Once oh-so-private, the debt-buying industry found itself squarely in the public spotlight after two IPOs touched off multimillion-dollar public and private investments in the business – creating several giants of the industry.
Financiers tossed money at the industry. The attraction? Smart profit margins, easy entry hurdles, and a sea of potential deals. Portfolio Recovery Associates’ IPO opened the financing floodgates two years ago and the aftershocks are still being felt: A subsequent investment boom that often demanded fast returns, thus spiking prices and squeezing profit margins.
Prices in the past two years are up for fresh chargeoffs and loans worked by multiple agencies. Credit card accounts worked by at least three agencies soared to as high as 4.5% from the once-standard range of around 2.5%. Prices for older accounts jumped faster than fresh chargeoffs.
There are five public companies now buying consumer bad debt – including Norfolk, Va.-based PRA and Warren, Mich.-based Asset Acceptance Capital Corp., which went public in February 2004. Most industry insiders have no quarrel with them or the remaining public buyers: Encore Capital Group, San Diego; NCO Group, Baltimore; and Asta Funding Inc., Englewood Cliffs, N.J. The belief is that they have experienced management teams and make smart purchases.
The fear instead is that a lot of money is supporting less-educated buyers that pay too much. “The pricing [hike] is not all being generated by the public companies,” says Brad Bradley, chief executive of Asset Acceptance. “By virtue of the fact that we are public and do disclose our information, we are actually forced to be disciplined in the way we purchase. If not, we’d get crucified. There is still a lot of private money that is driving pricing in certain segments of the market.”
Bradley believes the uptick in pricing eventually will ease, but he does not expect any spectacular industry fallout, as occurred in the late 1990s when Commercial Financial Services and Creditrust Corp. both collapsed. “We’re going to see some investors that overpaid and underestimated their ability to service their portfolios. They will try to sell in the resale market, and they should be able to do that,” he says.
Many insiders argue the industry could avoid this problem if investors would slow down a little. They tend to overlook that bad-debt buying is about as risky as it come, says Michael Bendickson, president of debt buyer Absolute Resolutions Corp., San Diego.
Louise Epstein, president of Austin, Texas-based Charge-Off Clearinghouse – which buys bad debt and repackages it for sale by select debt categories, says too much money is only good news when those behind it show patience. The industry’s rule of thumb is that it takes three years to turn a profit on any given portfolio purchase.
Two key problems come to mind: First, investors are rarely patient. Second, the industry has a history of repeating mistakes. When investors eyed bad debt in the mid-to-late 1990s, prices soared up to four times what could reasonably be expected to return.
And at a recent industry conference, one speaker stunned the audience by casually mentioning that the long-standing, three-year rule of thumb to make a profit on any given portfolio is now actually four years. “To say they’re hitting their goals, many are reprogramming their computers, their formulas,” says Gary Wood, president of debt buyer Collins Financial Services, Austin, Texas. “The effect of this will depend on a company’s cost of money. If it’s as low as we can assume for public companies, then maybe they can get by. But if investors are demanding 12%, 13% or 14%, it could lead to problems.”
And demand from investors can be intense, says Joel Lewis, president of InoVision and MEDCLR, buyers of utility debt and medical debt. “If you’re sitting on $50 million that the public put into your company, you’ve got to buy something,” he says. “Sometimes, the price you pay becomes secondary to the need to show you’re doing something – anything. That often means trouble.
“Public companies begin to factor the higher prices into their modeling but may find themselves in trouble later when the market corrects itself,” he adds. “Whatever industry you’re talking about, that’s a recipe for a market crash.”
Private companies, Lewis argues, do not usually have those pressures. “We can stick to sound pricing because we don’t have to buy product at unfavorable prices simply to placate shareholders,” he says.
InoVision and MEDCLR are both affiliates of Marlin Integrated Capital Holding – an umbrella company of several debt buyers.
Meanwhile, rather than engage in bidding roulette, many buyers began searching for alternative business. Some backed away from competitive debt classes, including the gold standard credit cards, and expanded into still-growing categories such as medical debt, bankruptcies, and unpaid gas and electric bills.
Collins Financial recently started purchasing utility accounts and dabbling in resold paper. “We’ve had to shift to buying retread paper from bigger companies that had originally bought it, before working it and reselling to us,” Wood says.
The firm also added to its contingency business. “We’re still able to find opportunities to buy debt from issuers, but pricing from many issuers out there certainly has gone out of control, to the point that it’s just impossible to understand,” he says.
Arrow Financial Services, based in suburban Chicago, had started funding other buyers’ purchases – a way to keep the work coming even as the firm shied away from portfolio bidding wars. Late last year, student lending giant Sallie Mae acquired Arrow Financial.
Sallie Mae joined the collections business a few years ago and began by collecting on credit card paper just like a regular contingency firm. Since then the company concluded that more student loans are collectible and the Arrow Financial acquisition likely will play a role.
That acquisition, meanwhile, could create a sense of urgency – much as if it were a public company. “Sallie Mae must get the product now to justify the purchase of Arrow, so now it’s competing in the same league as the public companies,” Lewis says. “Sallie Mae placed itself right in that cycle just as if it had an IPO.”
Some other debt buyers are dabbling in sideline ventures such as software development.
Ultimately, as prices stay on the high side, investors will either become disenchanted and back away, or they will adjust their success formulas. Now just a year or two into the boom, nobody is certain, says Joseph Chumbler, a debt-buying industry analyst with investment banker Stephens Inc.
Chumbler, who began following the industry last year, believes the numbers posted by the public firms look good so far. “Looking at the first-year collection data, the numbers seem to be holding up fairly well. There’s nothing of great alarm,” he says. “That could be simply that the public collectors are more efficient than they were a few years back.”
Pricing Structure
Meanwhile, not all issuers are buying into the new pricing structure, says Wood. “A few weeks ago a major national company sought us out for a purchase and told us that there is so much new and unsophisticated money coming into the market that they thought it made more sense to maybe sell for a little less to a company they know.”
Issuers fear becoming bogged down in a class-action liability suit should a company buy their debt and then violate the Fair Debt Collections Practices Act.
Stephens Inc. in the third quarter released a report analyzing past performance and imminent future for the public firms. “My perception of the industry,” Chumbler says, “is that pricing hasn’t been completely prohibitive so that large, experienced buyers have at least been able to maintain their receivables.”
To help keep the work flowing while prices rise and the purchasing climate becomes more challenging, public companies also tweaked their strategies. PRA began buying more non-credit card debt and also acquired skip-tracing firm, IGS Nevada Inc.
Encore Capital moved away from credit card debt and began buying more auto and telecom loans. The company also started outsourcing some collections to third-party contingency collectors, Chumbler says.
Asset Acceptance officials do not feel the need for an add-on company purchase but say they will always stay open to possibilities.
For now, the debt-buying industry is in transition – given the current state of pricing, the expanding categories of debt for sale, and ever-changing economic conditions – but most insiders, while cautious as always, believe the industry is stable enough to correct price problems over time.
“The smart money will win out,” says InoVision’s Lewis. “It’s a hot business and some bumps along the way have always been part of it. For now, the economy is turning around and people are paying off debts so there’s a rush to get into the market. A lot of firms are still raising money.”
Adds Chumbler: “There’s been a perfect storm. A lot of money has come into the industry as the sea of paper subsided. If we get into a rising rate environment, the supply side will pick up again,” he says.
And, with growth in non-credit card sales – including telecom, cell phone bills, and utilities – it is clear debt buyers once disenchanted with credit card prices have choices. “I also keep hearing about auto deficiencies picking up and none of the captive auto finance firms sell debt,” Chumbler says. “When they do, that could be a big boost.”
With some exceptions, most industry insiders do not believe the giants of the industry will crush the remaining buyers. With increasingly sophisticated debt buyers, and a seemingly bountiful supply of debt, there might just be room for nearly everyone to survive and even thrive.