Online Extra: A Live Opportunity in Deadbeats

Portfolio Recovery Associates has thrived going after delinquent accounts that credit-card companies have given up on

The sharp rise in credit-card delinquencies and defaults may be giving bankers heartburn, but it has created a windfall for Portfolio Recovery Associates (PRAA ). The seven-year-old Norfolk (Va.) outfit serves as the financial industry's equivalent of a scrap-metal dealer: After the major card issuers have exhausted all efforts to collect on their most delinquent accounts, Portfolio Recovery buys the collection rights to them -- often paying no more than two to three cents for every dollar of defaulted debt it buys.

Portfolio Recovery's collection agents then hit the phones, wheedling whatever extra they can from these deadbeat borrowers. "We define [it as] success if we can collect six cents on the dollar," admits Steve Fredrickson, the company's co-founder and chief executive.


  Fredrickson is proving to be adept at mining gold from this junk: Over the past three years, revenues have soared an average of 66%, to $55.8 million in 2002. Profits have risen an average 113% during the same period, to $11.4 million last year -- a performance that vaulted Portfolio Recovery to No. 25 on BusinessWeek's Hot Growth list this year. And despite the brutal climate for initial public offerings, the 43-year-old Fredrickson beat the odds with a $45 million IPO last November.

After debuting at $13, Portfolio Recovery's stock has more than doubled, closing at $30.96 on May 28, with investors betting that a pickup in the economy will enable the company to boost its collections. "As the economy improves, there's a lot of potential for upside earnings revisions here," predicts John Prys, research analyst at Veredus Asset Management, which holds 182,900 shares.

Truth is, Fredrickson has always had a knack for seeing value where others don't. After college, he worked briefly as a runner on the Chicago Board of Trade, then convinced his father to co-sign on a $20,000 loan so he could trade gold futures on the MidAmerica Commodity Exchange. Trading gold helped Fredrickson hone his ability to make snap decisions, but the Chicago native recalls that the stress of the open-outcry system "was aging me fast. I was living off of Sucrets. And I realized I was probably not the world's best trader." Fredrickson sold his seat and a year later joined Chicago's Continental Illinois National Bank with hopes of working as a commercial lender.


  After Continental failed because of sour loans, Fredickson was assigned to the workout team charged with boosting the bank's recovery of failed loans to clients ranging from a Miami condo developer to record giant K-Tel International. "I had to figure out what to do with a warehouse full of Greatest Hits of the '50s," he laughs. But Fredrickson soon sensed the upside in working out troubled assets.

After a similar stint handling collections in Household International's (HI ) credit-card division, Fredrickson and four Household colleagues bolted in 1996 to launch Portfolio Recovery. Fredrickson attributes the company's success first to the proprietary algorithms it uses to determine which of the loan pools being auctioned by the card giants have the most upside for collections, then its debt-recovery strategies, which include rotating accounts among his phone-based collectors to see which one establishes the best rapport -- and hopes for repayment -- with a borrower. And rather than browbeating borrowers for all the money upfront, Fredrickson offers a gradual repayment plan stretching out as long as seven years.

Portfolio Recovery also keeps a tight lid on costs. Even today, Fredrickson and the company's chief financial officer and chief loan buyer work side-by-side from their original metal desks in a single 15-by-30-foot office.

Still, some analysts question whether Portfolio Recovery can meet the 20% growth Wall Street is expecting, particularly given the notoriously fickle nature of the collections business. While Portfolio Recovery won't identify its suppliers, JMP Securities analyst David M. Scharf notes that Sears, Roebuck & Co. (S ) alone supplies more than 10% of Portfolio Recovery's current debt purchases -- a pipeline that could dry up now that Sears has disclosed plans to sell its credit-card operations.


  Some rival collections outfits note that Portfolio Recovery has taken relatively minimal impairments given the $160 million it manages -- raising the question whether Fredickson's collectors are that good, or whether the company is at risk of potential writedowns.

For his part, Fredrickson cites the "conservative projections" Portfolio Recovery makes when it buys the loans. At least for now, chasing deadbeat borrowers remains a growth industry.

By Dean Foust in Atlanta

Edited by Patricia O'Connell

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