Shilson: Why the Old BHPH Ways Do Not Work Like They Used To
I frequently receive phone calls from buy-here, pay-here operators who complain that the deep subprime auto market has changed.
Reasons cited are:
1. More competition
2. Customers are more selective about the vehicles they want to buy.
3. Operating and vehicle acquisition costs have increased.
4. There are more regulatory challenges
5. Customers are not paying off contracts like before.
They also indicate that old operating practices do not seem to “solve” the aforementioned challenges.
In this article, I will discuss each of these challenges and share some insights into how the most successful operators are addressing them.
Analyzing Reasons for Dramatic Change
Competition in the deep subprime has definitely increased and is coming from subprime finance companies fueled by low-cost capital from securitizations, credit unions seeking higher yields, and franchise operators selling deeper down the credit spectrum.
In 2014, special finance competition has begun to decrease as the losses from overly aggressive underwriting surface. However, credit unions and franchise dealers continue to pursue deep subprime deals aggressively.
The competition will not go away overnight but should decline over the next 18 months.
Customers who have been sold more vehicle than they can afford have been spoiled. As they default, economic reality will set in and reduce their expectations to match their ability to pay.
Costs have increased in both operations and vehicle acquisitions. Inflation will continue this trend. “Unbankable consumers” have not financially offset these increases with higher down payments or repayments. This has increased portfolio risk.
Regulations have also increased, and compliance with state and federal laws has become a much greater operating burden.
Customers have been “seduced” into buying more vehicle than they can afford by subprime finance companies who favor a transaction approach over establishing longer-term customer relationships. Many BHPH customers have voluntarily surrendered previously purchased vehicles for newer ones they really could not afford.
The loss metrics indicate that they really just “rented” those vehicles for a few months, and defaults will likely continue.
Looking for Answers
So what do the most successful operators do to meet these challenges? Here are four suggestions:
1. Because competition has increased, they must rebuild relationships with customers and prospects via the Internet, social media and through their own collection departments. They handle complaints promptly and work with customers when they encounter repayment problems. They regain market share by providing a “transportation solution” over the life of the installment contract.
2. As the industry economics tighten, good operators implement new technology to increase efficiency. They manage costs carefully and increase their equity to maintain financial flexibility. They adopt a “controlled growth” approach to the market, instead of underwriting “silly loans.”
3. More regulations are inevitable, and good operators now view compliance as a “cost of doing business.”
They are doing these four things now:
- Appointing a chief compliance officer
- Having their documents reviewed by competent legal counsel
- Installing a complaint resolution system
- Documenting their underwriting and collection procedures in writing.
None of these require significant expenditures and are, in reality, better operating practices.
4. In an effort to improve portfolio payments, good operators match customers with vehicles they can afford through tighter underwriting.
Some are reducing their grosses — not increasing them. Some shorten contract terms — not lengthen them. They maximize customer repayment amounts and recoveries when the customers do not pay, in order to mitigate risk.
If it were easy, everyone would do it, and competition would be even greater. However, many are finding that the deep subprime auto market does not generate higher returns unless customers keep paying.
This requires a combination of underwriting and collection expertise. The skills needed to operate successfully in the BHPH subprime auto finance market today have never been greater, but the profit opportunities are outstanding — particularly given the low-yielding economic environment of today.
Reading, networking and education help BHPH operators find solutions to these new challenges. Good luck.
Ken Shilson is president of the National Alliance of Buy-Here, Pay-Here Dealers (NABD), which will host a Boot Camp in Charlotte, N.C., on Nov. 8 and 9 and a BHPH Conference at the DFW Hilton Lakes Executive Center in Dallas on Jan. 18 through 20. To register or for more information, visit www.bhphinfo.com or call (832) 767-4759. Shilson is also president of Subprime Analytics (www.subanalytics.com) which performs electronic portfolio analysis and due diligence services for financial institutions that provide capital to the subprime automotive industry.