News & Views 4: Oct 09

Buying Fresh charge-off debt is difficult, because quite frankly, there is just not that much of this kind of product on the market. And apparently, there never has been. According to many brokers we have talked to, who have decades of experience in this business, the firms that can acquire this product from an issuer, generally collected it themselves. While they may make portions available for their approved business partners, typically it is not in small increments, nor is it usually available directly to industry newcomers. The closer the debt is to the issuer, the more difficult it is to purchase. Most new buyers will have a difficult time purchasing high quality fresh paper without the right qualifications (introductions, connections, licenses and insurance). One broker that we are all familiar with, does on occasion, offer fresh paper on a state basis. These packages are bid on at the state level and many of us have bid against each other to acquire the paper. In several auctions recently, the paper has actually been acquired by national buyers.

The most recent fresh paper was a $99.989 million package that was out for bid on a state level. Since many of you may have actually bid on that package you may be interested in a little bit of information. The product originally came from a major issuer on a forward flow basis to a national debt buyer. The debt buyer apparently has a large amount of inventory and was interested in selling the product on a "pass through" or direct flip basis. This major debt buyer (now the seller), would accept the higher price between the national package bid, and the total of all the state bids. A national buyer won the bid; paying somewhere shy of 6¢ we understand, which was better than all of the state bids. This same exact package was evaluated by our agent, who had run a stratification model as well as a liquidation or recovery model on this national file. The net standard liquidation (no legal work) for the first 6 months was a 2.75% return, for 12 months the number came in at 5.50% and for 18 months the recovery was 8.25%. These liquidation rates were based on the entire national file and does not account for variations that would be expected for the recovery rates that an individual state may yield.

Any statistical model is still only an educated estimate of recovery and the results of those estimates will vary between models. The particular computer model that was used in this analysis used over 3000 data points in its calculations. Each and every account in the file was scored and the total of all the accounts in the portfolio were combined to produce a statistical summary of how the entire portfolio should perform. This is proprietary information and each major broker or national buyer will use their own scoring system to analyze a package. What to pay for a product has to be tied to how the product should be expected to perform. In this particular product, using this particular recovery software, for this single national package of fresh charged-off credit card accounts, you would not expect to have your initial investment returned for well over 1 year, if you paid about 6¢ for the product. This is one reason that the buyers of fresh charge-offs tend to hold the paper from 3 to 5 years so they can milk the most from the files and get a stronger ROI.

Liquidation rates are down on all types of portfolio classes due to the economy and the high unemployment numbers for the most part. But we need to also be aware that the banks are not just waiting for accounts to be charged off before they take a more aggressive posture in collecting their own debts. This last week we were made aware of the one of the nation's largest banks, offering settlements at 15¢ on the dollar, with a 4 month payment plan on some $30,000 credit card balances more than a month before the charge off date. The bank would rather get the 15¢ for their files, than the 5¢ or less that they will receive after charge-off, if they don't try to collect on them themselves. These offers started about a year ago we now understand, and the offers are being made in the last 45 days or so prior to charge-off. The obvious problem with these offers for debt buyers is that the customer, who has not taken the bank up on the offer, is probably in very bad financial shape and will not be able to pay a debt buyers collector any faster right after charge-off. The debt buyer also might not be aware of the banks previous offer so when there is a conversation with the customer, that customer may believe that the new collector will settle for the same 15¢. These types of accounts decrease the value of the portfolio for the buyer.

Determine the Type of Paper to Buy

Zero or One Agency debt is far easier to obtain than Fresh charge-off and is much less expensive. Zero or One Agency paper can be collected quite profitably. It all depends on who worked the files first and how they were worked. In fact, if you really begin to understand how this industry works, you may find the behind the scenes story quite fascinating, and discover that there are so many things that we just didn't know. For instance, the banks typically don't go out and just sell their Fresh charge offs. Why would they? Just think about it for a moment. Would you sell an account for 5¢ or less on the dollar before you really tried to collect your accounts with professional agencies? Probably not!

The banks may work the accounts minimally when they are in house with their own collection staff, but at charge-off they typically place these accounts with their approved outside collectors. The banks are also very worried about their image, so the collectors have been given strict guidelines on how to talk to the customers and what they can say. The banks have a rigorous policy that is established for the amounts that the collectors can settle the accounts for (usually 75% of the balance). The outside agency must get approval for each account settlement which is less than those amounts. Most of these agencies also score the accounts prior to collection and generally will only work the higher rated accounts (this certainly creates a problem for the bank). Since the agency has an abundance of accounts and since they are on a very low fee basis with the bank, (in fact many have to front all of their collection costs) the collection agencies need to work only the best accounts to earn their fees.

What all of this really means is that the accounts the bank had that could have been sold as Fresh charge-offs, were sent to one agency for 3 months and maybe another for 3 months but the accounts were generally softly worked. So these Zero and One Agency accounts can still have a lot of meat on the bones depending on the issuer. This is usually not the same process that a typical contingency collection agency would follow, if the accounts were owned by an investor.

Of course, some portion of the banks' fresh charge-off is sold to their preferred vendors, which are almost entirely major national buyers who have a favorable forward flow arrangement. There are only 10 to 12 national buyers now, according to several reports, and maybe only 5 or 6 of them are buying on a regular basis. The others may either have enough inventory (which may be collecting slowly), old inventory where they may have paid far too much (which is also collecting slowly) or have had a decline in funding due to the tight borrowing requirements of the banks or loss of hedge fund capital. These forward flow arrangements typically were generated by ex-bank employees with strong industry ties, who in some cases now work for the debt buyer.

There are other ways that fresh product is sold, such as at an auction where buyers bid against each other to buy individual states. This process drives up the price for the issuer and accounts for a fairly small portion of the fresh debt being sold, we understand. Another way to acquire Fresh charge-off is from a national buyer who is just interested in working a certain region and selling the balance of the file. Others may just want to broker the entire file on a state by state basis. Most of these kinds of transactions are not advertised and can only be found by working with experienced people who have strong industry relationships.

A very important thing to note is that Zero and One Agency accounts that are about 12 months after charge-off have been reported to be performing better than Fresh accounts. This is not a statement of fact, only a recent consensus of opinion of many brokers. Bear in mind that many brokers have far more of this product available than Fresh paper from the issuer, but this information is also coming from account managers and collectors who only follow what is working at any given time. They are not buyers or sellers of paper, just contingency collection agencies who service debt buyer's accounts. Another point is that there are many types of Fresh paper as well as Zero and One Agency accounts available. The lower balance accounts ($1000 to $1500) for credit cards for example, are generally collecting better than $5000 credit card balances according to our information. Other types of loans such as Pay Day loans and DDA's are reported to be collecting well at the $700 to $800 level. We are not tracking auto deficiencies or real estate loans and medical, utility etc.; each exhibits their own specific characteristics. The lower balance credit cards are sometimes more available from non-prime lenders. Fresh, national credit card files from major issuers have had average balances from $4500 or $5000 to about $9000 recently.

Every broker has access to similar files from similar sources. As you can imagine there are only so many issuers of credit card debt in the first place, so no one broker can have truly a unique product. Several things are different between each broker including the price that they charge, fees, purchase contracts, confidentiality and non-compete contracts, broker service levels, reputation and even the quality of product. Some brokers have access directly to issuers, while others may not. Some brokers sell on a bid basis, others on a set price (which is generally negotiable) and some don't have any product at all on hand, they will just locate what you want. Our recommendation, is always stay as close to the source as possible for any product that your are purchasing. Adverse selection within a file is fairly common practice, so the fewer hands that touch a file, the better. We know of one file recently that was sold by a broker to a reseller who then sold the file for a 100% markup. These things happen far too often especially when sellers take advantage of newbie's (new buyers) in the business. While the reseller might have made a home run on this one transaction, they probably won't be getting much repeat business from the buyers of this account.

This business is not transparent and every seller, at each turn, protects their sources both on the buy and sell side, as well as the collection side of a transaction. Fees are generated for brokers (not the issuers) at every turn of a transaction and for the most part the fees are fairly small relative to the potential value of the product. Brokers all know each other; it's a small industry. The prices charged for the debt purchased is basically established by the market participants. If you can buy larger portfolios you will not only get better pricing, you will probably get a better product especially if you buy again soon. The brokers need buyers, and according to one of the largest brokers in this country, there are about 4000 debt buyers registered with their firm. Now many newer buyers might not have registered or have been approved yet, and other buyers might buy only from a few close sources. But in a country of 300 million people, this is not a very large number. (How can 6300 collection agencies be supported by this number of debt buyers? Well they can't. The agencies also buy their own debt directly from issuers and collect for many types of businesses, medical facilities, utilities, schools, government agencies etc.) This is a subject for a future article.

It is impossible to tell how many times a file might have been scored or touched in some fashion before you ever see it. But since you can run your own scoring model on the file in seconds with the right software, you can determine quite quickly what the computer says you might collect on a particular file in a given time frame. Based on all of your data that you accumulate on a given file and after you have reviewed the file with your collector (they will probably run a different model than you did), you can find guidance on the right price to pay for the portfolio. If you make money on the accounts, you will be back for more products. Getting the right file for you will be a process at first and everyone will have an opinion on what you should do. By far the best way that we can recommend is for you to talk to several collectors (at least 3 or 4 preferably more) who collect in the exact state or region that you are interested in acquiring a portfolio. And find out what type of product, what age of account, what agency level and what average balance is collecting the best right now. Many collectors also have knowledge of what other portfolios have recently sold for and may share that information with you as well. When you have your research complete, use that information to define exactly the type of portfolio that you want. Be very specific with your shopping list and get pricing from several sources and then perform your own due diligence on several files. Remember, success in this business is not entirely measured on how well you can bid on a file. Ultimately, our success in this business will be measured by how well we can collect and when.

New Debt Buying Service

In response to the many phone calls and e-mails that we have received regarding the frustration expressed in buying a file, we have started offering a new service where we help buyers work together and buy larger files as a group from sources not normally available. The objective of the service is to assist the group in buying a larger file that has been touched by fewer hands at a discounted price. The file would be divided up between the participants in a double blind process with an agent who stands as the holding company. The will provide a secure environment where multiple companies can join together without a conflict of interest. The agent's services will include scoring the files being considered for purchase, providing expert opinion on pricing, in addition to administrating the purchase and sale contracts and will also handle any put backs.

We will be searching for specific files to meet the criteria of the group and will be gathering the portfolios to be reviewed from many different brokers. Once a file is selected by the group, it will be divided up among the group. We (Crescent Bay Financial) will not participate in the group as a buyer. We will work with the agent, coordinate the group, search for the files, analyze the files with the independent agent and review all aspects of the purchase with the group. If you are interested in participating in this type of buying (which can also include collections with a network of preferred agencies if you desire), please send me an e-mail to gary@crescentbayfinancial.com. Please note; his is not an offer to raise money for an investment. This is a service being offered for interested buyers to purchase collectively in the wholesale arena. As a group, we are more likely to receive accounts at a discount from vendors who have larger minimum purchase requirements. We will be sending out more information on this Buyers Group in the next few days.

News & Views 4: Oct 09

Is Fresh the Best?