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This story appears in the October issue of Cards&Payments.
Credit card debt prices are on a downward path in a buyer's market where few are buying. Many bad-debt buyers predict anemic prices will continue through 2009 as the business wrestles with a troubled economy and debtors who are unable or unwilling to pay.
Fresh credit card charge-offs, at their highest, were selling for as much as 14 cents on the dollar in early 2008 but have been steadily declining, experts say. As of late August, fresh credit card debt was selling for between 4 cents and 7 cents.
"The larger percentage declines have taken place in the past six months or so as the economy has continued to struggle," says Mike Varrichio, president of Global Acceptance Credit Co., an Arlington, Texas-based debt buyer.
Although falling prices favor the buyer, decreasing liquidation rates on portfolios do not. Collection agencies are so busy trying to collect, there is less need to acquire more debt.
Despite the sizable decline in prices during a span of less than two years, a gap apparently still exists between what buyers and sellers believe portfolios are worth, says Al Zezulinski, executive vice president at NCO Group Inc., the largest collection agency based on revenue, according to research by Collections & Credit Risk, a Cards&Payments sister publication.
"A lot fewer deals are coming to the market. Pricing expectations on the part of the buyer are not matched by the pricing expectations of the seller," says Zezulinski. "The gap in some cases is so large that it's hard to bridge it."
The debt-buying and collection industries were hit with a "double whammy" in 2007 and 2008–a lack of available credit being extended to consumers and unemployment, says Lou DiPalma, managing partner at Garnet Capital Advisors, a Harrison, N.Y.-based bad-debt broker.
"People lived on credit and home equity [refinancing]. That game is over. They can't take home equity out. How much disposable income came out of a consumer's house? A lot," DiPalma says. "The home-equity business is not coming back any time soon, but we expect unemployment to ease."
Varrichio agrees that unemployment has had a huge impact. He believes the national unemployment rate, which hovered around 9.5% this summer, is the best barometer for the debt-buying industry. "Not only does it indicate what the charge-off rate is going to be, it has a significant effect on collection liquidation rates," he says.
"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%," he adds. "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."
Liquidation rates for Global Acceptance have declined 40% in the past year, and anywhere between 25% and 60% for the industry, in general, Varrichio says.
Garnet's DiPalma points out that buyers that purchased accounts at 14 cents on the dollar two years ago thus far are falling far short of seeing a return on that investment as unemployment climbs and consumers no longer can tap the equity in their homes to pay off debts.
On the other hand, because the economy is cyclical, debt purchased today likely will prove to be a good investment, DiPalma adds. "If you look at it as a long-term asset, it's a good time to buy."
The long shelf life of the debt is why some sellers are holding on to their portfolios. The industry's larger sellers are sophisticated, taking into consideration pricing versus liquidation, DiPalma says. As a result, sales volume is down.
"[Sales volume] hasn't gone down to zero because they still need to manage their inventory," DiPalma says. "But collection agencies are pretty busy. There is no lack of delinquent paper."
Supply And Demand
The fundamental principle behind most product pricing is supply and demand, and the theory holds true for credit card charge-offs. Currently, supply is high and demand is low, as is pricing.
"The charge-off rate is hovering 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," says Global Acceptance's Varrichio. "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."
Fresh charge-offs that are selling for what tertiary debt sold for just a few years ago is a sobering indicator illustrating the depths to which the economy has plunged.
Though some industry experts say debt pricing hit bottom and stabilized in August, others have a different view.
"As long as [buyers] are asking something, there's not a bottom. It may seem cheap, but as long as there's a market, it's not a bottom," says Louise Epstein, president of Austin, Texas-based debt broker Charge-Off Clearinghouse.
"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. There's no reason not to buy if you know what you're doing," Epstein says.
Varrichio agrees, adding that the comparatively low debt pricing becomes a future benefit to anybody buying debt today. At some point, the economy is going to rebound, and when it does consumers will go back to work and may pay off some debt, he says.
"We have been through this cycle before, from 2001 to 2005," Varrichio says. "We experienced low prices and an improving economy. That's what I believe will happen in the next few years."
There is the rub. It takes money to make money, and consumers are not the only ones affected by the credit crunch. Debt buyers, too, have found it difficult in this economy to secure financing for debt purchases. The question becomes: Who is in a good enough position to buy?
Industry Outlook
"Debt prices have gone down and are hovering in the downright totally reasonable range. But if somebody has blown their investor wad making bad decisions, they may be less able to take advantage of the opportunities that the market is presently offering," Epstein says.
In fall 2008, NCO's Zezulinski would have expected debt sales to have improved by now, but "we're not seeing it," he says. "Clearly at some point the market will come back. I don't know if it will come back the way it had during the golden years, so to speak, but we still have to see how the consumer economy revives itself before we can really make any solid predictions."
Spending on credit cards has changed dramatically as issuers cut back on the amount of credit they grant to consumers. This is a long-term trend that will be felt in the debt-buying industry for years, as there will be less credit card debt to be sold in the future, Zezulinski says.
This shrinking market "might mean prices go up," Zezulinski says. "On the other hand, it also might mean there are fewer buyers."
Debt prices will remain low, if not sink lower, as public creditors rid their books of bad debt by the end of the year, resulting in a flood of debt hitting the market, industry experts agree. The earliest that pricing will rebound is during the first quarter of 2010, many say.
Stability Ahead?
"You are going to see a lot of paper on the market in November and December, and it is going to drive bids down because debt buyers can't bid on every deal. You have to be selective in your bids, and you have to be very conservative," Global Acceptance's Varrichio says.
After debt pricing bottoms out, Varrichio expects some stability for the next couple of years, with pricing increasing as the economy improves. " I don't believe we will see a quick recovery of prices," he adds.
If optimism in the economy continues, debt prices could rise 15% from their current rates heading into the first quarter, says Garnet Capital Advisors' DiPalma. However, prices will not completely rebound to their 14-cent level, he adds.
A recent consumer trend noted by DiPalma and Charge-Off Clearinghouse's Epstein could bode well for collection agencies and debt buyers. Both say there is less consumerism as paying off debt is becoming en vogue.
"The fact that individuals are making more prudent financial decisions for their households, whether by choice or duress, gives them a greater opportunity to pay off the debts they have," Epstein says. "Sad to say, the more people who walk away from their mortgages, the more disposable income they have to pay off their other debts. And there is going to be a lot more [people walking away from their mortgages]." CP
