When most major banks reach the end of the road in their efforts to collect on defaulted credit card accounts, they often sell rights to the soured loans to debt collectors for pennies on the dollar. Those pennies can add up to tens of millions in dollars in revenue for a large card issuer, but American Express (Amex) and USAA have long left that money on the table.
The two companies say their policy of eating all of the losses is an outgrowth of business models that give priority to long-term relationships. Even if defaulted customers aren't welcomed back, the overall customer experience is undoubtedly critical to the issuers' reputations.
Amex and USAA may soon become role models for the rest of the industry. With regulators now threatening to scrutinize how financial institutions dispose of defaulted consumer debts, the banks' approach eliminates a potential source of legal risk, and that's worth something — maybe more than the pennies on the dollar — to mass-market credit card issuers.
The consumer debt problems on regulators' radar screens are similar to those seen in the foreclosure arena, centering on debt documentation.
The Office of the Comptroller of the Currency (OCC) has started an enforcement investigation into allegations of shoddy recordkeeping in JPMorgan Chase's (JPM) debt litigation and sales division; the bank has mothballed its legal collections operation for more than a year. The Consumer Financial Protection Bureau (CFPB) intends to focus on the debt-buying market, director Richard Cordray announced last month. And in the most specific threat yet to credit sellers, Minnesota attorney general Lori Swanson told a state attorney conference last week that banks can't shed legal responsibility for selling debt without reliable records.
"She made it very clear that she intended to go after both the sellers and buyers of debt when debt was sold with inadequate documentation," said Ballard Spahr attorney Chris Willis, who was present for the talk. "The regulatory interest in this issue probably does have the effect of changing the cost-benefit analysis of the decision to sell debt," he added.
Swanson's office did not immediately respond to inquiries. But her comments appear to be a broadside against the standard terms under which consumer debt is sold in the secondary market. Contracts for the sale of hundreds of millions in dollars of Bank of America debt explicitly disclaimed the reliability and completeness of the bank's records, ASR sister publication American Banker reported last month.
Because uncollectible debt often sells for just a small percentage of its face value, risks arising from debt sales may have an outsized impact on business practices.
For higher-end and specialty issuers, retaining debt makes sense as a simple business matter, says Claude Hanley, a partner in consulting firm Capital Performance Group's credit card practice.
"USAA and Amex are basically selling you on membership, and you can't turn around and say, we're going to turn the debt over to a collection company that will come after you with everything they've got," he said.
Since the beginning of the last decade, Amex has sold debt just twice, when recessions produced a short-lived spike in defaults among its generally affluent customer base. "Our goal is to maintain a long-term relationship with card members whose financial difficulties feel temporary in nature," says Sonya Conway, a spokeswoman for Amex.
USAA, which serves a coveted and reliable base of military families, does not sell credit card accounts under any circumstances.
"That's not USAA's approach to its customers," said spokesman David Pacholczyk. "It's not in our DNA."
But such issuers are the exception, Hanley says. "If you're in that business of granting mass unsecured credit to households for which you don't have an extensive relationship, the reputation risk of turning over accounts is not as great as the economics of selling the loans," he says. "It's just a different segment of the market, a different business."
Willis says the risk of blowback from debt sales may at least force a reevaluation of current practices. Banks may be able to sidestep trouble by bolstering sale documentation, relying on contract collections operations, or taking other steps.
"Even if credit card issuers don't make the decision to stop selling, they may restructure the way in which they sell," he says. "It may reduce the viability of debt sales as they've been conducted in the past."