Buying Debt Created by Local and State Governments

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There has been an influx of interest from local governments wishing to sell portfolios of debts that take the form of fines, parking tickets, taxes and unpaid fees. This type of debt comes with its own idiosyncrasies and nuances. Following are insights into how to get into this growing area and what to look out for before purchasing your first portfolio.

A traditional debt collector or law firm, on a first or third party basis, is today servicing these accounts. We are now seeing interest from local and state governments in considering the sale of those receivables, mainly because the government entities managing these receivables are strapped financially. As a result, they are considering a variety of different strategies to bring in cash to fund operations.

One of the concepts they have been exploring has been selling the account, but selling it in what we call a “wet re-leasing approach.” This means they are selling the debt, but the debt remains in the government’s authority. When it comes to garnishing wages or not being able to discharge the account as a result of bankruptcy, all of these factors would still apply as the government would be leasing, essentially the “master servicer,” and not selling the account to the debt buyer.

Government entities are modeling it out where the debt buyer is still giving over cash to the government entity, while servicing it on a first party basis, but the debt buyer is still paying value for it. The accounts can still be recalled by the government entity. It is a way of instead of just placing the accounts out and waiting for the cash to come back from the debt collector, the government entity is getting an immediate infusion of much needed cash. As such, it is a win-win for both parties. We like to think of it as a cash advance to the government entity.

Is the fact debt buyers are looking to new asset classes a natural evolution? Or is something more specific driving this particular trend? A couple of things are going on. The government regulatory environment at the federal level has calmed down when it comes to debt buyers. As a result, government entities that would never have thought of selling this paper are more open to it than they were a few years back.

Another trend we are seeing is traditional PE firms, family funds and high net worth individuals are looking to buy platforms in the ARM industry that are heavily focused on local and state collections work. Many buyers believe there will be additional growth in this market because government entities are strapped for cash, and debt buyers realize in the event of a market correction the volume of receivables will go up. Debtors can’t discharge these debts in bankruptcy and local and state government entities can garnish their wages in states that allow for this.

In fact, there are many more leverage points with these kinds of accounts. The liquidation that would occur during a market downturn isn’t as bad as would happen, for example, in unsecured credit card collection.

How can debt buyers avail themselves of these opportunities? You can’t just call Town Hall to ask for any extra parking tickets the government entity is having trouble collecting. These opportunities are RFP driven. States and cities typically put out an RFP for this kind of collections work. Applicants become approved vendors so they can bid on RFPs as they come up.

The bidding process itself can be time and resource intensive. Potential debt buyers must determine if there is enough return in these projects to warrant making that investment.

Companies that are exclusively focused in the local and state government market have an advantage. These companies have developed their own technology platforms to call into these governments at the state and local level to pick up RFPs. They have a template for how they respond to them, what the pricing is and how to bring in the business to service it in a way that works.

Another value-add regarding this area of the ARM market is many of these deals are multi-year contracts. Although they are performance driven, 1 – 3 and 3-5 year contracts are still assigned to the debt collector.

Is there a concern state and local governments will only sell this debt to a select group of buyers with whom they already have a relationship? Is this a repeat business that is hard for other firms to get into?

Because these are smaller trades – not gigantic trades from a big bank or large institution – these sales can be opened up to smaller and mid-sized buyers at a state or regional level. In fact, as part of the RFP, state and local government entities prefer the party to be local or regional serving local taxpayers. This gives local and regional players a leg up on large national players.

How do I get involved in this kind of work? The first step is to take a look in your area or region. What is going on from a collections perspective with respect to local and state government entities? The first place to sign up to receive RFPs for this type of work is in your local area. When you are focused on national markets for debt buying opportunities, you can sometimes forget about looking in your local market for profitable business lines. When looking for opportunities in this area of Accounts Receivables Management, it is best for debt buyers and agencies to start by looking in their local markets.

Another option, if you are already an established as a debt buyer, is to consider approaching an agency that specializes in local and state government collections and see if you can partner with them to offer a “wet re-leasing” debt sale option to its clients.  The agency would maintain collections on a third party basis.

About CAS

CAS oversees and executes on M&A engagements, investment opportunities, compliance/regulatory assessments, valuation and expert witness litigation matters for constituents of the Outsourced Business Services (OBS) sector.

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