Both subprime auto sales and financial competition are currently high. While there are more customers buying used cars, this does not necessarily translate into increased profits for average BHPH dealerships. In the changing BHPH industry, how can dealers keep customers, avoid loss, and earn more all while remaining competitive?
According to the 2017 benchmarks recently released by Subprime Analytics, auto bond securities are causing greater competition for BHPH financing. In fact, the sale of subprime auto loan bonds is at an all-time high. Many investors buying those bonds have been convinced that recent model year used cars with higher cash values will increase repayment rates and minimize losses due to default. That in turn is leading many BHPH dealerships to offer lower down payments and interest rates on newer used vehicles. Subprime auto loan terms have been extended to 5 to 7 years to finance these more expensive vehicles while still keeping monthly payments relatively low. While this is increasing subprime auto sales, it is also increasing risk. The hope has been that by selling newer used cars, dealers will have a greater return if vehicles are repossessed. However, this is often not the case. By the time the collections or repossession processes is finished, used cars have often been damaged or neglected, severely impacting values.
The fact is that the business model above is not sustainable long-term because it significantly increases lender risk. With the current high default rates in subprime auto sales, this presents a serious problem. The question is: what should BHPH dealerships do differently?
The first step is to change the way in which BHPH dealerships analyze performance. Most look strictly at the number of vehicles sold to measure success. While subprime auto sales are certainly important, Subprime Analytics suggests that it is even more vital to consider the number of customers that a dealer keeps sold. This is part of what makes benchmarks so important. By comparing benchmarks not only for sale prices and average monthly payments, but also for default rates, collections, and deficiencies, dealerships can better understand whether they are losing money, and if so, where. That will help to provide a clearer idea of whether something is wrong.
The second step is to adopt an approach that better deals with risk. While the current competitive financing market is pushing BHPH dealerships to take measures to attract customers, it is still important to remember that financing rates must match risk. How can this be done while remaining competitive? Subprime Analytics president Kenneth Shilson looked at around 2 million subprime auto sales contracts to answer that exact question.
“I concluded that ‘cash in deal’ best defines portfolio risk,” Shilson reported. “My analyses indicates that selling vehicles that will run the term of the contract at affordable sales prices increases the probability of ‘keeping them sold.’”
He went on to explain that pairing the correct customer with the correct vehicle is vital, and should occur during underwriting. By setting reasonable expectations and markups based upon a customer’s ability to pay, BHPH dealerships can often preclude defaults and ensure regular payments and profits. While on paper those profits may not look as attractive as the ones provided by more risky practices, they are far more reliable than the ‘fools gold’ gains offered by selling more expensive used cars at longer term. Those seemingly higher profits, it must be remembered, too often don’t materialize, and are lost due to defaults and vehicle damage.
So, while the BHPH industry is changing, and there is greater competition in the subprime financing, it seems that it is still wholly feasible for dealerships to make consistent and noteworthy profits. The methods being encouraged by investors and loan bond sales is not, however, the way to do it. By replacing risky practices with more stable approaches, BHPH dealerships can still take advantage of rising subprime auto sales without dangerously increasing losses. Sometimes an ounce of caution truly is worth a pound of cure.