Repo Men

Debt collectors don’t send thugs with baseball bats anymore. Now they sic lawyers on you.

Repossession: It's not just for sleazeballs anymore. Click image to expand.
Repossession: It’s not just for sleazeballs anymore

It’s a great time to cash in on the misery of others. As Americans acquire bigger and bigger mortgages and credit card bills, more and more of their debt is going bad—which is an economic opportunity for you. Loan sharks can’t do IPOs, but there are legitimate, above-board businesses that are making millions from uncollected debts.

In Barron’s last Sunday, Alan Abelson flagged the recommendation of Stephanie Pomboy of Macromavens to buy what she redubbed three “Repo-Men” stocks: Encore Capital, Portfolio Recovery Associates, and Asta Funding. The companies are small—they have a collective market capitalization of $1.2 billion—but thanks to easy money policies, low wage growth, and the impact of the new bankruptcy law, this is an exploding industry.

The investment thesis: With rates rising and consumers under economic stress, it follows that there’s likely to be more bad debt out there. And that means banks, credit card companies, utilities—all sorts of people who extend credit to customers—will find themselves with growing piles of uncollectible debt on their balance sheets. Consumer-oriented companies don’t like to be in the gritty business of collecting because it’s cost-intensive and using hardball tactics can bring negative press or regulatory attention. Instead, they do to collections what corporate America does with every other unpleasant task: They outsource it, selling the bad debt for a tiny fraction of face value.

And here’s where the repo companies come in. The terms “repo man” and “collection agent” may bring to mind the Emilio Estevez movie or Sylvester Stallone in the first Rocky. But this business has moved far beyond leg-breaking sleazeballs. These are fundamentally financial-services companies that buy up receivables at gigantic discounts and then hire collection agents or law firms to collect. To do so, they use a mix of persuasion and threats. They send letters to borrowers asking for—or demanding—payment. Collection agents spend time on the phone with their new customers—the debts are officially transferred to the collection companies—and persuade them to set up payment programs. Where appropriate and legal, lawyers can threaten to file liens. At root, however, collecting these debts is a matter of negotiation. The goal is not necessarily to get the debtor to make full payment but rather to pay enough to cover the company’s costs and allow it to turn a profit.

The largest publicly held repo company, by market capitalization, is Portfolio Recovery Associates. Founded in 1996, the Norfolk, Va.-based company went public in 2002. Its third-quarter results showed very good earnings growth. In the quarter, the self-described “benevolent” debt collector bought $445 million of face-value debt for only $16.5 million. PRA’s 10-Q filing provides interesting reading, including cool tables on the productivity of collection agents (Page 26) and another showing how much it’s able to collect on the receivables it buys. So far this year, it has collected $3.24 for every $1 it spent buying debt, meaning that $16.5 million could yield more than $50 million—only a fraction of its nominal value, but better than a sharp poke in the eye.

Encore Capital, based in San Diego and originally backed by buyout artists Peter May and Nelson Peltz, is the stylish innovator. Other companies may focus mainly on credit card debt. But Encore is also interested in bad debt from telecommunications, utility companies, and even health clubs, as an investor presentation from this spring notes. And it sees a big opportunity in health care. In September Encore entered the health-care market by buying “$274 million in face value of self-pay debt from a major healthcare provider for $4.27 million.” It turns out that the misery of hospital companies like HCA, which are unable to collect from the growing ranks of uninsured patients, could prove to be a boon to Encore. Encore President Brandon Black enthused that, “according to industry estimates, there are approximately $15-20 billion in annual charge-offs of self-pay receivables in the healthcare industry, which represents a huge opportunity for us.”

Asta Funding, based in Englewood Cliffs, N.J., takes a New Economy approach to debt collection. It outsources the outsourcing. The company buys up bad debt and then, as a corporate fact sheet notes, hires collection agencies and law firms to gather the cash. In the first nine months, it spent $93.5 million to buy $2.3 billion face value of debt. It reported record results in its most recent quarter.

As this chart shows, PRA and Asta have healthily outperformed the S&P 500 in the past year. And all three are bullish on the future—and rightly so. Why? Overall credit quality is deteriorating. The American Bankers Association found in September that credit card delinquencies are at a record high. Meanwhile, the new bankruptcy bill has made it harder for individuals to walk away from obligations to credit card issuers and other lenders—which is good for business. As Eric Dash reported in the New York Times, “more than 500,000 Americans filed for bankruptcy protection in the 10 days before the law took effect on Oct. 17.” That figure is equal to nearly one-third of total bankruptcies in all of 2004. The surge has led credit card companies to take steps to write off huge chunks of credit card debt sooner rather than later. This week, for example, Morgan Stanley’s Discover Card said it would take an extra pretax charge of $200 million to $250 million due to higher bankruptcy filings. And while it may theoretically be easier for banks to collect on loans with the new law, they still don’t want to deal with the hassle. Because they get to keep what they collect, the repo men may wind up benefiting from the stiffer bankruptcy requirements.

Many people find it unseemly to profit from the downfall of others. But the repo companies are in fact performing a vital service for the U.S. economy. By removing the dead weight of bad debt from big companies, they’re helping corporate America clean up its balance sheet and freeing them to engage in risk-taking, growth-fueling activities—such as extending more credit.