Card Issuers Find Market For Bad Debt
A new industry is emerging that specializes in taking bad credit card loans off the hands of banks. Though the buyers pick up the loans at steep discounts, most bankers welcome the card salvagers.
With delinquencies and chargeoffs mounting, they have little choice.
Banks and other financial institutions are expected to write off $9.73 billion worth of credit card loans this year, according to the Nilson Report, an industry newsletter published in Los Angeles. That's 11% more than written off in 1990.
The buyers tend to be traditional collection agencies that set up partnerships with investors. Recently, however, some regional banks and at least one Wall Street investment firm have shown interest.
Though they usually pay no more than 20 cents on the dollar for charged-off bank card assets, some of the groups are taking big risks in building their inventories.
Some are using a technique known as "forward flow delivery," in which they agree to buy chargeoffs that have not yet occurred.
Borrowing from the gunslinging world of commodities trading, buyers pay a fixed price for future chargeoffs on a monthly or quarterly basis.
The collectors say the risks are minor and say they are better equipped than bankers to put the squeeze on late payers.
"There are a lot of pretty creative things going on," said Wayne Johnson, the founder of Integratec, a credit card collections firm.
Trading Bad Assets for Cash
Mr. Johnson and a group of investors recently bid $160 million for a major bank's $1 billion portfolio of charged-off card loans.
"It's a very legitimate way for banks to turn their bad assets into cash," he said.
Corporate lenders - particularly those specializing in real estate, leveraged buyout, and debtor-in-possession lending - have long been familiar with bottom fishers who specialize in taking distressed assets from banks. But until recently, investors have not been active in buying credit card loans.
Bankers, for their part, felt they had fairly good control over the collection process and were not actively seeking buyers.
"It's an active endeavor right now," said Kevin Murphy, senior vice president in charge of collections for First USA Inc. Dallas, the nation's 15th largest credit card bank. "There are a lot more buyers out there than I ever remember in the past."
Jumping on the Bandwagon
As in any burgeoning field, satellite industries are growing right alongside the collectors. Several corporate and mortgage loan brokers have set up units specializing in brokering bad card debt. These businesses help banks package charged-off card loans so they can be easily digested by interested investors.
Bankers, particularly those from well reserved banks, are seizing on the chargeoff market as a way to turn bad loans into instant cash.
Traditionally, loans sit on a bank's books until it has enough strength to charge them off or until the workout department reaches a settlement with a borrower. In either case, that often means years of work.
Moreover, the collection process can send operational costs soaring and increase carrying charges.
Bypassing |Nebulous Recovery'
"It's an opportunity to cash in all at one time rather than receive recoveries over a couple of years," said Timothy Kirkpatrick, a Florida-based senior vice president for Principal Residential Advisors Inc., a loan broker in Des Moines. "It's an asset sale rather than a nebulous recovery."
In addition to the fact that banks frequently wait up to two years to recover funds from deadbeats, they never know just how much ultimately will be collected, some bankers said.
For these reasons, First USA - which is partially held by a unit of Merrill Lynch & Co. -- recently put up for sale about $10 million worth of charged-off card loans.
"We weighed getting immediate funds versus our projected recoveries over a stretched-out period of time," Mr. Murphy said.
The decision could not have been easy.
Boosting Collection Successes
Some of the newer chargeoffs in First USA's portfolio are expected to fetch from 6 cents to 10 cents on the dollar. More troublesome loans - those that have already been handed over to collection agencies -- are expected to bring in about 1 cent to 2 cents on the dollar, Mr. Murphy said.
According to Mr. Kirkpatrick, the collection success rate improves when loans are no longer owned by a bank.
A national credit card issuer, for example, might package its charged-off loans by region, selling them to a collector that specializes in a particular locale, the loan broker said.
Collectors who buy at deep discounts also tend to be more willing than banks to forgive a portion of the amount owed.
In an intriguing twist on the new collection process, Icon International recently paid for a small portfolio of delinquent card loans with advertising time on television. The New York-based barter finance firm said it bought the portfolio from a major money-center bank.
"The bank got prime, national cable TV time worth two-and-a-half times what their recovery would have been," said Lance Lundberg, Icon's founder.
The technique of paying with media time rather than cash is standard in barter finance, but has rarely been applied to credit card collecting.
Icon, however, did not take control of the recovery process. That is still being handled by the bank's collection agency.