(I found it on ASFI's board; and found it very informamative; thought it would be good idea to share)
Is that charged off collections are somehow tied to the macro economy. This is not the case. You can sit and review post-charge off vintage histories from all the top US issuers, and you'll find no correlation to unemployment, mortgage defaults, or any other indicator. What you do see over time since the 1970's is gradual increases which are tied to technology. The advent of WATS lines, computerization, entrance of predictive dialers, scoring and advanced database management, VOIP, and recently most importantly is wide adoption of litigation. Historically, if you defaulted on a credit card you had very low chance of being sued. CFS actually sued no one. Vast majority of all defaults during their heydey got a free pass, and that pool was held up under trustee to allow most to make it to SOL.
Think of it this way. Debt purchaser financial models assume that 80-90% of accounts will not pay. If, say, unemployment rises from 4 to 5 that represents a 20% increase. To a true lender/issuer that can be catastrophic. If their charge off rate increases 20% that can wipe out entire margin plus more. People mistakenly translate this concept to post charged off debt.
What percent of ASFI, or other purchaser, debtors are able to pay $50 a month towards the balance if they were truly motivated? How many are still meeting cable bill, eating out, renting movies, paying for broadband.. many are. To use an extreme example, lets say debtor's prison returned. What percent of ASFI accounts would commit to at least $50 a month and have ability to meet it? I'd estimate 85%+. This figure will vary with the macro economy, and in a severe recession with high unemployment it go down to 70-75%. That still leaves ASFI with 7 out of 10 accounts with ability to pay needing to motivate one of them. The difference between that and having 8 or 8.5 accounts with ability is meaningless.
The truly important dynamics are for internal operations your average collector tenure, and for outsourcers like ASFI how much you litigate and how motivated your servicers are to give proper work to your portfolio while still being able to extract margin for themselves from the gross servicing fee they are paid.
Look at PRAA and compare productivity between new collectors and those with at least one year tenure. If PRAA were to fire all non tenured collectors and cut purchases in half only to be worked by experienced collectors, their portfolio liquidity would go up by a factor of at least 60%. This would occur independent of any macro economic trend. The point is, the variation of liquidity based upon collection effectiveness (tenured collectors, technology, litigation) is huge.. the effect of macro events is white noise.
Judgements have very long horizons, and consumer's circumstances are cyclical. One can argue ASFI is better off suing, getting a judgement and letting it age at post judgement interest rates as opposed to collecting it in full immediately. This does assume access to capital for additional purchases, which hasn't seemed to be a problem for them to this point. Even a voluntary payment plan of $50 a month probably has higher NPV seeing statutory interest ranges from 6% to 12%, the national average definitely in excess of ASFI cost of funds.
Many people make this business more complex than it really is. One simple formula is that if you pay under 5 cents, litigate at least 20% of portfolio, exercise a decent (not great) regimen on rest, have cost of funds under 9%.. you will make significant (over 25% annualized ROI) returns.
If you do it really well plus have an efficient resale program capturing maximum residual value you'll do over 33%.
Why is collecting credit card debt from people that the major card issuers have not only written off to zero, but have decided it is even better to get rid of it altogether, a good business model? The standard argument is you buy it for 10 cents and collect 25 cents, but why should there be an expectation to collect anything, anytime?
>Why is collecting credit card debt from people that the major card issuers have not only written off to zero, but have decided it is even better to get rid of it altogether, a good business model? The standard argument is you buy it for 10 cents and collect 25 cents, but why should there be an expectation to collect anything, anytime?
Credit card companies are in the business to lend money, not to collect it. Debt collection takes a lot of infrastructure to achieve any sort of scale economies, and even then recovery rates are at best 15-20% over a fairly long curve. Because these collections are on written-off debt, recoveries can't go to reduce net credit losses...they're just cash. Cash over a long period is nice, but cash now is even better, especially when it comes at a very low cost to produce.
This is not to say that issuers don't have ever-improving processes to mitigate losses up to and just after chargeoff. Scoring, predictive dialers, better skiptracing, and other bad debt tools are just as relevant when accounts are seriously delinquent. Other things equal, if there was a good accounting reason for lenders to do long-term recovery, the debt buying business wouldn't be what it is now.
A recession is probably good for the debt buying business for a few reasons. The upcoming recession is PARTICULARLY good for debt buyers because of the subprime credit crunch: lenders cutting back on credit offered to people who still owe bad debt means that those folks should have a little more disposable income. There is an enhanced incentive to service lingering debts in order to gain access to new credit. This effect is factored down by unemployment, sure, but (a) the volume of charged-off debt is about to increase, (b) banks that are now writing down billions will have renewed incentive to sell their warehoused debt, and (c) the beatdown that the public debt buyers are taking in the market should imply that less entry will occur once the increase in supply is noted.
Points (a)-(c) imply that existing debt buyers should have more draws from the urn, so I expect that the smart ones can maintain credit quality and yield.
That doesn't mean that the business is recession-proof, especially in an inflationary recession. So far, the weak dollar has been a net positive for the economy. There is a chance that the upcoming year will be rewarding for debt buyers who can recognize and adapt to changes in account-level credit quality.
The Jeffries downgrade wasn't really a downgrade. They basically took the view that the entire sector has headwinds in its face from a collections standpoint and that the market will also not be willing to pay up for collectors in the current environment. They downgraded every company in the sector. They posted a $41 price target and complemented the business. They also stated that they believe the debt buying pricing will be more favorable for PRAA in the coming year.
Trading over the next few days requires confirmation of the signal but today's price action and above average volume have formed a hammer which could signal a reversal. This is not a hoo-ray message but one to watch and see. I personally bought more today on the signal and historical price action at this level.
Perhaps with jobs slowing and everything like houses underwater, PRAA won't be able to collect as much as they have during the last 5 years. After all, the last 5 years has been a good economy.
So I would wait to see how well they do next Q before buying.
"Perhaps with jobs slowing and everything like houses underwater, PRAA won't be able to collect as much as they have during the last 5 years. After all, the last 5 years has been a good economy.
So I would wait to see how well they do next Q before buying."
I would offer the long-term view. Companies like PRAA will benefit from economic malaise like higher unemployment, as credit card companies write off more debt. The cast-off debt will become cheaper to accumulate than in the past few years.
PRAA can smartly manage collecting on this debt -- even if the economic problems make it harder to collect this debt, it will have been cheaper to purchase.