Creditors Exercising Options for Receivables Management

Creditors typically place delinquent accounts with a contingency collection agency for the first time after an internal collection effort has proven unsuccessful, generally when these accounts are between 180 days and one year past due. However, many creditors now involve contingency agencies or first party collectors earlier in the receivable's life cycle to maximize their chances of collecting delinquent accounts.

The terms of the contracts vary, but discussions tend to focus on the commission rate and the length of time the collection agency has to collect on accounts. Creditors maintain leverage in these discussions by contracting with several agencies and creating a competitive environment for new business. Creditors can also terminate contingency contracts within 30 days after the contract is signed. Collection agencies improve their leverage in negotiations with creditors by demonstrating superior performance collecting on placed accounts. Collection agencies that can handle the greatest number of accounts tend to have more leverage with creditors and receive the most new business.

While commission rates vary with the age and sector of the debt being collected, fees for the youngest receivables are often less than 10% of the amount collected. Rates for older debt that has already been placed with other agencies may be as high as 50%. Overall commission rates generally range between 15 and 35%, depending on the age of the debt, its industry sector, the amount of information available about debtors and other factors.

Debt Buyers
Debt buying is one of the fastest growing and most dynamic parts of the ARM industry. For the provider of ARM services, purchasing and collecting distressed debt can be more complicated than collecting on a contingency or flat fee basis, but it can also be much more profitable. At the same time, creditors have recently been selling receivables in recent years at historically high prices. As a result, a number of creditors are considering or have made their first sales of debt portfolios in recent years, further increasing the size and visibility of the debt buying market.

This increase in interest in debt buying can be explained most directly by the benefits that creditors receive when selling portfolios rather than contracting collection to a third party. First, the sale of debt brings immediate cash to a creditor, which may choose the certainty of upfront revenues over the uncertainty and expense associated with a protracted collection effort. Second, the sale of a debt portfolio allows a creditor to avoid investments in personnel and infrastructure that would be required to collect the debt internally or to avoid the need to manage and share margins with a third party agency that has been contracted to collect debts. Finally, a creditor may decrease its legal liability and hedge its public relations risk when it transfers the ownership of receivables to a buyer.

These benefits have increased the types of debts being sold by creditors in recent years. The debt buying market has largely been focused on non-performing debt, but more and more debt purchases are taking place earlier in the receivable's life cycle. Some creditors are selling portfolios that have never been collected on a third party basis, as well as portfolios that have been worked a number of times by collection agencies.

Purchased debt is typically classified by age as fresh, prime, secondary or tertiary. Fresh debt is typically debt that is less than six months past due. Prime debt is six to twelve months past due. Secondary and tertiary debt is generally more than one year past due. These classifications are also based on the number of collection agencies that have worked the paper before it is sold.

Pricing varies widely with the receivable's age and industry sector. The older the debt, the lower the chances of successful collection and the lower its price upon resale. Fresh debt may cost as much as nine cents or more on the dollar, while tertiary debt may be bought for a couple of pennies on the dollar or less.