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When the News is Bad, This Company Wins

A buyer of defaulted consumer debt profits from a weakening economy.

Collecting bad debts from tapped-out consumers is hardly a glamorous way to make money. But it can be profitable. Portfolio Recovery Associates pays pennies on the dollar to buy accounts that credit-card companies, utilities, hospitals and other businesses have given up for dead. Its staff of 1,000 collectors then recover two to three times that amount over the next five to seven years.

The stock seems like a good way to profit from record levels of consumer indebtedness ($2.4 trillion, including mortgage debt, or 18% of disposable income). But nearly half of its shares have been sold short by speculators, who apparently expect PRA to stumble. And in the second quarter, the Norfolk, Va., firm did falter a bit. Collections were down 4% from the first quarter. The news came as the subprime mortgage market was melting down, feeding fears that consumers who couldn't make their house payments surely would be unable to pay down delinquent credit-card and consumer-loan accounts. At $49 in mid September, the stock (symbol PRAA) was down 25% from its July peak.

Making choices

But PRA chief executive Steven Fredrickson argues that consumers who bought homes with no-money-down mortgages may decide that their credit-card accounts are more worthy of salvation. "We're seeing more and more cases where you have delinquent mortgages, but the revolving credit is actually performing," says Fredrickson. In any case, he says, payment rates on the accounts in his firm's portfolio haven't changed appreciably. He attributes the second-quarter shortfall to a relatively low collection rate at a newly opened call center in Tennessee (one of seven nationwide) and a slowdown in collections on pools of bankruptcy accounts bought in 2005.

A more telling predictor of PRA's future may be the amount of new debt it has been buying. Although collection rates can dip in times of rising unemployment, more misery means more defaulted debt on the market at better prices. During the second quarter, PRA bought $2.5 billion in bad debts (at an average cost of 2.5 cents on the dollar), its second-highest quarterly total ever. Although these new accounts can take a year or more to begin paying off, they set the stage for future profitability. "The buying we have done in 2007 is really the cash collection we will see in 2008, 2009 and 2010," Fredrickson says.


The receivables-management business, as it is euphemistically called, has few dominant players, and almost anyone with capital (such as hedge funds) can play. Skeptics say new participants are driving up the cost of bad-debt pools and driving down profits for everyone. But PRA's robust buying indicates that prices for bad-debt pools have been moderating. The company recently doubled its line of credit with one of its banks to prepare to take advantage of what it hopes will be a buyer's market for bad debt.

Meanwhile, the stock trades at just 15 times estimated 2007 profits, and analysts forecast 14% earnings growth next year. PRA could top forecasts if its relatively new for-fee collection business -- it collects bad debts on behalf of others -- continues its recent growth. The unit's second-quarter revenues were up 45% from the year-earlier period.