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Executives

Jeff Tryka – IR, Lambert, Edwards & Associates

Brad Bradley – Chairman, President and CEO

Rion Needs – SVP and COO

Mark Redman – SVP, CFO, Secretary and Treasurer

Analysts

Mark Hughes – SunTrust

Rich Shane – Jefferies

Hugh Miller – Sidoti & Company

Lawrence Bernstein [ph] – Imber Mount [ph]

John Neff – William Blair

Bill Rikachi [ph] – Fox-Pitt Kelton

Asset Acceptance Capital Corp. (AACC) Q3 2008 Earnings Call Transcript November 4, 2008 10:00 AM ET

Operator

Good morning and welcome to the Asset Acceptance Capital Corp.’s third quarter 2008 conference call. All participants will be in a listen-only mode until the question-and-answer session of the conference call. This call is being recorded at the request of Asset Acceptance. If anyone has any objections, you may disconnect at this time. I would now like to introduce Mr. Jeff Tryka on behalf of Asset Acceptance Capital. Mr. Tryka, you may proceed.

Jeff Tryka

Good morning and welcome to Asset Acceptance Capital’s third quarter 2008 earnings conference call. On the call today are Brad Bradley, our Chairman, President, and CEO; Rion Needs, our Senior Vice President and COO; and Mark Redman, our Senior Vice President of Finance and CFO.

Earlier this morning, we announced the company’s third quarter 2008 financial results. If you have not yet received a copy of the press release, please contact Patrick Kane at area code 616-233-0500 to have one sent to you. The release is also available on many news sites, or it can be viewed on our corporate website at www.assetacceptance.com.

Before I turn the call over to management to comment on our results, I would like to remind you that this conference call contains certain statements, including the company’s plans and expectations regarding its operating strategies, charge-offs, receivables and costs, which are forward-looking statements and are made pursuant to the Safe Harbor provision of the Securities Litigation Reform Act of 1995.

These forward-looking statements reflect the company’s views at the time such statements were made in respect to the company’s future plans, objectives, events, portfolio purchases and pricing, collections and financial results such as revenues, expenses, income, earnings per share, capital expenditures, operating margins, financial position, expected results of operation and other financial items, as well as industry trends and observations.

In addition, words such as estimate, expect, intend, should, could, will, and variations of such words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence.

There are a number of factors, many of which are beyond the company’s control, which could cause actual results and outcomes to differ materially from those described in the forward-looking statements. Risk factors, include among others, our ability to purchase charged-off consumer receivables at appropriate prices, our ability to continue to acquire charged-off receivables in sufficient amounts to operate efficiently and profitably, employee turnover, our ability to compete in the marketplace, acquiring charged-off receivables in industries that the company has little or no experience, and the integration and operations of newly acquired businesses.

Other risk factors exist and new risk factors emerge from time to time that may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

Furthermore, the company expressly disclaims any obligation to update, amend or clarify forward-looking statements. In addition to the foregoing, several risk factors are discussed in the company’s most recently filed Annual Report on Form 10-K and other SEC filings, in each case under the title Forward-Looking Statements or captions similar thereto and those discussions regarding risk factors as well as the discussion of forward-looking statements in such sections are incorporated herein by reference.

With that said, I would like to turn the call over to Brad Bradley, Chairman, President, and CEO of Asset Acceptance. Brad?

Brad Bradley

Thank you, Jeff. Good morning and welcome to our third quarter 2008 conference call. During today’s call, I will provide high-level commentary on our third quarter financial performance, a review of our purchasing in the quarter, as well as the current collections environment, and finally I will conclude with a discussion of the plans and objectives we have in place as we look ahead to the remainder of the year.

Following my comments, Rion Needs, our Chief Operating Officer, will provide comments on current macro industry trends as we see them and an operational status report. Mark Redman, our Chief Financial Officer, will then provide a summary of our third quarter 2008 financials. At the conclusion of our prepared remarks, we will have a question-and-answer session.

During the third quarter, we continued to face a variety of challenges in light of the current economic environment. But our performance did improve from the third quarter of 2007. Revenues were up and we continue to control expenses, which enabled us to pose net income of $3 million compared with a net loss of $1.7 million a year ago.

With the continued economic slowdown, the overall supply of charge-offs from issuers continues to expand, while overall demand remained subdued as a result of lower levels of liquidity in the industry and the continued prospect of improved pricing. Consequently, the purchasing environment in the third quarter showed modest improvement. But we believe that as credit card charge-offs grow in the coming months, there will additional supply and better pricing in the coming year. Given this outlook, our purchases returned to more normal levels as we invested $36 million in the quarter.

With continued slowing of the global economy, consumers continued to face pressure from a rising cost, falling home prices, and a more challenging job market, resulting in an increasingly difficult collections environment in the quarter. In the face of these challenges, we continued working to optimize our collections efforts between our call centers, legal collections, and contingent legal and agency collectors, while controlling our operating expenses as a percent of cash collections.

Looking ahead to the remainder of 2008, we are encouraged by the opportunities presented in the current economic climate, but also recognize the challenges to our collections in this environment. We will continue to focus on efficiently growing cash collections, leveraging our associate talent, maximizing our collection capacity, and improving operational efficiency.

I will now provide an overview of our financial performance for the third quarter ended September 30, 2008. Third quarter 2008 cash collections increased slightly to $90.8 million compared to $90.7 million in the year-ago period. Total revenues increased 11% to $58.4 million in the third quarter of 2008 compared to revenues of $52.6 million in the prior year period.

Operating expenses as a percentage of total cash collections improved to 55.2%. Year-to-date operating expenses were 52.4% of total cash collections, an improvement of more than 200 basis points when compared to the first nine months of 2007 as a result of our diligence in managing this key metric.

Net income for the third quarter 2008 increased to $3 million or $0.10 per fully diluted share compared with a net income of $1.7 million or $0.05 per fully diluted share in the prior year third quarter. There were two primary factors, which contributed to the improvement in third quarter profitability. One, an increase in purchased receivables revenues of $6.1 million or 11.7% from the third quarter of 2007; and two, a reduction in operating expenses of $2.1 million or 4% compared with the same period last year. The improvement in revenues reflects a lower amortization rate of 36% versus 42.7% last year.

The current macro environment is characterized by increased supply, placing downward pressure on pricing. As a result, many issuers have pursued a strategy of selling through forward flow agreements to lock in better pricing. Continuing the trend of forward flows in the first half of 2008, over 90% of our purchases in terms of dollars invested during the third quarter were from forward flow arrangements, a significant increase from historical rates for us. We have locked up premium paper from preferred sellers at attractive price points and expect solid returns as we leverage the predictability and consistency that is inherent in forward flow contracts.

During the third quarter, we invested $66 million in 42 charged-off consumer receivable portfolios with an aggregate face value of $725.8 million, for a blended rate of 4.96% of face value. During the same period last year, we invested $35.1 million to purchase consumer debt portfolios with a face value of $1.9 billion, for a blended rate of 1.89% of face value. The increase in blended rate was a result of the much higher quality of paper we purchased in the current quarter versus the third quarter of 2007. Included in these purchase totals were 36 portfolios with an aggregate face value of $628.8 million purchased at a cost of $33.2 million or 5.28% of face value, which were acquired through 11 forward flow contracts. In the third quarter of 2007, we purchased 21 portfolios with an aggregate face value of $108.2 million purchased at a cost of $5.4 million or 5.02% of face value, acquired through eight forward flow contracts.

Now I’d like to turn the call over to our COO and incoming CEO on January 1, Rion Needs, who will discuss key industry trends and observations, as well as our operational performance.

Rion Needs

Thank you, Brad. Today I’ll provide some comments on the current macro environment as well as an update on several key operational initiatives that remain top priorities for our team, as we look ahead to the remainder of this year and into the coming year. As we approach the end of 2008 and look into 2009, most (inaudible) would agree that the US economy is either in a recession or at least a prolonged period of slow growth.

In the third quarter, we experienced unprecedented upheavals in the financial market with major bank failures, the collapse of large Wall Street firms, and the nationalization of Fannie Mae and Freddie Mac. Despite massive injections of liquidity by the Federal Reserve and central banks around the globe, credit markets remained frozen as (inaudible) cash and refuse to lend. The credit crisis is now having a substantial impact on the real economy as consumers tighten their belts and businesses look to reduce cost and curb investment.

Unemployment is rising and consumers are looking at significant wealth destruction, as the values of their homes and investment portfolios decline even as the cost for basic necessities remain higher than a year ago, causing downward pressure on disposable income. The current economic situation presents us with a double-headed sword. As these underlying fundamentals will likely have a positive impact on the supply of charged-off receivables for sale in the coming quarters creating improved pricing opportunities, but the significant pressures on consumers may inhibit their ability to pay down debt resulting in a much more challenging collections environment.

Overall, pricing environment continued to show modest improvement in the third quarter of 2008. However, we continue to believe that the overall economic picture may worsen before it eventually improves, presenting further downward pressure on pricing. The financial health of consumers continues to deteriorate. Unemployment is rising and credit card charge-off continued to increase. Even as these factors pressure the broad economy, the current credit crisis may prompt more issuers to turn to charged-off receivables sales as a source of ready cash and liquidity to replace other financial sources that are no longer available.

We expect this will result in further downward pressure in pricing and we are well positioned to meet this demand. Many analysts believe that the credit card industry may be the next to see away with consumer default, and charge-offs, with projecting charge-off to hit 100 billion by the end of 2009. Currently, credit card charge-offs have reached 5.5% of our outstanding balances, and some analysts are expecting losses to exceed the 7.9% level reach in the recession of 2001.

In addition, we continue to believe that some competitors are experiencing their own liquidity issues resulting in a reduction of their ability to fund portfolio of purchases, creating further erosion of demand. The major banks have also announced increased charge-offs, which provide further motivation for continued sales and increases in supply. Given these factors, we have been selective in our approach to purchases, including in the third quarter, as we believe the optimal purchasing environment will be realized over the next 12 to 18 months.

Let me turn to a review of our operations during the quarter. During the third quarter, our senior leadership team continued to focus on strategic and tactical initiatives to best leverage the people, process and tools, available to us to generate increased efficiency and maximize returns. In the past quarters, I’ve outlined a number of initiatives we’ve undertaken to improve organizational efficiency, reduce cost, and better manage our capacity constraints in light of the significant purchases we’ve made over the last several quarters. We continue to make progress on those initiatives while looking for additional steps we can take to continuously improve our operation.

In the third quarter, we continue to work on our overall capacity utilization in inventory management to generate improved results. Last quarter we discussed our efforts to increase our third call center capacity. We mentioned the opportunity to increase our internal resources to liquidate our existing portfolio and leveraging external partners to bridge the gap.

We indicated that our current internal capacity could be increased by 500 collectors to meet current inventory of accounts. However, as indicated, that did not mean that we would rapidly add such large numbers of collectors to our team. Rather we will continue to be focused and methodical in our growth, adding high quality collectors to our team that can more quickly add to our efficiency while we minimize the significant internal problems that rapid growth often entails.

Even with our longer term focus on adding reps, we must still work to improve our overall retention rate to ensure our investment in people is maximized. To supplement our internal capacity, we expanded our external relationships to enhance our overall capacity quickly and effectively. Maintaining a robust external partner network remained the critical component of our overall capacity management process.

As a result of our efforts with our outside network, legal collections rose 3.9% to $31.8 million, or 41.9% of total collection. Other collections consisting of primarily agency collections rose to $14.3 million or 15.8% of total cash collections. Given our efforts to effectively utilize our entire collections network to manage our receivables growth, we anticipate outsourced collections will continue to growth while we build our internal capacity. It is important to emphasize that our expectations from margins on external collections are in line with our internal collection targets. We have identified external partners with the requisite skill and expertise to successfully execute the strategy. Still we will continue to monitor our progress closely with our outside partner network to ensure we meet our margin targets and expense reduction goals.

During the quarter, account rep productivity on a full-time equivalent basis declined 12.5% when compared to the prior year period. We believe this reduction in productivity was primarily related to increasingly difficult collections environment with a relatively smaller impact from the continued rationalization of our portfolios, which shifted accounts away from our call center to the agency forwarding channel. Obviously, capacity planning and productivity remained key priorities for our management team, particularly as we seek to properly allocate the human resources necessary to collect on our significant inventory of charged-off receivable.

As we mentioned last quarter, we continued to work to better align our existing collection staff with our account inventory. And as a result, we anticipate that the elevated volume of accounts directed toward agency forwarding channel will continue in the short-term. As a result, we will likely see further negative impact on our account represented productivity metric over the coming quarters. However, we believe this approach will generate increased cash collections on our portfolios. I will provide you with further updates on the progress we are making in this area in the coming quarters. I remain convinced that we are on the correct path. It will take some time to arrive at the optimal mix of internal and outsourced collections efforts.

As we’ve emphasized in prior quarters, our senior leadership team is focused on creating a highly engaged, skilled workforce that will allow us to capitalize on the current and future market opportunities. We are working aggressively to improve the level of training, upgrade systems, and improve career development options for all of our associates. Ultimately our goal is to become an employer of choice in the markets we operate in, understanding that the investment we make in human capital will pay dividends through expanded capacity, productivity, and efficiency.

Let me reemphasize. We will not just go out and hire people on mass to increase our capacity by filling seats with warm bodies. This would have a substantial negative impact on our results. We will continue to improve our training and retention while steady and methodically adding the right people to our team. All of these efforts are beginning to show results as evidenced by the trend in our operating expenses during the quarter.

Our operating expenses were lower in the comparison to last year not only as a percentage of cash collections, but also in absolute dollars. The most significant improvement in our operating expense structure occurred from the initiative implemented in the first quarter to better match our legal collections with expenses. We believe that the recent improvements in our operating costs are sustainable and we will continue for the remainder of 2008 such that we should realize a year-over-year reduction in our cost to collect.

With that, I’ll hand the call over to Mark for a detailed review of our third quarter financial results.

Mark Redman

Thank you, Rion. This morning, I’ll review our third quarter 2008 financial results and metrics, provide a discussion on impairments and revenue recognitions, and finally I will end with our liquidity and capital structure. Starting with the review of our financial results. In the third quarter, total cash collections were up modestly to $90.8 million compared with cash collections of $90.7 million in the third quarter of 2007.

Traditional call center collections for the third quarter decreased 6.4% from the year-ago period to $38.4 million, representing 42.3% of total cash collections for the quarter compared to 45.2% of total cash collections in the prior year period. Legal collections grew 3.9% versus the prior year third quarter to $38.1 million, representing 41.9% of total cash collections versus 40.4% of cash collections in the year-ago period.

Other collections, including agency forwarding, bankruptcy and probate, increased 9.5% on a year-over-year basis to $14.3 million, accounting for the remaining 15.8% of cash collections during the third quarter of 2008, compared to 14.4% of total cash collections in the third quarter of 2007. The growth in other collections continues to be driven primarily by increases in agency forwarding collections. That is, cash collections from third-party collection agencies working accounts on our behalf.

During the third quarter, we generated total revenues of $58.4 million, up 11% from $52.6 million in the same quarter of 2007. I will go into more detail on revenue shortly.

Total operating expenses decreased 4% to $50.1 million in the third quarter of 2008 compared to total operating expenses of $52.2 million in the year-ago period. Total operating expenses were 55.2% of cash collections in the current quarter compared with 57.4% in the same period of 2007.

Now let me discuss the major categories of operating expenses in more detail. Salaries and benefits increased $900,000 or 4.3% to $20.9 million compared to $20.0 million in the year-ago period. The increased salary and benefit costs reflect an increase in a number of full-time equivalent traditional call center representatives as well as higher associate benefit expenses partially offset by lower performance incentives and decreased productivity in our traditional call center reps.

While we are discussing salaries and benefit expense, let’s take a moment to go over our account representative statistics starting with productivity. Collections per account representative declined 12.5% to $39,866 in the third quarter of 2008 compared with collections per account representative of $45.549 in the year-ago period. As Rion previously mentioned, we believe the drop in productivity was primarily the result of a more difficult collections environment combined with the capacity planning and strategic outsourcing undertaken.

For the third quarter 2008, we had an average of 966 account representatives on our team on a full-time equivalent basis, of which 53.9% of the total had one year or more of experience. In the third quarter of 2007, we had a total of 916 account reps, of which 59.7% of the total had a year or more of experience. During the current quarter, collections expense fell $2.5 million or 9.8% to $23.7 million compared to $26.2 million in the prior year period. The improvement was driven by a $4.2 million decline in variable cost associated with reduced in-house collection, lower data provider cost, and better expense management.

Fees paid to contingent collectors, both agencies and attorneys, increased by $1.7 million in the third quarter of 2008 versus the same period last year. Our collections from these third party relationships increased to 32.7% of total cash collections in the third quarter versus 28.6% in last year’s third quarter.

Occupancy cost declined $400,000 or 16.9% in the third quarter 2008 to $2.0 million compared to the year-ago period. Occupancy cost declined year-over-year due primarily to the consolidation of our two call centers in 2007. Administrative expenses increased 7.4% to $2.5 million in the third quarter 2008 compared to $2.4 million in the prior year period. The increase in administrative expenses was primarily the result of additional fees incurred through outside advisors and consultants.

Interest expense was $3.3 million during the third quarter of 2008, down from $3.4 million in the third quarter 2007, largely as a result of lower effective interest rates on our credit lines, partially offset by higher average borrowings during the quarter. Average borrowings on our credit facility in the third quarter were $183.7 million compared to $160.2 million in the last year’s third quarter.

The company reported net income of $3 million or $0.10 per share in the third quarter compared with a net income of $1.7 million or $0.05 per share in the third quarter of 2007.

Next, I will discuss revenue, impairments, and portfolio amortization. Third quarter purchase receivables revenues, our primary source of revenue, increased 11.7% to $58.1 million compared with $52.0 million in the year-ago period. Net impairments for the quarter were $3.1 million, a decrease from a net impairment charge of $13.8 million in the third quarter of 2007. Most significant impairment totaling $1.7 million came from the Q3 ’05 aggregate pool. We continued to see mixed performance from this pool, but in general, it has been trending negatively. As a result, we moved aggressively to impair this pool during the third quarter similar to our decision to move aggressively on impairments for the Q4 ’05 and Q1 ’06 pools in the second quarter.

Additionally, impairments of $1.1 million were recognized on 13 different pools from the 2004 vintage year. As you may recall, we did not aggregate our 2004 in prior year’s pools, thus resulting in increased volatility of collections. We have reversed $0.5 million in prior period impairments during the quarter. In the third quarter of last year, we had significant impairments as a result of the review and refinement of our revenue model. We continue to closely monitor our performance to remain cautious with regard to impairments and yield increases, given the current macroeconomic environment.

The amortization rate or the difference between cash collections and revenue decreased from 42.7% in the third quarter of 2007 to 36% in the third quarter 2008. This decreased amortization rate is primarily due to lower net impairments, which were partially offset by increased amortization due to lower average internal rates of return assigned to recent year’s purchases.

Collections on zero basis pools or fully amortized pools decreased 13.8% to $18.4 million in the third quarter of 2008 versus $21.3 million in the third quarter last year. Factoring out zero basis collections, the core amortization rate for the third quarter of 2008 was 45.1% versus 55.7% in the prior year quarter.

Moving on to our liquidity and capital structure. As we have discussed in the past, we disclose adjusted EBITDA in our quarterly earnings releases because it is an important measure we use to gauge the operational success of the business. It is a measure of the cash generated by the company that is available to purchase receivables, pay down debt, pay income taxes, or return to shareholders, among other uses.

The cash generated in our business has been the primary source of funding for purchases throughout 2008, as we’ve invested $123.2 million in purchase receivables even as we’ve reduced the outstanding debt on our credit facilities by $2.1 million.

For the third quarter of 2008, adjusted EBITDA increased by 5% to $41.9 million when compared to the third quarter of 2007. Please refer to the table in this morning’s press release and on the attachments of Form 8-K filed this morning, reconciling GAAP net income to adjusted EBITDA.

Turning to the balance sheet. As of September 30, 2008, our cash and equivalents balance was $8.8 million compared to $10.5 million at December 31, 2007. The carrying value of purchased receivables as of September 30, 2008 was $358.6 million, up from $346.2 million at December 31, 2007. Importantly, during the quarter, our cash collections were 25.5% of our purchase receivables opening carrying value.

As of September 30, 2008, we had outstanding borrowings of $189.1 million on our $250 million credit facility, a decrease of $2.1 million compared to the balance at the end of 2007. Borrowings on our $100 million revolver at the end of the third quarter were $41 million, leaving capacity on the current facility at $59 million. However, as in the last couple of quarters, our capacity was further limited by our debt covenants. I estimate that the capacity under the most restrictive debt covenant as of September 30, 2008 was approximately $35 million.

As Brad and Rion mentioned, we believe the prices for paper will continue to improve over the next 12 to 18 months as a result of increasing credit card charge-offs. We believe purchasing debt in moderation in today’s environment is prudent, given the expectation of these and better pricing down the road. We believe that over time we can increase our purchasing capacity to take advantage of the improving purchasing environment. However, we are not rushing to increase capacity immediately, given the current state of the credit and capital markets.

With that overview, I will turn the call over to the operator and begin the question-and-answer session. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We’ll take our first question from Mark Hughes from SunTrust.

Mark Hughes – SunTrust

Thank you very much. Any comment you can make regarding collections through the quarter?

Mark Redman

You are asking how collections may have come in month-by-month during the quarter, Mark?

Mark Hughes – SunTrust

Yes, exactly. Thank you.

Mark Redman

(inaudible) top of my head. Yes, we are talking amongst ourselves here obviously, Mark.

Rion Needs

Yes. What we have in front of me, Mark – this is Rion. I just don’t recall out of top of my head how each of the months came in.

Mark Hughes – SunTrust

No, it sounds like no notable trend.

Rion Needs

No. I could tell you, we have been tracking economic factors and we can tell you that it definitely has been getting more difficult out there as we look at things like average payment balance versus the total number of payments that we are taking. When we look at the return on investment for our letters, our outbound dialing calls, we are making all the same number and in fact elevated connections. But we’re seeing actually slight deterioration in some of those metrics because of the economy. So I’d tell you that overall the feeling that I have is that it’s getting tougher as we move through the quarter, but it hasn’t been material in our collection effort.

Mark Hughes – SunTrust

Right. You had suggested that 90% of collections came from forward flow. Was that year-to-date or the quarter? And then how did that compare with last year?

Mark Redman

Net –

Mark Hughes – SunTrust

I’m sorry, 90% of purchases, I’m sorry.

Mark Redman

Correct, correct. 90% of purchases did come from forward flows. That is up pretty significantly to historical trends for us. If I look at second quarter of this year, it was 30.3%. First quarter, which was a very small purchasing quarter, it was 49.3%. All of 2007, it was 14.4%. The highest quarter in 2007 was 18.6%.

Mark Hughes – SunTrust

Right. And then the pace you think for hiring those additional reps you talked about 500 reps, what are you thinking about that? I know you’ll do it depending on market conditions, but do you have any thoughts right now, what we might expect?

Rion Needs

We really haven’t laid out a specific timeline as far as the hiring of each of those reps, but we have undertaken a complete strategy around our inventory management. The real estate associated with it, the human capital associated with it, our network of external providers, as we mentioned before, we have some offshore collections already occurring and we’re looking at that as an expansion opportunity. So we’re looking at it holistically and blending in between them – between all of those. Obviously, as unemployment increases, we think that that will increase the pool of talented people for us. And we see that as a positive in this tough economic period. But we haven’t specifically kind of lined that out as to what that growth will be. It’s really about being sure that we’re improving our retention rates, increasing our training skills, and making sure that we get the right people onboard.

Mark Hughes – SunTrust

Okay, thank you.

Operator

Our next question comes from Rich Shane with Jefferies.

Rich Shane – Jefferies

Hi, guys. Thanks for taking my questions. Just a couple here. Obviously the pricing that you paid for receivables this quarter was the highest we’ve seen over the last four or five years. You’ve mentioned that the credit quality is better. Can you just sort of delve into that a little bit more, describe to us what makes it better and what sort of assumptions you’re making in terms of collectability over the long-term on those pools?

Brad Bradley

Yes. Hi, Rick, this is Brad. When we look at quality, we look at the asset class. For us, I think it’s safe to say the preferred product is credit card product, whether that’s general purpose or private label. We’re looking to do deals directly from the issuers. We look very much at the number of months from charge-off. So what we’ve seen over time that the collection cycle, the placement cycles by issuers have become shorter so that today we can be looking at tertiary or three (inaudible) paper that’s 12 to 18 months from charge-off as opposed to five years ago when it would be more like two to three years from charge-off. That’s very important to us just at the placement cycle. We also will have to take a look at the post sales support aspect of things. So that becomes more important to us. Average balance in of course [ph] state distribution and those are some of the primary factors that we look at when we do our due diligence and evaluate the quality of any given portfolio.

Mark Redman

And Rick, the second part of that question was collectability on these portfolios. And obviously we believe that we will collect well out on them. However, given the current economic conditions, we are being extremely conservative in our expectations on those collection curves as we set our yields for revenue recognition purposes.

Rich Shane – Jefferies

Got it. If you guys would indulge me one other set of questions – and thank you, that was actually incredibly helpful. I appreciate it. In terms of – it’s interesting. You’re basically saying that over the next year you expect pricing to come in, or come down and become more attractive. When we look at other companies that we follow that not necessarily sell charge-off receivables but sell different types of services, their strategy when they see pricing at risk over time is to extend the duration of what they are doing. If you are a leasing company, you think lease rates are going to come down. Your strategy is to extend your leases out more years so you can lock in pricing near the top of the market. It seems contradictory to me that your strategy right now is to increase your forward flow agreements at a time when you think marginal rates are going to come down. Doesn’t that diminish your ability to take advantage of that by increasing the percentage of receivables that you are taking, negotiated at a more attractive environment?

Brad Bradley

Rick, we’re getting involved in forward flow arrangements primarily because that’s where we can – we have the opportunities, the best opportunity to purchase the paper that we’re looking to acquire. And although the prices we believe will come down in the future, we are making acquisitions and locking in to some of these forward flows that by the way are anywhere from three months to 12 months at a time that we consider very attractive. Having said that, we don’t want to lock into an over abundance of portfolios even though the prices are attractive today again because we believe pricing will become even better over the next six to 18 months.

Rion Needs

Yes, Rick, I’d just add to Brad is that we recognize that’s exactly the strategy of the issuers. Right? That’s what they try to do, is to lock in to (inaudible) market and extend the price points. And to Brad’s point, during the call or the portion he spoke on, is that that’s all that they are actually offering today, is issuers will figure that out. And so we have very, very small software [ph] that’s even being offered. So our choice really in this market is, don’t play at all or play selectively on what you think are really good opportunities, leaving more dry powder for when the time comes, when they won’t be able to structure it quite the same way. So we are definitely recognizing that and have recognized it starting in the end of last year.

Rich Shane – Jefferies

Okay, great. That’s incredibly helpful also. Last question related to that, within the forward flow agreements, how – are there pricing grids? Is that how it works? And how do you manage what is – let’s ignore pricing for a second, but deteriorating fundamentals potentially in the receivables that you will be taking on under these forward flow agreements. How does the pricing scale related to that?

Brad Bradley

Well, we do an individual evaluation on all of the accounts that we purchase through forward flows. We do our complete due diligence evaluation on a sample of the product that we would be bidding on, just like the other bidders will. And then if we are the successful bidder and we enter into a forward flow agreement, we actually run diligence on each month’s portfolio that is delivered to us under those arrangements to make sure that there isn’t any significant difference in the makeup of the portfolios that we are purchasing. When we go into a forward flow bidding situation, we certainly have to think about the future and we do and try to factor in the future collectability under the economic conditions during the term of that particular forward flow. But at the end of the day, it’s a bid situation. And we’re bidding against competitors in the marketplace. And the market is going to determine the value of that portfolio. And as Mark said, we are going into these bidding processes cautiously. We are not bidding up the price on these forward flows because the pricing is more attractive today than it was a year ago. We are looking to be selective and looking to be smart and looking to be active in this market, but we don’t want to be guilty of jumping in full-bore too soon. And what we believe is a market that will continue to become even more attractive.

Mark Redman

Rick, this is Mark. Let me add some more data to this. I think there is maybe a misperception that all of these forward flows are entering into our 12-month forward flows. And I look at the forward flow investment during 2008, in the first quarter, it was $11 million. In the second quarter, it was about $20 million. So obviously, we entered into new forward flows in the second quarter, at least started to funding them in the second quarter versus the first quarter. In the third quarter, it jumps up to the $33 million number that we discussed on the call today. So, by the time we get to the third quarter, we’ve entered into even more forward flows and we may have had couple of drop-offs as well. Once our Q is filed, you will see that our commitments in forward flows for the fourth quarter are expected right now at least to be about $30 million. So that’s pretty consistent with the Q3, but in 2009 – the full year of 2009 right now – this probably falls into the first quarter, but I can’t tell you that factually. We have about $5 million worth of commitments in forward flows agreement that we would expect at this point. So, the point being is a lot of these things have been entered through the course of the year and for periods of less than 12 months.

Rich Shane – Jefferies

Got it. Hey, guys, thank you very much for all the time and I apologize to the other folks who are waiting.

Operator

We’ll take our next question from Hugh Miller with Sidoti & Company.

Hugh Miller – Sidoti & Company

Hi, good morning. I was wondering if you could talk a little bit about the account reps during the quarter obviously up on a sequential basis. I was wondering if that was more a function of lower turnover or hiring activity in the quarter?

Rion Needs

Actually, Hugh, it’s actually both. We are increasing in offices where we have improved our retention metrics. We are actually increasing staffing in those offices. And that is a component of it. And then so it’s both. Right. We’ve increased our retention in the third quarter over last year and then we’ve also been hiring up specifically in those offices that’s exceeded that metric.

Hugh Miller – Sidoti & Company

Okay. And I guess given the limited purchasing outside of the forward flows that you guys have signed, have you guys noticed any turnover in the purchasing department?

Rion Needs

In our department or in the issuers?

Hugh Miller – Sidoti & Company

Yes, in your department within purchasing.

Rion Needs

We have had some turnover. We have increased staff during the course of the year and we have lost couple of people very recently, yes.

Hugh Miller – Sidoti & Company

Okay. And obviously you guys were able to continue to improve on a year-over-year basis with your operating costs, but have you guys underwent any type of outside of the collection department, staff reductions to try and improve your operating infrastructure costs or –?

Brad Bradley

We have, Hugh. We took a look at the speed in which the economy started to decelerate. And we took action on a number of initiatives that reduced operating expense both on some of the operating expense lines as well as in salaries and benefits. The majority of the salary and benefit reductions were taken in overhead, in management, where we saw an opportunity to improve our span of control and get some alignment around some additional departments. It really is a precursor to the work that will follow the implementation of our new operating system that we’ve talked about that will afford us the ability to look at structural reengineering on a much more broad basis. So it’s just kind of the beginning, but we have an opportunity and we felt it prudent to take that time.

Hugh Miller – Sidoti & Company

Sure. And then I guess if you could just maybe add a little color on which areas you were finding that the reductions were taking place? And then from your comments, I’m assuming that there is the potential for additional cost cutting as we head forward.

Brad Bradley

Yes. To answer the second part of that, the answer is yes. We think there is opportunity in the future. On the first part of the question, where did that come from, the bulk of it – the majority of it actually came in our legal operations management structure where we were able to consolidate a number of departments in line more end to end on some of the process flows. And then also on our collection department management, we rolled out what we call a model office. So we restructured what the model or a typical office would like from an organizational structure. As we are implementing Call Solution One, which is call center management principles, that initiative has been rolling out all year. And as we move through both of those initiatives, we realign our span of control. We actually increase the amount of direct leadership over the account reps. And so we have a tighter span of control or smaller span of control to providers, and we increase that span of control at the subsequent layers of management above that. So we’re giving more time and attention to come on the management to productivity to skill developments, coaching and feedback at the AR level.

Hugh Miller – Sidoti & Company

Okay. And so the near-term focus is going to really be on the outsource relationships that you do have?

Brad Bradley

That’s correct.

Hugh Miller – Sidoti & Company

Okay. I know you guys mentioned – I didn’t catch it, but you gave a little bit of an update on the credit line – I’m not sure if you mentioned the debt covenants, but if you could let us know where the major ones are and where we stand now?

Mark Redman

Sure. I did address that in my prepared comments. The $100 million revolving credit facility is really the item that we have capacity. We had $41 million borrowed, as I indicated, as of the end of the quarter, leaving without covenants and capacity at $59 million. With the covenant restrictions, I figure that that capacity is about $35 million.

Hugh Miller – Sidoti & Company

Okay, great. Thank you. And I know you guys touched on the impairments. I was wondering if you could talk a little bit more about the 2007 vintage, maybe the type of paper that you were seeing some weakness in and which quarter it was purchased in?

Mark Redman

Those impairments were fairly nominal. And off of the top of my head, I couldn’t answer those questions for you.

Hugh Miller – Sidoti & Company

Okay. Maybe we can follow up offline.

Mark Redman

Okay.

Hugh Miller – Sidoti & Company

And in the past, you guys have given us a little bit of insight into the pricing trend that you are kind of seeing on a year-over-year basis. I know everyone talked about how they did come down. If you could just maybe talk about that – where you are seeing pricing relative to where you were seeing a year ago? And any insight into where you see things could potentially go to? I mean, obviously nobody has a crystal ball, but any insight would be very helpful.

Brad Bradley

I’d say that pricing since the beginning of the year has come down anywhere from 20% to 40%, Hugh. And that’s kind of a broad statement across all of our asset classes, and also taking into consideration that there has been more pricing contraction in the resale market than there has direct. As far as what we foresee moving forward, it’s really hard to say and I’m hesitant to put a number out there. We do know that sellers are sophisticated in the way that they look at managing their charged-off debt. And they look at what their third-party agencies can recover for them and they compare that to what that sell would bring, and they develop indifference points and make decisions based on those metrics. So I think there are factors other than simply supply and demand that play into that. Having said that, I do think it would be as much as $100 billion in credit card debt, flooding the market in 2009 that that’s going to put some stress on the capacity to service that charged-off debt throughout the industry. And that can help lead to better pricing for debt buyers as well.

Hugh Miller – Sidoti & Company

Sure. Great color there. And then I guess one last question, if you could just touch upon the medical paper portion of your business, and whether or not I guess you guys see more opportunities there relative to the credit card area, or where you see opportunities if you are focusing on that area, or you are really focusing more for opportunity to growth within charged-off credit card receivables?

Brad Bradley

Yes. I think in general when you look at the market, medical debt is actually heating up. I think that there are number of hospitals right now that are looking to put more paper into the mix that are coming into increasing pressure. And with the pressure on consumers they see that as increasing. So we think that in general that that is a marketplace that’s improving. However, we are focusing right now more on the credit card side. When we look at the volume or if we look at our relative expertise and the margin associated with it, that’s an area that we really want to focus on.

Hugh Miller – Sidoti & Company

Great, thank you.

Operator

We’ll take our next question from Lawrence Bernstein [ph] with Imber Mount [ph].

Lawrence Bernstein – Imber Mount

Yes, hi. Can you comment at all on where we stand on October collections?

Rion Needs

Typically we do not comment on an inter-quarter basis on the status of collections. I guess I would say that the collections have not been nearly as weak as the overall economic factors might concern people to be. And certainly they looked outstanding in relation to a lot of the other information that was coming out of Detroit yesterday.

Lawrence Bernstein – Imber Mount

And in your earlier comments you suggested that the prices of some of these receivables have been coming down. How should I think about the current market value of Asset Acceptance’s existing receivables portfolio?

Rion Needs

I think that if you generally look at our current receivables in a time of increased economic pressure, collectability decreases, but we hold these portfolios for the long-term. So we amortized now for seven-year period on average, and we believe that the lifecycle of a debtor is very long. And as evidenced by our zero basis collections, whether it’s in the current economic cycle as the economy improves, consumer confidence increases again, and there is a need for them to repair their credit, we will have increased opportunity to collect our model’s portfolio. So we – as we’ve indicated, we expect pressure in the short-term loan collections, but in the long-term we continue to believe that we’ll be able to extract that value.

Mark Redman

And we’ve taken actions from an accounting perspective, given the environment, and are being extremely cautious on raising yields, which I think is demonstrated when you look at the charts that are provided in our press release in terms of the amortization rate on 2007 and 2008 purchases. Those amortization rates in the quarter were up in the 51% range, which is a very high amortization rate early in a pool of lives [ph]. And that’s a factor of collections coming in probably better than we had originally expected, but a whole lot of caution in our raising of the yields, given uncertainty of where are the markets going and where collections will be in coming quarters.

Lawrence Bernstein – Imber Mount

Thank you.

Operator

We’ll take our next question from John Neff with William Blair.

John Neff – William Blair

Hi, guys. And I got on the phone late, so apologies in advance if (inaudible) some ground. If we have, I’ll just follow up with you offline. Could you give us a little explanation for the zero basis collection on such recent purchase vintages ’06, ’07?

Mark Redman

Those would be – the ’06 number, which was a big number as I recall, came from portfolios that we acquired from PARC that were refined fairly low basis upon the purchase and have fully amortized out, and now we are generating zero basis collections. 2007, $43,000 during the quarter of zero basis collections. It’s almost nothing, but that would come from a pool that was put on slow cost recovery and has undoubtedly recovered its cost.

John Neff – William Blair

Okay. Okay, great. And then again I think I came on late, but, Rion, I think I heard you talking about full-time equivalence, the expectation of hiring up to another 500 reps. Your FTE headcount is up about 9% year-to-date, I can (inaudible) that process is already underway?

Rion Needs

It is. It is, but we are taking much more of a methodical approach than just writing out there, John, and trying to build the capacity by putting anybody in a seat. We’re trying to make sure that, one, we’ve improved the retention on a long-term basis, and then two, that we are acquiring the right type of collector that will be able to add incremental value right out of the gate. So we don’t degrade our current returns.

John Neff – William Blair

Okay. And then a clarification on the forward flows. First, the numbers that you gave in terms of the dollar amounts entered into each quarter, did that refer to future committed purchases or does that refer to actual purchases of forward flows in the quarter?

Rion Needs

I gave a mix of both numbers, John.

John Neff – William Blair

Okay. Obviously the – I think you said $5 million for ’09. Obviously that’s future committed purchases.

Rion Needs

Right.

John Neff – William Blair

So I guess we should assume that the forward flows, you really haven’t committed much to buying in 2009 under current forward flows?

Rion Needs

No, most of that bidding process is occurring between now and the end of the year.

John Neff – William Blair

Yes, okay. And then just to be clear, part of the rationale for doing this – I think, Brad, you were mentioning, it’s not so much driven – if I’m understanding you correctly, if I heard this right, I want to make sure – it’s not driven by necessarily particularly attractive pricing more of a way of securing the types of portfolios that you want to purchase in terms of what’s hitting your definition of quality. Would that be fair to say?

Brad Bradley

It’s both, John. I mean, I guess historically we have had been as heavily involved in purchasing forward flows as we are today. That’s obvious in the – comparing the percent forward flows year-over-year. But we are certainly not averse to entering into forward flows, nor have we ever been averse to entering into forward flows. It just so happens that more of our purchases have been stock purchases versus the contracts. Having said that, the product that we want to invest in today where we see attractive prices for preferred product are being marketed through forward flows. And if we are not purchasing them through forward flows, then we are not getting an opportunity to see those deals as spot deals later on because they just don’t exist. If we are not locking them up in forward flows, somebody else will be. And it seems as if there is a little bit of concern about overpaying for portfolios in the future because we are entering into these forward flow contracts. But we also see some advantages to being involved in forward flows. And some of those advantages would be the predictability and consistency of the purchased flow that we’ve got coming in based on these forward flow experience – forward flow contracts. We also gain more in-depth collection experience on the product that we are purchasing through the forward flows. And so we become more efficient at collecting on that type of paper from those specific sellers. And then it also improves the post sales support side of the transaction. And it helped strengthen the relationship and made post sales support as good as it can possibly be.

John Neff – William Blair

That’s helpful. And certainly (inaudible) like you are over-committed. I mean, there is November. I mean, the year is almost over. You’ve got $35 million in borrowing capacity. It sounds like with the covenants, have you – again [ph] if I’m rehashing something. Have you explored alternative financing options? Do you feel like you’ve got enough dry powder to capitalize in 2009 and beyond on the borrowing environment?

Mark Redman

John, what we said in the prepared comments is that we will over time increase our purchasing capacity to take advantage of the opportunities that we believe will be coming forth in 2009 and hopefully beyond. We have conversations with the banks and other advisors on this from time to time, which we have done in very recent times. I did indicate that we aren’t rushing out right now to increase capacity given the current state of the credit and capital markets. So we expect that we should be able to do so in coming quarters, but now just doesn’t seem like the right time.

John Neff – William Blair

Okay, that’s very helpful. Thanks so much.

Operator

Thank you. We have one more question. We’ll take that question from Bill Rikachi [ph] with Fox-Pitt Kelton.

Bill Rikachi – Fox-Pitt Kelton

Hi. I actually would like a clarification on the forward flow question, a series of questions that have been brought up already. So by its very nature, forward flow agreement in a declining price environment is going to be one in which the price that you pay ends up being higher than what the price would be at a given point. For example, the price that you could have gotten during the third quarter on your purchases during the quarter would have actually been lower had you not entered into the forward flow agreement, because the forward flow agreement locked you into the previous period prices. Is that a correct statement?

Brad Bradley

That is correct. Bill, the thing I’d look at there is the duration of that forward flow, as Mark mentioned. Right? So, is it three months, is it 12 months? 12 months being the longest we ever engage in. We’ll determine – and then the speed of deceleration around that pricing. Right? So that will kind of give you the magnitude of what the risk is.

Bill Rikachi – Fox-Pitt Kelton

Right. And can you give a sense as to what your – I guess conceptually what your weighted average prices under the forward flow agreements are? You mentioned pricing had dropped during the course of the year, from the beginning of the year. So, are you basically getting like February pricing now or March pricing at this point in time? Or can you kind of give like a weighted average price that you are getting on your forward flow purchases that took place during the quarter, given that they did take place at a higher level and what they would have been absent the forward flow agreement?

Mark Redman

Sure. The weighted average prices on the forward flows was 5.28%. Without knowing the makeup of that, it’s impossible to draw any conclusions, just that metric.

Bill Rikachi – Fox-Pitt Kelton

Right.

Mark Redman

Let me finish, Bill. What we have been monitoring though is performance – not performance, but purchase price of – like paper over 18, 24, or 36 months depending upon the purchases. And this would include, I believe, certain of these purchases that are currently under forward flow. And depending upon the purchase, I believe – and I don’t have the numbers in front of me, we were discussing this last week – that the pricing that we were seeing in the third quarter is similar to – was it late 2005, early 2006 purchases?

Rion Needs

Yes.

Mark Redman

So, you could clearly see the paper over a period of time continue upwards where it’s old enough between 2005, 2006 peak and in the middle of 2007 and then start declining. And you can see that – I mean, I think we had almost half a dozen of these like purchases that we had such financial history on, and you could see it. I mean, it was the same trend on every one of them.

Bill Rikachi – Fox-Pitt Kelton

Okay. And can you give – there were some commentary around this and I wasn’t completely clear on where we came out. But can you indicate what the amount of purchases are that you are committed to under forward flow agreements going forward in Q4 and into 2009 at this point?

Rion Needs

In Q4, it’s approximately $30 million and in 2009, it’s approximately $5 million.

Bill Rikachi – Fox-Pitt Kelton

Okay. And finally, how do you think about everything that we’ve – that you’ve discussed with respect to forward flows and what (inaudible) pricing that you would get if you were a bidder in an auction type of setting? And I understand the benefits that you gave with respect to forward flow, but how do you think about balancing or weighing those benefits versus the benefits of being a bidder in a different type of – or any other type of arrangement in which you would be looking to deploy your capital?

Brad Bradley

I think for us it’s pretty simple. And that is, right now, if we are not participating in the forward flow transactions, which the majority of the major issuers are offering right now, then we could find ourselves waiting for spot deals that never materialize because all the papers committed in forward flows.

Rion Needs

Yes. So it is an auction or a bid process (inaudible) forward flow, just like a spot purchase. It’s just that they aren’t bringing them in that format today at all. So it’s really a choice of buy nothing or buy forward flows. But Brad and Mark, Bill, had talked about kind of the incredibly detailed diligence process we go through, and they talked about the fact that we discount our bids, we discount what the expected return is on those portfolios based on a future view of what the economic environment is and the collectability is. So we start out, what Mark talked about, looking at all of these curves for all these similar issuers, similar paper, that yields – we derive from that what the curve should be and what the yield should be, and therefore the bid. We then discount it even further, knowing that without forward flow we are going into a declining pricing market and collectability. So, as Mark said, we are really conservative right now in the way that we are evaluating these deals. So we are trying to count our assets, but we are in an auction environment, so we have to bid against our competitors. And frankly, some competitors are setting the market for this paper and we just withdraw from those bids because they are outrages given what’s happening in collectability and where pricing will go.

Bill Rikachi – Fox-Pitt Kelton

Okay. Thank you very much.

Operator

At this time, there are no further questions. I’d like to turn the conference back to Mr. Bradley for any closing remarks.

Brad Bradley

Thank you, operator. In summary, we are pleased with the progress we made during the third quarter even in the face of a volatile and deteriorating market condition and a difficult collections environment. We continue to make progress on the initiatives we outlined for you in previous quarters moving to optimize our overall capacity management with increased use of our network, of outside collections channels, managing our operating costs in absolute dollars and as a percentage of cash collections. And we continue to generate strong cash flows from operations, all while remaining profitable in an uncertain macroeconomic climate. We will continue to make necessary changes to optimize our capacity and build a solid team of collectors over the long-term. We continue to believe that pricing and supply of charged-off receivables will improve over the next 12 to 18 months, and we will remain judicious in our approach to purchases during these uncertain times. Overall, it was a challenging quarter, but it was also pleasing to see the initial positive results of many of the initiatives we put forth in 2008. We remain grateful for the support and commitment of our employees, investors and partners, each of whom will remain central to our future success. That concludes our conference call today. Thank you for joining us. We look forward to speaking with you during our fourth quarter 2008 conference call. Good day.

Operator

This concludes today’s conference. We thank everyone for your participation. And you may now disconnect your lines.

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