The huge rise in debt of American consumers has spurred the growth of the debt-buying industry, along with a growing interest in these firms from Wall Street investors.
Collectors seeking capital to fund their debt purchases are issuing stock and becoming publicly traded companies. This summer, three rising collections houses were added to the Russell 2000 Index, the home to publicly traded small-cap firms.
Though it began as a privately held firm 40 years ago, Asset Acceptance Capital Corp. took the plunge into the stock market, completing its initial public offering last February. The new leadership at Encore Capital Group Inc. has knitted together several privately held collectors to become a formidable competitor. And Asta Funding Inc. focuses on the buying and selling of portfolios, preferring to leave the down and dirty collections work to others.
But none of these firms can rest on their laurels. The interest in the collections field threatens to drive debt prices higher, impacting margins for buyers and possibly cutting revenues. Some collectors are looking to change the mix of the debt they work, expanding beyond credit cards to focus on health-related payments, auto deficiencies, mortgages and student loans.
The industry is big. About 6,500 agencies earned $10 billion in revenue last year, and the top 100 firms grabbed a 46% market share of that, according to an analysis from Horsham, Pa.-based NCO Group, the largest publicly traded collector.
The business keeps growing with consumer debt reaching $2 trillion last December, according to the Federal Reserve. That includes $743.5 billion in revolving credit, most of which is card debt. Many issuers have made regular sales of their chargeoffs important elements of their recovery strategies.
Market conditions today are in synch for collectors, says William A. Warmington Jr., an equity research analyst and director with SunTrust Robinson Humphrey in Boston who follows the collection market.
"Consumer debt is a growing business, credit standards are looser (for some consumers), interest rates are rising and the economy is improving," says Warmington. Simplified, that confluence of good signs means more consumers have some money to spend and the bank accounts to cover the bills.
Expectations
Going public can be advantageous because capital costs are cheaper than in the private equity market, says Warmington.
Of course, a public firm must also face the spotlight every quarter when it releases its results to expectant investors. "A public player (faces) growth expectations. A private player has more flexibility," Warmington says.
One collections firm that seems to have created a model for entering the stock-issuing arena is Portfolio Recovery Associates. The Norfolk-Va.-based collector launched its initial public offering in November 2002 at $13 a share ("Taking Stock of a Rising Agency," February 2003). Portfolio Recovery primarily collects card debt. Its stock has traded from $22.55 to $30.61 in the last year.
NCO is the fifth major publicly held firm that is often lumped with Portfolio Recovery, Encore, Asta and Asset Acceptance. NCO differs in several ways, partly due to its size-its accounts receivables group generated revenues of $637 million from 61 call centers in fiscal 2003. NCO also focuses on contingency collections, performing collecting activities for others while earning a share of profits.
Big Debt Purchaser
The firm that most recently joined the publicly held group of five is over 40 years old. Asset Acceptance Capital Corp. was founded in 1962 by Rufus "Bud" Reitzel Jr., who did much of his work meeting debtors face-to-face. The Warren, Mich.-based company now has nine offices in eight states.
In its initial public offering in February, Asset Acceptance sold seven million shares and raised $96.1 million ("The New Demand for Charged-Off Debt," April). The company's stock, trading under the symbol AACC on the Nasdaq, has moved in a range of $14.72 to $21.50. It was added to the Russell 2000 Index on June 25, indicating it is one of the 2,000 largest publicly traded companies in the country.
In brief, Asset Acceptance is a purchaser and collector of charged-off consumer debt. From 1990 through the first quarter of 2004, Asset Acceptance has paid $284.3 million for 670 portfolios with receivables with a face value of $15.3 billion. The average purchase price was 1.86% of face value, according to William Blair & Co. L.L.C., a Chicago-based investment house that was one of the underwriters of the company's IPO. Warmington's SunTrust also was an underwriter.
Card debt, including Visa, MasterCard and Discover along with private-label accounts, made up 57% of Asset Acceptance's portfolio in the first quarter. The remainder was made up of health-club debt, comprising 8%, auto loan deficiencies with 7.1%, telecom/utility with 7%, and installment loans with 4.4%. The remaining 16% is categorized as other, and includes student loans, mobile-home deficiencies and retail mail order.
Lots of Cash
The company had 1,562 employees in the first quarter and 60% were collectors. Top collectors earn between $50,000 and $60,000 annually. Asset Acceptance also has an in-house legal department with 311 employees.
Asset Acceptance focuses on debt 360 or more days past due, usually called secondary or tertiary debt. This long-term debt made up 68.4% of the company's $15.3 billion in charged-off receivables that the company held at the end of the first quarter. Fresh accounts, 120 to 270 days past due, accounted for 6% of receivables. Primary debt, 270 to 360 days old, made up about 21% of receivables. The remaining 5% didn't fit any category.
In the second quarter, Asset Acceptance reported revenues of $51.5 million, a 36% rise from the same period a year ago, and net income of $11.6 million, up from pro forma net income of $8.6 million in 2003, prior to the company's reorganization for its IPO.
In total, Asset Acceptance collected $67.6 million in cash in the second quarter with $38.1 million through traditional call-center collections, $21.4 million through legal channels, and $8.1 million through forwarding, bankruptcy and probate collections.
In the first six months of the year, Asset Acceptance paid $46.2 million for charged-off consumer receivables with an aggregate face value of $2.6 billion, for a blended rate of 1.81%.
Though Asset Acceptance is now publicly traded, 43% of its stock is owned by investor Quad-C Partners VO, L.P. Reitzel owns 9% of the company's shares while Nathaniel Bradley IV, the company's president and chief executive, owns 13%.
More Than Cards
Encore Capital Group Inc. made several major announcements this year, including its addition to the Russell 2000 index. San Diego-based Encore established a $75 million, three-year revolving credit facility with J.P. Morgan Chase & Co. It also paid $13 million for a portfolio with a face value of $421 million, the largest ever for Encore.
Only 16% of that portfolio was card debt, unusual for a large collector but a move that fits a possible new direction for the company. The shift is due to a black cloud the company operates under, a contingent loan with investor Cargill Inc. that Encore uses to fund its purchase of credit card portfolios. The Value Investment Group of Minnetonka, Minn.-based Cargill is a strategic investor in credit-intensive assets.
The $75 million secured financing facility began in 2000. Encore pays Cargill interest on the loan along with "contingent interest" or a percentage of the profits it earns from the portfolios it buys with Cargill's money.
Such loans are common in the business. But this one is onerous, according to an Encore spokesperson, because Encore pays more in interest as it collects more card debt.
In the first quarter of 2004, Encore drew on about $9 million from Cargill but paid it $9.2 million in a combination of interest and contingent interest, making the weighted average effective interest rate on the loan 110.6%, according to Encore. The company's contingent interest expense rose 158% from first quarter 2003 to the same period this year.
This Cargill loan deal expires at the end of the year, and Encore doesn't plan to renew the arrangement, says Carl C. Gregory III, president and chief executive. (However, Cargill will continue to earn "contingent interest" on any money that Encore collects on the portfolios it bought with Cargill's loan. The deal with Chase doesn't include any contingent interest.)
In recent months, Encore has been using its financing from Chase to buy non-card portfolios. Gregory contends that Encore's in-house software makes it easier to shift among different types of debt. Encore's database includes information on the four million-plus accounts it has purchased since 2000. The software reviews individual debtors and evaluates their ability to pay, unlike competitors that calculate the possible return on an entire portfolio of debt.
"We ask if John Doe can pay us back. It doesn't matter what type of debt," says Gregory. "We are comfortable moving across (different) asset types."
The market amongst collectors for non-card debt is still new and has some profit potential, says Warmington. "It's a less mature market. There are fewer regular sellers than the card companies. They may sell a big portfolio, then nothing for six to nine months," he says.
The down side is that prices for this non-card debt are sure to rise as more buyers enter the market, Warmington says.
Encore describes itself as a systems-driven buyer and manager of charged-off consumer debt. The consumer file is refreshed quarterly. From 2002 through 2003, Encore paid $152.3 million for portfolios with 3.88 million accounts and a face value of $6.09 billion. The average debt per account was $1,569.
When sizing up the competition, Gregory prefers to compare returns per employee. In 2003, Encore collected a monthly average of $23,385 per average active employee.
In the second quarter, that rose to about $25,200, says Gregory. "Our competition is about half that."
In the second quarter, gross collections of $57.4 million generated revenues of $43.6 million and net income of $5.6 million. Cards accounted for 67% of gross collections. The remainder was unsecured consumer loans and auto loan deficiencies.
Four years ago Gregory was an executive at West Capital Financial Services Corp. when it was bought by MCM Capital Group Inc. West's management took over the reins of MCM, a collector with its beginnings in 1953, and its wholly owned subsidiary Midland Credit Management Inc. out of Kansas. MCM's initial public offering in July 1999 sold 2.25 million shares at $10 a share. In April, 2002, the company's name was changed to Encore. Its trading symbol is ECPG.
In April 2003, MBNA Corp., the second largest card issuer in the U.S., paid a Midland subsidiary $11.1 million to settle a lawsuit first filed in 2001. Gregory declined to comment on the suit.
Asta's Story
Asta Funding Inc. grew out of a firm begun in 1963 by Arthur Stern that bought auto-loan installment contracts at face value. According to Asta's annual report for its fiscal year ending last September, Arthur Stern is the chairman of the board and executive vice president while his son Gary is president and chief executive and a director of the company. Asta's trading symbol is ASFI. The company declined to comment for this story.
The annual report notes that the Stern family effectively controls Asta. A third top officer is Mitchell Herman, secretary and chief financial officer. Herman Badillo, a long-time New York-area power broker, is one of seven directors. Badillo, a former Congressman and deputy mayor of New York, ran and lost against Michael R. Bloomberg in the Republican primary for mayor of New York in 2001.
Asta buys portfolios that consist primarily of card debt, then outsources most of its receivables servicing. In December 2002, it bought a call center with about 33 employees, according to its reports.
In fiscal 2003, Asta reported net income of $11.6 million on revenues of $34.8 million, down from $36 million in fiscal 2002. It bought portfolios with a face value of $3.6 billion for $155.6 million, or 4.3% of face value. Asta's cumulative managed portfolios totaled $7.4 billion at the end of last September.
In the three months ended June 30, revenues totaled $12.05 million, a 31% rise compared to the $9.2 million generated in the same period a year ago. Net income in this year's quarter was $5.6 million, up 121% from the same period a year ago.
This year is proving to be a good one for the collections industry. The rising number of sophisticated buyers such as these three are a plus and minus, as prices for bad debt may rise with the influx of bidders. At the same time, consumers carry a great deal of debt and seem to keep adding to their load. For strong competitors, that means continued growth.
