he current economic downturn
has affected the financial world in
ways never before experienced,
and the asset buying industry is no
exception. Predicting how the industry
will respond to the trouble and
determining the next best move for debt
buyers has many industry veterans
puzzled.
THE FACTS
With collection liquidation rates
dropping considerably in the past year
and portfolio prices experiencing a
dramatic dip as a result, debt buyers
have been forced to reexamine their
projection models when purchasing
delinquent debt.
Mike Varrichio, president of Global
Acceptance Credit Company, a
distressed consumer debt buyer based in
Arlington, Texas, said most debt buyers
are experiencing margin squeezes
thanks to the downturn.
“Although prices for distressed debt
have moved lower this year, so have
liquidation rates,” he said. “For those
debt buyers who paid relatively high
prices for portfolios between 2005 and
2007 and are experiencing lower
liquidation rates, margins are being
squeezed and impairment charges are
being taken.” An impairment charge is
an expense publicly traded debt buyers
incur when a portfolio doesn’t live up to
initial projection expectations.
Because most debt buyers base their
initial projections on historical data and
market conditions at the time of
purchase, their projections for portfolios
purchased between 2005 and 2007,
when prices were relatively high, were
projected to produce recoveries more in
line with the prices they paid. However,
when liquidations began to drop at the
end of 2007, buyers began to experience
tighter margins.
“Fighting your way through the
current economic climate has become
very difficult for debt buyers because
the downturn was unexpected at the
time the packages were purchased,”
Varrichio said. “Projections were based
on the market remaining relatively
stable. There were times in 2006 and
2007 when many debt buyers believed
that high prices were a permanent shift
and not a temporary bubble.
“Buyers making bids in the current
environment will have to adjust their
models to match the current economic
conditions with possible continued
liquidation degradation rather than
basing it on historical models.”
Buyers should work under the
assumption that conditions may not
improve any time soon and alter their
models accordingly.
“We have adjusted our models to
expect liquidations to continue to slide
until we see some light at the end of the
tunnel,” Varrichio said. “We are
predicting a worsening scenario.”
Funding portfolio purchases has also
become increasingly difficult due to the
lack of affordable capital, especially for
small- to medium-sized buyers. Gary
Wood, president of Collins Financial
Services, a debt buying firm in Austin,
Texas, with an affiliate collection firm,
Paragon Way Inc., said some companies
have exited the buying market because
their sources of funding have dried up.
“The capital they were accessing fell
into the category of companies that
thought the returns were going to be
good and, when they realized they
weren’t, found other places to invest
their money,” he said.
RISKS AND OPPORTUNITIES
Although the current economic
environment spurred the drop in
portfolio prices, the effects haven’t been
entirely negative. Lower prices also
mean increased acquisitions for
individuals with access to capital.
“With price degradation reaching 25
to 30 percent and possibly more, those
debt buyers with access to relatively
inexpensive capital are going to benefit
tremendously in the coming years,”
Varrichio said. “They’re going to be
accumulating distressed debt at lower
prices that should become more
collectible at some point in the future.”
This has had an adverse effect on the
resale market. According to Wood, as
prices have fallen, the prices resellers
have been able to demand have also
come down.
“The drops in both places have been
similar, but it has affected companies
hoping the margin would be higher,”
Wood said.
Similarly, buyers currently locked
into forward-flow agreements will have
to continue paying the prices they
initially negotiated, which might be
higher than the current market price.
ARE PRICES WHERE THEY SHOULD BE?
Some industry professionals believe
prices are in line with market
conditions, while others think we
haven’t seen the bottom yet. One thing
everyone can agree on is that prices
have dropped.
“The liquidation rates available in
the distressed economy we’re in have
dropped somewhat, so it doesn’t make
sense for people to pay the prices they
had been paying,” Wood said.
Although this means more purchases,
it also means the paper won’t yield as
much in the short run, according to
Steve Harb, chief financial officer for
RMB Inc. in Knoxville, Tenn. Whether
this affects how much buyers will buy
depends on the individual buyers and
their company’s business model.
However, it could also affect how much
sellers are willing to sell.
Harb believes it’s likely creditors
won’t sell much for the rest of the year,
but that sales will pick up in 2009 when
they’re trying to improve their bottom
lines.
“Their own balance sheets and
internal cash needs will drive whether
they sell or outsource,” Harb said.
“There are different constrains than
someone who is looking to buy since it’s
more market-driven, in that case.”
Varrichio agreed, noting that the
lower prices for portfolios could create
