HOUSTON — As I reviewed the year-end results of buy-here, pay-here operators throughout the nation, I noticed that 2009 produced some diverse results. Although my analysis (preparatory to compiling the industry benchmarks) is still in progress, here are some preliminary observations:

1. Some operators had lower sales in 2009 compared with 2008 but made more bottom-line profit.

2. Industry operators again struggled to "cover" bad debt losses with finance income in 2009 (where interest income equals or exceeds bad debt expenses).

3. In some instances repo rates (measured as the number of loans which defaulted, called frequency) increased but bad debt dollar losses, after recoveries (severity) decreased.

4. The lack of capital in 2009 restricted sales growth and caused some operators to reduce overhead and to downsize.

5. Acquiring and reconditioning the "right" inventory at a reasonable cost remained a major challenge.

In this article I will discuss the impact of the above, and how each may impact BHPH industry results in 2010 and beyond.

The decline in sales and corresponding increase in profits confirms the old axiom that "bigger is not always better." Capital limitations caused some operators to tighten underwriting, which reduced losses and related borrowings. Both of these reductions contributed positively to their bottom line. However, despite a low prime interest rate environment, many bank lines contained "rate floors" which increased interest expense.

During the last three years, the industry has struggled to offset bad debt losses with interest income. This trend appears to have continued in 2009. Some operators cut interest rates to attract new customers, while repo losses and "cash in deal" increased creating an unfavorable combination. It is important to note, however, that the most profitable BHPH operators did cover their losses with finance income. This measure continues to be a key element of profitability.

I was not surprised to see an increase in default (repo) rates in 2009. Many BHPH customers saw their income levels slashed due to layoffs, reductions in overtime and other pay reductions. In these circumstances, some surrendered their vehicles through voluntary repossessions while others tried to defer repossession by making partial payments, only to have the vehicle repossessed anyway. Operators who extended repayments without considering the underlying deterioration in collateral experienced greater bad debt losses.

Despite the increase in defaults, net losses in some cases declined. It appears that payment device technology (GPS) combined with diligent collections helped operators recover vehicles quicker, thereby increasing the yield on recoveries.

Tighter underwriting, in some cases, reduced early repayment defaults which have historically created the biggest bad debt losses. Mitigating losses through increased recoveries has become a key element of BHPH profitability.

As mentioned previously, additional capital was not available to most BHPH operators in 2009. Of course, the same can be said for almost all other industries. The recession caused lenders to be particularly cautious in extending credit. The absence of capital in BHPH is like trying to operate a vehicle without gas. Neither will go very far!

The capital shortfall in 2009 forced prudent operators to reduce leverage and increase financial flexibility. This trend hopefully will continue in the future even as the capital markets reopen. Successful operators must become more cash efficient and make more from less.

Implementing technology seems to be the best way to increase efficiency and reduce overhead. Further industry consolidation is likely in 2010 and those who have access to capital and have good systems and management, will prosper; while those who don't will fail.

Finally, acquiring the right inventory at favorable costs is a continuing challenge. As new-car sales decline and franchise dealers retain trade-ins and enter BHPH themselves, supplies of good BHPH vehicles decline for independents.

In addition, floor plan financing remains in short supply. As inventory acquisition challenges surfaced in 2009, many operators traveled further to obtain the vehicles they needed. If this trend continues the Internet becomes a more important tool in vehicle sourcing. Reconditioning costs increased as operators were forced to acquire higher-mileage vehicles. Those operators who controlled reconditioning costs enjoyed substantially greater gross profit margins.

Although 2009 was a challenging year for BHPH and for the automotive industry in general, some positive things emerged. Tighter underwriting, reduced leverage, improved use of technology, increased recoveries, and smarter vehicle sourcing will benefit BHPH operators in 2010 and beyond.

It is apparent that more changes are needed for some in order to adapt to the new economic conditions. Operators who understand these changes will prosper, while others resist them. Therefore, education and networking have never been more important. For those who recognize how to capitalize on these new opportunities, the best may well be ahead.

Kenneth Shilson, CPA, is the founder of the National Alliance of Buy-Here, Pay-Here Dealers (NABD), which will host its 12th Annual National Conference For Buy-Here, Pay-Here at the Venetian in Las Vegas on May 11-13, 2010. For registration or for more information, visit www.bhphinfo.com or call (713) 290-8171. Shilson is also the president of Subprime Analytics (www.subanalytics.com), which performs electronic portfolio analysis and due diligence services for financial institutions which provide capital to the subprime automotive industry.