News & Views 7: Dec 09

Editor's Message

Unemployment, Charge-offs & Recovery of Fresh Paper by Gary Baker   We have tackled a broad subject for this issues lead story. We are examining the relationships between credit card charge-off rates and unemployment rates for a ten year period. Then we have compared the pricing of Fresh charge-off credit cards and recovery rates, and combined the results in various graphs. This has been a very ambitious project.   To set the background in place, let's first examine the sources of the data. The United States Department of Labor, Bureau of Labor Statistics publishes a monthly unemployment rate which can be found on their website. (There is a graph on their website that reflects the unemployment numbers and also shows the quarters that were in a recession.) The current recession started in December 2007 and continues through the current period, which is October 2009. The information used for these graphs are the seasonally adjusted numbers. The data for the credit card charge-offs, is provided by the Federal Reserve (see website), and we used the seasonally adjusted numbers from all banks for the comparison. After converting the unemployment data into quarters, we plotted the two values together on the graph for 43 quarters, a little more than ten years. The relations between the two are very similar. In fact, when all the numbers are averaged together for the entire 10 year period, they are within 99.4% of the exact same value.       Since the first quarter of 2006, unemployment has increased from 4.73% to 9.63% which is a 103% increase. Credit card charge-offs have increased from 3.09% 10.24% which is a 234% increase. But even more sobering, is the residential real estate loan charge-offs, during the same period. In the first quarter of 2006 the bad real estate loans were at 0.09%, and by the end of the third quarter of 2009, that number has reached 2.43% which is an increase of 2600%! (Check the numbers; we have calculated this over and over again). Commercial real estate is even worse than the residential numbers, and all of this has happened in just the past 15 quarters with no apparent relief in sight. When we look at all consumer loans for the same period, which also includes credit card charge-offs, we see 1.76% in the first quarter of 2006 and 5.86% in the third quarter of 2009 which is an increase of 232%. This parallels the 234% increase in credit card charge-offs.   Fresh Charge-Off Credit Card Pricing - 10 Years Data for Fresh Credit Card Charge-off pricing, tends to come to us in price ranges and from multiple sources. There is also appears to be a  large discrepancy between the wholesale prices that a large collection agency or Debt Buyer will pay, if on a forward flow arrangement, compared to the price a smaller retail Buyer pays for the same product at the retail level or on the spot market. The price data shown on the chart below was developed from many sources. The pricing reflected is the average price paid for Fresh, One agency and Two Agency paper for the same 43 quarter period, as reflected in the Unemployment and Credit Card Charge-off graph above.       The pricing for Fresh, One Agency and Two Agency paper trend together. When we looked at the price of Fresh paper, we did not distinguish between Issuers, balances, State distribution or underwriting quality. We used an average and as we can see in the graph above, Fresh paper was selling at about 6¢ during 2002, climbing to about 12¢ in 2007, and the current price (in the third quarter of 2009), is back to the 6¢ range again. When we will overlay the price of Fresh paper on the Unemployment and Charge-off Graph, and make some observations, we note several interesting trends.    In the 2002 time frame, the unemployment and charge-offs were tightly grouped at about 6%. When the unemployment numbers and charge-offs started dropping in the beginning of 2004, Fresh charge-off paper prices began to rise. There was a large spike in Fresh paper prices in 2006 and 2007 due to amount of times paper traded hands (flipping) before the accounts finally went for collection. This price speculation peaked during 2007, and the Fresh paper pricing has fallen since. This brings us to our next points, which are the collections or recovery of the charged-off accounts. Obtaining data on charge-off pricing was simple in comparison to extracting meaningful recovery information. This is a closely guarded secret according to most of our sources we have talked with. While there are some general recovery numbers available, it is often very difficult to determine with great accuracy, the total length of time in which an account is being collected. We do have very good data for 1996 through 2003, and several sources of industry data for 2005 and 2006. The 2007 numbers were reported to us from reliable sources and the decline in recovery rates from 2007 through 2009 are widely available. So with these inputs, we were able to plot recovery rates for the 10 year period, which coincides with the price of Fresh paper and the Charge-off and Unemployment Rates which is reflected in the graph below.     The industry enjoyed very good times between 1999 and 2006 for collections with average returns in the neighborhood of 300% on a gross basis. But as the recovery rates peaked and then dropped dramatically, starting in 2007 and continuing through 2009, we are seeing a very different picture. The price of Fresh charge-off has returned to the 2001 to 2003 levels, but the recovery rates are still more than 50% below their average of the 2000 to 2005 time period. Projections and Trends   In our opinion, unemployment rates may start to stabilize at the 10% range, but without another stimulus plan that is directed toward creating jobs, it probably unlikely to fall anytime soon and may continue to rise slightly during 2010 and 2011. The charge-off rates are expected to turn up again and peak at about 12% to 13% in mid 2010, according to Moody's Investor Service. The price for Fresh charge-off is in a downward trend, but there will probably be a price which will be the floor, for the banks to sell the Fresh paper we believe. Why should they sell Fresh paper to Debt Buyers at these prices, when the banks can just as easily outsource collections and get a much better return? The recovery rates are beginning to stabilize based on our data. The new numbers we are now seeing are suggesting that the settlement plans are being replaced with many more payment plans, which bring in smaller amounts of revenue for longer periods of time. Legal collection work may be on the rise as voluntary collections are generally more difficult in this type of economic environment. We will continue to update these graphs as new information becomes available. If any of our readers would like to share any of your recovery rates for the next revision, please let us know.

 

 The Jobless Recovery Revisited

In our last edition Gary wrote about the Jobless Recovery and what it means for Debt Buyers.  A powerful visual demonstration of the magnitude of the un-employment problem came across our desk recently.  It graphically depicts statewide, how the unemployment "Virus" has spread accros the nation since January of 2007.  You must check this out!

 

Top 15 US Credit Card Issuers
1	Chase	$165.87 bil.		9	US Bank	$20.17 bil.
2	Bank of America	$150.82 bil.		10	USAA Savings	$12.96 bil.
3	Citi	$102.54 bil		11	Barclays	$10.67 bil.
4	American Express	$78.16 bil.		12	Target	$7.78 bil.
5	Capital One	$55.46 bil.		13	GE Money	$7.17 bil.
6	Discover	$48.90 bil.		14	PNC Bankd	$5.08 bil.
7	Wells Fargo	$30.89 bil.		15	First Nat'l Nebraska	$4.32 bil.
8	HSBC	$26.09 bil.
(Source: Nilson Report, August 2009)

 

 

Collection Agencies seem to be finding their footing after a rocky start this year. According to a recent Inside ARM article, by Patrick Lunsford, they are very optimistic about the future, in fact more than 55% are gearing up for major expansions in the next 6 months to handle the increasing load. 

 

This is more than just good news for the Collection Industry, it is potentially good news for the economy, as well.  "Debt Collection" is certainly not on anyone's official list of economic indicators from a recovery standpoint, but the huge backlog of uncollected debt may be a significant reason for the unwillingness of banks to lend, which is stifling a broader economic recovery. So maybe this is an indicator that should be followed far more closely. If we truly are seeing some early signs of economic recovery, as indicated by several key economic indicators in October and supported by the federal recovery website (recovery.gov which you should check out if you haven't had the chance), it is important to recognize that even after the recovery process has started, an over-abundance of bad debt in the market place will prevent a return to normalcy at the lender level.  As long as this preponderance of bad debt lingers, lenders will remain reluctant to ease credit, as was poignantly demonstrated by the TARP plan, which did little to coax banks into easing credit at all. 

 

Collateral, in the form of Real Estate equity, has almost completely evaporated in the past couple of years, so banks have become much more reliant on other forms of security.   Government guarantees, like the Small Business Administration or SBA loan program, have been one method used for years to collateralize business loans. But the number of new business loans approved in 2009 by the top ten banks, is still just a fraction of the number of loans approved a year earlier.  While on the one hand Fed reports indicate that credit standards for small businesses were not tightened, the table below represents a very different picture. To try to revive the market, Congress allocated funds in February's Recovery Act to temporarily eliminate fees for SBA loans and increase to up to 90% the percentage of the loan that is insured against default.

 

Bank of America made 3,296 SBA loans in 2008 (Average size $31,000) and many of the loans began defaulting, so the bank pulled back on issuing new loans and so far in 2009 Bank of America has made just 303 SBA loans. While Wells Fargo has increased the number of SBA loans slightly from 2008 levels, the total number of loans made in 2009 is 2,347. These are national numbers, not a state or a region, and at these loan levels is it any wonder why we are not generating very many new jobs.     

 

As long as credit remains tight, a full recovery is not likely.  Credit is the key that will start the recovery engine, and "ending capital is the fuel for economic growth.  With available credit for business, both large and small, companies can begin hiring again, ultimately reversing the unemployment trend, increasing production, stabilizing real estate, etc.  While recent increases in production in this country due to stimulus dollar infusions, has had some positive effect on the economy, lasting recovery cannot occur until lending resumes and credit is re-established. Consequently, it is critical to  the economic recovery process that bad debt also find resolution and be cleared from the system to remove another obstacle for the lenders in issuing new business and personal credit. 

 

Simple logic would then suggest that the entire Collection Industry is an integral and indispensable part of our Credit and Debt driven economic system.  While during good economic times the role of the Debt Collection Industry in reconciling bad debt is not much more than a footnote, in troubled times, the importance of its role in the recovery process should not be underestimated.   With consumer debt registering   at such massive levels relative to the entire economy, clearing it from the system will be a challenge.  Since full payment of accounts will quite likely be difficult to achieve in these unique times, the new standard for collection strategies will continue to rely on drastically discounted settlement plans or payment programs.  It appears that in the past few months, Banks themselves are drawing the same conclusion, implementing, in-house settlement plans as they never have before. 

 

As important as settlement plans in lieu of full payment are, complete "Debt Amnesty" is not good for our economy. If Debtors are not held accountable for their debts, the institution of credit will have no "legs".   Banks must be able to depend on loan repayments, or there will be no incentive to lend, and offering credit would become a risky proposition for the lender.  Without a political philosophy that recognizes the importance of maintaining credit as an institution, and lends support to upholding the value of credit in our economy, the cost of lending would skyrocket because borrowers, who do pay, would have to offset the cost of those who don't pay.   And after witnessing what has happened to this economy over the past year, it's not a stretch to imagine the consequences to a further tightening of credit. This underscores the importance of the Collection Industry as the mechanism that helps to maintain the integrity of the entire borrowing system.

 

This is also why debtor friendly States ultimately do a disservice to the country.  Letting Debtors off the hook too easily, creates incentive for credit exploitation and ultimately serves to dilute the value of credit.  Holding rogue Collectors to a decent standard of conduct is one thing.  Deceptive or abusive behavior should not be tolerated and appropriate guidelines for collection are clearly spelled out in the FDCPA, with enforcement mechanisms already in place in our court system.  Recently courts have become tougher on Collectors who break the law and give those instances are full exploited in the press.  Past abuses by unscrupulous Collectors, however, have created a strong bias against the Collection Industry, and recently, a "gotcha" mentality has emerged which focuses is on trying to trap a Collector on a technicality, rather than deal with the debt issue squarely.  In their zealousness to protect consumers from perceived 'hardball' collection tactics, some States are ultimately beginning to inadvertently undermine the Credit System, the very system that helps the economy function effectively.  A few States all but invite debtors to challenge the veracity of obligations which they have deliberately and willingly taken on, and by making the "burden of proof" of debt onerous for the Debt Buyer or Collector, they provide an easy way to dodge ones responsibilities for those who are inclined to take advantage.  

 

We believe that this misplaced compassion is harmful in the long run.  Many consumer advocacy groups exacerbate the problem by feeding debtors information that far exceeds what they need know to protect themselves from aggressive Collectors, but actually arms them with information to entrap Collectors.  Attorneys are notorious for this type of tactic, and there are now cottage industries popping up on the internet which provide consumers detailed instructions for essentially blackmailing Collectors into paying off the debtor to avoid a costly lawsuit.  These are abuses of the system every bit as wrong as Collector bully tactics are, and they incrementally erode the Credit System in this country.  While as with any business there are always a few outliers, the great majority of Collectors are respectful to their clients and very conscientious about adhering to the standard code of ethics that the FDCPA embodies and the industry works so diligently to promote. 

 

According to an ABC News online article by Isaac Wolf, Ira Rheingold of the National Association of Consumer Advocates is purported to be particularly critical about the lack of proof that exists when debtors are approached by Collectors, the implication being that many accounts might be fabricated. It is fairly clear by the article, which is full of assumptions, that neither Mr. Wolf, nor Mr. Rheingold knows much about the Collection Industry and how it operates.  While portfolios might occasionally include a wrongful account due to human error, the vast majority are legitimate debts. By making Media difficult or expensive to obtain, Credit Card Issuers hurt themselves by undermining future collection efforts, which opens the door to questions of veracity and frivolous law suits, ultimately causing damage to the entire institution of credit.  Mr. Wolf states that credit card issuers "eventually give up" after attempting to collect bad debt.  He seems to be unaware that Issuers are required by law to write-off bad debt, typically after only 180 days. The implication throughout the article is that the majority of debt that is being collected is extremely old, which is not often the case, and goes on to say that they just "don't get caught", as if debt collection is some kind of illegal activity.  In fact, Mr. Rheingold is quoted as saying "It's illegal, unethical and immoral" and "If you know that a debt is old, you should not be attempting to collect it". This kind of rhetoric demonizes the Collector and fosters the illusion that most debtors are victims, and therefore deserve amnesty.  It completely ignores the ethical issue of a debtor's responsibility for a legal obligation incurred, not to mention the consequence to society at large if we fail to support the Credit System on which we all rely.  Fortunately many of those who have fallen on bad times see it differently and sincerely wish to repay their debt.

Whenever, and however we do emerge from this financial meltdown, there are certainly some lessons to be learned at every level - consumer, institution and government.  While the experts grapple with the complexities of high finance and national economies, at the consumer level it is a reminder that Credit is a privilege, not an entitlement.  It will truly be a silver lining if we take the new lessons to heart, tighten our ships, and put policies in place that prevent such calamities from ever happening again.   While the Collection Industry is not holding it breath for a pat on the head, it should be acknowledged at some point that it is, indeed, an essential and positive part of a healthy operating economy.