Charles Dickens wrote David Copperfield in 1849, but its lessons remain vital. It features a clerk called Micawber, who lived beyond his means. He went to jail because he could not pay his debts. In those days, debtors could be jailed under English law.
Micawber is based on Dickens’ own father, John Dickens. John had the gift of writing, but had no money sense. He owed a baker GBP40, which is about $19.204 in today’s money. John Dickens, the father of eight, was imprisoned with his four youngest children. Charles Dickens, who was then 12, had to seek work in a factory to bail out his old man.
Imprisoning debtors is still a common practice in the Gulf. Happily, debtors do not go to jail in England anymore.
However, many may soon revisit the misery inflicted on the Dickens family. Covid-19 has not just claimed lives, but also millions of jobs. In many countries, including Singapore, job losses are mounting. In the US, unemployment is now at a 50-year high.
Joblessness is surging after a long consumer debt binge. US household debt hit a record US$13.7 trillion ($18.7 trillion) in 2019, which was around three quarters of GDP.
In the US, 68 million people had debt in collection on their credit report before Covid-19. That number will double by the end of 2020. Debt can be claimed by collectors after it is 180 days past due.
There is an industry that views bad debt as a godsend — debt collectors. This is an advanced industry. Though people associate debt collectors with loan sharks, it is a regulated business. Debt collectors play a vital function. If you cannot collect debts, the whole economy suffers.
Uncollected bad debts make it hard for legitimate borrowers to operate. Debt collectors are like plumbers. Their work can be dirty, but somebody has to drain the pipes of finance.
Opportunity lies in the highly advanced US debt collection industry. American debt collectors are governed by state and federal regulation. The debt collectors are barred from using threats of violence. They cannot shame debtors by publicising the issue. Instead, they collect by combining persuasion with threats.
Debt collectors make money in two ways. They could receive a fee from a creditor for collecting the money that is owed. For instance, let us assume a bank is owed a US$100 million in uncollected credit card debt. The debt collectors could get a fee of 5% of the face value for collecting it.
The second way that debt collectors make money is even more lucrative. The debt collector could buy the US$100 million debt from the bank. It could be bought at a discount of 20% to its face value — US$80m. They could then collect 90% of the face value of the debt. This would amount to a profit of US$10 million.
The bank benefits because it means that the bad debt is off their books. The bank receives cash up front. It also saves the bank from the grind of chasing down debt.
The last time that debt collectors had a bonanza like Covid-19 was in 2008–2010. The savage financial crisis put almost a tenth of the American workforce out of work. Also, the housing collapse meant that a fourth of sub-prime mortgages ended in foreclosure.
Debt collectors swept in on the bad debt like packs of hungry hyenas. Both the two major debt collectors listed in the US (Encore Capital Group and PRA Group) prospered. PRA Group’s net income doubled between FY08 and FY10. Its stock tripled over 24 months from its 2008 low. Encore, which was more aggressive in collection, saw its profits rise threefold over 2008–2010.
There are green shoots of a similar surge for these players in 2020. The lockdowns in the US provides them with a better chance of tracking down debtors. The stimulus package provides debtors with the means to trim their obligations. In 2Q2020, PRA Group said that cash collections rose 8% to record levels. At just 6x FY20 P/E, Encore stands out as a value play.
One man’s misery is another man’s fortune. The owners of jails prospered during the hardships of the Dickens era. As Covid-19 bites, investors may want to back debt collectors.
Nirgunan Tiruchelvam is head of consumer sector equity at Tellimer (Exotix Capital)
