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New Profits in Old Debt

Date: Mar 05, 2012 @ 07:00 AM
Filed Under: Portfolio Management
Related: Collections, Economy

Equipment finance industry executives are exploring every aspect of their businesses to figure out how to increase their profits. Because of the stagnant economy, bookings and new sources of revenue are flat, so increased profits have to come from cost reductions and other sources. One of these other sources can be found in an often-overlooked area:  the collection department. Many of the largest companies in the equipment finance industry have learned that their charge-offs, which even their collection agencies cannot collect, still have value.  In fact, there are companies that will purchase those charge-offs.

Brand Protection

Buyers of charge-offs share a major concern with the seller. The buyers want to protect the brand and reputation of the sellers. To do so, immediately upon closing a purchase, the buyer will notify the obligors that the buyer now owns the obligations and that the obligors should deal only with the buyer. The obligors always deal with the buyer as the new owner of the obligation, and they never insist on dealing with the seller.

The purchase/sale agreement limits the buyer’s use of the seller’s name in the buyer’s pursuit of the obligors on the purchased accounts. The buyer is restricted to using the seller’s name for two purposes only:  first, on the initial correspondence to the obligors to identify the buyer as the new owner of the account and, second, in the body of the initial pleading to show chain of title if the buyer files suit to collect on an account. In the rare instances where the obligors threaten to bring the seller into a suit, the buyer will dismiss the suit and release the obligors.

The purchase/sale agreement also prohibits the buyer from, in any way, suggesting that it is acting as the agent, or on behalf of, the seller.

All this is done to protect the sellers from any involvement with the charge-offs after they are sold and to ensure that the buyers will do nothing that can reflect negatively on the seller.

Benefits of Selling Charge-offs

There are many significant benefits to selling charge-offs and, frankly, no liabilities.

First, selling charge-offs is the easiest way of converting them into cash and improving cash flow. Once sellers complete their first sale of their charge-offs, they often see how easy it is to realize cash on these assets, and they are likely to start a proactive arrangement where they automatically sell their charge-offs, usually monthly or quarterly. The revenue from the sales then becomes a line item in their budgets that they can count on going forward.

Second, since these assets have been charged off the seller’s books as having no value, the purchase price is a “recovery” for accounting purposes. Therefore, the total purchase price goes directly to the seller’s bottom line as profits.  As a business strategy, many equipment finance companies will do end-of-the-year sales of their charge-offs to increase their annual profits.

Third, some companies sell their charge-offs as soon as they determine they cannot collect them internally instead of referring them to collection agencies. These companies have learned that the purchase price is more than they are likely to recover by using collection agencies. This allows the sellers to better manage the productivity and head count in their collection department by eliminating or redeploying those people who were dealing with the collection agencies.

Fourth, another reason some companies are selling charge-offs is that they have become uncomfortable using collection agencies. By the nature of their legal relationship with the seller, collection agencies are acting on behalf of, and representing, the owners of the charge-offs, so everything and anything that the agencies do to collect ultimately reflects on the account owners. These days, collection agencies are being more closely monitored and are increasingly being charged with violations of the law by governmental regulatory authorities for their use of illegal collection tactics. The last thing equipment finance companies need or want is to be associated with or responsible for any illegal actions by the collection agencies they have hired.

Fifth, buyers will agree that they will not resell the charge-offs. That way, the sellers do not have to be concerned that any possible secondary or ultimate buyer of the charge-offs will do anything that will reflect negatively on the seller.

When to Sell

There are two times in the collection process when the owner of the charge-offs should consider selling.  The first time is when the owner determines that it has exhausted its efforts to collect internally. Selling at that time will avoid the collection agency issues and possible liability for the collection agency activities done on behalf of the owner. Additionally, the owner will realize a significantly higher and more certain return because the entire sale price is paid at the time of the purchase and the amount of the sale price is higher than recoveries from the collection agency.

The second time to sell is after collection agencies have tried to collect and have failed. In this instance, the sales proceeds are truly found money because there is nothing further that the owner of the charge-offs can do to collect.

Reaching Higher for Profits

Unlike collection agencies, which are often motivated to pick only the low-hanging fruit of the charge-offs they are given, charge-off buyers are experts at reaching higher by identifying collectible charge-offs and successfully collecting on them. Because of their expertise at recognizing value, they are able to offer substantial prices for the charge-offs they buy. 

Here’s How It Works

Selling charge-offs is a very easy process. The sellers’ due diligence efforts consist of preparing an electronic spreadsheet of information from its database. The information is usually the account number, the names and addresses of the obligors, the unpaid balance, and the date of last payment. The buyer will perform its due diligence on this information and develop an offering price for the charge-offs. If the price is acceptable, a purchase/sale agreement will be prepared, and the transaction will be closed. The entire transaction, from the time the buyer receives the spreadsheet to closing, usually takes no more than one week. 

If the parties will have a forward flow arrangement, no due diligence will be required after the first transaction. The parties will agree on a price for subsequent transactions, and the purchase/sale agreement for the first sale will provide the terms for all subsequent sales. The only document required for each new sale under such an arrangement will be a bill of sale. At the time of each sale, the seller will simply e-mail the buyer a spreadsheet of accounts it wishes to sell, showing the account number, the name and address of each obligor, the date of last payment, and the outstanding balance. The buyer will then pay for the charge-offs by overnighting a check or making a wire transfer of the purchase funds.

Concerning back-up documentation, at the first sale the parties will agree on how the back-up documents will be made available to the buyer. Today, most of the documents are stored electronically, and the buyer is either given limited access to the seller’s database or the seller burns the data to a CD or DVD. 

Conclusion

Selling charge-offs is an easy way to convert an uncollectable asset. Many of the largest equipment finance companies have recognized its value and have included selling charge-offs as part of their annual business plans. It’s found money and found profits. 

- View TBF Financial LLC's Company Profile



Robert Boehm
Principal | TBF Financial LLC
Until 1998, Robert Boehm was a successful practicing attorney representing banks, finance companies, and leasing companies. Boehm observed that his leasing clients had accumulated uncollectable leases that they and their collection agencies could not recover. Boehm then organized TBF Financial LLC for the purpose of buying charged-off equipment leases, and today the company has become the premier purchaser of charged-off equipment leases.
Comments From Our Members

Kevin Lewis
Great article. Against the backdrop of a slowly stabilizing economy, charge-off rates are declining, which is causing debt prices to increase. For that reason, as well as the opportunity present value future cash flows and redeploy people to other areas, we are also seeing more and more banks and finance companies selling their non-performing assets.

Kevin Lewis
SquareTwo Financial
3.8.2012 @ 11:51 AM
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