BHPH Report – May 2018 – by Jim Leman — Buy Here-Pay Here operators don’t so much sell cars as they manage risk. When operators can better match customer stability to the right deal-structure, the result is more full-term contracts and fewer early defaults.

If you want to increase volume and manage risk to improve your profitability this year, make underwriting by the numbers a top objective, say BHPH dealers and industry experts.

Shifting used-car financing dynamics place a new burden on all operators today, but especially on those who continue to make underwriting decisions based on opinion, gut feel, and historical practice.

  • The used car supply, while plentiful, is tight for age, mileage, and price points of many bread-and-butter cars BHPH needs. Supply issues require operators to pay more for the right acquisitions, ultimately putting more funds at risk.
  • Franchised and independent operators are moving into the BHPH space – thinning inventory options and attracting your customers.
  • The margin for underwriting error – under or over – is now slimmer than ever.

Not only is tighter and better-researched underwriting necessary, but so is an underwriting discipline that adds consistency to the practice.

No two dealers will value factors the same when decisioning the risk a particular prospect presents. Repeatable and measurable customer suitability and deal-structure scoring homogenize underwriting based on quantifiable metrics, not the gut.

An underwriting system that can provide a time-lapse perspective can give you a competitive advantage. You’ll know what kinds of customers (their lifestyles and histories) to put into what vehicles at what terms and down-payment. The dealership will contract deals resulting in lower default rates, longer pre-default pay patterns, and overall reduced risk to the dealership.

“Like most BHPH dealers, I came from a retail environment, so my underwriting and collecting skills were virtually non-existent,” notes BHPH consultant Jim Holman of Oklahoma-based Strategic

Automotive Consulting. “I had to learn there’s more to running a successful operation in this high-risk industry.

“While risk is this business, dealers must manage it. That’s why the best operators in this business pay attention to the numbers,” Holman says.

Every BHPH operator practices some form of underwriting, whether structured or not. A problem with underwriting that’s not transferable, even if an excellent model, is those guidelines reside only in the operator’s noggin. Therefore, no other individual in the dealership having underwriting authority will be working the same kinds of deals the same way. This inconsistency erodes deal quality and increases compliance risk.

Scott Carlson, a former BHPH operator, indirect-lender, and developer of scoring system software points out how, by using consistent, structured, and objective underwriting practices dealers can more confidently maximize sales without compromising collectability.

“Do all the volume you can, but only if those contracts are properly structured,” Carlson cautions.

An underwriting scoring system should give operators trackable performance numbers – a CAT Scan of sorts. The numbers tell the team where the customer fits in the dealership’s scoring profile.

“The right stability scoring, which is an insight into a buyer’s ability and intention to repay the loan, goes beyond what a credit report tells you,” Carlson says. “For instance, I would look for proof of employment consistency over time rather than simply whether the candidate is employed now. I’m looking for historical proof the customer pays his or her other obligations too and on time.”

BHPH dealer Paul Scott of Fiesta Motors, Lubbock, Texas says it a different way: “The biggest challenge in this business is to get people to pay for the cars they buy.”

Fiesta Motors delivers 1,500 units a year from two locations. The dealership’s vehicle ACV range is $3,000 to $7,000, with an inventory balance of 60% cars and the balance trucks and SUVs.

At one time, not having repeatable and consistent scoring system for Fiesta’s operation created problems.

Scott recalls, “We were using an automated scoring system soon after we opened in 2001 but thought we could do as well or better scoring ourselves. What happened was our repo percentage went up as did frequency, with defaults happening earlier in the term.

“We kept tweaking what we were doing, but we just couldn’t get to the results we wanted. Finally, we concluded perhaps we weren’t asking the right questions. We called Scott Carlson to help us get a handle on this.”

Fiesta Motors installed the AutoZoom scoring analytics tool and saw repos decline and profitability increase.

“As BHPH is professionalized, there follows a more scientific or clinical approach to underwriting. Of course, it’s the dealer’s money, and thus he or she is free to override guidelines, but when using underwriting software the outcome of such decisions are there in black and white,” Holman says.

“Using a tool like this isn’t for justifying turning a deal down. Rather, it ensures underwriters have their eyes open and are matching the customer with vehicle and affordability in such a way that operators know for certain they’re not putting bad loans on the book from the get-go,” Holman adds.

By establishing and using underwriting guidelines based on consumer stability, deal-structure, and total scores, the best opportunity to satisfy a customer, manage risk, and be profitable depends on estblishing some thresholds. For its scoring technology (your scoring parameters may be different), AutoZoom recommends:

  • A stability score below 275 typically produces a repo rate exceeding 50% – upper management approval should be required for these deals.
  • A stability score range of 275 to 225 with structure scores below 225 should not exceed 15% of monthly sales unless each deal exceeding this percentage is approved by upper management.
  • Stability scores below 225 typically produce a repo rate of more than 60% and should only be considered if way overcollateralized and approved by upper management.
  • The deal-structures score determines how well the dealer will recover financially on future repossessions; AutoZoom recommends no floor for structure score.

Recognizing and leveraging such underwriting best practices, reminds dealer Scott, is critical to long-term success. “This business is about deliveries. Unlike retail, where a car is sold, and the dealership is on to the next customer, the BHPH relationship starts with the vehicle delivery and then you live with the customer for three or more years.

“The goal is to build a collectible portfolio. It takes everyone in the organization to build it and maintain the relationship with the customer as long as possible,” Scott says.

Finally, Carlson notes the right scoring and reporting methods can help dealers avoid or be alert to areas of compliance concerns. For instance, dealers who forget to present Adverse Action notices can quickly run afoul of federal regulation.

“This business is all about selling to risk and managing those risks – from defaults to non-compliance risks. A dealer structuring deals with the numbers and tracking outcomes using a proven compliance-tested underwriting system can defend their practices when regulators come calling, something a self-built score card or basic underwriting criteria alone cannot do,” Carlson says.