WHAT goes up must come down. Economic cycles are fundamental to free market economies.
Whether it is oil prices, the housing market, interest rates, or prices of charged-off credit card debt, the only thing that is certain is cycles. The most recent economic roller coaster ride has been rough and has challenged the resilience of most of the organizations in the industry.
Whether you call the current economic climate a correction, recession or a depression, these are tough times that ultimately will wring out the excesses and bubbles in the market. While declines in portfolio liquidity clearly pose challenges for debt buyers, price declines of 30% – 40% compared to this time last year are perceived as being more than sufficient to offset the deterioration of expected collections and, as a result, debt purchasing activity has risen to levels not seen in years. We have seen prices for fresh credit card paper drop to the $.07 – $.095 range, seconds at $.025 – $.045, and tertiary at $.015 – $.035. Obviously, this is a welcome trend that will continue to drive revenue and EBITDA growth restrained by years of prices in the clouds.
But why the greater deterioration in pricing? Stacey Schacter, President of Briannaco Investments, postulates that:
What we are seeing is really a two-fold effect. First, falling prices due to lower collections. Second, concerns about the near term resulting in investors requiring higher rates of return with quicker break-even points to mitigate risks. The combination results in what we are now seeing, retraction in pricing exceeding retraction in collections. There is a perception, which may be accurate, that the next twelve months will result in continuing deterioration in liquidations and that future deterioration must be accounted for now.
Another leader in the debt buying industry, Bob Morris, Founder of Oliphant Financial, and co-Founder of software developer BEAM 4D Enterprises, LLC, commented on the current situation:
While adequate demand and capacity in our market is very capable of absorbing the expected increases in chargeoff sales this year, the simple change in the production of chargeoffs (read: supply), which feasibly could increase 50% to 80% to the level we saw in 2007, will certainly provide additional downward price pressures. The Q4 sell-offs should prove this out since, historically, as much as half of the year’s sales volume will occur during this time. The good news is that well capitalized organizations should be able to replenish their inventories significantly in this new environment.
However, challenges remain in financing debt purchases as lenders begin to pull back and become more selective while tightening up interest rates and advance rates. Some lenders who have been very active in debt purchasing have reduced their advance rates to 60% in some cases while applying higher due diligence standards to new clients. Other lenders are raising minimums and demanding that new clients buy only paper which they have purchased previously or have experience collecting. Some lenders are shying away from financing even some of the most successful industry veterans who are starting up new ventures. These proven leaders are being rejected because of their perceived lack of an established collection platform and associated infrastructure.
So, what can a debt buyer do? Take advantage of the volatility and shop.
We’re seeing wide ranges of advance rates, from to 60% to 90%. Interest rates on senior debt range from LIBOR plus 4% to LIBOR plus 7%. Mezzanine rates continue to be in the high teens to low 20’s with varying coupon and residual structures. Some lenders insist on personal guarantees; others with more positive experience in debt buying or experience in financing collections companies will not.
The financing market is very competitive and the lenders are demanding of your time and will require a large volume of information before funding. A good advisor can bring you expertise and a process to create multiple alternatives so you do not have to settle for a proposal from a bank that does not offer reasonable market rates. A successful advisor also will have a large network of banks and hedge funds with years of history in financing debt purchases.
If you choose to go it alone, go to an established player and not a local bank that is new to the debt buying market. The education process for new entrants is long, painful and often futile. We know debt buyers who have spent six months or more trying to line up senior facilities!
So, don’t resist the roller coaster. Enjoy the ride. Cycles are good because they bring stability and create new opportunity. Act now and take advantage of the volatility to find the right financing deal for you and your business.