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PRAA: Some Good, Some Bad, And Some to Wait And See


Growth for this growth company continues to slow at an accelerated pace.

Portfolio Recovery Associates (PRAA) reported Q4 and full year results on February 14. I wrote about my reservations on the stock (here and here) given a number of risks which, IMHO, were (are) not priced into the equation. I'll review them one by one and keep score along the way:

Risk No. 1: There is a very real possibility that the ERC and/or the receivables on PRAA's balance sheet could show a nasty hit when PRAA reports the next quarter. There did not seem to be an impact on the balance sheet. We will not know the impact on the Estimated Remaining Collections (ERC) until the company files its 10-K. Management stated on the call that it expects the impact on ERC's to be "de minimis." I have no reason to dispute this at this point, unless the 10-K shows otherwise. This was a one-off risk directly related to the October 2005 changes to the Bankruptcy Code, so it's fair to say that this risk has now passed. PRAA 1 – Zucchi 0

Risk No.2: Receivables prices remain challenging, and recent account purchases will merely replace - rather than increment - existing loan pools. Since there was no apparent impact on receivables assets from the Bankruptcy changes, PRAA A/R buying spurt has meaningfully increased its receivables base. Pricing of acquired receivables, however, continues at the very high end of the historical range. Management concedes that pricing is difficult. I specifically asked the company, why would banks sell off bankrupt paper at a decent discount if the collection process in bankruptcy is the same for the banks and PRAA? A valid answer by the company was that banks would rather have the money now than over five years. Another reason given was that PRAA is "better" than banks at navigating the filing and approval process for claims. This is hard to believe since there effectively is no "process." To collect in a bankruptcy case the creditor files a one page Proof of Claim (99% of banks generate them automatically from their computer systems) and the claim is deemed allowed unless objected to. In 10 years of administering estates I cannot recall ever having objected to a bank's unsecured Proof of Claim, or needing any involvement by the creditor in the collection process. PRAA 2 (on adding to balance sheet assets) – Zucchi 1 (on pricing pressures)

Risk No.3: Impact of Labor Problems: The turnover disruptions seen in Q2 and Q3 appear to have settled down. There remains the issue of hiring new collectors to work on the new receivables purchased. PRAA concedes that this will impact their collection efficiency metrics, with the caveat that, since most of the new purchases were of bankrupt paper, there is much less collector involvement in working those receivables. PRAA 2 – Zucchi 1 (collection efficiencies remains an item to be monitored)

Risk No.4: Slowing Growth: Perhaps the most important of the issues I raised, growth went from slow to slower, with "cash collection on owned receivables" up 16% Y/Y. The last four quarters trend now shows: 34.6%, 27.2%, 22.2%, and 16.1%. The company cautions that things are not going to get better anytime soon because bankrupt accounts "can really sit and produce very little cash for a year or two before they kick in." (from PRAA conference call). I would suggest that 6 to 8 months is the outer limits of the time it takes for a Chapter 13 plan to be approved and payments to creditors to start. Whether unsecured claims such as PRAA's must wait in line 1-2 years may depend on whether there are higher priority claims ahead of it, but in my experience that is not too common. Whatever the case may be, growth for this go-go growth company is slowing at an accelerated pace. PRAA 2 – Zucchi 2: growth is slowing at an accelerated pace.

The company has made the point that its cash collections will actually get a big boost ultimately because of the higher quantity of receivables acquired. That's pretty much self-evident but speaks only to growing the overall size of the "receivables bucket" not the "rate of growth" of collections. . PRAA 2 – Zucchi 2: growth is slowing at an accelerated pace.

Risk No. 5: Does PRAA face a trend of poorer quality receivables? We will not know about quality trends until the 10-K is filed. PRAA 2 – Zucchi 2.

Risk No.6: Geographic Risk: None have shown up in the data released so far. PRAA 3 – Zucchi 2.

Risk No.7: Rising collection costs: Continue to rise as legal collections continue to comprise a higher portion of collections. PRAA – Zucchi 3.

Risk No. 8: Macro-economic risks and interest rate risks: still there and we'll have to see how those play out over time.
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Position in PRAA
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