March/April 2009
Brave New World of Debt Buying
By Phil Britt
Sharply falling prices for credit card portfolios show no sign of rising anytime soon, but they may be getting close to bottoming out, according to collection industry experts.
"In the last six to eight months what we're getting is credit card accounts that are getting 6 to 6.5 cents on the dollar, compared to 14 cents on the dollar a year ago," says Sean McVity, managing partner for Garnet Capital Advisors, NY.
Another industry expert, who spoke on the condition of anonymity, said the slide in pricing accelerated throughout 2008, with the decline picking up steam as the economic picture continued to worsen. More credit card debt continues to hit the market, but pricing is keeping pace with the drop in liquidity, he says. So spreads in profitability are remaining relatively consistent. But a lot of the debt hitting the market remains unsold because of the imbalance between supply and demand.
Liquidity left the economy as housing prices and the availability of home equity dropped sharply. The unavailability of secured debt put more pressure on unsecured debt. Also pressuring the economy throughout 2008 were high gasoline and energy prices.
The gasoline and energy prices have come down from their previous highs, but not enough to make a difference in the overall economy, which is still showing weakness in retail sales, durable goods sales, jobs, consumer confidence and just about any other measure, so pricing will stay low until there is some sign the economy is starting to recover. McVity adds, "So there's no more appetite for credit card debt from potential purchases, keeping pricing low.
"There's a lot more supply than demand," McVity says. "A lot of the [potential] buyers are moving to the 'what-if' scenario — what if the economy continues to get worse. They're trying to address that through their pricing. Some at the beginning of the year had said they were starting to see things get better, but buyers are bidding on the scenario that the economy won't be picking up. At the same time, creditors are looking at the pricing drops and re-evaluating their sales."
Another important element keeping pricing low is the lack of credit, adds Alex Hesu, director of consumer credit for Purchasing Power, an Atlanta-based retail consumer finance firm and until recently chief credit officer of debt purchasing firm Credigy, Atlanta. "Even if a debt buyer is interested in a portfolio, finding the funding to buy it has become extremely difficult, with no easing expected anytime soon," he said.
Some economic forecasters, including Gary Stern, president of the Minneapolis Federal Reserve Bank, and Charles Plosser, president of the Philadelphia Fed, have started to predict a recovery in the second half of 2009; but McVity says, "There are no indicators to back up such a forecast." So he doesn't expect to see a recovery and a pickup in credit card portfolio pricing until 2010.
More Data, Better Decisioning
Despite the assurances from Stern and Plosser, there is plenty of available information for potential credit card debt buyers to determine the direction of the economy and the acceptable pricing level for a credit card issuer's portfolio, McVity says. "Compared to 10 years ago, buyers have millions of more data points to rely on to tell them that they will lose money [if they buy above current prices]. In the past, debt buyers have always thought they would make money on the collections. But now, an increased amount of available data and better discipline is putting a natural cap on a buyer's exuberance. It's a different market than it was five or 10 years ago."
"Those additional data points are not only helping buyers not overpay for portfolios, the information is also showing that the debt market and the economy as a whole are unlikely to bounce back for some time," according to McVity.
"Buyers [of credit card portfolios] are bidding on the scenario that things will not be getting better in the economy anytime soon," McVity explains. Each reported job loss, such as the 2,300 announced by Macy's in early February, Microsoft's 5,000 a couple of weeks earlier and tens of thousands of others earlier in the year leads to more fallout in the financial markets, according to McVity.
Paul Legrady, for Kaulkin Ginsberg, says that all pricing, sales and other trends in the credit card debt market focus around the jobs market. So any pick up in pricing will depend on the end of the sharp job losses. "The stimulus package, which was still being debated in Congress in early February, was unlikely to help until it led to new jobs," Legrady added. One of the reasons the debate in the Senate was expected to take longer than it did in the House was the concern by many critics and economists that the stimulus package would do little to stem rising unemployment in the near term and not enough in the long term to make a difference in the overall economy.
No Help From Stimulus Package
McVity concurs, pointing out that many of the items in the stimulus package were unlikely to generate jobs for at least six months — meaning it would be August before there would be any positive effects, and at least a couple of months after that before there was enough confidence to change any pricing of the credit card debt portfolios.
The jobs and other reports continue to come out with worse projections than forecasted, McVity adds. "We need to make a major break with the past. Pricing has to be in line with the recoveries."
The credit card sellers hate the low prices and would like to hold on to portfolios until pricing improves, a strategy they've used during past pricing softness, but in the current market, with survival more of [a] concern than better potential profitability down the line; the concern is more about staying in business, according to McVity.
"Underneath it all, what [the issuers] need most is the best recovery [amount]; they're putting up sandbags in an attempt to stem the tide (of rising chargeoffs). Right now, it's all about living to fight another day," McVity says. "Any sale is reported as earnings, which helps their financial performance. There are corporate pressures to improve the financial reports." Selling credit card receivables is a way of doing this.
Although some issuers are selling more receivables more quickly, they're also holding on or using contingent collection agencies for those they feel they can get the best return on, according to Legrady. He expects that trend to continue until the employment situation improves. "Unemployment is the key barometer for all things collections-related," Legrady says.
Credit card issuers could sell more portfolios if they would accept much lower prices, but for now at least the 6 to 6.5 cent level seems to be holding. "Trades continue to be done at that level," McVity says. "There's a growing acceptance that this is where the market is at right now."
McVity adds that issuers now are starting negotiations with sellers at the level where transactions used to close. But they're also being more careful about the portfolios they sell and the ones they retain.
Better Account Selection
Credit card issuers also use more data than ever before, so they're using various collection analytics to determine the best portfolios to sell and the best ones to keep, says Dana Wiklund, research director of the global risk management practice at Financial Insights. "They're better able to cherry pick different accounts and determine the ones they want to work internally depending on the propensity to pay. So they're carefully monitoring the behavior of the account over time, outstanding credit [in each account], all interactions with the consumer and other information. That way, once accounts go bad, [issuers] can rank them in the order of probability of collection, collection over a certain time period, [and] levels of payments. ... They're increasing the quality of their bad debt, if there is such a thing."
Purchasing Power's Hesu agrees, saying that issuers are trying to use better segmentation strategies and the best collection methods for the portfolios that the issuers retain. "The issuers are trying to ensure they maximize the value of the portfolio before they put it up for sale," says Hesu, adding that pricing for these portfolios has dropped steadily since 2005-2006, with nearly half of the devaluation coming in the past year. Hesu and Wiklund add that the debt purchasers recognize this effort as well, and will use their own scoring models to determine or confirm the value of the portfolio based on the expected recovery. "If I was starting a debt collection firm and was looking at buying a [credit card issuer's portfolio], the first thing that I would do is get scoring from [a credit bureau] on the accounts to ensure that I wasn't getting a portfolio of all adverse selection."
Wiklund adds that the credit card issuers are some 10 years ahead of their mortgage lending counterparts in the use of analytics. So although credit card delinquencies have been rising and are expected to continue increasing for the next several months, Wiklund doesn't expect the credit card issuers to suffer the insolvency issues that caused many of the mortgage lenders to fail or to be forced into accepting mergers.
"The credit card issuers were able to sit back and watch as the mortgage market crumbled," Wiklund says. As the economy continues to falter, credit card delinquencies will continue to climb, but they won't vault up the way the mortgage delinquencies did last year."
It's not just issuers of consumer credit cards that are seeing portfolio sales and collection issues. Although not having a specific breakout of business credit cards, distributors and other suppliers to small businesses have been trending away from open lines of credit (typically 30 days) and to requiring credit cards or cash payments from their customers, says Lyle Wallis, vice president of research for the Credit Research Foundation, Columbia, MD. "This removes the risk from the suppliers and puts it on the credit card issuers."
According to industry experts, the credit card issuers who will best handle the ongoing delinquencies for consumer and business cards will be those who have the best technology to analyze the portfolios.
Cost control is a huge issue for accounts that credit card issuers retain, so the value of using different collection tools needs to be weighed. For example, skip tracing will increase the level of recoveries, but doing this for every account in a portfolio is too expensive. Analytics will indicate the accounts for which skip tracing will be more effective.
Having the right technology to collect the retained receivables is important along with the right analytical tools, collection industry experts point out. Although cash flows are tight, now is not the time to cut back on technology, as long as it adds to recoveries and isn't just something that's "nice to have." For example, a predictive dialer might be useful, but the return will be much better if the user employs all of the imbedded intelligence to hit calls at the right time(s) of day. Weigh the cost against the expected return.
And, industry experts agree, don't expect any better pricing anytime soon for selling those receivables in the market.