CFPB anyway to move from a director model to a panel of four or five, like the SEC, so that's out there.

Also, for having the Congress also control more of their capital expenditures, their budget. All those things are, in general, favorable for us. And we will let him meet Obama on Thursday and we will go from there, Bob.

Okay. Thanks. Thank you for commenting. I thought you might not. (laughter)

Bob, okay.

Let's see, the pricing discipline question was a good one. I was going to -- so you have not seen any other banks pull out of selling? One of the concerns always -- the big -- there are several banks that have not been selling. You haven't seen any new banks that have stopped selling, that have been consistent sellers?

No. Those that have been selling have been consistent. There's always the mix-and-match approach. Some tend to favor more bulk. Some tend to favor more forward flows. They take a position on where pricing is.

If you thought pricing was going to continue to rise, you may be more forward flow-oriented. If you think pricing is going to go down, you may want to do bulk sales in order to lock it in. They come up with their own -- whatever equation works for them. And we work either way, very comfortably, whether it be forward flow or bulk sale.

Okay and then --.

But we do -- I'm sorry -- I want to say -- regardless of which one it is, we do have higher return expectations, and we are pricing to our higher return expectations. I think the issuers are now, after the last couple of months, fully digesting that and see that as a trend, not as a one-off event.

Did they possibly hold back some volume to see if that was a one-off event, and then you're seeing more flow in the fourth quarter, or -- ?

Hard to say. I can't -- really hard to say. But we've done -- we've deployed -- either deployed or have committed to deploy, a fair amount of money this year, very consistent with prior years. I will say, they match our return expectations. So we're happy that we are deploying money at higher return levels.

Okay.

We don't go for the deployment at any return.

My last question, just on the legal collections and the regulatory changes. And I missed part of the call. Was there a change over the last -- it seems like your collections from legal and your competitors' collections from legal took a -- declined by a faster rate in this quarter and the last quarter.

And now you're suggesting that you're going to get caught up. And I just -- was there something that changed just over the last quarter or two, or is it just that you are -- and how confident are you of that $40 million? Why are you so confident you are going to get that -- those missed collections back?

We are going to break this up. First, I am very confident. And now Ashish is going to tell you why I am very confident. (laughter)

Okay.

Yes, Bob. There was a change. And the change was in the consent orders for us and for our competitor back effective in March.

And the change was the requirement for certain documents to always be attached and included. in the suit process -- in the litigation process. Previously, in some states he required; others you didn't require it in the beginning. You could need it later on.

So when that requirement came for all the accounts in the inventory and backlog, we needed a huge number of documents, which always we would always get. But we just needed them quickly from the issuers. And issuers had to re-engineer their processes and figure out a way to get us the documents, and that took a few months.

They have now completely caught up, and they are giving us -- have given us all the documents for these backlogged accounts. So we are ramping up the litigation process, and that's why we are very confident that the collections will catch up, and so will expenses catch up in next year, as well.

Now going forward, anything new we buy, issuers give us full documentation, as I said earlier, for the purchases at the time of the sale. So there is no waiting, there is no delay, and we have full documentation available to pursue any kind of collection activity, any channel collection activity we would want to.

Great. Are you seeing that already in the fourth quarter?

Yes. In fourth quarter, our legal collections and suit process or litigation process will ramp up, and so will expenses and collections.

Great. Thank you very much. Thank you.

You're welcome. Thanks.

Hugh Miller, Macquarie Research.

Hello. Thank you for taking my questions. One on the follow-up on the core cost. Did you say that operating expenses in the third quarter benefited from about $5 million worth of a push-out of legal costs, legal placements in the quarter, and that that should, obviously, then ramp up in ensuing quarters?

Yes. That is correct.

Okay. I guess we should think about that in terms of the run rate analysis that you guys did on the breakout. That should likely then be considered, as well. That was not considered in the breakout of the analysis that you guys provided.

No. You are right.

Okay. Thank you. That is helpful. The other -- we certainly appreciate some of the color you gave on the UK market and the differences in the bidding on the returns. Would you say that the irrational type of pricing that you are seeing from time to time, is that really solely in the UK markets?

Well, remember, we are predominantly -- Cabot is predominately in the UK. We entered into Spain and just entered into Portugal, and same thing with France. So, my color is predominately about the UK. Spain, there just seems to be more attractive pricing, and we see more volume coming up, both in unsecured and SME debt.

Got it. I'll ask a question on that in a second. But would you say then that given the improvements in liquidation rights you are seeing in the US and some of the improvement in pricing, would you say that you are now, as you head into 2017, buying to better returns in the US relative to the UK?

Yes. I would say that.

Okay.

I would add, we are not only buying to better returns, but I think our cost programs are also kicking in, too, as we go forward, and that is going to help.

Sure. And that would be included in your expectations for net returns, one of the drivers. Yes.

And then, obviously, we've seen some of your peers in Europe talking about very strong supplies coming to market in the fourth quarter in various jurisdictions, but Spain, in particular, being one of those areas. Can you provide any insight into -- as you think about supply coming from the direct issuers versus maybe some of the financial buyers that are exiting the market, how much of an opportunity is there in the resale market to be coming to market, aside from just the general direct market?

We are seeing portfolios offered from issuers and from resellers. All I will say is we look at both and we value them appropriately. We have -- at least in Spain -- you've got two sources of supply, which is good.

In the UK, for example, there aren't many resellers that are coming up. It is not like back in the US a couple of years ago, where you could buy directly from issuers, and you could buy some of the resellers, as well.

Okay. That is helpful. Thank you.

Operator, I think we have time for about one more call -- one more answer or question.

Mark Hughes, SunTrust Robinson Humphrey.

Thank you. The cost of legal collections was actually 14% of total collections in the quarter, which is higher end of recent range. You were lower in the second quarter and low in the first quarter, but compared to the third quarter, it seems like you were at fairly full run rate in the historical terms. Is that $5 million -- will you be layering on legal expenses, so you'll be above the recent trend on a go-forward basis?

Yes. I think if you are looking at the consolidated statements, you will have Cabot in there, as well. What you don't see is the Midland -- . In the Q -- .

We break out the cost to collect for the legal channel for the quarter and for the nine months separately, so you will see in that, it is much lower for the third quarter for the cost of legal collections for that channel as a percent of that channel's collections. All numbers -- European numbers are also a part of them.

Okay. Got it. And then the tax item, Jonathan, you had suggested another $10 million in higher taxes. Is that to say we would take whatever our assumptions for taxes would be, add $10 million, which is roughly $0.40 per share, and that is what the impact ought to be? So an extra $0.40 from -- add to that related to these items?

Right. You're right. It's basically, what you expect, and then you add $10 million.

Just so people understand, it's just with the loss we took, right, as I explained earlier, it cuts both ways. We lost money in a low tax rate jurisdiction. It pushes up your effective tax rate for the year.

If you look at three months ending September 30, it looks like a very low tax rate. And that's because we have already paid -- we've already accrued taxes in period one and two, so you get to period three, you are just effectively truing up to get to where you need to get to, right? You just had incurred a big loss, so you end up having a -- what I will call a somewhat understated number.

But fourth, if you look at the nine-month number, Mark, you will see that's 53% for the last nine months. And you're going to have a tax rate for the year of something in the mid to high 50s.

And then the tax rate for next year on the run rate basis?

It will be, call it mid to low 30s.

Mid to low 30s. Okay. All right. Thank you very much.

Okay. Thank you all for joining us today, and we look forward to spending more time with you on our Q4 earnings call. Thanks again, everyone.

Ladies and gentlemen, this concludes our program for today. You may all disconnect. Have a wonderful evening.