The online lending space is experiencing tremendous interest, leading to explosive growth and an influx of capital. Many companies grow overnight, raise big rounds of venture capital; vying for a piece of an increasingly competitive market. While top-line growth and customer acquisitions are top of mind for new and existing players, the increase of competition puts a lot of pressure on margins. When focus moves to profitability and unit economics, reducing defaults has a significant impact. After optimizing underwriting criteria, many lenders turn to optimizing collection and recovery strategy.
Now, there is a limited set of tools available to collection strategists, especially considering it’s a service that’s been around for millennia. Traditionally, companies collect in-house, outsource to an agency, sue debtors, or sell their debt (or any combination of the above). Are these tools efficient? Which ones are best? And specifically – should new lenders sell their debt?
Many companies choose to sell their debts after they’ve been written off. Debt buyers often get a bad rap from consumer advocates, but their operations are often better than depicted and importantly, provide a way for lenders to redeploy (part of) their lost capital back into the lending flow. On the other hand, working with the wrong debt buyer can result in problems, not the least of which is leaving money on the table. At TrueAccord, we work with both lenders and debt buyers, and see great benefit from both types of relationships. To the collection strategist, the pro and con analysis of working with a buyer is a daunting task. To help you think through this engagement, here are three reasons you shouldn’t sell your debt – and two reasons why you should.
You don’t control the operation – but you’re still liable
Don’t get us wrong – the leading debt buyers run a tight ship with closely followed quality standards (though some of the big ones did have some issues in the past). But to understand buyers’ operations, you have to understand their business model: debt buyers turn your acquired debt into long lasting streams of income through long payment plans and settlements (and some court judgments). Some of these plans may incur additional fees and interest, convenience fees, or other mechanisms for increasing the yield from every account. At times, consumer advocates and regulators may deem these strategies aggressive.
While historically, debt buyers’ actions reflected mostly on them, this is changing. The CFPB is taking an aggressive approach with its enforcement authority, holding lenders responsible for the actions of all their vendors. The Treasury Department recently voiced a similar sentiment regarding regulation of marketplace lenders and, in 2013, the OCC provided strict vendor management guidelines. This means that you’re tying your regulatory compliance to a vendor whose business you may not fully comprehend, nor have the power to audit and control. That is a significant risk that needs to be managed.
You don’t control the brand – but it’s still your customer
Even if you sell a defaulted customer’s debt to a buyer, they are still your customer. You acquired them, you gave them a loan and serviced it, and it is you they originally owed money to. Selling their debt may take them off your balance sheet, but anything those customers experience with a debt buyer will still be tied to your brand. In a competitive world where customers can easily express unhappiness with how they are treated on social media, you don’t want a part of your customer lifecycle to be an alienating one. While debt buyers understand the value of brand, it is not their top priority – liquidation is. Aligning your debt buyer’s operation with your own in an effort to control brand perception may work, but will likely result in lower purchase prices due to increased constraints you place on them.
Giving customers a consistent, on-brand experience, even on exit, is the preferred long term strategy. When you sell, you risk losing a lot of that control. This could lead to adverse results, limiting your ability to acquire new customers, or get repeat business.
You’re leaving money on the table
Selling early may be the right decision for your business. Yet, as you grow more sophisticated in segmentation and managing your strategy, you’ll find that it is not always the best bottom line answer. Often, extending your collections funnel and offering different flavors of collections efforts (for example: varying intensities, digital collections, a 3rd party collection agency) may convince more customers to set up a payment plan with you, versus with the debt buyer. Some of these customers can even be reintroduced to your lending solution, saving acquisition costs. Uniformly selling your debt portfolio reduces your conversion flexibility. The result often mixes easily convertible customers with those that tend to respond to debt buyers’ long duration and high-intensity collections process.
Side note: debt sales for marketplaces
Alternative lending marketplaces deal with another unexpected complexity: often their investors, not them, own the notes. This makes the sale more complicated if the institutional investor has control of how the note is handled.
Reason #1 you should sell: sophisticated debt buyers do exist
While concerns about working with buyers are sound, the buyer landscape isn’t tremendously broad. The growing burden of regulation (we think it’s a good process) purges bad actors and only leaves the sophisticated and highly compliant ones. Smart buyers like Cascade Receivables Management and Velocity Ventures are part of a small, but growing group of new-age buyers. These new-age debt buyers attempt to balance regulation, good returns, and brand awareness. Including these players in your debt sales strategy is a way to mitigate concerns about working with the debt-buying world.
Reason #2 you should sell: it’s money now
Finally, from a purely financial perspective, debt buyers provide immediate capital instead of having to work to get it over long stretches of time. Your defaulted customers may need years to repay their obligations. Debt buyers provide that breathing room. They also come with capital that allows them to offload debt from your books. When you’re just starting to see charge-offs, selling debts after a rather short in-house process makes a lot of sense. Even as you become more sophisticated, there’s always going to be a segment you’ll want to sell instead of engaging with. Debt buyers exist because they fulfill this very important need in the lending ecosystem.