Here’s a sobering economic indicator: freshly charged off consumer debts are now selling for what tertiary debts — those previously placed with two collection agencies — commanded just a few years ago.
Debt brokers and buyers say the fresh chargeoffs, including credit card accounts, now trade at 4 cents to 7 cents on the dollar. In early 2008, such portfolios fetched as much as 14 cents on the dollar, a 10-year high.
These historically low prices for the choicest portfolios of soured consumer debt would seem to point to a buyers’ market. Yet many buyers are waiting, perhaps anxiously, to see if they can snag portfolios at even deeper discounts in the coming months.
Whether prices have bottomed depends on whom you ask. While some industry experts say pricing hit a low mark and stabilized last August, others have a different view.
"As long as [buyers] are asking something, there’s not a bottom," says Louise Epstein, president of Charge-Off Clearinghouse, an Austin, Texas brokerage. "But I am not suggesting people wait. It never pays to get greedy. A good company can make a decent return by buying debt now."
Publicly owned buyers such as Portfolio Recovery Associates in Norfolk, Va., Encore Capital Group in San Diego and Asset Acceptance Capital Corp. in Warren, Mich. all have held off on making larger purchases.
Lou DiPalma, a managing partner at Garnet Capital Advisors, a Harrison, N.Y., brokerage, tells Collections & Credit Risk that on portfolios purchased in 2007 or earlier, when prices were steep, liquidation rates (cash collections relative to face amount of paper) have dropped. The drop resulted in impairment charges against results as companies missed their financial estimates, he said. Buyers do not want to get burned again.
For example, in February 2007 Asta Funding of Englewood Cliffs, N.J., paid $300 million for a $6.9 billion delinquent credit card portfolio from Great Seneca Financial Corp. In its fiscal fourth quarter, which ended Sept. 30 of last year, Asta recorded impairment charges of $137 million, including $53 million on the Great Seneca deal.
"A good portion of the impairments were recorded on portfolios acquired during the period of a healthier economy," Bob Michel, Asta’s chief financial officer, told investors and analysts last month. "With the slowdown in the housing market, the larger payoff of judgments associated with a robust housing market [was] substantially reduced. As the unemployment rate rose to over 10%, garnishments, which became a larger part of the collection base, began to slow down." Asta Funding was the No. 7 debt buyer in Collections & Credit Risk’s 2009 industry rankings, with nearly $115.3 million in revenue from purchased debt in 2008.
With unemployment hovering at 10%, buyers are skittish about the economy and the timing of the recovery. Mike Varrichio, the president of Global Acceptance Credit Co., an Arlington, Tex., debt buyer, said he believes the jobless rate is the industry’s best barometer.
"Not only does it indicate what the charge-off rate is going to be, it has a significant effect on collection liquidation rates," he said. "If you go back and look, you will notice similar trend lines for the charge-off rate and unemployment rate. Charge-offs go up to 10%, unemployment is right around 10%. While the supply side is affected by that, the liquidation rates and the demand side [also] are affected negatively because consumers can’t pay their debt if they’re not working."
His company has watched prices decline 50% to 60% from all-time highs in late 2007. What’s more, liquidation rates have declined 40% in the past year at Global Acceptance, and 25% to 60% for the industry, Varrichio said.
That trend, Varrichio and other buyers say, applies to all classes of soured consumer debt, not just credit cards. "They are all behaving the same way. Prices are coming down and liquidation rates are lower than in the past," he says.
The fundamental principle behind most product pricing is supply and demand, and this holds for chargeoffs. Currently, supply is high and demand is low, as is pricing. "The charge-off rate is around 10% for most of the major banks. That’s twice as high, and approaching three times as high as it’s been in better economic times. In essence, we have twice as much debt coming into the market," Varrichio says. "On the demand side, you have a credit crunch going on so it has become more difficult for debt buyers to get access to capital at reasonable rates. The drop in demand and the increase in supply are driving prices down."
But the economy is cyclical, DiPalma said, so the consumer will recover and debt purchased today has a long enough shelf life to give buyers time to monetize the asset. "If you look at it as a long-term asset, it’s a good time to buy."
Larry Berlin, an analyst at First Analysis Securities Corp. in Chicago, tells Collections & Credit Risk there is potential that collection companies may be more profitable from now on because the cheaper prices will boost incremental margins on whatever they recover. Purchasing portfolios at low prices helps buyers limit their chances of needing to book losses on them. Their profits could soar even if they can collect only a small part of the purchased portfolios.
Varrichio adds that the comparatively low pricing becomes a future benefit to anybody buying debt today. At some point, he said, the economy is going to rebound and when it does, consumers will go back to work and may pay off some debt.
"We have been through this cycle before from 2001 to 2005," he says. "We experienced low prices and an improving economy. That’s what I believe will happen in the next few years. Prices will stay low for the next couple of years and we’ll have an improving economy."
Spending on credit cards has declined dramatically as issuers cut back on the amount of credit they grant to consumers. Al Zezulinski, executive vice president at NCO Group, a Horsham, Pa., accounts receivable management company, said this change will be felt in the debt-buying industry for years, as there will be less credit card debt for sale.
A shrinking market "might mean prices go up," he says. "On the other hand it also might mean there are fewer buyers."
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