First debt lost its stigma and now bankruptcy is losing its sting. Two years ago, some 45,000 people were declared bankrupt in Britain. In 2005, the figure topped 70,000. That easily surpasses the rate recorded in 1992, back when the UK economy was last in recession. And around 45,000 of last year’s bankrupts actually chose to declare themselves insolvent, twice as many as were taken to court by their creditors.
In other words, bankruptcy is fast becoming a route out of trouble, rather than the ultimate financial stigma. And the debt that’s feeding this new boom market is quite simply staggering.
A very British disease
British consumers have run up two-thirds of all credit-card borrowing across the entire EU. Outstanding household debt now stands at a record high of £1.13bn, well over 140% of post-tax annual income. And yet the high-street banks are only too eager to offer further credit to those borrowers carrying more debt than they can ever hope to repay.
No wonder Grant Thornton, the accountancy practice, reckons that the first three months of 2006 will see nearly 20,000 personal insolvencies in Britain, the highest number since records began half a century ago. KPMG says the total for this year could hit 100,000.
But it isn’t just the number of bankruptcies that is increasing. The scale of personal indebtedness is also going through the roof. The Credit Counselling Service (CCS) now sees one new client a week with debts, excluding mortgages, in excess of £100,000.
The reasons for this epidemic are obvious. Credit is more freely available and aggressively marketed than ever before. And who thinks twice about running up a £1,000 bill on their credit card? Why save money for six months when you can buy what you want right now? Where’s the shame in living on credit? Most crucially, there’s little to fear in going bankrupt today. For all the finger-wagging in Whitehall committee rooms, the Government has done nothing to cap the lending excesses of the high-street banks.
And to help mop up after the bubble bursts, it’s also made bankruptcy much less onerous for over-indebted consumers. From April 2004, new rules, embodied in the 2002 Enterprise Act, have allowed debtors to be discharged from their debts within 12 months, instead of three years.
Since then, unsurprisingly, debtor bankruptcy petitions have skyrocketed. The number of people declaring themselves bankrupt averaged around 4,000 a quarter in 2002. By 2003, that figure had risen to 5,000, where it stayed in the first three months of 2004. But in 2005, the number of people declaring themselves bankrupt reached 9,400 in the autumn.
The wave of personal bankruptcies now sweeping over the UK afflicts middle-class earners just as much as poorer households. A very noticeable cohort of debtors beginning to emerge are those with good jobs, earning above-average salaries, yet owing £30,000-£40,000. They tend to be in their late 20s and early 30s. They began their careers saddled with debts from their university days: one in five students now graduates owing more than £15,000.
The debt crisis is different this time
Student loans don’t figure in bankruptcy proceedings. But 900 new graduates still chose to go bankrupt in 2005. Petitioners included a 19-year-old – and “it was not uncommon” for those earning £40,000 to have up to £150,000 in unsecured debts. The total number of bankruptcy petitions last year was twice the level of 2002.
And there’s no sign of the bankruptcy boom coming to an end in 2006, says The Guardian. In the first two weeks of this year, National Debtline took 12,000 phonecalls from people worried about their debts. “Calls are certainly up and we are taking on another 25 staff,” a spokesman told the BBC.
This crisis is different from the last time Britain witnessed a surge in bankruptcy rates. In the late 1990s, around 60% of insolvencies were failed firms. But today, most are a symptom of unsecured and unpayable consumer debt. According to the latest figures, there were 20,461 individual insolvencies in England and Wales in the fourth quarter of 2005. This was up 57% from a year earlier. The number of company liquidations, however, rose just 8.5% from the end of 2004. And at 0.7%, the rate of active businesses going into liquidation hasn’t changed in more than 12 months.
IVAs are the simplest solution
What can these individuals do to cure their debts? The first sensible step is to seek professional advice. And the scale of outstanding debt is such that the CCS is now advising 40% of its clients either to file for bankruptcy or opt for an Individual Voluntary Agreement (IVA). This is the fastest-growing solution to carrying more debt than you can afford to repay.
An IVA provides a legally binding agreement. The debtor promises fully or partially to repay their unsecured debts over a set period, usually five years. The creditors agree not to pursue the debts beyond the repayments agreed. The IVA is structured and monitored by an independent insolvency practitioner.
Such an arrangement particularly suits young professionals, who do not want the stigma and career disadvantages that a bankruptcy still entails. Accountancy and legal practices hiring new staff regard bankruptcy as an indelible black mark on an applicant’s CV.
At the end of the IVA period, the debtor’s credit rating improves and there are no recovery procedures by individual creditors. The creditors also benefit from the arrangement, in that they’re all treated equally and more funds are recovered under an IVA than via bankruptcy. Administration costs are also lower than with traditional debt-collection procedures.
So it’s not surprising that this remedy is becoming increasingly popular. The latest figures from the DTI indicate there were nearly 20,500 individual insolvencies in the fourth quarter of 2005, a 57% increase on the same period a year earlier. But during the same 12 months, the number of people choosing the IVA cure rose by 117%. Debt advisers expect 2006 to be even busier. And even if banks and other lenders reviewed their policies today, the backlog of problems will keep debt advisers occupied for the next three or four years.
How to invest in this booming market
IVAs are still in their infancy. In 2004, they accounted for just 9% of debt resolutions in Britain. And by far the most popular choice remain so-called “debt management plans”. You may have seen the TV advertisements recommending you “simplify your finances into one monthly payment”. But these schemes are often no cure at all. The consolidated debt may still increase, as interest charges often continue. Repayment schedules are lengthy and the debtor often bears the costs.
Indeed, given the advantages of IVAs for both debtor and creditor alike, it’s surprising that they’re not even more popular today. They enjoy a recovery rate for creditors in excess of 35%, compared with less than 10% from bankruptcies. It seems that lack of awareness about this product, plus saturation advertising by the debt consolidators, has so far kept a lid on IVA growth. But it’s clear that this is a booming market. Demand for IVAs will continue to increase as the UK economy slows, the labour market deteriorates further, and the housing market continues to cool.
The question for investors, however, is which companies are cashing in on this growth market? Publicly quoted companies accounted for around 30% of the IVA market in the second quarter of 2005. And their share is growing. The vitally important fact to remember as an investor is that it’s the creditors who pay these companies their fees. The IVA providers don’t rely for their incomes on the borrower, afflicted as he or she is with debts that they can’t repay in full. In fact, outstanding unsecured debts have to exceed £15,000 to make any proposal for an IVA economic.
How to profit from debt
There are three Aim-listed companies dedicated to the market for Individual Voluntary Agreements (IVAs). Curiously, for the financial services sector, they are all based in the northwest of England, where running costs are much lower than in London or the southeast. But not frittering away money unnecessarily is what these firms are all about.
Accuma (ACG, 256p), Debtmatters (DEBT, 162p) and Debt Free Direct (DFD, 311p) all earn their money by acting as insolvency practitioners (IPs). The debtor makes monthly payments into a segregated account controlled by the company, and interim dividends are then passed on to the creditors. Banks and other lenders seem to prefer this arrangement to traditional bankruptcy proceedings – it is thought that more than 90% of cases put forward to creditors by IPs are now passed.
Debt Free Direct is the clear market leader, managing 19% of all IVAs in Britain today. The company was established in 1997 by Lathams Chartered Accountants, and the aim was to provide the widest possible range of solutions to the burgeoning number of individuals with debt problems – from remortgaging and debt consolidation to more sophisticated solutions, including IVAs.
Debt Free Direct is not only expanding fast, but its growth is outstripping the market. The interim results released at the end of November were much better than the market expected and the board declared a maiden dividend. Turnover in January more than doubled to £6.4m from 2005.
The key to this impressive performance has been the surge in activity in drawing up new IVAs. In the three months to October 2004, the company was signing 117 new IVAs per month. Six months on and the monthly sign-up rate hit 250. By last autumn, that had vaulted to 346 per month.
Moreover, the fee structure of Debt Free Direct provides very good visibility of future earnings. Each new IVA attracts a fixed-nominee fee of around £2,700, but in the ensuing five years, £4,500 is paid in supervisory fees. So even in the unlikely event that new IVAs start to dry up, some £7,200 will still stream in from each existing arrangement.
And the firm experienced a flood of inquiries in the fortnight after Christmas. Indeed, chief executive Andrew Redmond this week described demand for help as “unprecedented”. About 17,000 people called Debt Free Direct between 27 December and 8 January – a rate of more than 170 an hour. The average amount owed was £29,000.
Not surprisingly, pre-tax profits at Debt Free Direct are expected to climb from £1.5m in the year to April 2005 to £4.6m in 2006. This would put the firm on a multiple of 35 times expected earnings – on the face of it a rather demanding rating. But this is a growth company. One City broker is forecasting earnings per share of 16.7p in 2007. In that event, the p/e would fall to 18. That’s on the cheap side for a market leader in a growing industry.
Brian Durrant is investment director of The Fleet Street Letter.