Posted 3 years ago
NOW’S
THE BEST TIME TO GIVE YOUR PORTFOLIO AN MRI!
B Y KENNETH
B. SHILSON , CPA
FOUNDER
/ PRESIDENT – SUBPRIMEANALYTICS
BHPH dealers
began this year with considerable optimism. Customer demand for affordable used
vehicles was high, interest rates were low, employment was strong and reduced
subprime competition were all the reasons for this optimism! Unfortunately,
along came the COVID-19 Pandemic in March which spoiled the promising start to
the new year.
With that
history in the rear-view mirror, what should operators do to emerge
successfully from the Pandemic disaster? The best answer: “look under the hood of
your portfolio now” so you don’t repeat your bad debt losses tomorrow.
Availability of
the capital needed to regain market share will likely constrain future growth
for several months. Therefore, operators must generate more internal cash flow
and “make more from less”. This means giving your portfolio a thorough MRI to
identify what is working best and what isn’t working at all! Simply, operators
must learn from their past losses instead of repeating them. Future success
will be determined by “keeping them sold” and customers paying. Cash and cash
flow will provide “the gas” which fuels your operations.
In these
circumstances, operators are encouraged to perform a “deep dive” review of
their subprime portfolio (in essence, a financial MRI) which should include the
following analysis:
1. Static pool
and loss/liquidation (the inverse of CRR) calculations which compute performance
statistics tied to the periods of origination. This allows operators to
determine whether losses are increasing or decreasing and to identify important
trends. In addition, it is also important to compare the pace of losses between
different periods of each year. If you are not familiar with these metrics,
visit the videos on the home page of my website at www.subanalytics.com for a
brief tutorial.
2. Loss rate
analysis should also include gross loss (before recoveries), net loss (after
recoveries) and default rate calculations which correlate to their dates of
origination. In this type of analysis, the entire portfolio is segregated by
origination (usually monthly) intervals so that loss trends can be identified
and compared. When your loss metrics are compared with your regional and
national peers from our $24 billion database, it puts your own performance in
perspective.
3. Recovery
rates must be calculated to ascertain whether yields on repos and other
recovery techniques are working successfully. Improving recovery rates will
help mitigate net losses even when default rates remain the same or increase.
Operators must maximize their recovery proceeds in the current environment.
This starts by identifying what your average recovery rates are currently.
1.
A
comparison should be made of bad debt losses with deals that performed to
identify underwriting differences and areas where future underwriting,
collateral or business model changes are needed. This comparison should focus
on all your business model elements such as the vehicle cost, sales price,
markup, down payment, payment amount, loan term and all the other components of
each deal.
There
are only three (3) key elements to every buy here, pay here deal: 1.) the
customer, 2.) the vehicle, and 3.) the deal structure. However, all three
elements are vitally important to repayment success or failure. In order to
maximize profits and cash flow, operators must avoid trial and error mistakes.
Such mistakes cost millions of dollars in losses! Alternatively, use portfolio
analysis to validate the most successful underwriting strategy before
additional bad debt losses are incurred.
Some
operators believe that credit scoring systems are the key to successful
underwriting. However, credit scoring only assures consistency and not that the
current credit decisions will be successful. Only when credit scores are
directly correlated to portfolio loss statistics can the results be accurately
validated. Individual portfolios perform differently and custom credit scoring
models are needed to produce predictable results based upon your own market
data and business model. This requires a detailed analysis of your existing
portfolio performance to identify the important customer attributes to include
in the scorecard.
Computerized
analysis prepared from a data extract provided by your software provider is the
most efficient and cost-effective way to perform all the above referenced
analysis. The use of data mining technology enables the analysis to be done
without requiring any input or data entry by your personnel. The cost is
minimal and the resultant reduction in losses and increased customer repayments
directly improves cash flow and profitability!
In
summary, compiling bad debt losses should be the start of portfolio analysis,
not the end! Without a “deeper dive” to identify the causes, underwriting
mistakes will likely be repeated and the future will be no better than the
past. Those who do not identify and learn from their past mistakes are destined
to repeat them.