Debt build-up in debt collectors

11/06/2018

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​The Corporate Credit Team at Janus Henderson Investors looks at some of the factors that are encouraging them to be cautious towards companies operating in the debt collection sector.


Debt collection companies buy receivables and non-performing loans – at a percentage of the debt’s nominal value – with a view to seeking to recover all or part of the original debt and make a profit. The sector has seen weakness in the past year with the price of bonds and equity of publicly-listed European debt collectors such as Arrow and Intrum trading at or close to 12-month lows (figure 1). Sentiment towards the sector among investors is varied, partly reflecting the large supply of bonds in the European high yield market. The debt collector sector has issued several billion euro worth of bonds over the last few years as the high yield market has supported the organic and inorganic growth of these businesses.
 
Figure 1: Arrow GBP 5.125% 2024 bond price
1
Source: Bloomberg, 31 May 2017 to 31 May 2018.
Past performance is not a guide to future performance
 
We believe that a cautious approach towards the sector is warranted and the following are some of the key reasons behind this view.
 
High leverage
Leverage across debt collectors has increased materially over the past few years particularly through bond issuance in the high yield bond markets. For instance, Arrow has seen its leverage, as measured by its net debt/cash EBITDA* multiple, increase from 2x to 4.4x over the period from 2013 to 2018 (Figure 2). It is likely leverage will rise further as companies continue to engage in aggressive purchases of non-performing loan (NPL) portfolios and debt-funded acquisitions of servicing platforms. With IFRS 9, an International Financial Reporting Standard, impacting banks’ balance sheets, banks will be forced to sell their NPLs faster than previously. As a result there will continue to be a large supply of NPLs in the market – increasing the temptation for debt collectors to raise their exposure.
 
*EBITDA = earnings before interest, tax, depreciation and amortisation
 
Figure 2: Arrow net debt over time
2
Source: Janus Henderson Investors’ calculations using Arrow company account data, LTM = last twelve months to 31 March 2018
 
Another example is Intrum, a Swedish debt collector agency. The company recently announced the acquisition of a €10.8bn non-performing loan (NPL) portfolio from Intesa Sanpaolo for approximately €3.1billion. This will increase leverage to 4.5x net debt/cash EBITDA, considerably above its 2.5-3.5x target. However, this excludes some of the off-balance sheet liabilities used to fund this transaction. Given the ambitious earnings per share growth targets the company has announced to its equity investors, combined with its acquisitive nature, it is highly likely that they will keep on investing aggressively in order to meet this target. 
 
Limited cash flow generation
Cash flow generation across the sector is limited, with most debt collectors having free cash flow (FCF) as a percentage of gross debt in the low single digits. In fact, all of the main debt collectors have been FCF negative in the last few years because of their aggressive growth plans. For example, Lowell, a UK debt collector, currently generates FCF to net debt of just 2%. This effectively means it would take Lowell 50 years to pay down its debt from the cash flow it generates assuming returns do not deteriorate over this period.
 
Opaque accounting
Accounting methods used across the sector are to some extent ambiguous. For instance, expected remaining collections (ERC), which represents the expected future core collections of the portfolios, have a black box nature. This leaves management with a degree of discretion in recording the company’s ERC in its financial statements. Historically, most of these companies have forecasted ERC accurately, but they have also written up their ERC estimates. It is unclear how much of this write-up is driven by favourable market conditions versus improved collection techniques.
 
Debt collectors mostly use EIR (effective interest rate) accounting, which makes it difficult to flag potential problems. Some also use off-balance sheet leverage for which there are no formal reporting requirements.
 
Assessing the debt sustainability of debt collectors is difficult because the companies usually focus on “cash EBITDA” as opposed to EBITDA. The use of this accounting method masks the deterioration in underlying returns of the acquired portfolios.
 
Rating methodology
Optically, bonds issued by debt collectors look cheap relative to the ratings. However, we believe the methodology used by credit rating agencies to construct a view on a company’s ability to pay back debt and determine the likelihood of default can be flawed. Ratings on the sector often do not reflect the true fundamentals of the company or default risk. This can be seen in the case of Getback, a Polish debt collector, which defaulted on its Polish Zloty bonds in April 2018 despite being rated B, positive outlook, by S&P and B+, stable rating, by Fitch. Furthermore, Fitch only gave the inaugural B+ rating three months before the company defaulted. It appears that the reason for the default stemmed from Getback’s management overpaying for NPLs, which was not picked up by the rating agency methodology.
 
Senior management instability
The sector has seen significant turnover in senior management with high level departures at Intrum (CFO), Arrow (CEO and CFO) and Hoist (CEO and CFO). This high amount of turnover is worrying.
 
Pressure is building
Returns on portfolios owned by debt collectors are likely to remain under pressure as capital continues to enter the market, such as private equity and credit hedge funds, resulting in intense competition. This is already impacting Intrum: the company released disappointing earnings in Q4 2017, driven by lower earnings in their servicing division reportedly due to increased competition. In a bid to diversify and grow to remain competitive, we have also seen companies operating in the industry pay high multiples to acquire businesses. An intensification of competition could see this negative trend continuing.
 
Increased regulation also remains a threat. The consumer element of debt collectors’ business models naturally attracts the attention of the UK financial services regulator, the Financial Conduct Authority, which is concerned with the fair treatment of customers. Whilst we are not aware of any particular regulation initiatives from the FCA or their equivalent in other countries, the risk of an increase in regulation, which could increase the costs of collecting debt from consumers, remains real, particularly if the economic or political environment changes. For instance, the Italian coalition of Five Star Movement (M5S) and Lega (League) Party has proposed pushing through radical reforms across the debt collector sector.
 
Macroeconomic tailwinds have led to improved cash collections from customer and write-ups of expected remaining collections.  An economic slowdown, however, could negatively impact cash collections. The high yield market has not really seen any of these businesses go through an economic downturn in their current form.  While most of these businesses survived the 2009 crisis, they were considerably smaller in size and, more importantly, a lot less levered at that stage. For now, we are steering clear of lending to the sector as we do not want to have to step into their shoes and potentially have to chase up defaulters.
 

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

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Important information

Please read the following important information regarding funds related to this article.

Janus Henderson Horizon Euro Corporate Bond Fund

This document is intended solely for the use of professionals and is not for general public distribution.

The Janus Henderson Horizon Fund (the “Fund”) is a Luxembourg SICAV incorporated on 30 May 1985, managed by Henderson Management S.A. Any investment application will be made solely on the basis of the information contained in the Fund’s prospectus (including all relevant covering documents), which will contain investment restrictions. This document is intended as a summary only and potential investors must read the Fund’s prospectus and key investor information document before investing. A copy of the Fund’s prospectus and key investor information document can be obtained from Henderson Global Investors Limited in its capacity as Investment Manager and Distributor.

Issued in Europe by Janus Henderson Investors. Janus Henderson Investors is the name under which investment products and services are provided by Janus Capital International Limited (reg no. 3594615), Henderson Global Investors Limited (reg. no. 906355), Henderson Investment Funds Limited (reg. no. 2678531), AlphaGen Capital Limited (reg. no. 962757), Henderson Equity Partners Limited (reg. no.2606646), (each registered in England and Wales at 201 Bishopsgate, London EC2M 3AE and regulated by the Financial Conduct Authority) and Henderson Management S.A. (reg no. B22848 at 2 Rue de Bitbourg, L-1273, Luxembourg and regulated by the Commission de Surveillance du Secteur Financier). We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Past performance is not a guide to future performance. The performance data does not take into account the commissions and costs incurred on the issue and redemption of units. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Tax assumptions and reliefs depend upon an investor’s particular circumstances and may change if those circumstances or the law change. If you invest through a third party provider you are advised to consult them directly as charges, performance and terms and conditions may differ materially.

Nothing in this document is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment.

The Fund is a recognised collective investment scheme for the purpose of promotion into the United Kingdom. Potential investors in the United Kingdom are advised that all, or most, of the protections afforded by the United Kingdom regulatory system will not apply to an investment in the Fund and that compensation will not be available under the United Kingdom Financial Services Compensation Scheme.

Copies of the Fund’s prospectus and key investor information document are available in English, French, German, and Italian. Articles of incorporation, annual and semi-annual reports are available in English. Key Investor document is also available in Spanish. All of these documents can be obtained free of cost from the local offices of Janus Henderson Investors: 201 Bishopsgate, London, EC2M 3AE for UK, Swedish and Scandinavian investors; Via Dante 14, 20121 Milan, Italy, for Italian investors and Roemer Visscherstraat 43-45, 1054 EW Amsterdam, the Netherlands. for Dutch investors; and the Fund’s: Austrian Paying Agent Raiffeisen Bank International AG, Am Stadtpark 9, A-1030 Vienna; French Paying Agent BNP Paribas Securities Services, 3, rue d’Antin, F-75002 Paris; German Information Agent Marcard, Stein & Co, Ballindamm 36, 20095 Hamburg; Belgian Financial Service Provider CACEIS Belgium S.A., Avenue du Port 86 C b320, B-1000 Brussels; Spanish Representative Allfunds Bank S.A. Estafeta, 6 Complejo Plaza de la Fuente, La Moraleja, Alcobendas 28109 Madrid; Singapore Representative Janus Henderson Investors (Singapore) Limited, 138 Market Street, #34-03 / 04 CapitaGreen 048946; or Swiss Representative BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich who are also the Swiss Paying Agent. RBC Investor Services Trust Hong Kong Limited, a subsidiary of the joint venture UK holding company RBC Investor Services Limited, 51/F Central Plaza, 18 Harbour Road, Wanchai, Hong Kong, Tel: +852 2978 5656 is the Fund’s Representative in Hong Kong.

Information on this document is on Janus Henderson Investors’ best endeavours.

Specific risks

  • This fund is designed to be used only as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
  • The value of a bond or money market instrument may fall if the financial health of the issuer weakens, or the market believes it may weaken. This risk is greater the lower the credit quality of the bond.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Any security could become hard to value or to sell at a desired time and price, increasing the risk of investment losses.

Risk rating

Janus Henderson Horizon Euro High Yield Bond Fund

This document is intended solely for the use of professionals and is not for general public distribution.

The Janus Henderson Horizon Fund (the “Fund”) is a Luxembourg SICAV incorporated on 30 May 1985, managed by Henderson Management S.A. Any investment application will be made solely on the basis of the information contained in the Fund’s prospectus (including all relevant covering documents), which will contain investment restrictions. This document is intended as a summary only and potential investors must read the Fund’s prospectus and key investor information document before investing. A copy of the Fund’s prospectus and key investor information document can be obtained from Henderson Global Investors Limited in its capacity as Investment Manager and Distributor.

Issued in Europe by Janus Henderson Investors. Janus Henderson Investors is the name under which investment products and services are provided by Janus Capital International Limited (reg no. 3594615), Henderson Global Investors Limited (reg. no. 906355), Henderson Investment Funds Limited (reg. no. 2678531), AlphaGen Capital Limited (reg. no. 962757), Henderson Equity Partners Limited (reg. no.2606646), (each registered in England and Wales at 201 Bishopsgate, London EC2M 3AE and regulated by the Financial Conduct Authority) and Henderson Management S.A. (reg no. B22848 at 2 Rue de Bitbourg, L-1273, Luxembourg and regulated by the Commission de Surveillance du Secteur Financier). We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Past performance is not a guide to future performance. The performance data does not take into account the commissions and costs incurred on the issue and redemption of units. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Tax assumptions and reliefs depend upon an investor’s particular circumstances and may change if those circumstances or the law change. If you invest through a third party provider you are advised to consult them directly as charges, performance and terms and conditions may differ materially.

Nothing in this document is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment.

The Fund is a recognised collective investment scheme for the purpose of promotion into the United Kingdom. Potential investors in the United Kingdom are advised that all, or most, of the protections afforded by the United Kingdom regulatory system will not apply to an investment in the Fund and that compensation will not be available under the United Kingdom Financial Services Compensation Scheme.

Copies of the Fund’s prospectus and key investor information document are available in English, French, German, and Italian. Articles of incorporation, annual and semi-annual reports are available in English. Key Investor document is also available in Spanish. All of these documents can be obtained free of cost from the local offices of Janus Henderson Investors: 201 Bishopsgate, London, EC2M 3AE for UK, Swedish and Scandinavian investors; Via Dante 14, 20121 Milan, Italy, for Italian investors and Roemer Visscherstraat 43-45, 1054 EW Amsterdam, the Netherlands. for Dutch investors; and the Fund’s: Austrian Paying Agent Raiffeisen Bank International AG, Am Stadtpark 9, A-1030 Vienna; French Paying Agent BNP Paribas Securities Services, 3, rue d’Antin, F-75002 Paris; German Information Agent Marcard, Stein & Co, Ballindamm 36, 20095 Hamburg; Belgian Financial Service Provider CACEIS Belgium S.A., Avenue du Port 86 C b320, B-1000 Brussels; Spanish Representative Allfunds Bank S.A. Estafeta, 6 Complejo Plaza de la Fuente, La Moraleja, Alcobendas 28109 Madrid; Singapore Representative Janus Henderson Investors (Singapore) Limited, 138 Market Street, #34-03 / 04 CapitaGreen 048946; or Swiss Representative BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich who are also the Swiss Paying Agent. RBC Investor Services Trust Hong Kong Limited, a subsidiary of the joint venture UK holding company RBC Investor Services Limited, 51/F Central Plaza, 18 Harbour Road, Wanchai, Hong Kong, Tel: +852 2978 5656 is the Fund’s Representative in Hong Kong.

Information on this document is on Janus Henderson Investors’ best endeavours.

Specific risks

  • This fund is designed to be used only as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
  • The value of a bond or money market instrument may fall if the financial health of the issuer weakens, or the market believes it may weaken. This risk is greater the lower the credit quality of the bond.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Any security could become hard to value or to sell at a desired time and price, increasing the risk of investment losses.

Risk rating

Janus Henderson Horizon Global High Yield Bond Fund

This document is intended solely for the use of professionals and is not for general public distribution.

The Janus Henderson Horizon Fund (the “Fund”) is a Luxembourg SICAV incorporated on 30 May 1985, managed by Henderson Management S.A. Any investment application will be made solely on the basis of the information contained in the Fund’s prospectus (including all relevant covering documents), which will contain investment restrictions. This document is intended as a summary only and potential investors must read the Fund’s prospectus and key investor information document before investing. A copy of the Fund’s prospectus and key investor information document can be obtained from Henderson Global Investors Limited in its capacity as Investment Manager and Distributor.

Issued in Europe by Janus Henderson Investors. Janus Henderson Investors is the name under which investment products and services are provided by Janus Capital International Limited (reg no. 3594615), Henderson Global Investors Limited (reg. no. 906355), Henderson Investment Funds Limited (reg. no. 2678531), AlphaGen Capital Limited (reg. no. 962757), Henderson Equity Partners Limited (reg. no.2606646), (each registered in England and Wales at 201 Bishopsgate, London EC2M 3AE and regulated by the Financial Conduct Authority) and Henderson Management S.A. (reg no. B22848 at 2 Rue de Bitbourg, L-1273, Luxembourg and regulated by the Commission de Surveillance du Secteur Financier). We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Past performance is not a guide to future performance. The performance data does not take into account the commissions and costs incurred on the issue and redemption of units. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Tax assumptions and reliefs depend upon an investor’s particular circumstances and may change if those circumstances or the law change. If you invest through a third party provider you are advised to consult them directly as charges, performance and terms and conditions may differ materially.

Nothing in this document is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment.

The Fund is a recognised collective investment scheme for the purpose of promotion into the United Kingdom. Potential investors in the United Kingdom are advised that all, or most, of the protections afforded by the United Kingdom regulatory system will not apply to an investment in the Fund and that compensation will not be available under the United Kingdom Financial Services Compensation Scheme.

Copies of the Fund’s prospectus and key investor information document are available in English, French, German, and Italian. Articles of incorporation, annual and semi-annual reports are available in English. Key Investor document is also available in Spanish. All of these documents can be obtained free of cost from the local offices of Janus Henderson Investors: 201 Bishopsgate, London, EC2M 3AE for UK, Swedish and Scandinavian investors; Via Dante 14, 20121 Milan, Italy, for Italian investors and Roemer Visscherstraat 43-45, 1054 EW Amsterdam, the Netherlands. for Dutch investors; and the Fund’s: Austrian Paying Agent Raiffeisen Bank International AG, Am Stadtpark 9, A-1030 Vienna; French Paying Agent BNP Paribas Securities Services, 3, rue d’Antin, F-75002 Paris; German Information Agent Marcard, Stein & Co, Ballindamm 36, 20095 Hamburg; Belgian Financial Service Provider CACEIS Belgium S.A., Avenue du Port 86 C b320, B-1000 Brussels; Spanish Representative Allfunds Bank S.A. Estafeta, 6 Complejo Plaza de la Fuente, La Moraleja, Alcobendas 28109 Madrid; Singapore Representative Janus Henderson Investors (Singapore) Limited, 138 Market Street, #34-03 / 04 CapitaGreen 048946; or Swiss Representative BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich who are also the Swiss Paying Agent. RBC Investor Services Trust Hong Kong Limited, a subsidiary of the joint venture UK holding company RBC Investor Services Limited, 51/F Central Plaza, 18 Harbour Road, Wanchai, Hong Kong, Tel: +852 2978 5656 is the Fund’s Representative in Hong Kong.

Information on this document is on Janus Henderson Investors’ best endeavours.

Specific risks

  • This fund is designed to be used only as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • The value of a bond or money market instrument may fall if the financial health of the issuer weakens, or the market believes it may weaken. This risk is greater the lower the credit quality of the bond.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Any security could become hard to value or to sell at a desired time and price, increasing the risk of investment losses.

Risk rating

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