Editor’s Note: Today, we are featuring a guest blog from ARM industry leader, Scott Barton:
Many issuers of private student loans, including their collections managers, are asleep at the switch. They dozed off a few years ago when losses were low due to strict credit underwriting, benign credit conditions, and the existence of guarantees for some loans.
Back then, traditional student loan collection practices — copied and pasted from check-the-box federal standards for collections practices — were a ticking time bomb, albeit with a very slow fuse. Deferments and forbearances could delay a loan from requiring a first payment for five years, and even longer in some cases. This meant the collection manager did not see the impending explosion of losses for some time.
And many sat back, content with their laissez-faire approach to collections. With annualized credit losses at less than 1%, no one from corporate was questioning them and they generally were accountable to keep costs down. One could understand why investing in state-of-the-market Collections practices would have low returns if 120 DQ’s were going to stay in the 50bp range forever. But they weren’t — the bomb started going off in early 2007:
Between the beginning of 2007 and the middle of 2009, industry 120 day delinquency rates went up by a factor of 7 times! Not surprisingly, some collections managers were jolted from their slumber and started importing more sophisticated collection practices like higher intensity calling, account segmentation, and multi-channel contact tools and strategies.
But old habits die hard and many firms are still way behind, using anachronistic collections practices based on the federal check-the-box standards. This means as few as four attempts per month at borrower contact in Buckets 2 and beyond. Credit card portfolios with similar loss expectations of 3-5% annually are making more attempts than that per day! Many also still use ineffective letters, don’t measure the effectiveness of segmented strategies (or try new ones), and don’t monitor their agencies for performance. One issuer was surprised to find that their agency, which was paid by the hour with no incentive for cures, had set up a dialing strategy to minimize the likelihood of making contact in order to reduce their own expenses. They did this by setting the dialer to redial an account right after it received a no-answer.
So who can capitalize on this inefficiency to make money? First, the obvious answer is owners of student loan assets who are not using state-of-the art collection practices. Many of these assets sit in securitization trusts or represent a small amount of the assets in a particular bank so are easily neglected. We have seen default rates cut almost in half within 6 months by a firm switching to a more aggressive program with effective agencies and agency management.
Another group that can profit is debt buyers. With many of these assets stranded and defaulting every month, there is low hanging fruit if those loans have not been collected on effectively. The majority of the neglected assets pre-default are also neglected post-default so cash is sitting there to be scooped up. By finding the student loan pools where collections activity is scant, a savvy debt buyer could find gold where competition has not eroded margins.
While sales of defaulted student loan portfolios have been rare, they are growing rapidly and competition for purchasing them is almost non-existent. Finding the pools is not easy but where else is there the possibility to buy defaulted assets where you can recoup the investment in under a year.
The ARM industry is highly competitive but a short detour away into the student loan sector has some virgin territory not yet staked out.
Scott Barton has been CEO of 2nd Order Solutions, a Collections and Recovery advisory firm, for over two years. As head of 2OS, he has created game changing Collections and Recovery improvements for clients across asset classes, in both the US and the UK. He has led numerous best practice assessments of Collection practices. Prior to founding 2OS, he was CEO of Axiant, a US based Collections and Recovery firm. Prior to that, Mr. Barton ran Risk Operations for Capital One, where he was responsible for all aspects of Collections and Recoveries performance, including strategy, analytics, Operations management, systems, data infrastructure, debt sales, management of over 1,000 internal associates, all vendor management (4,500 agents), as well as all offshore management. Mr. Barton is a renowned expert on Collections and Recoveries and was a featured speaker on Collections best practices at the annual Consumer Banker’s Association meeting in June, 2010. He has a BA in Mathematics from Duke University and an MBA from Dartmouth College.