This article appeared in the January issue of Collections & Credit Risk.
The credit squeeze that first gained traction on Wall Street 18 months ago has hit Main Street with blunt force, leading to forecasts of lower liquidation rates and higher placements for collection agencies in the months ahead.
Unemployment climbed to 6.5% in October as economists predicted that the rate could rise to as much as 8.5% by the end of 2009. October retail sales tumbled 2.8%, the largest monthly decline in 16 years as consumers pulled back amid spreading fears of a deep recession.
"We are seeing a more challenging environment for third-party collections," says Jay Gonsalves, president at Action Collection Agency of Boston, based in Middleboro, Mass., and current president of ACA International. "Consumers are feeling the pinch."
The economy is in a "transition stage," says senior economist Adolfo Laurenti at Mesirow Financial, based in Chicago. He explains that consumers will rely less on credit going forward as they rebuild their savings. Eventually, this will improve the ability of consumers to obtain credit and also provide the cash needed, say, for a down payment on a home purchase.
The government will probably approve some type of economic stimulus package in 2009, Laurenti says. That could be good news for both consumers and collectors. But questions remain about how the new Obama Administration will handle taxes. "Who will bear the brunt of tax increases?" asks Laurenti. "It creates a lot of uncertainty."
Meantime, "Things will get worse before they get better," predicts Karolyn Rubin, senior vice president at Bonded Collection Corp., based in Chicago, and president-elect at ACA International. She believes the housing sector will hit bottom around mid-year, then the economy will begin to improve.
Rubin says account placements are up 20% from about one year ago but collectability is down about 15%, a number echoed by several agency executives. "Consumers are tapped out," she says.
Look no further than credit card charge-offs for a peek at the problems facing issuers and collectors. Charge-offs continue to worsen. An October report by Fitch Ratings shows prime charge-offs rose to 6.57% in September from 6.46% in August. Fitch expects charge-offs to creep above 8% in 2009.
On subprime credit cards, delinquencies of 60 days or more increased to 6.1% in September, Fitch says, the worst month since 2005. As a result, Fitch expects charge-offs in the subprime segment to deteriorate from a current level of 12.97%.
U.S. consumer bankruptcy filings jumped 40% in October from a year earlier, according to the American Bankruptcy Institute. With 106,266 consumer filings, it was the first time bankruptcies topped 100,000 since the Bankruptcy Abuse Prevention and Consumer Protection Act went into effect in October 2005.
Then, the housing problems that kick-started the economic freefall have not been solved yet either. Foreclosures are rising as lenders and government agencies scramble to create programs to keep people in their homes. About 73% of U.S. counties had year-over-year increases in their mortgage delinquency rates in the first quarter of 2008 (the latest period with full data available at press time), according to an October report by the Federal Reserve Bank of New York. (The same report showed 71% of counties had higher delinquency rates for bank credit cards than a year ago.)
Like other agencies, Bonded Collection is focused nowadays on arranging payment plans with indebted consumers rather than payments in full.
Installment plans stretched as far as 12 months for a $500 balance are not unheard of. "The collection agency that takes those plans is smart," Rubin says. "It keeps the consumer in the habit of paying, instead of not paying."
From August to October, right-party contacts declined at third-party portfolio manager The Affiliated Group – another possible sign of economic weakness. "We are making more dials and not reaching people," says Mark Neeb, president and CEO at the Rochester, Minn.-based company. "We have to exert more effort to talk to the same number of people."
The decline in contacts also could have been because of the recent election as individuals became weary of phone calls from candidates and therefore avoided all automated calls.
Even so, collectability has certainly declined, according to the Settlement-in-Full Composite Index report, a monthly measure of consumer debt payments made to a handful of debt buying companies. The Index decreased 13.4% in September to 64.1%, its lowest level since the same month in 2005, says the report.
"We see confirmation of more challenging times for collections," says Mark Hughes, research analyst at SunTrust Robinson Humphrey, the Nashville-based company that produces the Settlement-in-Full Index report.
Though Hughes expects more tough times ahead for collections, he does not see the market completely falling apart. "There's erosion, but it's not dramatic," he says. Though, he adds, rising unemployment will make it harder to collect bad debt going forward.
Whether this is a good time to purchase debt is unclear. "That's the million-dollar question," says Neeb at the Affiliated Group. Debt buyers must weigh the balance between slowing recoveries and falling debt prices. "Will the economy turn around in the near enough future to make discounted debt buying today worthwhile?" asks Neeb.
Asset Acceptance Capital Corp., a consumer debt purchaser, has been selective in its purchases, and the Warren, Mich.-based company expects debt supply to increase and prices to decline in the next 12 to 18 months, said Brad Bradley, chairman, president and CEO at Asset Acceptance, in its third quarter earnings statement.
On the plus side, gas prices have been cut nearly in half since July. In mid-November the nationwide average price for gas was $2.22 a gallon. Collectors say this has helped consumers repay some bills, especially small balance accounts.
At the same time, lenders are turning up the heat on collectors to produce results. "Credit grantors are under a lot of pressure," says Rubin at Bonded Collection Corp. "They want as much revenue as quickly as possible." Lenders are getting accustomed to taking payment plans rather than payments in full. But contingency rates haven't been lowered, she says.
At Action Collection Agency, Gonsalves sees more creditors, seemingly having exhausted all other approaches, he says, using credit bureau reporting as a passive way to cure accounts. The agency, at the request of the creditor, reports those "non-payments" to the credit bureau. When the individual applies for credit in the future, he or she must pay the outstanding bill before it is granted.
Industry executives are concerned about fallout from the presidential election, pointedly whether any new regulations will favor more government intervention in the industry.
Gonsalves at Action Collection recently met with Congressman Barney Frank, chairman of the U.S. House Financial Services Committee. There is a sense that consumer disputes may rise with delinquencies. "We have to look at quality assurance," says Gonsalves. "We have to work toward dispute resolution."
Industry executives expect some consolidation, or that some smaller companies probably will be forced out of business because of the demands of collecting during a recession. Most agree that agencies with the right technology and processes should be able to survive.
Looking back at the industry over the last 40 years, Neeb says there have always been reasons to think "the sky is falling." But, he adds, "The more things change, the more they stay the same. The downturn is a cleansing process for consumers, creditors and businesses. You have to be an optimist." CCR