How to streamline a debt portfolio to maximise the gain from a successful asset sale. A Decision Analytics briefing paper from Experian

Transcription

1 How to streamline a debt portfolio to maximise the gain from a successful asset sale A Decision Analytics briefing paper from Experian January 2010

2 Introduction As the recession continues to bite, it has become increasingly important for businesses to improve cash flow and reduce balance sheet liabilities. A strategy which can accomplish this goal is the selling of debt to a third party for collection, which seeks to gain value from debts which might otherwise be written off. Managing the process strategically enables in-house resources to focus on performing debts and reduces capital adequacy requirements on the balance sheet. In the last decade the debt sale market reached its peak, industry profits soared and created a win-win situation for both buyers and sellers. Cheap consumer credit was readily available, resulting in a rise in the volume of consumer debt being sold and a buoyant debt sale market. However, the business of debt sale has been severely impacted by the recession and debt sale prices have fallen dramatically, driven by purchaser uncertainty and the sheer volume of debt in the market. Following many years of liberal purchasing and subsequent losses, investor confidence is low and funding committees now insist that debt purchase panels have a clear line of vision for the future performance of newly purchased portfolios. Consequently, this has made the debt sale process much more difficult for sellers. Although market experts predict that the debt sale industry will recover, it is unlikely to ever return to the previous model. To achieve success in this difficult market, creditors need to adapt to the situation. This briefing paper explores the ways in which a debt portfolio can be segmented in order to appeal to purchasers and gain the best price as well as the key factors to consider for a successful asset sale. Debt sale management Despite current economic difficulties, the opportunity for businesses to gain value from non-performing debt still remains, especially if the sales process is managed well. The key to successful debt sale management is to ensure that the right accounts portfolio is sold at the right time to the right buyer. Understanding the current market, the appetite of debt purchasers and the drivers behind their funding decisions is crucial. Buying habits have changed dramatically and the successful sellers will be those who recognise where value lies and can organise and align portfolio assets appropriately. Clean, well segmented and externally validated data will provide purchasers with confidence in the quality of assets they are buying. Portfolio Analysis In the first instance, the debt seller should consider a portfolio analysis to identify and evaluate a range of debtor groups, via the process of segmentation. This will allow the business to assess the value of each group and the financial implications behind a sale. In recent years, sellers have struggled with accurate provisioning levels and downward price trends have resulted in some debts being retained longer than Streamlining a debt portfolio for maximum asset sale - 2

3 usual. Segmentation should always be steered by the organisation s provisioning policies and should satisfy these policies appropriately, to maximise value. Ultimately, segmentation is driven by behavioural scoring; a process to ensure that good customers are retained by the business and subjected to further collections treatment, leaving all other accounts in a debt sale portfolio, ready to segment and sell on. Powerful decision engines used in scoring can accurately fulfil any business debt strategy and ensure that all remaining good accounts meet the collections system capabilities. The behavioural scoring process gathers client data internally and highlights trends concerning the recent history of a particular type of account. It will consider factors such as the average balance in the past three or six months, the number of missed payments and the highest/lowest balance over time. A business strategy may dictate that all gone away accounts should be sold on but ignores the importance of customer relationships. Fortunately, behavioural scoring is aimed at a customer level, so as not to destroy a customer relationship by making a decision to sell on the basis of one bad account if the customer has a number of other accounts that are performing well. Intuitive decision engines used in the scoring process will also determine a customer s propensity to pay, which is a crucial factor. Historically, debtors were classed as either those who can t pay, or those who won t pay and the recent economic crisis has resulted in a surge of the former. It is incredibly important for sellers to pool information across all accounts belonging to a customer, to get a clearer picture of their value and their propensity to pay. Only then will the business know which customers to retain, and which accounts to sell on. Segmentation Once debt sellers have established which customers to retain, they can begin the segmentation process for the remaining debt sale portfolio accounts. Sellers need to understand the range and quality of portfolio assets and segment data effectively, to guarantee that buyer requirements are fulfilled. A specialist decision engine will fuel this process and allocate debtor accounts strategically. Typically, debt portfolios are segmented by specific products, as standard collections best practice would dictate. However, this is not always the best way to optimise a balance sheet and drive up economic value. Debtor accounts should be segmented on a variety of characteristics relevant to the buyer s internal processes and collections specialities. Across a typical debt portfolio there will be various types of indebted account and assets may cover trace accounts, shortfall recoveries, unsecured loans and litigation. In turn, the debt purchase market comprises a number of specialist and general debt purchase organisations, whose buying habits and capabilities vary. The most attractive proposition for a potential buyer is the best segmented portfolio with the cleanest data, so portfolio assets should be sub-divided into segments that are commercially meaningful. A dedicated debt management system will ease this process and allow sellers to further organise portfolio data, depending on market demand. Sellers should ensure that each sales segment contains clean, precise data and contains only those accounts which appeal to the buyer. The number of segments will depend on the purchaser s budget and their capacity in terms of how many accounts they can take on operationally. Ultimately, fine tuning asset portfolio segments to specific markets and buyers will attract a sale. Streamlining a debt portfolio for maximum asset sale - 3

4 How to sell One of the first priorities in the debt sale process is to ensure that both buyer and seller are matched, not just for their own financial advantage, but in terms of market aims. Debt sellers need to align their sales approach to market conditions and understand the buying appetite of purchasers. As previously highlighted, the segmentation process should be executed with buyers in mind. Well segmented, organised data will help the seller put together an appropriate sales package, typically containing three or four bundles of debt. The sales package and supporting sales collateral should be targeted at specific markets and should offer an in-depth explanation of contents to reassure purchase panels and their nervous investors. The diagram below highlights the key stages of the debt sale process: Seller Know the market Segment Package/collateral Pitch Purchase Panel Buyer Funding confidence Investor Funding confidence Understanding how to buy/sell in the current economic climate Typically, the bidding process is divided into three rounds; first, second and final round bidding. It is important that the debt seller has clear knowledge of purchase power and the opportunity to have dialogue with the purchasers is key; sellers need to understand what drives them. Debt sellers also need to apply a suitable price modelling strategy to their debt portfolios and should consider how to get the best possible price. Getting the best price Historically, debt sellers sought to gain the highest possible price for their debt portfolios, but this is no longer viable; they now need to look for the best value. The longer an account is in collections, the higher the cost to collect, so the cost of collections effort needs to be weighed against how much a segment can be sold for. The perceived value of a segment often rests with the debt purchaser and the higher bids will be for a package that promises to offer value. In other words, debt purchasers will pay the right price if the segment matches their buying requirements and operational capabilities. Another consideration is the level of perceived risk found across portfolio segments; debt purchasers are unlikely to pay for a sales package that contains high risk accounts and are increasingly considering past price models and purchase assets based on historical performance. In response to this, debt sellers should align their price modelling in accordance with previous performance of similar asset portfolios. Streamlining a debt portfolio for maximum asset sale - 4

5 Moreover, as a result of the economic crisis, investment banks are hesitant to offer funding for debt purchase and many support the growing trend for performancebased pricing and purchasing. In essence, this model allows debt purchasers to test the water and obtain asset portfolios without paying the full price up front. Purchasers may buy portfolio accounts one by one, carefully monitoring the performance of each group before buying again. Buyers and their funding committees may be keen to pay for a proportion of the portfolio at once and the remaining proportion once it has performed as this helps to mitigate risk. Alternatively, buyers may agree for debt to be managed on a contingent basis for a set number of months, with the right to buy after an agreed placement period. Others may choose to employ a shared upside arrangement, sometimes with a guaranteed minimum return. Debt sellers should welcome these strategies and offer a flexible purchase plan to potential buyers, showing an understanding of risk averseness and further highlighting their own market expertise. Conclusion The debt sale process has changed dramatically and the market is showing few signs of a full recovery. With mainstream funders moving away from the market, funding is hard to secure because investors are demanding higher returns. In addition, the shift in supply-demand dynamics caused by substantial bank losses and dropping purchaser demand has caused significantly lower portfolio prices. In spite of the challenging environment, sale remains the best tool for maximising returns and reducing operational risk. By focusing on deals that work, the market will begin to stabilise and liquidity will improve. Sellers need to understand the market and, specifically, what buyers are looking for. They should then segment asset portfolios to make them look attractive, with comprehensive sales collateral, flexible pricing policies and clean data. When sellers embrace a new approach to debt sale they will instil confidence in investors and purchasers and earn the business an excellent reputation. The debt sellers best placed to gain value from the debt sale process are those who adapt and modify their internal processes and sales strategies and can prove the quality of their assets in a difficult market. Streamlining a debt portfolio for maximum asset sale - 5

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