CFPB Supervision: A Challenging And Changing Chessboard

Michael FlockManaging A Competitive Position Leave a Comment

Competitive PositionThe game we played well is not only changing but becoming more challenging. As executives, we understood the chessboard and had confidence that we could make the right moves. The FDCPA laws and licensing requirements were straightforward. Regulatory violations were often political and not always newsworthy. The supply and demand, and economics of the debt buying marketplace were predictable.

Now the CFPB has aggressively established itself as a major force with creditors, collections agencies and debt buyers. The regulators vow to leave no stone unturned, and no bad guy unpunished. Everyone is trying to understand where individual companies and the debt industry as a whole are headed. The chessboard has changed.

Do you recognize any of these quotes:

Under tighter federal oversight a regulatory board is created with broad powers to punish corruption …to monitor firms and establish stiff criminal penalties. “The era of low standards and false profits is over.” proclaims the President.

Regulatory regimes are changing dramatically, and government policymakers continue to push back expected completion dates. “The ongoing regulatory uncertainty means that we are forced to make important investment in product and other strategic decisions based on incomplete information” comments an executive leadership forum participant.”

On April 21, 2011, at the request of President Barack Obama, …federal and state enforcement agencies launched a working group which is “aggressively focused on identifying civil and criminal violations …and insuring that American consumers are not harmed by unlawful conduct, which remains an important priority.”

The first quote was from George W. Bush, in 2002, as he signed the Sarbanes-Oxley Act putting the accounting industry under tighter federal oversight and spelling out how accounting, for both the accounting firms and corporations, was going to change. The bill was an extensive overhaul of corporate fraud, securities and accounting industry and punishment for corrupt auditors.

“This law says to accountants: the high standards of your profession will be enforced without exception; the auditors will be audited, the accountants will be held to account. There was now going to be both individual and organizational accountability to the industries’ best practices to reduce corporate corruption,” stated the President.

The second quote was from an insurance executive participating at the May 2013 Insurance Governance Leadership Network sponsored by Ernst and Young. The issue was the uncertainty being created by the government’s anticipated regulations on risk-based standards. The uncertainty produced overly conservative practices and investment for developing new capabilities and selling new products. Despite concerns over continuous regulatory uncertainty, insurers are keen to concentrate individual and collective energy on moving forward. We need to get our own house in order” noted an insurance director.

“The industry has clunky, creaking and expensive legacy systems. The insurance industry is full of data to identify, mitigate and manage compliance. Improving our infrastructure now would go a long way to helping us in the future.”

The third relates to an article in the April, 2013 Oil & Gas Journal by industry attorney, Edward Schwartz. The article describes how antitrust enforcers stepped up their oversight of the oil and gas industry over the last two years, in part because of the public’s concern over gasoline prices. The government’s concern stems from the collaboration among oil and gas competitors.

The result of this oversight creates “risk reduction” for innovative approaches and collaboration that could benefit both the industry and the consumer. Every collaboration, of any kind, with a competitor, raises some legal risk as well as the potential scrutiny of antitrust regulators. Before entering into agreement for a transfer or sale of product with a competitor, an operator has to feel comfortable that the arrangement will not result in the risk of scrutiny.

The debt buying industry is not the only game in which the government has injected “oversight”. Oversight is a form of supervision used to monitor selected industries. Supervision is then used to insure the conformity of a specific institution to the operating standards of the industry’s regulated prescription.

What are the implications of CFPB supervision to the debt buyers’ chessboard?

Lessons Learned

What are the lessons learned from other industries experiencing government oversight that will help debt buyers make the right moves? Looking at the above three industries along with observations from telecommunications, utility, healthcare, transportation and financial services industries, three common market factors emerged. In one way or another, companies in these industries have a more challenging chessboard. The common market factors that have changed the chessboard are identified as: Fundamental Change, Process Alignment and Industry Dynamics.

The first, Fundamental Change, refers to major strategic and operational changes each company must make to compete.

This Fundamental Change causes management to set new strategies; develop new resources that reduce the risk of non-standard operational behavior; and create new controls to demonstrate compliance. Ownership has to make a strategic decision to stay or exit the game. If the decision is to stay, then additional resources, both capital and expertise, have to be committed. This includes infrastructure changes, technology and/or acquisitions of capabilities. The risk of regulatory scrutiny “checks” potential financial gain.

The second, Process Alignment, refers to the industries’ key processes and decision making practices that need to be standardized.

Examples of standardized processes include: sales, billing cycle, product distribution, customer contact, and collections, and chain of ownership. Process alignment reduces the risk of non-compliance. This alignment allows the originator to outsource their work. Key aligned processes have to be supported by systems and technology, which moves industry data and information from one entity to the next. Partnerships and long term arrangements are put into place to insure that all parties collaborate and provide the resources needed to continually improve the aligned practices.

The third, Industry Dynamics refers to the structural shift the total industry makes in response to government oversight.

Some key factors that contribute to the structural shift are the size of the market, number of companies, distribution of market share, availability of capital and technology. The result of these changing industry dynamics is the consolidation of companies at all levels. Consolidation reduces risk of compliance. The number of companies that share common processes, practices and culture shrinks. Risk aversion of an industry also affects the size of product bundles. Small bundles will need to be consolidated for distribution or sale. These two dynamics create a higher barrier of entry for the industry’s players. A higher level of entry means that industry players are required to have more capital, knowledge and capacity to participate.

As a result of consolidation and a higher entry level; an industry starts to divide into two groups: those who decide to compete and those who do not. Those who do not decide to compete will eventually exit, either through acquisition, merger, or “just shutting their doors”.

Debt Buying Market Factors

There is no reason to believe the collection and debt buying segments of the financial services industry will not experience similar market dynamics that comprise the chessboard. To complete the composition of the chessboard, three other market factors need to be added: The Economy, Social Trends and Capital Structure. These factors are not a result of CFPB Supervision, but they impact the chessboard.

The Economy, over the last five years has seen consumers deleveraging debt, along with a continuously high employment rates.

For the collector, this means fewer accounts to service. For the debt buyer, this means higher prices. The result is reduced volumes and reduced margins.

Social Trends are also having an impact on collection strategy and practices.

In the past, the populace tended to view “bad debt” as the result of an individual’s poor financial decision making. The holder of the debt had all the rights to recover the asset. After the federal government’s bailout of the banks in 2008, the perception of bad debt changed. The inability of a consumer to pay off debt was no longer the debtor’s fault; environmental factors have become the reason for the inability to pay. The debtor now has consumer rights in the recovery of the debt.

Capital Structure is the financial factor impacting a company’s cash flow, equity and debt.

All three, Fundamental Change, Process Alignment and the Industry Dynamics are going to demand capital. Not only are debt buyers going to have to fund the infrastructure changes required of CFPB Supervision, they will have to balance this with the funding needs of larger portfolios.

These six factors compose the chessboard, a chessboard that has more uncertainty and complexity. This is nothing that has not been experienced by other industries that have government oversight.

Implications for Debt Buyers

What are the implications for the collector or debt buyer from these six Market Factors?

Debt buyers will have to:

Fundamental Change: Debt buyers will have to understand what different originators are doing to eliminate the risk of government intervention. Presently, the banks have made the strategic choice that the cost of government intervention is greater than the profits from selling debt. The debt buyer will have to provide the capital and expertise for strategic, infrastructure and controls needed to reduce the originator’s risk of outsourcing/selling. Being able to demonstrate compliance has the greatest value.

Questions that arise are: “What is our sweet spot in the market?” “Can we scale?” “How do we diversify our product offering?” “How are we going to differentiate ourselves?”

Process Alignment: For the originators, the cost of government intervention may be greater than the profits from a debt portfolio sale. The banks are changing their debt selling processes and practices to reduce the risk of non-compliance. Debt buyers will have to demonstrate that the culture, capabilities and systems are not only the compatible, but are transparent.

Questions that arise are: “What changes are originators making? What processes and capabilities to I have to implement?” How am I going to demonstrate that I can reduce their risk?”

Industry Dynamics: Debt buying companies of all sizes will have to scale and diversify asset classes. The industry is moving from a highly fragmented industry with low levels of entry to a consolidating one with higher levels of entry. The large debt buyers are consolidating and carving out market segments and products that are scalable. Middle market debt buyers will have to become nimble and find emerging markets and products.

Questions that arise are: “Do I want to compete or exit?” “Do I have a growth strategy or exit strategy?”

The Economy: The cost of sales will continuously have to be reduced. The economy has put pressure on the industry’s margins. Debt buyers will need to use training and consumer analytics to increase productivity. An example is that Encore’s cost structure was lower than Asset Acceptance, which made Asset Acceptance’s portfolios more valuable to Encore. Debt buyers will have to use emerging technology, off-shoring and increase capacity to reduce their cost structure.

Questions that arise: “Do I have the infrastructure base and knowledge to develop a low cost structure? “Do I know how to use predictive analytics to create productivity?”

Social Trends: Consumer centric collection strategies will have to be developed. These strategies will also include holding accounts longer to consider “positive life changes” for those debt buyers who have the “willingness” but not the “ability”. The industry leadership will have to continually demonstrate to congress, media and consumers that the industry is not run by the ‘bad guys”. There is 6 Sigma Quality.

Questions that arise: “How will I balance my liquidation rate and consumer centric approach?” “How will I use consumer predictive analytics?”

Capital Structure: Debt buyers need to have a strong equity foundation for their new funding needs. Developing and aligning CFPB compliance will have to be balanced with the scaled purchase of diverse asset classes. A review of the public debt buying companies demonstrates an increased investment in infrastructural changes. Building equity and balancing funding requirements will require a different set of financial competencies, especially for the middle market.

Question that arise: “How are these new investments to be funded?” “Do I have the knowledge needed to manage my capital structure?

As demonstrated, industries that have government oversight face a chessboard of more complexity and uncertainty.

Debt buyers must be flexible and nimble and design new business strategies to succeed on this new chessboard. This challenging game will be comprised of fewer, but stronger players. To be a stronger player will require an understanding the six market factors that define the chessboard. After understanding the chessboard, an owner has to have the right strategy and resources to make the winning moves.


Debt buyers must realize that past success can be the enemy of future success. They must question the status quo and ask if they have the right combination of capital and expertise to win. What new moves will be required to win on this chessboard full of uncertainty?

Debt buying now requires leadership. It is about dealing with uncertainty. It is going outside our comfort zone to get results. It is about going forward without knowing what is in front of us.

Debt buyers will need to:

  • Create an environment to maximize the potential of their assets, people and equity
  • Set up processes that support the industry’s new direction
  • Coach people out of their comfort zones but keep them focused
  • Focus on new strategies that will make their companies successful
  • Measure and control the new behavior
  • Constantly communicate to the originators, employees and service providers, and this will create trust

The CFPB will bring uncertainty and complexity to the debt buying and the credit and collections industries.

The chessboard has changed and it will take creative thought leadership to play and win at this new game. But these changes really are no different than what the banking, insurance, and oil industries have experienced.

As the famous French proverb states: “The more things change, the more they stay the same.”

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