Valuation: Normalizing the ‘COVID Effect’

Excerpt from ‘Determine Your Approach’ – Collector Magazine

When the COVID-19 virus hit last year, most credit originators tightened up their underwriting and pulled back lending.

“The charge-of volumes are significantly lower, 30-40% for collection agencies and debt buyers, which creates strain on those organizations because they don’t have the inventory to collect,” said Greg Paulo, vice president of business development at Flock Specialty Finance.

That has been counteracted in part by the COVID-19 government stimulus packages rolled out in 2020 and 2021, which gave many consumers a significant financial boost. For some, the money was a lifeline. For others, it put them in a position to get their finances in order and proactively pay off debts.

As a result, while delinquencies dropped because there weren’t as many loan originations, some agencies collected a lot more money than expected, particularly from accounts under $2,500, Paulo said. Higher balance accounts that often require legal work didn’t fare as well due to temporary court closures. In fact, many courts are still not caught up on their caseloads.

That basic economic reality, coupled with ARM companies swiftly moving their employees to a remote environment, realigning their expense structure and, for some, obtaining Paycheck Protection Program (PPP) loans, helped inflate their numbers.

“We recently drew a payment trend and overlaid several years of data on similar portfolios, and we can see that there was about a 20% lit in payments that we attribute specifically to the government incentives,” Paulo said. “It really takes an educated buyer to be able to adjust for that in their purchases because those payments won’t be there in the future.”

What does that mean for sellers? For many, it’s setting the stage for a good exit. “There will come a time when the collectability of these accounts falls off, namely when the government incentive programs go away and the unemployment rate catches up with the economy,” Paulo cautioned. “It will become a lot more difficult to collect this money, and there will be a lower supply of charged-of debt on the market that needs collecting because we still haven’t seen originations start to increase. It makes sense for some of these collection agencies and debt buyers to sell their inventory now when it appears that there’s more value.”

Translation: If you own a medium-size or small company and you have a three-year exit plan in mind, consider accelerating it to get more value out of your company before the market shits and you must rebuild.

But sellers should understand that buyers are looking at both 2019 and 2020 numbers in an attempt to normalize the “COVID Effect,” as Lamm called it. his is both for the consumers-lush-with-cash scenario, as well as the benefits of PPP money.

“We are telling people that simply getting a multiple on your COVID-inflated EBITDA [Earnings Before Interest, Taxes, Depreciation, and Amortization] is not going to be a slam dunk,” Lamm said. “[Buyers] want to understand how much of a bump it was—was it 10%, was it 30%? When they can normalize those numbers to produce a base case for valuation.”

Buyers are also looking closely at how companies have structured their work-from-home program, if and how they are planning to have employees return to the office, and how their data security efforts have changed in the last year.

Read the full article at Collector Magazine