Buyers of charged-off consumer debt and other experts on the market say recent entrants have bid up portfolio prices over the last 18 months to unsustainable levels.
Not surprisingly, some of the market's veterans dismiss the new participants as dabblers that lack the discipline, infrastructure, or experience to succeed. (The veterans would not identify these newcomers, except to say they are hedge funds and private equity firms.)
But there is more than exuberant demand at work here. Experts also said that sellers are getting savvier and holding out for better prices, and that consolidation is creating tougher competition.
That competition has pushed many companies to expand beyond traditional credit card debt purchases into utility, health-care, phone bill, and auto deficiencies.
Lilia Kozicky, an analyst at SunTrust Robinson Humphrey Capital Markets, said that recently charged-off paper, which had been fixed at 4 cents on the dollar last year, is now selling at 8 to 9 cents on the dollar.
Over the past 12 months the pricing of more seasoned paper has jumped from 3 cents on the dollar to 5 cents, she said.
Timothy Bauer, a vice president at Outsourcing Solutions Inc., a St. Louis debt buyer, said that prices for older paper have increased anywhere from 50% to 100%.
"We have entered into some irrational pricing," Mr. Bauer said. "The numbers don't justify the prices right now. … Many newer companies have been buying for the sake of buying."
Carl Gregory, the president and chief executive of Encore Capital Group Inc., a San Diego debt buyer, agreed with that assessment.
"New entrants into the market will hit the wall pretty soon," he said. "People are being undisciplined in their purchases. They are starting out in positions in which they can't make money."
Analysts and executives say the profits reaped by large debt buyers over the past two years have attracted newcomers.
"Because of the success some of the larger companies have enjoyed, more people have been entering the industry over the past year," Mr. Gregory said.
Joseph Chumler, an analyst at Stephens Inc. of Little Rock, said Thursday that in the past week he has fielded calls from four private equity companies looking to get into the bad-debt market.
"Private equity firms and hedge funds are very interested in entering the industry," he said.
Andrew Zaro, the CEO of Cavalry Portfolio Services LLC, said that to succeed in this niche, companies need three things: "capital, an infrastructure to process debt, and an understanding of the pricing around the product."
The newcomers don't have "the infrastructure they need," Mr. Zaro said.
Sour grapes? Maybe not.
Undisciplined buying has caused trouble for debt buyers in the past. The failure of companies to acquire only what they could handle led to the fall of a number of buyers, such as Creditrust Corp. and Commercial Financial Services Inc., in the late 1990s.
"Once you overpay for a portfolio, the risk is fairly great that you are going to do certain things you would not have otherwise done, which can be very dangerous," Mr. Bauer said.
Industry experts agreed that the supply of charged-off debt is increasing as quickly as the demand for it.
"More of the institutions that create and originate consumer debt have started to embrace selling it over the past year," Mr. Zaro said.
However, as Ms. Kozicky said, "as new money comes into the market, paper suppliers are becoming more sophisticated and are demanding higher prices."
Gary Stern, the president and CEO of the Englewood Cliffs, N.J., debt buyer Asta Funding Inc., said portfolio prices have reached a plateau. "I don't think that there will be any more entrants."
Mr. Stern said companies would soon realize that they have overpaid, and they will start buying in a more disciplined manner and bringing prices down.
But Ms. Kozicky said the pricing environment has not shown any signs of correcting this month. "Our hope is that pricing will begin to improve in the second quarter."
In the meantime, the seasoned buyers are diversifying.
Portfolio Recovery Associates Inc., whose portfolio had been concentrated heavily in credit card debt, acquired IGS Nevada Inc., an asset-location services company, in October for $14 million.
Asta has diversified into telecom receivables, according to Mr. Stern. Cavalry has moved into auto, utility, and health-care debts.
Mr. Bauer said many debt buyers are looking with "fairly high hopes" at the health-care industry.
Because collecting on overdue medical bills requires special expertise, companies see that market as one with little competition, he said.
Mergers and acquisitions are also reshaping the debt-buying market. Consumer Portfolio Services Inc., an Irvine, Calif., buyer of auto deficiencies, nearly doubled its portfolio in 2001, when it bought MFN Financial. In May 2003, Consumer Portfolio bought TFC Enterprises Inc., a subprime auto lender.
Cavalry, of Hawthorne, N.Y., acquired First Credit Solutions, which serviced nonperforming consumer loans, in August 2002.
Just over a year later Cavalry sold a large minority stake to Bear, Stearns & Co. Inc.'s merchant banking arm, and Mr. Zaro said his company would be open to the idea of selling another stake.
Arrow Financial Services LLC, one of the industry's largest debt buyers, sold the majority of its shares in September to SLM Corp., better known as Sallie Mae.
The older players cited consolidation as yet another reason why the neophytes should fail.
"Most of the capital that has come in over the past 12 months is going to achieve returns far less than expected," Mr. Gregory said. "I think we're going to see some real train wrecks in 2005."
