In the 16 years I’ve worked as a buyer of non-performing commercial leases, loans, lines of credit, and other commercial accounts, I’ve learned firsthand how to evaluate these so-called “charge-offs.” I’ve also learned that this routine evaluation process—which I and every other buyer of charged-off accounts undertake—remains a mystery for those who could stand to gain the most from it. Oftentimes, when I attempt to explain my business to leasing company executives, commercial or asset-based lenders, or anyone else new to the notion of selling their charged-off accounts, I am met with equal parts skepticism and curiosity.
“Why would you want to pay me money for my charged-off accounts?” is a typical reaction I receive. “We’ve charged them off because they don’t pay and are worthless,” we are told, “And we know they’re worthless because we’ve already tried to collect on them.”
Well, yes, they very probably are worthless to a lessor or lender who feels, quite sincerely, that he or she has exhausted every tool and technique available to collect on them. But to companies like mine that have made a business out of buying charged-off leases and commercial loans, they are our stock in trade. We buy charged-off accounts outright, paying cash up front for them, and then collect on them. We would not be in business if we could not do this profitably. Understanding how we evaluate the charged-off accounts we buy could help lessors and lenders recognize the hidden value in their own non-performing paper—the first step toward transforming their charge-offs into a source of revenue.
What You Don’t Know Can’t Hurt You—But It Also Won’t Generate Revenue
Dispelling a few common misconceptions about selling charged-off accounts can help lessors and lenders see firsthand how easy it is to transform a perceived worthless liability into a steady source of revenue.
First, many leasing companies or commercial lenders don’t realize that buyers of charged-off commercial accounts are experts at identifying the value of these accounts and successfully collecting on them. Remember, that’s the cornerstone of their business, and they have developed sophisticated analytical tools, a wealth of direct experience, and extensive databases of information on collecting on comparable accounts to help them determine a realistic valuation for the charged-off accounts they buy.
Buyers know the questions to ask: Are the lessees still active? Are there guarantees? What are the balances that are owed? How old is the charged-off paper? How many times has collection been attempted on it, and by whom? Is the debt secured? Is there value in any of the equipment, or has it been repossessed? What is the status of any litigation?
Answers to questions like these are critical to establishing the value of the charge-off.
The Collectability Factor
Buyers of charged-off accounts establish the value of those accounts by determining their likelihood of extracting any residual value out of the portfolios they purchase. A few general guidelines contribute to this so-called “collectability factor” and are often the foundation of any success the buyer realizes in making a profit on a given portfolio that has been purchased.
For example, most buyers will admit that commercial lines of credit that have been charged off are historically more difficult to collect on than a comparably sized secured loan or lease that has been charged off. Buyers of charge-offs recognize that a commercial line of credit is issued so that a company can use it to grow and build its business. They also know that growing, successful businesses that are generating revenue tend to pay their bills—especially the payments due on their lines of credit. By contrast, failing or failed businesses that have exhausted their line of credit do not pay their bills because they cannot; they have exhausted their line of credit in the final slide toward bankruptcy. Buyers will be very cautious in the purchase of a charged-off unsecured line of commercial credit because they know its collectability factor is in all probability quite low.
A charged-off truck lease is another type of account that traditionally has a very low collectability factor for the buyer. As with charged-off commercial lines of credit, a charged-off truck lease almost always indicates a bankrupt lessee. A trucker without a truck has no way of making a living—or lease payments. Inasmuch as the truck is the critical asset for revenue generation, if it has been repossessed, the chances of the lessee having any other assets—and the buyer collecting on the charged-off truck lease—are slim.
On the other end of the spectrum are equipment leases. Because leasing companies are acting essentially as a finance company, equipment lease agreements very often contain strong warranty clauses that ensure the lessor will get paid. Oftentimes, when leases fall into default, it is because the lessee has made a conscious decision not to pay—usually for reasons that wholly ignore the strength of the lease contract. These are cases where the lessee has stopped making payment because it is unhappy with the equipment, is receiving poor service, feels it has been somehow defrauded, or any one of a myriad of other reasons for why it doesn’t feel it should have to make its lease payments. Unlike the scenario of the previously mentioned charged-off unsecured lines of commercial credit, charged off leases are often the product of companies that still have money. Unfortunately for these lessees, the lease agreements they signed will withstand almost any of their claims for why they don’t feel obligated to pay. The collectability factor for buyers of charged-off leases is therefore typically quite high.
More Tools for the Buyer, Less Liability for the Seller
Once buyers of charged-off accounts have weighed the collectability factor of a portfolio and made the decision to buy it, they are able to succeed at collecting because they have greater freedom to pursue recovery than the seller may have been willing to exercise. It’s important to realize that once a lessor or lender sells a non-performing account to a buyer, all the seller’s ownership ties to it are severed. This means the buyer has far greater leverage available to pursue collection—leverage that the seller may not have wanted to utilize. The buyer always collects in its own name, whereas the lessor or lender’s in-house or subcontracted collection agency was always working for them, under their name, and potentially exposing them to the inevitable liabilities associated with the collections process. When charge-offs are sold, so too are any liabilities associated with their future collection.
Selling charged-off accounts is emerging as one of the most mutually beneficial relationships available between sellers and buyers of charged-off paper. Once sellers fully understand the benefits buyers are seeking and the unique tools they have at their disposal, they’ll be able to realize their own unique benefits as sellers.