Once Viewed as a 'Poison,' Bad-Debt Resales are Booming

  The bad-debt resale market, once a shunned offshoot of the debt-buying industry, is now a multibillion-dollar business, growth fostered by a rise in specialty buyers and high prices that creditors are now commanding for bad debt.
  While statistics on total resales do not exist, a near-impossible task because some accounts are sold again and again and again, and mostly among privately held firms, industry insiders believe the byproduct market grew ten-fold since 2000.
  Garnet Capital Advisors LLC alone brokered $3.8 billion in total bad-debt sales, $3.6 billion in resales, in the first half of this year. National Loan Exchange Corp. expects to broker $1.5 billion in resales this year.
  "Resales once were poison. Now they're gold," says Garnet's Sean McVity, a managing partner with the company. "Some say the resale market is a bubble waiting to burst. That's a false notion."
  Not everyone backs McVity's assessment, however. Stephen Kass, chairman and chief executive of debt buyer CreditMax LLC, believes there definitely is a bubble. Because credit issuers are holding accounts longer, working them internally before offering them for sale, they are ensuring demand and prices stay high.
  There is a dangerous trickle-down effect that comes with that strategy, Kass says. "The undercapitalized buyers on the back end, the third and fourth buyers, are in danger of not having enough debt available for them at a price they can afford," he says.
  With buyers paying higher prices for debt from credit issuers, they are presumably having more difficulty or taking longer to receive a return on investment. The first buyer seeks an elevated price when it resells to the second buyer, hoping to make up the extra it paid.
  That cycle continues. At some point, the food chain dies and there is nobody else to whom to sell. These are elements of a greater problem Kass refers to as "sewage backup."
  "It's a shortsighted strategy by the issuers to cause this sewage backup. The resale market is going to get soft as a result, and prices will have to come down," says Kass, who developed the "Debt Sales System" to give smaller buyers options to paying what he says are premium prices. The system allows registered buyers to handpick loans electronically by traits such as ZIP code, account size and chargeoff date.
  Meanwhile, despite widespread industry concerns about rising prices for debt, pricing has stabilized this year, says David Ludwig, president of debt broker National Loan Exchange Corp. That is a significant change from a year ago when prices were up 10% to 20% each quarter.
  The pricing benchmark is that resold loans should trade at just less than half of the original loans. (Fresh chargeoffs are in the 10 cents to 12 cents on the dollar range. Loans that have been to two agencies are averaging around 4 cents.)
  Credit issuers all along have considered resales little more than a necessary evil. Just five years ago, many would not allow it and some still limit it. MBNA, for example, bans buyers from reselling for at least one year. In part, it gives originators control over those accounts just a little longer, should debtors try to make good on their delinquent loans.
  Their concerns about allowing resales include possible reputational damage should a subsequent buyer violate the Fair Debt Collection Practices Act, but also the threat of legal action. "Simply put, if the buyer of their accounts sells to somebody who screws up, they'll face getting sued, too," says Dr. Gary Wood, president of Collins Financial. "Think about it. Would you rather sue a [J.P. Morgan] Chase or a Collins Financial?"
  First Tennessee Bank, a bad-debt seller, allows resales, but buyers must notify the bank first, says Melanie Thomas, recovery supervisor in the Asset Recovery Department. "When we put debt on the market for sale, we watch closely who's bidding. We have a clause in place to make sure it doesn't just go out to anybody," she says. "It still is bank paper. It still has the bank's name attached to some degree no matter where it ends up.
  Anyone banning resales is hurting the value of what they will receive for their bad debt, Wood says. Buyers are more likely to pay top dollar when they know they can repackage some loans and sell them to buyers that might specialize in those loans. "If we have somebody who wants to buy debt from us, they often don't want to wait 10 days while you notify your seller that you plan to resale," Wood says. "It's just another hoop that we don't want to jump through but we will if that's asked."
  Most sellers, to help limit post-sale problems, deal with members of an industry association such as ACA International or the Debt Buyers Association, Wood says. Such affiliations instill more confidence that the buyers will be around for awhile.
  First Tennessee uses NLEX to handle its sales, Thomas says, and counts on the original buyer of its accounts to ensure any subsequent buyers are legitimate and honest. "We don't worry at that point," she says. "We don't have too many problems."
  The bank has taken steps to limit its liability, Thomas says. "We do what we can to remove our name once the buyer of our accounts resells those accounts. It [contract language] is there so we aren't held liable for any later actions as much," Thomas says, acknowledging that such language will not necessarily hold up under legal scrutiny. But thus far, legal issues have not been significant for First Tennessee.
  For the most part, industry insiders are celebrating the emergence of resales, which have come far from the days when "people would buy old, bedraggled accounts, collect them to death, and try to turn them around. Everybody knew the loans already had the crap beat out of them," McVity says.
  Most, if not all, of the top 25 debt buyers beefed up their resale desks in the past five years, including industry leaders such as NCO Group and Arrow Financial Services. McVity believes the resale market is healthier than ever.
  Midland Credit Management, a San Diego-based debt-buying arm of Encore Capital Group-one of five public debt buyers-began resales three years ago. "We view it as a liquidation channel that can be used opportunistically when the market will pay us more for a select portion of our inventory than we think it is worth," says J. Brandon Black, Encore's president and chief operating officer.
  Many turned to the resale market for price relief, says Tom Ferris, chief executive of The Sagres Co., a debt buyer in La Jolla, Calif. "We're in a sellers' market for all bad-debt products. It's being fueled by too much money chasing too few deals," Ferris says.
  That investment boom began at least four years ago and heated up when debt buyer Portfolio Recovery Associates, Norfolk, Va., went public in November 2002. Asset Acceptance Capital Corp. followed in early 2004. At the same time, private equity poured into the debt-buying industry. Prices for bad debt edged up as investors pushed buyers to make deals.
  In 1991, charged-off sales hit $3 billion. By 2005, estimates are anywhere between $75 billion and $100 billion for the total market for charged-off and non-performing loan sales.
  The growth of resales followed the primary market, and today it is estimated that up to half of all debt eventually will be repackaged and sold again.
  NLEX's Ludwig, meanwhile, does not worry about a bubble in the market. Debt buyers seem to be adjusting their prices based on their recovery models.
  Even non-paying accounts can be sold, thanks to the resale market, and that was not the case 10 years ago. "There's a market for everything because different buyers have different expertise. Even an account worked five or six years and beyond the statute of limitations has some type of value," Ludwig says.
  For now, higher prices for debt should motivate buyers to keep reselling. But while the resale niche is trendy today, and appears to have legs, its popularity always will lag one step behind.
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