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Portfolio Recovery Associates, Inc. (NASDAQ:PRAA)

Q3 2009 Earnings Call Transcript

October 29, 2009 5:30 pm ET

Executives

Jim Fike – VP, Finance

Steve Fredrickson – Chairman, President and CEO

Neal Stern – COO, Owned Portfolios

Kevin Stevenson – EVP and CFO

Analysts

Bill Carcache – Fox-Pitt Kelton

Mark Hughes – SunTrust

Hugh Miller – Sidoti

Bob Napoli – Piper Jaffray

Sameer Gokhale – Keefe, Bruyette & Woods

Rick Shane – Jefferies

Thomas Morton – CPMG

John Neff – William Blair

Edward Hemmelgarn – Shaker Investments

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2009 Portfolio Recovery Associates, Inc. earnings conference call. My name is Melalia [ph] and I will be your coordinator for today. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today’s Mr. Jim Fike, Vice President of Finance. Please proceed.

Jim Fike

Good afternoon and thank you for joining Portfolio Recovery Associates third quarter 2009 earnings call.

Speaking to you today will be Steve Fredrickson, our Chairman, President and CEO, Kevin Stevenson, our Chief Financial and Administrative Officer, and Neal Stern, our Chief Operating Officer of Owned Portfolios. We will begin with prepared comments and then follow up with a question-and-answer period. Afterwards, Steve will wrap up the call with some final thoughts.

Before we begin I'd like everyone to please take note of our Safe Harbor language. Statements on this call which are not historical, including Portfolio Recovery Associates' or managements' intentions, hopes, beliefs, expectations, representations, projections, plans or predictions of the future, including with respect to the future portfolio's performance, opportunities, future revenue earnings growth, future space and staffing requirements, future productivity of collectors, expansion of the RDS, IGS and MuniServices businesses and future contribution of the RDS, IGS and MuniServices businesses to earnings are forward-looking statements.

These forward-looking statements are based upon management's beliefs, assumptions and expectations of the company's future operations and economic performance taking into account currently available information. These statements are not statements of historical fact. Forward-looking statements involve risks and uncertainties, some of which are not currently known to us.

Actual events or results may differ from those expressed or implied in any such forward-looking statements as a result of various factors, including the risk factors and other risks that are described from time to time in the company's filings with the Securities and Exchange Commission, including but not limited to its annual reports on Form 10-K, its quarterly reports on Form 10-Q, and its current reports on Form 8-K filed with the Securities and Exchange Commission and available through the company's Web site, which contain a more detailed discussion of the company's business, including risks and uncertainties that may affect future results. Due to such uncertainties and risks, you are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date hereof.

The company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in the company's expectations with regard thereto or to reflect any change in events, conditions or circumstances on which any such forward-looking statements are based in whole or in part.

Now, here's Steve Fredrickson, our Chief Executive Officer.

Steve Fredrickson

Thanks, Jim, and thank you all for attending Portfolio Recovery Associates third quarter 2009 earnings call.

On today's call I'll begin by covering the company's results broadly. Neal Stern will then talk to you in more detail about our operational strategies, and finally Kevin Stevenson will discuss our financial results in detail. After our prepared comments we'll open up the call to Q&A.

Economic conditions remain difficult as PRA began the second half of 2009. Yet, we continue to perform solidly excelling in the third quarter in area such as productivity, efficiency and team work that speak to a business design for success over the long run.

Not only did we produce strong results operationally, but we continue to build for the future, further refining our best-in-class platform and taking advantage of our access to capital to acquire large amount of portfolios that we believe are well priced, even in a market where collections have grown more difficult.

Overall, PRA is in a position to emerge from this economic downturn stronger and more efficient competitor. I can honestly say that I am as excited about our future today as I have been in years.

Now, on to our third quarter numbers. Despite the weak economy, PRA acquired $76.7 million of defaulted debt during the quarter. The cash collections were a record $92.4 million, up 11.3% from $83 million in the year ago period. These help drive our near record cash receipts of $106.6 million in the quarter, up 7.8% from $98.8 million in the same period a year ago. Fee revenue was $14.2 million in the third quarter, a decline of 10.1% year-over-year.

Operating expense to cash receipts continued its general trend downward. In the third quarter of 2009, the ratio stood at 46.7% compared with 47.7% in the third quarter of 2008. We continue to tightly control operating expenses despite the difficult economic conditions particularly at our fee subsidiaries were expenses are mostly fixed over the short-term.

PRA realized productivity of $144.69 per hour paid for the first nine months of 2009, which compares with $131.29 for full year 2008. This includes an increase of 31 net collectors to our company wide owned portfolio call center staff from Q2 2009 and an increase of 45 from the end of 2008. Of course, not all our key metrics were positive in the quarter. The recession did have an impact on both the top and bottom-lines.

PRA recorded a sizable $8 million allowance charge in the quarter. Kevin will provide much more granularity on the charges in a few minutes.

We did managed to keep total revenue steady compared with the year ago quarter at $68.6 million despite the charge. EPS was down 13% and $0.65 versus $0.75 from the third quarter of 2008.

Net income of $10.1 million was down 11.8% from $11.5 million, a year ago.

In terms of year-over-year comparisons, we booked net interest expense of $1.96 million in the third quarter which was down about 35% from $3 million in the year ago quarter due to lower interest rates.

In terms of resources our balance sheet remains strong with ample cash availability to continue building for the future. During the third quarter we slightly increased absolute debt outstanding to 308 million which included 1.7 million of long-term financing not associated with our line of credit.

This continues the very controlled financial leverage that we have employed over the past several years. Our debt equity ratio at quarter-end stood at 96%, up just slightly from 95% at year end 2008, while we maintain $59 million availability under our lines of credit.

Now let's review our operations in detail, beginning with third quarter portfolio purchases and overall market conditions.

During the quarter we acquired 100 portfolios from 12 different sellers. The majority about 95% of our third quarter purchase volume in terms of dollars invested was from the major credit card asset class. The remainder came from pools of utility and installment loan accounts. The majority of the bankrupt accounts acquired during the quarter are included in the major credit card category. Bankrupt accounts accounted for about 61% of our purchase activity in terms of dollars invested.

In Q3, the vast majority of our bankruptcy purchases were fresher bankruptcy filings. Remember, since we buy the similar IRRs regardless of the age of the account we tend to see slightly higher collections to purchase price multiples from fresh filings with more delayed cash flows and slightly lower multiples with more mature already cash flowing filings.

Portfolio pricing was steady to higher during the quarter. The resale market continues to experience little to no volume in terms of offerings. Most competitors with access to reasonable amount of capital appear to be exerting a fair amount of discipline.

On our last call, I spoke about governments at all levels contemplating or adopting shorten statutes limitations, restricting collection activity post statute. This generally speaking defines the time after which an account becomes delinquent they can be in force with the lawsuit.

I said on our prior call that such actions would force collectors like PRA to prefer to work out payments with consumers directly to take them to court much more frequently and much sooner in the collection process than we would otherwise.

During Q3, we saw this come to pass in one stay and in response we had to move swiftly to sue a large number of accounts in that state which would have otherwise been uncollectible after the effective date of the statute.

As a result, during Q3, we incurred more than a million dollars in legal costs were about $0.04 in EPS terms that we would not have otherwise. Neal will provide more color on our strategy in this area in a few minutes.

To account for the risk of these regulatory activities as well as the weak economic environment we have lowered our collection expectations for new purchases and continued to book new purchases with cash collection expectations they are further discounted from our already discounted buying models.

In addition, we continue to build our internal legal capability so as necessary we can quickly and cost effectively move accounts into the legal channel for further collection activity.

Over the longer run we feel confident these moves will help us liquidate purchased accounts are relatively higher levels helping to curtail the larger loan charges we have taken recently.

Moving on to collections as I mentioned earlier Portfolio Recovery Associates recovered a record $92.4 million in the third quarter from owned portfolios up 11.3% from $83 million a year earlier. Each month of the quarter had very similar year-over-year growth rates.

Offering a bit more detail on our collection performance call center and other collections were $48.6 million, up 11% from the same quarter last year. Cash collections from our purchased bankrupt accounts were a record $22.3 million, up 45% from Q3 2008.

As we've discussed for the past several quarters, collections from our internal legal collection strategy, in which we use our own staff attorneys or in select cases use third party attorneys working on a fixed-price basis, were once again a record at $6.2 million in Q3 2009. This is up 194% from the same quarter last year. We expect continued strong growth from this channel for the foreseeable future.

External legal collections were 17% of total cash collections in Q3 2009 at $15.3 million. This compares with 26% in Q3 2008, which was $21.6 million, representing a 29% year-over-year decline. We track owned portfolio productivity in terms of recoveries per hour paid, the core metric that measures the average amount of cash each collector brings in.

As I said earlier, this metric finished at $144.69 for the first nine months of 2009 compared with $131.29 for full year 2008. Excluding the effect of trustee-administered purchased bankruptcy collections, PRA's productivity for Q3 2009 was $115.2 versus $109.82 for the full year 2008. When excluding legal and trustee-administered purchased bankrupt collections, productivity for Q3 2009 was $88.08 per hour paid versus $75.47 for all of 2008.

During Q3 we saw improved site-specific productivity per hour paid of about 11% year-over-year, even as we worked against the recession. As a reminder, this site-specific productivity figure looks only at hourly paid productivity by collection reps. It excludes not only legal and bankrupt collections, but also any non-collector assigned inbound generated collections or collections coming from external activities such as collection agencies.

Productivity was up year-over-year at every call center location. In Jackson, Tennessee, productivity was up slightly year-over-year and down 7% sequentially. Productivity was up 7% year-over-year and down 4% sequentially in Hampton, up 4% year-over-year but down 11% sequentially in Kansas, was up 13% year-over-year, and up 4% sequentially in Norfolk, and was up 100% year-over-year and up 9% sequentially in Birmingham. The Philippines office was up 85% year-over-year but down 15% sequentially.

Tennessee was able to increase its productivity substantially even as it increased hours paid by very significant 37% year-over-year. Kansas to a lesser extent also experienced higher hours paid with 17% growth over the prior year. On an absolute basis, Kansas remained our top call center for the quarter, although monthly productivity there was surpassed by the Norfolk office during September for the first time in a long time.

During the quarter on a relative basis Jackson improved to about 80% of the Kansas standard, Hampton improved to 90%, Norfolk improved to 96%, and Birmingham improved to 60%.

Productivity in the Philippines office did improved somewhat to 36% of the Kansas standard. As a reminder, we recently began focusing the center on accounts that are more difficult to collect. Since the Philippines collectors are cheaper to employ we end up risking less to work these tougher accounts. Because of this change the Philippines centers 36% performance measurement does understate that centers relative capabilities.

Companywide at quarter’s end our owned portfolio collector headcount was 1,312, up about 31 from the end of June. As it relates to staffing, please remember that a majority of our recent bind has been related to pools of bankrupt accounts which require relatively low levels of staff to handle. Please also note that our bankruptcy staff is not included in the collector headcount numbers I just shared with you.

Our fee-for-service businesses and the collateral location skip tracing and government services arenas. Our-fee-for service businesses saw revenue decline 10.1% from the same period a year earlier to $14.2 million.

The revenue and income of our skip tracing unit fell somewhat from the same period a year ago as it dealt with volume and business mix changes from clients. As I mentioned on our Q2 call, our increased capacity in Las Vegas together with several newly signed clients and the development of new product offering should work to restore growth to the IGS business over the short run. We saw this improvement during the quarter as both revenue and operating income increased when compared with Q2. We expect this trend to continue.

The government services business performance was hurt during the quarter by declining sales-and-use tax in California, driven by the recession. Although we continue to sign new clients and see strong demand from municipalities given the fiscal pressures many of them face these days. This recession related revenue slowdown from some of our larger clients was disappointing.

Although we anticipated seasonal improvement in Q4 due to year-end business license processing the sales–and-use tax decline will undoubtedly keep persistent pressure on the government services business for some time.

Before I turn the call over to Kevin Stevenson, PRA's Chief Financial and Administrative Officer, I'd like to have Neal Stern, our Chief Operations Officer of the owned portfolio business, give you a summary of our operating strategies.

Neal?

Neal Stern

Thanks, Steve. PRA's operational strategies and results in this third quarter as in prior periods reflect our efforts to operate as effectively as possible amid the current macroeconomic and evolving legislative landscape. Two collections trend illustrate this particularly well.

On recent calls I discussed the fact that our total number of payments has been growing dramatically. Now is again the case in the third quarter. In Q3, the total number of accounts makes a monthly payment to 689,000. 33% higher than in Q3 2008. Further, the total dollars our call centers received directly from refinancing companies fell to just over 1.5 of 15 of total collections in the third quarter, down from the still modest 2.5% a year ago.

In total, our average call center payment size was down 12% over the prior year. In addition, we continue to see increase collection and accounts purchase more than five years ago. Excluding legal and bankruptcy collection our call centers in the third quarter collected over $4 million on these portfolios, a 61% increase over Q3 of 2008.

Our ability to continue operating effectively given these two trends highlight the true value of our increased dialer capacity which in Q3 was 22% higher than last year. And our improved ability to this quarter commence. In addition, they demonstrate our ability to be a patient collector, because we do not resell accounts we can work with consumers as their financial circumstances evolve.

In fact, the only burden imposed by a shift away from one-time settlements to a monthly payment are in increase need for efficiency and a revised view of our collection curves. In the end we believe that with these managed properly we stand to collect a larger percentage of the balances owed to us.

Our ability to continue with more patient approaches to collections was impacted as Steve discussed by new legislation that eliminated our ability to call consumers and asking them to pay them debts that will be on the statute of limitations. Because of this legislation we had to file suit and approximately 7500 additional accounts that we might have otherwise chosen to work in our call centers. This raised our legal expenses for the quarter in undoubtedly will result in a modest offset of cash collections from our call canters to our legal channel in the coming quarters.

Despite this recent uptick of activity for our legal channel, total legal collections remained disappointing. For the quarter our external legal collection dollars were down 29% over the prior year, partially reflecting economic conditions but also reflecting our shift to the internal collection process.

Staff was added in Last Vegas and Norfolk to accommodate growth in internal collections which in the third quarter finished 45% higher than Q2 2009 and 75% higher than in Q1.

Overall, our total legal cash collections in Q3 finished 9% lower than the prior year of the net impact after fees is closer to 5%. Moreover, we believe that we are well-positioned to realize important savings from our internal process in the coming quarters.

I will reiterate our absolute commitment to continue working with external law firms that continue to produce great results for us. But firms that under produced know that we have a very viable alternative. Closing the productivity gap between our collection sites remains at the front of our operational objectives given the sizable opportunity that gap represents.

Had all our call centers delivered the same cash collections per paid hour as our top site we would have realized another $5.8 million in collections for the third quarter. This estimated value gap was down by almost $3 million from Q2 and in September our Norfolk site displaced our Kansas site as our most productive location and showing a very strong but healthy competition for the coming quarter.

With that I will turn the call over to Kevin Stevenson, PRA's Chief Financial and Administrative Officer. Kevin?

Kevin Stevenson

Thank you, Neal. Although on aggregate I was very pleased with our cash collection performance this quarter as it exceeded our accounting projections by a solid margin. Several legacy pools continued to underperform and caused us to post allowance charges totaling $8 million. These allowance charges were doubled the year ago period and caused us about $0.31 of EPS.

As a result, in the third quarter, net income decreased 11.8% to $10.1 million while EPS came in at $0.65 compared with $0.75 in the year ago period.

Total revenue for the quarter was $68.6 million, which was flat in the same period one year ago. Operating income was $18.8 million, down 12% from the year earlier period, while net interest expense decreased from $3 million one year ago to $2 million in Q3.

Return on equity was declined from Q2, remaining unacceptably low at 13% for the third quarter due to a large part to our continued large allowance charges. We are very focused on bringing that number back towards our historical 20%.

Our weighted average interest cost on the acquisition line during the quarter was 2.56%, down from 2.7% in Q2. At quarter-end borrowing levels, each 100 basis point swing in LIBOR either costs or saves us about $200,000 monthly.

Breaking our third quarter revenue down into three components, the majority of total revenue are $54.3 million came from income recognized on financial receivables. This is revenue generated by our owned debt portfolios.

Income on financial receivables is derived from the $92.4 million in cash collections we recorded during the quarter, reduced by an amortization rate including the $8 million allowance charge of 41.2%. The amortization rate compares with 40.3% in Q2 2009, 42.9% in Q1 2009, 36.5% in Q3 2008, and our full year 2008 rate of 36.8%.

As I mentioned, during the quarter PRA recorded allowance charges totaling $8 million, which compares to $3.8 million in Q3 2008. Allowance charges for the first nine months of 2009 now total $18.2 million versus $19.4 million for all of 2008. Life to date reserves since the change to SOP 03-3 now stand at $41.8 million.

I would like to continue the approach discussing allowance charges I initiated on our Q2 call. I will talk about a few of the larger charges, but not step through each and every pool. Those interested in additional detail we have included a chart in our press release that details our allowance charges by fiscal quarter, broken down by year purchase.

I want to remind everyone that we account for revenue from our overall portfolio on a pool by pool basis. When pools underperform as they are more likely to do in a recessionary environment we do not lower the yields rather we move relatively swiftly taken allowance charges which show up right away as a revenue reduction on our income statement.

In contrast, when pools overperform that overperformance is not reflected right away. Only after there is sustained evidence of overperformance we make an upward adjustment and then we will raise the yield on that pool going forward. This adjustment of an increased yield will not show up on our income statement right away but will only show up in the future and gradually over the pools remaining life. I believe this bias exist today to a greater extent than we have seen in years.

In particular, our 2009 purchases have been overperforming expectations by a sizable margin. However, we feel it is still a bit too early to significantly adjust yield and/or cash flow expectations for these pools. This conservative implementation of accounting guidelines is currently further compounded by a longstanding position against permitting accretion during the first six months of a new pools life. Instead of allowing accretion we adopt to use cost recovery or cash method as permitted by the SOP.

Accretion or recognizing more revenue than cash collected adds to the net finance receivable now of the given pool instead of amortizing it. In other words, capitalizing revenue. Accretion is a technically acceptable event under the SOP and generally occurred in situations where cash flows are ramping up early in a pools life. Pools with low forecast initial cash flow curves are more apt to experience accretion than pools with a more front end weighted cash flow curve.

Bankruptcy pools with mostly freshly filed account are perfect example of this kind of phenomenon. Although we are not about to change our position on accretion it did cost us about $3 million in delayed revenue in Q3 2009 from purchases made in 2009 loan. Of course, these revenues will be recognized in future periods.

The size of the allowance charges is driven to a great extent by variability across our pools. Once again, if we had accounted for our portfolio this one giant pool or in quarterly aggregated pools using the older accounting rules of PB6. We would have taken no allowance charges whatsoever in Q3.

As we said before given what we believe to be the correct and conservative application of our accounting policies some allowance charges are always going to be with us. As I promised I will not step you through each quarter’s aggregated deals today, instead, I would just briefly mention the larger reserved portfolios.

2003 and 2004 contributed net reversals. While 2005 to 2007 contributed a net charge of $3.5 million, up rather sharply from the $1.9 million in Q2 2009. The change quarter-over-quarter centered on one in 2005 pool and one in 2006 pool that incurred $1.1 million and $1.3 million on allowance respectively. The net shift in those two pools totaled $1.5 million. Several of pools increased and decreased but they essentially netted zero dollars.

If I could generalize the shift it was generally a weak July and August that led to this change. When you review the chart in our press release you clearly see this approximately 60% of the third quarter’s net allowance charge came from the 2008 tranche of accounts.

The majority of the accounts in these pools come from several forward flow transactions that were priced in one during 2007. But we were required to continue to buy throughout 2008. In hindsight these portfolios are likely some of the least profitable purchases we have made in our 14 years of business.

As you look more closely at the $4.8 million in allowance charges from that 2008 tranche we find that 2008 Q1, Q2 and Q3 non-bankrupt portfolios contributed all of the $4.8 million reported. Looking back into Q1 and Q2 of this year we have incurred $2.1 million and $2.4 million on these very same deals. We continue to be very focused on these tranches to paper as they represent 60% of our total quarterly balance charges and we will keep you apprised of their status.

Our bankruptcy portfolios are performing nicely as a group and ended up with a net allowance charge for the quarter of $90,000. As I mentioned on our Q2 call, we are closely watching our bankrupt portfolios and we are evaluating book yields and deal multiples. I promise to keep you apprised on that front.

In Q3 we did indeed allow our bankruptcy portfolio yield to increase. As I mentioned on prior calls one of our goals has been to be very cautious on increasing yields and deal multiples on bankruptcy pools. Given the allowance as we incurred in 2007 and 2008 on older bankruptcy pools. However, they are performing nicely and we had no allowances on bankruptcy pools purchased in periods after Q1 2006

Before mentioned changes to yields and to a lesser extent deal multiples impacted primarily to 2008 and 2009 bankruptcy deals, all of which are performing strongly relative to expectations.

Moving on, approximately $589,000 of operating expense in Q3 was due to non-cash equity compensation that was booked during the quarter relating to our 2009 performance-based restricted share plan as well as other equity-based awards. During the quarter, cash collected on fully amortized pools was $6.6 million compared to $7.1 million in Q2 2009, $5.9 million in Q1 2009 and $4.8 million in Q3 2008. In referring to fully amortized pools I mean purchased pools with no remaining debt basis on our balance sheet.

This 37% year-over-year improvement is attributed to numerous recent advances in scoring and segmentation strategies which are permitting us to more efficiently and effectively uncover individual accounts that are more prone to make payment from our portfolios.

Eliminating the fully amortized pools from our amortization calculation, the core amortization rate for Q3 of 44.3%, up substantially from the 38.7% we saw in the third quarter of 2008, but sequentially up modestly from the 43.7% experienced in Q2 2009.

After a very strong Q2 for our government services group, sequential revenue and income fell substantially in Q3. As Steve described, this decline is largely related to the recession-driven decline in sales-and-use tax revenue in the state of California.

Where we derive fees from auditing sales-and-use taxes, we are paid a percentage of recoveries and typically bill over certain break points. So when tax revenue falls below a certain point as in Q3, our fees can drop fairly substantially.

We do have a good pipeline of clients in government services and are working hard to overcome this decline, although we do anticipate the impact will continue while the economy is slow.

At IGS, lower revenue drove reduced operating income for the year-over-year comparison. However, sequentially we did see improvement as a result of new clients.

Total commissions and fees generated by our fee-for-service businesses were $14.2 million in Q3. This compares with $15.8 million in the year ago quarter. Our fee-based businesses accounted for 20.8% of the Company's overall revenue.

As a reminder, our quarterly amortization expense related to acquired intangibles from our various business acquisitions is about $668,000 per quarter. The third component of total revenue or cash sales of finance receivables was once again zero for the quarter as it has been in every quarter since we became public in late 2002.

Operating expenses in Q3, grew 5.6% when compared to Q3 2008. This was primarily driven by compensation and play services growing $3.9 million, or 17% and communication expense increasing by $1.2 million, or 53% primarily as strategically targeted letter campaigns increased.

The increase in compensation expenses during Q3 relates primarily to the addition of IT employees as we seek to increase project throughput inside legal employees as we continue to build that capability as well as growth in our call center collectors.

These cost increases were partially offset by a decrease in legal and agency costs and fees of 21% or $3.1 million as we pull more legal work in-house and as our IGS business with repossession agency stall somewhat with a decline in volume there.

Operating margins during Q3 were 27.4% compared with 29.9% in Q2 2009 and 31.3% in Q3 2008. Without the margin dilution caused by the fee businesses, the operating margin would have been about 510 basis points higher at 32.5% in Q3. Without the amortization of intangibles, operating margin would have been at 28.4% in Q3 2009 versus 32.3% in Q3 2008.

Operating expense to cash receipts as I mentioned before is perhaps a more insightful efficiency ratio since it removes the effect of variations in purchase price amortization rates as well as allowance charges.

Operating expenses as a function of cash receipts during Q3 2009 were 46.7%. This is down from 47.7% in Q3 2008, but up somewhat from 46.4% in Q2 2009.

Our balance sheet remains strong during the quarter despite substantial purchases of new finance receivable portfolios in the amount of $76.7 million. As of quarter end, the outstanding balance in our line of credit was $306.3 million, up $16.5 million during the quarter. Our total credit facility is $365 million, leaving us with $59 million of availability.

Cash balances increased sequentially during the quarter to $19.9 million. While our leverage has increased dramatically from zero two years ago, on a relative basis, it remains quite low at 96% of equity. We are producing strong internal cash flow and are well capitalized.

To further update you on our financing situation, as I mentioned on our Q2 call, between our line of credit and our internally generated free cash flow, we believe we have sufficient liquidity to take advantage of current investment opportunities.

We remain, however, very cognizant of current market fundamentals in the debt purchase market, which because of significant sales supply and tight capital, could cause unforeseen buying opportunities to arise.

In order to preserve all of our options we did file a $150 million shelf registration during the quarter. Although it is our strong preference not to issue new shares it is our stronger preference to be able to capitalize on appropriately profitable acquisitions of portfolios and companies. Should we find more highly profitable opportunities than we have currently available capital we will turn to our shelf.

We continue to operate all aspects of the business with a long-term focus. We feel this is particularly important in today's difficult economic environment and its impact on our businesses. We view our own portfolios as long-term asset and we never make collection strategy decisions that favor short-term over longer-term results. Likewise, we continue to invest in all of our businesses so that we can compete from a position of strength regardless of the economic conditions.

I would like to close with several final important points. First, as I've described in great detail, our revenue recognition methods typically cause us to take allowances quickly when pools underperform while recognizing overperformance slowly over a pools future life. This occurred to a significant degree in the third quarter, driving financial results down to levels we reported today.

Second, we've been making significant investments in well priced pools of charged off debt over the past 18 months. Based on our underwriting curves and actual collection trends, we anticipate strong cash production from these pools over the next 24 months to 36 months.

Third, we have recently been very successful in improving our already strong account scoring and segmentation analytics as well as our collection processes. We believe these will continue paying dividends in the form of improved operating ratios.

Fourth, related to the prior point and also related to the payment versus settlement phenomenon described by Neal, we are modestly bullish on the longer-term tails of even some of our older portfolios, but yet to have a comfort to increase the ERC expectations which could lead to higher future yields.

Finally, our bankruptcy business has now achieved a level of underwriting expertise and operational scale that we feel will allow it to produce significant growth in cash collections and income contribution over the next several years. As a result, our internal budget calls for revenue and earnings to grow substantially in 2010.

With that, I've completed my prepared comments. I would like to open the call up to Q&A. Steve, Neal, and I will be available to answer your questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Bill Carcache with Fox-Pitt.

Bill Carcache – Fox-Pitt Kelton

Good evening. First question I guess is given with your greater emphasis on legal collections, how do you think about the impact on your expenses and how should we think about that going forward if we see a shift from call center collections to legal, kind of the net bottom line impact or at least the net impact on your expense ratios?

Steve Fredrickson

This quarter there was again kind of a unique set of circumstances where we pushed through more volume than we might have otherwise chosen to do because of some legislative changes, but the answer to your question over the long run is, we think it's possible that, that legislative trend could continue and we think it's possible we could need to push a greater percentage of our accounts into the legal channel.

It's always our stated preference to try and work this out in our call centers and avoid legal action, if we can. That said if this trend should continue or grow that's really the reason we're building this internal capability. We can have much stronger collection results and do so at a much more reasonable rate in the markets that we're currently operating so, we're very excited about building up this internal capability.

We'll still rely on some external firms where we have strong performance and I think the combination of the two will lead us to have very negligible impact from a net fee perspective, if we have to increase our legal collections significantly.

Bill Carcache – Fox-Pitt Kelton

Can you say anything about any kind of impact on margins or I guess what that would do to just overall expenses?

Kevin Stevenson

This is Kevin. I think Bill, one of the things it would be it would shift kind of geography a little bit. You would end up from external to internal legal the internal costs are going to be centered around salary line for our attorneys and you still have the same costs in the legal line, but the fees you would have paid the contingent guys would move up into the salaries and our hope would be that our people will be a lot more efficient from an expense to cash collections ratio.

Bill Carcache – Fox-Pitt Kelton

Relative to the external lawyers.

Kevin Stevenson

Right.

Bill Carcache – Fox-Pitt Kelton

Right, but what about relative to if your first choice was to, and you guys have a huge competitive advantage in collections via your call centers, I guess the shift from call center to in-house lawyers as opposed to I could see how you guys have stronger performance from your in-house lawyers relative to external lawyers, but I guess how do you think about the shift from call center collections to in-house lawyers?

Kevin Stevenson

Bill, I think certainly it would accelerate the process you'd end up with – so first of all, it would be the cost. Don't forget the cost. We do expense those so they'd be upfront. Secondly, you would have attorneys on staff which you should be able to model. I think if you're looking to build models, I think that maybe a real concern should be focusing on bankruptcy, because I think if you start looking at salaries to cash collection ratios, that's probably going to influence it more than the core business. Do you want to say something, Neal?

Neal Stern

My answer would just be that if there were a shift from call center to legal channel in general, you would have an upfront higher cost ratio because you have to pay for the court costs and what not upfront over the longer run with this internal legal channel I think that they would be fairly comparable over the long run.

Bill Carcache – Fox-Pitt Kelton

Right, so, forgetting about the accounting though just thinking about the economics and ignoring the timing and just looking at the actual collections, net cash collections, would that actually come down as a result of this shift or –?

Neal Stern

I'd say they be on par.

Bill Carcache – Fox-Pitt Kelton

Okay, and separately, given your available capacity under your line of credit is now at $58 million, you talked about kind of having the shelf there for any opportunities that come up. Would you consider deploying part of the capital from that shelf instead of maybe the acquisition of attractively priced portfolios, maybe another kind of fee-based businesses basically for M&A?

Kevin Stevenson

Yes, yes.

Bill Carcache – Fox-Pitt Kelton

Okay and just to be clear, your third quarter '08 numbers reflect the acquisition of MuniServices and Broussard, right?

Kevin Stevenson

Yes.

Bill Carcache – Fox-Pitt Kelton

Okay. So, we're looking at the year-over-year numbers there, it's out their apples to apples?

Kevin Stevenson

Yes.

Bill Carcache – Fox-Pitt Kelton

So, I guess final question then is thinking about this basically the first ever year-over-year decrease in commissions for these fee-based businesses. Some people have kind of viewed them historically as kind of being uncorrelated businesses, but it sounds like from your comments about the sales-and-use tax and the negative impact from the economy, is it fair to say that you don't really view them as uncorrelated that they are essentially at least to some extent impacted by the recession?

Steve Fredrickson

I think that what we saw is businesses that are weakly correlated at best due to the extreme economic situation that we had to deal with. We saw a number of behaviors occur that we don't typically see. On the skip tracing repossession side we saw clients experiment with strategies that would help them keep their costs down and that interrupted some of our placements. We believe that those experiments didn't turn out as positively as anticipated and so we are as a result seeing an increase in volume once again.

On the government services space, we deal with this sales-and-use tax especially in California on a delayed basis and it's generally a two quarter to three quarter look back for us and so we are right now, in this quarter, we're coming through the very low point of Q4 2008 and we simply saw some things occur there that we typically wouldn't model in so, I think it was more of the extreme economy that caused that to occur as opposed to really being a tightly correlated businesses.

Bill Carcache – Fox-Pitt Kelton

Okay, and sorry, finally, when you said the seasonal improvement, that's relative to Q3, so we would expect a seasonally stronger number in Q4, but can you give a sense as to what you think it would look like relative to Q4 of last year?

Steve Fredrickson

I think that we're out on a limb as far as we want to be as far as predicting the future. Last year, we saw some particularly nice pickup at RDS. They do a lot of business license processing and we'd anticipate a similar type pick up, but beyond that we're just not comfortable commenting.

Bill Carcache – Fox-Pitt Kelton

Okay, great. Thank you very much. Appreciate it.

Operator

Our next question comes from the line of Mark Hughes with SunTrust.

Mark Hughes – SunTrust

Thank you very much. This is something about the 2008 paper and the four flow contracts that makes it difficult to get ahead of the game in terms of allowances. You had mentioned that last quarter as well. When do you think that will be mark-to-market so to speak?

Kevin Stevenson

Mark-to-market for, Mark, good. I'll tell you the same thing I did last quarter. We're chasing that curve. We're trying to get that thing shaped right. And that's one of the reasons though we kind of gave you the insight to 2010. I understand the challenge that you guys experience. So all I can tell you is that we're moving the curve down. We're trying to get the stuff shaped correctly. In fact, Neal brought it up as well. Additionally, being priced in '07 we've got issues with (inaudible) arrangements today as opposed to a plain old Jane [ph] payment.

Neal Stern

I said in my comments, our monthly payers were up 33% over the prior year, which is fairly stunning, but average payment is down 12% and all of that really messes with curve shape, but we're seeing very strong collections from pools that we've owned for more than five years so there's reason to be optimistic that those tails will perform well, but that's not booked into any of (inaudible) curve at this point.

Kevin Stevenson

And that's why I put it in my script that, but with all that considered these deals will probably still be some of the least profitable deals we've purchased. They were booked at kind of lower IRRs and they are underperforming those curves so it is still a challenge for us.

Mark Hughes – SunTrust

Right. You talked about the $3 million in foregone revenue because you don't accrete. How much capital or how much purchase price is tied up in those, I guess those are fresh BK, which will as I understand eventually pay off, but just are not generating revenue now. How big of an impact is that?

Kevin Stevenson

That $3 million would be generally related to the Q3 and Q2 again primarily and some Q1 BK. So I guess you can probably do the math yourself, just look at how much we bought Q1, Q2 and Q3. The bulk of its going to be Q3 and Q2.

Mark Hughes – SunTrust

Right and so, what you're saying is there's not any yields on that at this point?

Kevin Stevenson

Well, we'd have used the cash method on those.

Mark Hughes – SunTrust

Right. So, since you're not getting much cash in the door, you're not recognizing much revenue that –

Kevin Stevenson

That's correct. And with these freshly filed BKs, there can be kind of a long kind of a low tail for quite a number of months and so again we refer to it as cash capped internally and that's where we stop the income recognition. It's about $100 million. Is that right guys? About $100 million of purchase price that's in that group.

Steve Fredrickson

And Mark, I don't know if it helps or not, but just to give you a little feel how the age of the bankruptcy portfolio has shifted, it had been running pretty steady at around the average age of an account since filing was around 12 months during most of 2007, 2008 and on the trailing 12-month look back as of 9/30, that has been reduced to about five months so we are getting fresher paper and with it much lower payments in these periods that obviously will accelerate as those accounts age.

Mark Hughes – SunTrust

Right. But, had you invested in other assets then the cash and revenue impact would be much more positive.

Steve Fredrickson

From an immediacy standpoint, cash related to investment, this type of bankruptcy investing is about as extreme or bad from that perspective as it gets.

Kevin Stevenson

I guess, I would add just from a technical accounting standpoint, we're talking about cash collections because the revenue, remember, revenue is based on a yield so theoretically if you deployed $100 million on freshly filed like we did it was a $3 million cash cap. If those deals had been more aged or seasoned portfolios, theoretically, you buy with the same IRR, the revenue would be roughly the same, you'd have had a lot more cash.

Steve Fredrickson

Right, exactly.

Kevin Stevenson

$3 million higher though.

Steve Fredrickson

Right, sure.

Mark Hughes – SunTrust

And then, with respect to your outlook for next year, the consensus is around 350. Is that substantial growth?

Kevin Stevenson

We had a lot of internal discussion on this matter and that's why we settled on. So substantial is probably bigger than significant. I don't think I want to put a number on it though.

Mark Hughes – SunTrust

Okay, thank you.

Operator

Our next question comes from the line of Hugh Miller with Sidoti.

Hugh Miller – Sidoti

Thanks for taking my questions. Obviously I'll be quick because I think a lot of people have questions. First one was with regards to the $77 million acquired in the third quarter portfolio. I didn't catch what the split was between bankruptcy and traditional. If you could give that to me that would be great.

Kevin Stevenson

It's about 60%.

Neal Stern

61% BK.

Kevin Stevenson

Yes, Neal's right, 61% BK.

Hugh Miller – Sidoti

61% BK, wow. So that means, is it safe to say that given the reduction in multiple discount on BK to traditional that you guys are much more pleased with the opportunities in the BK market now?

Steve Fredrickson

We don't feel as though we are shifting acceptable investment dollars from one bucket to another. We're generally acquiring everything that we see that meets a current hurdle rate that we're using. We just hit on more bankruptcy deals this year than core. I guess it's just kind of the way things are settling out.

Hugh Miller – Sidoti

Okay. And on a sequential basis there was a drop in communications expense there. What was driving that? Was there a pullback in like mailers during the quarter or something like that? Any color there?

Kevin Stevenson

No, in fact, we had a pretty strong mailer program. Again, you're comparing it to Q2. I've got a little more granularity here than you're looking at. A lot of stuff in there, but yes, it would have to be based on the level of campaigns.

Hugh Miller – Sidoti

Okay, so nothing that's jumping off the page then?

Kevin Stevenson

No, nothing that's jumping off the page right here to me.

Hugh Miller – Sidoti

Okay, and Steve's comments on pricing, I heard steady, was it steady to slightly higher or steady to slightly lower on pricing that you guys were seeing during the quarter?

Steve Fredrickson

Our view is that it was steady to slightly higher.

Hugh Miller – Sidoti

Okay, so possibly a little bit more competition coming in here. Okay, great. And last question is do you have the ERC figure as of the end of the third quarter?

Steve Fredrickson

We'll get you in a second.

Hugh Miller – Sidoti

Okay, you can take the next caller and I'll get that.

Steve Fredrickson

All right.

Hugh Miller – Sidoti

Thanks.

Operator

Our next question comes from the line of Bob Napoli with Piper Jaffray.

Bob Napoli – Piper Jaffray

Good afternoon.

Steve Fredrickson

Hi, Bob.

Kevin Stevenson

Hi, Bob.

Bob Napoli – Piper Jaffray

Let's see here. How to go about this? If you look at and your goal was 20% return on equity. If you didn't have any impairments this quarter your return on equity would have been pretty close to 20%. As you look at next year's earnings and substantial growth, are you targeting getting back to that 20% ROE?

Steve Fredrickson

Well, Kevin commented specifically that that's our long-term goal. We're not prepared to specify whether that's a 2010 achievement or not, but that's definitely our long-term goal, Bob.

Bob Napoli – Piper Jaffray

Okay, if you looked at payment supply to principal this quarter, which includes the $8 million impairment, if you backed out the $8 million impairment, your amortization rate or your payment supply to principal as a percentage of cash collected would have been about 32%. Now that seems low. Does that –?

Steve Fredrickson

That's right.

Bob Napoli – Piper Jaffray

Shouldn't it be with the amount of bankruptcy paper in there, shouldn't that number be a higher number?

Kevin Stevenson

No. So first of all, we're using the cash method, right, for the bankruptcy. So while we kind of left that $3 million on the table in my script, theoretically, if we'd booked that you'd have negative, for those pools, you get negative amortization or accretion. So by capping it using the cash method, you had zero amortization for those pools.

Additionally, I would say that we are getting our curve shape better. So we are tending to perform closer to our expectation so that should kind of narrow that amortization because remember if you look at kind of a core deal, let's just think about a core deal for a second, that amortization in the first fiscal year should be pretty low. It depends on how your curve looks, but 32/5 x allowance strikes me as, based on how much we're buying it strikes me as a good number.

Bob Napoli – Piper Jaffray

Your substantial growth next year means that you feel like your impairments are going to be mostly behind you. It's got to be, right? I mean, I know you always said there are always going to be some impairments but the size of impairments has got to moderate.

Kevin Stevenson

I would say very good catch, yes, I'd say allowances will always be with us, but between some combination of reduced allowances or increased yields, that's how we feel. That's how we submitted our budget in some combination thereof.

Bob Napoli – Piper Jaffray

How much is left in that forward flow on your balance sheet that is the least profitable paper that you guys have ever purchased?

Kevin Stevenson

I can't dig that out, because we're talking about these flow transactions that are inside a quarterly deal. We evaluated that statement really on the deal level itself, not the quarterly aggregated deal.

Bob Napoli – Piper Jaffray

Have you tried to kitchen sink it to the extent that you can? I mean, I think from an impairment perspective, rather have the kitchen sink than the Chinese water torture method.

Kevin Stevenson

I guess what I'll think about is that we – so what Neal has done, you mean from an operational perspective?

Bob Napoli – Piper Jaffray

No, I mean, from an accounting perspective as you look at those pools.

Kevin Stevenson

I got you. I'm thinking operationally. It's been our practice, if you look back at the deals, if you look at the disclosure on the press release you're going to see kind of a consistent approach at the way we look at these curves and we're shaving stuff off these curves, trying to deal with allowances that are current, and trying to get those curves kind of brought down to the right level. We feel that, I feel it from an accounting perspective the kitchen sink is not a good accounting method.

Bob Napoli – Piper Jaffray

Okay, all right. Thank you very much.

Operator

Your next question comes from the line of Sameer Gokhale with Keefe, Bruyette & Woods.

Sameer Gokhale – Keefe, Bruyette & Woods

Okay. Thank you for taking my question. Just a couple of questions. First one, Steve, you know you had referenced the one state which I think you talked about last quarter, North Carolina and the change there to the statute of limitations and the impact, and then, the you had referenced to New York, it has been potentially another state exploring that same issue. Now, there seems to be a coalition of that purchasing companies that are trying to approach this issue and dialog with the regulators. Can you give us an update on where that stands specifically?

Steve Fredrickson

I mean, I think you have provided as good of an update as we have. There are even beyond North Carolina and New York, there are other states where there are in various levels or various states of approval process, other such bills. And as you can imagine, the debt buying community, and in some cases, financial institutions as a whole, which would be affected are trying to communicate to the legislative world what we believe are lot of negative unintended consequences, which could result from continued changes like this.

I think that we have had a few of these early ideas pop through. I think we feel better in a lot of situations that we were able to get in there and start the communication process earlier. And so, we have a reasonable shot at getting a good education program going and hopefully, either shooting the stuff down or getting it thoughtfully amended, so that it doesn’t impact us to as greater degree. But at this point at least, it is all kind of a fluid situation.

Sameer Gokhale – Keefe, Bruyette & Woods

Okay. Thank you for that color. And then another question, which I think is for Kevin, you know, I would like your thoughts as to how to think about this, or what may be wrong in this thought process, but if I look at or I calculate your, like an estimate of monthly collections, gross collections for you guys, I think it’s in the ballpark of about $23 million or $24 million a month now, this is for the portfolio less your bankruptcies, the non-bankruptcy receivables.

And if I look at least as of the last quarter, the carrying value of those receivables was about $401 million, I assume it’s gone up this quarter, but if I use that and calculate like a multiple, so I take that would be carrying value divide that by the monthly collections, that multiple works out to be somewhere in the ballpark of about 17 times, and if I run the same calculation for competitors, I come up with about 13 times for Encore Capital and about 11 times for Asset Acceptance.

So, what might account for that disparity? I mean, this is all again non-bankruptcy stuff. Shouldn’t we be in pretty close ballpark and how do you think about that differential? Should we think okay, well if you were to normalize PRA and get it to the other multiples of the other two companies, there is like $85 million or $100 million of revenue that won’t be collected in the future if the multiple comes down, I mean, what is wrong with the thought process?

Steve Fredrickson

I think that part of what you could be missing is assuming that all debt collectors go after the portfolios at kind of the same pace. We believe that there are some people whose – and understand me, I am not faulting the strategies, I think different debt buyers can employ different strategies and still have very satisfactory result. But I believe some of our competitors would rather get settle more quickly, get cash flow in more quickly, and forego the tail of the portfolio. We go at things a little bit more slowly. We purposefully try to work with people before we sue them, and we tend to have longer tails, and as Kevin and Neal both commented based on the economic situation and everything that we are dealing with, we have what we think is a lot of opportunity in those tails that we have not yet recognized. So, it’s kind of pent-up ERC, if you will, and to the extent we get comfortable recognizing that ERC, you would see those relative ratio shifts somewhat.

Sameer Gokhale – Keefe, Bruyette & Woods

Okay. So, in your case if we say we, average use by competitors, let’s say about 11 or 12 times, and yours is about 17 times, and that differential, let’s say $80 million to $100 million. That $80 million to $100 million is the kind of incremental revenues that you expect to collect over the next two to three years on a weighted average life of the portfolio, because of your differentiated collection strategy. That’s another way of capturing that, is that fair?

Steve Fredrickson

I think it’s a potentially very complicated issue with a lot moving parts, and you are trying to simplify it. You know, I will just go back to my comments and say I think that strategy and pace is a part of it, and I think also our approach on the tails and recognizing ERC on tails is a part of it as well. Certainly, buying pace relative to the competitors plays a news as well.

Sameer Gokhale – Keefe, Bruyette & Woods

And then how should I think about the trend line in that multiple? If we look at it for you guys versus your peers, for your company, it is going to promote 11 to 17 for the other peers, it’s gone somewhat 11 to 13 or 9 to 10. So, there’s that more of a move up, how should we think about the slope of that, is that due to changing selections practices that, that’s attributable to or is there some other reason for that?

Steve Fredrickson

We have specifically stated that we are experiencing far fewer balance in full and settlement in full than we have historically. And generally, those balance in full and settlement in full are aided by a strong economy where people either have the ability to refinance to gain access to other consumer credit, or get assistance from friends, relatives, you name it. We have chosen not to compromise what we believe is the future collectability of our portfolio by changing the rates at which we are ready to settle out accounts.

So, in keeping those relative settlement amounts rather steady, what we have done is driven down the amount of accounts that we settle, driven down the amount of accounts that we are taking payments in full on at the same time, and we are driving into more payers. I don’t know what our other competitors are doing. They may be choosing different strategy and saying whereas in the past, they may have had a 60% average settlement rate, they may have dropped that to 50% or 40% in order to try to accelerate cash flow. I do not know if they are doing that or not, but that could be another possible explanation. But that’s definitely happening with us. We are seeing more and more of our payments come in via payments stream. I mentioned in my script there was a 61% increase in cash collections and portfolios owned more than five years for our call centers, that was $4 million, and so, I think inherent in that is some optimism about how older portfolios will perform in the future.

Sameer Gokhale – Keefe, Bruyette & Woods

Okay. That’s interesting and helpful commentary. I guess we will try to circle back with the other companies and try to put things on an apples-to-apples basis, but thank you very much for your call. Thanks.

Steve Fredrickson

You are welcome.

Operator

Your next question comes from the line of Rick Shane with Jefferies.

Rick Shane – Jefferies

Thanks guys for taking my questions. Kevin, you made the comment that you beat your cash collections projections for the quarter, how much was the variance?

Kevin Stevenson

I didn’t disclose that, Rick.

Rick Shane – Jefferies

Okay. Was it significantly – do you think the terminology used before about significant or material, was it a material beat or was it pretty close?

Kevin Stevenson

That was pretty healthy; it was a pretty healthy number. So, that’s a new word for you.

Rick Shane – Jefferies

No problem, thanks. As we head into the fourth quarter, obviously you guys have pretty detailed internal projections. This is an interesting quarter, because by your estimates, or by your assumptions, you beat what, your expectations. Are you expecting given seasonality that cash collections are going to be up or down sequentially during the fourth quarter?

Kevin Stevenson

If you call a value, our insight to 2010 is all we have given. So, I think that we will leave it at that and we didn’t provide any guidance or insight on Q4.

Rick Shane – Jefferies

Okay, I will respect that, I will move on. In terms of, you made the comment regarding basically having to – with the regulatory changes, changing the tail assumptions on some of your pools and accelerating legal channel or driving things to the legal channel or more quickly so that you can prevent a statute of limitations from towing. What was the implication in terms of the increase in allowance associated with potentially reducing those tails?

Kevin Stevenson

So, actually –.

Steve Fredrickson

I just wanted to clarify. So, what happened here was nascency changed the length of the statute of limitations, what happened in this scenario was, is that you can’t call people who are past the statute of limitations. So, there is a some set of accounts that we would normally let go beyond the statute of limitations knowing that we would have some call center opportunity with them. Without that opportunity, if and the only choice that was left was to file a suit. So, it’s an important distinction.

Rick Shane – Jefferies

Okay, that doesn’t near to my question, but it brings up another interesting question. Basically, you were calling people after the statute of limitations had towed and trying to get them to essentially voluntarily prepay given that the debts at that point were abolished?

Steve Fredrickson

When you say –

Rick Shane – Jefferies

Or the obligations were obligated or whatever the terminology would be?

Kevin Stevenson

There is a subset of people who want to repay their debt, and we certainly would call and ask them to do so.

Steve Fredrickson

And I don’t want any of us to turn into jailhouse lawyers here, but the mere occurrence of statute of limitations running, in most cases, doesn’t forgive aggregate blow away the debt. It simply makes it unenforceable via legal needs.

Kevin Stevenson

We have never, obviously never sued anyone who is beyond the statute of limitations knowingly, and so that was an impact, and there’s just a subset of people we thought we would we able to work within our call centers where that wasn’t an option. So, I don’t know that, that affects the tails at all. We expect that after pursuing legal action, there is a very healthy tail legal collection. So, I am not sure that it impacts the tail in any way.

Rick Shane – Jefferies

Okay, so it didn’t – there was no impact related to the allowance from this?

Kevin Stevenson

I got it. So, your question is, was this event – did I trigger somehow part of this 8 million?

Rick Shane – Jefferies

Exactly.

Kevin Stevenson

I did not. Yes. We ended up with a million dollars more expenses and that was hard enough to deal with.

Rick Shane – Jefferies

Okay. Last question, and this goes to some of yours, what I thought was a very interesting line of questioning. Basically, the implication is that your accounting suggests that you are willing, do you think that there is a higher MPV to longer collection tails? When we look at, and again, it’s hard to tell because these vintages are, at least the new vintages you are down far enough out, but if we look back at some of your peers on a 2005 basis, the actual collection multiples for you were a little bit lower. So, do you think that this is something that really goes out even beyond five or six years, and does that actually make sense from an MPV basis.

Kevin Stevenson

Obviously, I will just say that the whole thing is being in our call and kind of hit with that kind of level of detail of numbers is a little difficult to assimilate. So, I just don’t know. I would have to see something in front of me to look at what you guys are talking about in terms of your flow, but I guess what I will say in terms of tail, especially if you are looking older deals, I assume you guys have pulled sales out, you know, like in a stuff. And I know we have talked about settlements and there’s a bunch of noise

As Steve said, it’s kind of a complicated thing to turn it generalized. So, again, we are modestly bullish on those older deals on the tails, so there’s probably some ERC there that we haven’t put in yet. But clearly, if your point is, if company A can collect a higher multiple more quickly than company B, and can do so at less expense, company A has figured out something that company B hasn’t, that is obviously is not a point we would ever argue if indeed those were the facts.

Rick Shane – Jefferies

And I apologize to you in terms of the details. I will circle back with you guys. Thank you very much. I appreciate your patience.

Operator

Our next question comes from the line of Thomas Morton with CPMG.

Thomas Morton – CPMG

Hi, guys. I was wondering if you guys could give us some color on the IRS issue, and by that I mean what’s the company is positioned, what the IRS is positioned and what if any potential acceleration of the deferred tax liability is out there, what kind of timing we might expect in terms of that getting to a point of resolution?

Kevin Stevenson

That’s your questions. So, more we follow in our Qs, in our Ks, it continues, we are certainly in the appeals process. We just don’t have any feel for how that appeals process is going to run. Some estimate could say it’s nine months, 12 months still on the road. We just don’t know. I think the IRS is very busy right now, and we are certainly pushing on it, because we think that from a industry standpoint, for instance, we have got what we think is kind of rock solid data in two cases, and I think most of the industry participants look at those sent cases. And so, at some degree, we kind of feel like we should be out there on the tip of that sphere, and talking to the IRS, let them understand what our position and how are industry works. But it’s a maddening slow grinding process.

Thomas Morton – CPMG

Does it basically boil down to your on-cost recovery basis in IRS, things that should be something that’s more accelerated in terms of income or revenue recognition?

Kevin Stevenson

Right, that’s correct.

Thomas Morton – CPMG

We are getting into detail here, but what are those two sort of landmark cases somebody could check out and sort of expenses sort of thing.

Kevin Stevenson

Lipton and Underhill.

Thomas Morton – CPMG

Lipton and Underhill, Lipton?

Kevin Stevenson

Yes, and so in short, what you will find is that these guys bought assets that were, in my opinion, dramatically better than the assets we are buying, and of course, the IRS disagreed with them, too. And they had to take them to Tex court and of course they won. So, it works, I guess complicated, but those are two court cases that most industry use.

Thomas Morton – CPMG

Okay, thanks guys.

Kevin Stevenson

Steve just asked me, you know, kind of interesting crisp on that is that the IRS also doesn’t have a position on what they should be using either, because it depends on who you are, you might be audited, and they will give you one answer, and someone else may be getting a complete different answer. And they really can’t do that, and so, that’s one of the reasons we are out there fighting the same. They have got to either come up with a homogenous clear piece of guidance that everyone can use, or we are going to use Lipton and Underhill as such, which I think should happen.

Steve Fredrickson

The interesting thing is the IRS is not offering their own version of Lipton or Underhill. They would rather not see cost recovery, but we are having a very difficult time in getting a more kind of reasoned case or law supported guideline on what exactly they do want.

Thomas Morton – CPMG

Okay, thanks, guys.

Kevin Stevenson

Yes.

Operator

Our next question comes from the line of John Neff with William Blair.

John Neff – William Blair

Thanks guys. I will try to keep it really quick here. The call is a bit long, so thanks for the patience. Just here, you described what’s happened to the, in terms of breaking down the impairment charge in the quarter, you sort of described that the 2008 allowances are mainly related to the fact that you purchased some 2008 stuff under forward flows and pricing one against you relative to those locked in prices. Can you describe sort of the drivers for timing the ’05 and ’06 write-downs? You mentioned they were just related to one pool each vintage. And also I think, maybe we touched on this, but I just wanted to confirm, was there any part of the impairment charge related to sort of an expectation, or a reaction to some of the regulation changes that you have seen in North Carolina, possibly New York and an expectation if that trend continues?

Kevin Stevenson

Okay, so no to that question. Never the allowance is related to some legislative expectation. The 2005, 2006 charge, I stated in my comments, that was kind of buried back in our page 17 or something, that it was really related to one 2005 pool as you heard and ’06 pool, and it was kind of, you know, not that all allowances aren’t unforeseen, but I would look like these two into kind of a weak July and August. So, again, we just thought, hey, it was a weak July and August, we are going to take the allowance now. What’s interesting about that is should Neal recover that and say November, it’s just going to end up being excess amortization. So, that’s kind of one of the downsides of the accounting. But Neal is laughing about that, but that’s how it works.

Neal Stern

John, given the economy, we are trying to be very careful with signs of underperformance, and if you were to look at many of our pools, especially if the pools get a little older, you would be looking at a curve that can really start to get some fluctuation in it, up and down. And we have two ways to go. When something like this happens, we can either say, hey, it was a fluctuation down, we will let it ride, and based on our long experience, it’s probably going to bounce back up next quarter, and they will be fine. The problem in doing that is if you are wrong, you get behind an 8-ball, especially when you have a decent sized yield on these things, and the hit you got to take in the future is even worse. So, what we are trying to do as we deal with this little weak economy is just be as quick on the allowance pattern as we ever have been, and Kevin sees two out of three bad months, he’s hitting the portfolio. We are not waiting.

John Neff – William Blair

Appreciate that. Something else related to just the increase in legal expenses related to the legislative change, but I just want to make sure, trying to narrow down this, you know, if I think I understood you correctly, what you are doing is – this isn’t a situation where you let certain accounts go past the statute, because you were planning to call them, and the increase in accounts referred to the legal channel, was that simply – were those simply people you had otherwise planned to let go past the statute and call them, or is this just, you have to put everybody, you have to just sue everybody that’s in that state for statute hits, and that’s the plan going forward?

Neal Stern

Okay. So, we are obsessed with what kind of ROI we are going to get on a legal expense around the call center expense. There is, I mean, the number of accounts we talked about is a tiny, tiny portion of the accounts that we have in any state. I mean, a fraction of our portfolios and legal auditing, again not our preferred method. But there is a small group of people for whom we think the way that we score them, the way that we seem them, we think that they would respond to calls over a period of time, and their financial situation is likely to evolve, and let’s say get back to work or some other situation changes, we think that we will get paid voluntarily from a phone call.

So, very tiny, tiny number of people that we think we are going to see that from, but nonetheless if there is some population. If that possibility is gone for that population that we were going to continue calling in the call center, then we have to go legal. There is a huge number of people that has the statute of limitations that we won’t bother calling, because we don’t think they have the score, and we don’t think we will get a decent ROI out of that phone call. I have said in previous call, by far the most important decision we make every day is what not to do and what to leave alone. The vast majority of our accounts won’t pay us, and one way to go bankrupt is to attempt calling people who have no intention of paying you. So, we really try and focus our efforts on people that we believe have the wherewithal to pay us via channel or the other.

Kevin Stevenson

And I think it’s an important point, especially as you think about this line of questioning that we have gotten about, you know, comparing multiples between competitors, and I am not suggesting in the lease, that’s not a valid analysis to do, but a debt buyer can generate a huge variance in the amount of collections that they can drive out of any given pool. The question is how profitably are you doing that, and if you are to drive your expenses out very high, you can do that, and you can create a higher multiples in the guy who is setting a lower threshold for how much they want to spend to create another set of collection results. And so, that’s all got to be factored in, and it’s something we try to understand here to a very great degree, and manage as we make any strategy decision, be it as Neal said, legal or call center, be it letter or phone, whatever we do. We are keenly aware of the ROI revolver efforts, and any portfolio that is in danger of an impairment, that’s not lost on us, and we will look closely, but we certainly aren’t going to have a negative ROI trying to chase after a possible impairment.

John Neff – William Blair

Thank you. And last really quick housekeeping one. Kevin, my typical total collectors and supervisors, the number was 1,526 last quarter.

Kevin Stevenson

Yes, 1,549.

John Neff – William Blair

Thanks guys.

Kevin Stevenson

Yes.

Operator

And our final question comes from the line of Edward Hemmelgarn with Shaker Investments.

Edward Hemmelgarn – Shaker Investments

Great. Just a couple of questions about the bankruptcy portfolio. First is, are you seeing a leasing in these bankruptcy accounts that you are purchasing, As the kind of curve lengthen on those just as you are seeing the curve, collection curve lengthen on your non-bankruptcy accounts?

Kevin Stevenson

Yes, Edward, I think the generally the courts are keeping people to a program. We have seen dividend rates come down somewhat overtime, but the length of the typical case is not moving to our view at least.

Edward Hemmelgarn – Shaker Investments

Okay, all right. Well then, the second question is, is I guess is at some point given the extent of your purchase as how the mix has changed rather significantly and your greater bankruptcy paper versus non-bankruptcy, would you expect in coming years that your ratio of your compensation expense will decrease relative to your revenue as your –?

Kevin Stevenson

Right. Yes, Edward.

Edward Hemmelgarn – Shaker Investments

The amortization rate increases, I guess, what I am trying to say is –

Kevin Stevenson

That’s right. That’s what we are trying to say earlier. I think it was the first caller; they were really kind of focusing on the shift of collections from internal collectors through internal legal people. And just, I mean the comment that if you are really trying to think about modeling, probably the better thing to do is focus on the bankruptcy factor which you have just done. That should have happened. So, theoretically you should have amortization rates that are creeping up, but theoretically, cost to collect out is kind of dramatically smaller and you would have a lower ratio in salaries, so cash collections.

Edward Hemmelgarn – Shaker Investments

And so, that’s something we should be focusing on in the future and is driving some of your upside in ’10?

Kevin Stevenson

Yes, I would say something that you are building the model and you at least need to think about that mix. That’s correct. Yes.

Edward Hemmelgarn – Shaker Investments

Okay, thanks.

Kevin Stevenson

Yes.

Operator

And ladies and gentlemen, this concludes our question-and-answer session. I would now like to turn the call over to Mr. Steve Fredrickson for closing remarks. Sir?

Steve Fredrickson

Thank you, operator. I would like to reiterate a few key points about our third quarter performance before concluding this call. While economic conditions remain difficult, PRA continue to perform solidly in the third quarter of 2009. Not only did we produce strong results operationally, but we continue to build for the future, further refining our best-in-class platform and taking advantage of our access to capital to acquire large amounts of portfolios that we believe are well priced even in a market where collections have grown more difficult.

Overall, PRA is in a position to emerge from this economic downturn of stronger and more efficient competitor. I can honestly say that I am as excited about our future today as I have been in years. I would like to thank all of you for participating in our conference call. We look forward to speaking with you again next quarter.

Operator

Thank you for your participation on today’s conference. This concludes your presentation and you may now disconnect. Have a great day.

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Source: Portfolio Recovery Associates, Inc. Q3 2009 Earnings Call Transcript
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