The risks that you raise certainly exist and we mustn't lose sight of those. Achieving a 4 x multiple is relatively huge and is a big ask. If the default rate remains where it is then I believe it is achievable, although not a given. Personally I would probably underpromise and over deliver and there is a risk in the tail that that won't play out. They do have a downward calibration in their valuation that would appear to provide some protection risk in the run off.
A couple of things we should bear in mind...the debt Pioneer is acquiring is tier 1 debt that was all good credit at origination by the bank and was credit screened (no low doc etc.). The debts are also of a higher average size. A very different make up and thus acquisition price when compared to say a telco or utility debt or even payday type loans. The characteristics of PNC debt would appear to be at the "better end" of defaulted debt - i.e. people who know and acknowledge they have a debt, were good credit and wanted to pay, probably fell on hard times due to life circumstances and once they start paying again (i.e. once on a payment arrangement) have an intention of paying the money back and getting back on track. Particularly if a heavy handed approach isn't applied and some compassion is shown to the customer. A longer liquidation period is a good thing if it helps and attracts the customer to keep paying as it's affordable - from a valuation perspective the debt is also discounted so those cash flows at the end of the tail won't currently be valued at that much (out of interest we could fairly easily estimate the effective discounting of customers who are presently paying by using the risk adjusted discount rate disclosed, plus default rate disclosed, plus the downward adjustment of around 9% they disclose that they put on top of this).
From a bank perspective the equation isn't quite losing out on a higher return. I've put a couple of reasons I see for this and there are plenty of others as well.
Firstly banks get limited risk asset weighting (if any) for debts that are delinquent beyond a certain point (would depend on whether they are using simple or advanced methodology based on if APRA has approved certain parts of their portfolios). This costs real money as effectively equity (and thus cost of equity) gets chewed up as the asset counts for nothing on their books for capital purposes, even if it still has some value from a valuation perspective.
Secondly, banks aren't in the business of being debt collectors - this seems an odd statement when talking about institutions that are in the business of originating debt, but most banks don't have the in house functions or inclination to develop them to collect the debt. It is a pretty specialist skill set. This leads to opportunity for other niche players in the form of companies like PNC, CCP, CLH, BayerCorp etc. to acquire the debt and make appropriate risk adjusted returns.
The price paid at a macro level will be driven by participants in the sector's bidding for debt which will be driven largely by their collection efficiency for the type of debt bid for and the value the particular bank places on other non-financial metrics (for example, protecting their brand by not selling to people who try and collect via intimidation and baseball bats). If a magical collection company entered the market who suddenly was capable of getting virtually all customers acquired to pay within a very short time and managed to collect virtually all of the cash back in a very short timeframe then the price that particular company could afford to bid for the debt would be significantly higher than present prices, while still achieving a good return on equity/capital. this would basically drive others out of the market or force them to improve to a similar level. A market participant at this extreme doesn't exist and so if banks want to recycle capital by passing debts onto others to collect it will always do so at rates that reflect long liquidation periods and the non-collection of much face value and thus values that return relatively low %'s of the dollar originated. If the industry gets more efficient generally this would be good for the banks (higher price on sale) at no expense to the capital providers of the debt collection companies (as their return on capital would still be achieved).
Next, it is important for the bank, with politicians crawling all over the sector, to be doing business with reputable companies who treat their customers well. PNC has no adverse findings against them, work with the customer to let them pay back over a realistic timeframe etc..
There are lots of reasons I see for why a bank would still sell the debt even if the party they are selling to will collect a high multiple back in return.
All said and done the proof will be in the pudding once multiple 7-10 year periods have passed. In the meantime we need to keep a close eye on liquidations (outcome of locating customers and getting them to pay), default rates etc.. The power of compounding at least means that cash that is expected to be collected in the tail isn't presently valued at that much. The following might not be the actual numbers but illustrates the point with a 20% discount rate, 3.5% default rate, and a downward calibration of 9% (I think they mention this somewhere). Cash that is expected to be collected in year 10 is only valued at 6% of the cash expected to be collected (which is already a fraction of face value). The default rate would have to rise a fair bit before the downward calibration is fully absorbed. If the customer keeps paying the effect of the discounting will unwind as revenue.
Column 1
Column 2
Column 3
Column 4
Column 5
0
Discount rate
Default Rate (pa)
Downward calibration
Discount factor
1
1
20%
3.50%
9%
0.754717
2
2
20%
3.50%
9%
0.569598
3
3
20%
3.50%
9%
0.429885
4
4
20%
3.50%
9%
0.324442
5
5
20%
3.50%
9%
0.244862
6
6
20%
3.50%
9%
0.184801
7
7
20%
3.50%
9%
0.139473
8
8
20%
3.50%
9%
0.105262
9
9
20%
3.50%
9%
0.079443
10
10
20%
3.50%
9%
0.059957
Not really a direct answer to your questions, those risks are valid, must be monitored and as investors would be negligent not to react if data shows a different trend emerging. However, these are some of my general thoughts around those topics.
PNC Price at posting:
$2.48 Sentiment: Buy Disclosure: Held
(20min delay)