The mortgage mess and the deepening economic malaise may dampen sales for franchised dealers, but not necessarily for buy here, pay here stores.
This is a recession-proof business, notes Brent Carmichael, a consultant with NCM Associates BHPH 20 Group programs. Yes, the mortgage crunch has pushed some of the BHPH buyers’ credit scores down, but not by much. Our customer is out there, in good or bad economic times.
That is the good news about this business, the bad is that being a success as a BHPH dealer demands skills not usually required by franchised new car dealers, including:
- Expertise to diligently monitor cash flow
- Diligence to keep collections current
- Ability to secure capital for high-risk buyers
- Tolerance for buyers tendency to skip payments
Ok, so some of these skills are shared by most dealers, but the BHPH entrepreneur is largely a solo act operating without a safety net. A few wrong moves and the show is over. That is critical to keep in mind for new car dealers exploring this market. This is a collections, risk, and receivables management business, Carmichael explains.
The fatal mistake that new car dealers entering the BHPH market make is not understanding the difference between selling cars and managing a subprime finance portfolio, notes Ken Shilson, president and founder of the National Alliance of BHPH Dealers (NABD). Understanding this difference and being willing to take the appropriate steps to minimize that risk is another important key to success in the BHPH business.
Sourcing capital is also an increasing challenge. Lenders and banks are tightening their requirements across all credit levels- many finance sources simply don’t understand why a business would want to make loans to consumers who present such high risk of default. That makes finding sources who will buy BHPH paper an increasing challenge. Whereas capital sources a few years ago would advance 60-65 percent of the note balance, they might advance 50-55 percent today, plus they’re changing their parameters regarding vehicle age, mileage, and note term, says Rick Potter, president of CAR Financial Services.
Yes, securitization can be difficult, but one thing that helps is if the book of business features payment-protection devices on these assets should their buyers default, notes Bob Blackburn, vice president of sales for AutoLending Network, a nationwide network of finance companies and dealerships focusing on helping the credit-challenged.
The BHPH market
The BHPH market is fractured, with little or no consolidation underway, unlike the franchised market. Even the top five BHPH dealers comprise no more than five percent of overall used car sales, according to Carmichael.
The average vehicle sold by BHPH dealers sells for $10,000. Buyers are predominately male, aged 25 to 40, who have worked at their current job for nine to 12 months- most of them are renters- their average gross monthly income is $2,000- and most have credit scores in the mid to upper 400s. They are true payment buyers.
For BHPH dealers, the average gross profit per deal is $3,500 to $4,000, with an average cost per vehicle with reconditioning of $4,900, and an average note term of 34 months. Eighty-five percent of the vehicles on the BHPH lot are sourced from auctions and dealers are having to source inventory from increasing distances from their bases. On average, a vehicle remains in inventory for about 70 to 75 days. Historically, thirty percent of the deals a BHPH dealer puts on the street will fail, requiring repossession and locating and transporting the units back to the lot.
A cash flow business
The BHPH business runs on cash flow. Cash flow is the most-critical factor to be watched, managed, and prayed over.
The key to a successful BHPH business is having the right cash flow model-where the cash comes from, how it is spent, and how it is managed, Carmichael says. Everyone who gets into this business knows it will take a lot of cash. Cash flow is different from net profit or what you see on paper. Cash flow means how much you are putting into your pocket. A lot of BHPH dealers say their net profit is good, they’re making X dollars a month, yet they’re still having to fund the business from their own pocket.
Given cash flows life-sustaining properties to the business, BHPH dealers need to pay prudent attention to it. The goal is to slow the outflows as much as possible. There are a number of ways to accomplish this:
- Purchase inventory at the right price.
- Implement ways to reduce transportation costs for new inventory.
- Reduce overhead like rent and utilities.
- Reduce staff.
- Find ways to reduce marketing costs without negatively impacting business opportunities.
- Get better (much better) at weeding out the wrong kind of buyer before you start.
- Improve collections and get abandoned or repossessed units back quickly, through recon, and on the lot again right away.
Any number of these points can help reduce costs, meaning more money stays in your pocket. Some, like reducing rent, may not be something that can be implemented quickly, but a sharp pencil taken to transportation, inventory, and marketing costs should.
Underwriting is vital
Given the histories of many BHPH buyers, many BHPH dealers are inclined to brush off any checking of the individual’s risk.
The BHPH market is very competitive right now, and to be more competitive, dealers sacrifice underwriting guidelines, Carmichael notes. Yet underwriting should be conducted, even if only to confirm a place of employment and residence.
Jim Krueger, president and CEO of PayTeck, a technology company whose products help BHPH dealers improve collection success, agrees, noting that while its human nature to want to do no more than is necessary, better underwriting is one area deserving of the extra effort.
The dealers who do some sort of background check, (Are they employed? Where do they work and for how long? What is their credit score?) have fewer problems losing vehicles than those who don’t, he says.
Shilson adds the acronym CASH provides an underwriting guideline for BHPH dealers. The acronym stands for Credit score, Analysis of financial capacity or ability to pay, Stability or length of time on the job and at their residence, and History of credit.
Krueger notes, When you look at a particular customer, this due diligence, this underwriting, is necessary to make sure that customer is as legitimate a customer as possible. If you have to put an interrupt device in the car, you expect to get paid and you may have to shut off the car once or twice to reinforce this obligation with the owner.
Some experts conclude that credit scores as an indicator of risk for BHPH buyers have lost value in today’s market.
We’ve thrown out credit scores- we don’t even use them anymore, says Mike Simon, president and CEO of Sekurus, Inc., an asset protection, management, and tracking service for BHPH dealers. The tools to mitigate risk in this market have changed. The recession is hurting these buyers. Their jobs are in jeopardy and they’re slower now in paying debt. Even finance companies are drying up for this market because the B customer is now a C customer and the former C customer is now a D.
Yet that credit scenario may change suggest NABDs Shilson. In the long term, the credit squeeze will create more and better customers for the BHPH industry, he adds, because of today’s economics, customers with better credit will be coming into the BHPH market. Yes, short term the economy is going to reduce the sales opportunities for all dealers. Dealers will still sell cars though, and if BHPH dealers want to collect their money they’re going to have to tighten their underwriting.
If underwriting is tight, your collectors still have a job to do. Getting the payments in-house, when due, is an important key to cash flow, remember?
What makes a collection good or bad depends on how often collections call the customer and how good they are at making collections and how effective their repossessions are, notes Simon. Dealers are learning that unless they put technology on these cars to ensure payment they can’t fund the deal.
Two options available today can improve collections significantly.
One idea is to outsource collections to a professional collections business. This may be one way for you to reduce overhead and improve cash flow, while at the same time getting more payments in-house to ensure profitability.
The other option is to install a payment-protection device, a.k.a. a starter interrupt, on all vehicles sold.
Sekurus markets two types of interrupt devices: A code-based device that requires the owner to input a code into the car-mounted device in order to start the vehicle because the required code is changed monthly, skipped payments or defaults eventually mean a car that won’t start. The other type of device is GPS-based and does not require a code to operate- instead it lets the dealer track the vehicles location and find it quickly if it needs repossessing.
These tools, Simon notes, can help dealers move a traditional 40 percent BHPH delinquency rate to 95 percent current. Krueger says he wouldn’t describe these devices as a magic bullet. Dealers will still lose a small portion of their portfolio, but they can reduce losses greatly.
If these devices make it possible for the dealer to collect payments 96 percent of the time and reduce his collections time for the remaining four percent, he is a better businessman and will be better off financially, Krueger notes.
PayTeck favors a Web-based asset tracking and management tool over code or GPS devices. Krueger recommends that dealers who use these products place them on all of the vehicles they sell. Use of this tool, however, will still require some activity by your collections staff. The Web tool shows each vehicle sold by VIN, owner, and payment due date. If a payment is not made on time the collections staff simply checks a box on the Web page, which prevents the vehicle from being started. Once payment is received the box can be unchecked and the vehicle can be started.
We’ve seen dealers using this tool reduce their collections staff significantly and the remaining staff can easily handle the account load. It is a more efficient, but not automatic, way to get and keep collections current, Krueger says.
As noted, today there are less capital sources for the BHPH market than a few years ago. At that time, hedge funds saw the BHPH market as a winning proposition, but due to a lack of familiarity with the dynamics of the market, they invested in portfolios doomed to crash, notes Potter of CAR Financial Services.
What these funds thought they were buying was the buyer’s ability to pay, but in reality they were buying the dealers ability to have good policies and procedures as well as good deal structuring guidelines, he continues. Too many of these portfolios were comprised of very high mileage vehicles and terms that were too long, which resulted in high default rates. That access to wild capital is now gone.
Partly as a result of this, capital sources today are setting mileage limitations of no more than 100,000 miles, vehicles not more than 10 years old, and terms in the 30-month range.
These limitations are forcing dealers to pay attention to how they structure their deals, with an eye toward a higher probability of the customer paying the full term of the note. This is bottom line structuring versus structuring deals so they can get funded, Potter explains.
In today’s market BHPH dealers should be requesting beefier down payments and limiting terms to 25 to 30 months, if they want to have their deals funded.
While capital sources have tightened they’re still there for the right portfolios, and wholesale prices for inventory are declining. Post-hurricane Katrina, wholesale prices jumped as the disaster wiped out a considerable supply of used vehicles. This pressure has now subsided and supply is now good, thus prices are lower.
Dealers who’ve weathered these storms (hedge fund fiascos as well as natural disasters), are better positioned today because there is less competition for vehicles in the five to eight year range, Potter notes. In fact, he adds, one auction service recently noted a five to six week inventory of vehicles in the six to 10-year age range.
We’ve now gone through a cycle of unrealistic deal structures due to unrealistic wholesale prices for vehicles, which chased a lot of capital lenders off because too many of those deals were not structured properly to perform. And even though capital, from a cost perspective, is cheap right now, it is not as readily available because many funding sources dropped out of the market, Potter says.
Independent dealers were early adopters of such marketing mediums as the Internet. In fact, at a recent profitability seminar sponsored by AutoUpLinkUSA, CarFax, eBay Motors, and other online marketing innovators, it was noted that by far the most aggressive exploiters of online classified car ads are independents.
For independent dealers looking to reduce marketing costs, marketing their inventory online is proving to be the most effective medium for reaching buyers and selling cars today, notes Bruce McHoul, CEO of AutoUpLinkUSA, a provider of inventory imaging, uploading, and publishing services for car dealers.
Digital marketing tools like this are ideal for BHPH dealers. While some BHPH dealers might operate under the impression their buyers don’t use or have computers, industry experts say that is not the case.
BHPH dealers can list their vehicles affordably online, and for as little as another 15 cents to two dollars per listing, add streaming videos of each vehicle to tell a visual and verbal story that hits shoppers’ emotional hot buttons. Many dealers using such tools have eliminated most, if not all, traditional print media advertising because this is less costly, it is measurable, and lets the dealer brand the store, McHoul notes.
NCMs Carmichael notes that BHPH dealers’ use of computer systems for mining business data, managing inventory, and keeping in touch with customers is growing. Many are finding, as McHoul notes that marketing via the Internet helps them sell cars for a lower cost per vehicle retailed.
BHPH dealers seeking to improve their profitability in today’s market will do well to embrace business practices that reduce risk and help them better manage the risk they do undertake.
Experts advise BHPH dealers to implement business processes that:
- Embrace better underwriting practices.
- Enforce more diligent collections.
- Require the use of payment-protection devices on all cars sold.
- Adopt more effective marketing tools.
By embracing these marketing tools, BHPH dealers can also reduce their marketing costs. Furthermore, marketing tools such as online advertising not only help dealers reach buyers more affordably, they help them brand their store and ensure better communications after the sale to reinforce the relationship the customer has with the dealer.