By John Donaldson, CPA, CGMA
For many consumers, the prospect of large IRS refund checks means they’ll want to get a new car. For buy here-pay here (BPPH) dealers, the prospect of getting larger down payments during tax refund season means selling more vehicles, with less risk. More down typically means fewer finance contract defaults, as consumers have more skin in the game, and are more likely to make their payments on time. That’s the theory anyway.
But tax season has changed. The federal government passed the PATH (Protecting Americas from Tax Hikes) Act in 2015, which changed a number of tax laws pertaining to individuals, families, and businesses. One aspect of the law, designed to thwart fraudulent refunds by identity thieves, mandates that the IRS not process a tax return for those who claim the Earned Income Tax Credit or Additional Child Tax Credit until Feb. 15. Given that date, the overwhelming majority of these tax refunds are in consumers’ hands around Feb. 27-28. This means that the traditional “tax season,” has changed dramatically.
There seems to be two schools of thought about tax season for buy here-pay here dealers today. Some say, “Tax season has become compressed to just a week or two after the tax refund checks are delivered in late February as a result of the PATH Act.” While others are adamant that, “Tax season pull ahead programs that estimate refunds have stretched the season into the fourth quarter of the previous year.”
There’s truth to both, but for finance companies that provide capital to BHPH dealers one thing is certain — BHPH dealers are moving into their busiest season of the year, and many need access to capital to feed the beast, and the beast is hungry.
The average cash in deal for BHPH dealers rose 3 percent to $6,116 in 2018, from $5,992 in 2017, according to the recently released NIADA Used Car Industry report. The average Actual Cash Value of vehicles sold, including reconditioning costs stood at $6,820 in 2018, and there’s solid evidence to indicate these NIADA Dealer 20 Group Benchmarks have risen for 2019. Average recon costs now stand at $1,018. Average down payments slipped to $895 down from $972 in 2016.
At roughly $7,000-plus in cash out-of-pocket for every vehicle on the lot, on average, it takes more than $175,000 for one month of inventory if selling 25 units a month. Gearing up for the busiest season of the year, a dealer may need a quarter million dollars or more.
Unless dealers have a very mature portfolio and an abundance of cashflow, gaining access to capital to grow their business can be an expensive and complicated process — one that can could be a disaster should the dealer default, both for the business and personally.
Dealers can choose a less risky, and far less complicated option to create up-front cash flow — selling a portion of their retail installment sales contracts to a third-party, who then manages the collections seamlessly.
There are advantages and disadvantages to selling off “notes” to a third-party in exchange for capital, but when done with a reputable company that works in concert with dealers can prove lucrative.
One of the biggest reasons for failure in the BHPH results from having a mindset of “selling more is better.” The BHPH business is first and foremost a collections business. Think about it. If you can’t sell a car to someone who absolutely needs a vehicle, but is a very high credit risk, sales may not be your forté. The trick is selling this consumer a vehicle, then getting him or her to make $90 a week payments for three and half years — keeping the car sold.
BHPH dealers know that doesn’t happen in most cases, and they have to manage collections, collect the vehicle when a default occurs, liquidate that asset and move on and do it all over again. When defaults exceed projections, dealers can quickly become cash strapped. One advantage to selling notes is the dealer can access capital quickly. Compared with securing a line of credit from a bank or a loan to fund operations, selling notes is far more efficient, and less expensive. Because BHPH dealers engage in high-risk loans, capital comes at a premium. Selling notes eliminates the high interest rates, and gives the dealer more control over the process.
Selling notes isn’t for every BHPH dealer. It does result in reduced gross profit, but there are many programs that offer the dealer “back-end” money when the portfolio of the notes they sell-off achieve certain benchmarks.
Some dealers complain that by selling off notes, they lose contact with the customer. While that’s true to an extent, it was more accurate years ago when consumers would cue up at the dealership on Fridays to make their payments. With ACH, online banking, and other payment methods available, and encouraged, today, the truth is dealers have less contact with customers as they did in years gone by. It’s really important, to maintain contact with the customer through other methods by getting multiple points of contact for seasonal service specials, customer-appreciation events, and referral requests. Even when selling off notes that are collected by a third-party, the dealer can, and should, maintain contact with their customers.
Finally, the biggest disadvantage, and many dealers have a huge problem with this, is the loss of their reputation when the third-party collections department treats customers poorly. Despite, the third-party not really being associated with the dealer nor his or her staff, poor collections practices and heavy-handed collections tactics will reflect badly on the dealership. Consumers treated poorly will blame the dealership, not the finance company that purchased their contract. The key here is to look for a reputable company to which to sell your notes. If you’re in a 20 Group, ask your fellow members for recommendations. Check with the Better Business Bureau. Do your due diligence.
Remember, during this tax season whether it’s long or compressed, it’s very likely you will need additional cash to operate your business, put more vehicles on your lot, recondition, and market them. Cash has always been and will remain king. Unlocking access to cash can be relatively easy by turning your deal jackets in new inventory.
John Donaldson is the president of Glenview Finance, a North Carolina-based finance company offering capital to buy here-pay here dealerships across the country. He has a long history in the finance and automotive finance marketplaces spanning two decades. He can be reached via email at firstname.lastname@example.org or by calling (704) 954-8489.
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