Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDR) and senior unsecured debt ratings of Jefferson Capital Holdings, LLC (Jefferson) at ‘BB-‘. The Rating Outlook remains Stable.
Key Rating Drivers
The rating affirmation reflects Jefferson’s growing franchise within the debt purchasing sector, where it benefits from a recognized market position in the U.S., a leading franchise in Canada and a growing presence in the U.K. and Latin America; its diversification across secured and unsecured asset classes; and consistent through-the-cycle operating history via predecessor entities. The ratings also reflect Jefferson’s conservative leverage profile and limited near-term refinancing risk.
Ratings are constrained by its limited scale relative to top-tier peers, monoline business model primarily servicing charged-off debt, and a history of business acquisitions, which presents execution risks. Additional constraints include potential regulatory scrutiny associated with the consumer collections businesses, the company’s reliance on internal modelling for portfolio valuations and associated metrics such as estimated remaining collections (ERCs) and its private equity ownership, which can yield uncertainty around strategic and financial targets.
In 1Q23, Jefferson reported cash collections of $108 million, which was up 3% yoy. Cash collections declined 15% in 2022 as they normalize from a record high level in 2021, reflecting the wind-down of fiscal stimulus, the weakening economic backdrop and consumer financial health. Portfolio purchases have been robust and increased by over 200% in 1Q23 underpinned by strong deployment opportunities as industry supply of non-performing loan portfolios continues to improve. Portfolio diversification, with a reduced reliance on credit card receivables, also helped Jefferson maintain yoy growth in portfolio purchases since the latter half of 2021. As a result of strong deployments, ERCs grew 29% yoy in 1Q23.
Adjusted EBITDA was $274 million for the trailing 12 months (TTM) ended 1Q23, generally consistent with FY22, but down from a record 2021. The adjusted EBITDA margin (adjusted for portfolio amortization) was 66.4% for the TTM ended 1Q23, compared with 67.9% in 2022 and a four-year average of 68.2%. Fitch expects earnings metrics to be pressured over the near term given continued normalization of collections, but profitability is expected to remain strong and consistent with the assigned rating category.
Jefferson’s leverage (gross debt-to-adjusted EBITDA) was 2.0x for the TTM ended 1Q23, which corresponds to Fitch’s ‘bbb’ category benchmark range of 1.5-2.5x. Leverage has increased in recent quarters due to portfolio growth. Fitch expects leverage to increase further but to remain at-or-below 2.5x, consistent with company’s stated leverage target of 2.0x-2.5x.
Fitch also considers gross debt-to-tangible equity as a complementary leverage metric. On this basis, leverage was 3.0x at end-1Q23, which provides meaningful headroom against Fitch’s 5x downgrade trigger. Tangible equity growth has been supported by solid internal capital generation, but leverage is expected to rise over the medium term with improved portfolio acquisition opportunities.
Jefferson’s funding profile is comprised of senior unsecured notes and a secured revolving credit facility (RCF) totaling $537 million. The unsecured funding represented approximately 56% of total debt at end-1Q23, which compares favorably with peers. Fitch expects the unsecured funding mix to trend lower in the near term as utilization of RCF increases to fund portfolio purchases.
Fitch believes Jefferson’s liquidity profile is adequate. At end-1Q23, the company had $23 million in cash and $146 million in available capacity under its RCF (subject to borrowing base calculations). The company has no material debt maturities until 2026. Additionally, debt purchasers have the option, over shorter periods, to moderate their rate of portfolio purchases to conserve liquidity.
The Stable Outlook reflects Fitch’s view that the company’s conservative leverage, good profitability and discretionary nature of portfolio purchases mitigate risks of potential slowdown in debt-collection activities and/or changes to estimated recoveries. The Stable Outlook also assumes that any possible changes to Jefferson’s collection practices arising from new regulatory rules will have a minimal negative impact on the business model.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
–A sustained increase in debt/adjusted EBITDA above 2.5x or debt/tangible equity above 5x, resulting from EBITDA contraction and/or an increase in debt-funded acquisitions;
–Failure to maintain a diverse funding profile and/or a shift to a largely secured balance sheet funding model;
–A weakening in asset quality, as reflected in acquired debt portfolios significantly underperforming anticipated returns or repeated material write-downs in expected recoveries;
–An adverse operational event or significant disruption in business activities (for example arising from regulatory intervention in key markets adversely impacting collection activities), thereby undermining franchise strength and business-model resilience.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
–An enhancement of scale and franchise strength relative to peers and demonstrated earning resilience through the current economic cycle;
–Further diversification of the funding profile and maintenance of an unsecured debt funding mix at greater than 40% of total debt on a sustained basis;
–Leverage maintained consistently below 2x through the cycle on a debt/adjusted EBITDA basis and below 4x on a debt/tangible equity basis.
DEBT AND OTHER INSTRUMENT RATINGS: KEY RATING DRIVERS
Jefferson’s senior unsecured debt rating is equalized with the Long-Term IDR, reflecting Fitch’s expectation of average recovery prospects under a stressed scenario. The negative impact from an increase in secured funding in a priority position is offset by relatively low leverage.
DEBT AND OTHER INSTRUMENT RATINGS: RATING SENSITIVITIES
Jefferson’s senior unsecured debt rating is primarily sensitive to changes in the group’s Long-Term IDR and secondarily to the funding mix and recovery prospects on the unsecured debt. A material increase in the proportion of secured debt, which weakens recovery prospects for unsecured debtholders in a stressed scenario could result in the unsecured debt rating being notched down below the IDR.
ADJUSTMENTS
The Standalone Credit Profile has been assigned below the implied Standalone Credit Profile due to the following adjustment reason: Business Profile (negative).
The Business Profile score has been assigned in line with the implied score. Business model was identified as a relevant negative factor in the assessment.
The Earnings & Profitability score has been assigned below the implied score due to the following adjustment reason: Revenue diversification (negative).
The Capitalization & Leverage score has been assigned below the implied score due to the following adjustment reason: Historical and future metrics (negative).
The Funding, Liquidity & Coverage score has been assigned below the implied score due to the following adjustment reason: Historical and future metrics (negative).
Best/Worst Case Rating Scenario
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Jefferson Capital Holdings LLC has an ESG Relevance Score of ‘4’ for Customer Welfare – Fair Messaging, Privacy & Data Security due to the importance of fair collection practices and consumer interactions and the regulatory focus on them, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.
Jefferson Capital Holdings LLC has an ESG Relevance Score of ‘4’ for Financial Transparency due to the significance of internal modelling to portfolio valuations and associated metrics such as estimated remaining collections, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors. These are features of the debt purchasing sector as a whole, and not specific to the company.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of ‘3’. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg.
Source: Fitch Ratings
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