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Fair Value Measurements

6 Months Ended

Jun. 30, 2019

The authoritative guidance for fair value measurements defines fair value as the price that would be received upon sale of an asset or the price paid to transfer a liability, in an orderly transaction between market participants at the measurement date (i.e., the “exit price”). The guidance utilizes a fair value hierarchy that prioritizes the inputs used in valuation techniques to measure fair value into three broad levels. The following is a brief description of each level:


•	Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.


•	Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.


•	Level 3: Unobservable inputs, including inputs that reflect the reporting entity’s own assumptions.

Financial Instruments Required To Be Carried At Fair Value

Financial assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):



	Fair Value Measurements as of June 30, 2019
	Level 1		Level 2			Level 3			Total
Assets
Foreign currency exchange contracts	$	—	$	1,403		$	—		$	1,403
Interest rate cap contracts	—		311			—			311
Liabilities
Interest rate swap agreements	—		(10,779		)	—			(10,779		)
Contingent consideration	—		—			(3,819		)	(3,819		)



	Fair Value Measurements as of December 31, 2018
	Level 1		Level 2			Level 3			Total
Assets
Interest rate cap contracts	$	—	$	2,023		$	—		$	2,023
Liabilities
Foreign currency exchange contracts	—		(237		)	—			(237		)
Interest rate swap agreements	—		(4,881		)	—			(4,881		)
Contingent consideration	—		—			(6,198		)	(6,198		)

Derivative Contracts:

The Company uses derivative instruments to manage its exposure to fluctuations in interest rates and foreign currency exchange rates. Fair values of these derivative instruments are estimated using industry standard valuation models. These models project future cash flows and discount the future amounts to a present value using market-based observable inputs, including interest rate curves, foreign currency exchange rates, and forward and spot prices for currencies.

Contingent Consideration:

The Company carries certain contingent liabilities resulting from its mergers and acquisition activities. Certain sellers of the Company’s acquired entities could earn additional earn-out payments in cash based on the entities’ subsequent operating performance. The Company recorded the acquisition date fair values of these contingent liabilities, based on the likelihood of contingent earn-out payments, as part of the consideration transferred. The earn-out payments are subsequently remeasured to fair value at each reporting date based on actual and forecasted operating performance.

The following table provides a roll forward of the fair value of contingent consideration for the six months ended June 30, 2019 and year ended December 31, 2018 (in thousands):



	Amount
Balance at December 31, 2017	$	10,612
Issuance of contingent consideration in connection with acquisition	1,728
Change in fair value of contingent consideration	(5,664		)
Payment of contingent consideration	(271		)
Effect of foreign currency translation	(207		)
Balance at December 31, 2018	6,198
Change in fair value of contingent consideration	(2,199		)
Payment of contingent consideration	(131		)
Effect of foreign currency translation	(49		)
Balance at June 30, 2019	$	3,819

Non-Recurring Fair Value Measurement:

Certain assets are measured at fair value on a nonrecurring basis. These assets include real estate-owned (“REO”) assets classified as held for sale at the lower of their carrying value or fair value less cost to sell. The fair value of the assets held for sale and estimated selling expenses were determined at the time of initial recognition using Level 2 measurements. The fair value estimate of the assets held for sale was approximately $38.6 million and $26.7 million as of June 30, 2019 and December 31, 2018, respectively.

Financial Instruments Not Required To Be Carried At Fair Value

In accordance with the disclosure requirements of ASC Topic 825, Financial Instruments, the table below summarizes fair value estimates for the Company's financial instruments that are not required to be carried at fair value. The total of the fair value calculations presented does not represent, and should not be construed to represent, the underlying value of the Company. The carrying amounts in the following table are recorded in the consolidated statements of financial condition at June 30, 2019 and December 31, 2018 (in thousands):



	June 30, 2019				December 31, 2018
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial Assets
Investment in receivable portfolios	$	3,224,568	$	3,293,067	$	3,137,893	$	3,525,861
Deferred court costs	92,595		92,595		95,918		95,918
Financial Liabilities
Encore convertible notes and exchangeable notes⁽¹⁾	626,006		652,063		619,639		553,744
Cabot senior secured notes⁽²⁾	1,106,031		1,132,027		1,109,922		1,036,905

________________________


(1)	Carrying amount represents the portion of the convertible and exchangeable notes classified as debt, while estimated fair value pertains to the face amount of the notes.


(2)	Carrying amount represents historical cost, adjusted for any related debt discount or debt premium.

Investment in Receivable Portfolios:

The Company records its investment in receivable portfolios at cost, which represents a significant discount from the contractual receivable balance due. The Company computes the fair value of its investment in receivable portfolios using Level 3 inputs by discounting the estimated future cash flows generated by its proprietary forecasting models. The key inputs include the estimated future gross cash flow, average cost to collect, and discount rate. In accordance with authoritative guidance related to fair value measurements, the Company estimates the average cost to collect and discount rates based on its estimate of what a market participant might use in valuing these portfolios. The determination of such inputs requires significant judgment, including assessing the assumed market participant’s cost structure, its determination of whether to include fixed costs in its valuation, its collection strategies, and determining the appropriate weighted average cost of capital. The Company evaluates the use of these key inputs on an ongoing basis and refines the data as it continues to obtain better information from market participants in the debt recovery and purchasing business.

In the Company’s current analysis, the fair value of investment in receivable portfolios was approximately $3,293.1 million and $3,525.9 million as of June 30, 2019 and December 31, 2018, respectively, as compared to the carrying value of $3,224.6 million and $3,137.9 million as of June 30, 2019 and December 31, 2018, respectively. A 100 basis point increase in the cost to collect and discount rate used would result in a decrease in the fair value of U.S. and European portfolios by approximately $55.9 million and $73.7 million, respectively, as of June 30, 2019. This fair value calculation does not represent, and should not be construed to represent, the underlying value of the Company or the amount which could be realized if its investment in receivable portfolios were sold.

Deferred Court Costs:

The Company capitalizes deferred court costs and provides a reserve for those costs that it believes will ultimately be uncollectible. The carrying value of net deferred court costs was $92.6 million and $95.9 million as of June 30, 2019 and December 31, 2018, respectively, and approximated fair value.

Debt:

The majority of the Company’s borrowings are carried at historical amounts, adjusted for additional borrowings less principal repayments, which approximate fair value. These borrowings include Encore’s senior secured notes and borrowings under its revolving credit and term loan facilities and Cabot’s borrowings under its revolving credit facility. The carrying value of the Company’s revolving credit and term loan facilities approximates fair value due to the short-term nature of the interest rate periods. The fair value of the Company’s senior secured notes was estimated using widely accepted valuation techniques, including discounted cash flow analyses using available market information on discount and borrowing rates with similar terms, maturities, and credit ratings. Accordingly, the Company used Level 2 inputs for these debt instrument fair value estimates.

Encore’s convertible notes and exchangeable notes are carried at historical cost, adjusted for the debt discount. The carrying value of the convertible notes and exchangeable notes was $626.0 million and $619.6 million, net of the debt discount of $30.0 million and $36.4 million as of June 30, 2019 and December 31, 2018, respectively. The fair value estimate for these convertible notes and exchangeable notes, which incorporates quoted market prices using Level 2 inputs, was approximately $652.1 million and $553.7 million as of June 30, 2019 and December 31, 2018, respectively.

Cabot’s senior secured notes are carried at historical cost, adjusted for the debt discount, if applicable. The net carrying value of Cabot’s senior secured notes was $1,106.0 million and $1,109.9 million as of June 30, 2019 and December 31, 2018, respectively. The fair value estimate for these senior notes, which incorporates quoted market prices using Level 2 inputs, was $1,132.0 million and $1,036.9 million as of June 30, 2019 and December 31, 2018, respectively.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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