BHPH is coming of age. Those who learn to manage the risks of BHPH through the use of tried and true methods and evolving technologies will create fortunes. When growing a BHPH business, it is vital that you start with or change to the best dealership management software available today. Information is the key to properly managing your BHPH business.

Additionally, standardized underwriting and BHPH credit scoring is proving to be a beneficial component for competing in the current market. BHPH customers are becoming more spoiled every day. Prospective buyers are expecting a lot more car for a much lower down payment. Considering the cost of a good BHPH vehicle these days, your company’s ability to more consistently and accurately decision deals will determine your degree of success in the future.

In order to maximize your BHPH business, consider the following:

Product range

Most dealers get their start in BHPH offering vehicles with ACVs of $2,500 and less. While the yields associated with these vehicles can be impressive, the challenges related to the vehicle’s condition can be cumbersome. The sweet spot in the industry is an ACV range of $3,000 to $6,500. Realize that the greater the spread between the cost of the low-end and the high-end vehicle, the greater volume and range of customers you will attract and close. The goal in BHPH should be to match product range with your ability to fund your business.

Risk dollars

Markets vary across the nation. Where there is less competition, customers are willing to pay larger down payments. Therefore, dealers are able to recover more of the cost of the vehicle at the time of sale. Contrary to popular belief, the size of down payment has very little to do with the performance of the note, unless you are dealing with extreme low-end customers. Utilizing BHPH scoring enables dealers to more accurately match customers with dollars at risk or cash-in-deal. Industry leaders are learning to sell more cars for a lot less down.

Repo rate

In BHPH, just as in banking, there will be repossessions. Dealers do not create repos. Most repos are a result of the following: good people with poor means and good intentions, ultimately not being able to pay in a timely manner, mechanical failure, and/or physical damage. While the repo rate (number of vehicles that ultimately come back as compared to the number sold) is an important factor to measure in your business. A 30% to 40% rate is not alarming.

Repo frequency

Frequency is much more important than repo rate. The months in which the repos occur can make or break a BHPH dealer. 80% of all repos traditionally occur within the 12 months of the life of BHPH originations. Repos usually peak during the third 90-day period of the installment contract. BHPH scoring enables dealers to build portfolios that have repos peaking in later periods. To maximize sales, dealers should target a 30% to 40% repo rate, coupled with a repo frequency peaking in the fourth or fifth 90-day period following retail installment contract originations. A protracted frequency will minimize losses traditionally associated with a higher repo rate.

Collectability

Measuring dollars paid prior to repossession plus the ACVs of the vehicles repossessed. Next, include all of the dollars paid on the good accounts to help determine a portfolio’s overall collectability. Comparing that result to the total dollars to be paid by customers on all contracts originated (including both the amount financed and interest) will result in a ratio. On average, BHPH dealers realize 70% to 75% collectability. Through the use of today’s technologies, dealers are pushing all the limits in BHPH without compromising collectability. Dealers should target collectability in the 80% to 85% range, while at the same time pushing the limits on repo rate and properly managing repo frequency in order to maximize sales.

The master plan of BHPH should be to keep your customers paying your dealership for a minimum of ten to fifteen years by providing the broadest range of products for the lowest down payment. Draw on the experience of industry experts and utilize evolving technologies to grow your BHPH business. Those who do so may far exceed their wildest expectations of growth in their businesses, as did my family and I.

One of the biggest factors contributing to dealers being cash strapped is the tax law change that took place in the 1980s. The Retail Installment Sales Act requires that dealers selling and financing vehicles must pay federal income tax on the entire profit of the sale in the same tax year of each sale. This means that dealers will pay taxes on phantom income unless they circumvent the law via establishing a related finance company that purchases each of the retail installment contracts.

Assume that a given dealer takes on the task of forming a related finance company. Just because he has shifted the tax burden to the future, does not mean that he has met every challenge related to the funding of his business.

Actual Cash Value (ACV) Creep and Competitive Down Payment pricing will consume much of the high net profits in his BHPH if the dealer does not have a good handle on his business model. Most all dealers realize that the wholesale cost of goods for used cars is climbing. But, many have yet to realize the impact this can have on cash flow when coupled with the natural tendency most dealers have to move up in car cost as they grow their BHPH business.

IndependentDealer.com shows that the average ACV, average down payment and average number of annual retail units sold for 2005 were $3,288, $808 and 768 respectively. Lets assume that this was a specific dealers business model. If this dealer had allowed his average ACV to move up to $4,500 for 2006, he would have needed an additional $930,816 to fund his 2006 sales. This assumes that the dealer maintained the same average down payment and sales volume as he did in 2005.

In most cases, however, when a dealer increases his average ACV he usually insists on larger down payments. Assuming he did so, he could still have a cash flow challenge. Even if the dealer had produced an average down payment of $1225 in 2006, his average cash-in-deal would have increased. In other words, the average ACV of $3,288 minus the average down payment of $808 would have required the dealer to risk $2,480 of his capital on each sale. His total 2005 sales would have consumed $1,904,640 in capital. Using the same math, the dealers risk for each sale for 2006 would have required $3,275 in capital. Therefore, one can see that the total capital requirement for the 2006 sales would have been $2,515,200.

Failure to properly control ones BHPH business model can create a cash flow disaster. However, once sales growth levels off and the business model is well established the dealership can become a cash cow.

As big money continues to pour into this industry, the need for more sophisticated methods of evaluating potential customers and deal structure is becoming a necessity rather than a luxury. BHPH scoring models can be the solution. These models can be designed to maximize sales by focusing more on the prospective customers strengths and less on the down-payment. BHPH scoring is nothing more than the application of numeric values to standard underwriting criteria. Best case, scoring models should not be designed to eliminate repossessions. They should be built wide in scope so that they offer as many prospective customers as possible an opportunity to prove that they will pay for a vehicle.

BHPH scoring should not be confused with FICO®-, BEACON®-, or EMPIRICA®- scores. Credit bureau scores are produced from models developed to access and measure data related to past payment history, amount of debt, amount of credit used as compared to the dollar amount of credit available, length of time credit is established, number of times paid late, search for and acquisition of new credit, and types of credit established. These scores usually range from 300 to 850.

Imagine creating your own scoring model and the number 375 as it relates to your company’s ideal BHPH customer. This score considers his type of residence, length of time at residence, number of residence changes, time in area, type of job, time on job, number of job changes, monthly income, previous car credit, previous repossessions, length of credit history, and credit bureau score. Now, imagine limiting your sales to only those prospective customers that score 375 or greater during the next 30 days. The repossession rate on those accounts would be low and the accounts that do repossess should do so later in the life of the note rather than earlier because all of the customers would be stronger than your company’s ideal. Conversely, if every deal that you originated during the next 30 days scored below 375, you could expect that the repossession rate on that pool of notes would be greater and the repossessions that do occur would do so earlier in the life of those particular notes.

While scoring models can greatly enhance a dealers ability to sell more cars, they can also show a user where to limit risk if the models also work in conjunction with a static pool analysis feature. During each month, BHPH dealers originate retail installment contracts with varying ranges of risk as shown in the example given in the previous paragraph. When using a properly designed scoring and static pool analysis system dealers are able to identify the degree of those variances and the financial impact of such.

We have all heard the saying, It takes money to make money. Anyone who has created a BHPH business will tell you that funding growth in their business is like feeding large amounts of cash to a money-eating monster. Funding BHPH operations is becoming more costly every year as vehicle wholesale values continue to increase. Recently, I consulted with a dealer who funded his BHPH business using very little capital and more than $400,000 in credit card debt. Though all turned out well for the dealer, I would not say that he used the ideal funding method. Fortunately, funding sources for BHPH dealerships are maturing and meeting the capital needs of larger dealers on a regular basis. Ten million dollar credit lines are no longer unusual in the BHPH industry.

So, what good is a funding source geared to large dealerships if a dealer is just starting out with a few thousand dollars and good credit? It is not much help now but it improves ones chances of building a giant BHPH company in the future. Individuals who understand the money making power of BHPH, and is willing to throw everything they have at it, stand a chance of becoming a powerhouse some day. Dealers owning automobile accounts receivables with the total principle balance exceeding $2,000,000 are now good candidates for multi-million dollar credit lines.

If a dealer learns the fundamentals of mastering 100 BHPH contracts, he possesses the core knowledge to eventually master 1,000 or even 10,000 plus BHPH contracts. However, knowing the basic fundamentals of buying, selling and financing vehicles is not enough to secure lines of credit. Regardless of a dealerships size, its owner must be able to demonstrate to potential capital sources that they understand all aspects of their BHPH business. They must be able provide reporting, statistics and analysis in comprehensive formats to secure even small lines of credit, unless the funding source is relying upon assets other than vehicles and auto receivables to secure the dealers debt.

As I have spent much of my time consulting dealers, many have shared with me that they started on a whim and/or shoestring. The ones that have become most successful were able to demonstrate early on that they had control of all aspects of their business. Many went to friends and family when they first needed more money to feed the BHPH monster. Eventually, they moved up to local banks that normally loaned each less than $1,000,000. Some built their client-base principle balance to above $2,000,000 and were able to demonstrate that they were in control of all aspects of their business. This enabled some to secure multi-million dollar lines of credit.

I have learned that in most cases, dealers who are willing to invest the time and money required to have audited financial statements completed by regional accounting firms early with their business, will come out far ahead of the others when pursuing large credit lines. Dealers that utilize strong relational database technologies and credit scoring systems have a better understanding of their business and are more able to direct extreme growth that usually goes hand-in-hand with large credit lines.

If you are not taking the action steps required to benefit from a multi-million dollar line of credit now or in the future, I would be glad to talk to you about why you should.

My first underwriting experience in BHPH proved to be less than stellar. Her name was Marilyn and I was only sixteen years old. The year was 1970. My father had always insisted that every blank on each credit application must be completed. The day finally came for me to fly solo. Marilyn insisted that she must have that 1964 yellow and black Chevrolet Impala coupe-now! The decision-maker was off of the lot and nowhere to be reached. So, I decided that the time had come to prove myself. It wasn’t until later that I learned the importance of verification.

I was so proud. I had done it. I had done what I had seen my father do many times-I thought. Yet when he made it back to the lot to see what I had done, he was fit to be tied. His first words were not exactly encouraging, This woman will never pay for this car and we will never see it again. He was right! What had I missed? What did he know that I did not know? Information alone was not enough. Not only did it have to be the right kind of information, it had to reflect reality. I have never since forgotten that lesson.

Dealers, as I did, learn difficult lessons of originating BHPH deals the hard way. I have yet to meet a BHPH dealer that was born knowing which customers to finance and how to structure deals to survive. In consulting with them every day about underwriting and scoring, I find that many dealers are still trying to find their way or fine tune their operations.

Beginners have the biggest challenge. They are in a steep learning curve regarding every aspect of the BHPH business. Short-timers usually lack the understanding for the best dynamics of a deal approval. Because of limited staffing in most small dealerships, many functions that should be handled by several different people are usually relegated to one salesperson. As soon as is possible, dealers should separate the verification and approval processes from sales. Multi-lot dealerships should seriously consider and implement centralized credit approval.

Most of all, dealers should always be open to new and/or proven methods. After all, had I stuck with my original method of deal approval mentioned in the paragraphs above, you most likely would be reading a veterinary trade publication in order to see anything that I might have written.

Credit discipline is a learned trait. Families teach credit discipline to their children by example. A persons level of education often determines the type of job one will be able to secure. Different types of jobs will produce varying ranges of income for families. That being said, there is a growing new class of people in America. They are referred to as the working class poor. Therefore, underwriters should be especially aware of varying credit disciplines.

Properly evaluating the ever-changing credit disciplines of our country’s population in today’s competitive buy here, pay here (BHPH) and sub-prime markets can prove challenging-even for the most seasoned credit managers. BHPH dealers are seeking more effective ways to arm their credit departments. The name of the game today is –- Who can offer the most car for the least down-payment to the right customer?

In my opinion, credit discipline is a two-way street. BHPH dealers around the country display their own kind of credit discipline when they continuously strive to improve their credit approval processes. There are still a few BHPH dealers that have yet to pull a single credit bureau on a prospective customer. Others have gone to such extremes that they should consider adding the word bank to their company name.

As I consult with dealers, one of the questions that I ask is, Do you consider that your company is aggressive, neutral, or conservative in your underwriting? and after reflecting a bit, most will answer with one of the three descriptive words that I offered to them in my question. However, after continued discussion, things tend to get more complex. You see, some dealers will only offer low-end cars with high down payments to low-end customers. Other dealers will offer high-end cars to high-end customers with low down payments. Both scenarios could be considered aggressive. One scenario is aggressive regarding customers and the other is aggressive in regard to the deal structure. Even though both methods can be profitable, I consider the first example to be conservative, because the dealer is not willing to take the risk required to maximize sales.

After continued conversation, most dealers will tell me that they are not sure if they are reaching the full sales potential of their dealership and would like to learn more. Whether you consider yourself aggressive, neutral, or conservative in your credit underwriting discipline, continue to seek greater understanding of the BHPH world around you. It is changing rapidly and your company’s particular credit disciplines can help you win the race.

My experience led me to create a Web-based BHPH credit scoring and repossession analysis tool. Since 2002, my company has aggregated hundreds of thousands of score sheets and repossession data from hundreds of dealers nationwide in forty-plus states.

BHPH dealers must ensure they have the correct deal structure for both them and the customer. Amount riding, cash-in-deal, money-on-the-street, target-risk, and/or deal structure are all essential to a buy-here pay-here dealers business, and that is why they are our specific focus today. BHPH dealers eventually develop a gut sense for how many dollars they should put at risk with the various types of substandard credit customers they evaluate. The thing that most dealers don’t realize, however, is exactly how much improperly matching deal structure with customers can affect their profits and sales.

While there is a direct relationship between low deal structure scores involving high-risk customers and wholesale dollar losses on repossessions, there is also a direct relationship between a dealers unwillingness to settle for low deal structure scores on low-risk customers and missed sales. The maximum deal structure score should be targeted on the highest risk customers- the minimum score should be considered on all low-risk customers, if necessary, to salvage a sale.

An ideal score should be 225, but remember to consider all of the deal-structure components that you feel are necessary for proper collateralization while structuring a deal. Deal structure scores between 375 and 75 should be targeted depending on the range of credit risk. Deals structured above the ideal of 225 generally produce better results than deals structured below. When a low deal structure score is coupled with a low-risk customer, however, the results may be even better.

Parachutes have been around since at least the ninth century when Armen Firman jumped off a tower in Cordoba using a cloak stiffened with wooden boards to slow his fall. I have learned that there is a direct relationship between low deal structure scores involving high-risk customers and wholesale dollar losses on repossessions- and, there is a direct relationship to a dealers unwillingness to settle for low deal structure scores on low-risk customers and missed sales.

In 1783, Sebastian Lenormand invented the modern parachute. Since that time, parachutes have evolved into precision canopies that give skydivers pinpoint accuracy to hit their targets. As the BHPH business continues to mature and competition abounds, it is becoming increasingly difficult to hit the target. Consider re-packing your parachute.