To say the sub-prime market evolved in 1977 may quite possibly be the understatement of the year. During 1997, sub-prime market volume grew, however, a great deal of moving and shifting occurred behind the scenes. We saw numerous new lenders enter the marketplace while no less than six exited via bankruptcy or by simply ceasing to buy paper. In this volatile market, how does a dealer carve out their niche and generate profit while minimizing the risk of being impacted by this constantly changing environment?
Let us first examine the market. The sub-prime market is in a consolidation phase. Sub-prime auto paper, by design, requires a lender to assess a risk and price that risk for profitability. There is a balance between dealer profitability and lender profitability. Intense competition for business has caused some lenders to ignore pricing for profitability to gain market share. Many of these lenders have felt the sting of questions regarding solvency when delinquencies and loan loss rates increase. Dealers have had a few scary moments or actually lost income when a sub-prime lender filed for bankruptcy and there were outstanding contracts to be funded or unpaid dealer reserve accounts. This is a trend that is certain to continue into 1998. In a recent sampling of seventeen sub-prime finance companies by Non-Prime Auto News, the following results were found:
· Eight of the seventeen public companies had a reduction in earnings per share for the third quarter of 1997.
· Delinquency rose at sixteen out of seventeen of the companies
So now back to our original question. How does a dealer capitalize on this segment of the automobile business with minimal risk? Can it be done? Is anyone doing this successfully? The answers to these questions are definitely yes, yes and yes!
During the past three years, NCM Associates, Inc. has had the opportunity to consult, train and assist many of our more than 3,000 clients in establishing sub-prime finance departments. This has entailed on-site consulting, seminar training for both dealers and lenders, and the moderating of Twenty Groups heavily focused on the sub-prime business. During a poll prepared for the National Conference of Special Finance '97 held in Dallas in September, it was determined that one out of every three franchise dealers currently offers some type of sub-prime financing alternative and approximately one out of every two independent dealers offers sub-prime financing. Among these dealers there are some very consistent common denominators which result in success.
It is my observation that the single most important contributing factor to success in dealer sub-prime financing is the quality of personnel managing the program. There are two components of this factor. The first is the person managing or directing the program. The second is the organization of the department with respect to sales and administrative personnel. Dealers who carefully select, train and develop personnel generally lay the foundation for profitable results. This is confirmed when we see two dealers virtually in the same vicinity produce dramatically different results. Often this contrast may be traced to the management and direction of two very different programs. On the surface, items such as advertising, inventory, etc., may be similar. However, get behind the door and look at the management and skill level of the individuals responsible for producing results and you may see reasons for differing results. One area that is arguably the most important is the compliance or administrative component. This key function controls the pipeline which keeps contracts in transit down and cash flowing. We are seeing compliance related issues resulting in more and more returned contracts, buy back requests, dealer cancellations and even legal or criminal action. Compliance is so very important that it is a cornerstone of NCM's Certified Special Finance Manager (CSFM) Education Program.
The second most significant contributing factor is identifying and obtaining the right "menu of lenders." Counting all national and regional sub-prime finance companies, we estimate there are over 300 players. The single biggest concern of a dealer when reviewing a potential lender should be the financial backing and stability of that lender. Many lenders require you to provide a year-end financial statement when submitting a dealer agreement. Every dealer should make it mandatory that a lender exchange their own audited financial statement, prospectus or annual report. If a lender cannot provide a financial statement or, if proformas or projections are supplied in lieu of one, it is a wise choice to look for a different lender. Again, remember more than a few dealers have been burned when an unstable lender tightens the checkbook or files for Chapter 11 protection. Do your homework and focus on lenders which have stability you can bank on. Most large, reputable lenders belong to NAFA (National Automotive Finance Association). These lenders adhere to a code of ethics and have adopted standards of performance. Does this automatically guarantee stability and problem free operation? No, but it does show a lender's participation and commitment to the market.
While there are many factors for success, we have highlighted two of the most significant which provide a foundation for success. Next issue, look for industry data and averages relating to the sub-prime department.