Auto Industry ArticlesBHPH topics covered by Gene Daughtry in various publications
Factors for Good Underwriting
By Gene Daughtry
For many years I have been in a BHPH operation. I first learned what was important from experiences in Special Financing back in the early 90’s. From there I started managing a small BHPH operation that was many years old where I learned quite a bit from the people that began the operation years before. I asked a lot of questions and worked hundreds of deals always thinking how I would have done things differently. I left that organization and moved to a much larger company with a BHPH business that was 5 times the size and a completely different business model than where I had just come from. This operation was 16 years old when I joined them and was run by folks that been in the business for closer to 30 years. I spent 6 years there working thousands of deals and asking questions every day.
So when it was time for my startup, I used what I learned from all that experience. We all agreed you need 3 things for a successful BHPH loan. Ability, Stability and Desire and you might be surprised what that truly means.
Yes, ability means “being able to pay” for what they want to buy. Many dealers I speak with use a percentage of the customer’s gross or net pay, usually 20 to 30% depending on the business model and comfort level of the dealer. I look at this a little differently. First, only consider net pay (after tax income) for the buyer and other signers on the deal. If there is “other income” is it from a source that is verifiable and in the control of your buyer. For example child support is only verifiable if paid via the Child Support Office where an official record is kept. Or through a bank account where funds are direct deposited into the account of your customer. Selling a vehicle based on income from someone not in your deal is not a good way to succeed. There are many examples of what not to do. The primary take away being: use solid proof from a reliable source or do not count the income.
On your application ask about rent, number and ages of people living in the house, what type of dwelling, other bills like rent to own and whose name is on the lease (if one exists)? These few questions imbedded in your application will tell you quite a bit about what your prospect spends monthly to take care of his or her household. For example: the utilities when you live in a mobile home or an old neighborhood house are much higher than utilities in an apartment. How many people and how old they are gives an indication of how much is spent on food, laundry and other expenses that are necessary to run a home. I always use $100 per person in the household as a “grocery” expense. Groceries being everything you buy at Walmart which includes soaps, personal care items and other sundries.
I use a formula of rent plus utilities plus groceries plus insurance (including our vehicle) and other payments (rent to own, credit cards, day care) then deduct that from the provable net pay. If the remaining balance allows for our car payment and leaves about one week’s pay then they can afford a vehicle.
In BHPH you and I are gambling everyday on the success of our loans. A simple percentage of income decision could be setting up customers to fail. Have a guideline to follow but do not make it absolute. A good pay history on previous vehicles can indicate the customers desire to succeed and should not be disregarded even if income is short.
How long have you been at your job? How long have you lived at your current residence? These are questions dealers are asking customers every day. It has always amazed me how many people claim they have lived and worked for 1 year where they are now when they actually means “this is my first year”. I am sure by now you have written many deals where 2 years actually means 13 or 14 months. You get the picture.
I have learned over the years that stability has more to do with where your customer is from and where is he today? Does he or she have children? If so there needs to be a core of support around them to help. I want to know where Grandmother is. Where are the parents? Where did your customer grow up? These things to me are more important than how long have they lived at a certain address. How many deals have you delivered just to find out within 30 to 60 days your customer already moved, again.
Where your customer grew up is home. If times get hard that is where your customer will run to while they get their life back together. Or if there are children, needing help or family pressure will pull your customer back closer to grandma especially if there is more than one child or if the times get tough. Oh and “living with parents with no rent” is not stable and probably not true. I always dig deeper when this is put on an application.
I do want my customer to have a stable full-time job with more than minimum wage income. As we discussed in the ‘Ability’ section you can see that $7.25 an hour will not support someone on their own with rent, utilities, and a car payment. In talking with dealers and with my own experiences I know that job changing isn’t critical as long as your customer is changing to improve his hours, income level or position. The question is where they are jumping. If your customer is moving between employers in your market, where his family lives, he is still basically stable for your needs. If he or she has been jumping and there are big gaps (2 or 3 months not working) between jobs or they jump in and out of state, I would hold out for 6 or more months of current job time. If someone can go without work for months they realize it can be done and might not mind doing that again which raises a flag for me. Conversely, if someone claims they have 20 years on a job but have recent, very bad credit that is another flag. I had a customer with a great job for over 10 years. When called, the HR person verified the job time. When proof of income was produced it showed very little income. A call back to the company HR and we find our customer has not worked in 2 years due to a workman’s comp issue and time spent in court, but was still carried on the payroll. Again there are plenty of examples of things to avoid. The primary take away: Verify everything, every time and look for stability in your area and near family support.
How many repossessions have you experienced where the customer’s excuse is “I hate that car, you made me buy that car”. This is one reason for a loss I do not want to hear. If your customer “hates that car” how can you expect them to dig deep every paycheck and pay you for it? Yes, they need a car to get to work. Of course, having “that car” is better than not having anything. Human nature says your customer will find a way to get away from it if they don’t want it. If your customer came to your lot to buy a truck you have and you tell them they can only buy the Sentra due to income or down payment, odds are your customer may take the Sentra because he feels he has no choice but “backed into a corner” is not a good reason to sell a car. I had a customer try to be a paint contractor out of an Escape. It worked for a while though he was a sporadic payer when he finally found a truck he could buy elsewhere we got the Escape back covered in dents and spilled paint, inside and out.
Desire is an important factor in the success of your portfolio. When there are mechanical issues and your customer has to pay more to keep driving due to repair charges, I want them in something they like owning and not the Geo Prizm I told them they had to buy. This is where everyone on your team needs to understand the importance of putting together good loans and not just selling another vehicle. Your inventory should fit your available customer base. This applies to Special Financing as well as BHPH. I call it 80 & 80. 80% of the vehicles you stock need to work with 80% of the customers you deal with. This way when you say yes to a customer they can pick out almost anything you stock and drive it home.
If you spend a little time setting up your underwriting in anticipation of who is coming into your store and stock inventory closer to their desire and affordability you will have better success with your portfolio. Being disciplined and maintaining your guidelines plays a big role. If you throw the rules out because of a big down payment or someone wants the purple PT that just hit 300 days, you will be creating your own losses. Underwriting is gambling but you can make smarter decisions and help make the gamble less risky.
Controlling Delinquency in BHPH
By Gene Daughtry
Underwriting is the first and most important way to control delinquency. You have to determine the amount of risk you want to endure and design your underwriting to fit that business model. You should sell vehicles that are in a price range aligned with your risk model, so that your losses are tolerable and the customers you are selling to are happy to pay for the vehicle after they purchase it. In my operations we used a strong closing with visual aids to help the customer remember what they agreed to.
From the moment our sales people “upped” a customer, they were working to assist in collections. Our sales people knew there job was to gather information. We trained everyone about the process of underwriting and how it affected the collector long after the car left the lot. One step in our process was after the underwriter approved the customer our sales people would use a handwritten document to write up trade figures, pickup payments, regular payments and payment dates (always paydays). The handwritten page was signed by the customer and kept on file. Later if disagreements ensued during collection efforts, having that handwritten page usually ended the argument quickly. Most of the time when a customer disagreed with collector activity it was not about your actions as a dealer. It is usually about their job/family situation or ill-advised spending when they should be paying their bills first.
Another important way to control delinquency is to make sure your collector is being diligent and organized. If a customer cannot pay the full payment due, your collector needs to receive a payment agreement from the customer when they call or come in. Whatever that agreement, your collector must follow up and attempt to make the customer adhere to it. You being flexible is important when dealing with people. Flexible is agreeing to change payment dates when paydays change, helping customers who have fallen behind by waiving late fees or deferring payments for them if they prove the reason given. Both sides should follow an agreement put together between customer and collector.
Remembering that you are dealing with human beings is important. Establishing LTR (Like, Trust, Respect) with the “regular contacts” should be a goal of your collectors. I worked with our collection and cashiering staff to make sure they were friendly and understanding (within limits) so customers wouldn’t avoid calling out of a hatred of explaining an issue to an unsympathetic ear. Being flexible is fine but customers are people and you should listen with a dose of skepticism. My collectors ask customers to bring proof (doctor bill, check stub, garnishment notice, funeral program) of whatever story they are telling in exchange for us forgiving a late charge or deferring a payment.
In our operation, I would be the only person who could physically make account changes. That way, I was involved in the decision and the collector kept me in the back of their mind when talking to someone about an account. If the customer broke two agreements, we picked up the vehicle in an attempt to show the customer we were serious. In many cases, if redeemed, the payments on the repo would be paid more consistently in the future. Do not allow your customers to think you are the easiest of their payments to miss while they pay other bills or buy lottery tickets. Also, give the car back to them. If the customer comes in, seems to understand the importance of keeping current and has some money (and proof of insurance) work with them.
Thirdly, the way you handle mechanical failure plays a huge role in your delinquency rate. If the car won’t go, they won’t pay. You have to decide how you are going to handle breakdowns and make sure your customers understand your policy so expectations are controlled later. We offered a third party, 24,000-mile extended service plan on every vehicle we sold and had penetration on 98 percent of our loans. The policy covered far more than just the power train and allowed our customers to receive repairs for a small deductible while our shop consistently made a profit. The service contract we used offered nationwide roadside assistance and up to 150 miles per incident towing so our vehicles were not left on the side of the road or in a parking lot. Even if the service policies expiration date or mileage limit had passed, many of our customers would still call to check coverage, which informed us of a problem.
Your controlling of delinquency is about anticipating problems that arise in our business and having policies in place to deal with them. In most cases, delinquencies are personal customer issues projected onto you. Making certain your associates and customers understand your expectations in each situation will help you keep better control of your portfolio performance.
Say “Yes” to Profitable BHPH Service Contracts
by Gene Daughtry
Fourteen years ago I became a manager of a BHPH operation associated with a large multi-franchise dealer group in Texas. We had a Related Finance Company with a $17 million portfolio. There were 2,500 open loans averaging 180-week terms at 26% interest. This operation was what I referred to as “Highline BHPH.” I convinced the RFC manager to allow us to begin selling service contracts on the vehicles that qualified. I marked the contracts up $600 to add gross to our sales operation.
A few months later, we were having a manager meeting when the discussion turned to an improvement in the performance of the service department. Our fixed operations had actually turned a small profit for the first time. The service manager gave credit to the service contracts and what he could charge for repairs. He was finding he could do multiple repairs to vehicles, adding to his average labor hours and parts sales. The collection manager commented about seeing an improvement in customer satisfaction due to the purchase of the “warranty.”
In the months that followed, the portfolio showed some improvement in collections, which the RFC manager attributed to fewer complaints about repairs. And although the RFC lost a collector through attrition, they did not replace the person. Instead, they shifted the accounts to the other collectors and continued to make improvements as we saturated the portfolio with ESP covered vehicles.
A few years later I got an opportunity to handle a startup for a franchise dealer in Arkansas. In the business model I put together, I included a 24,000-mile service contract. I decided our inventory would be determined by the limits of that service policy so that every vehicle we sold could be covered. We advertised that fact in all our marketing and realized a 98% penetration on service contracts throughout our portfolio. We marked up the service contract 50% which generated profit for the sales department as a backend product. The service contracts allowed us to maintain our customers’ vehicles at a much higher level than our competitors. The service contract included day one coverage, which helped keep the expense of policy work to a minimum, and a roadside program that included towing up to 150 miles to get our vehicle to the shop from almost anywhere in our state for no additional charge.
Imagine being able to repair almost everything mechanically wrong with your customers’ vehicles at retail labor rates and parts markups and making a 65% profit on the ROs! The success of the BHPH operation was, in part, due to the capability of saying “yes” to most repair issues our customer experienced while making a profit from the shop. Being able to say yes not only helped our portfolio numbers, it added to cash flow while positively affecting employee and customer morale. We enjoyed a 75% repeat and referral business which I attribute to several aspects, but having the service contract and our inventory mix were the biggest drivers of customer retention. Since we were maintaining the vehicles much better during the loans, the vehicles were in better mechanical condition when we did get them back. Our portfolio experienced only a 0.6% loss ratio (charge-offs to portfolio balance).
Not many dealers in BHPH consider selling a third-party service contract to customers. In BHPH, any product you sell has to be capitalized out of your operating cash flow, and that can limit the number of cars you sell. Some dealers choose to be obligor and offer an in-house program and administer a reserve to hedge against future repairs, either through reinsurance or on their own. We were offering a third-party service contract or “admin obligor” program where the reserve and risk are taken by the service contract provider. The latter is how I have handled repairs for many years and thousands of loans.
Look at it another way; as a dealer, you invest $5,000 in a vehicle with a markup of 80% to 90%. If you’re offering a similar service contract to the one mentioned, you’ll invest the same $5,000 in multiple service contracts that in our operation we marked up 50%. You would get less ROI on that $5,000 upfront but with enough coverage, the return in your portfolio performance, customer satisfaction, and repeat business the shop profit with a reduction of towing and policy expense will more than justify the difference.
Gene Daughtry is an experienced trainer and consultant specializing in /LHPH dealership operations. Gene’s experience encompasses retail direct financing, leasing, DCF/ RFC general management with full operational control and portfolio management. He has 21 years total of experience covering three uniquely different operations.