Get ready to update the customer lists.
As serious trouble roils the financial markets in wake of the mortgage mess, a wave of bank mergers seems more and more likely. The recent near collapse of investment bank Bear Stearns punctuated the depth of the financial crisis. As Wall Street contemplates the question of who might fail next, Main Street faces a banking landscape poised for realignment.
Talk of bank takeovers is widespread as financial stock prices continue a decline. On March 17, the stock price of Washington Mutual, an often mentioned takeover target, hit a 52-week low of $9.11. Other banks on the takeover short list are National City and SunTrust.
Potential buyers remain cautious because of uncertainty about losses that might be lurking in the balance sheets but some experts expect bank consolidation to pick up at the end of 2008 when the markets stabilize and the credit picture becomes clearer.
Fears are growing that banks may need to be rescued as their exposure to bad mortgages and construction loans comes to light. Federal Reserve Chairman Ben Bernanke said in February that some banks will fail. A few analysts expect the number of failures to rival those seen during the S&L crisis of the late 1980s. Many believe a lot of banks will be sold before they reach the point of failure.
Meanwhile, collections itself could be poised for more consolidation. In February, giant NCO Group acquired Outsourcing Solutions in a $325 million deal – forming a combined company with more than 29,000 employees in 10 countries.
More bank mergers could put collection agencies and debt buyers in the hot seat, trying to sort out new business relationships amid a shrinking pool of clients. Agencies will need to remain flexible, observers say. Bank mergers also mean that, to succeed, agencies must offer the sophisticated systems and services to meet the requirements of large financial institutions.
"Collection agencies will need to be more nimble," says Ali Raza, executive vice president at consulting firm Speer & Associates in Atlanta. "Agencies will need to offer more specialization."
For now, most industry observers agree there is plenty of business to go around. As recession looms, delinquencies on all types of loans are rising and financial institutions are eager to recover as much of the outstanding debt as they can – and as quickly as possible.
Last December, about 7.6% of credit card loans were 60 days delinquent or in default, compared to 6.4% the year before, according to Risk Metrics Group. In late January, Bank of America said credit card delinquencies in states with high foreclosure rates – California, Florida, Arizona and Nevada – had increased five times as fast as in other states.
"Every credit card company has increased their internal collections staff, or done so in partnership with their vendors," says Dean V. Nicolacakis, co-managing director of the financial services practice at Chicago-based Diamond Management & Technology Consultants. The pressure for issuers to ramp up collections is "intense," says Nicolacakis, whose office is in San Francisco.
The Fight for Business
Who will win more collections business in a merger era? Everyone agrees that all banks, especially those in merger mode, are seeking economies of scale. In years past, banks acquired by large financial institutions may have been allowed to keep their systems and vendor relationships. But that model has proven too costly, says Nicolacakis. Banks are more inclined nowadays to impose their systems on the acquired institutions. "Collection agencies working for the acquired bank could lose those contracts," he says.
But collections executive Rick Corica has seen bank consolidation cut both ways. "It all depends on who you're working for," says Corica, executive vice president and chief operating officer at Elite Recovery Services Inc. in Buffalo, N.Y. "It's a two-sided event." Being on the right side of an acquisition, he says, could boost collections work but a consolidation that results in a change of strategy, say, to hire only large agencies, could impact business. "It just depends on who is in control of the merger," he says.
Banks also could choose to beef up their internal collections departments. "As banks get bigger there is a tendency to see what specialty solutions they can bring to the table," says Raza. "They might take the business in-house." Raza points to consolidation among big banks that has led to more in-house credit card processing.
Raza believes big new entities will have the muscle to work delinquencies internally. These big banks also will have the resources to test their decisions and quickly change course if needed.
Small and mid-size agencies could stand to lose the most business, some say. That could necessitate a shift in strategy to concentrate on community and regional banks for business instead of large institutions that probably will throw more business to big operators such as NCO.
Collection agencies can still position themselves to work with large customers, though, says Nicolacakis. "Collection agencies need to have a turnkey offering," he says. They must ready themselves to be up and running quickly. Another strategy: Secure "overflow" work from a big bank. If the bank is acquired, the agency is already plugged in.
Even so, large financial institutions will continue to have multiple contingency agencies. Big banking operations seek out champion/challenger systems. Large financial institutions test collection results against several competing agencies. At U.S. Bank in Cincinnati, for example, a large internal collections staff is supplemented with three or four contingency agencies at a time. Agency results are scored monthly. Weekly conference calls are held with the agencies to discuss liquidation rates and to provide feedback. If one agency is not performing well, it is replaced by another. Several agencies are kept in a pool waiting for work.
Of course, mega-banks that result from mergers will demand top-notch service and systems. To compete, collection agencies will have to provide integrated systems that support all loan types.
Collection agencies that hope to win new business must have sophisticated security and compliance systems. "Bankers won't even get into a serious discussion with a collections firm unless they have these things in place," says Brian Greenberg, managing director at mergers and acquisitions firm Milestone Advisors, Washington, D.C.
Bank mergers may produce a more intense focus on metrics, says J. Brian King, senior vice president at BenchMark Consulting International in Atlanta. "We've had 10 years of low losses and delinquencies. A once-a-month report was sufficient. That's no longer the case," he says.
Banks want more timely information and they carefully examine processes and policies. Predictive modeling will become even more important as banks strive for efficiency, says King.
Technology and automation enable segmentation of accounts that will "self cure" or eventually pay up. Though delinquencies may rise temporarily, staff can be devoted to accounts that will not self cure, which leads to better long-term results. "In the past we couldn't do this," says King.
Debt buyers are becoming just as stringent as the big banks, says Greenberg. "Debt buyers want collections to be done ethically and efficiently. A lot of requirements are being put on collection agencies that work with debt buyers," he says.
As bank mergers heat up, Greenberg expects more mergers among collection agencies too. Last year, by his count, about 55 deals closed in the accounts receivable management arena. "Agencies that are not prepared from a technology or compliance standpoint will have to get up to speed," he says. That will take capital, he explains, which means collection firms will be seeking equity or merger partners.
At the same time, debt buyers fret about the fallout from possible bank mergers. The acquiring bank may not have a debt sale program, choosing instead to work the receivables. Or, a big bank might only be inclined to sell its charge-offs to big debt buying firms.
"Medium- and small-size firms will feel pressure or get squeezed out, especially of the fresh charged off paper market," says Gary E. Wood, president at Collins Financial Services, based in Austin, Texas. He thinks big banking entities will simply find it easier to sell off a large portfolio to a large debt buyer, instead of breaking it into pieces. "That's bad news for debt buyers," says Wood.
Another concern is the documentation of purchased accounts, says Corica, a debt purchaser as well as a collection agency. To collect, buyers need documentation such as the loan application and payment schedules. When banks merge, the integration process can take a long time and that slows the flow of information on sold accounts.
Bad debt that has been resold several times could present even more of a documentation problem, adds debt broker Louis DiPalma, managing partner at Garnet Capital Advisors in New York.
He believes technology advances will make documentation easier, especially for purchasers buying directly from large banks. But, he warns, buyers must carefully track the documentation for older debt. Says DiPalma: "They'll have to check it out."