Thar's Gold in Them Thar Bills
In the late 80s in the United States, "Savings and Loans" roughly analogous to building societies, hit something of a bad patch. They went under in droves. In the aftermath, the survivors and the liquidators of those that didn’t survive looked for ways to salvage cash from countless small bad debts, and thus was created a market in the US for buying and selling bad debt.
A decade later, that market has become quite sophisticated. In America there are now companies to provide services to both buyers and sellers. For example, there are businesses which will analyse ledgers for either buyers or seller. They identify the bankrupts and deceased debtors, work out how many phone numbers and other pieces of key information are missing, analyse the age of the debts and identify those which are outside the US Statute of Limitations.
The value of a debt portfolio will be based on:
Age
Prior work effort
Past collection rate
Balance of the accounts
Type of account
The age of the debt is crucial. The following graph shows the "collectability" of commercial (as opposed to consumer) debts over time, based on the age at which they have been given to US collection agencies. It makes the reasonably obvious point that the older a debt, the less likely is collection.
SOURCE: COMMERCIAL LAW LEAGUE OF AMERICA, 1996
A less obvious point is that some debts eventually become more collectable as circumstances change. Think of a 24 year-old who buys a car on HP. He falls behind on his payments and after a year the car is repossessed and sold. There is a shortfall of $1000 for which the debtor is liable. However, he ignores it. He moves to Australia and is not seen for three years. At that point, he returns. His earning power is improved and he is a more mature and settled citizen. His attitude to paying debts has changed. Also, he is now intending to get married and buy a house. He and his partner talk to a bank about a mortgage only to find that his old debt - recorded on a credit reporting system - is held against him. He approaches the car finance company and pays off the old debt.
In New Zealand, the Limitation Act gives a creditor six years to pursue a debt through the courts. That’s six years from the date of the breach of contract - the date the debt was due - or the last payment, whichever was the later. If, after the six years is up, the debtor signs a written acknowledgement of the debt or makes a part-payment, time starts running afresh. The good news is that many consumer debtors are not aware of the Limitation Act and, when tracked down after many years, will start paying old debts.
In New Zealand I am aware of only one significant buyer of debt - Baycorp - whose experiences with the purchase of government department ledgers have apparently been happy ones and whose sophisticated collection systems lend themselves to this type of work.
There are also factoring companies in New Zealand but they are - generally - a different breed. Factoring serves two main purposes. It provides a source of immediate finance to a creditor and it largely dispenses with the need for credit management staff. A factor buys good, new debt for 90 cents in the dollar, not old, bad debt for five cents in the dollar. Most if not all New Zealand factors buy on a recourse basis - that is, if they haven’t collected the debt after, say, three months, they ask the original creditor to repay the money and take over collection.
With only one buyer there is no real market for bad debt in this country - yet - but expect one to start to develop over the next few years. Other potential players are certainly showing interest.
Here is a list of issues for buyers and sellers of debt to consider.
Sellers:
How much can I recover myself, either by in-house collection or use of outside collection agencies, and what is the complete cost of doing so (including cost of money and staff time)?
Be aware that agencies which are involved in credit reporting potentially get value from buying ledgers in the sense of increasing their credit reporting database. That should make the ledger more valuable to them, providing those debts are not already loaded.
Be aware that any sensible buyer will contract for your support and involvement in any disputed debts. Make sure that your contract covers these post-sale issues.
Don’t underestimate the cost of getting a portfolio ready for sale.
Don’t sell your debts to complete cowboys who are going to take actions which will impact on your good name.
Make sure that your accounts receivable system identifies sold accounts.
The more professional your approach to selling, the more attractive is the portfolio.
Buyers:
How much will it cost to collect the accounts?
How long will it take?
What percentage will be uncollectable?
How much return is needed to cover both the cost of the money paid up-front and the costs of collection?
How much profit is needed to make the risk worthwhile?
What will other prospective buyers offer?
How much debt can you handle?
What technology do you need?
Do you have the collection experience or can you get it by joint venture or employing staff?
Are these a type of account you know how to collect?
What post-sale support can you get?
You should also be aware that most creditors will have very little real idea of their true recovery rates. Ultimately, you must rely on your own analysis.
Buying and selling debt is an interesting but uncertain area. There may well be fortunes to be made on it but there will also be businesses that buy debt, find they have paid too much, and become bad debtors themselves.
Chartered Accountants Journal of New Zealand