Two distressed-asset specialists claim a Kansas servicer of charged-off loans dumped nearly worthless ones on them and other unsuspecting buyers.
Midland Credit Management"grossly misrepresented" a pool of CoreStates loans it was selling, according to a lawsuit.
Serious efforts had already been made to collect on the loans, but Midland had claimed otherwise, the suit says.
The plaintiffs, Varmint Investments Group and Panagora Partners, are two of several recent entrants in the business of resolving bad debt.
The Midland suit centers on a bundle of charged-off credit cards loans sold by CoreStates Bank of Delaware last year.
Varmint and Panagora each $8 million of loans-that was their face value- from that bundle.
The buyers were told the loans were "fresh" accounts that were for sale because of a "manpower shortage" at Midland, the suit said.
But the loans were not as fresh as claimed, the suit says; the borrowers had already been approached several times by collectors. Indeed, the portfolios had been "creamed" or "cherry picked" - that is, the good accounts had been removed-the suit says.
Midland executives and lawyers for the plaintiffs declined to discuss the case.
Distressed-asset veterans, while not commenting specifically on the Midland case, said that some newcomers to the market were finding it more difficult than they had imagined.
"This is a terrific business," said one. "There are people who see the profitability and investors throwing money at it, but they don't know what they are doing and can't collect it," he said. "A lot of people jumped in, and I know they got bloody noses from it."
The distressed-asset business took off after the savings and loan crisis a decade ago, which resulted in the creation by the government of the Resolution Trust Corp.
Such firms as Ocwen Financial Corp. and Wilshire Financial bought up failed thrifts and used special collection skills to wring profits from failing real estate loans.
A handful of distressed-asset firms have been created in the past two years, spurred on by growing credit card and subprime businesses that generate more charged-off debt, and, until recently, an availability of capital on Wall Street.
"Now, more so than 10 years ago, the selling and purchase of distressed assets is an everyday thing," said Peter O'Kane, senior vice president, acquisitions for Wilshire Financial. "Prior to the RTC bailout, banks held on to these loans and worked them out. Now it's easier to take the hit and sell them."
Established specialists in real estate debt are also entering the distressed credit card business. Ocwen, of West Palm Beach, Fla., is testing its credit card savvy wth a pilot program, said Christine Reich, president.
"There's an opportunity out there," she said. "We can use our collection tools. It's a natural fit."
Some specialists in charged-off real estate debt say that the credit card business is too labor-intensive.
"You can buy these portfolios for 1 cent to 5 cents on the dollar, but they require a lot of manpower to collect," Mr. O'Kane said.
Demand for distressed-asset specialists will rise in the next few years, Mr. O'Kane predicts. "The way that the economy is now, and the way that Americans have been borrowing, I expect to see a lot of distressed assets," he said.
Buying charged-off real estate portfolios is risky enough, executives say. "These loans have been sold a lot of times, from a number of different companies to another," Mr. O'Kane said. "If you have a borrower that's savvy enough to try to test you, a judge could throw out a case because you're missing paper."