[Editor’s note: This is a guest post from Brett Boehm, principal and director of business development for TBF Financial. He can be reached at bboehm@tbfgroup.com, phone 847.267.0600, Ext. 101 or via LinkedIn and Twitter @TBFfinancial.]
Business models for online small business lenders focus on speed, agility and customer service. When it comes to managing non-performing loans, however, many fintechs rely on tactics that worked in their grandparents’ era but conflict with newer business models.
They chase non-performing loans (NPLs) past the charge-off date when there is a better option: selling the loans to a reputable commercial debt buyer. More fintechs are learning about this strategy and a major online small business lender is using it to earn money on NPLs, then reinvest the money into making more loans.
Commercial debt buying is an accepted practice for recovering payment in financial services that works well with fintech models but in fact was pioneered in the banking and equipment finance industries. The online small business lender in the example above is using commercial debt buyer services to reduce internal overhead, earn cash now versus waiting for recoveries 12-18 months or more and improve budgeting. If the lender expects to charge off $100 million of NPLs a year and the purchase price is $.05 per NPL, then the lender knows it will recover about $5 million. (The purchase price in this example, $.05, has been weighted against the outstanding balance on the NPL.)
Like all businesses, however, some commercial debt buyers and their brokers are reputable and others are not. Vetting buyers and brokers is a necessary but manageable process, described below. But first, it is important to understand the recovery options available.
Recovery Options
A small business lender knows that a certain percentage of loans will become NPLs and typically has parameters the business must stay within to remain profitable. The lender may pursue NPLs on an in-house basis indefinitely past the charge-off date or turn them over to a collections agency at some point. Both options create problems in the fintech business model.
Managing NPLs in-house throughout the life of an account is slow, inefficient and diverts resources that could be used to support customer lending. There is one upside: the lender maintains control over the account and may win the customer’s future business in the event its finances improve.
Lenders that instead have collections agencies chase bad accounts improve internal efficiency but the process is a lengthy one offering relatively little return. The biggest drawback is the potential for negative customer contacts that can sever the possibility of a future relationship.
The best recovery option for online small business lenders is to manage NPLs in-house until they become charge-offs, then use the services of a reputable commercial debt buyer. This is how it works.
- The lender works with the commercial debt buyer on a one-time basis, periodically, or in a forward-flow relationship where NPL information is sent regularly to the buyer.
- A non-disclosure agreement (NDA) is signed and the lender provides information to the buyer on the pool of non-performing assets. This includes the number of accounts and amount of outstanding balances.
- Buyer assigns a value to the NPLs and offers a price.
- Lender signs the purchase agreement. Typically, buyers in forward-flow relationships will send payment within 24 hours.
- Reputable buyers then work to collect the debts over time, without using the lender’s name and in a sensitive manner, and without reselling the debt.
Deal Only with Reputable Buyers, Brokers
The following are important steps to take before using the services of a commercial debt buyer or brokers representing them.
- Meet in person or by phone to discuss the buyer’s philosophy, collection process, experience, references from similar sellers and security procedures.
- Make sure collection tactics are sensitive to debtors and that the buyer does not re-sell the debt. This way, any issues that arise post-sale can be resolved by repurchasing the loan from the buyer.
- Never provide financial information without a signed NDA.
- Carefully vet brokers who represent commercial debt buyers. Verify that they have a buyer accessible that they have worked with before. Make sure the broker uses NDAs to protect all parties’ confidential information. Find out how the broker is going to disseminate portfolio information and where it is going. Ask how the NPLs are going to be collected and if they could be re-sold at some point.
Some brokers are reputable but there are dangerous ones, too. Deals have fallen apart because a broker showed a portfolio around without NDAs, or parts were sold off without the seller’s knowledge. In these cases, reputable commercial debt buyers will refuse to touch the portfolios.
Deal only with a reputable commercial debt buyer and its broker, and the deal will be smooth and legitimate.
This makes a lot of sense to deal in-house until the loan becomes a charge off. Selling it off too quickly can cause all sorts of long-term problems as you point out. Some debt collectors can be ruthless, and that can really turn away potential good customers down the road.