Expert Roundtable: Debt Purchasing for Collection Agencies

With debt purchasing getting a lot of talk everywhere (this site included), a lot of collection agency owners and managers asked us for information on how to get started in the world of debt buying. To that end, we assembled a panel of debt purchasers that have a connection to transitioning from a contingency-only shop to one with full debt purchasing capabilities.

Moderating the discussion was Patrick Lunsford, Editor of CollectionIndustry.com

The panel discussion is also available for download in PDF format. Download PDF (16 pages, 83kb)

Patrick Lunsford: We are fortunate to have assembled a panel of experts today on the topic of debt purchasing; and not just debt purchasing in general, but debt purchasing as it relates to collection agencies. The group we have here has experience, whether it is firsthand or in a consulting role, in the transition from a contingency collection operation to one with full debt buying capabilities.

We’ll start off by having everyone introduce themselves and give us some background on their experience in the debt purchasing sector.

Rick Corica: I’m the Executive Vice President and Chief Operating Officer with Elite Recovery Services. We are a debt buying/collection agency in Buffalo, New York. We’re just a little over three years of age as a company and have been buying debt for nearly three years.

Personally, I’ve been in the business nearly 20 years mostly on the contingency side of the business. When my partner Paul Niedzialowski and I started our company we were very intrigued by the debt buying side. We’ve been very fortunate over the past three years; the investment of dollars into this has grown ten-fold since we started. We had an initial credit line and we’ve expanded it by 10 times for this year. We are excited about the future in being an active player in the debt purchasing market. Obviously everybody’s concerned with pricing, and I know there are questions later in this discussion. We’ve have had successful growth as we’re about 100 strong right now, and look forward to the other dialog from everybody else on this panel.

Jim Curry: I’m Jim Curry with Capital Financial Group. We handle various acquisitions. We have consulting relationships by setting up legal networks, as well as doing sales for various companies and issuers. I’ve made 250+ acquisitions for a total of $6 billion, and handled sales in excess of $4 billion for various companies. We handle setting up evaluations on portfolios as well as setting up legal networks.

Lou DiPalma: Lou DiPalma, Garnet Capital. I have been in an intermediary position since about 1987 in the capital markets arena. My two partners and I have Wall Street backgrounds, and we’ve been brokers of charge-offs for issuers and also for debt buyers, bringing an analytical approach to the debt sales market. We have collectively sold over $30 billion of loans.

John O’Donnell: John O’Donnell from Afni, Inc. With over 4,000 employees, Afni provides business process outsourcing services focusing on customer care, technical support and accounts receivable management for a variety of industries including Communication and Insurance. For the sake of today’s conversation, I will focus on our Accounts Receivable division and specifically our debt purchase operation.

We first started buying portfolios in 1997. Since that time we’ve purchased dozens of portfolios primarily within the communications industry. That’s the sector that we serve and that’s, for the most part, where we have stayed in our purchasing habits.

Patrick Lunsford: What advice would you give to collection agencies seeking to purchase debt for the first time?

Jim Curry: Well, "buy what you know" is pretty much one of the key things. Obviously, most collection agencies have certain focuses; whether it’s first party or third party or in stat or out of stat accounts. I think a direct focus on whether it’s credit card, auto, utilities, small balance, direct marketing, et cetera, would be one of the main things that I would focus on right off the bat if I was getting into it.

John O’Donnell: I would echo those comments. Sticking with what you know is probably the best advice I can provide. When you look to purchase a portfolio, you first need to be able determine what you are willing to pay. If you don’t have history with the seller or with similar portfolios determining the ultimate liquidation of the portfolio and setting a purchase price can be a very difficult task. One thing for sure is that if you miss on the purchase price and pay too much you can get hurt pretty badly.

Lou DiPalma: Debt Purchasing Rule 1A — and I agree with both those gentlemen — is to buy the type of account that you are most familiar with. Rule 1B is: know your counterparty. Know who you’re buying from and that what you’re buying is what’s described.

John O’Donnell: Good point.

Rick Corica: I agree with all these gentlemen. We’re the new kid on the block with this group, which is three years, but we did a lot of planning and educating of ourselves in the due diligence process prior to our first buy. And we think that’s what you need to do instead of getting wrapped up in the excitement of owning a new asset. I think some sound advice was given by Jim in regards to knowing what you’re good at, what product, balance etc.

John O’Donnell: One other thing: start small. This can be a capital intensive game that requires up front cash as well as up front treatment costs. There’s a cash flow component to it, however if you get into your first opportunity and you buy right, it will soon begin cash flowing and could help you generate and roll into your second portfolio.

Patrick Lunsford: What are some of the issues that first-time debt buyers or collection agencies should be aware of — the common issues that come up all the time?

John O’Donnell: There are probably several from a contractual standpoint. You need to be cognizant of whether you have the ability to resell the file, whether you have the ability for put-backs and things of that nature. There’s a whole slough of things and I won’t delve too deep into contractual issues, other than to say be aware of what they are and what impact that may have on the portfolio.

Jim Curry: Also check on the contracts. I think one of the big things that we see are people who come to us and ask us to resell what they have bought, especially for the first time, and they don’t have the proper chain of title. If you don’t have the proper chain of title, you really can’t sell the portfolio in a legitimate way, and that’s something that a lot of new debt buyers don’t understand.

Rick Corica: I would say that the first thing is "buyer beware" because of the issues of fraud. I think that organizations like the Asset Buyers Division of the ACA and the DBA would certainly help first-time buyers.

Jim Curry: There’s also a program out there called E-Strat from Pimsware that will strat the portfolio and let you know what’s in stat and out of stat. It’ll also let you know what state the debtor’s in and the different information that the first-time buyers should really be looking at to understand the portfolio.

Someone can tell you that it’s an in stat portfolio, but understanding that credit card is open and consumer loans are written — knowing the differences in those is really important.

John O’Donnell: Beyond that, once you have obtained the portfolio and you start working at it operationally, there are obviously a lot of similarities between working contingency business. But there are some differences. We like to look at these portfolios and actively treat them over a longer horizon.. In most cases you can treat the portfolio for years instead of months. So at times, you’re looking at what’s best for the long-term interest at an account level. Is it better to take a longer-term payment arrangement than settling today for the entire portfolio?

So I think operationally you need to really look at it in a different light than what you do in a traditional agency scenario. And you do have the ability to invest, once you’ve purchased that portfolio. We’ve shown that we had the ability to invest a little bit more in working different options and different strategies than we do in our traditional agency side of the house.

Rick Corica: I would like to add some additional differences between purchase and contingency. A big adjustment for contingency agencies in becoming debt buyers is that they need to have a comprehensive plan, a cradle to grave process that includes legal, arbitration, outsourcing and re-selling.

Jim Curry: You can also look at the difference in using tools such as scoring as well as skip tracing. With a contingency client the cost of doing intense skip tracing can be a little bit overwhelming because you don’t reap the benefit of it; you’re on a fee basis. As a debt buyer you can really see the difference in liquidation that it brings because you actually own a portfolio and you get to recoup that money back as a whole.

Patrick Lunsford: Someone mentioned something about investment length. Does that factor into the age of debt? Meaning, if you’re going into it with a long view, would first-time buyers be more likely to go towards fresher paper so that there’s a longer period of time to collect on it?

Jim Curry: I think that goes back to your strengths. I think you have to look at what you do best, and also use your fellow agencies, if you’re competitive with them, to your advantage.

If there are two or three agencies that are, say, in the second or third market with you, and you’ve gone through your cycle internally for a certain period of time — six months, 12 months, whatever that is — you can still outsource your accounts to one of your fellow competitors to gain liquidation as a different approach towards the collection of that portfolio.

John O’Donnell: Yes, I would agree with that. The time notion is really a relative factor in the entire equation. If you’re purchasing a book of bank card business that is multi-aged and the average account is three, four years old, you have a fairly tight window to go after those accounts. At the same time however you should be taking that fact into purchase price and should apply a discount accordingly. If you are looking at a fresher file that’s only six months old, you’ve got a much longer window and you’re obviously going to reap greater liquidation and the price will be higher. So it’s one of the due diligence factors that play into the overall equation.

Jim Curry: But I think one of the things that most debt buyers don’t understand, especially when they’re new to it, is that there’s always a certain percentage of each portfolio that gets "back on its feet" again. So, putting it into different cycles and keeping it over a longer period of time, you’re constantly going to get some of it. Obviously, your greater lift is at the beginning.

Rick Corica: The segmenting of the inventory as you go out over that period of time is critical: having your own internal collection models will help on your long term strategies.

John O’Donnell: We typically buy in the communication space. Our average balance is $400-$500. So, definitely, it keeps the number of strategies that we can employ down to a few; we can’t use the same strategies you might use on $4,000-$5,000 balance paper. The scoring in our world is pivotal, and it’s not uncommon for us to purchase 2-3 million accounts in a portfolio. You can’t put the same level of effort at all into the bulk of those accounts. Applying the right technique and the right strategy to the right account at the right time is what drives some of our value proposition.

Patrick Lunsford: Should collection agencies approach their current clients for debt purchasing opportunities? And if so, what’s the best way to do that?

Rick Corica: Well, certainly, you’re one away if you’re dealing with a bank client. The important thing, I think, is to realize that when you get on the list, you have to be active on that list. So I think it’s important to understand that if you are planning to buy debt with a direct issuer, you are going to have to be active in bidding.

Jim Curry: You also have to look at it from another angle. If you’re not one of their top agencies constantly on a month-to-month basis, you’d look pretty silly going to them and saying, "Hey, I’d like to buy your debt because I think there’s a lot more meat on the bone." I really don’t think that it would be wise to point out that you still think there’s a lot of value on the accounts, yet you can’t seem to perform as well as the other agency.

Lou DiPalma: It’s a double edged sword; buying and contingency collections are not an alignment of interests for the seller. You have to be careful where you tread there.

Jim Curry: Very careful. I agree with that.

John O’Donnell: I do think that, if you are brand new to the game — and depending upon what your client base looks like, and how readily that market space sells — to me current clients are one of the easier ways to get into the market. If you have a client, you have a collection history and that’s one of the biggest items in your back pocket. You’d at least understand what the liquidation is and you can value that portfolio better than if you jumped out and started looking at – even in the same sector — another client that you do not currently do business with. So, it may be a double edged sword, but I do think if you’re brand new to the marketplace, it’s your easiest entry point.

Lou DiPalma: And I think that tactic works best with local credit issuers and lenders, or contacts, and not as well with national issuers who look to package their debt into huge blocks. Your local issuers will have smaller pools for you to buy and therefore the entry fee or the purchase price is probably less; and there will be less competition for their paper.

John O’Donnell: There are still some markets there just are not tapped. People are not selling regularly, so there is an education factor that goes into play; you have to make the issuer understand what the value of selling is over their current process. We’ve spent a lot of time — not so much in the last couple of years, but five, six, seven years ago — really educating the sellers, the issuers, as to why it’s in their best interest to sell.

Patrick Lunsford: What financing options exist for collection agencies that are interested in purchasing debt?

Lou DiPalma: It’s a spectrum of financing, and the industry as a whole is following each individual buyer’s experience. But generally speaking, when you’re small and you don’t have a big balance sheet, it’s equity financing, which means either your money, your friends’ money, your families’ money or, you know, groups of lawyers, doctors or other professionals in town that you raise money from. So that’s equity money where they’ll own 100 percent of the portfolio.

Following that, after you have some purchased portfolio liquidation history and experience you would move to what we call "participation lenders". Participation lenders will put up anywhere from 80 to 95 to, more recently, 100 percent of the purchase price, and that begins to look like a contingency relationship. They will take a preferred rate of return, which is relatively high. Call it high single digits, low double digits, plus a skim of the backend profits. And if they’re putting up most of the money, they will take most of the backend profits.

As you reach certain rates of return, if they’re putting up 90 to 95 percent of the dollars, they will get 80 percent of the backend profits after a servicing fee, and then that might ratchet down to 60, 40, 20 after they’ve received certain hurdle rates.

The next stop on the financing train would be hedge funds, and I think anybody who has been to conferences has seen that there are a lot of hedge funds that are looking to put capital to work. The purchasing of distressed debt is an alternative class that’s attractive to them, so they would be priced somewhat inside the participating lenders.

The debt rate, call it a high single digit. The funds are looking for a more established collector or partner, so they would put up, 70 to 85 percent of the purchase price and be looking for a smaller backend participation profit.

The next step as a buyer becomes more established would be bank financing, and that could either be a local bank that you have your corporate banking relationship with, or there are national banks that lend to this sector.

And finally, the largest players can do securitizations, where they essentially establish low rate, fixed term financing for a specific pool of assets. That’s sort of the spectrum as we see it.

Jim Curry: That’s a very good and detailed answer on everything. I agree with that completely. And I think the track record kind of sends you farther and farther down that road as far as getting better and better financing. And you’re typically looking at a track record of three years, kind of in the middle of all those comments Lou just made, and then looking at more of a five to six-year track record to get more of the traditional bank financing with a substantial loan amount. Obviously, you can always get your smaller lines of credit with any bank regardless of whether or not you have a debt buying track record. You may just do it against your company revenue. But to get a significant size loan, you’re looking at about a five to six-year track record from the bank.

Patrick Lunsford: So it sounds like someone that’s initially starting out is going to be looking at equity financing; their own money or money from personal contacts.

Jim Curry: Right, or a home equity line of credit. The leverage you get for dollars in this business is pennies on the dollar. I would say that the two pieces of advice I would give to new buyers on every portfolio: track how you got to your purchase price, what you expected your liquidations to be before you purchase the portfolio, and then track liquidations after the purchase. The cleaner that information is, the more able you are going to be to tap the capital markets.

Rick Corica: We’re very pleased with the relationship that we have because of our partner’s knowledge of the industry. And it makes it a much easier road when you’re dealing with somebody who understands, as I believe Lou was just saying, on what does liquidation mean and what are the expectations. If a source has a history, and that option is out there for somebody who is new, then it’s certainly something they should look into.

Lou DiPalma: And I would call that specifically participation lenders. They can also be sources of product that help you to evaluate portfolios coming in. They take a pretty hefty return, but they provide a lot of value.

John O’Donnell: Because of the history we’ve had, we’ve been fairly fortunate that we’ve been able to stay at the bank level, but there are not too many banks that are very comfortable lending towards this asset class. And they certainly are not comfortable lending up to that 70-80 percent range. The old saying, "He who has cash is king," is certainly true in this area.

Jim Curry: And you have to look at it from the banks’ perspective. Even the ones that have loaned in the past have traditionally looked to get their full investment back in 12 months. And as a new debt buyer, and where the pricing level of most of the different asset classes are at, that’s not going to happen typically in this industry anymore. So look at what you’re signing, as far as your loan docs, because you may not be able to hit those targets.

Patrick Lunsford: Speaking of targets and returns, what kind of returns can reasonably be expected by a collection agency just starting off purchasing debt portfolios?

Jim Curry: It’s all across the board based on the different product types. I mean, that’s tough to answer based on performance. If you’re buying a product that you’re familiar with and you know how it’s going to liquidate over the life of the deal, you can come up with a type of return that your investors are looking for. If not, you can pass on that particular deal and move on to another one that makes sense for whatever type of investment group you have.

Rick Corica: What we’ve heard recently at the ACA, Asset Buyers Division Conference in Chicago, was the talk of numbers like 2.2x over five years. And as we all know, it was much better even when we started three years ago. The internal modeling that you have will set the course for your expectations.

Lou DiPalma: The old rule of thumb was pretty loose: with collections to purchase price being about a three to one ratio; and this rule was in effect as recently as three years ago. Breaking down the "three times purchase price": one time was the price itself, the second one was the cost to collect, and the third was profit. Now, that’s a rule of thumb and there were other portfolios that were probably north of those metrics and there were several that never even made it into profitability at all. But in the aggregate; I would say that rule was fairly accurate for an extended period of time.

Three to five years ago, those metrics — the three times over three years — were true and that would get you a low-30′s IRR. Since then, though, there’ve been some efficiencies that have come into the market with the large buyers. First, there’s technology. Also, the cost of financing these portfolios has come down dramatically, and finally, buyers are accepting lower rates of return in exchange for the certainty of returns on debt with which they are very familiar. This is also why people are still able to get fairly good rates of return.

Five years ago, 10 years ago, 15 years ago you were putting up 50 percent or more, most times 100 percent of the purchase price. Now you’re putting up five, 10, 15 percent equity, that’s how they’re keeping their IRRs. Not in the 30s, but high teens to mid-20s.

Patrick Lunsford: Due to some of the high prices right now and the stiff competition in bank card/credit card market, should first time debt buyers focus their time and resources on trying to acquire these types of portfolios? And what other market segments are out there besides the credit cards for a collection agency or a first time buyer?

John O’Donnell: We have not bought any bank card or credit card portfolios. I would start off just staying true to what you know. If your agency is built and that is what you do and you have a preponderance of bank cards and you’ve got a preponderance of those clients and you know the segment well, I would say stay true to that, especially if you’re a first-time buyer.

Looking at different segments, medical is a new growing market. I know it’s fairly controversial, but we are beginning to see some sales in medical debt. We’re not in that market, but we’re certainly staying close to it. But if that is what your agency is built on and what you know and you have those client contacts, then to me, that would be the easiest point to jump off and look at. There have been some pretty big flashes in the news of agencies that have jumped out of their comfort zone and bought different asset classes, and things haven’t gone as well as what they might have expect. And these are very experienced big debt buyers. You know, if it can happen to them, it’s probably more likely to be a negative to a smaller agency getting into something for the first time.

Rick Corica: There are opportunities out there, but then again, we focus very much on what we do best. The talk is out there now is regarding medical debt and it’s something that we are educating ourselves on, but we haven’t dabbled in it yet. At the end of the day it gets back to what John was saying do what you do best.

Patrick Lunsford: Is it possible in the current pricing environment for a first-time collection agency/debt buyer to be successful going in and buying a fairly high priced credit card portfolio?

Jim Curry: I still think that there is value to the credit card industry. It may be more in a state-specific level for a first-time buyer. If they’re in a certain state, obviously, most of the time is spent going in and doing due diligence and consulting work for collection agencies. I’ve seen that the majority of them always perform better in the state they are in than in other states. I have a lot of historical data based on the liquidation rates on various states, and that could make the difference in being a little bit more successful or giving them a little bit of a better edge, being more state specific.

Lou DiPalma: It is still the biggest market out there, and that’s where the product is. It is where there’s the most information and liquidation history. The originators of that product are very good about putting out very accurate electronic information, so the data is cleaner than some of the other types of portfolios. So, you can’t ignore it; it’s a $1.5 trillion market.

John O’Donnell: If you’re a relatively small agency, you’re not going to be able to go out and really realistically play with the big banks. But there are several small regional or local banks that have paper; they have loans that aren’t successful — whether it’s credit card or traditional loans — that you may be able to go out and do very well on.

Lou DiPalma: And to your point, the small mom-and-pops are successfully buying from some of the primary buyers that then will resell the accounts to the secondary markets, or the resellers who will buy accounts and repackage them to local buyers.

Rick Corica: Having your expectation set by your model at the time of purchase will validate your investment into a product. One of the expectations I mentioned at the ACA conference, and most of the models that we have now for our purchases, has been around that range of 2.2 to 2.5. And this is mostly credit card paper, and we’ve been exceeding that. You just don’t want, especially with investors, to be buying to high because you can lose them that way.

Patrick Lunsford: If you’re looking to acquire a portfolio for the first time, what do you think is the best route to take: broker, reseller, or direct?

Lou DiPalma: I think the returns we have been discussing are very reasonable, but if you’re looking to enter into the business, you won’t be able to participate in the primary markets. The purchase prices are just too big. The secondary market is product that comes either from primary purchasers of product or aggregators who resell. And I think that there are a lot of people purchasing in the secondary market on a small basis very successfully. I will also go back to what I said when we started this: know your counterparty, don’t rely on verbal representations, do your own electronic due diligence and make sure you read the contract very carefully and know what representation the seller’s making and what your put-back rights are or what your recourse is in the document.

Patrick Lunsford: Besides financial resources, what do collection agencies need to be successful debt buyers? This is also taking into account that they want to continue to do contingency work as well.

Lou DiPalma: It’s financial controls, it’s having a view as to what your purchase price is, and projecting liquidations, which gets you to an internal rate-of-return on that purchase price, and then very carefully tracking the performance of each and every purchase. And also, I think, as Jim mentioned earlier: chain of title. Make sure you keep chain of title records because your ultimate exit strategy is to resell those accounts, generally speaking, and if you don’t have clean chain of title, you’re not going to have that opportunity, and then you have a wasted asset.

Jim Curry: Tools are important, too. You need to be able to strat a portfolio. You need to be able to understand that you can invest money in the skip tracing process and that it is a little bit different operation from contingency skipping. You have to have certain procedures in place for put backs and media requests, understanding that your put-backs are generally your bankruptcies, your deceased, your fraud, etc. So you need to be able to put those back. Typically you’re looking at a schedule from three to five percent of a portfolio that you’ll want to put back, and that could be meaningful dollars.

Lou DiPalma: And if you missed whatever window you had for that or if you missed getting that in your purchase and sale agreement, you’re starting at a disadvantage.

Rick Corica: I think on the agency side, the operation side of it, what has been working well for us is that you really need to segment your agencies so that you limit your cross collecting. You need to make sure that if your collectors are working for a contingency client, then they’re really only working for them. If they’re working your purchases, they have to be working only that. What we have found is that you really have a system that creates the separation because a collector will always be gravitating to what they think is better paper or where they think they’re going to make more money. So we have found that we’ve really had to separate the business.

John O’Donnell: We’ve likewise gone down that path of separating the agency work from the purchase work. I think there are two sides of the whole debt buying equation. The first half is progressing through your due diligence process and appropriately pricing the portfolio. And the second piece is operationally fulfilling the treatment strategies and collecting the money.

In the course of the last couple of years, we anticipated pricing going up and we thought that the best way of combating that and still being able to play in the market is to collect more. So we’ve been in a collect more/collect faster/reduce the cost of collection model for the last couple of years and trying to align everything we do along one of those three items.

Operationally, at the end of the day, it comes down to this: are you able to this: are you able to collect and are you able to perform? Everyone is familiar with this on the agency side; you’re just competing in a different fashion on the purchase side. Here you’re competing by putting your cash up front and trying to get it back.

Rick Corica: I agree, because on the contingency side, you’ll be competing against other agencies and really on the purchase side, you’re working against a profit model.

Edited by: Patrick Lunsford and Mike Bevel