As another year closes BHPH operators should focus on how to make next year better!
The answers will NOT be found in your year-end financial statements or by reviewing annual sales numbers.
This article will discuss how every buy here, pay here operator should evaluate their installment portfolio in order to improve their cash flow and profitability as follows:
1. Identify important indicators that your installment portfolio needs a “tune up”!
2. Discover proactive ways to improve underwriting by using metrics as your guide.
3. Maximize year-end tax deductions for bad debt losses and reduce income taxes
4. Increase the return (“ROI”) on your business model.
5. Learn from your losses so you do not repeat them next year!
Here are some indicators that your installment portfolio needs to be analyzed!
1. Your receivables are increasing but your collections are decreasing.
2. You are selling more vehicles but your portfolio is not growing at the same rate.
3. 3. Your bad debt losses are increasing but you don’t know why!
4. Your portfolio is more than 50% liquidated and you aren’t replacing the “run off” with new originations.
5. Your portfolio performance is worse than the NABD industry benchmarks which are available at www.subanalytics.com.
Hoping that next year will get better is not a prudent strategy. Waiting for the competition to decline or disappear isn’t the answer either! You need a proactive approach to improving your internal collection performance and not depend on your competition declining.
The first step is to develop portfolio metrics: static pool, loss/liquidation, and default rates which are needed so you can compare your performance with your peers and identify performance trends. Here is what you can learn from the aforementioned metric calculations:
· Net Static Pool Rates – measures the frequency and severity of your bad debt losses after recoveries (in dollars) over the life of pools of installment receivables. (This is your performance report card!)
· Net Loss/Liquidation Rates – measures the pace of losses in your portfolio (after recoveries) in dollars before pools of receivables are fully amortized. This measurement is important for projecting cash flow, anticipating future losses, and for identifying changing trends.
· Default Rates – measures the frequency of bad debt losses in units (not dollars) over the life of your installment portfolio. This metric is used to measure volatility and portfolio quality.
If you don’t have these metrics your access to capital to fund growth will be very limited. Capital providers use the aforementioned metrics to evaluate credit risk, to project loan repayment, and to determine advance rates. You can’t expect to borrow millions of dollars without these barometers.
The next step is to charge-off your bad debts when losses become known. Bad debts in BHPH are not like wine; they don’t get better with age. When BHPH customers become delinquent 60-90 days their ability to “catch up” is unlikely. It is important that delinquent debt be charged off when identified so that losses can be mitigated and the appropriate corrective action can be taken. If a charged-off account is subsequently collected the recovery should be recorded when received. A timely and consistent charge-off policy provides a more realistic picture of your portfolio performance and helps you avoid financial surprises. These bad debt charge-offs are deductible for federal tax purposes so your corresponding tax liability is reduced.
Your business model often dictates your BHPH success! You should evaluate your business model periodically for cash efficiency. That means determining the cash return (ROI) on your portfolio investment. You would not make any other investment without considering its ROI and the same holds true for a BHPH portfolio. These calculations require the use of static pool and loss/liquidation metrics to project future cash flow, after bad debts and recoveries. Such projections are needed to identify capital needs and to predict future performance.
A new Credit Loss Measurement Standard passed by the AICPA in June 2016 will require you to reserve for estimated future bad debt losses over the remaining life of your portfolio. You must determine how this new standard will affect your loan covenants and borrowing relationship as soon as possible. Metrics will be needed to estimate future losses and to adjust the reserve for bad debts in your financial statements.
Those who do not make adjustments periodically should not expect better results. The BHPH industry can regain lost market share by “keeping them sold”. Do not begin another year without “looking under the hood” of your own portfolio! The more you learn, the more you will earn! Good Luck!
Kenneth Shilson, CPA is President of Subprime Analytics which uses data mining to perform computerized portfolio analysis for operators and capital providers to the subprime auto industry.