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SECTOR FOCUS SWINGS AND ROUNDABOUTS What next for the debt purchase market? AUTHOR – Heather Greig-Smith THERE was then, and there is now. Little more than a month ago, debt buyers were looking into a future they felt confident they could predict. As an industry, debt purchase has consolidated, firms have moved into the mainstream investment market, all have been through the process of FCA authorisation and operations have become increasingly sophisticated. Predictions were clear, plans had been made. And then. A virus that initially seemed to be a worrying headline relating to events on the other side of the world has become a pandemic. All bets are off. Of course, at the moment the world is dealing with the immediate concerns at hand – isolation, health and financial support. But what does the future hold for the industry when debts are set to rise dramatically but reliance on past data and performance may not be possible? “The economic shock is happening, it’s just how deep that shock is going to be,” says Andrew Birkwood, Founder and Chief Executive of Azzurro Associates. “I don’t think any country’s government is going to be able to spend their way out of it. There is going to be much more debt – both consumer and commercial. The market is going to have a new paradigm.” PRICING MATRICES One of the biggest issues for debt buyers is the fact that their pricing and collections matrices no longer apply. “We and a number of other buyers have pressed the pause button on a number of different deals,” says Andrew. Antony Dear, Global Solutions and Consulting Director at TDX Group, agrees that lower transaction levels will be an immediate effect – albeit continuing a trend from 2019. There has been a shift in funding models at many of the major buyers. Less favourable bond yields and pressure from funders to deleverage have seen most reduce leverage ratios that were as high as 5x equity. Some had already found they were unable to borrow more from their traditional sources of funds. “This meant that there was less capital available to acquire portfolios for some purchasers, leading to lower prices in some industries such as banking for non-performing loans. This led to slowed growth or lower acquisitions for some purchasers in 2019,” says Antony. He adds: “There has been quite a lot “I don’t think any country’s government is going to be able to spend their way out of it. There is going to be much more debt – both consumer and commercial. The market is going to have a new paradigm.” of change in the last year. Before that everyone used bonds to finance their growth but the cost of funding has changed significantly in the last two years which means people have looked at other things.” CHANGING DYNAMICS To this end, many purchasers have focused on co-investment or fund investment models. However, one purchaser says this emphasis on funds “…massively changes the dynamics of the sector. “Businesses may only be investing 25p in the £1 themselves. They aren’t taking the risk and reward. It raises the capital available, but the problem is there is only so much for sale in the market. “The question is, what returns are investors going to expect? Buyers have stated some quite strong returns they are going to deliver. What does that really mean and are they really going to achieve it?” Recession will most likely lead to fewer portfolio acquisitions at lower prices, says Antony. “Just like we saw in the aftermath of the 08/09 financial crisis, where year on year sales volumes dropped 50 percent between 2008 and 2009 and prices reduced by over 50 percent.” Comparisons with 2008/09 are rife. Andrew Fox, Head of Portfolio Investments at Arrow Global, says the effects will play out similarly. “Debt levels for consumers will likely rise. The forbearance measures that Arrow brought in as a result of the 2009 crisis will continue to be available to many of our customers, together with additional strategies set out by the FCA to tackle the current situation. Many of the forbearance tools have been used in the past, but there is now a need to make them available for large groups of people more quickly. “At the moment the high yield bond market is mostly closed for further raising for debt purchasers – we’d expect high yield bond costs to increase and there will be limited appetite from bigger investors. People will still lend but a risk premium will be attached. Larger private equity appears to have mainly backed out of the market, but it wouldn’t surprise me if in the downturn they step back.” HISTORICAL PERFORMANCE When it comes to using the financial crisis as a predictor, others urge caution. “All the debt buyers use historical performance as the basis Advancing the credit profession / www.cicm.com / May 2020 / PAGE 16
SECTOR FOCUS AUTHOR – Heather Greig-Smith for pricing,” says Andrew Birkwood. “There is no basis for this market. The 2008 credit crisis wasn’t anything like this situation in terms of how deep, broad and universal it is. A lot depends on how long this goes on for.” Others agree that the current situation is different from the crash but suggest there may be a quicker recovery. “No-one knows and that’s the weird thing,” says one purchaser. “Before the government started coming out with loan schemes, everyone was thinking this could be catastrophic.” Debt buyer Intrum has already announced that it will reduce its rate of investment, saying that its previous 2020 targets are no longer achievable. It added that refinancing in 2019 has extended loan maturities: “We have limited levels of debt that are due in 2020 and 2021, and that these can be honoured, inter alia, by our credit facilities,” says Mikael Ericson, Intrum’s President and CEO. “What is happening will have consequences for virtually every business worldwide, and places considerable demands on us at a time when clients and individuals are experiencing extreme uncertainty about the global outlook. Although operating results for the first and second quarters will be lower than our previous internal expectations, we anticipate what is happening now will create substantially larger business volumes to work with in the latter part of 2020 and the years ahead,” Ericson adds. “Conversations with sellers continue,” says Intrum UK Managing Director Eddie Nott. “Clearly the uncertainty is likely to have a downward impact on pricing – this is to be expected after an economic shock of this severity. However, the industry has an important skill set in dealing with financial distress and clients have already asked for help in tackling this in the months ahead.” POSITIVE THINKING Hoist Finance also believes the outlook for the debt purchase market remains positive, despite there being a temporary pause in the supply of debt portfolios. Chief Executive Officer Klaus-Anders Nysteen says he anticipates that banks will continue to divest portfolios and will do so at an earlier stage than historically. “The European estimated loan stock has decreased from EUR 1.2 trillion in 2014, to approximately EUR 635 billion in 2019,” he says. “This is good for the financial eco-system, and I am confident in the market for non-performing loans as all market participants have become more diligent and structured.” Advancing the credit profession / www.cicm.com / May 2020 / PAGE 17 continues on page 18 >
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