An unusual situation was unfolding on a June evening in Baltimore. In a crowd of 2,500 commercial credit managers, several firms were enticing companies to sell their distressed debt. The site was the National Association of Credit Management’s annual Credit Congress, where credit executives in charge of their company’s accounts receivable gather to learn how to enhance and better manage their commercial portfolios.

These cautious executives typically don’t even outsource collections for fear of jeopardizing relationships with customers who have fallen behind on payments but still conduct business with their company. Therefore, it seems almost counter-intuitive that these same managers would actually relinquish ownership by selling receivables to outsiders.

But competition, strong economic conditions, and the need to improve portfolio performance are drawing more commercial creditors into the industry – opening a potential mother lode of new accounts to be purchased. From January through June, Collections & Credit Risk’s sister publication, Debt Sales Bulletin, reported on 12 commercial portfolios that came to market with an estimated face value of $1.38 billion, which does not include a whopping $60 billion portfolio from a Mexican governmental agency that contained some non-performing commercial loans.

Although commercial portfolios typically are smaller than their cousins on the consumer side, there are new buyers who want to focus solely on this segment. “We certainly believe there will be a healthy market,” says Forrest Old, vice president of marketing at Dun & Bradstreet Corp. “We are following an historical pattern where the commercial side follows the consumer side.” The only downside, says Old, is the challenge in putting a value on the commercial debt portfolio. Buyers and sellers will have to find a set of benchmarks for commercial paper, such as credit scoring measures and the likelihood of collecting. “You have to find measures that cross multiple industries,” Old says. “Bringing technology and information into play, we will have the edge in pricing portfolios.”

Indeed, the boom in the distressed-debt market is luring new sellers into a more-liquid business where charged-off assets are sold daily by banks, retailers, credit unions, and other financial institutions. In the last year alone, the industry has experienced new types of debt offerings, growth in the amount of performing assets sold, an explosion of Internet companies trying to get a piece of the brokerage action, and dozens of smaller players starting to resell debt.

There’s been a major growth spurt among resellers – those companies that buy debts from creditors and then place the portfolios back on the market after collecting on the accounts for a time. Companies like Oliphant Financial Corp., U.S. Creditcorp, and Asset Acquisition Group have carved out a niche in the resale market. Newcomers, such as Cavalry Investments, Cramer Financial Group Inc., and Downs Financial, among others, have also entered the playing field.

Between May 1 and June 30, 56 resale portfolios came to market with a face value of $65.2 billion, including the Mexican government’s $60 billion offering, says Debt Sales Bulletin.

Resale transactions are likely to continue. “The big market is in handling the resale of debt purchasers after they have worked the accounts,” says Louise Epstein, president of Charge-Off Clearinghouse, an Austin, Texas-based brokerage that mostly purchases debt portfolios from originators and splits it into smaller parcels. “The next wave is in end-users wishing to resell.”

Others agree. Robert E. Cagle, president of debt buyer and reseller Houston Funding Corp., says most debt buyers must resell. His company resold $78 million in 1999. “When you are figuring profits, you figure you can resell some of that product and that will influence bottom-line profits,” Cagle says. “Reselling is becoming more and more important to the bottom line of most companies.”

Resellers are finding an increasing role in the marketplace because collections law firms and collections agencies are receiving fewer placements from creditors, says Roger K. Neustadt, chief operating officer at Oliphant Financial Corp. in Sarasota, Fla. “It is a shift in the way they think,” he says. Collections agencies now are purchasing accounts, working them, and then reselling them.

Epstein, who resold $550 million in charged-off debt in 1999, believes that resales will become a staple – if buyers receive accurate documentation on accounts. In some cases, accounts that are resold come with less-than-stellar documentation, leaving buyers unable to sue, or even find, debtors.

Some believe the documentation issue may be cleared up by an onslaught of new website companies that trade distressed-debt portfolios. Several new websites let buyers and sellers eliminate some legwork during the transaction. E-Debt.com, for instance, allows buyers to view portfolios, perform due diligence on accounts, and transmit relevant documents. Sellers can peddle their portfolios at a set price, by auction, or through private online negotiations. The online smorgasbord doesn’t stop there. Other sites include The Debt Trader’s noteandpapertrader.com and The Debt Marketplace’s debtmarketplace.com. Both list portfolios on bulletin boards.

DistressDebt.com, due to launch this summer, will broker the debt of firms that are in default or at risk of default. D&B’s Old believes the website will catapult commercial debt to the forefront. "E-tools of the future will help facilitate the growth of this industry," he says.

Cagle believes Internet technology will ultimately improve the industry. Buyers may be able to track the chain of title on distressed accounts to see who originated the loans and how many times the portfolio has been bought and resold. Potentially, the Internet may facilitate locating the debtor’s address, Social Security number, and employer, he says. And it could create a demand for standardized documentation. “It makes the information you need for due diligence very accessible,” Cagle says. “It is a perfect conduit for what we do.”

Cyberspace can also offer an opportunity for smaller buyers to find the portfolio they want via Internet postings. Mark J. Miller, president of MJM Financial Services, views the Internet as the portal that will make the reselling market more efficient. But, he cautions, “the Internet can’t replace relationships.”

‘A Relationship Business’

In fact, companies launching portfolio-trading websites may have a difficult time starting. “This is a relationship business,” says David V. Ludwig, president of St. Louis-based debt broker National Loan Exchange Corp. “Coming in is going to be difficult.”

Ludwig’s firm will begin acting as an Internet broker this summer when it posts portfolios from three originators. As part of the deal, NLEX will provide post-sales services on the portfolios. The site will enable originators to get higher prices for charged-off portfolios, Ludwig contends. The portfolios will be split up by region and state. Sellers only have to draw up one contract for the multiple sales. The buyers will enter into a standard contract for the purchase. “We have tried to come up with a way for originators to benefit from higher prices,” Ludwig says. “Any time we break up portfolios, we see prices rise 25% to 30%.”

The Internet boom has grown too quickly, says Walter Collins, president of Collins Financial Services in Austin, Texas, who foresees three or four websites dedicated to trading chargeoffs. “A lot of them jumped on the bandwagon,” he says. “They don’t have the background in the charged-off market.”

Epstein agrees. “The dot.coms that survive are the ones that will do their homework,” she says. Not only will the dot.coms make the market more efficient, but they could lead to lower prices for charged-off debt. “Sellers will fetch less for their products,” Epstein says, “because of efficiency and competition.”

And the Internet will not focus only on the traditional credit card chargeoffs. Buyers and sellers will see growth in non-traditional sale categories, such as medical loans, tuition contracts, and credit union paper as competition among credit card buyers lures many into new fields.

Virgin Fields

“I see all areas of consumer debt opening up in the future,” Miller says. New debt categories will also provide untapped business for smaller buyers. “It is a natural for smaller players to find opportunities [with less] competition,” Miller says. Those include telecommunications, utility, medical, retail, and government debt. “There is a dwindling supply of older debt,” he says. “The demand [for new debt types] is going to increase.”

Cagle subscribes to that theory. He is considering buying loans from the U.S. Small Business Administration, which came to market this summer with a $1.2 billion disaster assistance loan portfolio. “The potential for expansion is tremendous,” he says. “There is a lot of product out there we haven’t had access to. Everybody will be looking for more avenues of profitability.”

Performing debt, which sells at par value or a slight discount compared to hefty discounts for distressed assets, also will continue to boom. Selling performing loans at a higher liquidity rate gives originators more capital. “The performing market will blast open the doors to new players who will cross over to the distressed-debt market,” Epstein predicts.