WLN Articles

Key Considerations For Selling Charged-Off Equipment Leases and Loans

For many asset managers, it may not seem worth the time and effort to ready a portfolio of charged-off accounts for sale to a debt buyer when those assets might generate cents on the dollar.

But take into account the reasoning of the largest commercial banks and credit card issuers, who regularly sell charged-off accounts to debt buyers, and the strategy may have beneficial applications for equipment lessors as well. In fact, more banks, bank-owned leasing companies, captives and independent lessors are discovering how to bolster their bottom lines by wrangling the trickiest of assets in their debt portfolios – those stagnant equipment leases and business loans – and selling them at the right time to a debt-buying partner.

In most situations, when a credit-issuer more closely examines – possibly through a net present value analysis – the liquidation assumptions of its charged-off portfolio (segmented by age and prior collection efforts), it may often find a debt buyer’s offer price to be higher than the company’s net recovery through internal and third-party liquidation efforts over time.

Further, the sale of distressed debts to a debt buyer can provide additional benefits as well:
• Lessens reliance on third-party agencies.
• Reduces costs associated with internal collections and management of third-party agencies.
• Generates revenue now vs. waiting months or years for collection efforts to yield value.
• Protects your brand – the effect of a debt buyer owning the purchased accounts outright, having a longer time horizon, and therefore, a strong incentive to work well with debtors and issuers for repeat business.
• Eliminates months or years of waiting without a guarantee of a return – a major benefit when factoring in the time value of money and economic cycles.
• Creates immediate liquidity from the sale of the charged-off debt portfolio.

One Perspective: Q&A With Asset Manager Of Top 5 Bank

Consider the reasoning of a senior asset management executive for one of the nation’s five largest banking institutes, which has regularly sold distressed commercial and consumer debts to a debt buyer for more than 10 years:

Q: How do debt sales fit into your overall recovery strategy?
“Debt sales typically are the end strategy for us. We start by trying to collect it in house, then we send it to an agency, and once it’s returned we sell it.”

Q: What is the timeline for these steps?
“For us, by the time they come back from the collection agency, they are approximately 12-to 18-months past charge-off date. It’s a 12-18 month life cycle within our recovery unit.”

Q: What factors drive your decision to sell debt?
“It’s strictly financial, quite frankly. If we thought we had the resources to work them and get a higher return than selling them, then we would do that. But we have finite resources internally, so it’s financially advantageous for us to sell them, take the cash and let someone else deal with collecting the debt.”

“We could place them with another level collection agency, but the net return on that — because the commission goes up with each level of agency you go to — doesn’t outweigh the price we could get to sell in the market straight out.”

Q: What are the most important things to consider when engaging with a debt buyer for the first time?
“You have to have a comfort level that the individuals with the debt-buying company are going to conduct themselves professionally and not cause any undue risk to the seller. We can write all kinds of indemnity agreements into the contract, but if things go wrong and customers decide they want to sue because they think the new owner of the account has wronged them, they’re going to sue the issuing bank along with the owner.

“When we’re considering selling debt we treat the relationship with the debt buyer like a partnership, because you have to really understand whom you are working with. In most cases, the issuing bank is going to have much deeper pockets than the debt buyer, so if someone’s going to hire an attorney and file a lawsuit because of actions by the debt buyer, they’re going to sue the issuing bank. You have to be very careful who you partner up with.”

Q: So you are also factoring your company’s reputation into your decision?
“Yes. I think people should consider what the buyer is going to do with the debt. Ideally, you want to sell to somebody who is going to work the debt and not flip it and resell it multiple times, which ultimately has an impact on our reputation with our customers. It’s important to understand the debt buyer’s strategies.”

Q: What do you look for in a debt-buying partner?
“We look for stability. We look for how long they’ve been in business and what their strategies are. We try to understand whom we are dealing with as individuals, so we always meet the principal folks.

“We don’t always sell to the highest bidder. If the highest bidder is someone we think is going to create for us additional risk, we’ll take a few less dollars to have someone who gives us a higher comfort level.”

Q: What else would you like to add?
“I would say that selling debt is certainly a very viable recovery strategy, but it’s only viable if you have a product you can get the right price at and if selling the debt isn’t going to cause any undue risk.”

The Debt-Selling Application For Equipment Lessors And Other Credit Issuers
When it comes to selling distressed assets to a debt buyer, the key drivers for commercial banks and credit card companies also apply to smaller banks, lessors and other credit issuers. They include:
• Accelerating income and cash flow.
• Satisfying cost-reduction objectives.
• Coping with limited in-house staff and time to manage bad debt portfolios.
• Benchmarking market conditions (debt buyer prices) against their own recovery results.

Currently, credit-card debt comprises about 70 percent of the accounts sold to debt buyers, with the remainder made up mostly of automobile loans, retail accounts, personal loans, utility bills, telecommunications debts, medical bills, and primary and secondary mortgages, according to published industry reports. Commercial equipment leases and business loans are a smaller but rapidly growing segment for major lenders and lessors as well.

How does the strategy apply for equipment lessors? Generally speaking, debt buyers will purchase equipment loans and leases with or without collateral still in place, although prices will vary dramatically depending on collateral status. This also means prices paid for debt will vary, but in general, expect the debt to garner anywhere from 2% to 12% of the debt’s face value. To come up with an offer price, the debt buyer will compute an anticipated recovery rate for the debt that depends on the age, remaining balance, prior collection efforts, collateral status, and credit scores or other debtor profile data.

It’s important to note: If a leasing and finance company averages a 20% net recovery on all charged-off accounts across a three-to-five year period, a debt buyer’s price to purchase the distressed assets today may be equal to or better than the recovery when considering the time value of money.

As familiarity with the debt-selling process grows within the leasing and finance industry, more lessors are likely to make sales of charged-off assets a regular practice, one that will generate a new revenue stream, ease the burden of managing distressed debt and provide brand protection in the process.