Muted collections may spoil party for debt collectors

By Sweta Singh and Archana Shankar

BANGALORE (Reuters) - The weak financial health of the U.S. consumer is expected to hit third-quarter results of debt collectors, who buy bad loans from big financial institutions and chase the defaulters to make money.

Companies like Portfolio Recovery Associates Inc (PRAA.O), Asset Acceptance Capital Corp (AACC.O) and Encore Capital Group Inc (ECPG.O) buy bad debt at very low prices -- pennies on the dollar -- and then aggressively pursue repayment on them.

"The unemployment rate remains quite high, and until that starts to come down, collection rates could be pressured," said analyst Sameer Gokhale of Keefe, Bruyette & Woods.

In addition, fewer tax refunds in the second half of the year mean that money is tighter for consumers who are looking to repay debt.

Analysts expect impairment charges to remain elevated in the third quarter.

Under accounting rules, debt collectors have to take impairment charges when their collections fall short of expectations or slip below their purchase prices.

These companies buy troubled consumer debt portfolios sold by banks and other institutions and then aggressively pursue at least partial repayment from borrowers, badgering them via phone calls, text messages and emails.

Regulatory hurdles are yet another challenge for these companies as several state regulators are trying to make it harder for these companies to make recoveries.

Analysts on average were expecting earnings of 77 cents per share for Portfolio Recovery, 27 cents a share for Encore Capital and 8 cents a share for Asset Acceptance, according to Thomson Reuters I/B/E/S.

Going forward, debt collectors could benefit from collecting on debt that they buy now, given the low prices of debt portfolios.

"Pricing has improved radically. Over the short term I see pricing as more of an opportunity than a risk," analyst Robert Napoli of Piper Jaffray said.

Availability of paper in coming quarters is expected to be high, given the large volume of credit card charge-offs.

These charge-offs -- loans the companies do not expect to be repaid -- usually track unemployment, which rose to a 26-year high of 9.8 percent in September. The U.S. jobless rate is expected to top 10 percent by year-end.

"I would expect pricing to become less attractive as we approach the second half of 2010 -- particularly if the unemployment rate starts to fall -- suggesting supply of charged-off debt will begin to decrease by the middle of next year," analyst Bill Carcache of Fox-Pitt Kelton said.

Some debt collectors' shares have risen recently due to attractive pricing of bad loans. Portfolio Recovery's stock has soared 36 percent in the past six months, while Encore Capital has jumped 160 percent and Asset Acceptance 13 percent.