ATLANTA — Buy-here, pay-here and special finance dealers had to tighten their belts during recent years as the wholesale cost of older units has risen, leading dealers to either lower their standards for purchases or charge their customers higher payments to cover the higher cost of inventory, according to industry reports.

While hope has appeared at the end of the tunnel, with both ADESA and Manheim reporting that these prices have stabilized of late, industry professionals say the market remains tough and finding the best candidates for inventory will continue to be a challenge, as competition is fierce.

To shed some light on issues facing dealers, SubPrime Auto Finance News recently requested market insights from corporate auction executives and general managers. The professionals responded by offering their input on the fluctuating cost of inventory, recommended the best auction channels for older units and forecasted what they see as the future of the market.

Cost of Inventory

As Ken Shilson, founder of the National Alliance of Buy-Here, Pay-Here Dealers, reported late last year and again this year at his group's collection conference, dealers are feeling a squeeze as the price of older units at auction has risen over recent years.

Confirming this growth, Tom Webb, Manheim's chief economist, said that if a dealer spent $5,000 on a unit in 2006, the vehicle would have on average 21,000 more miles than what he could buy for that price in 2003.

Webb said he realized that $5,000 tends to be above the prince point for most BHPH dealers, but that he offered this example to highlight this recent trend in the marketplace. According to Webb, dealers should be beginning to now notice an easing in the prices.

"Prices for older, less expensive vehicles have started to stabilize and will continue to do so," he explained. "The upward movement in past prices was driven in large part by the growing and successful BHPH business and was not related to supply. If measured either by units in operation or vehicles sold at auction, the supply of older units has grown."

For instance, in 2006, nearly 25 percent of the vehicles sold at Manheim facilities were 1999 models or older, Webb pointed out.

When faced with the higher cost of inventory, Webb said dealers have two options:

—"Spend more for the average unit put in inventory, or raise the weekly payment. The downside is that the dealer typically can't get more upfront money from the customer and the dealer must extend the note, which means he has more money on the street at risk for a longer period of time."

—"Spend the same amount, but get less car. This increases the possibility of a significant mechanical problem occurring sometime during the term of the customer's note. And mechanical problems are the leading cause of payment default. To counteract, I suggest dealers do better pre-sale inspections, do post-sale inspections, buy from sellers that consistently and fairly disclose vehicle condition, and buy from auctions with effective arbitration policies."

Meanwhile, at the recent NABD Collection Conference in Atlanta, Rick Potter, president of CAR Financial Services, attributed the higher cost of older models to the hurricanes that hit the Gulf Coast in recent years.

"In 2004, Florida was hit by four hurricanes. It seemed like every two weeks we were hit by another hurricane," said the Florida resident. "These storms wiped out about 250,000 units, meaning dealers had a harder time finding cars. You could not take that many cars out of the market without feeling the impact.

"Then came Katrina," Potter explained. "There was simply not enough supply, which created an artificially high expense for vehicles, which we're still seeing now."

Also discussing the inventory dilemma, over at ADESA's corporate headquarters in Carmel, Ind., Tom Kontos, vice president of analytical services, went to work analyzing AuctionNet data to see what he would find. He discovered that the average wholesale price for vehicles in the six-to seven-year-old category was $4,592.

Referring to the graph provided by ADESA (please see the Late February edition of SubPrime Auto Finance News), Kontos said, "I have also provided a trend that substantiates Shilson's observation that the cost of acquiring older models has been growing of late, though I would add that this price premium has been shrinking a bit in recent months."

Commenting on the differential between the rate of growth in prices, compared to overall growth in wholesale prices, Kontos said this differential was high from 2003 to 2005, but found it diminished (and even went negative for several months) in 2006.

"This decrease should be welcome news for BHPH dealers," he said.

At ABC Minneapolis, managing partner Jay Fahrendorff said competition is high on the older units, as dealers bid fiercely on these vehicles in the lanes.

"I'm not so sure that I believe that the cost of older units is necessarily going up, as much as I believe the competition to purchase them is pretty intense," he told SubPrime Auto Finance News. "The price dealers pay for used units is still rooted in how much a particular model sells for new. Allowances for age, mileage and condition will fairly well determine how much a vehicle should be worth.

"The key here is desirability," he continued. "When older units are desirable, as they are right now, the competition to purchase them means a significantly lower percentage of no-sales."

Mark Hammonds, general manager of ABC West Michigan, added that prices appear high due to supply issues.

"Overall, I think the $4,000 to $8,000 vehicle has the strongest demand right now," he remarked. "Thus, the prices are certainly high because of supply."

Finding the Right Channel

For some dealers, finding a strong source of older inventory can prove difficult when the competition is so lively over units.

Bill Cieslak, with ADESA Sarasota, said the Notify Me service available through www.adesa.com can prove very helpful in finding specific inventory.

"The best tool available to help buyers locate specific types of vehicles, and the tool I offer our dealers, is the Notify Me service offered through adesa.com," he said.

"This tool allows the dealer to find vehicles anywhere in the U.S. or Canada, or at their auction around the corner," Cieslak added. "It also allows dealers to be as general or specific on the year, model and trim as they would like."

Brick-and-mortar auctions can also be a good resource for these units, according to Cieslak.

"When considering all the vehicles sold at our location each week, about a third of them are between seven and 12 years old," he highlighted. "Approximately 40 percent of vehicles sold are selling at a price point between $2,000 and $7,500.

"There are two primary driving forces for having a solid number of older units consigned at our location," he explained. "The first is that we have a large base of franchise stores consigning their trades at our location. Secondly, we are in a geographic area where a higher percentage of older vehicles on the road are well-maintained with lower mileage."

Charles Nichols, president and co-owner of BSC America's Bel Air Auto Auction, pointed out, "Not every retail buyer who is in the market for a replacement vehicle can afford to buy a new or late model. The dealer demand for used vehicles to stock dealer lots exists at all levels within the wholesale retail market as the subprime market continues to grow."

Charles Nichols said he saw higher traffic at his facility in December and he expects it to continue to heat up as the tax season approaches and dealers are looking to fill their inventory with older cars for consumers who plan to use their tax refund as a down payment.

"Many auctions witness a significant increase in December and at the beginning of the year, as they are a major source to provide certain types of desired units for the subprime market," he noted.

"This is the time of year that dealers who are engaged in the retail subprime business are buying in anticipation of the seasonal surge that comes from the economic boost stimulated from income tax refunds," Charles Nichols added.

Mike Ainsworth, of Majestic Motors, said he's found Bel Air AA to be a good source for older units because of the facility's diversity in the lanes.

"Subprime is a big part of our business, and I try to get a jump on the spring market by buying cars before and just after Christmas," he explained. "It is always harder to find the kind of vehicles that fit our market profile after the New Year comes because I think more dealers are looking for similar vehicles."

Michelle Nichols, vice president and co-owner of Bel Air AA, pointed out, "Many of our auction buyers are smaller, independent dealers. For those dealers, subprime financing programs are their major channels for retail financing, so it is important that they can find a reliable source to buy the vehicles that fit their various lending program requirements."

As for Manheim, Jim Currey, director of national accounts, pointed out that each of his company's operating facilities have a dedicated dealer sales team that can help match dealers with the units they are looking for.

"Just as dealers find their ‘niche' markets, so do auctions," he explained. "Some auctions specialize in late-model, low-mileage vehicles, while others specialize in the older vehicle segment with higher miles."

At NABD's Collection Conference earlier this year, Currey highlighted the fact that Manheim's Anaheim, Calif., facility sold 5,300 five-year-old or older units in 2006, while the Manheim, Pa., auction sold 6,000. As for NADE Bordentown, N.J., it moved 8,000 of these vehicles, he said.

"More dealers than ever are using our operating locations to trade in vehicles that do not fit their inventory model," Currey continued. "Our online technology is designed to save dealers time and improve their search for pre-sale listings via our power search tool. This tool can search one or all of our locations and can be set up by specific make or model, in addition to mileage and equipment."

He pointed to OVE.com as a good avenue for dealers looking for certain inventory. Lois Rossi, Manheim's director of public relations, also noted that dealers can do power searches on most Web sites, such as AutoTrader.com and OVE.com, to find units that meet specific criteria.

Talking to Hammonds, of ABC West Michigan, SubPrime Auto Finance News found that his facility has a specific sale designed for BHPH buyers.

"We have a 30-day float sale every other week. It starts one hour before the regular sale," he said. "The only vehicles allowed in the sale are those $4,000 and under. We typically consign 300 or so every other week."

The average price per unit since the inception of this specialized sale is usually about $2,300, Hammonds said.

"This event certainly opened up a whole market for ‘low-end' buyers, and at the same time, it gives an opportunity for sellers in this market, also," he explained. "In general, most buyers are not looking for ‘projects.' They want to be able to put the units up for sale as fast as possible."

Fahrendorff, of ABC Minneapolis, reported that his facility tends to have a strong mix of older, lower priced units that attract BHPH or subprime buyers.

"While on the fleet side of our business, we do handle the repossessions for many subprime lenders, one of the things we have done is telemarketing directly to the used-car dealers who ‘write the paper' for these companies, encouraging them to purchase these vehicles that many times they may have sold retail," he mentioned. "As a result of our efforts, we have created the atmosphere and the inventory that keeps these dealers coming back.

"While we don't get dealers asking specifically for our assistance finding units for them, they acknowledge that the more subprime finance companies we get as customers, the bigger the selection of vehicles for them," Fahrendorff noted.

Another source for older units at the ABC Minneapolis facility is the unwanted trade-ins franchise dealers send to auction.

"We work hard to keep as many of these dealers in the ranks of our consignors as we possibly can," Fahrendorff said. "They tend to be serious sellers, converting more than 75 percent of their consignments into sales, which indicates to buyers they have a higher likelihood of buying the cars they bid on."

The Future of the Subprime Market

Despite the difficulties and risks professionals in the BHPH and special finance business face, executives and GMs agreed that with caution and a strong understanding of the challenges involved, the future appears bright for dealers.

According to Michelle Nichols, with Bel Air AA, "Each year, the subprime market fuels growing demand for units, and it helps drive the wholesale market prices."

Kontos reaffirmed that the cost of older units at auction is beginning to lessen and said dealers should be starting to witness this in the lanes.

As for Manheim, Webb also mentioned that prices are starting to stabilize and should continue to do so in the future.

Meanwhile, Fahrendorff, with ABC Minneapolis, explained, "We see values on these older units continuing to hold their own. Vehicles are better built and more reliable than in years past. Cars last longer. Manufacturers have done a great job building vehicles without many failure-prone features. Even here, where rust can determine a vehicle life, it's not uncommon to see 10- to 12-year-old vehicles in surprisingly good physical condition.

"On the flipside, however, is the rising cost of vehicle repair," he continued. "The increased use of non-repairable electronic parts and ever-rising labor rates can make many of these older vehicles simply not worth the repair costs needed to make them drivable. An older unit that drives fine may be worth $1,000 in the lanes. That same unit that will not run because it needs a battery, starter and alternator will be hard-pressed to sell for prices much above scrap value — $100 — due to the expense of working on them."

Editor's Note: To view the graphs provided by ADESA and Manheim and hear more input, please see the Late February edition of SubPrime Auto Finance News.