Industry regulation is generally put in place to protect the interest of the customer, but in some cases that same regulation also serves to improve and sustain the industry itself. This is certainly the case now with commercial asset recovery and management, also known as commercial debt buying.
Both the consumer debt and commercial debt recovery industries have undergone a complete transformation following the Congressional formation of the Consumer Financial Protection Bureau (CFPB), which resulted from the 2010 enactment of Dodd-Frank legislation, the most sweeping overhaul of the financial services industry in our nation’s history.
Through this sea change, forward-thinking debt buyers have maintained an unwavering focus on compliance and customer experience, recognizing the legislation can and will benefit their customers. When regulation is understandable, meaningful, and cogent, it provides a framework that encourages business models that are effective, legal, ethical and appropriate to create sustainable performance. Intelligent regulation also limits the missteps by those companies that may be taking shortcuts.
Today, regulation speaks solely to consumer debts but provides a reasonable oversight for how charged-off commercial debt should be sold and serviced.
In this environment, prudent commercial credit issuers would be wise to ensure that commercial debt buyers generally apply similar or comparable measures to the servicing of small biz loans and leases, which serves the best interests of customers and mitigates reputational risk for sellers.
Small-Business Debt Market
The Office of the Comptroller of the Currency has said banks have an ongoing duty to continually monitor and audit the activities of their downstream partners, so it is reasonable for manufacturer captives and independent non-bank leasing and finance firms to also be selective when choosing a buyer for their charged-off loans and leases.
While large banks are keenly aware of CFPB oversight and have adjusted in their own ways, mid-tier and community banks, captives, and independents may be less aware, especially if they don’t routinely sell their charged-off accounts.
It’s important to note: Even though there is more regulatory oversight in the marketplace, neither the OCC nor the CFBP has said banks, in-house leasing divisions and independent non-bank leasing companies can’t sell their charged-off accounts.
Commercial debt in the broadest sense is any credit facility, whether loan, line of credit or equipment lease, offered to a business for business purposes. Such debts range from a multi-billion credit facility issued by a consortium of banks, to a mid-tier company with a $300 million line of credit secured by assets, to a loan for a Main Street business, whether retailer, restaurant, distributor, small manufacturer or even a not-for-profit.
The market for small business loans and leases is somewhere between $100 billion to $150 billion in total outstanding debt. The charge-off rate, or annual volume of accounts that go bad, is in the 2% to 3% range.
When considering selling charged-off small-business leases and loans with balances of $250,000 or less, it is helpful to apply the same framework as that of consumer debt.
Considerations for Charged-Off Small-Business Debt
Banks, manufacturer captives and independents have three choices when it comes to handling charged-off debt — including small-business charge-offs:
- Use internal collections to recover the debt;
- Place accounts on a contingency basis with a third party collection agency or law firm;
- Sell the accounts outright to a debt buyer.
Leading debt buyers appreciate the OCC’s best practice guidance for consumer debt because it separates legitimate, upstanding, compliant debt buyers from less scrupulous market players.
When selling charged-off accounts, the most prudent route is to view those sales as the same as consumer debt.
Here are some good questions to ask before selecting a debt-buying partner:
- To what level is the debt buyer outsourcing collections work?
- To what level is the debt buyer reselling accounts?
- What is the debt buyer’s philosophy around litigation of accounts?
- Is there technology in place to monitor and control all communications and ensure accurate accounting?
- How strong is the buyer’s compliance management system?
- How willing is the buyer to facilitate seller’s post-sale audits of the charged-off accounts?
Recent guidance from the OCC on the sale of fully charged-off debt also describes expectations for banks that engage in debt-sale arrangements, and this same guidance also serves the market for small-business charge-offs:
- Ensure that appropriate internal policies and procedures have been developed and implemented to govern debt-sale arrangements consistently across the entity.
- Perform appropriate due diligence when selecting debt buyers.
- Ensure that debt-sale arrangements with debt buyers cover all important considerations.
- Provide accurate and comprehensive information regarding each debt sold, at the time of sale.
- Ensure compliance with applicable consumer protection laws and regulations.
- Implement appropriate oversight of debt-sale arrangement.
By following these best practices in small-business charge-off sales, banks, captives and independents can gain guidance when they are making decisions that will both help recover losses, and ensure the highest levels of compliance and protection of reputation.