Mon 11/20/2023 11:34 AM
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Credit Research: Wayne Jambawo, Jason Iheuko

Relevant Documents:
Intrum Justitia OM
Lowell GFKL OM
Encore Capital OM

Intrum Justitia’s Capital Markets Day 2023

In case you didn’t hear, the golden age of nonperforming loans, or NPLs, is over, and the silver and bronze ages have passed too. Debt collectors had grown in prominence and entered the high-yield universe in the aftermath of the 2008 global financial crisis as banks rapidly offloaded NPLs, often at steep discounts, to improve asset quality. As a result, NPL ratios reduced to 1.8% in 2023 from 7.5% in 2014 in Europe, well below the European Banking Authority’s, or EBA’s, 5% guidance - the trigger limit at which banks need to develop NPL-reduction strategies. The fall in NPL ratios across Europe to below this 5% limit has reduced the need for banks to offload NPLs at steep discounts, while higher interest rates have pushed up funding costs, raising concerns over the debt collector business model.

The Covid-19 pandemic was expected to be a mini blast from the past and result in a new surge of defaulted loans but robust lending standards and solid support from central governments scuppered the prospect of a large supply of NPLs flooding the market again.

Across the pond NPL ratios remain near record lows in the U.S., despite inflationary pressure and significantly higher interest rates. But in spite of the similar NPL landscape in the U.S., we can see that pricing for NPLs in the U.S. is holding up compared with Europe.

Aside from the tighter supply, investors and debt purchasers are also concerned about the cost of funding in a higher rate environment versus the internal rate of return, or IRR, of the existing back books of NPLs. The image below shows the spread between Intrum’s IRR and cost of funds at the end of 2021 compared with the third quarter of 2023, which decreased by a full turn.

Source: Intrum Q4’21 presentation page 18 & Q3’23 presentation page 19

According to some market participants, although macro conditions remain challenging, the tight regulation imposed upon banks just doesn’t favor the pricing of NPLs, however, others commented that it may just be a matter of waiting the situation out until pricing improves again.

Year-to-date 2023 primary activity for debt collectors, which we have summarized below, remained challenging with funding costs on the rise and was not aligned with the rebound experienced in the wider primary market in the first half of the year.
  • iQera, arguably the most successful of those that have come to market in 2023, managed to sneak in a liability management exercise at the beginning of the year, tendering its outstanding notes and exchanging the bulk of the issue for €500 million of new notes due 2027. Of the €570 million that was originally outstanding, €133 million remained after the settlement of the transaction.
  • Intrum issued 1.1 billion Swedish kronor ($102.7 million) two-year senior unsecured floating rate notes with a STIBOR+800 bps coupon and SEK 400 million two-year senior unsecured fixed notes at 11.875%. The remaining shortfall for the SEK 2.9 billion notes due 2023, was paid using the group's liquidity.
  • Axactor managed to raise a four-year senior unsecured FRN of 2.3 billion Norwegian kroner ($214 million) paying three-month NIBOR +8.25%, of which NOK 750 million was subscribed to by the largest shareholder, Geveran Trading Co. Ltd., ultimately owned by John Fredriksen. This was used to refinance the €200 million bond due 2024.
  • Encore Capital managed to price a small €100 million tap of its existing 2028 notes at 99.01, the proceeds were used to refinance RCF borrowings.
We expect a choppy road for those issuers that will still have to refinance, such as Lowell. Summing up the debt maturities of issuers listed in the chart below, we estimate a maturity wall of €1.1 billion in 2024 and €3.5 billion both in 2025 and 2026. Where new debt of these issuers will price will have implications for peers.

In this piece we give an overview of the different business models of debt collectors, changing dynamics in NPL markets and the likely implications on different credit managers. We explain some of the complex accounting behind the sector, given a regulatory update in Europe ahead of year-end changes. We also provide a ratings summary of the issuers that we will discuss in our Sector Review Part II.
Key Takeaways
  • Supply of NPLs has decreased due to improved bank lending standards post the global financial crisis. Combined with low NPL ratios, banks have no immediate need to sell these loans, and they can keep them on their books for longer or sell them for higher prices than historically. This means that debt purchasers are spending more for less, constraining their profitability and cash generation.
  • Debt purchasing in the U.S. is starting to look more attractive than in Europe from a pricing and regulatory perspective. Since the start of the year, NPL supply has increased as lending levels have surpassed pre-pandemic levels and delinquency rates have increased leading to lenders selling increasingly fresher portfolios.
  • There has been a noticeable uptick in Stage 2 loans in Europe, according to the EBA, though weak macroeconomic conditions, which may lead to an influx of Stage 3 loans, seem to be absent. Companies that are adapting their business model, moving away from the capital intensive debt purchasing and toward servicing business and integrated asset management, will be well placed in the current macro environment.
  • The increase in Stage 2 loans suggests potential future NPL supply. Issuers anticipate better pricing and increased NPL supply amid worsening macro conditions.
  • Higher cost of funding will meaningfully increase hurdle rates for debt purchasers in a low NPL pricing environment. For example, Intrum’s spread between its funding cost and unlevered IRR has decreased to 2.9x compared with 3.9x at the end of 2021.
  • Uncertainty around the NPL Directive in Europe may have a long-term impact on profitability and on cost clawback mechanisms for European players. The directive aimed at protecting consumers could affect statute of limitations, preventing extensions on debt recoveries or extending periods of nonpayment for consumers, lowering collections in the short term or reducing the overall amount that could be collected.
Credit Managers Driven by the Same Fundamentals Operate Different Business Models

Debt is created when a debt originator extends credit to a person, or a legal entity, who in turn becomes a customer. Essentially, financial institutions extend loans or trade sector companies (including telecommunications and utilities companies) issue invoices for services rendered. When a debtor does not repay the debt according to the terms on which it was extended, the debt becomes overdue, and is then considered nonperforming. Overdue debt is either collected by the originator itself or by a credit management company.

The debt lifecycle includes several services to clients throughout the cycle as shown below. Debt collectors operate across the invoice servicing for performing credit, debt collection surveillance and recovery stages.

Source: Intrum OM PDF page 119

Broadly, the credit management services, or CMS, industry can be divided into servicing of third-party debt, information providers and debt collection of owned portfolios:

Debt servicers collect on behalf of a third party, usually the debt originator. Servicers generally receive a fee related either to the face value of the debt portfolios they manage or the collections generated, depending on the nature of the managed portfolio. This service is also used by performing credit originators. The contracts are often multi-year and with base fees and and other variable fees based on milestones or KPIs.

The reasons for outsourcing nonperforming and performing debt collection as a service can vary. Mainly it is done for cost efficiency for the original lenders as many originators may not be specialists in recovering nonperforming exposure and do not have the infrastructure, economies of scale and experience compared with the service providers.

The terms and fees structure of servicing agreements are dependent on whether the loan is performing, the type of loan, security and whether the debtor is a business or a consumer.

NPL service agreements: Debt servicing agreements for outsourced NPLs typically have a defined minimum term with automatic renewal and at least a three-month termination notice by either party. Some contracts are for a fixed value of NPLs or for a fixed period of time without any renewal.

Service agreements for NPLs can take a wide variety of forms with specific guidelines regarding reporting obligations, thresholds for debt forgiveness and guidelines regarding incurrence of costs.

Performing debt service agreements: Debt servicing agreements for performing debt typically have a stated term in line with the remaining life of the portfolio but can be terminated with an advance notice. Performing debt servicing agreements typically include either a flat fee per month and/or per loan, which varies depending upon the size, duration and nature of the debt, or a variable fee based on assets under management, which also varies depending upon the size, duration and nature of the claims.

Service agreements tend to have customary confidentiality, compliance and data privacy clauses, as well as a service level agreement and an audit clause that permits the bank to monitor the quality of the provider’s services. Typically, these agreements also limit the financial responsibility for the servicer.

Within the servicing side there are also other credit-related services such as:

Invoicing: The clients outsource their accounts receivable process, including collection activity. This is a particularly reliable and cost-efficient solution for clients with high invoicing volumes.

Payment: This enables retailers and other consumer companies to make a real-time credit decision at the time of purchase, and gives them the ability to offer customers payment through invoice or a part-payment solution. The CMS company manages the entire credit process, from scoring and credit decision to processing and distributing invoices.

Information Services: This typically includes credit analysis, data extraction and modeling, as well as selection and scoring of potential customers. These solutions help clients mitigate potential losses from new customers with reliable and efficient information.

Debt purchasers acquire overdue debt from originators through either one-off transactions, which entail buying a portfolio of claims that are received in one transaction upon payment, or forward flow agreements, where debt claims are sold at a predefined price or price range and for a given volume or volumes from a client on an ongoing basis or specified period of time.

Selling overdue debt helps debt originators increase their liquidity, strengthen their balance sheets, release resources to focus on early-stage delinquencies and reduce operational risks, reporting requirements and regulatory demands. How overdue debt is sold is dependent on the debt originators' needs and balance sheet strategy.

Purchasing debt is capital intensive as the NPL is purchased in its entirety. For a debt collector to maintain its size, it needs to invest a minimum sum that generates returns equal to what has been collected over any period to keep the Estimated Remaining Collections, or ERCs, the same.

Summary of Operating Models
  • Third-party servicing only: Collection and servicing of portfolios on behalf of a third-party, typically, a fund, a bank or a utility company, without any direct investment in the underlying loan portfolio. Dovalue is the only pure servicer we discuss in this piece.
  • Debt purchasing and collection: Direct investment in or acquisition of an underlying portfolio from a third-party debt originator and collection and servicing of acquired portfolios for the debt purchaser’s benefit. PRA Group is the only pure debt purchaser we discuss in this piece.
  • Hybrid debt purchasing, collection and third-party servicing: A hybrid combination of debt purchasing and collection whereby a debt purchaser acquires, collects and services portfolios for its own benefit but also provides its expert debt collection and servicing capabilities to third-parties creating a more diversified and stable business model. This business model allows purchasers the opportunity to acquire portfolios that they have already worked on, and are therefore familiar with, making it easier to price, reducing the risk of a competitive bidding scenario. Intrum, Lowell, Axactor and iQera are the predominant issuers who operate this business model. However for Lowell, Encore, Kruk and DDM Debt third party servicing revenues are less than 20% of their total group revenues.
  • Fund management: Direct investment in or acquisition of an underlying portfolio on behalf of other investors. Fund managers typically employ the services of one of the above operators to collect and service the portfolios they have acquired and earn management and performance fees from their investors.
  • Integrated asset manager: Integrated asset manager operating in the European NPL market that combines debt purchasing, debt servicing and fund management, where the three business models are complementary, fully integrated and able to maximize the synergistic benefits across their revenue channels and cost base. Arrow Global operates under this business model.

Regardless of whether the debt is serviced on behalf of the original lender or purchased, the composition, the supply and its dynamics remain broadly the same.

The type of debt sold can vary but the main types of debt sold are NPLs, phone and utility bills, retail debt and to a lesser extent real estate debt.

Nonperforming Loans

The bread and butter of the credit management business is NPLs, which can consist of business loans, loans to small and medium-sized enterprises, or SMEs, personal loans, overdrafts, credit card debt and auto loans amongst other lines of bank credit. It is a loan on which the borrower has stopped making regular interest and principal payments or has fallen significantly behind on payments. NPL portfolios are purchased from banks at a discount or serviced on their behalf by third parties, usually financial institutions through their servicing operations.

How overdue debt is sold is dependent on the debt originators' needs and balance sheet strategy. In the immediate aftermath of the financial crisis there was a pressing need for financial institutions to quickly de-lever balance sheets, and therefore NPL sales took the form of larger one-off transactions. Over the past 15 years as banks have de-levered their balance sheets and regulators imposed tougher lending standards, the ratio of delinquent or nonperforming loans have decreased from the 2008 highs.
The U.S. Remains the Most Mature Market, Followed by the U.K. and Scandinavia

The U.S. is the largest and most mature market globally for consumer debt. Growth in consumer credit has been a critical driver in the overall expansion of the debt recovery sector. Following the financial crisis of 2008, the industry saw increased regulatory oversight of purchase and collections practices.

Regulatory supervision from the Consumer Financial Protection Bureau, or CFPB, temporarily impacted the supply of charged-off consumer debt as a couple of large established sellers exited the market. New supply declined slightly as stricter underwriting standards tapered growth in revolving consumer credit outstandings and led to a decline in net charge-off rates. From 2016 to 2019, the debt collection market in the U.S. experienced sizable annual growth, driven by higher levels of consumer debt and stabilizing charge-off rates, according to Encore Capital’s management.

The debt recovery sector in the U.K. is considered the second most mature market. The sector has expanded rapidly since its inception in the late 1990s, fueled by the increased outsourcing and sale of defaulted consumer debt in the financial services sector.

The credit management sector in the U.K. eventually came under increased scrutiny from regulators, primarily as a result of the high levels of consumer indebtedness, which ultimately led to debt collection activity falling under the purview of the Financial Conduct Authority, or FCA, in 2014. The sale of “fresher” debt led to larger deal sizes, which was a key factor in driving industry consolidation, with the larger more established players able to access new sources of funding and also benefiting from economies of scale.

Since the start of the Covid-19 pandemic, the U.K. debt recovery sector experienced a slowdown as the level of consumer credit and charge-offs are yet to recover to pre-pandemic levels. However, credit card lending has begun to rebound and the U.K. market for debt purchasing is expected to continue to recover, albeit at a slower rate compared to the U.S. market, which has already surpassed pre-Covid levels.

After the U.K., the Scandinavian region is considered the third largest.

An overview of the maturity of markets across Europe and the U.S. is below:

Source: Lowell 2020 OM PDF page 160

An overview of the cumulative debt purchased by various institutions in Europe since 2015 is below:

Source: Intrum capital markets day presentation PDF page 81
NPL Ratios Have Reached Record Lows in Europe, While the US Has Seen an Uptick Post Covid-19


Currently the EBA guidance limit for NPL ratios is 5%, in order for a bank’s balance sheet to remain resilient, before it is recommended that banks should develop an NPL reduction strategy. As shown below European banks are currently well below the guidance limit at approximately 1.8%. As the NPL ratio has come down, the money on money multiple (see below for further discussion) has followed the same trend highlighting the reduced discount at which NPLs are sold at as regulatory pressure has eased.

In Europe it is important to highlight the different classifications of loans on a bank's balance sheet. Loans are classified in three stages: i) Stage 1 loans are performing loans with little to nearly nil expected credit risk, ii) Stage 2 loans are considered underperforming loans that carry a significant credit risk compared with Stage 1 loans; iii) Stage 3 or NPLs are considered credit impaired or have taken credit losses.

Source: ECB supervisory banking statistics on significant institutions for the first quarter of 2023

NPL stock on banks balance sheet in Europe

Source: Intrum OM PDF page 121

Supply has dwindled due to significant improvement in bank lending standards, prompted by regulatory changes in response to the global financial crisis. With improved NPL ratios coupled with better economic conditions, banks have less urgency to sell NPLs, resulting in reduced volumes, discounts and write-downs. This is evident in the reduction in the reported gross money on multiples, which have decreased to around 2.0x in 2023 from over 3.0x pre 2010. (See the Key Performance Indicators section below).

While there has been a contraction in Stage 3 loans, an increase in Stage 2 loans indicates that rising supply of newer NPLs could be expected further down the pipeline. Many issuers have stated that they expect worsening macro conditions to lead to better pricing and an increased supply of NPLs.


In the U.S., supply has followed a similar trend in Europe. Overall commercial loan balances have increased by over $1 trillion since the global financial crisis.

Source:Board of Governors of the Federal Reserve System (US), Consumer Loans: Other Consumer Loans: Automobile Loans, All Commercial Banks [CARACBW027SBOG], retrieved from FRED, Federal Reserve Bank of St. Louis;, Nov. 12, 2023

But delinquency rates have contracted to just under half of what they were since the financial crisis.

Source:Board of Governors of the Federal Reserve System (US), Delinquency Rate on Consumer Loans, All Commercial Banks [DRCLACBS], retrieved from FRED, Federal Reserve Bank of St. Louis;, Nov. 12, 2023

Looking at total consumer debt, nonhousing debt in the U.S. has more than doubled in the last 20 or so years and has increased by over $2 trillion from $2.65 trillion after the financial crisis, according to data from the New York Fed. This data includes auto loans and credit card debt, which reached $1 trillion for the first time in U.S. history.

Source: Household and Credit Report Q3, 2023

Like the U.S., European delinquency rates have also trended down across both the commercial and consumer sectors. Whilst the volumes will still be there, the key issues facing debt collectors is that there is less pressure on the lenders to offload the NPLs.

Source: ECB supervisory banking statistics on significant institutions for the first quarter of 2023

Typically the debt collectors discussed within this article focus on unsecured consumer debt, with a smaller focus on SMEs, opportunistic focus on large corporate and secured debt. Arrow Global, also known as Sherwood Financing, is the exception with an almost 50:50 split on the secured and unsecured debt.

However, consumer loan borrowers’ current ability to pay is far better than previous periods.

On the other hand, in the U.S. we can see that debt service as a percentage of income is coming under pressure, but the U.S. household debt to income ratios remain well below their record highs during the financial crisis.

Source: Board of Governors of the Federal Reserve System (US), Household Debt Service Payments as a Percent of Disposable Personal Income [TDSP], retrieved from FRED, Federal Reserve Bank of St. Louis;, November 12, 2023.

In our view, debt service payments as a percentage of disposable income is expected to increase in the U.S. as interest rates rise and wages lag behind inflation.

In the U.K. the household debt to income ratio excluding student debt remains considerably below levels reached during the global financial crisis.

Source: Bank of England Financial Stability Report July 2023 page 30

Similar to the U.S., Reorg expects the debt service payments as a percentage of disposable income to increase in the U.K., which will likely have an impact on the credit quality of performing and underperforming loans.

This could also affect the impaired loans, which issuers service/own, leading to a reprofiling of the collection profile. It is partially mitigated by the average monthly payment being low, with Arrow Global and Lowell reporting average monthly payments of £13 and £18 respectively for the full year of 2022.

Source: Bank of England Financial Stability Report July 2023 page 29

Tying this back to the earlier Stage 2 loan data, this data underpins a strong pipeline of Stage 2 loans, however, in Reorg’s view, the trigger to cause a large tip of these Stage 2 loans into Stage 3 is not apparent.

As many debt collectors now operate along all stages of the credit value chain, worsening economic conditions not translating into impaired loans may not be an issue for issuers with exposure to both nonperforming and performing loans.

Source: Slide 25 of Intrum’s Capital Market Day presentation

Credit managers have mentioned that they expect the current macro environment to lead to an increase in NPLs, citing increased Stage 2 NPLs as a good indicator. Our opposing view is that almost record high employment levels on both sides of the Atlantic will likely prevent a massive uptick in stage 3 loans. See data below.

The unemployment rate evolution in the U.S. is below:

Source: US Bureau of Labour statistics civilian unemployment rate

The unemployment rate evolution in the EU is below:

Source: Eurostat indicators August 2023

And the unemployment rate evolution in the U.K. is below:

Source: Labour market overview, UK: October 2023

In summary, we anticipate a buildup of Stage 2 loans, which will need to be serviced but the conditions for loans to transition to Stage 3 do not yet exist.

And in any case with NPL ratios at around 1.8%, a significant uptick in the ratio would be required to hit the 5% trigger limit for banks to change their NPL strategy. Given the already tight pricing environment, the issuers focused solely on purchasing debt with their own money, particularly in the more mature markets will struggle in the interim, although we expect they will still generate cash.

In Reorg's view the value proposition will lie in the Stage 2 loans, which banks are not selling as heavily. The business models that operate along the full value chain, exposed to Stage 1, Stage 2 and Stage 3 loans may stand to benefit as there will be a larger number of loans with borrowers struggling to pay, but not in default. A larger proportion of Stage 2 loans will require greater attention from the banks driving greater need for outsourcing these services to specialists. However, we should note that banks have significantly improved their in-house servicing capabilities for forborne loans since the financial crisis.

For this reason, we think European issuers with a degree of servicing operations and strong relationships with banks will be better placed going forward. On the other hand, as many existing issuers aim to reduce their respective portfolio investments, the diminished demand could result in better-priced NPL portfolios for the remaining purchasers in the market.

Whilst delinquency rates have trended down in the U.S., it is important to note that post-Covid there has been a noticeable uptick in delinquency rates.

Additionally some market participants say they think that higher interest rates have not yet fully impacted consumers due to a time lag stemming from: fixed rate terms of mortgages, high level of savings in wealthy economies, social safety nets and cultural tendencies to make good on mortgage payments. If the current macro conditions persist, it may create conditions for a noticeable influx of Stage 3 loans, they added.

Other Receivables

Telecommunications and Utilities. Led by mobile phone companies, telecommunication firms have increasingly looked to debt sales to recover unpaid bills. Debt sales in this sector mostly comprise balances outstanding on unpaid mobile phone bills or mobile phone contracts set up to provide a discount on a mobile device that were terminated prior to their agreed maturity. Typically, telecom loan portfolios have lower balances than debt in other sectors and are sold at the primary and secondary stages. Similar attributes apply to a broad range of utilities.

In the U.S. the supply or the balance of utility bills in arrears has been rising sharply, according to the National Energy Assistance Directors Association as of March 31, 2023. Residential utility arrears reached $19.5 billion compared with $17.8 billion at the end of 2022 and $15.7 billion a year ago.

In the U.K. the cost-of-living crisis has been markedly worse than the rest of Europe, and whilst energy prices have come down from the record highs seen in the first year of the Ukraine invasion, there is still an expectation that the average consumer may struggle with this aspect amidst generally high inflation impacting other consumer cost items and the negative impact of higher mortgage payments as a result of higher base rates.

Retail. Charge-offs resulting from short-term credit offered by catalog, phone or online shopping companies as part of their sales growth strategy are generally sold at an early stage, usually before being placed with a debt collection agency and thus often resulting in higher value debt portfolios.

Real Estate. Real estate assets range from a variety of sources, including mortgages, physical real estate, real estate-backed assets and partially completed development projects. In Reorg's view these may be considered the least favorable receivables as the cash flow associated with real estate is often lumpy and the recoverable amounts subject to valuations heavily influenced by external factors - noticeably valuations in the sector are under pressure.

Government. Assets acquired through the rescue/nationalization of banks in the U.K. (managed by UK Asset Resolution) and Ireland (managed by The National Asset Management Agency) as a result of the global financial crises and ongoing stresses of the 2007-2008 global financial crisis continue to be unwound through auction processes.

Litigation-Related Bankruptcy & Distress. Assets acquired through court and bankruptcy proceedings (such as through the Italian concordato procedure).
Changing Regulatory Landscape in Europe Could Impact the Ability to Collect

Credit management providers are subject to various laws and regulations in the jurisdictions in which they operate. The credit management industry is highly influenced by legislation, judicial rulings and regulatory decisions and oversight. Credit management companies additionally must comply with various licensing, registration and other similar requirements in order to operate their businesses.

Changes to the Regulatory or Political Environments

Each country has developed its own set of rules for debt collection operations. The regulations covers: the methods by which claims can be assigned or transferred; the ways in which a customer can be contacted and a debt collected; and the types and level of fees, interests and costs that can be imposed, and whether those fees, interests and costs can be passed to the customer or the client.

The NPL regulatory landscape relating to debt collection and credit purchases is currently undergoing an overhaul that is driven by initiatives at EU-level aimed at tackling the build-up of NPLs across the EU.

On Nov. 24, 2021, the European Parliament and the Council adopted a directive on credit servicers and credit purchasers also known as the NPL Directive.

The NPL Directive places various obligations on credit institutions, credit purchasers, and credit servicers, covering both consumer and corporate NPLs. For example:

EU banks selling NPLs must disclose information to potential buyers about loan rights and collateral for recovery assessment. Credit purchasers must meet specific requirements, such as appointing an EU representative for non-EU entities and using third-party servicers in certain cases.

Entities engaged in "Credit Servicing Activities," such as payment collection, generally need EU national supervisory authority authorization, with some exceptions. This broadly defined term could include activities typically performed by facility and security agents in enforcement or distressed loan situations, such as renegotiating loan terms or taking enforcement actions.

The new framework won't apply to the sale of performing loans from credit institutions or NPLs sold by credit institutions before Dec. 30, 2023. It also won't apply after that date to EU credit institution NPL sales or sales of performing loans or NPLs from noncredit institutions.

However, the NPL Directive is exempting already supervised entities such as AIF/AIFMs and consumer credit institutions that are used for credit servicing and/or credit purchasing in some EU countries such as Poland, Czech Republic and Slovakia.

A U.K.-based measure mirroring the EU Directive has not yet emerged.

In Europe many debt collection operations are licensed or regulated; the collection business is carried out in accordance with local rules and regulations; consumer lending operations are conducted in accordance with sound lending practices; the directors of the board have sufficient knowledge and experience and have not misused any debt collection permissions; and the directors meet other general suitability and reliability checks.

Statutes of Limitations

Rules regarding the length of time after which an unpaid debt may not be pursued by creditors and the ways in which the statute of limitations can be tolled so that a debt can remain collectible also vary across jurisdictions. In a majority of the countries in which credit managers or debt collectors operate, it is possible to extend the statutes of limitation on historic debt claims indefinitely by using various methods, including enforcement actions, notification of the customer or otherwise interrupting the limitation period with continued court proceedings, whilst other countries have changed the statutes of limitation for certain debt including by limiting the ability to extend or interrupt the limitation period, or have discussed doing so.

Enhanced Consumer Protection

There has been a trend in recent years to afford more protection to consumers. Laws, regulations and judicial decisions in various jurisdictions have changed the way debt collectors in Europe operate.

Consumer protection laws can limit enforcement on debt claims. Some examples in Europe include;

In Finland, enforcing consumer debt claims after a default involves certain restrictions, including waiting periods and considerations for force majeure circumstances. Similarly, Spanish Law 5/2019 introduces provisions that extend default periods for mortgage loans.

Several countries, including Sweden and Norway, have implemented debt restructuring options, allowing eligible customers to initiate shorter payment plans or receive relief from certain debts after a specific period, which can impact the total collections under an NPL.

Other jurisdictions have imposed moratoriums, formally agreed periods of time where a debt is not collected on, or introduced out-of-court payment arrangement proceedings. For instance, in Spain, an out-of-court payment arrangement procedure is available to people with specific criteria, offering options such as debt reduction, asset assignment and moratoriums.

Customers may also become subject to insolvency proceedings, which may result in a delay or prevention in the enforcement of the claims held by debt collectors, including reductions in principal or interest. This particularly affects unsecured loans where collection from insolvent estates is limited to available funds.

Consumer Credit Development

Consumer credit operations have received increased regulatory attention in many of the European jurisdictions. Some countries have imposed caps on interest rates or total cost of credit and further regulated consumer loans with small principal values.

This focus on consumer credit has been to increase the scope of which entities must hold a consumer credit license.

In reaction to a recent European Court of Justice case, Verein fuer Konsumenteninformation v. INKO, Inkasso GmbH, which held that debt collection companies were credit intermediaries and thus not required to provide pre-contractual information to consumers, many countries took legislative action to impose a requirement on debt collection companies to register with the local authority or obtain a consumer credit license. Stricter regulations in general may increase the compliance burden and operating costs.

A Consumer Credit Directive review is currently underway and some of Europe’s largest debt collectors are engaged in this process.
Complex Accounting Discourages Investors

To explain some of the accounting complications in this industry, we have used some illustrative examples.

As mentioned earlier, portfolio investments, namely NPLs and other overdue receivables are acquired from institutions at a substantial discount from their face value and classified as purchased or originated credit impaired in line with IFRS 9 (Financial Instruments).

The discounted cash flow that each portfolio investment is expected to generate over the 12 months following the date of the statement of financial position is calculated, and this portion of each portfolio investment carrying value is classified as current. The remaining portion of this carrying value is classified as noncurrent.

The carrying value of each portfolio corresponds to the estimated future cash flows discounted by an expected interest rate or EIR. The initial EIR is based on the relation between purchase cost and the projected future cash flows on the date of purchase. The initial EIR represents the expected IRR on an investment.

The initial book value of the portfolio is equal to the initial purchase price, the effective interest rate or EIR is calculated based on the future expected cash flows. In future periods the carrying value of the portfolio is the expected future cash flows discounted back at the EIR.

This is how portfolio amortization is calculated. It is also how noncash charges are taken to the portfolio to the extent there are changes to the anticipated future cash flows.


Revenue is reported as cash collections less portfolio amortization, which is the change in the book value of the portfolio calculated as above using the original EIR in the given period, and portfolio revaluations, which are also calculated as described above, in addition to servicing revenue as well as other services.

Below revenue, the cost of sales or collection activity costs, as the name suggests, is the cost associated with sales or in the case of the debt collectors, collection.

What this comprises differs between issuers; for example Lowell describes these costs:
“as the direct third-party costs incurred in providing services as a debt collection agency or collecting debts on owned debt portfolio investments; examples include printing and postage, third party commissions, search and trace costs, litigation, telephone and SMS text costs.”

Whereas according to Intrum this includes:
“costs for personnel, postage, purchase of external information, legal and bailiff costs, bank charges for client funds bank accounts, apportioned rent and office costs as well as depreciation on related fixed assets. Other costs included in cost of sales includes relationship maintenance costs value ad services, such as complaints management and related IT expenses including the running and maintenance costs for IT infrastructure.

The other costs are the variable and semi variable overheads like sales, marketing, administrative and other external expenses. According to Reorg's understanding these are not often accounted for in the cost for the collections, nor in net IRR calculations.

This is relevant as it has been a key point that issuers’ performance is not always comparable as investors are unable to compare cost efficiency across issuers and IRRs do not always consider un-allocated costs.

Credit Discussion

Part II of this sector overview, to be published in the coming days, will be focused on individual credit discussions and relative value analysis.

Now that we have introduced the industry and dynamics and accounting overview we will introduce some of the nonfinancial KPIs and provide a brief overview of the sub-investment grade ratings agencies assigned to the main issuers in the sector.
Inconsistent KPI Reporting Limits Comparability Between Peers and Paints Overly Rosy Picture

Gross, Net IRR & Net Deal IRR

Gross Internal Rate of Return, or gross IRR, pertains to the gross internal rate of return of a loan portfolio. It is computed by utilizing the actual cash collections starting from the date of the purchase of the loan portfolio up to the present date. Future cash collections are projected for each portfolio, and these values are subsequently employed to construct the Estimated Remaining Collections, or ERC.

Net IRR, sometimes known as net deal IRR, is gross IRR net of servicing costs including servicing margin. As highlighted in the accounting overview, servicing costs/ cost of sales can differ across issuers so this metric is often not directly comparable across players.

Not all issuers report the IRR of their portfolio, but the few that do all report their IRRs on a different basis. Note Axactor’s gross back book IRR of 18% is lower than Lowell’s net IRR of 20%. It is important to remember that net IRR assumes that cash proceeds can be reinvested back into the investment or in this case the portfolio at the same rate.

Cost of Funding /Debt/WACC

A somewhat simple cursor for figuring out whether a project is profitable is comparing the IRR to the weighted average cost of capital, or WACC, or cost of funding. This is particularly relevant to the debt collectors given the majority of their operations’ performance is measured by gross IRR and net IRR. However it's important to remember that these IRRs are estimates and do not fully show the profitability. Also, most IRR figures will not include corporate level costs or costs below the gross profit line.

The WACC reflects the cost of funding the business through debt and equity. Debt is typically cheaper than equity and the large growth through the NPL golden age was funded by the cheap debt which characterized the mid-to-later stages of the 2010-2020 period.

The new high interest rate environment alongside stale IRRs equates to a business model that may not work for all the debt purchasers.

Gross Money on Multiple

The gross money multiple is the forecast absolute cash return expressed as a multiple of the invested amount. It can also be considered as the price that purchasers were willing to pay. As shown the companies below have experienced pricing pressure as the money on money multiple has fallen by a full turn over a decade. This was largely a result of falling pressure on banks to reduce NPL ratios.
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Collection Performance

The collection performance is the collections expressed as a percentage of the amount expected to be collected usually 12 months prior to the point of reporting. The collection forecast, whilst still a good indicator of how the companies make good on forecast collections after 12 months, is not as good as comparing collections compared to the forecast collection amount at underwriting.

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Varied Ratings Outlook for Debt Collections

Encore Capital Group, Kruk SA and PRA Group are the top-rated debt collectors in the European and North American region, sitting just below the investment grade area at a Ba1 rating.

To access Moody's rating updates and outlook changes for Encore Capital Group, Kruk SA, and PRA Group, refer to the following links HERE, HERE and HERE, respectively.

PRA Group might face a potential downgrade due to its underperformance in the U.S. market, marked by weak earnings reported in the first half of 2023.

Along with the stable outlook given by Moody’s, Kruk could see a possible upgrade if the company continues to maintain its strong profitability without incurring a substantial increase in leverage.

Similarly, DoValue holds a BB rating with a stable outlook from S&P. For Moody's and S&P rating updates for DoValue, see HERE.

In the single B rating category, Intrum Justitia, Arrow Global, and Axactor are positioned at the upper end, while iQera, DDM Debt, and Lowell fall just below this range in the mid-tier.

At the high end of the single B spectrum, we highlight Intrum Justitia, Arrow Global and Axactor with a B1 rating from Moody’s.

Intrum Justitia, Arrow Global, and Axactor have received a B1 rating from Moody’s, although Intrum Justitia recently underwent a downgrade to B1 from Ba3, reflecting its failure to reduce leverage, declining profitability and deteriorating interest coverage since late 2022. The outlook for Intrum remains stable, taking into account the company's strategic measures aimed at deleveraging and improving operational efficiency. In contrast, S&P has reported a negative outlook for Intrum with a BB rating, citing execution risks associated with its revised business strategy.

Moody’s outlook update for Axactor can be found HERE.

Arrow Global has been assigned a B1 rating by Moody's, There is potential for an upgrade if the company improves its interest coverage and leverage ratio. Click HERE for the ratings update.

Further down the single B spectrum, we find iQera, DDM Debt, and Lowell. S&P has assigned both iQera and DDM Debt a B rating, while Moody's gave Lowell a B2 rating. S&P has since withdrawn its rating for DDM Debt AB at the company's request. For ratings outlook and updates for iQera, DDM Debt, and Lowell GFKL, refer to these links following links: HERE, HERE and HERE, respectively.

Deep into the sub-investment grade ratings is Anacap Financial Europe, trading as AFE SA SICAV-RAIF. Moody's has issued a Caa2 rating with a negative outlook, following a downgrade from B3. This downgrade reflects AFE's constrained liquidity position and high risks associated with refinancing its 2024 notes. The company has experienced consistent downgrades since mid-2019. For the latest ratings update, click HERE.

Disclosure: Reorg and Garfunkelux-Lowell Group are both Permira portfolio companies.
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