So, Where’s the New Money?
Economists agree that the worst of this recession is finally behind us.
So, where’s the new money?
Looking back over the history of the accounts receivable management industry, we see cycles at play. “Buy low, sell high” applies to this industry, as it does to others. New money put to work at the end of a recession has the best chance of creating the best returns.
So, where’s the new money?
At one point or another, it will come in a variety of forms:
From private equity firms looking to put capital to work – Private equity firms in the U.S. are sitting on $400 billion of capital, cash that has been raised from investors but has not yet been put to work. As the economy continues to improve, the profitability of collection agencies will improve as well, increasing their attractiveness to private equity.
From specialized sources of portfolio funding – specialized providers of debt funding for portfolio purchases have gotten burned in recent years, having funded the acquisition of debt portfolios at the top of the market. Some have exited the industry, and others have been sitting on the sidelines. As the economy continues to improve, debt funding for portfolio purchases will be increasingly profitable.
From business owners – owners of successful ARM companies had the luxury during boom years to take money off their balance sheets in the form of shareholder distributions, or in the form of high salaries. Weak balance sheets have resulted from this practice and put some companies at risk. As the economy continues to improve, owners will be investing back into their businesses.
Perhaps most importantly...
From consumers – at some point in the not too distant future, mortgage refinancings will reappear as a viable method of collection. Judgments will kick in. ARM companies that learned how to operate in leaner times will bring those efficiencies to a period of better collectability. As the economy continues to improve, liquidation rates will certainly improve as well.
Exceptional long-term returns are available today in the ARM industry for investors and business owners who have the stomach for short-term risk.
Where’s the Outrage?
Responses to NBC Dateline’s recent appraisal of the collection industry have, in my opinion, been way off base. Those of you who were sleeping around 10:45 on Friday night missed some deeply disturbing coverage.
NBC interviewed a woman who played a message on her answering machine that was left by a collector working for the Philadelphia-area Academy Collection Service:
“The message said, ‘Have you ever been raped?’ And then the guy laughed. My first reaction when I heard it was, ‘I can't be hearing this.’ So I replayed it. As a woman, that's gotta be one of the most terrorizing things you could ever hear… Should I grab the kids and go to my parents? Should I grab the kids and just get away? I don’t understand why people could do this to me, or to anybody. This is not a good thing. You can't, you cannot do this to people.”
Later in the program, NBC played recordings of collection calls by Final Claims Asset Locators, a collection agency in Buffalo, whose collectors pretended to be Maryland police officers when making calls. As part of a collection call, they said,
“If you don't want to pay sir, that's fine. I'll just have to have you picked up. There is going to be a detainer, sir, where you'll be brought to Maryland to face charges here. So what we'll do is, we're going to have you picked up.”A reader on InsideARM responded by writing,
“So what's the big deal? The law gives debtors protection. It is not like they can break your leg or arm. The bill collectors are behind a phone possibly hundreds if not a thousand miles away… The rest is nonsense, they got to collect somehow.”The rest is NOT nonsense. It is true that the media’s descriptions of rogue collectors and rogue agencies give an incomplete picture of this industry. It is also true that if we as an industry do not regulate ourselves, then we should fully expect more regulation as Congress revises the FDCPA.
Rozanne Andersen of ACA International said it best at the conclusion of the show. When asked, “Is there a gap in regulation? Is enough being done?” she responded,
“(From) what we’ve seen today, I think the answer is clear.”I agree with Rozanne. If we can’t regulate ourselves as an industry, we should expect to be further regulated. And, in my opinion, we should respond to facts like the ones described on Dateline NBC not only as incomplete reporting (which it obviously is), but also with outrage. These things do happen in our industry, and they are abhorrent.
Collections Approach in Need of a Significant Shift in Current Economy
The barrage of horrible macroeconomic news continues today as the Department of Labor reported that another 651,000 jobs had been lost in February, sending the unemployment rate to 8.1 percent. Measures are being considered that would allow judges to restructure underwater mortgages as part of bankruptcy proceedings. It goes without saying that nest eggs are being cracked or crushed with the recent performance of the markets.
How does this impact the collection industry, and what should its role be in the broader economy?
My first answer today is obvious, and widely discussed. My second answer today is more complicated, and more controversial. Please hear me out and let me know your thoughts below.
Answer #1 goes like this: Unemployment is the key barometer for collectability; fewer jobs mean less collectable paper and lower profit margins for both credit issuers and their service providers. Fewer refinancing events mean fewer pops as ARM companies have less access to this collection method. Falling net wealth around the country makes people less inclined to pay past debts. So, economic conditions are making collections and recoveries much harder, requiring companies in this industry to work smarter to maintain their margins.
This argument is straightforward and discussed regularly here on insideARM.
Answer #2 goes a little deeper. This recession will only correct itself based on improved consumer spending, and new spending by consumers is contradicted by many collection methods. Payments in full may legally satisfy a past due obligation on the part of a borrower, but it may not practically recognize her existing plight, or, more broadly, her role in an economic recovery.
A reader commented on an insideARM blog recently by saying, “debt is the responsibility of the individual. Hiding is not a consumer protection right.” In general, this is hard to argue with – a legal transaction has occurred when purchases are made on credit. The collection industry keeps this process efficient and allows the credit economy to function. But I don’t think this position confers an absolute right to collect all past due accounts on all terms, especially given our extremely challenging economic conditions.
In these challenging times, a more consultative collection approach is needed. As an industry, we should be reaching out to distressed consumers and structuring repayment schedules that recognize their plight and take their future prospects into account. We should not be wasting our time and money trying to collect from consumers who have the least likelihood to pay; in this recession, the costs of these efforts are almost sure to exceed the revenues that follow.
“Every dollar, plus interest, right now” may have been effective in 2006, but, I argue, it is not always effective in 2009 (or 2010 as the recession – depression? – continues). As an industry, let’s figure how to help the American consumer get back on her feet, and benefit more as the economy recovers.
Is Forecasting Dead?
The current economic upheaval is forcing many credit issuers and their service providers to scramble for better results. As financial performance wanes, long-term plans are giving way to short-term exigencies. If banks are to change hands, why worry about recovery performance in the future? Given their challenges today, why bother with strategic planning?
In collections and recoveries, a bird in hand is generally worth two in the bush. But is it worth three? Four?
The fundamentals of corporate finance continue to apply, even in these chaotic times. Given the time value of money, a dollar today is worth more than a dollar tomorrow. But even with a high degree of risk, two dollars next week are almost certainly worth more than a dollar today.
This framework has many applications in our world. Should an agency settle in full with a debtor today, or encourage a longer-term payment plan? Should a credit issuer sell debt today or take a more patient approach with contingency agencies? Should a law firm pay for a judgment today in hopes of receiving payments when the economy turns around? These questions should be answered based on thoughtful financial analysis, not based on the daily news.
In this time of sound and fury, let's not scramble around like chickens with our heads cut off. The future should still inform our decisions today. It may not be perfectly healthy, but forecasting in recoveries is not dead.
Accounts Receivable Management in 2009: Hitting the Wall
Last January, I made some predictions for post charge-off recoveries in 2008. These included “the economy will slip into recession by the second half of 2008” and “recoveries will be 5 to 10 percent more challenging in 2008 than in 2007.” “These forecasts as a whole,” I wrote,” are rather gloomy.” In retrospect, they were not gloomy enough. The government now says that the current recession began in the fourth quarter of 2007, around the time I made my forecasts. And I think it goes without saying that any credit issuer or accounts receivable management company would be delighted if 5 to 10 percent degradation in recoveries took place between 2007 and 2008. Now we see more “apples to apples” liquidation decreases of up to 30 percent year over year. If you think this figure is shocking, consider that the Dow Jones index of U.S. financial services companies fell 56 percent in 2008!
With all of this as background, here are my five predictions for accounts receivable management in 2009.
- The current recession will deepen more than many expect. President-Elect Obama’s transition team has forecasted unemployment of greater than 9 percent by the end of 2009. Some of the recovery executives we’ve spoken to are modeling unemployment even higher. Unemployment is the principal barometer of all collection activity, and as it spikes in the coming year, all of us in the field of post-chargeoff recoveries will be strained.
- Credit issuers will test the capacities of their specific service providers and their recovery networks as a whole. Chargeoffs will increase in rough proportion with increases in the unemployment rate. As economic conditions continue to turn, credit issuers will sell more and more paper to debt buyers, and place more and more accounts with collection agencies, continuing to flood the market with their paper. In turn, the operating capacities of specific service providers and the recovery networks of issuers as a whole will be put to the test in 2009.
- TARP and TALF will restructure many recovery efforts. Essentially all of the country’s largest banks and financial services companies have accepted bailout money under the Troubled Asset Relief Program. The Term Asset-Backed Securities Loan Facility (TALF) also makes federal funding available to student loan, auto, and small business lenders. As the government finances more private sector debt, executives within credit issuing companies will increase their expectations of recovery operations in light of closer government scrutiny. As this takes place, more and more ARM companies will seek to gain approval as government contractors.
- Revisions to the Fair Debt Collections Practices Act will make collections even harder. The Federal Trade Commission held hearings on revisions to the FDCPA in October 2007, and has since brought unprecedented enforcement actions against large ARM companies. The General Accounting Office is now assessing the ARM industry on the request of the Senate’s Government Oversight Committee. It is likely that President Obama and a Democratic Congress will make consumer-friendly revisions to the FDCPA and other collections laws in 2009.
- Success in collections will rely more and more on advanced technology solutions. It goes without saying that in a recession, placements increase as liquidations decrease. The most successful recoveries will be conducted by those who know how to segment, score, model, and reach the most likely payers. The days of “smiling and dialing” are done. If this has been true for some time, it is especially true in this recession.
All marathoners understand what it means to “hit the wall.” Around mile 20 of a 26.2 mile race, legs cramp, brains fog, spirits sag, and for many, the race ends. Runners who have trained properly, conserved energy, and maintained a consistent pace throughout the race cross the finish line -- sometimes in better shape than expected. So it will be with recoveries in 2009.
The Debt Sales Market is Turning Again
The balance of power in the debt sales market has unquestionably shifted in the current recession from sellers to buyers. This is widely discussed. In 2008, this market has experienced:
- Higher chargeoff rates for sellers
- Stressed capacities in the contingency networks of sellers
- Higher costs of capital for buyers
- Decisions on the part of buyers to sit out sales or exit the market entirely
Of course the debt buying market is cyclical, and based on several conversations with credit issuers, we see an end to the current cycle in sight, perhaps even closer than current economic conditions would suggest. The turn will be mainly caused by stricter underwriting standards on the part of credit issuing companies.
It is no surprise that through the second half of 2008, as the credit crunch has deepened, all issuers have made it more difficult for borrowers, especially those with lower credit ratings, to obtain credit.
Let’s walk this through the recovery cycle. Say stricter underwriting standards were instituted by credit issuers in the summer of 2008. Less consumer credit is extended through the fall of 2008. Some chargeoffs – importantly, fewer chargeoffs – take place 180 days later, say in the spring of 2009. Potentially, the U.S. economy resumes its growth towards the end of 2009 or early in 2010.
How does this affect our bullet points above?
- Lower chargeoff rates decrease the supply of debt portfolios made up of higher quality accounts
- Excess capacities of contingency networks decrease the supply of debt portfolios
- Lower costs of capital for portfolio purchases, based on more funding sources chasing better deals
- Decisions on the part of debt buyers to enter the market, chasing better deals with a line of sight to better liquidation rates
Supply decreases, demand increases, prices rise.
Stricter underwriting standards are already reshaping the debt sales market. All ofther things being equal, well-funded debt buyers should buy more now. All other things being equal, credit issuers should wait to sell more later.
As Director at Kaulkin Ginsberg, Paul provides management consulting services, helping clients improve accounts receivable management strategies and operations. Clients include lenders, A/R service providers, and industry investors. Contact Paul at 240-499-3818, or by email.
Recovery Operations to Diversify with Financial Services Industry
The executives who lead recovery operations at large financial services companies are far from immune from the upheaval that is engulfing the financial services industry. Simply put, diversification by financial service companies through acquisition will require more diversification on the part of the recovery operations within the resulting conglomerate corporations. Executives who lead these efforts will not only see more demand for their services in the form of greater placements; they will be called on to diversify their own recovery operations, as parent corporations extend more products and services to their customers.
At the root of these challenges is a reality that has been overlooked by many recovery operations: the same borrower who takes out a mortgage takes out an unsecured personal loan, a credit card, a student loan, an auto loan, etc. Financial services companies that extend customer credit in a variety of forms must understand and react to a customer’s entire set of financial obligations, at least within that institution, as post-chargeoff recoveries take place.
As a result, it is increasingly unlikely that recovery operations within these companies will remain fragmented as financial services companies emerge from the current crisis. We have seen separate recovery operations within the same parent companies for different types of debt, and different sets of service providers utilized to recover those dollars – all from the same customer, in many cases, who can receive disassociated collection calls from the same ultimate parent company. At a time when credit issuers will be striving to retain all customers, these collection strategies are counterproductive.
It is tempting to argue that the wealth management functions of investment banks being absorbed into broader, consumer-focused depository financial institutions will be immune from these trends. Without sounding like a Cassandra I would argue that the market should continue to turn, that personal fortunes should continue to be lost, that personal bankruptcies should continue to rise, and that the customers of wealth management operations will increasingly find themselves in post-chargeoff collection pools – a staggering development, in my opinion, that matches the staggering changes being experienced by financial services companies in this current upheaval.
In a recession, recoveries should return to a holistic focus on the consumer -- along with the financial services products and services being offered to the same consumer.
