HOUSTON — During the last year the credit markets have tightened significantly for the subprime industry. This contraction of capital threatens the ability of many buy-here, pay-here dealers to continue in business.

Without capital, BHPH dealers can't grow or even replace the notes in their portfolios. This threatens the very existence of an important source of transportation to the American public.

Although dealers are frantically knocking on lenders' doors, networking with other dealers and capital formation contacts, their efforts appear to be failing.

The primary reason for this negative reception is that subprime lending is perceived as very risky business in today's economic environment. Many banks and financial institutions have concluded that the current interest rate environment simply outweighs the potential return (yields on these loans).

In these circumstances, the BHPH industry must turn to more sophisticated credit analysis techniques to show capital sources that subprime lending need not blindly expose a lender to undue risks.

Static pool loss analysis has long been the standard way to measure portfolio performance. Under this methodology, loans are grouped into pools by dates of origination, and the losses on each pool are tracked as a percentage of the loans originated.

This allows lenders to identify loss trends associated with loans originated over different periods of time. When these results are correlated, predictable patterns are identified and loss rates can be forecasted.

Unfortunately, this methodology causes the user to believe that the past will be a mirror image of the future. In the BHPH subprime lending industry, subtle changes in underwriting practices can skew the predictability of loss rates.

A major problem in the BHPH industry is that much of the information used in making the initial credit underwriting decision is buried in customer jackets in the file cabinets of dealers. This information is not easily gathered and correlated because this process, in the past, has been performed manually.

Recently, software has been developed that permits dealers to take credit applications online from customers and to store such credit applicant information (like time in residence, credit history, income/debt levels, time on job, credit bureau scores and other pertinent information) in computer files.

This change will allow pertinent data to be electronically extracted, analyzed and correlated to identify favorable and unfavorable trends in portfolio performance. Using this information, underwriting practices can be altered and trend information can be used to control losses.

It will be possible to electronically compare credit quality between dealers and with the BHPH industry through benchmarking. As these statistics are made available lenders will be able to monitor changes in credit quality for individual portfolios and avoid lending on portfolios with poor performance.

Kenneth Shilson, CPA, is president of Subprime Analytics (www.subanalytics.com), which performs electronic portfolio analysis, consulting and due diligence services. Shilson is also the founder of the National Alliance of Buy-Here, Pay-Here Dealers, which will host its 11th annual Buy-Here, Pay-Here Conference in Las Vegas on May 12-14, 2009. For registration to the conference or for more information, visit www.bhphinfo.com or call (713) 290-8171.