During the last year the credit markets have tightened significantly for the subprime industry. This contraction of capital threatens the ability of many buy here, pay here dealers to continue in business. Without capital, buy here, pay here dealers can’t grow or even replace the notes in their portfolios. This threatens the very existence of an important source of transportation to the American public.
Although dealers are frantically knocking on lender’s doors, networking with other dealers and capital formation contacts, their efforts appear to be failing! The primary reason for this negative reception is because sub-prime lending is perceived as very “risky business” in today’s recessionary environment. Many banks and financial institutions have concluded that the current low interest rate environment simply outweighs the potential return (yields on these loans).
In these circumstances, the buy here, pay here industry must tum to more sophisticated credit analysis techniques to show capital sources that sub-prime lending need not blindly expose lenders to undue risks!
Static pool loss analysis has long been the standard way to measure portfolio performance. Under this methodology loans are grouped into pools by dates of origination, and the losses on each pool are tracked as a percentage of the loans originated. This allows lenders to identify loss trends associated with loans originated over different periods of time. When these results are correlated predictable patterns are identified and loss rates can be forecasted. Unfortunately, this methodology causes the user to believe that the past will be a mirror image of the future! In the buy here, pay here sub-prime lending industry subtle changes in underwriting practices can skew the predictability of loss rates.
A major problem in the buy here, pay here industry is that much of the information used in making the initial credit underwriting decision is buried in customer jackets in the file cabinets of dealers. This information is not easily gathered and correlated because this process, in the past, must be performed manually.
Recently, software has been developed which permits dealers to take credit applications on-line from customers and to store such credit applicant information (like time in residence, credit history, income / debt levels, time onjob, credit bureau scores, and other pertinent information) in computer files. This change will allow pertinent data to be electronically extracted, analyzed, and correlated to identify favorable and unfavorable trends in portfolio performance. Using this information, underwriting practices can be altered and trend information can be used to control losses. It will also be possible to electronically compare credit quality between dealers and with the buy here, pay here industry through benchmarking. As these statistics are made available lenders will be able to monitor changes in credit quality for individual portfolios and avoid lending on portfolios with poor performance.
When will the “data mining” of this credit information be available? The answer is very soon! My firm has been working on the development of this new technology and plan to preview it at the National Convention for Buy Here, Pay Here Dealers on May 22 – 24, 2002 in Las Vegas.