Riding the Wave of a Wrecked Financial System

That's what Portfolio Recovery (Nasdaq: PRAA  ) is doing. And, man, it's a beautiful thing.

We had a big, ugly debt boom, and someone was bound to profit off of it. Portfolio Recovery buys defaulted credit receivables that banks and other lenders have given up on, and then squeezes a few pennies out of the defaulted borrowers. Since it buys the debt for something close to nothing (about $0.03 on the dollar, on average) getting even a sliver back from those borrowers can mean big profits.

Right now, profits aren't much to be giddy over. In the third quarter, the company earned $10.1 million, or $0.65 per share. That was down from $11.5 million or $0.75 per share in the same period last year.

But the allure here is not what happens today or tomorrow, but one, two, or three years down the road.

As consumers default in droves, Portfolio Recovery has been scooping up piles and piles of defaulted receivables:

Period	Face Value of Receivables Purchased
Q3 2009	$1.75 billion
Q2 2009	$3.38 billion
Q1 2009	$960.9 million
Q4 2008	$1.32 billion
Q3 2008	$857.2 million
Q2 2008	$957.4 million
Q1 2008	$1.46 billion

The market for this stuff is huge because banks like Bank of America (NYSE: BAC  ) , Citigroup (NYSE: C  ) , and American Express (NYSE: AXP  ) suffered through massive increases in defaults over the past two years.

A lot of those defaults are because people took on debt they never, ever could have afforded. But a lot is also caused by relatively responsible borrowers being whacked by unemployment.

And that's where the big appeal comes in: Portfolio Recovery can purchase mounds of defaulted debt now, wait until unemployment improves in the years ahead, and then collect on borrowers who, by then, actually have the means to pay.

Banks typically want to ditch debt after it's been delinquent for between 90 and 180 days. By simply extending that patience level and using a little elbow grease, Portfolio Recovery exploits banks' short-termism in an incredibly profitable way. It's really a fascinating business model.

But know this: Portfolio Recovery's business model relies on patience. Investors will need to do the same. As this quarter shows, profits aren't anything to smile over ... yet. The big rewards are likely to come down the road, when tangible improvements in economic growth and unemployment start to take hold.