The State of the Industry: What is Next for ARM?

Bank mergers will continue
Early in 2007, we watched as Bank of America acquired LaSalle Bank for $21 billion, State Street Corporation acquired Investors Financial Services Corporation for $4.2 billion, and Bank of New York Company acquired Mellon Financial Corporation for $18.3 billion. Consolidation among larger banks translates to greater revenue concentration among the top-performing collection agencies and debt buyers that are focused in the financial sector.

On the international front, TD Bank Financial Group acquired Commerce Bank for $8.5 billion, Royal Bank of Canada acquired Alabama National Bancorp for $1.6 billion, and China Minsheng Banking Corp purchased a 9.9% stake in San Francisco-based UCBH, the first such deal by a Chinese bank. If a weak U.S. dollar persists through 2008, foreign banks may continue to acquire their way into the U.S. market. We believe that foreign banks seeking to employ best accounts receivable management practices may look to U.S. collection agencies to handle their own collection needs, creating a growth opportunity worth watching.

As the housing market and the economy continue to slow down, larger banks will continue to pull back from extending credit, thus opening up opportunities for local and regional banks to step in and fill the void created in the market. However, smaller banks are not immune to the economic conditions affecting larger players and some will be forced into mergers in order to cut costs and boost their branch networks. As the dust settles, we expect increased M&A activity among small to mid-sized regional banks in 2008 and beyond. This trend should be watched carefully by ARM service providers and debt buyers. Some collection agencies dependent upon bank clients may find themselves in an environment where they will need to consolidate in order to keep up, or risk losing these now larger clients to larger agencies that can offer a broader array of service offerings at lower fee rates. Debt buyers should see attractive buy opportunities as banks seek to clean up their balance sheets to position themselves as more attractive merger candidates.

Healthcare ARM firms continue to attract M&A interest
Regarding healthcare M&A, two trends are noteworthy as we look into 2008. On the offshore front, Firstsource Solution’s acquisition of MedAssist for $330 million marks the first time that an Indian BPO company acquired a healthcare collection and receivables management company. In the past, heathcare providers shied away from enabling their service providers to off-shore collection efforts. Is this changing? It is important to note that MedAssist was the largest company of its kind in the ARM industry and therefore, we are not likely to see other healthcare M&A transactions of this magnitude. But we will watch to see if smaller healthcare agencies become targets of offshore companies.

Also in 2007, at least six M&A transactions were completed involving small and mid-sized healthcare collection agencies selling to private equity-backed, healthcare-focused buyers. We are confident that M&A in general will continue to remain active within this market sector as the players try to reposition themselves as larger, multi-state participants in a market that historically has been reserved for local businesses.

Another catalyst for increased mergers and acquisitions among healthcare collection agencies could come from reform at the state level. Four states—Illinois, California, North Dakota, and Nevada — each passed healthcare collections reform legislation in 2007. These reforms could provide the tools for other states to regulate the way healthcare providers and their ARM services providers recover bad debt. If they do, this could impact collection strategy from state to state and may encourage some local agencies to merge or sell to larger regionally focused players.

Trends are shifting on the pricing of delinquent debt portfolios

In the debt purchasing marketplace, we began seeing the effects of declining prices within the secondary market during the second half of 2007, with prices dropping as much as 50% as compared to a year ago. This trend has also made its way up the chain to the issuers themselves but with less significant price decreases.

We expect that pricing on a national level will continue to wane in 2008, but pricing on a regional, state, and local level will not be as heavily impacted and may even improve, enticing sellers to segment their portfolios to maximize yield. Issuers will continue to feel the pressures from buyer demands around contract language, terms and provisions and will strive to be more creative with their offerings as it relates to vintage, portfolio make-up, documentation, and contract language to keep prices elevated.