Group Purchasing of Charged-off Consumer Assets at Wholesale Pricing - National Portfolios, Issuer Direct
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Debt Buying


The Business


When banks charge-off their credit card accounts, they hold and work these accounts through their own collection departments, outsource the collections to third parties or sell accounts directly through bids or agreements with large debt buyers, or through brokers on the open market. In 2009, these fresh charged-off accounts were selling for 4¢ to 6¢ on the dollar and now, half way through 2011, these same accounts have risen to 8¢ to 12¢ on the dollar for some products reflecting an increase in the recovery rates over the same period.

 

In 2009 the banks charged–off $83.27 billion in credit card accounts (This does not include the mortgages, auto loans, medical, student loans, etc. that are also acquired by debt buyers). Some forecasters have predicted, that the 2010 figures, will top $100 million in fresh bank charge-offs. Our study shows that about half of the 2009 charged-off credit card accounts, have been sold to debt buyers, and the remaining accounts are still owned by the banks.

 

Debt buyers purchase defaults with the intent to collect the outstanding balance. Buyers of charged-off debt either collect the accounts in-house or they are outsourced to third party collectors, and a portion of the accounts usually are taken through a legal collection process. Collection fees are generally on a contingency basis and vary from about 25% to 50%, depending of the age of paper being worked and previous collection placements. The amount recovered through collections from the portfolio, less collection and management costs, plus the resale value, will determine the profitability of any portfolio.

 

The business model for the debt purchase and collection industry is simple and there are four basic steps in the process:

 

  • Locate accounts available for purchase and model the recovery rates
  • Buy only accounts that meet the predefined criteria for the right price
  • Collect the accounts purchased utilizing existing 3rd party agencies
  • Manage the collections, put-backs, track the performance and distribute the monthly revenues. Move accounts into the legal strategy and sell the balance of the portfolio to optimize returns.
  • Repeat the process

                             Charged-off Credit Card Debt 2005 Through 2009

 

Total

Charged-off

 

Charge-

Percent

 Number of

Outstanding

 

Credit Card

Credit Card

Avg.

off

Still in

 Accounts in

Unpaid

Year

Debt - Billions

Debt

Bal.

Rate

Collect

 Collections

Balance

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2009

$902.17

$83,270,000,000

9858

9.23%

94.50%

      8,446,947

$78,690,150,000

2008

$958.00

$52,881,600,000

8188

5.52%

80%

      5,166,742

$42,305,280,000

2007

$942.90

$37,716,000,000

7977

4.00%

60%

      2,836,981

$22,629,600,000

2006

$872.20

$31,748,080,000

7379

3.64%

40%

       ,721,102

$12,699,232,000

2005

$830.50

$40,279,250,000

7026

4.85%

20%

       ,146,613

$8,055,850,000

 

 

 

 

 

 

 

 

 

Total

$245,894,930,000

 

 

 

 19,318,383     

$164,380,112,000



                               Uncollected Credit Card
 Inventory (Estimated)



                                


Debt Buying History 


Debt buying traces its roots to the isolated retail stores in the 1960’s and the bankruptcy courts of the late 1970’s. However, debt buying in the United States began in earnest during the mid-1980’s when the Resolution Trust Corp., a division of the Federal Deposit Insurance Corp., sold large portfolios of delinquent credit card debt to fund the bailout of failed savings and loans. The sale of debt on the open market not only increased the supply of paper but signaled the government’s endorsement of this new business activity.  A number of firms were involved with purchasing charged-off consumer accounts from the
RTC and many of them are still is business today. More firms have entered the debt buying business since the 1980’s and five of these are publicly traded companies.

Many of the public companies buy Fresh charge-off accounts direct from the issuer and never sell any of their holdings. We buy at the issuer level on occasion as well, but the bulk of the debt that we prefer to acquire, is paper that may be a little older and worked one or two collection cycles. This paper is far cheaper to acquire and we find that charge-offs, between 9 months up to about 24 months, model the best for us. The customer has had a little time to get back on their feet and we lose far less accounts to bankruptcy.



Credit Card Debt Small Portion of Collection Industry


Consumer Credit Outstanding has been tracked by the Federal Reserve in two categories, Revolving and Non-revolving and credit cards are part of the Revolving category. Auto loans, Student Loans, Mobile home loans and all other non credit card loans except for home mortgages are including in the Non-revolving loan category. Overall, consumer credit has decreased at an annual rate of 5 ½% in February 2010 with Revolving credit decreasing at an annual rate of 13% and Non-revolving credit decreasing at 1 ½%.  The following chart shows the distribution of new collection accounts in 2007 as reported by the ACA (American Collection Association). Real estate and commercial loans are tracked separately by the Federal Reserve.

                     
                         


Credit Card Charge-Off Rates


We have seen a flattening out of credit card charge-offs in 2010 with the industry wide numbers holding at about 11%. This is about 0.4% lower than the year ago figures, and some analysts believe that the charge-off rates have already peaked. While the worst may be behind us, we must bear in mind that the unemployment rate has probably not yet reached the highs that have been forecasted, which may occur later this year.
 

 

 

        

Source of Inventory - The Largest Issuers

 

The top 10 issuers combined, represent over three quarters of the entire inventory of credit card accounts. These are the major US banks and are led by Chase, Bank of America and then Citibank. The total outstanding credit card debt now stands at $858.1 billion as of February 2010, down from the peak of $958.1 billion in the fourth quarter of 2008. The following chart was developed from data obtained in June of 2009 and reflects the total outstanding balances by the top 15 issuers. The “Other” category is the remaining banks, department stores and other revolving charge issuers.

 

                             


Portfolio Evaluation

Every portfolio is evaluated with a computer model utilizing current recovery data obtained from a large number of collection agencies, several large banks, as well as some of the largest debt buyers in the country. Each month actual collection results are fed into the data base for a variety of different products, and from this data we can determine how various types of accounts are currently liquidating. Every month the model is updated with the current Bureau of Labor Statistics data, current unemployment, bankruptcy, and foreclosure data etc. The model considers over 3000 individual data points in the evaluation. This is not a scoring model which determines how an account should pay based on predictive behavior, but a model based on how accounts are actually liquidating right now. With this data we can determine with some degree of accuracy, how similar files should collect next month, in three months and beyond. Knowing how a particular portfolio should liquidate, we can determine what we can pay for a given file to achieve the targeted returns.

Using the raw data output from the analysis, and have developed a series of charts and graphs that display all of the portfolios relevant performance information in an easy to read format. We highlight the projected net portfolio returns, by month, along with collection costs and anticipated resale value of the file. We also compare each portfolio to similar agency age performance characteristics, so we have a several baseline comparisons. Additionally, we test alternative purchase prices and collection rates and chart the differences in net returns. We have evaluated over $2.0 billion in credit card portfolios consisting of 800,000 individual accounts from a variety of Issuers, using these methods.
Since a national file is heavily weighted by the larger states, the portfolio is subject to regional unemployment and economic differences which have a great impact on the current value of a file. The positive side of examining a National file is that we can compare recovery projections against a much larger data sample, and we are less likely to have any data outliers having much meaningful impact on the results. The Issuers generally only sell national files, so there is much less of a concern for adverse selection within the file that may skew the results.

Selecting Files:

All files are not the same. Issuers are different, the balances are different and the products are indeed quite different; yet there is one common element between most of the portfolios that we review. That is, many of the files are overpriced, based on the recovery rates that we are seeing today. Recovery rates among all classes of assets have dropped the past few years. And often times, the asking price for a portfolio being presented to us, is based upon the price paid by the Seller and not what is recoverable in today’s market.

The majority of the Fresh and Zero agency accounts we have examined over the past year are overpriced based on our projected recovery analysis, and will yield inferior results if we pay to much for the files. We have found that some of the older accounts provide much better returns than the Fresh charge-offs. The events that lead to account being charged off are still Fresh for the customer 30 days after charge-off. People need time to get back on their feet, and get a new job or get healthy if that was the problem. Some people may need years to recover. Even with reduced settlements and payment plan offers, people who are just trying to put food on the table and keep a roof over their head, will not pay if they don’t have a job. Bankruptcy is also a much larger problem now. When these people get harassed enough, they just file with the court to dismiss the debt and the bulk of these filings are within the first year or two, after their accounts went to charge-off.

We are closely following the sub-prime market, which makes up a large portion of the lower balance credit card accounts. Many are borrowers who may have already had a bankruptcy, which means they can’t file again for a number of years. Most of these card holders are also people who tend a have a job or two and manage to keep employed, but are often not great money managers. These are not executives who were let go after years of service to company and are now searching for a new $100,000 per year job (or have to be retrained for a $60,000 a year position).

Purchasing the Assets:

The Loan Buyers Group acquires assets directly from the banks and through relationships that we have with other large Debt Buyers. We also purchase accounts from very large collection agencies and we share purchases with other Debt Buyers. We typically do not purchase many portfolios from Brokers or Resellers. The nature of the business is to submit bids for the purchase of portfolios or directly negotiate for the purchase of accounts. There are five primary categories of debt sellers in the U.S.:

FDIC - The FDIC disposes of the assets from the failed banks and they generally consist of real estate loans, residential, agricultural and commercial. Most of the offerings also require servicing of the performing loans in the portfolio. (Wholesale)
Banks – The major issuers represent the majority of all charged-off accounts. To purchase from the issuer requires prior approval and often time’s purchasers are required to acquire accounts under forward flow agreements. (Wholesale)
Debt Buyers – Large buyers who acquire portfolios direct from issuers who sell a part of their inventory to qualified buyers. These firms purchase large volumes of debt and may also be collection agencies. (Wholesale and Retail)
Brokers - Ready, willing and able to sell today. (Retail)
Resellers- Sellers of aged accounts. (Retail)

How Much to Pay for the Assets:

Deciding on what debt to buy and how much to pay is a function of how much you believe that can be collected and in what time frame. The number of accounts to be purchased also has an influence on the price that can be paid because the larger number of accounts in a purchase means more diversification of risk for a portfolio. The current status of each customer’s account also impacts the price, as does knowing how much effort has been previously expended, and for how many accounts. The model we utilize provides liquidation rates, which are expected from the portfolio, as compared to other similar known files. Once the liquidation rate, estimated resale value, and collection costs are established, we can determine the correct pricing based on our targeted return objectives.

Other factors in deciding on the final price to be offered include the average size of the accounts, the geographic areas of the accounts, and the quality of the original credit worthiness of the customer. The previous prices paid in recent auctions for the debt will also have an impact on the bid amount.

Generating Revenue:

The collection strategy generaly utilized on a new portfolio is a voluntary collections approach with a straight settlement offer for the first period of collections. Following the offered settlement period, generally the collection strategy will shift to a PPA (Partial Payment Arrangement) where the collection agency will work with the customers on developing payment plans. Accounts not collected following this approach, may transition to a legal collection strategy, or will be sold. This may occur at the 12 month, or 24 month mark, per the recovery model.

By utilizing current technology, including several innovative collection techniques, and offering a variety of settlement options for the customers, we will typically outperform the originating banks in collecting these accounts. Our customers typically respond more favorably to techniques which offer them flexibility in structuring payments for their obligations. Training, incentives, working environment, and management are all contributing factors for higher rates of return.

Our goal is to perform consistently with our targeted projections. We want to buy for the right price, professionally manage our collections, and resell the portfolio balances at the optimal times. Collections of all accounts purchased are managed by our Professional Portfolio Managers (PPM). They are assigned specifically for the portfolio purchased, and select and place the accounts with competent, licensed, bonded and insured collection agencies with proven performance of similar accounts, regional or state specialty, availability, and other factors as determined by the PPM.

The PPM also identifies new purchase opportunities, maintains detailed records of all portfolios being managed, monitors agency compliance with the regulators and tracks the liquidation of the portfolio and makes adjustments where required. The PPM administers the put-backs and data requests with the sellers, provides weekly status reports, reviews agency capacity levels, provides portfolio purchase and sales support and performs collection agency audits on a quarterly basis as well as random unannounced audits.

The price paid for a file and placed for collection, does not determine how the file will ultimately liquidate. Two files with identical characteristics will generally liquidate the same, even if one file costs twice as much to acquire as the other. Regarding collection costs, it is important to note that cheaper is not always better. If the 40% collector is recovering 50% more than the 25% agency, the debt buyer would realize about 17% more in profits by using the more expensive agency.

Tracking Performance:

Once a portfollio is identified which meets the Loan Buyers Group criteria, we negotiate for the purchase of the file. When we have acquired the file, the initial base run and recovery projections have already been established, and we track our actual results based on these numbers. In addition, we have the collection agency provide their estimates for liquidation for the first 6 months of the file, and we track these results as well. When the liquidations are on target with the model, we seldom make any changes. We will make adjustments within the agency or the collection strategy to bring the results in conformance to the projections. If these steps do not produce the desired effect, we have the option of selling the uncollected accounts or placing them with a different agency.

Every month several reports are generated for the portfolios that are in collections and are distributed only to the participants of the portfolio. Performance of the portfolio is monitored based on both the initial liquidation targets set when the portfolio was purchased, and the projections supplied by the collection agency when the accounts were placed.

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