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."

Finding good value is becoming harder as sellers become more sophisticated at analyzing the debt they sell, according to Epstein. "They're much more particular about what they sell and what they keep," she says. Epstein, however, acknowledges that Charge-Off Clearinghouse earned a profit of several million dollars last year. "It's all garbage," she says of the debt she buys, "but there's a lot that's salvageable."

Bill Bartmann's legacy

In September 1997, Bill Bartmann made the cover of this magazine (" The Billionaire Nobody Knows"). His comeback after the collapse, in 1985, of his Hawkeye Pipe Services Inc., a manufacturer of pipes for oil rigs, seemed miraculous. Starting over from scratch, he had built a very different business--Commercial Financial Services (CFS), which bought and collected charged-off credit-card receivables and repackaged them as bonds--into a $350-million-a-year dynamo.

His astonishing success helped foster a new and vibrant market in the trading of delinquent debt. But Bartmann's poster-boy status didn't last. Late last year an anonymous letter to bond-rating agencies accused him of inflating his collection rates, an allegation that prompted the agencies to drop their ratings for CFS's bonds. Facing an investigation by the Securities and Exchange Commission and a bondholders' suit, CFS filed for bankruptcy and in June closed down for good.

Still, the market that relaunched Bartmann continues to attract many other entrepreneurs, including some CFS refugees. Among recent start-ups: two bad-debt buyers and collectors--Eagle Credit Resources Inc., based in Tulsa; and Onyx Financial, based in Oklahoma City--and Tri-S Ltd., based in Tulsa, a publisher of a guide to help debtors ward off rabid collection agents.

Popular market viewed as 'modest risk'

Jesse Snyder is managing editor of Credit & Collections Risk, a monthly magazine based in Chicago, and a close observer of the bad-debt market. He spoke recently with senior staff writer Emily Barker.

Q: Why is consumer debt increasing in a time of prosperity?

A: People are very optimistic about their future, and they're incurring much more credit-card debt.

Q: Of all the distressed debt sold, how much is credit-card debt?

A: It used to be about 75% of all debt sold. That proportion is going down.

Q: How did the market for distressed debt originate?

A: It originated with the savings-and-loan crisis in the 1980s, when debt buyers bought from the Resolution Trust Corp., which disposed of the assets of failed savings-and-loan institutions.

Q: Who sells the debt?

A: The biggest sellers tend to be financial institutions that are credit-card issuers. Citicorp Credit Services alone charges off $250 million a month.

Q: What are the opportunities for entrepreneurs?

A: For those who team up with people who understand collections, there is an opportunity to jump into a high-margin business with modest risk and pretty low barriers to entry.

Q: How many start-ups have emerged in the past two or three years?

A: Hundreds. Many of the founders are contingency-fee collection agents or collection lawyers, who typically have created a separate corporate shell.

Q: What about entrepreneurs starting from scratch?

A: Dozens. Typically, people who are jumping into the business have capital and have found a contingency-fee agency to do the work for them.

Year U.S. Consumer Debt Charged-off* Debt Sold
1994 $961 billion $9 billion
1995 $1.10 trillion $12 billion
1996 $1.18 trillion $16 billion
1997 $1.23 trillion $17 billion
1998 $1.30 trillion $18.5 billion

*In arrears for six months or more.
Sources: Federal Reserve; Debt Sales Directory.