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Consumer Debt: The Deeper The Hole, The Better For Business


When is bad debt good business? A small cadre of public collection agencies that specialize in the purchase of unpaid credit-card obligations and other bills is expected to get a lift next year as the so-far resilient consumer starts to show some signs of overload.

Consumers have borrowed a bundle in recent years -- to the tune of over $2 trillion in credit card and auto debt, according to the Federal Reserve. Add mortgages and the figure jumps to nearly $10 trillion. All in all, the average U.S. household is deeper in the hole than it was four years ago, carrying debt of about $9,200, up from $7,200.

Since household income isn't keeping pace with debt growth, more consumers are getting close to the edge. Credit card charge-offs, or the bad debt that banks and others write off the books, were expected to hit a record $65 billion in 2004, up from $57.3 billion in 2003, according to the Nilson Report, a consumer credit newsletter. Nilson forecasts the market for such debts will increase to $2.8 trillion by 2010.

Who makes money on these bad debts? If they aren't trying to collect on the loans internally or through a third-party collection agency, lenders -- banks, credit unions, auto finance companies, and retailers -- sell these bad loans in bundles to specialty companies, such as Englewood Cliffs (N.J.)-based Asta Funding Inc., NCO Group in Horsham, Pa., Portfolio Recovery Associates of Norfolk, Va., and San Diego's Encore Capital Group. The loans are typically sold at 3 cents to 5 cents on the dollar.

The more bad debt on the market, the less expensive the portfolios are. "Right now the banks are doing well, and delinquencies are low, so the market, and pricing, are a little tight," explains Andrew Zaro, CEO of Cavalry Investments LLC. It bought $1.7 billion worth of receivables through Sept. 30, a 55% increase from the third quarter of 2003, and a boost of its total portfolio to $13 billion. But with interest rates on the rise, the dollar sliding, and inflation looming, execs such as Zaro are betting the tides will soon turn. "Eventually...some of the debtors will have trouble meeting their obligations," he says.

Even so, consumers need not be in dire straits for these businesses to boom. Portfolio Recovery Associates went public last fall at $13, for instance, and hit $35 by yearend. Asta Funding had a record $22 million profit for the year ended Sept. 30, a 92% jump. Gary Stern, Asta's CEO, expects to exceed the $2.8 billion in purchases it made last year. "We're looking for more to buy," he says.

Ultimately, collection companies make their money from bad-debt portfolios by working out reasonable solutions with borrowers. The old days of terrorizing customers with threats is self-defeating, says Cavalry's Zaro: "If you don't help them, you don't help yourself."

By Mara Der Hovanesian


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