Why do banks shy away from collecting on unsecured debt

In many ways the repos and foreclosures are very similar to the collection of unsecured debts. Repos and foreclosures are usually handed off to a "professional" to execute, as an unsecured debt is given to a CA/JDB.

A business difference is due to a few items:

1) Most times the amount involved with a secured debt is much higher (i.e mortgage, auto loan, etc.), hence a greater interest in recovery,

2) Secured debts have a physical asset that can be siezed, hence a greater probability of recovering or minimizing losses.

3) "Banks" cannot "charge off" the bad debt until normal activities have been exhausted. So, there is an economic advantage to "charging off" by turning over to a CA. If banks held onto the bad unsecured debts, it becomes very sticky trying to write off the amount as a business expense. You will notice that some banks do have their own collections arms, but these are often a separate business, which in essence the debt is sold to.

Believe me, it's all about money, banks are not in the "collections" business, as they are not in the real estate or car selling business. They really do not want to be in any of them, and will hand off these activities to professionals.

In brief, it is a value analysis

 

I tend to think it also depends on the size of the bank. Large banks tend to use 3rd party debt collectors more often than small banks do. The small state banks seem to usually have their own attorneys who handle their collections on loans, secured or not.

I thik they normally use collection agencies to collect on small stuff like overdraft charges when an account has been closed for whatever reason.

There seem to be lots of variables but the size of the bank seems to be a big factor in how they handle things like that.

 

So let's say an OC charges off an account. What legal right do they have to collect once they write it off?

If the account has not been sold to a CA/JDB, can the OC still attempt to collect the debt if they have already gained the financial benefit of the charge off?

 

The answer to that lies in knowing what a chargeoff actually is. A chargeoff is nothing more than an internal bookkeeping mechanism. Banks are required to keep a bad debt reserve in cash and it is against that reserve that bad debts are "charged off" meaning that the amount of the "chargeoff" can then be returned to their operating account and the money loaned out. So of course they have every legal right to do with the chargedoff account as they please. They can sell it, assign it for collection or forgive it. They can also claim it as a bad debt on their tax returns thereby lowering their tax liability.

What financial benefit? There is no financial benefit from an account that went sour.

Even the value of the tax writeoff is not a financial gain. It simply lowers the cost of doing business.

 

Thanks Cap1. I was using the term financial gain to include lowering their tax liability. To me that is a gain.

On the first point, let's say an OC charges off an account. Once they sell it to a CA they have transferred virtually all rights to collect on it unless they purchase it from the company they sold it to, correct? So for a large amount of a CC debt, say $20,000: it is in their interest to charge it off within the six month period but want to attempt collection, keep it on their books?

 

While I can't give you a definite answer on this I can say that I have heard that the banks have to charge off bad credit cards within a certain length of time.

What I have heard various times is that it is 150 days and I've also seen 180 days so don't know which is correct or even if either one is correct. But banking rules say there is a time certain when they must charge off a delinquent account.

Chargeoff is not the same as selling or assigning it.

As I am sure you have seen there are several others who are qualified to give you more definitive answers on that than I can.

I'm not a banker or a debt collector.

 

Charging off a bad debt is recognizing for accounting purposes that you are unlikely to be paid back.

It is not in the interests of the bank to carry it on its books as an asset when it may have little or no value, and is on average, certainly not worth the money originally loaned out, since in effect the bank would find itself paying taxes on that amount, when it could avoid those taxes by recognizing the loss.

It is also not in the interests of the bank regulatory and insurance agencies for banks to carry loans on their books as assets past the point when they are likely to be paid off, as that distorts the apparent risk to the insurer. The insuring agency would normally either require the bank to increase capitallization, decreased lending, or improve the quality of the loans to future borrowers, either by raising lending standards, or by requiring more security, to start reducing risk when an increasing number of loans start going bad.

If too many loans go bad, the regulatory agency may require the bank to sell off some operations, or possibly even merge with a stronger institution, as we saw in the late 1980's with the savings and loan problems. In all the above cases, you are better off taking corrective action sooner rather than later, so it is important that the value of assets carried on the banks books accurately reflect the likelyhood of payback.

 

Great answers! Thanks.

 

There are both laws and regulations that require banks, (and other financial institutions) to maintain a minimum "liquidity/net worth". The objective of these is to ensure financial health of the institution, and hence continued operations so as to maintain the monetary system.

So, a "bad debt" for us, is actually a "bad asset" to a bank. After a period of time, the likelihood of repayment becomes statistically low, and the "asset" has to be discounted (as to its worth). At the point of "charge off" the value has approached zero, and the balance sheet of the institution must reflect this. "Charging Off" the account is an accounting entry which removes it as an asset from the balance sheet of the financial institution, and moves it an "expense" item, which in turn lowers the "owners' equity" on their balance sheets. The accounting entry of moving it to an expense item does reduce tax liability for the expense. This is still a "loss" to the financial institution. Because all accounting must balance (in the big picture), this "expense" to the bank, becomes "income" to you the debtor (as an accounting view). This is where the 1099s for bad debt come in. But legally, if the debt is sold (and this means "transferred") you really cannot be issued a 1099 for it as income. Only if the institution "truly" writes the debt off can thay claim it is income to you.

If a bank does somehow collect, they then must claim the income as a "recapturing" of the bad debt.

The Savings & Loan crisis of the 80's was a good example of this not being done, and in fact, quite the opposite of the intents of these laws and regulations.

But, the posters are correct in the sense they give up their right to collect IF they sell the debt. They have sold their right to any interest in the debt. Legally, if you somehow pay an OC for a "Charged Off" debt, they must forward the payment to the debt buyer. The way around this is to sell the debt to a related "company" owned by the financial institution.

This is also why a Charged Off account must be listed as a $0 balance, as legally you do not "owe" that institution that amount anymore.

The general rule is 180 days without payment to classify a debt as "uncollectable", but this is somewhat of a "gray zone". The FCRA amendment to "detail" the dating of a charge off was also done to coordinate with banking regulations, and "prevent" misrepresentation of a bank's true financial position. (again see the S&L example of the 80s!).

This is another reason banks do not usually do their own "collections" on these types of accounts. It gets a bit murky in teh accounting and financial reporting portion. The sale of bad debt is much cleaner for the financials.

Hope this helps,...

 

Yes, this helps, no doubt. I know nothing about the savings and loan mess of the 1980's, though, so that does not help me understand. Your description is entirely adequate and complete.

Thanks.

I have been wondering what the standards are for buying and selling unsecured debt from an OC to any form of collection company. Does a collector get to do research on the " quality " of a debt before actually purchasing it? So let's say a person is in debt, or in pre BK status, has a load of unsecured debt. Could the CA considering the purchase of a CC account from that OC do a pull BEFORE that account was purchased to find out if it were likely to be collectable from someone with no assets?

 

All CA get a masked spreadsheet of the accounts before they purchase them to run their numbers on. Usually the OC will segment out the BK accounts and sell those off to some banko agency to collect. If they file just after the sale to a CA then the CA is stuck with the account, and will probably sell it off to some banko agency as well.

 

What do the terms "Banko agency" and "banko account" mean?

Secondly, if the bank has monetized the account through the securities markets then how can they get around the fact that you can't legally sell the same asset twice?

Do they have to buy it back from the trustee of the securities bundle they sold or what?

What causes me to wonder about that is that you cannot legally get paid twice for the same asset or sell that which you have already sold to someone else.

In otherwords, you cannot legally sell an asset on the securities market and then sell it to a debt collector too.

 

There are some agencies that specialize and purchase banko accounts.

 

Thanks much. I have always wondered about the possibility of a debt buyer " checking out the merchandise " before signing on the dotted line. So that is not something you would do as a collector, it is done by a separate department before purchasing the account? Is that department able to do a " line item veto " and take out certain accounts from the bundle, or must they accept or reject the whole lot of them? Probably varies from OC to OC, eh?

 

I know in the securities markets, they are bundled according to "rating", and you purchase/sell based upon an average "credit rating" (not like we speak of here). This is done to spread risk, and give some allowance for losses on "non performing" debt. The bundle will have a mix of "performance" in it.

Now, my business side is wondering if there is a "market" for opening a CA where you could gain an advantage by "not reporting" to CRAs! (PFD in reverse!)

 

Now that's a darn good idea...the exact opposite of your traditional CA.

 

No the collectors will never see the information. All agencies will have a debt purchaser/marketer that will sell and buy the debt and review all files. Really all we can exclude on a purchase are certain balances, banko, deceased, fraud.