Fitch Ratings has assigned an expected rating of 'BB+(EXP)' to the proposed $350 million unsecured notes to be issued by PRA Group Inc. (PRA).

PRA has a Long-Term Issuer Default Rating (IDR) of 'BB+' with a Stable Rating Outlook.

The issuance is expected to be leverage neutral as proceeds from the issuance are to be deposited into a segregated account to be used by PRA to paydown the 2023 convertible notes.

Key Rating Drivers

IDR AND SENIOR DEBT

The proposed unsecured debt rating is equalized with PRA's Long-Term IDR, reflecting Fitch's expectation of average recovery prospects in a stressed scenario as the negative impact from the presence of significant secured funding in a priority position is offset by lower total leverage. The proposed ratings are consistent with the ratings on the existing unsecured debt.

PRA's rating remains supported by its leading global franchise within the debt purchasing sector, with a dominant market position in the U.S. and a strong presence across 18 countries in Europe, the Americas and APAC; a consistent performance track record spanning several business cycles; and a conservative leverage profile.

The ratings are constrained by PRA's monoline business model, primarily servicing charged-off consumer debt, continued lack of portfolio growth opportunities, and limited contingent liquidity resources. Additional constraints include the potential for heightened regulatory scrutiny of the consumer collections businesses and a reliance on internal modelling for portfolio valuations and associated metrics, such as estimated remaining collections (ERCs), which makes comparability difficult.

PRA's leverage (gross debt-to-adjusted EBITDA) was 2.0x for the TTM ended 3Q22; slightly above 1.9x at YE 2021. Proforma for the proposed issuance and planned paydown of the 2023 convertible notes, and based on the preliminary 4Q22 adjusted EBITDA guidance provided, leverage is expected to be between 2.1x and 2.4x at YE 2022. The increase is primarily driven by the continued decline in adjusted EBITDA while total debt remains consistent as proceeds are used to pay down existing unsecured debt.

While leverage could trend up further given continued pressure on EBITDA from lower collections as well as potential portfolio growth opportunities, Fitch believes PRA has adequate flexibility to manage within its targeted leverage range of 2x-3x. Fitch also considers debt-to-tangible equity as a complimentary leverage metric, which was 3.3x at 3Q22; slightly above the 3.2x at YE 2021. Fitch believes PRA's tangible equity position and limited shareholder distributions are strengths compared to most peers.

PRA's long-term funding consists of secured revolving credit facilities and a term loan, which are subject to ERC-linked borrowing base calculations, as well as unsecured and convertible notes. The unsecured funding mix was 42% of total debt as of Sept. 30, 2022, up from 38% at YE 2021, however, Fitch expects the unsecured funding mix to trend lower from here as PRA funds portfolio growth with secured borrowings. PRA recently executed a refinancing of its European secured credit facilities in addition to adding a UK credit facility, both of which extended the maturity of the secured funding, offset somewhat by lower advance rates.

The planned paydown of the $345 million convertible notes significantly reduces remaining near-term maturities, which Fitch views favorably. Near-term liquidity is supported by cash and undrawn, unrestricted, revolving credit capacity of $454.3 million at end-3Q22. Fitch believes liquidity is adequate as debt purchasers also have the flexibility in the short-term to moderate their rate of investment vis a vis collections and conserve liquidity.

Preliminary reported FY22 results indicate cash collections of $1.73 billion at the midpoint, which was down 16% from 2021. Cash collections were resilient during 2021 but have been moderating in 2022 driven by the expiry of supportive measures that benefitted consumer credit and liquidity post the pandemic, as well as lower portfolio purchases. ERC at YE 2022 is expected to be down 5.1% from YE 2021 at the midpoint, but up 7.1% sequentially which would be the first ERC growth since 2019 driven by strong purchases in 4Q22.

Adjusted EBITDA was $1.1 billion for FY22 at the midpoint of the preliminary reported range, down 19.7% from FY21, driven by the lower collections. Still, the calculated adjusted EBITDA margin, as a proportion of revenues (gross of portfolio amortization), remained strong at over 64% for 2022. Fitch believes earnings and the margin could be pressured from normalizing collection and operating costs, however, the outlook for portfolio growth is improving and current profitability remains strong relative to the assigned rating category.

The Stable Outlook reflects Fitch's belief that any risks stemming from a potential economic stress, including from any associated slowdown in debt-collection activities and/or changes to estimated recoveries and extended unavailability of unsecured funding, are mitigated by the company's conservative leverage profile and its ability to moderate portfolio purchases to generate cash. The Stable Outlook also assumes that any changes to PRA's collection practices resulting from the new rules by the CFPB or the resolution of the Civil Investigative Demand will have a minimal negative impact on the business model.

Rating Sensitivities

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

IDR

A sustained reduction in earnings generation, particularly if it leads to a weakening in key debt service ratios or other financial efficiency metrics;

A sustained increase in debt/adjusted EBITDA above 2.5x or debt/tangible equity above 5x, whether resulting from a lack of EBITDA growth, an increase in acquisitions or reduction of tangible equity;

A shift to a largely secured balance sheet funding model with unsecured mix below 20%;

A weakening in asset quality, as reflected in acquired debt portfolios significantly underperforming anticipated returns or repeated material write-downs in expected recoveries; or

An adverse operational event or significant disruption in business activities (for example arising from regulatory intervention in key markets adversely impacting collection activities), thereby undermining franchise strength and business model resilience.

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

Given the current operating environment, an upgrade is unlikely in the short term. However, over time, positive rating action could result from:

Unsecured debt greater than 40% of total debt on a sustained basis;

Leverage maintained consistently below 2.0x through the cycle on a debt/adjusted EBITDA basis and below 4.0x on a debt/tangible equity basis; and

Demonstrated franchise strength and earnings resilience through the current economic cycle.

SENIOR DEBT

PRA's senior unsecured debt rating is primarily sensitive to changes in the group's Long-Term IDR and secondarily to the funding mix and recovery prospects on the unsecured debt. A material increase in the proportion of secured debt, which weakens recovery prospects for unsecured debtholders in a stressed scenario could result in the unsecured debt rating being notched down below 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

Date of Relevant Committee

07 July 2022

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

PRA Group, Inc. 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, which has a negative impact on the credit profile, and is relevant to the rating[s] in conjunction with other factors.

PRA Group, Inc. 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 estimated remaining collections, which has a negative impact on the credit profile, and is relevant to the rating[s] in conjunction with other factors. These are features of the debt purchasing sector as a whole, and not specific to the company.

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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