The use of Part IX debt agreements by individuals unable to meet their debt obligations are on the rise. This asset class is of increased importance for creditors; with revenue growth in both the funds returned through dividends
and amplified debt sale activity. This translates to increasing consolidation in the market and new strategies for credit managers. Our overview of incentives and structure in the field sheds some light on these changes.
Personal insolvency is fast becoming a focus of credit managers and professionals as the volume of agreements continues to rise, drawing attention to the rate and structure of returns, as well as the impact on customers. The emphasis on alternatives to bankruptcy has been a concentration of legislative policy in Australia and overseas for some decades, with Part IX debt agreements being the predominant formal alternative. Yet it is only recently that the number of debt agreements proposed annually has neared the number of personal bankruptcies declared.
Debt agreements provide an alternative to Bankruptcy where individuals pay a negotiated percentage of their total debt over a period of time where single payments are made to a debt administrator rather than individual creditors. Debt agreements are established once the majority of creditors (by dollar value) vote to accept the proposal with the remainder of the debt unrecoverable once the required payments have been made. On AFSA’s statistics, the number of proposed Part IX agreements has increased at rate of 8.43% per annum over the five years ending 2017. At Kessler, not only are we observing increases in volumes of these agreements consistent with this trend, but also more pronounced interest in the sale and purchase of the rights to debts under these agreements. Many of the reasons behind these shifts are likely to be familiar to credit professionals, but the long-term implications of strategic changes are anticipated to raise new opportunities as to how these accounts are managed.
Background to Part IX Agreements: Creditor strategies
Debts subject to Part IX agreements are typically held by customers with a larger number of outstanding debts across a range of creditors. Creditors may be first alerted to a proposal by customers themselves providing notice or directly by way of a proposal from a debt agreement administrator. Many creditors have varying strategies or policies in place to guide
their response to these proposals. When faced with a proposal for a debt agreement, often with an indicative rate of return in the range of 60-65c/$, many creditors may follow blanket policies in favour of approval, whereas others may more closely scrutinise the agreement and the customer’s situation. AFSA reports that creditor acceptance rates hover between 77% and 88% of proposals over the past five years. The dividend for equivalent bankruptcies is in the range of 6-7c/$, so it is at least intuitively reasonable for many creditors to support proposals generally.
Once an agreement has been established, collections activity on the account is prohibited as the Debt Administrator works on the customer’s behalf to manage the impacted creditors. Payments made under the agreement are apportioned and distributed by the appointed Debt Administrator.
To the creditor, a Part IX agreement looks like an agreed series of cash flows, albeit one with a degree of volatility by way of variations and terminations. An agreed series of cash flows can be transformed by the financial services market to meet different liquidity and maturity preferences. They can be (relatively) easily priced, sold and purchased, securitised and otherwise transformed. It is because of this likeness that specialised insolvency purchasers value Part IX debts.
Current trends: Increasingly frequent sales
Until recently, only major banks were engaged in the sale of debts pursuant to Part IX arrangements. Growth in the breadth of issuers has now meant that major banks have followed suit, alongside telecommunications providers, utility companies and automotive finance providers.
Primary reasoning behind the increasing transition to Part IX sales are operational for many creditors, with requirements to manage the formal voting and administrative processes via AFSA sitting outside the standard collections processes. Further to this, the presence of the Debt Administrator appointed by the customer who has opted to utilise the protection of the Part IX agreement reduces any brand and reputational risk exposure, with limited customer interaction for the purchaser of the agreement throughout the term of the agreement.
The operational requirements become increasingly onerous as the volume of Part IXs continue to grow at extraordinary rates, with many creditors establishing dedicated teams to manage these agreements given the expected rates of return and potential compliance risk in the event of mismanagement.
Once an agreement has been established, collections activity on the account is prohibited as the Debt Administrator works on the customer’s behalf to manage the impacted creditors.
Whilst this and other arguments have substantial weight, we find that the core reason for the sale of Part IX debt separately from other non-performing debt is essentially definitional.
The management of traditional non-performing debt is fundamentally a collection activity, focused on distinguishing between customers with different payment capabilities, enforcing debts where appropriate, and potentially facilitating alternative repayment structures. It is relatively labour-intensive and subject to much regulation.
On the other hand, the purchase of rights assigned under Part IX agreements does not give rise to the requirement to collect, rather a requirement to service the debt, principally through monitoring. Not only does a Part IX agreement represent a series of cash flows, it is a passive income stream (again, not without risk).
Underlying this distinction is a profoundly different business model for insolvency purchasers as opposed to traditional purchasers, with distinct core competencies and risk appetites for each. It follows that even the traditional debt purchasers which own rights to Part IX debts look to the secondary market to on-sell debt to specialised insolvency purchasers.
Value as a unifying principle in debt sales
The core rationale in all sales of Part IX agreements is this: both originating creditors and traditional debt purchasers have limited scope to add value to a debt once it has transitioned into a Part IX agreement. Value can be best extracted by specialists with expertise, lower servicing costs or lower costs of funds.
Rather than receiving a trickle of cash flows over the course of the debt agreement, a Part IX sale permits the creditor to accelerate their expected cash flows. For example, a portfolio of Part IX accounts with an expected return to the creditor of
60% over a 5 year time horizon may sell for between $0.30 and $0.40 in the dollar. This accelerates and guarantees up to 66% of expected returns, without exposure to potential variations or terminations to these agreements.
In this way, maturity is transformed and immediate liquidity is provided. Part IX buyers are likely better placed to mitigate risks through a combination of diversification, pooling, and potentially other forms of hedging their exposures.
Increased acceptance of Part IX sales is a testament to the development of newer, more efficient models of debt risk management. Under these conceptions, rights to a debt are assigned to different organisations across the debt’s life cycle, depending on who can best extract value from the debt at its particular stage.
Making meaning for credit managers
There are a number of conclusions that can be drawn from our observations.
The primary observation is that Part IX sales are likely to further cement themselves as the predominant strategy in dealing with debt agreements. Our experience is that sellers are obtaining favourable pricing for these agreements, with prevailing market prices typically consistent with valuation on fundamentals. Provided that pricing remains acceptable to sellers, we shall continue to see a greater degree of Part IX creditors preferring the cash inflows from sales as opposed to
maintaining an interest in the debt.
This acceptance of the sale of Part IXs to specialist purchasers has extended to secondary sales, whereby originating creditors are approving the subsequent sale from a traditional purchaser, who has acquired the accounts from an originating issuer, to an insolvency specialist. Driving these approvals is the ability of the primary purchaser to deploy additional capital from the sale of non-core accounts on future purchasing, as well as minimal exposure to risk with limited customer interaction permitted under these agreements.
The single largest influence on the future of this market will be the outcome of the referral of the Bankruptcy Amendment (Debt Agreement Reform) Bill to a parliamentary committee for inquiry. The proposed changes will see potential amendments to the term of debt agreements, proposed caps to payment to income ratios, voting rules for Debt Administrators/ related entities, asset thresholds and additional scrutiny of Debt Administrators.
These changes are not expected to restrict sale activity, rather increase the volumes of accounts sold and alter the average rates of return. The committee is due to report in March before voting in parliament.
The single largest influence on the future of this market will be the outcome of the referral of the Bankruptcy Amendment Bill to a parliamentary committee for inquiry.
Kessler Financial Services
T: 61 2 9252 2811
March 2018 - FNSCRD501 - Respond to personal insolvency situations - FNS51520 Diploma of credit management