U.S. Firms Help Fuel Canada Debt Sales

  Five national banks control 75% of Canada's credit. None is selling bad debt. Not Royal Bank of Canada. Not CIBC. Not Bank of Nova Scotia. Not Bank of Montreal. And not TD Canada Trust (although it did so quietly five years ago).
  Yet, even without them, the market is growing, fueled by Canadian retailers and U.S. companies with operations in Canada, says Gerry Coffin, vice president of acquisitions at London, Ontario-based Portfolio Management Canada. "Sales are steady in the past few years, and there are nice opportunities out there," he says. "Interest in bad debt from Canada is at a high mark."
  The market grew from an estimated C$100 million, or US$79.4 million, face value of bad debt sold in 2000 to between C$300 million and C$400 million forecasted for 2005, says Stephen J. Sheather, principal with Score Statistical Consulting, a Toronto-based debt broker and host of a yearly debt-buying conference. (By contrast, in the much larger U.S. credit market, debt buying after 15 years is a $75 billion business).
  Companies selling Canadian debt in the past include Hudson Bay department store, Citibank Canada (a $10 million sale to Equifax) and GE Capital Canada (a $17 million sale to Portfolio Management Canada).
  And, American Express sold a charged-off credit card portfolio this spring in a confidential deal. The seller and the anonymous buyer did not release details.
  In general, Coffin says, Canadian companies more often are working the loan-exit strategy into their budgeting equations and quarterly projections.
  "The good news is there's much more activity up here than there's ever been," adds Sheather. "The bad news is banks still haven't entered the market, and I'm not sure when they're going to. At least not this year."
  There are several reasons why Canada's banks are not selling their debt, ranging from fears that the public will perceive them poorly and lose business to the current lack of need because delinquencies are low. Those reputational concerns beg the question: Why worry about losing customers who do not pay their bills?
  "Good customers can get into short-term financial messes," answers Ronald Giles, Bank of Montreal's national director of collections. "Those same customers could become lucrative mortgage customers one day, but not if you sold their credit card debt to a buyer you have no control over, a buyer that could prove to be shifty."
  And there is more, he says, including U.S. privacy laws that are confusing and that are not being properly explained by prospective buyers. "Would we have a liability surrounding what happens to our accounts if mismanaged by a U.S. debt buyer? We don't know. We need to know," Giles says. "The Patriot Act is such a big unknown. The way I understand it, any time information is with a third party, the government can seize it.
  "If I'm a buyer, I'm working to understand these laws and I'm explaining it to us. That's not happening."
  So while some Canadian banks eventually might be interested in selling to U.S. buyers, a potentially lucrative area given there are hundreds of possible buyers, they want better answers before they "stick their necks out and brave the Patriot Act," Giles says. "U.S. privacy legislation might make it less risky for us to sell to Canadian debt buyers, but of course then you significantly reduce your pool [of potential buyers]," he says.
  Another drawback for banks, at least for now, is the question of need. "You sell debt when you need capital. We don't need capital," Giles says. "We're sitting on $1.5 billion to $2 billion in capital. Profits are nice. Our loan losses are abnormally low. We're even considering buying back shares, the opposite of selling bad debt."
  U.S. banks, of course, did not embrace bad-debt sales until they witnessed the success of a Bank of America groundbreaking sale in the late 1980s and the later move by the Resolution Trust Corp. to sell assets from failed banks.
  Coffin believes it is only a matter of time before Canadian banks start selling, too. "Everybody wants the other guy to go for it, to go first," he says. "It's a matter of which one wants to start out on the ledge."
  For now, how much potential is there in a bad-debt market where the leading lenders will not sell? Many buyers believe there is room for at least a dozen buyers to carve a profitable niche.
  David Ludwig, president of National Loan Exchange Corp., a U.S. debt broker that handled Canadian sales from Citibank, Associates and GE Capital, cautions there are limits. The top 10 U.S. issuers, for example, each year separately write off accounts equivalent to the entire bad-debt market potential in Canada, he says.
  "But that doesn't mean there's no place for buyers," Ludwig says. "Obviously there are opportunities."
  National Loan handled Toronto Dominion's (TD Canada Trust) $25.5 million bad-loan sale to Capital One Financial Services five years ago, a deal many thought would be the touchstone to banks' selling full-time. Ludwig remembers it as a "successful venture."
  "It priced out at a little less than what U.S. paper does," he says. "There was no more than a 10% reduction."
  TD Canada Trust officials would not discuss the sale. Industry speculation suggests bank officials had some concerns about later resales of the debt.
  Today, price pressures in the U.S. have helped raise interest in Canada. With an estimated $350 million in new public and private equity capital parked with U.S. buyers in the past two years, says industry analyst Stephens Inc., prices are inflated for all debt classes.
  U.S. buyers active in Canada or that are considering buying in Canada include NCO Group, of Horsham, Pa., and Northbrook, Ill.-based Hilco Receivables. Neither company would share information about its strategy in Canada. "I'm not really that high on inviting competition," says Bruce Passen, Hilco president and CEO.
  Beaverton, Ore.-based Genesis Financial Solutions opened GFS Canada in April to pursue Canadian debt. And Cavalry Investments bid on a Canadian debt portfolio but has yet to successfully buy anything, says Alfred Brothers, executive vice president of the Phoenix-based company. Brothers views the Canadian market as a nice secondary option.
  Meanwhile, even as buyers wait for the banks, a lesser-known threat looms-statute-of-limitation laws governing how much time can pass before legal action on accounts is banned. The laws are different in the various provinces: three years in Quebec, up to five years in Alberta and new legislation calls for as little as two years in Ontario.
  "This could pose a serious problem in truly assessing what these portfolios are going to be worth," Coffin says. "It's certainly going to suppress the prices, and if that happens, you can bet that banks are going to be less enthusiastic about taking on the reputational risk."
  Bank of Montreal's Giles, however, acknowledges that with delinquencies at record lows for Canada's banks, it is natural to assume they will rise, boosting the likelihood of debt sales.
  "Never say never. Debt selling is another tool in how I look at doing business," Giles says. "In two to five years, I believe the market will see Canadian banks actively selling bad debt. But there are a lot of barriers to overcome first."
  So, for now, Canada's bad-debt market will keep relying on retailers and U.S. firms. Whether Canada's banks one day follow their U.S. peers and make sales part of the regular financial plan will go far in determining whether the market grows slowly or blossoms into a sophisticated industry.
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