Note 7: Investment in Receivable Portfolios, Net

In accordance with the authoritative guidance for loans and debt securities acquired with deteriorated credit quality, discrete receivable portfolio purchases during a quarter are aggregated into pools based on common risk characteristics. Once a static pool is established, the portfolios are permanently assigned to the pool. The discount (i.e., the difference between the cost of each static pool and the related aggregate contractual receivable balance) is not recorded because the Company expects to collect a relatively small percentage of each static pool’s contractual receivable balance. As a result, receivable portfolios are recorded at cost at the time of acquisition. The purchase cost of the portfolios includes certain fees paid to third parties incurred in connection with the direct acquisition of the receivable portfolios.

In compliance with the authoritative guidance, the Company accounts for its investments in consumer receivable portfolios using either the interest method or the cost recovery method. The interest method applies an internal rate of return (“IRR”) to the cost basis of the pool, which remains unchanged throughout the life of the pool, unless there is an increase in subsequent expected cash flows. Subsequent increases in expected cash flows are generally recognized prospectively through an upward adjustment of the pool’s IRR over its remaining life. Subsequent decreases in expected cash flows do not change the IRR, but are recognized as an allowance to the cost basis of the pool, and are reflected in the consolidated statements of comprehensive income as a reduction in revenue, with a corresponding valuation allowance, offsetting the investment in receivable portfolios in the consolidated statements of financial condition.

The Company utilizes its proprietary forecasting models to continuously evaluate the economic life of each pool. The collection forecast of each pool is generally estimated to be between 84 to 96 months based on the expected collection period of each pool. The Company often experiences collections beyond the 84 to 96 month collection forecast. As of June 30, 2013, the total estimated remaining collections beyond the 84 to 96 month collection forecast, which are not included in the calculation of the Company’s IRRs, were $147.1 million.

The Company accounts for each static pool as a unit for the economic life of the pool (similar to one loan) for recognition of revenue from receivable portfolios, for collections applied to the cost basis of receivable portfolios, and for provision for loss or allowance. Revenue from receivable portfolios is accrued based on each pool’s IRR applied to each pool’s adjusted cost basis. The cost basis of each pool is increased by revenue earned and decreased by gross collections and portfolio allowances.

If the amount and timing of future cash collections on a pool of receivables are not reasonably estimable, the Company accounts for such portfolios on the cost recovery method as Cost Recovery Portfolios. The accounts in these portfolios have different risk characteristics than those included in other portfolios acquired during the same quarter, or the necessary information was not available to estimate future cash flows and, accordingly, they were not aggregated with other portfolios. Under the cost recovery method of accounting, no income is recognized until the purchase price of a Cost Recovery Portfolio has been fully recovered.

Accretable yield represents the amount of revenue the Company expects to generate over the remaining life of its existing investment in receivable portfolios based on estimated future cash flows. Total accretable yield is the difference between future estimated collections and the current carrying value of a portfolio. All estimated cash flows on portfolios where the cost basis has been fully recovered are classified as zero basis cash flows.

The following table summarizes the Company’s accretable yield and an estimate of zero basis future cash flows at the beginning and end of the period presented (in thousands):


	Accretable Yield		Estimate of Zero Basis Cash Flows		Total
Balance at December 31, 2012	$	984,944	$	17,366	$	1,002,310
Revenue recognized, net		(135,072)		(5,611)		(140,683)
Net additions to existing portfolios⁽¹⁾		173,634		7,061		180,695
Additions for current purchases⁽¹⁾		66,808		—		66,808

Balance at March 31, 2013	$	1,090,314	$	18,816	$	1,109,130

Revenue recognized, net		(144,186)		(7,838)		(152,024)
Net additions to existing portfolios⁽¹⁾		30,458		10,784		41,242
Additions for current purchases^(1), (2)		645,865		—		645,865

Balance at June 30, 2013	$	1,622,451	$	21,762	$	1,644,213


	Accretable Yield		Estimate of Zero Basis Cash Flows		Total
Balance at December 31, 2011	$	821,527	$	32,676	$	854,203
Revenue recognized, net		(119,340)		(7,065)		(126,405)
Net additions to existing portfolios⁽¹⁾		131,039		3,608		134,647
Additions for current purchases⁽¹⁾		119,533		—		119,533

Balance at March 31, 2012	$	952,759	$	29,219	$	981,978

Revenue recognized, net		(131,624)		(7,107)		(138,731)
Net additions to existing portfolios⁽¹⁾		77,473		13,738		91,211
Additions for current purchases⁽¹⁾		178,332		—		178,332

Balance at June 30, 2012	$	1,076,940	$	35,850	$	1,112,790

⁽¹⁾	Estimated remaining collections and accretable yield include anticipated collections beyond the 84 to 96 month collection forecast.

⁽²⁾	Includes $381.2 million of portfolios acquired in connection with the AACC Merger discussed in Note 3 “Business Combinations.”

During the three months ended June 30, 2013, the Company purchased receivable portfolios with a face value of $68.9 billion for $423.1 million, or a purchase cost of 0.6% of face value. Included in this amount is the purchase of investment receivables related to AACC of $381.2 million with a face value of $68.2 billion or a purchase cost of 0.6% of face value. Excluding the AACC receivables, the Company purchased receivable portfolios during the quarter with a face value of $0.7 billion for $41.9 million, or a purchase cost of 5.8% of face value. The lower purchase rate for the AACC portfolio is due to the Company’s purchase of AACC which included all portfolios owned, including accounts that have no value. No value accounts would typically not be included in a portfolio purchase transaction, as the sellers would remove them from the sale file. The estimated future collections at acquisition for all portfolios purchased during the quarter amounted to $1.0 billion.

During the six months ended June 30, 2013, the Company purchased receivable portfolios with a face value of $70.5 billion for $481.9 million, or a purchase cost of 0.7% of face value. Included in this amount is the purchase of investment receivables related to AACC of $381.2 million with a face value of $68.2 billion, or a purchase cost of 0.6% of face value. Excluding the AACC purchase, the Company purchased receivable portfolios during the six months ended June 30, 2013, with a face value of $2.3 billion for $100.7 million, or a purchase cost of 4.4% of face value. The lower purchase rate for the AACC portfolio is due to the Company’s purchase of AACC which included all portfolios owned, including accounts that have no value. No value accounts would typically not be included in a portfolio purchase transaction, as the sellers would remove them from the sale file. The estimated future collections at acquisition for all portfolios purchased during the six months ended June 30, 2013, amounted to $1.1 billion.

During the three months ended June 30, 2012, the Company purchased receivable portfolios with a face value of $6.0 billion for $231.0 million, or a purchase cost of 3.8% of face value. The estimated future collections at acquisition for these portfolios amounted to $407.4 million. During the six months ended June 30, 2012, the Company purchased receivable portfolios with a face value of $8.9 billion for $361.4 million, or a purchase cost of 4.0% of face value. The estimated future collections at acquisition for these portfolios amounted to $643.6 million.

All collections realized after the net book value of a portfolio has been fully recovered (“Zero Basis Portfolios”) are recorded as revenue (“Zero Basis Revenue”). During the three months ended June 30, 2013 and 2012, Zero Basis Revenue was approximately $4.7 million and $6.1 million, respectively. During the six months ended June 30, 2013 and 2012, Zero Basis Revenue was approximately $9.4 million and $12.2 million, respectively.

The following tables summarize the changes in the balance of the investment in receivable portfolios during the following periods (in thousands, except percentages):


	Three Months Ended June 30, 2013
	Accrual Basis Portfolios		Cost Recovery Portfolios		Zero Basis Portfolios		Total
Balance, beginning of period	$	801,525	$	—	$	—	$	801,525
Purchases of receivable portfolios⁽¹⁾		423,113		—		—		423,113
Transfer of portfolios		(6,649)		6,649		—		—
Gross collections⁽²⁾		(269,710)		(842)		(7,836)		(278,388)
Put-backs and recalls		(1,543)		(31)		(2)		(1,576)
Revenue recognized		143,607		—		4,743		148,350
Portfolio allowances reversals, net		579		—		3,095		3,674

Balance, end of period	$	1,090,922	$	5,776	$	—	$	1,096,698

Revenue as a percentage of collections⁽³⁾		53.2%		0.0%		60.5%		53.3%


	Three Months Ended June 30, 2012
	Accrual Basis Portfolios		Cost Recovery Portfolios		Zero Basis Portfolios		Total
Balance, beginning of period	$	741,580	$	—	$	—	$	741,580
Purchases of receivable portfolios⁽¹⁾		230,983		—		—		230,983
Gross collections⁽²⁾		(233,437)		—		(7,107)		(240,544)
Put-backs and recalls		(891)		—		—		(891)
Revenue recognized		131,443		—		6,126		137,569
Portfolio allowances reversals, net		181		—		981		1,162

Balance, end of period	$	869,859	$	—	$	—	$	869,859

Revenue as a percentage of collections⁽³⁾		56.3%		0.0%		86.2%		57.2%


	Six Months Ended June 30, 2013
	Accrual Basis Portfolios		Cost Recovery Portfolios		Zero Basis Portfolios		Total
Balance, beginning of period	$	873,119	$	—	$	—	$	873,119
Purchases of receivable portfolios⁽¹⁾		481,884		—		—		481,884
Transfer of portfolios		(6,649)		6,649		—		—
Gross collections⁽²⁾		(534,269)		(842)		(13,447)		(548,558)
Put-backs and recalls		(2,421)		(31)		(2)		(2,454)
Revenue recognized		278,622		—		9,405		288,027
Portfolio allowances reversals, net		636		—		4,044		4,680

Balance, end of period	$	1,090,922	$	5,776	$	—	$	1,096,698

Revenue as a percentage of collections⁽³⁾		52.2%		0.0%		69.9%		52.5%


	Six Months Ended June 30, 2012
	Accrual Basis Portfolios		Cost Recovery Portfolios		Zero Basis Portfolios		Total
Balance, beginning of period	$	716,454	$	—	$	—	$	716,454
Purchases of receivable portfolios⁽¹⁾		361,446		—		—		361,446
Gross collections⁽²⁾		(457,380)		—		(14,172)		(471,552)
Put-backs and recalls		(1,625)		—		—		(1,625)
Revenue recognized		252,189		—		12,158		264,347
(Portfolio allowances) portfolio allowance reversals, net		(1,225)		—		2,014		789

Balance, end of period	$	869,859	$	—	$	—	$	869,859

Revenue as a percentage of collections⁽³⁾		55.1%		0.0%		85.8%		56.1%

⁽¹⁾	Purchases of portfolio receivables for the three and six month periods ended June 30, 2013 include $381.2 million acquired in connection with the AACC Merger discussed in Note 3 “Business Combinations.”

⁽²⁾	Does not include amounts collected on behalf of others.

⁽³⁾	Revenue as a percentage of collections excludes the effects of net portfolio allowances or net portfolio allowance reversals.

The following table summarizes the change in the valuation allowance for investment in receivable portfolios during the periods presented (in thousands):


	Valuation Allowance
	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Balance at beginning of period	$	104,267	$	109,867	$	105,273	$	109,494
Provision for portfolio allowances		—		2,116		479		3,875
Reversal of prior allowances		(3,674)		(3,278)		(5,159)		(4,664)

Balance at end of period	$	100,593	$	108,705	$	100,593	$	108,705

The Company currently utilizes various business channels for the collection of its receivables. The following table summarizes the total collections by collection channel (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Legal collections	$	133,682	$	114,876	$	255,955	$	224,448
Collection sites		116,853		111,641		243,415		221,511
Collection agencies ⁽¹⁾		27,853		14,043		49,188		25,629

	$	278,388	$	240,560	$	548,558	$	471,588

⁽¹⁾	Collections through our collection agency channel include accounts subject to bankruptcy filings collected by others.