Posted 4 years ago
By Kenneth Shilson
President / Founder
NABD www.bhphinfo.com
Subprime Analytics www.subanalytics.com
With 2019 in the
rearview mirror BHPH operators should be identifying ways to improve their
portfolio performance in 2020!
Improvement can’t be found by comparing financial statement results or
reviewing the number of units you sold in 2019.
Both of these measurements measure sales originations, but success in
Buy Here, Pay Here results from “keeping them sold”. Financial statements and unit sales are
merely snapshots of a point in time and not a predictor of the future.
In this article I
will focus on ways to improve your future portfolio performance and discuss whether
credit scoring tools need to be implemented into your underwriting procedures.
Over the past 15
years I have analyzed more than 2 million subprime auto installment contracts
aggregating $24 billion. In addition, I also
perform portfolio analysis services for capital providers and subprime
operators around the nation. After
studying my aforementioned database, I have the following conclusions:
1.
Each installment portfolio represents the
operator’s most important financial asset because these contracts generate the
cash flow which is the “mother’s milk” of their operation. BHPH really is the “finance business”, not
the car business.
2.
Asset quality is more important to success than
size. The best portfolios are built over
time, not overnight! Bigger is not necessarily
better!
3.
The best portfolios are built using a consistent
underwriting approach which is best developed by correlating the underwriting
characteristics of the customers, the vehicles, and the deal structures with
historical loss rates. This is most
efficiently done by using data mining technology and correlation analysis on your
own data.
4.
Centralized underwriting does not assure
positive performance – it only assures consistency! Successful underwriting matches the vehicle
being sold with each customer’s ability to pay.
5.
The local economic environment for operators
impacts performance, either positively or negatively, more than the overall
national economic conditions. For
instance, a significant plant closure in an economic area can have a
devastating adverse impact on portfolio repayment performance even when
national employment data is improving.
Therefore, it is imperative to monitor portfolio performance periodically
and adjust to changes occurring in your local economy.
6.
The differences in local economic conditions
like income, employment data, and customer stipulations necessitate the need
for different business models nationally.
I believe that is the reason why many of the nation’s most successful
operators utilize different business models, and why regional performance can
vary when the same business models are used in different regions. There are many ways to succeed in BHPH and
not just one way! This is the major
reason why a custom credit scoring system should be built around your own
underwriting experience using your own customer base.
7.
Bad debt losses are a reality in BHPH (because
customers lack adequate financial capacity to withstand normal life events like
medical problems, job changes, divorce, etc.)
It is imperative that operators mitigate their losses by maximizing
recoveries when they occur. When vehicle
costs rise more rapidly than down payments and repayments, maximizing
recoveries becomes critical to profitability.
Therefore, you should identify and respond quickly to changes and
trends.
8.
The most successful BHPH operators are able to
maintain consistency in their performance regardless of how the national
automotive industry performs. They
adjust to local economic conditions quickly and avoid “trial and error”
mistakes which result in significant charge-offs. In addition, they monitor recoveries closely
and seek to maximize them as part of their overall collection strategy. This is the case, even in states where
remedial recoveries (garnishments and property liens) are not permitted.
9.
A custom credit scoring system should integrate
your data with your underwriting experience.
This is accomplished by correlating your credit score bands with actual
default rates. The best score bands
should have the lowest defaults and vice versa.
However, the real test is all the scores in between! The default rates on these should correlate
in a lineal progression. When score
bands don’t correlate you should determine the reasons why. That requires analyzing the underlying
data. If you are using a scoring system,
do you have direct access to the underlying data? If so, have you identified the most important
customer attributes?
My subprime data contains metrics and data
mining evaluations of installment portfolios for many of the nation’s most
successful BHPH operators. These metrics
include static pool (measures the severity and frequency of losses) and loss /
liquidation (measures the pace of loss occurrences), and “drill downs” covering
virtually every aspect of each installment deal. This analysis looks at customer attributes,
vehicle types, and all the various components of each deal structure, including
the amount financed, contract term, repayment intervals, payment amount,
interest rate, markup, etc.
Using historical metrics, I am able to
forecast future loss rates and predict collection performance by plotting loss
curves. I then utilize cash recovery
projections for each portfolio to compare the cash returns with each operator’s
investment in the portfolio. This
enables me to determine their return on investment (ROI). In addition, I have created ROI performance
gradients for below average, average and above average returns. Such gradients allow me to rate each
portfolio’s ROI and collective performance against an overall master database
of comparable peers. In addition, it
allows me to assess the cash efficiency and profitability for each operator’s
business model.
A detailed study of the above has caused
me to conclude that the best performance results are achieved by studying the
losses in each portfolio to identify what is working and what isn’t!
When studies are performed utilizing data
from multiple periods (months and years) of originations, the results can be
used to make the underwriting adjustments needed to maintain and improve
portfolio performance. Significant
underwriting changes should be avoided; “trial and error” mistakes can cost
millions of dollars! A custom credit
scoring system can be developed from your data to make future results
consistent and predictive.
In addition, the capital markets today are
extremely competitive for subprime operators.
Metrics and consistent underwriting are needed to attract the necessary
capital. If you don’t have metrics or a
scoring system, you should get both!
Now is the perfect time to “look under the
hood” of your own portfolio. Maybe it
needs a tune-up? Good luck!