ARTICLE...
Tessera Viewpoint
Debt sale and purchase - put the 'For Sale' sign up
Originating in the USA, the practice of selling non-performing consumer credit portfolios crossed the Atlantic to British shores in the mid 1990s. By 2005 an estimated £3.5 billion (face value) was traded, doubling to reach an estimated £7-8 billion by 2007. Estimations of 2008 sales put this figure at close to £10 billion - or beyond.
Debt sale represents a popular strategy for financial directors in larger organisations who wish to improve cashflow and reduce balance sheet liabilities. The benefits for lenders (credit card companies, mobile phone operators, utilities etc) are simple: it enables them to substantially reduce the number of accounts needing to be actively managed, unlocking valuable working capital normally tied up in receivables.
The portfolios are priced at a fraction of the cost of the original face value (based on the likelihood of recovery) and are usually bid for by the purchasers, who in acquiring the portfolio acquire the rights and duties of the original creditor. For purchasers too, the practice offers numerous benefits not least the possibility of a substantial return, assuming the debt has been correctly priced.
Growth in the market from 2000 onwards has been fuelled by increased confidence in the ability to sell on non-performing debt, and as a result of large amounts of capital injected by outside investors into the industry to make these purchases possible.
Many debt collection agencies (DCAs), both large and small, have turned to debt purchase as a way of diversifying; according to research from the DBSG, some DCAs will now purchase far more debt than is referred to them on a traditional contingency collection basis.
The Evolution of Debt Sale
As the industry has become more established, so the transactions have become more sophisticated. Most early sales were 'spot' deals, one-off transactions between the buyer and seller relating to an agreed portfolio of debt, which were typically old debt of low quality. More recently, portfolios have come to market at much earlier stages with consequent increases in value and prices, commensurate with the likelihood of recovery.
Alongside 'spot' sales are 'forward flow' transactions, which take a more long-term view to debt sale, enabling the seller to structure a series of portfolios over a pre-determined timeframe. A debt sale can take the shape of a one-off sale, or a more regular arrangement; it is a flexible process mutually agreed between seller and purchaser.
The market began with the sale of financial debt portfolios, but now includes non-financial debt such as utilities companies, commercial debt portfolios, and increasingly, government debt. What was once quite radical is, in certain areas at least, now almost mainstream. This transition from obscurity to prominence within the credit industry is evidenced by the presence of a number of household names on the DBSG membership list, including high street banks and utilities companies. The group was established in 2004 through the CSA to represent the needs of the industry and underpin its growth.
In just four years, the DBSG has rapidly expanded, in line with the exponential growth of the industry itself. Membership to the group has continued to rise, to include all of the major buyers, and most of the big names in the debt sale arena.
The DBSG works for the benefit of those involved in buying or selling debts (or intermediaries in the sale process), offering expertise and guidance, facilitating meetings and exchange of ideas, and ensuring best practice. It also acts on behalf of members at representative consultations with industry regulators or quasi-regulators, steering the course of the sector. Though membership is not compulsory, most reputable players are actively involved in the group, which self regulates through a strict Code of Conduct in terms of debt collection ethics and debt sale and purchase transactions.
There are now closer links to relevant government departments and regulators through regular involvement with consultations and regular meetings with those departments that have an impact on the industry.
Challenging Times
Despite the growth and success of the sector to date, the current economic climate will be crunch time for many debt sellers and purchasers. Perhaps the biggest challenge, with the ongoing credit crunch, is a likely constriction in funding capital for buyers and its impact on the industry, particularly in terms of pricing and in volume of sales.
Contrary to popular belief, the credit crunch is not, as might be expected, 'bonanza time' for the collections industry. "Debt purchasers like most other businesses, are not immune from the economic downturn," says Ken Maynard, Group Chief Executive of Cabot Financial Group. "Dented consumer confidence and a lack of refinancing options available have had a huge impact on the collections environment.
"It's not just consumers who are finding new lines of credit hard to come by," he continues. "Purchasers too are finding it tough to fund the acquisitions of portfolios as banks' lending has become more expensive and criteria more stringent. The huge expansion in the debt purchasing marker over the last five years means many companies are sill in their infancy and banks are looking more closely at companies' track records as a determining factor in deciding whether to renew credit and on what terms."
Dave Berry, Managing Director of the Lewis Group, agrees: "To date the volume of debts being traded has continued to rise year-on-year, fuelled by the liquidity of finance previously available on debt purchase. As buyers are inevitably afforded less credit, this growth may plateau, with a decrease in volume of debt sold and, with less demand, an inevitable fall in prices.
"Reduced availability of credit to individuals is also impacting the sector," he adds, "Whereas previously consumers with poor credit records might have been granted some credit, bank policy now is to increase the quality of the loans and decrease exposure to individuals with a poor credit rating. Equally, many consumers are reining back their exposure to debt, which could also result in lower volumes of debt for sale going forward as fewer loans are agreed."
And, if fewer debts are sold, will this impact the nature of the debts on the market? "Absolutely," continues Berry, "We are already noticing a shift in the market towards fresher, higher quality debt, rather than older debt which has been languishing for longer, thus making it harder to collect. This trend will continue as buyers seek to purchase debts that more predictable and reliable, offering more certainty in uncertain times."
Changing volumes and characters of debt will inevitably shape the profile of the players in the market, argues Maynard: "We might also expect the rate of new entrants in the market to slow down, with the number of buyers potentially falling. The inability of some purchasers to compete as effectively as before is certainly likely to create opportunities for those companies that are well funded and will hopefully drive down prices - although we have not yet seen a wholesale move to softer prices."
James Cornell, Chief Executive Officer of Lowell Group, suspects that prices will continue to decrease as economic conditions worsen and liquidation levels drop.
"On one side of the equation, purchasers are going to find it much more difficult to raise money for the acquisition of new debt portfolios. On the other side, recovery rates on existing portfolios are going to suffer as the credit crunch and rising unemployment take their toll.
"There will be a greater need for more intelligent prospecting of the 'can pays' versus the 'can't pays'. Also debt purchasers will need to be more transparent with customers, providing them with more proof and a better understanding of the breakdown of their debts."
Going Forward
Alongside the economic challenges, new regulations are also set to shape the path of the sector going forward. With the Consumer Credit Act 2006 and other recent guidance coming into practice, the DBSG has been working with both buyers and sellers to implement regulations properly, including the creation of a new DBSG Compliance working group.
"The regulatory environment and the provisions of the CCA06 that came into force in October are having an impact," says Maynard, "The responsibility of lenders to provide more information to debtors about their accounts is being passed on to purchasers when portfolios are acquired increasing costs incurred when managing debt portfolios."
Challenging times ahead then, but given the extent to which the sector has already grown and shaped itself in such a short space of time, change is a familiar theme to the sector.
By Leigh Berkley, CEO of Tessera Group PLC and Chair of the DBSG
(Article previously appeared in Raconteur)
