OCTOBER 2020

 By Jim Rhoads - BHPH Magazine August 2020

What could be more important than portfolio performance in Buy Here Pay Here?! But, what are the right “benchmarks” or “analytics” to follow? Which ones should prompt BHPH dealers to take corrective action? There are a handful that we monitor on behalf of our clients but I’ll give you one to put at the top of your dashboard: principal collected as a percentage of principal charged off. We urge our clients to strive to stay above 125% on that ratio. Allow me to explain.

The table shown in Image 1 (right) was pulled from an actual client’s portfolio performance report. Rows 4 and 5 are among the data points we chart regularly for all clients. But, row 6 shows the ratio that I view as key if I were to pick one that will apply to virtually all BHPH operations, regardless of business model, average pricing, loan terms, etc. Using the 6-month average of 545K collected per month and about 306K charged off per month, the result is a ratio of 177.9%. Said another way, for every dollar that this operation charges off, $1.77 is collected – a very healthy ratio. 

Buy Here Pay Here dealers should collect more principal than they charge off! If necessary, read that sentence again. We don’t need a Harvard statistician to tell us that this should be true. Yet, I see far too many dealers running below the line – charging off more principal dollars than they are collecting. If I were to advise someone looking to buy a dealer’s portfolio or business, this performance indicator would be in the first 3 figures I’d calculate.

It is clear from the data laid out in the illustration above that this dealer is managing the portfolio well. The results are consistent, making projections predictable. The value of predictability is too often overlooked in this business. Effective management is a crucial component in achieving such stability and reliability.

What’s the fix if running below 125%? The answers are many and vary by the operation. Some fixes may be quite simple and improvement may be evident right away. Others may take more time to produce dividends. If a client engaged us to identify and correct the problem, I’d be examining the typical inventory/collateral, pricing strategy, underwriting/approval method, length of contract and other finance terms, reconditioning practices, solutions for post-sale support, etc. All of these are what we’ll call “slow fixes” to portfolio performance. But, the problem solver in me knows that hemorrhaging must be first attacked at the source. Otherwise, Band-Aids provide temporary relief at best but the bleeding continues. My approach is always to solve the larger problem in the most permanent way possible.

Quicker fixes can include collections training, updating pay plans, implementation of key technology, and timelier and deeper performance tracking, to name a few. Of course, personnel changes are recommended in some cases. More often, subtle changes translate into significant improvement in profitability and cash flow.

In the management education or mentorship we received, most of us heard the statement that “You can’t manage what you can’t measure.” I find the sometimes-overused statement to be true. Fixing a collections problem like the one described here starts with reliable, comprehensive, and timely reports. We must first do everything we can to identify the root cause of the problem(s). Good numbers can be a huge help. Then, we can begin to turn to the less tangible parts such as processes, attitudes and motivations.

Naturally, there may turn out to be multiple drivers of the collections problem. Until those factors can be determined, it important to begin by acknowledging that charging off more dollars than we collect is a problem that can and should be improved.   [JR]

 By Jim Rhoads - BHPH Magazine April 2020

I’ve heard it too many times. Dealers approaching retirement or otherwise looking to exit the business say there are no buyers for their established Buy Here-Pay Here operation. The feedback they receive is there are no parties willing to acquire and operate an established BHPH business. They’re told the only way to exit is to sell off the assets – inventory, any real estate and the portfolio of contracts. Of course, the contracts would be sold to a third-party bulk buyer at a significant discount. Years of building a successful business to end up there? In a liquidation “fire sale”? 

Now, I’ll be the first to recognize not everyone has the stomach for BHPH – at least not as so many from the outside perceive it. And acquiring a portfolio of contracts originated and serviced by someone else has its dangers. But bulk buyers do it all the time. Why? Because there is interest income and profit and cash flow in it for them. In short, the portfolio has more value to them over time. Nothing earth-shattering about that. How is it, then, that other entrepreneurs are able create businesses that build equity and value and can eventually sell their enterprises for three, five or 10 times their net profit [or some multiple of their cash flow]? How do they fetch a juicy multiple and move on to their next venture or retire in comfort? What are those sellers able to convey or transfer to the buyer/next operator that BHPH dealers cannot? 

Of course, the answer as to what makes any business marketable can vary. And what might appeal to one buyer might not interest the next. Some buyers are looking for growth and  expansion opportunities. Others might be looking to increase market share within their industry. There are buyers that seek underperforming businesses with the expectation they will be able to improve margins and volume and sell at a higher value/multiple. I’ve known buyers looking to simply sustain a successful business and pull down a salary or management fee along the way. The point is buyers have many motivations for acquiring businesses as a going concern or continuing operation. So why not our Buy Here-Pay Here operations? 

There are many reasons, some of which are too complex to take on here. From a high-level perspective, let’s tackle it this way. If I were to buy your established BHPH operation, what would I be getting? If I could examine the balance sheet, I could easily understand the asset section. If I had a look at the income statement and perhaps the sales reports from the DMS, I could identify sales volume and margins – gross and net. And if I looked under the hood at the historic portfolio performance, I could probably project future repo losses and cash flow to be generated – if the portfolio was to continue to convert to cash at the same rate. But that last “if” is a big one. What could you show me that would give me any degree of certainty that performance would be sustainable? Could I expect the relationship you’ve had with all those customers would remain the same once my name was on the letterhead? 

One way to cash in on value is to create and demonstrate sustainability. Any of us can buy a solid used car and expect when we fuel it up and maintain it  properly, it will start and run and deliver us reliably to our next destination. We can reasonably expect it will perform the same for us as it did for the previous owner. Can we say the same about our established BHPH enterprise? If so, how would we prove it? 

The best way to demonstrate sustainability is through well-documented systems. Do we have systems in place that can be adopted and maintained by someone else? Returning to the used car analogy, does our business have an “owner’s manual” and “maintenance record” to provide to the next owner? If not, we open ourselves up to questions and can expect to take a hit on resale value. Or worse, we might be limited to the liquidation type of exit. And that’s unfortunate. 

The sellers of those other businesses fetch the multiples because they have created something repeatable and sustainable. They’ve developed systems and can hand over that “owner’s manual” at the time of closing. We know BHPH businesses can generate tremendous profit margins and positive cash flow, and there are plenty of buyers who would be happy to acquire both. As sellers, we must be able to demonstrate during the “test drive” that we have sustainable systems in place. We must be prepared to show transferable value. Only then can we expect to enjoy the fruits of those years of labor spent building a great business.   [JR]

Pay plans can be difficult in Buy Here Pay Here. Should we tie collectors’ and managers’ compensation to delinquency? Repo losses? Recency? If I were to pick one, it would always be net collection efficiency. The formula: weekly principal and interest collected (net of large, unexpected payments such as insurance payoffs) as a percentage of P&I contractually projected for that same period. To do this, the dealer’s software would have to produce that projected payment report. Regrettably, not all systems do that reliably. For our clients, we capture the data every Sunday. We archive the projected amount, then at the close of the week, we measure the net amount collected compared to the amount anticipated for that period. There is some work to arrive at the filtered or net figures, but it is a simple process overall. We track results over a longer range, typically a 10-week rolling average to sufficiently cover all types of payment schedules (bi-weekly, monthly, etc.). 

Have a look at this sample, a 10-week period from an actual client (Figure 1):

[Images not translating. Email jrhoads@octane.group for complete article]

The green cells indicate weeks where the net collected amount exceeded the target we set for all clients: 93%. This client’s average is at 94.7% over 3 full years. Very good! Let’s examine that number carefully. What does the 94.7% mean? In a nutshell, it simply means that the dealer collected almost 95% of the dollars they were contractually expected to collect each week. Remember, this is net of insurance settlements or other premature payoffs. These are regular car payments. 

So, why is the dealer deficient 5.4%? Why would The Octane Group suggest a target of 93%, allowing for a shortfall of 7%? Perhaps an illustration of a sample customer will help to better understand the source of the deficiency. Imagine that Mary Smith shows proof that she has a short paycheck due to illness. She can only pay $40 of her scheduled $100 payment in Week 1. See Figure 2 below. 

[Images not translating. Email jrhoads@octane.group for complete article]

In this illustration, the collections department draws up a payment arrangement for Mary to pay $120 (extra $20) for each of the next 3 weeks. Once she meets that agreement, she will be current again and can resume her regular $100 payment. In this example, Mary would clearly run past due for a few weeks but would have paid $400, or 100% of what was contractually expected in weeks 1 – 4. In other words, all customers who fell behind but caught back up would pay 100% of the expected amount over time. This is why I promote flexibility and cooperation and urge that collectors and managers be compensated based on collection efficiency rather than delinquency. 

The 7% shortfall over a long range would come from two sources: 1) unresolved delinquency that ultimately results in repo and eventual charge-off or 2) deferrals. While in the case of deferrals it could be argued that the consumer ultimately pays 100% of the payments, the customer would not pay what was contractually expected during the range of time being measured. The money did not come at the time that it was expected. That expected but deferred money will not help the dealer pay this month’s payroll. Allowing managers or collectors authority to defer payments creates shorter delinquency reports but it also hurts cash flow – painful for dealers!

Managers and collectors on a pay plan tied to collection efficiency quickly learn to limit unresolved delinquencies and resist deferrals. To maintain efficient net collections ratios, dealers will need to process repos and charge-offs in a timely manner. The latter is something I recommend anyway – a weekly process. When these practices are followed, the portfolio is clean. Accounts in the active portfolio are performingaccounts. 

How much delinquency, then, is tolerable? To answer that, let’s study Figure 3 below (same client as Figure 1):

[Images not translating. Email jrhoads@octane.group for complete article]

Note first that the delinquency is reported as of Sunday with all our clients. Clearly, this number will run higher than Friday morning’s low. Figure 3 above shows that this client’s delinquency (10-wk rolling average) typically runs 25 to 30%. Should that be a concern? I say not at all. This client runs a portfolio of about 1800 accounts. 25% of accounts past due on Sunday would be 450 customers. 15% would equate to 270 customers. This difference translates into a question of management. How much more time is required week in and week out to manage the delinquency? If it is easily managed using the general rule of 300 accounts per collector, then I’d suggest that the 450 past due customers is not a problem. In fact, it has not been a problem at all during the 3-year period we’ve provided analytical services for this dealer. Consider this: across 3 years (156 weeks), this clients collection efficiency was 94.7%. Think about that for a minute! All poor credit customers. 100% Buy Here Pay Here. And the client collected 94.7 cents of every dollar expected. The 25-30% delinquency means very little.

Understanding how collection efficiency is measured, it is easy to see that collecting efficiently will translate into healthy recency (time to last payment), collateral recovery rates, etc. Flexibility with poor credit customer is crucial. Applying excessive pressure, especially in response to delinquency, will result far too many repos and charge-offs. Deemphasizing delinquency, at least in pay plans, and shifting the emphasis to getting the money in the bank (even if a bit late) can be the difference in saving more accounts, cutting repo losses, and increasing cash flow. In other words, it pays to cooperate! [JR]