What is Debt Sale?
Non-performing loans (NPLs) can be a big risk for businesses because they are past-due loans that have a lower probability of recovery. In these situations, companies consider selling these bad loans as a way to deal with these risks and improve their financial standing. After all, there’s only so much that your In-house and Recoveries teams can do, and at some point selling them might be the most logical move for your company.
There are numerous benefits to selling NPLs, and here are a couple of them in case your company is thinking of doing so:
Reduce Risk
By selling non-performing loans, a company can reduce its overall risk by transferring the potential losses associated with those loans to a debt purchasing company. In case you’re wondering what a debt purchasing company is, these are companies that buy NPLs for pennies to a dollar. The difference between the amount they are able to collect from these delinquent loans and their purchase price is their profit.
Improve Credit Rating
A company’s credit rating can be improved by reducing the amount of non-performing loans on its books, making it more appealing to investors and lenders. Additionally, the sale of non-performing loans can also help a company free up capital and improve its cash flow, which can be used for other business opportunities or investments.
Improve Liquidity
In the event that a company is experiencing financial difficulty, the proceeds from the sale of non-performing loans can be used to improve its liquidity. The cash generated from the transaction can be funneled toward the repayment of some of the company’s financial obligations.
Tax Benefit
Some countries have specific tax laws and regulations on the sale of non-performing loans. In some cases, a company can reduce its tax liability when it claims a loss on the sale of non-performing loans. For instance, in the U.S., if the sale of non-performing loans results in a loss, the company may be able to claim a capital loss deduction on its tax return, which can offset other capital gains and potentially reduce the company’s overall tax liability.
However, I would like to reiterate that this is totally dependent on where your company operates. It’s best to consult with a tax lawyer or professional to learn if your company will get a tax benefit from the sale of non-performing loans.
Reallocate Resources
A company can reallocate resources, such as staff and capital, that were previously dedicated to managing non-performing loans to more productive activities. For example, even if your company outsources the collection of delinquent accounts to third-party collection agencies, you will still need to hire people to train, audit, and manage these them.
In my experience, this is the reason why most companies consider doing a debt sale. When the recovery rate falls below a certain threshold, they will decide to sell these non-performing loans in exchange for a fixed amount. Doing so will eliminate the need to hire additional manpower who will manage the debt collection agencies that will work on these accounts.
When to Sell Non-Performing Loans?
As discussed above, there are several benefits to selling NPLs. The reason for doing so will depend on your company’s current situation and what its objectives are.
Financial Difficulty
If a company is experiencing financial difficulty, such as cash flow problems or a lack of liquidity, it can consider selling non-performing loans to improve its financial position. This can help the company raise cash quickly and help it meet its financial obligations.
Improve Financial Standing
A company may consider selling non-performing loans if it wants to improve its financial standing. By selling these loans, a company can reduce its overall risk and improve its balance sheet. This can help the company appear more financially stable to investors and lenders. As a result, this can potentially increase its access to funding and help it raise capital faster.
Focus on Core Business
A company may decide to sell non-performing loans as part of a portfolio clean-up in order to remove assets that are no longer strategic or beneficial. Doing so will allow them to focus on their core business and reallocate resources to functional areas that need them the most. In our example in the previous section, selling non-performing loans at a certain stage will reduce the need to hire personnel who will work on these delinquent accounts or manage the debt collection agencies that do. Aside from the increased operational efficiency, you also get cash in exchange for these delinquent loans that no longer yield positive returns. In my experience, this is usually the reason why companies sell their non-performing loans.
Regulatory Requirement
In some cases, a regulatory body, usually the country’s central bank, may require the sale of non-performing loans. This is done to get rid of problem assets and keep the financial system stable.
Conclusion
It’s important to note that the decision to sell non-performing loans will depend on several factors. The reason can be financial, compliance-related, or to simply increase operational efficiency. However, if your company is unsure whether it’s time to do a debt sale, the simplest approach to determining this is by answering this question. Does the cost of collection outweigh the potential returns from the delinquent portfolio in question? If the answer to this question is yes, then you should consider doing a debt sale.
By the way, we are a debt collection management consulting company, and one of our clients is a multinational debt management services company. One of the services they offer is debt purchasing. If you need to get in touch with them and your company is based in Singapore, Malaysia, Thailand, Philippines, Indonesia, India, or Vietnam, send us an e-mail at info@ludasof.com so we can refer you to them.
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