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Upstarts: Bad-Debt Market

Even with the economy going at full steam, bad debt is on the rise. Here's why sorry news for compulsive spenders has created opportunities for various start-ups like Charge-Off Clearinghouse.

Start-up finds silver lining in credit-card woes

A former Austin city-council member turns bad debt into good business

Louise Epstein has two credit cards, Visa and American Express. Although it sounds almost un-American, she pays both off in full every month. "I hate debt," the 41-year-old Epstein says, meaning her own.

Other people's debt is a different story.

Americans' credit-card profligacy--U.S. consumer debt hit a record $1.3 trillion last year--is to Epstein what drunken driving is to a tow-truck owner. Her company, Charge-Off Clearinghouse LLC, based in Austin, acquires portfolios of charged-off consumer debt, from credit cards and consumer loans in arrears for six months. Epstein buys the debt from department stores and banks and other financial institutions, paying less than 10¢ on the dollar. Along with five contract employees who work virtually, she weeds out dead and bankrupt debtors and packages the debt for resale to collection lawyers and collection agencies. Her markup is minimal, but the volume is enormous: last year she handled debt with a face value of $550 million.

Although she founded Charge-Off Clearinghouse only two years ago, Epstein is already an important player in the delinquent-debt market that has emerged since the mid 1980s--a market born during the massive government fire sale of distressed savings and loans' assets. Once the province of collection agencies working on contingency, bad debt is now a commodity traded by entrepreneurs like Epstein. "There's a huge number of start-ups in that area," says Jesse Snyder, editor of the Debt Sales Directory, which published its first listing this year. Unlike many others in the field, however, Epstein sells all the debt she buys without attempting to collect any of it.

Many of her competitors, she claims, cherry-pick the portfolios they buy, culling the debts that they can most easily pursue and selling only what's left. Epstein's strategy, in contrast, is to cultivate buyers of her relatively collectible and customized packages of debt. "This is not the way to maximize revenues, but it is the way to stand out in the crowd," Epstein says.

A knack for analyzing the value of bad-debt portfolios is, of course, critical to her business; Epstein holds an M.B.A. from the University of Texas, with a specialty in management information systems, and has worked as a financial manager for the Texas treasurer and two other state agencies. She also did a stint as an Austin city-council member from 1990 to 1993.

In 1996 Epstein took a job with Walt Collins, founder of Austin-based Collins Financial Services, a newly launched buyer and seller of bad debt. After starting a trading desk for Collins, she left when the company changed hands and became a collection agency. She was then approached by a local certified public accountant, who offered to lend her $40,000 in seed capital to strike out on her own. Working closely with a computer programmer, Epstein wrote specs for software that could sort and analyze large portfolios of delinquent accounts according to collectibility.

Bolstered by $500,000 from another private investor, Epstein was ready to buy inventory. But she hit a snag. Reluctant to sell to an unknown reseller, creditors wanted a premium price for the debt and a cut of the resale. Epstein balked. To establish a track record of selling to reputable collectors, she teamed up with an established company, Denver-based Collectamerica, for a few deals. Thus validated, she could finally buy on her own for what she considered a fair price.

Since then, Epstein has built a national network of more than 1,000 customers--predominantly collection lawyers to whom she sells debts bundled by geographic region. She outsources accounting, legal services, computer programming, and data recording. The debt buying and selling she does herself. So virtual is her business that she was able to move last December from rented work space into her home office.

By keeping overhead low, Epstein tries to stay competitive. There are no barriers to entry in her market--no licensing requirements, for example. You just need a clean reputation and enough capital to bid on bad-debt portfolios that typically fetch $1 million to $2 million. Last spring, to strengthen her bidding clout, Epstein raised an additional $20 million from private investors. The big risk for bad-debt dealers, experts say, is overpaying. "There's a lot of people who come into the industry expecting to make a huge return on their investment and find it's not as profitable as they expected it to be," says Dennis Hammond, president of the Debt Buyers Association, based in Santa Fe Springs, Calif. "It takes a certain amount of knowledge."