Taking Stock of a Rising Agency

  There's a new gunslinger in Collections Town. This one is fast on its feet, a savvy buyer of promising debt portfolios, and quick to recover. The challenge for this rising winner is to compete with much larger firms. That means keeping an eye on the long-term payoff and avoiding pressure to take risky positions for a possible short-term gain.
  Last November, Norfolk, Va.-based Portfolio Recovery Associates made a splash in the debt-recovery business through an initial public offering of stock at $13 a share. Though there are an estimated 6,000 collection agencies in the U.S., most are small and the collections business remains primarily privately owned.
  Portfolio Recovery is a full-service provider of outsourced receivables management, servicing debt through the delinquency cycle. The firm buys debt portfolios from issuers and collects for its own account. Portfolio Recovery also acts as a third-party collector, collecting debt on a fee basis for issuers.
  Clients include 11 of the top 13 bank credit card issuers and four of the top five store card issuers. More than 90% of PRA's receivables come from card portfolios. In the debt-recovery industry, bank cards account for about 60% of purchased debt revenues. Portfolio Recovery declines to name its clients.
   The company should be credited for bucking the trend and going public at a time when the IPO market has been weak, says Michael Ginsberg, president and chief executive of Kaulkin, Ginsberg Co. In early January, PRA's shares were trading in the $20 to $21 range-more than 50% above the IPO price.
  Ginsberg also credits Portfolio Recovery for raising capital to better compete when seeking to buy debt portfolios.
  "They've positioned themselves very wisely," says Ginsberg, whose Bethesda, Md.-based firm consults on mergers and acquisitions in the collections industry.
  Portfolio Recovery is competing with two other industry heavyweights, both for debt portfolios and for investor dollars. Outsourcing Solutions Inc. and NCO Group both dwarf PRA in revenues. NCO is publicly traded while privately held OSI releases revenue numbers because some of its debt is publicly held.
  In 2001, NCO's revenues reached $701.5 million, while OSI reported $612.3 million. Portfolio Recovery's revenues for 2001 were $32.3 million and $40.1 million for the first nine months of 2002.
  Growth has been impressive. Revenues jumped from $6.8 million in 1998 to $19.3 million in 2000, an almost 200% increase. And earnings have followed suit. Pro forma net income grew from $130,000 in 1997 to $3.5 million in 2001. Through the first nine months of 2002, earnings reached $8 million.
  One of the advantages of being smaller is that growth will be all the more impressive, something watchful investors should notice, says analyst William A. Warmington Jr., director, SunTrust Robinson Humphrey in Boston. There are other pluses.
  "Debt recovery is a very fragmented market," Warmington says. "There's a lot of opportunity for a niche player. Firms with less than $50 million annual revenue are more nimble. (They) can cherry pick the best portfolios." Warmington is the creator of the Settlement-In-Full Index, which tracks segments of the debt industry. He doesn't cover Portfolio Recovery.
  Though the firm may be newly listed on the Nasdaq National market-its ticker symbol is PRAA-it's not fair to call the company new. It has been in business since March 1996 and its owners are experienced in managing an agency that specializes in credit card debt.
  Four of the top seven executives worked in collections-related divisions at Household Financial Corp., a part of 125-year-old Household International Inc. Household, which claims managed assets of $101 billion, serves middle-market consumers. Household Credit Services Inc. is the 10th-largest card issuer in the U.S., with about 16.8 million cards, according to Thomson Media's 2003 Card Industry Directory. Major programs include the GM Card. Its private-label card programs include Best Buy and CompUSA. (Last November Household agreed to be taken over by HSBC Holdings Plc, Europe's largest bank, for about $14 billion in an all-stock deal.)
  Expertise and Power
  Portfolio Recovery's Steven D. Fredrickson, president, chief executive and chairman of the board, says he wanted to combine the expertise and financial power wielded by larger institutions like Household with the agility found at a smaller agency. "We were seeking to create an independent debt-buying firm that was not part of a major institution but had that look and feel," Fredrickson says. "We want to be well-capitalized and professionally run like a debt buyer at a major firm."
   That concept caught Wall Street's eye. Portfolio Recovery sold 3.9 million shares and raised $50.7 million during its IPO on Nov. 8. The company walked away with $41.4 million after fulfilling its agreements with its underwriters-William Blair & Co. LLC of Chicago and U.S. Bancorp Piper Jaffray of Minneapolis-and PRA Investments LLC, a long-time investor that owned 430,000 of the shares that were sold.
  Portfolio Recovery used most of its gains to pay off a $29 million loan carrying an average interest rate of 6.37% from Westside Funding Corp., a subsidiary of the German bank WestLB.
  Another $1.9 million will be spent developing a new 21,000 square foot call center in Hampton, Va., with 250 to 300 seats. Plans call for it to be operating by the third quarter. The remaining $9.5 million will be used to buy debt portfolios and for the possible acquisition of complementary businesses.
  The IPO income gives Portfolio Recovery the strength to build its presence in the industry, according to Ginsberg. "They have a war chest of capital to draw down when investment opportunities arise-whether it buys another company or a (debt) portfolio," he says.
  Much of Portfolio Recovery's stock is still privately held. New York City-based investment house Angelo, Gordon & Co., which manages $9 billion, holds 62.7% of the company. Portfolio Recovery's officers and directors own 18.9%.
  Timing may be on PRA's side as 2003 is shaping up as another good year for collection agencies, according to Stanley A. Myers, principal of Card Analytics Consulting in San Mateo, Calif.
  "The volume that agencies saw in 2002 was enormous and there will be a further uptick in 2003," Myers says. "There should be more work and higher volume of debt."
  The continuing supply of paper or debt to collect is indicated by the credit loss rate, which will be in the range of 6.5% of receivables this year, says Myers. To calculate the rate, Myers tracks the top 15 credit card issuers and finds the non-weighted average of accounts written off after 180 days. He predicts that will be about 4.25% to 4.4% this year. To that he adds bankruptcy filers which he estimates will be about 2.25%.
  Timing is on the side of many in the debt business as more consumers have trouble paying their bills. The market in consumer debt rose from $73 billion in 1990 to $135 billion in 2000, according to an August 2001 report from Kaulkin, Ginsberg. The U.S. debt-collection market generated about $13 billion in revenue.
  That growth has the industry, and professional investors, plowing money into the business. Last August, Horsham, Pa.-based NCO and its subsidiary NCO Portfolio Management Inc. paid $33.5 million for Great Lakes Collection Bureau Inc. As part of the deal, NCO signed a multi-year agreement to provide services for Great Lakes owner GE Capital Corp. And Boston-based Parthenon Capital LLC invested $45 million in Niles, Ill.-based Arrow Financial Services.
  Besides allowing firms to buy more debt, the investments demonstrate the maturing of the debt-receivables arena, says Ginsberg. "The industry is taking hold. It is attracting the investment community's interest."
  Portfolio Recovery's entry into the public markets allows Average Joes another way to invest in the debt industry. And the money it raised allows it to be a little more competitive in purchasing portfolios.
  Fredrickson says that plays to his firm's strength in portfolio pricing. Through last June, it had purchased 292 portfolios with a face value of $4.2 billion for $116 million, or a 2.8% rate. The purchased accounts have ranged from $3 million to $200 million in value.
  Portfolio Recovery's goal is to collect at a rate of 2.5 to 3 times its cost of a debt over five years, a figure common for the industry, says Dennis Hammond, executive director of the Debt Buyers Association.
  In round numbers, a typical goal for a debt buyer is to pay 10 cents on the dollar for a portfolio, then recover 30 cents on each dollar in the portfolio, he says. The return is split up three ways-10 cents for the debt, 10 cents for overhead, and 10 cents for profit, says Hammond.
  Portfolio Recovery's focus is almost entirely on credit card collections with 91% of its finance receivables last June made up of card debt. Receivables on Visa, MasterCard and Discover Card accounts made up $32.1 million or 63% of its $51 million portfolio. Another $14.2 million, or 28% of finance receivables, were private-label credit card accounts. The remainder was consumer finance debt.
  Fredrickson says the company is considering expanding into other forms of debt like auto finance, health care and long-distance telephone. But if card debt provides the best return, then it will stick with cards. "We won't diversify just for the sake of diversification. We focus on profitability of the paper," says Fredrickson.
  Portfolio Recovery emphasizes the quality of its collectors which make up about 500 of the firm's 598 employees. It holds an open house seeking employees four times a month at its Norfolk headquarters.
  About 90% of PRA's new collectors have no collections experience so they go through a six-week training program, with three weeks in the classroom and three weeks on-floor where they make supervised calls.
  The annual salary range for new collectors is $19,000 to $25,000, Fredrickson says. Top collectors can make between $40,000 and $50,000, according to Piper Jaffray. Turnover of collectors at the company is 34%, lower than the 42% found in agencies that specialize in bank card and private-label card collections, according to a survey in November from Kaulkin, Ginsberg ("Collections Agencies: On the Rebound?" Card Watch, January).
  Fredrickson says several employee perks have led to lower turnover. "We offer a flexible schedule. We have an on-site fitness facility. We don't share seats. Everyone has their own area."
  The firm gives kudos to the high number of active-duty military personnel near Norfolk. Military spouses and retirees make great collectors, according to Portfolio Recovery.
  Just over half of PRA's collectors have more than 12 months experience. These comparative old-timers are 90% more productive than collectors with less experience, according to the company.
  Possible Pitfall
  The firm's in-house computer system allows collectors to call up and view all the scanned documents from a consumer's account. Depending on their experience, a collector may have anywhere from 650 to 1,000 accounts in queue on PRA's computers.
  In March 2001, Portfolio Recovery introduced Anchor Receivables Management, a new unit offering clients collections on a commission fee basis. Through 2001, Anchor posted a net loss of $644,000 due to normal costs associated with a start-up, says Fredrickson.
  That may be turning around. Portfolio Recovery doesn't break out revenue numbers for the unit but Anchor generated $1.3 million in commissions through the first nine months of 2002, compared to $54,000 in the same period in 2001, according to Fredrickson. As of last September, about 10% of Portfolio Recovery's collectors were working for Anchor, which counted 11 clients.
  Going public has a possible pitfall. Impatient shareholders may pressure management to grow quickly through rushed debt purchases, says Louise Epstein, president of the Charge-Off Clearinghouse in Austin, Texas. The Clearinghouse buys and resells large packages of bad debt.
  "The challenge in debt purchasing is finding the right portfolio," Epstein says. "There is a finite amount of high-quality bad debt."
  The situation can be likened to a surfer waiting to catch the right wave, she says. There's no end to the waves available, just as there is an over-supply of debt. But the champion surfers know the best wave to ride, she says.
  Danger
  Ginsberg concurs that there is a danger to overspending after a sudden capital infusion. But keep in mind that PRA's managers are an experienced group, he says. "This company is smart and well-established. They know how to stay the course," Ginsberg says. "Good management sees through 'Let's grow quickly.'"
  Another potential danger is focusing too closely on one client. More than 10% of Portfolio Recovery's 2002 revenues came from one major retail credit originator. Fredrickson wouldn't name the firm. Instead he emphasizes that his firm has worked with more than 30 of the top debt originators. They could replace any drop in volume if one large client were lost.
  Like others in the receivables management industry, Portfolio Recovery could be affected by two macroeconomic events this year-an economic recovery and bankruptcy reform. Fredrickson downplays both.
  True, a recovery could mean less consumer debt to buy, he says. At the same time, it usually means people have more money to pay their debt.
  Bankruptcy law reform, which federal lawmakers have worked on for about six years, could arise again this year. Fredrickson says previous proposals would have pushed more debtors into filing for bankruptcy under Chapter 13, where they are required to repay more of their debts. That benefits collectors.
  Even with those challenges, this appears to be a good time to be in the debt receivables business. After the flurry of attention generated by its IPO, it seems to be business as usual at low-key Portfolio Recovery. "We maintain a low profile, stick to our knitting," says Fredrickson. "We hope sellers enjoy doing business with us and the results we provide."