Commercial Debt Sale / Commercial Debt Purchase (2003)

The current Debt Sale and Purchase Market is largely made up of the sale and purchase of delinquent receivables, particularly where the receivables are low value, high volume. This mainstream debt sale and purchase market place predominantly consists of delinquent financial receivables, in particular credit card debts and personal loan agreements.

Due to the significant values being traded in this market place, buyers of such debts have been required to have deep pockets in order to participate in the market. This has been the primary barrier to market entry and a major factor in this market place originally being structured as an oligopoly with a small number of debt purchasing companies making profits in a highly concentrated market.

The UK is now in its 8th year of debt sale, and it is evident that the market has undergone, and is continuing to go through, significant change. For example, by the end of 2002 there were 62 debt buyers, thus demonstrating that the marketplace had become increasingly competitive. The marketplace continues to grow today, aided by the fact that financing debt purchase is now easier than ever before with some major lenders setting up divisions that deal specifically with debt sale and purchase. For example, high street bank, Barclays, now has a specialist team set up purely to deal with debt sale. Not only to administer it, but also to search for qualified new buyers and to work with them generating the best possible price.

Despite the fact that the competition in the UK debt sale and purchase market has significantly increased at levels greater than increases in the availability of debt for sale, we do not see the debt sale and purchase market as being a maturing one (unlike some commentators). What we do anticipate happening is for the market to restructure itself somewhat, and for the market to move away from its focus on a single product area (consumer financial products) to develop niche segments of specialisation where similar product fundamentals exist. This ‘Second Stage' of market growth/ restructuring will occur as commercial awareness of the debt sale and purchase markets increases.

Will the UK Debt Sale and Purchase market continue to grow?

It is common for the UK credit markets to follow the trends that have prevailed in the longer- established US credit markets. If we take a look at the debt sale and purchase market in the US at the present time, we can see that a large proportion of the debts that are bought and sold are actually commercial debts. Initial commercial debt sales are likely to be in the form of receivables that are small in value and high in volume, and generally not a core focus of collection activities of the company selling the receivables ledger.

Debt purchase companies are also more able to produce increasingly sophisticated modelling techniques for the valuation of sales ledgers. This has been achieved through building data warehouses, developing partnerships with suppliers and constantly re-evaluating pricing models. This means that although the seller of the debt always has the informational advantage and therefore knowledge of the real value of receivables, the purchasing companies are able to make fairer assessments as to what the price of each individual debt should actually be, particularly if a purchasing company specialises in a certain industry.

In the instance where new or differing market segments become present in the debt sale and purchase market, the purchasing companies hope to adopt these models in order to take advantage of the illiquid market conditions that exist. Examples of non-financial delinquent receivables coming on to the debt sale market and being traded are Utilities and Telecommunications receivables (although the volumes of these trades are very small at present).

What evidence exists for this future growth?

In the US the debt sale and purchase market is well established. It is estimated that the face value of debt purchased was over $60 billion in 2000, which had a collection value of around $3.6 billion. (Credit Management Research Centre, (2002) “Debt Survey, 2001/2002 pp.89”)

Few commentators have been prepared to suggest the value of the debt sale and purchase market in the UK due to the limited availability of market data. However, in 1999, Rob Levick estimated the value of the UK debt sale and purchase market to be around £1 billion.

From the table above, we can see that the US debt sale and purchase market was estimated to be 4.78 times larger than the UK 's as a percentage of GDP for the year 2000. This suggests that the market in the UK has huge potential for growth

As a competitive market has already been developed for delinquent consumer receivables in the UK , we can suggest that if the UK is to achieve similar growth in this market, it will either come from commercial debt sale, or from non-delinquent receivables. The sale of non-delinquent receivables is now a common feature in the more competitive areas of the US debt sale markets as purchasers seek to maximise shareholder value by building up the value of assets on the balance sheet (at a relatively low cost), whilst sellers gain the benefit of instant profit and an added benchmarking tool against their own collection activities: a win-win situation for all concerned.

We would not expect to see the immediate entrance of non-delinquent receivables (debts either commercial or consumer) onto the UK debt sale markets at present due to the fact that many UK companies are still worried about their reputations being damaged if they sell on receivables at such an early stage. There is also the fact that we do not have efficient commercial receivables sales markets in place at the present time, thus meaning that sellers are unlikely to be offered efficient (generally higher) prices for their receivables.

The recent formation of the Debt Buyers and Sellers Group (DBSG) under the umbrella of the CSA organisation may help increase the listings of non-delinquent receivables, as their governance over this sector is geared to regulating debt sales and purchases within the framework of the CSA. This should therefore relieve worries about reputations being damaged and increase commercial awareness and therefore participation in debt sales (commercial and consumer, delinquent and non-delinquent).

If the DBSG can increase the commercial awareness of potential debt sellers and attract them to the market, it is likely that a greater number of buyers will also participate in the debt sale market. Due to the increased levels of finance available for debt purchase, the buyers entering this market are increasingly likely to be debt collection agencies (DCAs), particularly DCAs that specialise in collections for certain industries as they will have more specialist knowledge to accurately price the purchase of debts based on their experience in that area of collections.

This increased level of market participation will widen the spread of credit risk across the debt collection industry, thus increasing the efficiency of the debt sale market. It is this efficiency that should then stimulate further delinquent debt sales (particularly commercial ones) and further open up the sale of non-delinquent debt. It was similar market stimulation that acted as the catalyst for the growth of the credit derivatives market, shaping it to the way we know it today.

However, from our standpoint at The Credit Agency, not only do we predict that the commercial debt sale and purchase market will grow due to the primary sellers of debts being risk-averse, but we also predict that t third party debt sales will increase.

A further debt sale market - Insolvencies

A particular example of where the debt sale and purchase market is likely to open up to commercial debts is in the area of insolvencies. We believe that this will happen as part of the second stage of the growth of the debt sale market due to the fact that although Insolvency Practitioners get involved in the collection of debts, they are generally not specialists in this area of credit management. Their key function is to ensure that secured creditors are paid the monies owed to them and then to ensure that the remaining creditors receive a fair distribution of any monies remaining from the insolvency.

Assuming that the quality of the sales ledger of the insolvent company is good - i.e. the risk of default is low, the sales ledger can be accurately verified, and the debt sale market is liquid - the sale of insolvency sales ledgers is an ideal alternative to contingency collections for an insolvency practitioner.

The reasons we suggest this are:

1) Insolvency practitioners can increasingly focus on their core competencies.

2) Unsecured Creditors can be dealt with instantaneously as opposed to drip-feeding through funds.

3) Unsecured Creditors receive greater returns as collections costs are removed (thus reducing insolvency practitioner fees) and there is no lead-time for collection of monies to be borne, thus removing a further cost of credit.

4) Insolvency Practitioners will receive a fee for the sales ledger that is likely to be higher than the level of returns, if collections were carried out in house. The safer the debt, the easier collections will be, therefore competition for the purchase of the debt will be greater and the lower the profit margins debt purchasers are willing to make.

The benefits of points 3 and 4 are summarized by the equation below:

P SL > V SL – F – C

P = Price

SL = Sales Ledger

V = Value (after completed collections)

F = Fees incurred as a result of collections activities

C = Costs of credit incurred (lead times, loss of interest etc.)

Debt Sale / Debt Purchase Market Conclusion

The debt sale and purchase market is likely to continue to grow as greater market potential is unlocked through the creation of greater efficiencies in the market. This second growth phase will initially be stimulated through current market participants diversifying into other high volume, low value delinquent receivables.

This growth will continue to be fuelled through the sale of insolvency ledgers (where loss of reputation is not an immediate issue). We also anticipate that many Insolvency Practitioners will adopt the sale of receivables ledgers as a primary feature of their corporate governance so as to appear increasingly ethical (by generating greater returns for unsecured creditors) and by allowing them to intensify their focus on their core competencies.

Once these market conditions prevail, and the Institute's DSBG has established a clear set of guidelines for the sale and purchase of debt, an increasing level of non-delinquent receivables will appear on the debt markets. These debts will be bought and sold in niche market segments by various sizes of specialist collection agencies and debt purchasing agencies.



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