Debt ColleCtion & Debt buying

[Pages:27]Debt Collection & Debt Buying

The State of Lending in America & its Impact on U.S. Households

Lisa Stifler and Leslie Parrish April 2014



Center for Responsible Lending

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An Introduction to Debt Collection and Debt Buying

O nce a consumer obtains a loan, an entirely different set of actors and rules comes into play in collecting the loan should it go into default. For many consumers, defaulting on a loan is inevitable when unemployment, medical emergencies, or some other financial crisis leaves them unable to cover the payments. The Great Recession only made this outcome more likely for more U.S. households. Currently, more than one in seven adults is being pursued by debt collectors in the U.S., for amounts averaging about $1,500 (Federal Reserve Bank of New York, 2014).

Currently, more than one in seven adults is being pursued by debt collectors in the U.S., for amounts averaging about $1,500.

If a borrower is unable to make payments on a loan for a certain period of time, the lender will typically deem the obligation to be in default and attempt to collect on the debt. The lender can do so by pursuing the borrower itself using an internal collections department or by outsourcing collection activities to a third-party debt collector or law firm. The lender generally will also report the debt to the major credit reporting agencies (CRAs).

The third-party debt collection industry has grown tremendously over the past few decades, with 2010 revenue more than 6.5 times that of 1972, after controlling for inflation (Hunt, 2013). The industry's participants make more than one billion consumer contacts annually for hospitals, government entities, banks and credit card companies, student lenders, telecommunications companies, and utility providers (Hunt, 2013).

The federal Fair Debt Collection Practices Act (FDCPA) prohibits unfair, deceptive, and abusive debt-collection practices, such as threatening consumers, misrepresenting consumers' rights, and making harassing phone calls. However, the FDCPA only applies to third-party debt collectors and thus does not apply to creditors--such as many banks and hospitals--that collect their own debts. The Consumer Financial Protection Bureau (CFPB) has the authority to write and enforce rules related to this statute and can also examine "larger participant" debt collectors for compliance. In many states, debt collectors must be licensed in order to collect debts in the state and thus are also subject to state oversight.

Although debt collection plays an important role in the functioning of the U.S. credit market, it may also expose American households to unnecessary abuses, harassment, and other illegal conduct. The Federal Trade Commission (FTC) received over 200,000 complaints about debt collection in 2013--second only to complaints regarding identity theft (FTC, 2014a).

As federal and state regulators look at ways to address debt collection abuses, a growing concern is the expansion of the debt-buying industry (FTC, 2013). Debt buyers are specialized companies that purchase charged-off or other delinquent debt from credit card companies, banks, and other creditors for pennies-on-the-dollar. These companies then attempt to collect the debts themselves or through collection agencies or law firms. Some debt buyers also repackage and sell the debt they have bought to another debt buyer, either almost immediately or after already having attempted to collect the

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The State of Lending in America and its Impact on U.S. Households

debt. Credit card debt is the most prevalent type of defaulted debt purchased by debt buyers. Debt buyers also purchase student loans, medical debt, utility and phone bills, tax liens, car loans, and mortgage and auto deficiencies.

When debt buyers acquire portfolios of charged-off debt, they rarely purchase documentation of the debts, but instead purchase an electronic file containing limited information on all of the debts in the portfolio. These portfolios are typically sold "as is"; often, account information is inaccurate, outdated, or missing, particularly if the debt is resold multiple times. The inaccuracies and lack of basic information--as well as the collection tactics used by debt buyers--result in consumers being harassed and wrongly sued for debts they do not owe or have already paid or settled, and courts around the country are overwhelmed by a flood of cases filed against consumers.

Consumers have no say in whether and to whom their accounts are sold and are not informed when the debt they owe has been sold. Instead, they receive an onslaught of collection phone calls, letters, and e-mails from a company they do not know.

Consumers have no say in whether and to whom their accounts are sold and are not informed when the debt they owe has been sold. Instead, they receive an onslaught of collection phone calls, letters, and e-mails from a company they do not know. Sometimes consumers learn of collection attempts only after having been sued or having had a default judgment entered against them, often when they discover their wages being garnished or their bank accounts frozen.

As described more fully later, consumers (many of whom are of low and moderate incomes) are being sued for old debts without their knowledge and often with little proof of the claims. As a result, debt-buying companies are taking advantage of financially-distressed consumers and have overwhelmed state court systems, extracting billions of dollars in judgments against consumers around the country for debts that may not even be owed.

Center for Responsible Lending

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Market and Industry Overview

Industry Beginnings and Growth

The large-scale sale and purchase of charged-off debt portfolios had its start in the aftermath of the savings and loan crisis. In 1989, Congress created the Resolution Trust Corporation (RTC) to deal with insolvent and soon-to-be insolvent thrifts by closing, selling, and merging institutions as well as disposing of thrift assets to the private sector (Davison, 2005). In order to rid itself of thrift assets quickly, the RTC began selling the assets in bulk sales to companies that began buying, collecting, and profiting from the low-cost debt portfolios (Davison, 2006).

The FTC considers debt buying to be one of the most significant changes in debt collection in recent years. Revenue in the debtcollection industry has increased by more than six times the levels of the early 1970s.

Since the 1990s, the debt-buying industry has grown substantially, with companies shifting toward buying (and re-selling) charged-off consumer debts. Three main trends have spurred industry growth: increasing availability of consumer credit, particularly credit cards, in the 1990s and 2000s; higher delinquency and charge-off rates in the 2000s; and the routine incorporation of sales of charged-off debts into creditor accounting strategies (FRB, 2013; FTC, 2013).

The FTC considers debt buying to be one of the most significant changes in debt collection in recent years (FTC, 2010). Revenue in the debt-collection industry has increased by more than six times the levels of the early 1970s (FTC, 2010). According to the FTC (2013), credit card debt consistently makes up the majority of debt sold to debt buyers. The FTC's own analysis of more than 5,000 debt portfolios found that credit card accounts made up 65% of the face-value of debts purchased and represented 44% of the total number of accounts in those portfolios (FTC, 2013). However, while credit card debt will remain a significant portion of debts purchased by debt buyers, decreasing charge-off rates and amounts in recent years1 and changes in banks' sales practices mean that debt buyers are looking to purchase other types of debt, including cell phone bills, auto loan deficiencies, student loans, and mortgage deficiencies (FRB, 2013; OCC, 2013; Hebeisen, 2012).

1 According to Federal Reserve Board statistics, charge-off rates of credit card debts (and other consumer loans) peaked in 2010 (FRB, 2013). Similarly, the OCC recently reported that charge-off amounts by the 19 largest banks have declined from their peak of $130 billion in 2010 to $67.8 in 2012, a 48% decline (OCC, 2013).

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The State of Lending in America and its Impact on U.S. Households

Figure 1: Type of debt acquired by large debt buyers, as a share of total accounts purchased

Auto Loan 1%

Other 9%

Utilities/Telecomm 17%

Credit Card 44%

Consumer Loan 1%

Source: FTC, 2013

Medical 28%

Figure 2: Type of debt acquired by large debt buyers, as a share of total face value of debt

Other 11%

Auto Loan 7%

Utilities/Telecomm 6%

Consumer Loan 4%

Medical 7%

Credit Card 65%

Source: FTC, 2013

Center for Responsible Lending

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The Debt-Buying Market

Debt Buyers

Although expansion in the debt-buying industry has slowed in recent years, it remains relatively new and growing. DBA International, the industry's trade association, reports it has over 400 debt-buying company members, in addition to associated vendors (DBA, 2007). The majority of debt buyers-- including the largest debt buyer, Sherman Financial Group--are privately-held companies. Only four companies are publicly-traded.2 As a result, only sparse data and other information are available on the size and attributes of the industry as a whole, although reports in recent years shed some light.

From 2006-2009, the top nine debt buyers purchased more than 5,000 portfolios comprising almost 90 million consumer accounts for about $143 billion of consumer debt.3 These companies paid less than $6.5 billion for the debt, or about 4.5 cents-per-dollar (FTC, 2013). Publicly-traded debt buyers, as well as the larger privately-held ones, purchase large portfolios of credit card and other debt from originators (DBA, 2007). This market is heavily-concentrated: These nine debt buyers purchased three-quarters (76%) of all consumer debt in 2008 (FTC, 2013).

Over the past decade, debt buyers experienced significant revenue growth, despite the Great Recession. Analysis of company 10-K public filings between 2003 and 2012 shows that Encore Capital Group saw a 373% increase in revenue, and Portfolio Recovery Associates experienced almost 600% revenue growth. These increases in part result from larger debt portfolio purchases and changes in collection strategies and technologies, including an increased focus on using lawsuits to collect the purchased debts.

Debt Sellers

Banks are the most common entities that sell charged-off consumer debt, as they originate some of the common debts purchased by debt buyers: credit card balances, student loan debt, mortgage deficiencies, auto loan deficiencies, and other forms of consumer credit. Other common debt sellers are healthcare providers, telecommunications companies, utility service providers, and municipalities.

Bank debt sales are highly concentrated among the largest banks. According to the Office of the Comptroller of the Currency, the 19 largest banks make up the majority of bank debt sales, with 82% of annual total average sales of debt concentrated among the five largest banks (OCC, 2013). Over the past few years, those 19 banks sold approximately $37 billion in charged-off debt annually (OCC, 2013). In part because of increased regulatory focus, at least two banks--Wells Fargo and JPMorgan Chase--stopped selling charged-off debt in 2013 (Aspan, 2013; Aspan & Horwitz, 2013).

2 These publicly-traded debt buyers are Encore Capital Group, Inc.; Portfolio Recovery Associates, Inc.; Asta Funding, Inc.; and SquareTwoFinancial Corp. Encore Capital Group acquired another previously publicly-traded company, Asset Acceptance Capital Corp. in June 2013 (Encore Capital Group, 2013b).

3 More than 80% of these debts were acquired from the original creditor (FTC, 2013).

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The State of Lending in America and its Impact on U.S. Households

Sale and Pricing of Debt

Various factors--including the demand and availability for the type of debt, age of the debt, and number of times it has been placed for collection or sold--influence charged-off-debt prices (GAO, 2009). The constriction in the credit market since the Great Recession has resulted in the lower supply and higher prices for charged-off debt portfolios (Collections & Credit Risk, 2011). In addition, debt becomes less expensive as it ages or is sold multiple times. The FTC's recent analysis of approximately 3,400 debt portfolios bears this out, finding that the average price of debts was 7.9 cents-on-the-dollar for debts less than three years old, while essentially nothing for debts older than fifteen years (FTC, 2013). Other factors that can influence the price of the debt include the geographic location of the accounts 4 and the amount of documentation included for the debts in the portfolio5 (GAO, 2009).

Figure 3: Cost of buying $1 of debt by the age of the debt

$0.09 $0.08 $0.07 $0.06 $0.05 $0.04 $0.03 $0.02 $0.01

$-

7.9 cents

3.1 cents

2.2 cents

< 3 years old

~0 3-6 years old 6-15 years old > 15 years old

Agreements Between Buyers and Sellers of Debt

The purchase and sale agreements between the portfolio seller--typically a bank--and the debt buyer dictate the price and face-value of the debt being sold. The agreements also outline what is being sold to the debt buyer: the types of debts included in the portfolio, the information accompanying the accounts, the accuracy of the account information, and any documentation supporting the accounts.

When the seller is the original creditor, the seller controls portfolio creation and dictates which accounts are included in the portfolio (FTC, 2013). The seller also determines what account and portfolio information is shared with prospective debt buyers in the bidding process prior to the actual sale (FTC, 2013). The seller is also the party that tends to dictate the purchase-and-sale agreement contract terms (FTC, 2013). These contracts dictate which debts are included in the portfolio, the

4 Debts located in states where debt collection laws or statutes of limitations are less favorable to debt collectors or debt buyers are less expensive.

5 The more documentation associated with the accounts, the higher the price will be, all else being equal.

Center for Responsible Lending

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pricing, the information that flows with the accounts at the time of sale or is available later, the resale of the debts, and any guarantees (or lack thereof) on the debts and accompanying information.

When debt buyers purchase debt portfolios, they receive an electronic database or spreadsheet (or access to such a database) summarizing the debts included in the portfolio (DBA, 2007). These files often include only a name, last known address (sometimes the address on the original credit application), the amount allegedly owed, the charge-off date, and the date and amount of the last payment (FTC, 2010). Notably, very few portfolios include documentation for the debts being sold. Based on an analysis of 3.9 million accounts purchased by six of the largest debt buyers from March to August 2009, the FTC estimated that debt buyers received documentation for as little as six percent of the accounts at the time of purchase (FTC, 2013).

Figure 4: Share of accounts with documentation provided at time of purchase

Provided 6%

Not provided 94%

Source: FTC, 2013

Further, charged-off debts are often sold "as is," without any representations, warranties, or guarantees as to the accuracy of the amounts claimed to be owed or the collectability of the debts (Horwitz, 2012). Although some contracts allow debt buyers to obtain documentation of the debt for a small percentage of cases or for a certain period of time, subsequent purchasers of the debt often either are unable to obtain documentation from the original creditor or have to rely on previous purchasers of the debt to obtain the documentation (GAO, 2009). Even if a debt buyer may have the contractual right to obtain documentation from the original creditor, the creditor may no longer have such documentation or, if it does, may charge a high price for it (Holland, 2011).

Collection Practices

Like original creditors, debt buyers use a variety of practices to collect on the debt they have purchased, including keeping the collection attempts with their in-house operations or outsourcing the collection actions to other collection agencies or law firms (GAO, 2009). The collection activities range from using phone or mail contacts with the help of technologies like skip-tracing and predictive dialing systems to track down consumers, to reporting debts to credit bureaus and refinancing the debts into new credit products (FTC, 2008; GAO, 2009).

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The State of Lending in America and its Impact on U.S. Households

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