As the rise in delinquent credit card accounts mounts, the marketplace is responding with a panoply of alternatives for banks to get rid of bad credit card debt, including selling it through brokers, online or at auction.
Banks are even turning charged-off non-performing debt into performing assets by participating in forward-flow contracts, relatively new products that can totally eliminate collection agencies from the debt recovery process. Of $40 billion in charged-off bad debt in 1996, an estimated $4 billion was marketed and sold. With another $100 billion in delinquent credit card paper waiting to be charged off, it's no wonder brokers are smiling.
One such broker is Foster City, CA-based Koll-Dove. Six years ago, Koll-Dove, a pioneer in the brokering of distressed consumer debt, noticed the growth in credit card debt and found that there was no uniform way for card issuers to get rid of the burden of non-performing accounts.
The upshot was a program that enables credit card issuers to create liquidity for these debts by turning them into a product and taking them to market, says Ross M. Dove, chairman and CEO of Koll-Dove.
The rise of disposition companies like Koll-Dove echoed what was happening in other parts of the industry. The Resolution Trust Corporation (RTC) and other federal agencies were liquidating insolvent thrifts during the S&L crisis, making very collectable debt available at cheap prices. They also created a new pool of capital for the purchase of non-performing assets. Brokers realized that if the FDIC could sell the bad debt of insolvent institutions, then they could market traditional bank debt, too.
Now Koll-Dove contracts with banks and other credit card issuers to make their charged-off portfolios available for sale to a database of 2,500 potential buyer groups. "We buy the paper, restratify it and resell it." says Dove. Some of the paper is targeted to collection agencies and some to investment bankers for securitization.
In a securitization, the defaulting receivables are placed into a trust that issues a bond, which can be rated and sold just like any investment product. "If we do our job right, it's a win-win-win situation with seller and buyer and sometimes even the debtor gaining an advantage," says David Ludwig, senior vice president of Koll-Dove.
The selling credit card issuer gets rid of its bad debt, realizing much higher recovery rates up front with significant savings in overhead and carrying costs. Buyers can expect to turn the purchased debt into a profit by collecting more than they paid for it, or by issuing credit cards to high-risk customers. Debtor credit card holders, in some instances, gain because the sale distances them from collection agencies.
When a bank charges off a bundle of non-performing credit card accounts, the debt is purged from the system and sent to a collection agency where it becomes primary paper. The portion that remains uncollectible after six to nine months is returned to the bank. After a period of 30 to 60 days a bank may send it to a second collection agency as secondary paper. When it is sent to a third collection agency it becomes tertiary paper.
A few years ago banks were only interested in selling off tertiary paper-truly dead accounts. But that has changed. As bad debt portfolios have become easier to sell, banks are moving from sales of tertiary paper to secondary and even primary paper.
Some banks now are getting out of the collection business by using forward-flow contracts to sell credit card debt immediately at write off and turn it into an evolving asset. In a forward-flow contract, a bank contracts with a single buyer or group of buyers that agree to buy the charged-off debt on a month-to-month basis at a set price.
"After an account is charged off, it may take an issuer three years to recover 18 percent," says Ludwig.."If a bank can get 10 or 11 cents on the dollar when the account is written off, it might make sense to sell the paper immediately, given the time value of money, staff, and other overhead."
The delinquency rate (account balances in which a monthly payment is 30 or more days past due) increased sharply to 5.49 percent in December from 4.44 percent in December 1995, the 14th consecutive monthly increase, according to Moody's Investors Service.
And increasingly sophisticated scoring is enabling banks to chart those consumers that are maxing out credit cards or sliding back in payments. In some cases, .banks are charging off such accounts as bad risks, even when delinquent 60 days or less. " I expect that in the next six months, these early write-offs will become a maturing market, " says Ludwig.
Charged-off debt continues to climb. In the fourth quarter, the average charge-off rate compared with the fourth quarter of 1995 increased by 175 basis points (4.22 percentage points) to 5.60 percent of receivables for eight big banks tracked by securities analyst, George Salem, senior vice president of Gerard Klauer Mattison, a New York institutional brokerage and investment banking firm.
At Citibank, the fourth quarter charge-off of credit card debt as a percentage of average loans annualized was 5.45 percent compared with 3.89 percent a year earlier. At Chase it was 5.11 percent compared with 4.18 percent and at Bank of America it was 5.04 percent compared with 4.20 percent, according to Salem. Other analysts say some charge-off percentages can be very high, even into the teens.
"I don't think credit card debt is running away from us, but it hasn't stopped going up, and I don't see any end to the increases this year," says Salem. He notes that the only thing that could make it a real problem would be a recession which he said is unlikely.
How the market looks: More than one million Americans petitioned the courts to stay debt collection under either Chapter 7 or Chapter 13 of the federal bankruptcy code in 1996. About 70 percent sought maximum relief under Chapter 7, asking the court to erase all of their dischargeable debt. Bank-issued credit cards account for about 15 percent of a filer's total debt.
With the increase in bankruptcies, observers might wonder if the bundling and sale of Chapter 7s and Chapter 13s can be far behind. Some brokers are already selling lists of debtors to clients who see a profit in selling high interest, secured credit cards to bankrupt consumers.
Maxing out on credit cards could be the item that tips a typical consumer into bankruptcy, according to Bliss Morris, president and CEO of Oklahoma City-based First Financial Network, Inc., also a broker of credit card debt. "We're seeing performing credit card debtors, she says."
In this kind of an unpredictable market, Bliss thinks the seller is better served when portfolios of bad debt are opened to competitive bidding on a monthly, quarterly or semi-annual basis with no forward-flow attached. "Not everyone can participate in a forward-flow agreement. They don't have the capital to buy ongoing month to month," she says.
Brokers of any kind can be expensive, charging up to eight percent, depending on the size of a contract. Many banks consider the process too public, since brokers advertise in highly visible forums, such as The Wall Street Journal. Banks can avoid brokers entirely by using exchanges such as Resources Management Services, Inc. of Sante Fe Springs, CA, which uses the Internet to bring sellers and buyers together.
Some banks which once used brokers are selling credit card debt directly to buyers with much success, according to sources. One major bank eliminated its debt recovery department of more than 60 people by entering into a forward flow contract with a single buyer.
Bank of America sidestepped brokers by holding an auction that produced a marketing list of buyers so that the bank could sell directly. "Bank of America has become its own broker," says Tom Oliver, vice president of the bank's recovery management center. "We save the commission that the bank would have to pay the broker or an exchange." peterson tfn.com