As investors have gone up the risk curve to find yield, areas including consumer credit have gotten onto the menu. What happens at the debtor front when matters go wrong? We hope fixed income investors find this interview with an expert in the field valuable.
A trend for wealth managers and family offices has been direct investing, with more niche areas such as private credit, peer-to-peer lending, and other non-bank routes. Amid a hunt for yield when conventional market yields have been squeezed, firms are tempted to go up the risk scale in credit. That creates a heightened risk of default as there are no free lunches in capitalism. And default means that practitioners must think about wise ways to recover money and do so in a way that maximizes recoveries.
A regular contributor to these pages, Diane Harrison, who is principal and owner of Panegyric Marketing, recently interviewed Mark Meisenbacher, an experienced figure in the world of consumer debt. His most recent role is that of chairman and chief executive of MSW Capital. We thank Diane for this interview - for feedback, please email the editor: firstname.lastname@example.org
In the consumer debt industry, few activities are more loathsome to lenders than collecting on defaulted debt. These accounts represent high complexity in regulatory compliance and operational execution, yet traditionally offer a relatively small return in success. They occur in a variety of consumer lending areas, including credit card, auto, student loans, and healthcare. The reward/cost recovery ratio of this defaulted consumer debt frequently proves unpalatable to lenders, resulting in a pool of default debt sold away to bad debt buyers for pennies on the dollar.
Chief financial officers of lending institutions have typically followed a predictable format: they would sell off this nuisance debt pool to first-tier buyers, who would collect a percentage of accounts from it and sell off the remainder to a second-tier buyer, who would do the same, then sell the remainder to a third party for a final gnaw on this tired debt bone. Lenders were able to relieve themselves relatively easily from their problem debt, with a pool of ready buyers willing to take it off their hands.
Times have changed. Ownership transfer used to require limited effort from the debt originator - but things are very different now. Regulatory requirements to retain management of the consumer debt collection generated through lending activities now includes tracking in detail the contact communication records with debtors - something previously not required. Lenders are primarily focused on underwriting or servicing performing loans, and are rarely skilled enough or equipped to collect nonperforming debts. Today, these regulatory changes may force CFOs to hold onto their nuisance debt and handle a host of activities related to it that they used to avoid through reselling.
I recently sat down with an industry expert in this specialized debt collection process who offered his insights on the changes happening in the debt industry as a whole and the specific challenges they represent for CFOs. Mark Meisenbacher has over 30 years of consumer collection experience, including management and P&L responsibility for over $10 billion in purchased consumer debt. He sees tremendous opportunity in the industry for CFOs currently unable, unwilling, or unaware of the missed opportunity they have to convert debt into revenue within their own default portfolios.
Mark, can you describe how you see defaulted consumer debt as a poorly-exploited opportunity for profit for lenders?
In the US, the sale, purchase, and collection of consumer debt is a multi-billion dollar industry. In this era of economic turmoil and uncertainty, the growth of distressed consumer debt continues to mount. Companies and institutions that extend consumer credit are generally not equipped to pursue the consumers who lapse into default. As such, a vast majority of these credit issuers have chosen to write off nonperforming consumer debt on their books, package it, and sell it to other entities that are better equipped and specialized to pursue debtors throughout the country. For the original issuers of credit, the nonperforming assets have a zero basis and, consequently, selling that debt in pools or portfolios of debt generates true cost-free revenue, even if such pools of consumer debt are sold for pennies on the dollar.
So what is changing in this debt equation? If lenders can pass the buck, literally, and make a few cents on it, why not stay the course?
In short, government regulation is imposing its will on lenders. Increasingly, US banking regulation authorities have signaled an intention to have banks retain control of debt collection on the funds they lend, so pressure to manage this activity has risen over the past several years, and is likely to increase going forward. The days of selling off bad debt from a lender’s portfolio and walking away are over. Post-sale restrictions on debt re-sales and collection compliance diminish the value of the debt to any debt buyer who has a re-sale strategy, thus reducing the price a buyer is willing to pay for this debt.
Compounding this price pressure is the regulatory burden on lenders and buyers to collect, capture, and document sequentially the chain of evidence of the full collection process. This is referred to in legal terms as “meaningful evidence of debt” over the full debt cycle. This “cradle to grave” process forces the debt buyer into a buy/collect/hold strategy requiring them to need an enormous amount of post-sale support from the lender.
It’s almost a ‘damned if I do, damned if I don’t’ scenario for CFOs. For those who retain their debt collection process, CFOs face the burden of both retaining management and regulatory oversight of their defaults and providing a greater level of record-keeping detail on the collection process undertaken. For those who are able to offload their debt to others, the field of buyers has shrunk considerably. In the past, there was a large pool of buyers willing to buy this debt and collect a small percentage of it to make a profit. This demand kept a healthy bidding level for lenders, who were happy to offload the debt and its requirements onto third parties. Today, with the changing regulatory requirements for record-keeping and compliance, the buying pool is consolidating and the price for debt sales is falling. Without a strong pool of buyers, CFOs need to consider retaining their default debt and deal with it somehow internally. Chief financial officers need help with building or buying expertise in the specialized debt collection practice to comply with changing regulations.
Do you see an upside for CFOs who now may need to manage this segment of the debt collection process?
I do, in fact. Beyond the opportunity gain of capturing collection returns that have been previously ignored or offloaded for pennies on the dollar, there is an additional benefit for CFOs in managing the collection activities: protecting reputational risk to their firm’s brand through a professional and competent process.
What I mean by this is debt collection is a small but important part of the full customer relationship spectrum. Defaulted consumer debt represents a small subset of clients who the lender relies upon in the primary business of lending. While the majority of these defaulted accounts are undesirable customers who the lender likely won’t want to retain, there is also an increasing pool of consumer defaults that represent customers who have experienced an episode of credit dislocation in their spending practice not representative of their long-term habits and reliability to repay. They are otherwise desirable customers who could return to the lender in future positive lending transactions.
Handling both of these types of default customers, “desirable episodic” and traditional delinquent, in a professional and reasonable manner increases the likelihood that these customers can respond to the collection process with general satisfaction. They will arrive at a repayment schedule and amount that both closes the issue in their lives and returns some percentage to the lender for resolution. More importantly, such a process decreases the chance that these default customers will engage in negative criticism about the lender with their network of contacts. This is hard to quantify for CFOs, but is nevertheless a real concern for all lenders to guard against in brand management.
You make a strong case for not just ignoring these debts if they stay in-house. Preserving a lender’s reputation and making a profit from nonperforming debt is a double plus. Is the cost of taking it on worth the gain?
The pools of defaulted consumer debt found in credit cards, auto lending, student loans, and healthcare are all well represented in most lending portfolios and, overall, present an enormous collection opportunity for properly positioned organizations and their investors. This area is a poorly exploited opportunity for most lenders, yet can offer a compelling rate of return that is essentially a zero to most of these firms currently. That makes the opportunity worth exploring for virtually all CFOs now considering handling their debt defaults internally.
What are the greatest challenges for CFOs embarking on an in-house collection process?
In short, expertise, operations, and compliance are all essential to the successful debt collection process. To elaborate on that, the keys to success in this industry require a disciplined and comprehensive knowledge of the debt collection regulations in each state, an ability to evaluate the collectability of component parts of each pool of debt, and a network of licensed professionals in each state to pursue collection. This is a large burden for most lending institutions to build in-house. It has also given rise to debt buyers who attempt to handle the complexity of the process. Again, the “meaningful evidence of debt” laws surrounding the supporting account level documentation have changed all of that.
Lenders who retain ownership of their debt have often turned to outsourcing this debt collection and management process to collection network managers. But all debt collection vendors are not equal. For most, these vendors aggregate their debt accounts in one process. Therefore, you are typically just one of their many other creditors and debt buyer clients. Your data may very well be co-mingled with other creditor/debt buyer data. If so, this puts your confidential customer data at risk. Also, it is very likely that your data is captured in an antiquated, de-normalized muddle of data records in a data structure created in the 1990s which provides very limited analytical value back to the lender. I have developed a platform that can both segregate each pool of assets in the debt collection process and provide chief financial officers with the level of data detail required to ensure regulatory compliance as well as optimal liquidation performance.
This sounds compelling yet complicated. How important is technology to making this happen on a large scale and with repeatable results?
Technology is vital to success in this industry. One of the positives in taking on this additional burden is that CFOs can retain control and manage this debt with minimal investment in operational overheads. Technology can be the driver of this largely automated process, and with the right techniques, can generate exponentially more revenue through collection versus sell-off at rapidly falling prices. And not just automated data collection, but technology that delivers networked analysis and operational processing that can link disparate pieces of the process seamlessly to create information flow for tracking and communication at each step of this complex collection process.
In 2013, I built a proprietary technology platform, AsseroNetSM, which is a cloud-based, software system providing an easy-to-use, robust, and analytically-driven means of communication. The platform seamlessly connects my network of law firms across the country who deploy unrelated collection service providers, centralizing both the efficiency of its robust processing platform with a means of maintaining and tracking all necessary compliance and security practices throughout the network. This capability to connect multiple small entities with disparate processing practices through a centralized portal means that AsseroNetSM has been able to harness the power of a national network coupled with a unified and powerful central technology platform.
This expertise sounds pretty daunting for most lenders to acquire. So how do you see this process as a natural extension of their debt focus?
This is the $10,000 question—or, in the case of this debt collection area, more like a multi-billion dollar question. I see this not as a glass half-empty in terms of a process that’s just too hard to master, but as a glass half-full of unrealized potential. By that, I mean these portfolios of debt that are sold - yet still require a meaningful level of management by financial operations of banks and other lending institutions - have within them the pool of funds currently being ignored, for the reasons already mentioned - too hard to manage, too small a success rate on collection, too labor-intensive to deploy internal resources on in general.
Yet, imagine if a CFO could have access to a technology platform that could activate the collection process on this component of their debt portfolios and begin to convert the zeros they hold into collected assets for the lender? To use the “hidden treasure in the attic” analogy, this would be like unleashing a debt treasure hunter in the lender’s house to scour the small consumer debt portion of their portfolios hiding in the attic and unlock the monies that can be found within.
Doesn’t this all really come down to the legal collection process and what can be actually won back to the lender through lawsuits?
In a nutshell, yes. To get to the point where you can successfully prosecute such cases means that you have to know what you need to do and manage the data detail necessary to do it well. All while understanding and being licensed to pursue the national debt on a local and regional level with both technological and legal resources. This is one of the primary reasons why CFOs dread the concept of keeping this process in-house, and have sold it off or ignored it in the past. Now, more than ever before, a CFO needs a dedicated and skilled debt collection platform to work the process through the legal channels that ultimately provides a payoff for doing so.
What recovery percentage could you possibly hope for with small balance defaulted consumer debt?
I have designed and managed recovery strategies that have produced over 60 per cent collections on accounts placed for legal treatment. To illustrate the process within my own experience, AsseroNetSM has been used since 2013 by a national debt buyer to manage over 600,000 charged-off credit card accounts and a national network of collection agencies and law firms contracted to collect the debt. They have achieved this 60 per cent collection rate on low balance, sub-prime credit card portfolios, representing over $4 for every $1 spent on court costs.
This platform is scalable, capable of handling exponentially more volume, and can work the same way across the consumer lending platform with auto loans, student loans, healthcare loans and the like. That’s real-time, real money back in the pockets of the lenders.
How do you see this new role in debt collection taking shape for CFOs?
Optimally, a lender will align with an expert partner with the technology development and operational process expertise including litigation, and revenue share of the collected returns on this currently unexploited segment of their debt. Again, speaking from my own experience, with our proven track record of success in such collections, I believe CFOs will be excited to join forces with a technology-driven practitioner who has generated $4 on every $1 of litigation costs incurred in such activity.
The alignment requires them to educate themselves about the partner, but then step aside to let the process run. No additional resources are required from the lender to expedite the collection process. And, with a state-of-the-art data management collection partner, all relevant and regulatory information is tracked and retained for the lender to ensure compliance across all 50 states. This sounds like a true win/win scenario and an answer to what some CFOs had been viewing as a glass half-empty dilemma.
What excites you about the opportunities for this type of defaulted debt collection in the coming years?
For the first time, the impetus for ownership of the process by lenders is coming from the regulatory side to spur CFOs to take action on this portion of their debt portfolio. As a long-time provider of debt collection, I’m excited to see this congruence that aligns our forces on the collection of small consumer debt.
For CFOs in charge of consumer lending, a partnership with a turnkey debt collection specialist, harnessing the power of my technology platform and a national network of legal collection forces, means that conversion of the unrealized “attic treasures” in their debt portfolios is right on the horizon. I look forward to 2019 and the years to come as I help to build out a network of strategic alliances with these lenders.