With headlines pointing toward a likely economic downturn - Deloitte, for instance, expects Canada to enter a recession in Q2 - it’s likely time to revisit the recession playbook. But I wish to focus on my favourite chapter - collections. Specifically, should you hold on to your bad debt portfolio and ramp up collection efforts, or sell it to build up immediate liquidity?
Perhaps you plan to do a bit of both. Whatever the strategy, here’s a concise framework to help guide your approach as economic conditions evolve.
Sell
During times of economic uncertainty, debt sales form an alluring part of a company's collection policy. Perhaps debt sales already play a significant part of your business-as-usual collections approach. Whether you are considering it for the first time, or it's already a steady component of your collection strategy, ensure you pay attention to the following:
Depressed prices - By selling debt, you are locking in a predictable cash flow in the immediate term, rather than having to wait. Whether you are raising funds for investment in more lucrative ventures, looking to build a rainy day fund during times of hardship (such as an impending recession), or simply hoping to improve your financial statement for borrowing purposes, debt sales can be a handy tool to obtain a source of cash at a pinch.
That said, the debt buying industry would not exist if there was no money to be made. You must accept that by taking the debt sale route, you are handing over long term profits for short term gain. That’s not necessarily a bad thing, but you’re going to want to make sure that when you shake hands with a debt purchaser, they don't take your fingers with them.
Keeping up-to-date NPV models on your bad debt portfolio's long-term value is going to be critical in making the decision to sell debt and at what price. Recessions in particular are a time when debt buyers will be looking to take advantage of the uncertainty and your anxiety. As the supply of bad debt for sale increases, it may start to outstrip demand from debt buyers. This combined with an increase in cost of borrowing from rising interest rates for debt buyers culminates in depressed prices buyers can offer. During the Great Recession of 2008, the value of credit card bad debt portfolios more than halved, falling from a high of 14 cents on the dollar in 2007-2008 to between 4 and 7 cents on the dollar.
Getting your debt to market early - before the full scale of the downturn is reflected in pricing - may yield better offers. But be prepared to walk away if the price doesn’t align with your portfolio’s intrinsic value.
Residual OPEX - For most businesses, collections is not their primary focus. A debt sale can provide, on the face of it, a seamless way to still tend to your bad debt without getting stuck in the weeds, allowing for focus to be diverted back to your core business, and cutting operating expenses in the process. However, it’s a mistake to assume that once the contract is signed, you will no longer have anything to service.
Customers will still reach out to you rather than the debt purchaser, you will still need to be in contact with the purchaser over many months to ensure all data has been successfully migrated over to their platform, and you will need to have retained vendor managers to continue to support the debt purchaser in the short term to facilitate the migration of accounts. Make sure to factor in these continuing operations costs in your NPV models and workforce management.
Steps you can take to limit the amount of continuing expenditure:
- Ensure transfer of data is accurate, well-documented and fully comprehensive to limit purchaser outreach for additional context and data points.
- Facilitate a clean break. Ensure customer portals are closed and inaccessible. If customers are able to access their accounts and repay directly, you will be on the hook to continuously transfer payments to your debt purchaser.
- Communicate with CX teams the transfer protocol to send inbound calls to the purchaser (or their vendors) for servicing.
- Ensure all data points on an account are up to date. By providing inaccurate information to your buyer, you may have to issue continuous refunds unless conditions are specified in your contract (e.g., accounts that entered bankruptcy before sale but not reported in the original listing).
Reputational risks - If done correctly, liability for your customers is moved to the debt purchaser, but don’t make the mistake of thinking the reputational risk is carried over, too. Poor service, heavy-handed collection tactics, and operational errors, whilst conducted at the debt purchaser's side, are still going to be associated with the originating company; after all, you made the decision to sell the debt. Be prepared to continue to handle complaints originating from sold customers, and make sure you do your due diligence on selecting a reputable partner to purchase your portfolio.
Steps you can take to limit continuing reputational risk:
- Stipulate expected service and restricted collection tactics in your contract with the debt purchaser.
- Make sure the buyer is reputable and has a solid track record of servicing accounts of a similar nature to yours.
- Provide as much information to the debt purchaser as possible on each account to ensure they can eliminate customer concerns without having to reach out.
Hold
You’ve updated your NPV models, you’ve assessed the reputational risk, you’ve budgeted for operations expenditure, and you’ve decided it is in your best interest to hold, continuing to service your debtors in-house and through your collections vendors. Business as usual, then. Not quite.
Here are a few metrics lenders should keep at the forefront of their minds as they navigate through a downturn:
Attrition rates - One might assume that economic downturns are money making machines for collection agencies, but this is not always so. It’s true that defaults will increase leading to more accounts moving into collections initially, but consumers may also be pulling back on lending, leading to a reduction in forward flow.
Whilst the dot com crash saw revenue continue to grow for collection agencies, the 2008 recession was the opposite, with revenue dropping ~8%. If your partnered collection agencies are not prepared for the reduction in recovery rates, you may start to see their staffing numbers drop. This is an early indicator that your collection partner is facing pressure and may not be able to properly staff and service fluctuating debtor volumes.
Warning signs should be flashing at this point. If you have other collection vendors (we highly recommend having 2-3 vendors depending on portfolio size), you may want to consider moving market share to those that are able to maintain staffing levels by increasing efficiencies, updating collection models etc. Remember, your pool of debtors is going to be volatile, you need vendors that are able to adjust staffing levels at speed to accommodate this.
Settlement rates and payment plan dropoff rates - Your customers are going to be hurting and so rigidity in your repayment options is not advised. Consider loosening settlement rates in response to declining economic circumstances giving your collection vendors more flexibility, or extend longer payment plans to give customers the time to gather funds. Make sure you are keeping a close eye on the settlement rates reported from your collection vendors to ensure they are effectively utilizing this tool.
Penetration rates and inbound service levels - As account volumes fluctuate, make sure to keep a magnifying glass to your partnered collection agencies key service metrics, specifically their penetration rates (# of customers interacted with/# customers assigned), and inbound service levels (% of inbound communications handled within agreed upon SLA time). A decline in either could suggest that your vendors are not staffing appropriately or identifying efficiencies to handle the influx of new debts. Similarly, too high, and your vendors may be overstaffed. Consider reviewing their self-service tools, such as IVRs, chatbots, and payment portals to limit the need for proactive debtor outreach and help minimize the need for additional resources as debtor volumes rise.
Recovery rates - Okay, so this isn’t exactly a groundbreaking insight. Any vendor manager worth their salt should be looking at their collection agencies' recovery rates. However, how do you assess performance when recessionary forces are at work, a drop in recovery rate doesn’t necessarily mean your collection agencies are underperforming. If you have multiple agencies working your bad debt portfolios, see if the decline in performance is uniform across each. Look at the proportional drops in other KPIs and apply them to your recovery rate forecasts to give a more realistic target to your vendors.
Agent feedback - We always advocate an intense focus on quantitative analysis, but don’t ignore the feedback you are getting from your customers. Now might be a good time to increase the frequency of agency touchpoints. Listen to what collectors are telling you from the ground. What are some of the common customer stories? Who is being impacted the most? This recession has the potential to disproportionately impact certain regions more than others, think of the automotive industry in Windsor, or the steel industry in Quebec. Debtor feedback is invaluable in zooming in on certain segments of your bad debt portfolio that could benefit from a more customized approach.
What are your thoughts?
Whether you choose to hold or sell, the decision should align with your broader business context. Execution is what ultimately determines success. Having a clear understanding of your bad debt’s value, the implications of each path, and the right metrics in place will position you to navigate the downturn with greater confidence and agility.
At Payson Solutions, we help lenders and credit providers optimize their collections strategy with bespoke data solutions and risk analytics. If you're re-evaluating your approach to bad debt in this economic cycle, reach out—we’d be glad to help you chart the best course forward.
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