Many of you saw the news today that JP Morgan Chase had decided to forgive the outstanding balances of its Canadian credit card holders as it exits its business in the country. When a bank makes a decision to effectively forego millions of dollars (plus interest) that is due and owing to it, many intelligent readers wonder: “What’s the catch?”
The answer to the question concerns the cost of collecting debt. The affected accounts concern debt that is mostly between one and three years old. Typically, the average collection rate if pursued through all legal recovery methods is 19% for debt over a year old. As in, if JP Morgan or some debt collector that purchases an assignment of JP Morgan’s debt rights were to try and collect every last penny of a $100 million debt portfolio, it would come out with $19 million.
Now, here is where things are interesting. It costs approximately $619 on average to hire an attorney to file a lawsuit over a debt, obtain a judgment on the debt, and then file the garnishments and writs in order to collect the debt. We don’t know the number of Canadian cardholders affected, but the average credit card debt at the point of delinquency is $4,281. If we are evaluating a $100 million portfolio, this would be that there are 23,359 card holders affected who would cost $14.4 million to collect again. In order words, JP Morgan would have to spend $14.4 million to collect $19 million. As I mentioned before, JP Morgan did not disclose these specific amounts, but this gives you a sense of the proportionality of the collection practice.
Alternatively, in the case of debt forgiveness, JP Morgan can mark the entire portfolio as a loss and deduct the loss against its profits. Due mainly to the Trump tax cuts, JP Morgan’s effective tax rate has lowered from 24.9% to 18.0% over the past two years. The erasure of the $100 million debt portfolio (or whatever the amount may be) can be used to offset the $19 million tax payments that would be required on the company’s profits that are being offset by the tax forgiveness.
In other words, JP Morgan would need to find someone who would either pay more than $19 million for the debt portfolio of $100 million in years-old debt, or it would need to collect more than $19 million if it were to pursue the recovery itself (an unlikely event, as the projections above indicate that JP Morgan would end up with less than $5 million if it attempted to collect the debt itself).
Typically, companies sell overdue debt immediately or at the ninety-day mark because they can fetch a much higher price than debt that is a year old. Once in the hands of a debt collector, their opportunity cost is difference because they might be looking at a portfolio of $100 million that they spent $8 million acquiring so the point of debt forgiveness would be irrelevant because the tax code is not as accommodating to discounting debt that had been purchased for pennies on the dollar in that the tax benefit is proportional to the rate of discount that the debt collection company paid for the debt.
In short, the story here is that credit card companies or unsecured debtholders typically sell their unpaid debt much earlier so it can command a higher rate. Having failed to do that, JP Morgan’s best financial outcome was the tax benefits associated with debt forgiveness which would not have been nearly as attractive if that had already been sold to a debt collector.
Plus, there is some reputational economic value to JP Morgan circulating a positive news story about a bank helping out its adversely-situated customers. But the basis for the decision was unlikely to be corporate altruism or more likely that JP Morgan was able to earn a 19% return by forgiving the debt that could not have been matched by collecting the debt outright or selling the debt portfolio.