Every Auto Finance Company has “bad debt” [losses after recovery of security]. In truth a significant sector of the industry (subprime lending) is experiencing resurging defaults [8-9%] [https://www.bloomberg.com/news/articles/2017-07-17/new-u-s-subprime-boom-same-old-sins-auto-defaults-are-soaring]
Significant default rates and the need to recovery lost capital REQUIRES every auto finance company to ramp up its recovery strategies.
The true value of pursuing recovery of defaults should be clear; recovered “bad debt” means recovered CAPITAL for reinvestment. To that end, a serious auto finance company must analyze and embrace the costs and commitment necessary to implement successful recovery strategies. AND it must analyze and embrace implementing strategies (against a reasonably expected return) that are short AND long term.
Here are six (6) strategic considerations (post security recovery) EVERY auto finance company needs to examine carefully based on its “bad debt”:
Maintain a separate “in house” collection department
Outsource lower balance claims to “agencies” that know auto finance
Outsource higher balance claims to “law firms” that know auto finance
Manage your own outsourced “vendors” [in house network]
Outsource management to a network “vendor” that knows auto finance
Sell your “bad debt”
A small auto finance company, upon analysis, may find it is possible, though unlikely, that it does NOT HAVE a “bad debt” problem! See Example below
Example: Take a company with an annual charged off ”bad debt” (after recovery of security) of less than 4% of the total amount of loan payments due and payable annually, AND less than $300,000.00. The cost of implementing a reasonable and recommended strategy will probably outweigh any reasonably expected return.
In this case, if a single, non legal outsourced strategy is used for all of the bad debt charged off (least expensive strategy) the industry expected recovery will range from 1% to 4% over 4 to 10 months with no significant long term recoveries likely [4% of $300K= $12,000.00 less fee (1/3) = net return of $8,000.00 which over 12 month averages $667.00]. However the related management, accounting and compliance costs internally to manage and oversee the collecting agency will likely exceed that sum. What may be even worse is the cost to the company for diverting resources away from the prime directive; namely, acquiring contracts and keeping paying customers.
In this same example, now consider outsourcing to a legal network for larger balance accounts. Expect the network to forward just larger balance accounts*** (accounts over $2500.00 probably averaging about $5,500.00 per deficiency or charge off account) to one or more lawyers. The short term yield given a need to commit to a litigation program of recovery (court costs) will run negative for about 12-16 months. The long term yield [16-48 months] will significantly outperform any non legal recovery strategy [5%-15%], but will a small auto finance company find the legal outsourcing distractions and internal costs worth even that return?
In this scenario, might “walking away” OR “selling” the “bad debt” be a better choice? A sale, today, could net you 2-4% of the gross value of accounts with little administrative cost. However, selling comes with a risk that the buyer/holder of your accounts might act in a manner that will taint your reputation (or worse). So, is that 2-4% (pre judgment paper) worth it?
This or any hypothetical scenario is just for illustration. The only important analysis is the one your Company should conduct for its particular size and needs.
COMING NEXT: Understanding the basic strategies [short and long term] to recover “bad debt” losses starting with “In House Collections”.
**Recovering “bad debt” is important to improve profits BUT there are two other critical reasons: to recover “reinvestment capital” and to maintain confidence in the bond market created by securitizing subprime contracts now nearly TEN (10) times the level as existed in 2009
***Even this figure may be high given customers who will file for bankruptcy relief, are “judgment proof” (no assets), skip without a trace or where deficiency balances have problems (Notices not sent) and/or too low a balance for one to consider suit