Liquidation Rates Can be Higher

We rarely hear the word liquidation at industry conferences. I think that’s because if liquidations were actually talked about some folks might have their feet held to the fire. It’s easy to say, "You will make three times your money in five years." Remember when the smartest people in the industry said three years?

What’s harder to say is that to achieve that return you will liquidate only 3% a year for 5 years. So, if you paid 5 cents on the dollar, a portfolio will have to produce 3% a year for five years. That’s not a great return on 5 cent paper.

The pronouncements of three times your money in 3 or 5 or however many years is a tired, worn out theory that needs to be put to rest. What will happen when it can’t be done in five years?

So let’s talk liquidation. Liquidation rates will be all over the board. Liquidation is achieved through collections, legal strategy and resale. No matter how much is spent on a portfolio it should only achieve so much in liquidation. On a super large portfolio, the liquidation rates may take longer to achieve. But we’ll aim for a shorter period than five years. If we liquidate better, we can buy more debt, or we don’t need to buy as much — it depends on your business model.

In discussing collection to achieve liquidation, we will say that "heroic" and expensive measures are not to be taken. Just normal collection efforts and a good solid skiptracing process.

If ongoing purchases are $150 million in chargeoff balance a year from a major prime issuer, we would expect to see the following liquidation rates. These are 12-month overall liquidation rates:

Prime (no previous agencies): 8% liquidation.

Seconds: 3%

Tertiary: 1.5%

If the purchases are more than $150 million in chargeoff a year, these numbers may go down; if less they may go up.

We believe that targeting a higher liquidation rate and then working to achieve it in a realistic way might produce better results. For example, smaller specific portfolios could liquidate at 2.5 times more at prime, 4.5 times more at seconds and 10 times as high on tertiary.

Most portfolios could liquidate better if people would quit comparing their liquidation to the "industry standard."

Liquidation to a debt buying collection agency or a collection law firm means one thing, and to an investor it means another. Remember, the investor has collection fees to pay.

I like to say that the price of the portfolio should mirror the liquidation achieved. If, after our internal processes and scoring indicates we should purchase a portfolio, we would expect the following 12-month liquidations:

If the portfolio price is less than 3.33% we expect 3 times that in liquidation.

For example, if the price is 2%, then we expect a 6% liquidation rate in 12 months. If we pay 3%, then we expect a 9% liquidation rate in 12 months.

Now, if the portfolio price is more than 3.33%, we expect a 10% liquidation rate in 12 months.

Liquidation can be achieved through collections, legal collections and resale. But every portfolio we buy is viewed from the standpoint of, "can we collect this?" Making the money through high priced back end sales is a poor model. It is risky to count on high prices in the resale market.

These liquidation rates are for agency purchasers. Investment purchasers may show different liquidation rates. If we are collecting, we can be very selective and buy fewer portfolios that play to our collection strengths. Investment money needs to work. To accomplish return rates for investment money, we target a 30% annualized return.

So, if we pay 3% for an investment portfolio, we would need a gross liquidation rate of about 8% in 12 months. After collection and management fees this would achieve a 30% annualized return. In our models most of the portfolio is gone at the end of 12 months. Accounts in a payment status continue to produce into the next year and beyond.

A legal collection strategy will also yield different liquidation rates. We still would expect to see the price of the portfolio recovered in 12 months.

Achieving these rates requires constant management of portfolios. Strategy, scoring, segmentation and better internal processes can all make portfolios liquidate at a better rate. If liquidation rates stay at the "industry standard", the industry is in trouble.

John Pratt has been in the collection industry since 1988. He began working in the field as a skip tracer, and within three years assumed a more specialized role responsible for streamlining a large-scale skip tracing process for a major credit card issuer. The focus of this process was to develop methods to increase contact rates while lowering cost, without jeopardizing liquidation rates.

Since July of 2001, John and his partner, Rick Shell, have been operating a collection agency known as Locate Services, LLC. Locate Services deals primarily with collecting purchased debt. John has become known as an expert in debt evaluation and the process used to maximize liquidations.

With Rick, John has written a book for debt purchasers titled Debt Purchasing: An Investor’s Guide To Buying Debt.