Summary of PORTFOLIO RECOVERY ASSOCIATES INC

Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Overview
PRA is a financial and business services company. Our primary business is the purchase, collection and management of portfolios of defaulted consumer receivables. We also service receivables on behalf of clients on either a commission or transaction-fee basis as well as providing class action claims settlement recovery services and related payment processing to our corporate clients.
PRA is headquartered in Norfolk, Virginia, and employs approximately 3,200 people. The shares of PRA are traded on the NASDAQ Global Select Market under the symbol "PRAA."
On January 16, 2012, we acquired 100% of the equity interest in MHH, a United Kingdom debt collection and purchase group. Based in Kilmarnock, Scotland, MHH employs approximately 176 people and offers outsourced and contingent consumer debt recovery on behalf of banks, credit providers and debt purchasers, as well as distressed and dormant niche portfolio purchasing.
On December 21, 2012, we acquired certain assets of National Capital Management, LLC ("NCM"), a bankruptcy debt buying and claims processing business. These assets include secured and unsecured consumer bankruptcy accounts and operating assets associated with the underwriting and collection of secured bankruptcy claims. The transaction also included the hiring of approximately 25 employees. Earnings Summary
For the year ended December 31, 2012, net income attributable to PRA was $126.6 million, or $7.39 per diluted share, compared with $100.8 million, or $5.85 per diluted share, for the year ended December 31, 2011. Total revenues were $592.8 million for the year ended December 31, 2012, up 29.2% from the same year ago period. Revenues during the year ended December 31, 2012 consisted of $530.6 million in income recognized on finance receivables, net of allowance charges, and $62.2 million in fee income. Income recognized on finance receivables, net of allowance charges, for the year ended December 31, 2012 increased $128.7 million, or 32.0%, over 2011, primarily as a result of a significant increase in cash collections. Cash collections were $908.7 million during the year ended December 31, 2012, up 28.8% over $705.5 million in the year ended December 31, 2011. During the year ended December 31, 2012, PRA recorded $6.6 million in net allowance charges, compared with $10.2 million in the year ended December 31, 2011. Our performance has been positively impacted by operational efficiencies surrounding the cash collections process, including the continued refinement of account scoring analytics as it relates to both legal and non-legal collection channels. Additionally, we have continued to develop our internal legal collection staff resources, which enables us to place accounts into that channel that otherwise would have been prohibitively expensive for legal action and to collect these accounts more efficiently and profitably.
Fee income increased from $57.0 million for the year ended December 31, 2011 to $62.2 million in 2012, primarily due to the acquisition of MHH in the first quarter of 2012. This increase was partially offset by declines in revenue generated by both our PLS business and CCB. The decline from PLS is due primarily to the adverse impact of the economic slowdown on automobile financing and related collateral recovery activities. The decline from CCB is due primarily to larger distributions of class action settlements in the year ended December 31, 2011 as compared to the year ended December 31, 2012. A summary of how our revenue was generated during the year ended December 31, 2012, 2011 and 2010 is as follows:

(in thousands)                                   2012          2011          2010
Cash collections                              $ 908,684     $ 705,490     $ 529,342
Principal amortization                         (371,497 )    (293,431 )    (194,510 )
Net allowance charges                            (6,552 )     (10,164 )     (25,152 )
Income recognized on finance receivables, net   530,635       401,895       309,680
Fee income                                       62,166        57,040        63,026
Total revenues                                $ 592,801     $ 458,935     $ 372,706

Operating expenses were $376.7 million for the year ended December, 31, 2012, up 33.5% as compared to the year ended December 31, 2011, due primarily to increases in compensation expense, legal collection costs, legal collection fees and outside fees and services. Compensation expense increased primarily as a result of larger staff sizes, including the acquisition of MHH on January 16, 2012, as well as an increase in share-based compensation expense. Compensation and employee services expenses increased as total employees grew 22.0% to 3,221 as of December 31, 2012 from 2,641 as of December 31, 2011. Legal collection costs were $72.3 million for the year ended December 31, 2012 compared to $38.7 million for the year ended December 31, 2011, an increase of $33.6 million or 86.8%. This increase was the result of an increased portfolio size as well as a refinement of our internal scoring

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methodology that expanded our account selections for legal action. This strategy to expand the accounts brought into the legal collection process resulted in significant initial expenses, which may drive additional future cash collections and revenue. Legal collection fees increased from $23.6 million for the year ended December 31, 2011 to $34.4 million for the year ended December 31, 2012, an increase of $10.8 million or 45.8%. This increase was the result of an increase in cash collections from outside attorneys from $106.3 million in the year ended December 31, 2011 to $157.8 million for the year ended December 31, 2012, an increase of $51.5 million or 48.4%. Outside fees and services increased primarily as a result of legal related expenses as well as increases in costs related to software development. Results of Operations
The results of operations include the financial results of PRA and all of our subsidiaries, all of which are in the receivables management business. Under the guidance of the FASB ASC Topic 280 "Segment Reporting" ("ASC 280"), we have determined that we have several operating segments that meet the aggregation criteria of ASC 280, and therefore, we have one reportable segment, accounts receivables management, based on similarities among the operating units including homogeneity of services, service delivery methods and use of technology.
The following table sets forth certain operating data as a percentage of total revenues for the years indicated:

                                        2012                      2011                      2010
Revenues:
Income recognized on finance
receivables, net               $ 530,635       89.5  %   $ 401,895       87.6  %   $ 309,680       83.1  %
Fee income                        62,166       10.5         57,040       12.4         63,026       16.9
Total revenues                   592,801      100.0        458,935      100.0        372,706      100.0
Operating expenses:
Compensation and employee
services                         168,356       28.4        138,202       30.1        124,077       33.3
Legal collection fees             34,393        5.8         23,621        5.1         17,599        4.7
Legal collection costs            72,325       12.2         38,659        8.4         31,330        8.4
Agent fees                         5,906        1.0          7,653        1.7         12,012        3.2
Outside fees and services         28,867        4.9         19,310        4.2         12,554        3.4
Communications                    29,110        4.9         23,372        5.1         17,226        4.6
Rent and occupancy                 6,781        1.1          5,891        1.3          5,313        1.4
Depreciation and amortization     14,515        2.4         12,943        2.8         12,437        3.3
Other operating expenses          16,484        2.8         12,416        2.7         10,296        2.8
Total operating expenses         376,737       63.5        282,067       61.4        242,844       65.2
Gain on sale of property               -          -          1,157        0.3              -        0.0
Income from operations           216,064       36.4        178,025       38.9        129,862       34.8
Interest income                       10        0.0              7        0.0             65        0.0
Interest expense                  (9,041 )     (1.5 )      (10,569 )     (2.3 )       (9,052 )     (2.4 )
Income before income taxes       207,033       34.9        167,463       36.6        120,875       32.4
Provision for income taxes        80,934       13.7         66,319       14.5         47,004       12.6
Net income                     $ 126,099       21.3  %   $ 101,144       22.1  %   $  73,870       19.8  %
Adjustment for net
loss/(income) attributable to
redeemable noncontrolling
interest                             494        0.1           (353 )     (0.1 )         (417 )     (0.1 )
Net income attributable to
Portfolio Recovery Associates,
Inc.                           $ 126,593       21.4  %   $ 100,791       22.0  %   $  73,454       19.7  %

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Year Ended December 31, 2012 Compared to Year Ended December 31, 2011 Revenues
Total revenues were $592.8 million for the year ended December 31, 2012, an increase of $133.9 million or 29.2% compared to total revenues of $458.9 million for the year ended December 31, 2011.
Income Recognized on Finance Receivables, net Income recognized on finance receivables, net, was $530.6 million for the year ended December 31, 2012, an increase of $128.7 million or 32.0% compared to income recognized on finance receivables, net, of $401.9 million for the year ended December 31, 2011. The increase was primarily due to an increase in cash collections on our owned finance receivables to $908.7 million for the year ended December 31, 2012 compared to $705.5 million for the year ended December 31, 2011, an increase of $203.2 million or 28.8%. Our finance receivables amortization rate, including net allowance charges, was 41.6% for the year ended December 31, 2012 compared to 43.0% for the year ended December 31, 2011. During the year ended December 31, 2012, excluding the initial investment in the MHH portfolio, we acquired finance receivables portfolios with an aggregate face value amount of $6.2 billion at a cost of $538.5 million. During the year ended December 31, 2011, we acquired finance receivable portfolios with an aggregate face value of $9.8 billion at a cost of $408.4 million. In any period, we acquire defaulted consumer receivables that can vary dramatically in their age, type and ultimate collectability. We may pay significantly different purchase rates for purchased receivables within any period as a result of this quality fluctuation. In addition, market forces can drive pricing rates up or down in any period, irrespective of other quality fluctuations. As a result, the average purchase rate paid for any given period can fluctuate dramatically based on our particular buying activity in that period. However, regardless of the average purchase price and for similar time frames, we intend to target a similar internal rate of return, after direct expenses, in pricing our portfolio acquisitions; therefore, the absolute rate paid is not necessarily relevant to the estimated profitability of a period's buying.
Income recognized on finance receivables, net, is shown net of changes in valuation allowances recognized under FASB ASC Topic 310-30 "Loans and Debt Securities Acquired with Deteriorated Credit Quality" ("ASC 310-30"), which requires that a valuation allowance be recorded for significant decreases in expected cash flows or a change in timing of cash flows which would otherwise require a reduction in the stated yield on a pool of accounts. For the year ended December 31, 2012, we recorded net allowance charges of $6.6 million, $8.6 million of which related to purchased bankruptcy portfolios acquired mainly in 2007 and 2008, offset by a net reversal of $2.0 million on Core portfolios. For the year ended December 31, 2011, we recorded net allowance charges of $10.2 million, $6.6 million of which related to Core portfolios acquired mainly in 2005 through 2008 and $3.6 million of which related to purchased bankruptcy portfolios acquired mainly in 2007 through 2008. In any given period, we may be required to record valuation allowances due to pools of receivables underperforming our expectations. Factors that may contribute to the recording of valuation allowances may include both internal as well as external factors. External factors which may have an impact on the collectability, and subsequently to the overall profitability, of purchased pools of defaulted consumer receivables include: new laws or regulations relating to collections, new interpretations of existing laws or regulations, and the overall condition of the economy. Internal factors which may have an impact on the collectability, and subsequently the overall profitability, of purchased pools of defaulted consumer receivables would include: necessary revisions to initial and post-acquisition scoring and modeling estimates, non-optimal operational activities (relating to the collection and movement of accounts on both our collection floor and external channels), and decreases in productivity related to turnover of our collection staff.
Fee Income
Fee income was $62.2 million for the year ended December 31, 2012, an increase of $5.2 million or 9.1% compared to fee income of $57.0 million for the year ended December 31, 2011. Fee income increased primarily due to the acquisition of MHH in the first quarter of 2012. This increase was partially offset by declines in revenue generated by both our PLS and CCB businesses. The decline from PLS is due primarily to the adverse impact of the economic slowdown on automobile financing and related collateral recovery activities. The decline from CCB is due primarily to larger distributions of class action settlements in the year ended December 31, 2011 as compared to the year ended December 31, 2012. We anticipate, based on available data on hand at December 31, 2012, that CCB's fee income should increase in 2013. In particular, we believe there will likely be one large class action settlement which could generate approximately $4.0 to $6.0 million or more in fee income. Operating Expenses
Total operating expenses were $376.7 million for the year ended December 31, 2012, an increase of $94.6 million or 33.5% compared to total operating expenses of $282.1 million for the year ended December 31, 2011. Total operating expenses were 38.8% of cash receipts for the year ended December 31, 2012 compared with 37.0% for the year ended December 31, 2011.

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Compensation and Employee Services
Compensation and employee service expenses were $168.4 million for the year ended December 31, 2012, an increase of $30.2 million or 21.9% compared to compensation and employee service expenses of $138.2 million for the year ended December 31, 2011. Compensation expense increased primarily as a result of larger staff sizes, including the addition of new employees as a result of the acquisition of MHH on January 16, 2012, as well as an increase in share-based compensation expense. Total employees grew 22.0% to 3,221 as of December 31, 2012 from 2,641 as of December 31, 2011. Additionally, existing employees received normal salary increases. Compensation and employee service expenses as a percentage of cash receipts decreased to 17.3% for the year ended December 31, 2012 from 18.1% of cash receipts for the year ended December 31, 2011. Legal Collection Fees
Legal collection fees represent contingent fees incurred for the cash collections generated by our independent third party attorney network. Legal collection fees were $34.4 million for the year ended December 31, 2012, an increase of $10.8 million, or 45.8%, compared to legal collection fees of $23.6 million for the year ended December 31, 2011. This increase was the result of an increase in our external legal collections which increased $51.5 million or 48.4%, from $106.3 million for the year ended December 31, 2011 to $157.8 million for the year ended December 31, 2012. Legal collection fees for the year ended December 31, 2012 were 3.5% of cash receipts, compared to 3.1% for the year ended December 31, 2011.
Legal Collection Costs
Legal collection costs consist of costs paid to courts where a lawsuit is filed and the cost of documents paid to sellers of defaulted consumer receivables. Legal collection costs were $72.3 million for the year ended December 31, 2012, an increase of $33.6 million, or 86.8%, compared to legal collection costs of $38.7 million for the year ended December 31, 2011. This increase was the result of an increased portfolio size as well as a refinement of our internal scoring methodology that expanded our account selections for legal action. This strategy to expand the accounts brought into the legal collection process resulted in significant initial expenses, which may drive additional future cash collections and revenue. These legal collection costs represent 7.4% and 5.1% of cash receipts for the years ended December 31, 2012 and 2011, respectively. Agent Fees
Agent fees primarily represent costs paid to repossession agents to repossess vehicles. Agent fees were $5.9 million for the year ended December 31, 2012, a decrease of $1.8 million, or 23.4%, compared to agent fees of $7.7 million for the year ended December 31, 2011. The decrease was mainly due to reduced business activity associated with PLS.
Outside Fees and Services
Outside fees and services expenses were $28.9 million for the year ended December 31, 2012, an increase of $9.6 million or 49.7% compared to outside legal and other fees and services expenses of $19.3 million for the year ended December 31, 2011. Of the $9.6 million increase, $8.1 million was attributable to an increase in legal reserve accruals and corporate legal expenses and the remaining $1.5 million increase was attributable to other outside fees and services including increases in non-capitalized software development costs. Communications
Communications expenses were $29.1 million for the year ended December 31, 2012, an increase of $5.7 million or 24.4% compared to communications expenses of $23.4 million for the year ended December 31, 2011. The increase was primarily due to additional postage expense resulting from an increase in special letter campaigns. The remaining increase was mainly attributable to telephone expenses incurred by MHH. Expenses related to customer mailings were responsible for 84.2% or $4.8 million of this increase, while the remaining 15.8% or $0.9 million was attributable to increased telephone and telecommunication related expenses.
Rent and Occupancy
Rent and occupancy expenses were $6.8 million for the year ended December 31, 2012, an increase of $0.9 million or 15.3% compared to rent and occupancy expenses of $5.9 million for the year ended December 31, 2011. The increase was primarily due to the additional space leased for our Birmingham call center operations, the addition of our MHH foreign operations as well as increased utility charges.
Depreciation and Amortization
Depreciation and amortization expenses were $14.5 million for the year ended December 31, 2012, an increase of $1.6 million or 12.4% compared to depreciation and amortization expenses of $12.9 million for the year ended December 31, 2011. The increase

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was primarily due to the additional depreciation and amortization expense incurred as a result of the acquisition of MHH and its related property, equipment and intangible assets.
Other Operating Expenses
Other operating expenses were $16.5 million for the year ended December 31, 2012, an increase of $4.1 million or 33.1% compared to other operating expenses of $12.4 million for the year ended December 31, 2011. Of the $4.1 million increase, $0.9 million was due to an increase in the provision for doubtful accounts, $0.8 million was due to an increase in travel and travel related expenses, $0.4 million was primarily attributable to additional taxes, fees and licenses, $0.5 million was due to an increase in repairs and maintenance and $0.4 million was due to increased insurance expenses, when compared to the year ended December 31, 2011. None of the remaining $1.1 million increase was attributable to any significant identifiable items. Gain on Sale of Property
Gain on sale of property was $0 for the year ended December 31, 2012, compared to $1.2 million for the year ended December 31, 2011. The 2011 amount was the result of the sale of a parcel of land adjacent to our Norfolk headquarters during 2011.
Interest Expense
Interest expense was $9.0 million for the year ended December 31, 2012, a decrease of $1.6 million or 15.1% compared to interest expense of $10.6 million for the year ended December 31, 2011. The decrease was mainly due to a decrease in our weighted average interest rate which decreased to 3.27% for the year ended December 31, 2012 from 3.71% for the year ended December 31, 2011, as well as a decrease in our average borrowings to $258.0 million for the year ended December 31, 2012 compared to $263.2 million for the year ended December 31, 2011.
Provision for Income Taxes
Income tax expense was $80.9 million for the year ended December 31, 2012, an increase of $14.6 million or 22.0% compared to income tax expense of $66.3 million for the year ended December 31, 2011. The increase was mainly due to an increase of 23.6% in income before taxes for the year ended December 31, 2012 when compared to the year ended December 31, 2011. This was partially offset by a decrease in the effective tax rate to 39.1% for the year ended December 31, 2012 compared to 39.6% for the year ended December 31, 2011. The decrease in the effective tax rate is primarily attributable to the tax benefits created by our international operations.
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010 Revenues
Total revenues were $458.9 million for the year ended December 31, 2011, an increase of $86.2 million or 23.1% compared to total revenues of $372.7 million for the year ended December 31, 2010.
Income Recognized on Finance Receivables, net Income recognized on finance receivables, net was $401.9 million for the year ended December 31, 2011, an increase of $92.2 million or 29.8% compared to income recognized on finance receivables, net of $309.7 million for the year ended December 31, 2010. The increase was primarily due to an increase in cash collections on our owned finance receivables to $705.5 million for the year ended December 31, 2011 compared to $529.3 million for the year ended December 31, 2010, an increase of $176.2 million or 33.3%. Our finance receivables amortization rate, including net allowance charges, was 43.0% for the year ended December 31, 2011 compared to 41.5% for the year ended December 31, 2010. During the year ended December 31, 2011, we acquired finance receivables portfolios with an aggregate face value amount of $9.8 billion at a cost of $408.4 million. During the year ended December 31, 2010, we acquired finance receivable portfolios with an aggregate face value of $6.8 billion at a cost of $367.4 million. In any period, we acquire defaulted consumer receivables that can vary dramatically in their age, type and ultimate collectability. We may pay significantly different purchase rates for purchased receivables within any period as a result of this quality fluctuation. In addition, market forces can drive pricing rates up or down in any period, irrespective of other quality fluctuations. As a result, the average purchase rate paid for any given period can fluctuate dramatically based on our particular buying activity in that period. However, regardless of the average purchase price and for similar time frames, we intend to target a similar internal rate of return, after direct expenses, in pricing our portfolio acquisitions; therefore, the absolute rate paid is not necessarily relevant to the estimated profitability of a period's buying.
Income recognized on finance receivables, net is shown net of changes in valuation allowances recognized under FASB ASC Topic 310-30 "Loans and Debt Securities Acquired with Deteriorated Credit Quality" ("ASC 310-30"), which requires that a valuation allowance be recorded for significant decreases in expected cash flows or a change in timing of cash flows which would otherwise require a reduction in the stated yield on a pool of accounts. For the year ended December 31, 2011, we recorded net allowance charges

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of $10.2 million, $6.6 million of which related to core portfolios acquired mainly in 2005 through 2008 and $3.6 million of which related to purchased bankruptcy portfolios acquired mainly in 2007 through 2008. For the year ended December 31, 2010, we recorded net allowance charges of $25.2 million, the majority of which related to non-bankruptcy portfolios acquired in 2005 through 2007. In any given period, we may be required to record valuation allowances due to pools of receivables underperforming our expectations. Factors that may contribute to the recording of valuation allowances may include both internal as well as external factors. External factors which may have an impact on the collectability, and subsequently to the overall profitability, of purchased pools of defaulted consumer receivables include new laws or regulations relating to collections, new interpretations of existing laws or regulations, and the overall condition of the economy. Internal factors which may have an impact on the collectability, and subsequently the overall profitability, of purchased pools of defaulted consumer receivables would include necessary revisions to initial and post-acquisition scoring and modeling estimates, non-optimal operational activities (which relate to the collection and movement of accounts on both our collection floor and external channels), as well as decreases in productivity related to turnover and tenure of our collection staff. Fee Income
Fee income was $57.0 million for the year ended December 31, 2011, a decrease of $6.0 million or 9.5% compared to fee income of $63.0 million for the year ended December 31, 2010. Fee income declined as a result of a decrease in revenue generated by our PLS fee-for-service business, which was partially offset by an increase in revenue generated by our PRA GS government processing and collection business. The decline at PLS was due primarily to a decrease in volume related to a continued decline in automobile financing activity nationwide. Operating Expenses
Total operating expenses were $282.1 million for the year ended December 31, 2011, an increase of $39.3 million or 16.2% compared to total operating expenses of $242.8 million for the year ended December 31, 2010. Total operating expenses were 37.0% of cash receipts for the year ended December 31, 2011 compared with 41.0% for the year ended December 31, 2010. Compensation and Employee Services
Compensation and employee service expenses was $138.2 million for the year ended December 31, 2011, an increase of $14.1 million or 11.4% compared to compensation and employee service expenses of $124.1 million for the year ended December 31, 2010. This increase was mainly due to an overall increase in our owned portfolio collection staff as well as an increase in share-based compensation expense. Total employees grew 6.8% to 2,641 as of December 31, 2011 from 2,473 as of December 31, 2010. Additionally, existing employees received normal salary increases. Compensation and employee service expenses as a . . .