Note 6: 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 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 (up to 120 months for Cabot’s semi-performing pools). The Company often experiences collections beyond the 84 to 96 month collection forecast. As of December 31, 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 $129.8 million. The collection forecast estimates for Cabot include a 120 month collection period which is included in its estimated remaining collections and is used for calculating its IRRs.

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 revenue 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, 2011	$	821,527		$	32,676		$	854,203
Revenue recognized, net		(519,136	)		(26,276	)		(545,412	)
Net additions on existing portfolios⁽¹⁾		229,207			10,966			240,173
Additions for current purchases⁽¹⁾		453,346			—			453,346

Balance at December 31, 2012	$	984,944		$	17,366		$	1,002,310

Revenue recognized, net		(717,733	)		(27,119	)		(744,852	)
Net additions on existing portfolios⁽¹⁾		357,189			18,218			375,407
Additions for current purchases⁽¹⁾⁽²⁾		1,767,071			—			1,767,071

Balance at December 31, 2013	$	2,391,471		$	8,465		$	2,399,936

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

⁽²⁾	Includes $383.4 million of portfolios acquired in connection with the AACC Merger and $559.0 million of portfolios acquired in connection with the Cabot Acquisition discussed in Note 3, “Business Combinations.”

During the year ended December 31, 2013, the Company purchased receivable portfolios with a face value of $84.9 billion for $1.2 billion, or a purchase cost of 1.4% of face value. Purchases of charged-off credit card, telecom and consumer bankruptcy portfolios include $559.0 million of portfolios acquired in conjunction with the Cabot Acquisition and $383.4 million acquired in conjunction with the AACC Merger. The lower purchase rate for the year ended December 31, 2013 is due to the portfolio acquired in conjunction with the AACC Merger, which included all portfolios owned, including accounts that have no value and which the Company has no intention to collect. 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 year amounted to $1.3 billion.

During the year ended December 31, 2012, the Company purchased receivable portfolios with a face value of $11.4 billion for $478.8 million, or a purchase cost of 4.2% of face value. The estimated future collections at acquisition for all portfolios amounted to $842.8 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 years ended December 31, 2013, 2012, and 2011, Zero Basis Revenue was approximately $17.2 million, $22.6 million, and $20.6 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):


	Year Ended December 31, 2013
	Accrual Basis Portfolios			Cost Recovery Portfolios			Zero Basis Portfolios			Total
Balance, beginning of period	$	873,119		$	—		$	—		$	873,119
Purchases of receivable portfolios⁽¹⁾		1,203,706			1,073			—			1,204,779
Transfer of portfolios		(6,649	)		6,649			—			—
Gross collections⁽²⁾		(1,249,625	)		(2,764	)		(27,117	)		(1,279,506	)
Put-backs and recalls		(2,331	)		(296	)		(2	)		(2,629	)
Foreign currency adjustments		49,634			—			—			49,634
Revenue recognized		715,458			—			17,201			732,659
Portfolio allowance reversals, net		2,275			—			9,918			12,193

Balance, end of period	$	1,585,587		$	4,662		$	—		$	1,590,249

Revenue as a percentage of collections⁽³⁾		57.3	%		0.0	%		63.4	%		57.3	%


	Year Ended December 31, 2012
	Accrual Basis Portfolios			Cost Recovery Portfolios			Zero Basis Portfolios			Total
Balance, beginning of period	$	716,454		$	—		$	—		$	716,454
Purchases of receivable portfolios⁽¹⁾		562,335			—			—			562,335
Gross collections⁽²⁾		(921,730	)		—			(26,276	)		(948,006	)
Put-backs and recalls		(3,076	)		—			—			(3,076	)
Revenue recognized		518,617			—			22,574			541,191
Portfolio allowance reversals, net		519			—			3,702			4,221

Balance, end of period	$	873,119		$	—		$	—		$	873,119

Revenue as a percentage of collections⁽³⁾		56.3	%		0.0	%		85.9	%		57.1	%


	Year Ended December 31, 2011
	Accrual Basis Portfolios			Cost Recovery Portfolios			Zero Basis Portfolios			Total
Balance, beginning of period	$	644,753		$	—		$	—		$	644,753
Purchases of receivable portfolios⁽¹⁾		386,850			—			—			386,850
Gross collections⁽²⁾		(740,402	)		—			(20,609	)		(761,011	)
Put-backs and recalls		(2,843	)		—			(9	)		(2,852	)
Revenue recognized		443,367			—			16,170			459,537
(Portfolio allowances) portfolio allowance reversals, net		(15,271	)		—			4,448			(10,823	)

Balance, end of period	$	716,454		$	—		$	—		$	716,454

Revenue as a percentage of collections⁽³⁾		59.9	%		0.0	%		78.5	%		60.4	%

⁽¹⁾	Purchases of portfolio receivables include $383.4 million acquired in connection with the AACC Merger in June 2013 and $559.0 million acquired in connection with the Cabot Acquisition in July 2013 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
Balance at December 31, 2010	$	98,671

Provision for portfolio allowances		17,707
Reversal of prior allowances		(6,884	)

Balance at December 31, 2011	$	109,494

Provision for portfolio allowances		6,745
Reversal of prior allowances		(10,966	)

Balance at December 31, 2012	$	105,273

Provision for portfolio allowances		479
Reversal of prior allowances		(12,672	)

Balance at December 31, 2013	$	93,080