Fitch Ratings has affirmed Encore Capital Group, Inc.'s Long-Term Issuer Default Rating (IDR) at 'BB+' with a Stable Outlook.

Fitch has also affirmed Encore's super-senior secured private placement notes at 'BBB-' and its senior secured debt at 'BB+'.

Key Rating Drivers

IDR

Encore's Long-Term IDR reflects its leading franchise in the debt purchasing sector in its chosen markets, its strong recent profitability and its low leverage relative to the sector. These factors are counter-balanced by the concentration of its activities on debt purchasing and a longer-term need to maintain a flow of receivable purchases (and associated funding) to support estimated remaining collections (ERC) from which future earnings are derived.

Encore has a record of over 25 years in debt purchasing, focusing principally on the structurally deep credit markets of the US and the UK. It acquires portfolios of defaulted receivables from financial service providers including banks, credit unions, consumer finance companies and commercial retailers.

In 2021 Encore reported pre-tax earnings of USD437 million, a second successive annual record, as debt repayments from consumers remained strong, assisted by the economic support provided by governments amid the pandemic. Collections in 1Q22 were slower but still sound, with Encore reporting pre-tax income of USD231 million, having written up the value of expected recoveries by USD167 million.

Portfolio purchases in 1Q22 were consistent with 1Q21 at USD170 million, but have still yet to return to pre-pandemic levels, as economic support measures slowed the rate at which financial institutions generated new non-performing loans for purchase. At end-1Q22, Encore's ERC had reduced to USD7.7 billion, from USD8.3 billion at end-1Q21. Although collections in the last two years have generally been robust, we see potential for pressure on consumer repayment capacity from current higher inflation, while collections tend to slow as the average age of portfolios lengthens (amid tight supply of fresh receivables).

Fitch's primary leverage metric for debt purchasers is gross debt/adjusted EBITDA (including adjustments for portfolio amortisation). Fitch calculates Encore's gross debt-to-adjusted EBITDA at end-2021 at 1.9x, which compares favourably with the typical profile of European debt purchasers. Fitch also considers debt-to-tangible equity as a complementary leverage metric. This has improved in recent years, as Encore's profitability has offset the effect of past goodwill, but at end-1Q22 was still high at 7.9x.

At end-1Q22 Encore had comfortable available liquidity of USD560 million, via cash and headroom from an undrawn revolving credit facility (RCF). Additional funding sources comprised USD1.6 billion of senior secured notes, USD98 million of outstanding super-senior private placement notes and a USD460 million asset-backed facility, supplemented by unsecured convertible and exchangeable notes totalling USD273 million. In March 2022, USD150 million of convertibles were repaid from available cash.

In 2020 Encore implemented a revised global funding structure, under which the previously legally separate funding structures of its US and European businesses were combined, with the majority of Encore's debt now equally guaranteed by most subsidiaries across the group. Since then several new issues of senior secured notes have extended the maturity profile of Encore's funding, and fixed much of its cost at attractive rates. While the debt purchasing business model requires replenishment of assets over the longer term with fresh portfolio acquisitions, companies have the option over shorter periods to moderate their rate of investment, and thereby conserve liquidity.

SUPER-SENIOR SECURED NOTES

Encore's 5.625% super-senior private placement notes rank equally with its multi-currency RCF, and super-senior to other senior secured debt. The notes' rating is notched up once from Encore's 'BB+' IDR, reflecting Fitch's expectation of above-average recovery prospects. Under Fitch's NBFI Rating Criteria upward notching of secured debt from sub-investment grade issuers is capped at 'BBB-'.

SENIOR SECURED NOTES

Encore's senior secured notes are guaranteed by most group subsidiaries and rank equally with other senior secured obligations. Their rating is equalised with Encore's Long-Term IDR, due to prior claim on available security of the higher-ranking super-senior debt. This results in average rather than above-average recoveries for Encore's senior secured notes.

Encore has an ESG Relevance Score of '4' for customer welfare - fair messaging, privacy & data security in view of the importance of fair collection practices and consumer interactions and the regulatory focus on them, particularly in the US.

Encore has an ESG Relevance Score of '4' for financial transparency on account of the significance of internal modelling to portfolio valuations and associated metrics such as ERC. These factors have negative influences on the rating, but their impact is only moderate, and they are features of the debt purchasing sector as a whole, and not specific to Encore.

RATING SENSITIVITIES

IDR

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Gross debt/adjusted EBITDA leverage consistently below 2.5x, while continuing to grow the tangible equity position

Demonstration of ongoing earnings resilience despite near-term contraction of NPL supply and medium-term uncertainty as to customer repayment performance amid post-pandemic inflationary pressures

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A sustained fall in cash collections, resulting in materially reduced earnings generation or write-down of the value of portfolio investments

Failure to adhere to management's public leverage guidance of maintaining net debt/adjusted EBITDA of 2x-3x

A material adverse operational event or regulatory intervention undermining franchise strength or business-model resilience

SUPER-SENIOR AND SENIOR SECURED DEBT

The ratings of the super-senior and senior secured notes are primarily sensitive to changes in Encore's IDR. However, a downgrade of Encore's IDR would not automatically lead to negative rating action on the notes, depending on Fitch's view of the likely impact on recoveries of the circumstances giving rise to the downgrade.

Changes to Fitch's assessment of relative recovery prospects for senior secured debt in a default (e. as a result of a material shift in the proportion of Encore's debt which is either super senior or unsecured) could also result in the senior secured debt rating being notched up or down from the IDR.

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Encore has an ESG Relevance Score of '4' for customer welfare - fair messaging, privacy & data security due to the importance of fair collection practices and consumer interactions and the regulatory focus on them, particularly in the US.

Encore also has an ESG Relevance Score of '4' for financial transparency due to the significance of internal modelling to portfolio valuations and associated metrics such as ERC. These factors have negative influences on the rating, but their impact is only moderate, and they are features of the debt purchasing sector as a whole, and not specific to Encore.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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