With the close of another year, most Buy Here, Pay Here (BHPH) operators will evaluate last year’s performance by comparing their results with the past. Most often, these comparisons consist of identifying the changes between the last two years for the following: number of units sold, gross sales revenues (in dollars), outstanding dollars in their installment portfolio, and net income. Although I acknowledge that these are the typical financial barometers used for measuring BHPH performance, none of these, individually or collectively, tell how prudently the company managed portfolio risk which affects their future performance.

For the last eight years, I have performed computerized analysis of BHPH installment portfolios for operators from coast to coast and Canada. These analyses are equivalent to giving each portfolio an “MRI”, and now include more than 900,000 loans aggregating almost $9 billion.

This database 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 these historical metrics, I am able to forecast future loss rates and predict the collection performance by plotting loss curves. I then utilize cash recovery projections for each portfolio to compare the cash returns with that 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.

After studying the aforementioned database, I have reached 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” and 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 always better!

3.) The best portfolios are built using a consistent underwriting approach which is prudently developed by correlating the underwriting characteristics of the customers, the vehicles, and the deal structures with actual historical loss rates. This is most efficiently done by using computer technology and correlation analysis.

4.) Centralized underwriting does not assure positive performance – it only assures consistency!

5.) The local economic environment for operators often impacts performance, either positively or negatively, more than overall national economic conditions. For instance, a significant plant closure in an economic area can have a devastating impact on portfolio repayment performance even when national employment data is improving. Therefore, it is imperative to monitor portfolio performance periodically and to adjust to important changes occurring in the local economy, as needed.

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 this is a 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!

7.) Although 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. Where vehicle cost is rising more rapidly than down payments and repayments, maximizing recoveries becomes more critical to profitability.

8.) The most successful BHPH operators are able to maintain consistency in their performance regardless of how the nation, or the automotive industry, performs. They adjust to local economic conditions quickly and avoid “trial and error” mistakes which can 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.

A more 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 well and what isn’t working at all!

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!

In conclusion, as you evaluate your own company’s performance I advise you to take a “deeper dive” and learn from your losses, don’t repeat them. Improve your profitability and cash flow by recognizing, understanding and correcting past underwriting mistakes.

Good luck!