Two years ago it was all looking so good for personal insolvency companies making money out of the misfortune of others. The banks were on board, everyone was rolling in cash and share prices rocketed up. But then it all went wrong. Rupert Cornford reports.
The growth of a consumer debt industry based on individual voluntary arrangements (IVAs) has been staggering. In the space of three years to the end of December 2006 the sector grew a massive 600 per cent nationally and saw a collection of hungry insolvency practitioners in the North West make a lot of money.
Between 1999 and 2003 the annual number of agreements hovered around 6,000 to 7,000, according to The Insolvency Service. At the end of 2004 that had risen to 10,752; in 2005 it was 20,293 and by the end of 2006 a whopping 44,332 IVAs had been undertaken.
But beneath the success story was a weak link in the chain just waiting to be snapped. The industry had grown out of the banks' willingness to approve IVAs and the lucrative fee structures charged by insolvency practitioners. As debt management firms toasted their success, creditors were becoming increasingly unhappy with the situation.
"We believed that the IVA industry was a gravy train and that creditors would get bothered about the fees," says Andrew Smith, marketing director at Cheshire-based ClearDebt. "But it took longer than we thought it would."
IVAs are a relatively new player in the debt management sphere. Five years ago most personal insolvency companies were placing their clients on debt management plans - a monthly fee would be paid to the creditor based on what an individual could afford at the time. It got the creditors off the back of the debtor but meant that some people were stuck in a plan paying off what they owed for a long time. At the other end of the scale is bankruptcy, where the debtor declares him or herself unable to pay what they owe, and the bank takes the hit.
An IVA occupies the space between debt management plans and bankruptcy and works like this: if a person owes £330,000, for example, they can apply for a formal arrangement to their creditor - via the go-between of an insolvency practitioner - to only pay back what they can afford. It means the bank doesn't have to write off the entire debt and the debtor can avoid the stigma associated with bankruptcy. But, of course, the insolvency company takes a fee for the service out of the bank's overall total.
In the early 2000s, as consumer debt moved higher on the agenda, there was a greater recognition in the insolvency industry that those on debt management plans may be better suited to IVAs and those who where considering bankruptcy could also opt for them. Alongside this realisation, it was also in the bank's interests financially to pursue IVAs over bankruptcy and so the cork was popped and the boom began.
The market grew exponentially under heavy advertising and expensive fee structures as people jumped on the bandwagon. And the banks let it happen because they were doing well financially and were keen to see IVAs take off. Between 2004 and 2006 the industry was in overdrive, but in early 2007 the banks decided they had had enough of the middlemen taking such a high cut and dug their heels in, causing a blockage in the number of IVAs being approved.
The banks ramped up their hurdle | rates - the number of pence they expect to get back in the pound - and set about reducing and restructuring the insolvency companies' fees. Although the creditors were better off with IVAs than bankruptcy, most agreed that the industry needed to become more efficient and regulated. As profits started to fall for themiddlemen, spare cash for direct marketing reduced - a vital method to attract business - and companies found themselves in all sorts of difficulties.
For Debtmatters, it was the end of the road for its IVA order book. The Bolton-based business, which was set up in 2003, floated on AIM in June 2005 and had a market capitalisation of £371.1m towards the peak of the industry boom. Chief executive Ges Ratcliffe told Insider in August 2006 that there were significant opportunities for the company to grow its business and that its admission to the market had given it the chance to drive forward revenue growth. But in February 2008, with a market capitalisation of just over £32.5m, Ratcliffe was telling a very different story.
"It was becoming difficult to operate a successful direct marketing IVA business with acceptable profit margins, in the face of increasing costs of case acquisition and reduced fee levels, in tandem with ongoing sector uncertainty," he says. "As a result of a review, the board concluded that the best strategy would be to exit the IVA sector completely and focus on Loanmakers, the profitable loan broking part of the business."
Debtmatters recently offloaded its IVA order book to Creditflex Group for a consideration of £3800,000 and has voted to change its name to Loanmakers in order to emphasise a renewed focus for the business, although the company is reportedly thinking of selling its loan broking division in the face of its struggling share price.
Manchester-based Accuma Group has also struggled. Its IVA division came under severe pressure in 2007 in the face of creditor pressure on fees, which led to acceptance rates of IVA proposals dropping from 96 per cent to 78 per cent.
"Accuma experienced difficult trading conditions throughout the five-month period to 31 December 2007, particularly within its insolvency division," says chairman Charles Taylor. Although this division has been restructured and costs have been cut, which has now stabilised its trading performance, the effects of these trading conditions have had a significant impact on these results.
"We have altered our business model to take advantage of referrals from newly acquired businesses within the group rather than relying on costly advertising. I am pleased to say that this radical surgery seems to have stemmed losses: the business is currently trading profitably once again and continues to accept approximately 80 new cases per month."
But due to "significant exceptional costs", the company posted an EBITDA loss of £32.7m for the period and is open to offers for its insolvency division.
"Current macro economic conditions favour the group's debt management division, which is performing well, and the board is confident of its future prospects," says Taylor. "The board has received some approaches, which may lead to a satisfactory offer for the insolvency division: with the restructuring of this business now completed, the board believes that the realisable value of this business alone considerably exceeds our existing market capitalisation."
According to research from KPMG, the number of IVAs in the North West fell by 12 per cent in the last quarter of 2007 and 14 per cent of agreements put forward by consumers in financial distress were rejected. As a result of the declining popularity of the IVA against an increasing level of pressure from creditors, The Insolvency Service sat down with the British Banking Association and the IVA companies in 2007 to thrash out the terms of a new protocol, which was introduced in February 2008 and provides a code of practice for both debtors and creditors to follow to increase transparency in the sector.
Although the banks remain in control of tighter fees and increased hurdle rates for companies to reach, forcing the industry to become more efficient, the protocol is expected to ease some of the deadlock over the falling acceptance levels for the agreement. One of the key outcomes is that if a lender rejects an IVA, it will now need to give a specific reason justifying the rejection.
So, who are the winners in all of this? Obviously the banks are happy because they have managed to jump on cowboy fee structures and bring the industry more into line. But how will the debt management firms survive when their business model has been squeezed?
In many cases firms are concentrating on diversifying their skillset to become more efficient in their approach to managing financial distress. In June 2007 AIM-quoted ClearDebt went on the acquisition trail and bought Timperley-based Abacus for £36.2m to complement its IVA business with debt management plan capabilities. Although it faced the industry headwinds in 2007 and posted a pre-tax loss of £3495,178 for the six months to 31 December, the firm remains upbeat and says the Abacus acquisition is now proving its value.
"This has been a trying period that has ended strongly," says David Mond, chief executive of Cleardebt. "Our debt management arm has proved a huge advantage and is now profitable in its own right. We believe that our wider offering of debt management products will provide us with a wider customer base and financial flexibility."
Chorley-based Debt Free Direct was renamed as Fairpoint after it acquired Clear Start UK in June 2007 for £312.1m. Clear Start offers a range of debt management services including consolidation loans, remortgaging, debt management plans, IVAs and bankruptcy.
Andrew Redmond, chief executive of Fairpoint, says: "We completed a strategic review following the acquisition of Clear Start and confirmed our intention to broaden our products and services. We have emerged from this period as the market leader with a strong position.
"We expect reducing competition and limited growth in the overall IVA market to continue into the first quarter of 2008 before the market starts showing significant growth again."
But the future is uncertain. While the industry is going through a period of consolidation, as the banks wanted, the market performance of these companies suggests 2008 will be exceptionally tough.
"The market has had its downs, but it still remains to be seen what the outcome is going to be," says David Youngman, deputy chief executive of WH Ireland. "Certainly, the share prices of these companies have not recovered yet. You could argue this is a result of the market in general, but they have done no better than companies in other sectors."
If the new IVA protocol works, it will provide a much-needed structure for the industry in which to work and set limits for the behaviour of banks and insolvency companies. But the fact remains that fees have been cut and profit margins have been reduced, which still leave the banks in the driving seat. There is still some way to go to repair the damage done to the relationship between the creditors and the middlemen and the IVA sector remains on a knife edge. One thing is for sure - those who survive will be companies with more products to offer than just this form of debt management.