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Profit potential drives car dealers to risky end of market: Collecting on high-interest, buy-here-pay-here loans requires adept, relentless managers to succeed Management-intensive

April 11, 2005

A handful of the city's new-car dealers are cautiously backing into the buy-herepay-here lot, a risky but potentially lucrative used-car business long the bastion of neighborhood lots and chains such as J.D. Byrider Systems.

The allure of making in-house loans is interest rates that can top 21 percent and profit margins that can be 10 times higher than peddling fresh metal. While rebates on new cars come and go and make for volatile sales, the poor and those with credit problems will always be with us, dealers say.

But the pitfalls are many, including a loan default rate that can easily hit 20 percent. And breakdowns of these often high-mileage cars can spell disaster when cash-strapped customers can't afford to fix them, leaving the dealer to call the repo man.

"It's a dangerous business to be in," said Tim Dowling, executive vice president of the Automobile Dealers Association of Indiana, who has seen plenty of dealers get burned by trolling for those with bad credit. "I think what you're seeing now is dealers inching back into buyhere-pay-here."

There are 236 buy-here-pay-here outlets in Indiana, according to the Indiana Department of Financial Institutions, although it's not clear what fraction of those are new-car dealers.

"They see there's profit in it. The problem is, it's such a complex business. It's different than just selling cars. We're in the finance business more than in the car sales business," said Bill Ackermann, vice president of franchise operations at Carmel-based J.D. Byrider.

"I was in the business 10 years ago and lost a lot of money. We lost a small fortune," Gary Pedigo, owner of Pedigo Chevrolet, said of a venture he invested in.

But Pedigo said he's learned from his mistakes and is back in the buy-herepay-here business. He's tapped a people-savvy manager to run the business out of a corner of his West 38th Street new-car dealership. In just over a year, the dealership has racked up about 100 accounts, with only a couple of those gone sour.

"Our delinquency rate is about 2 percent," said Henry Tipps, the seasoned salesman Pedigo hired to run the unit because Tipps has a "gut' for sizing up whether people are good for the money.

Other dealers are running their buyhere-pay-here ventures off-site. Pearson Ford in Zionsville has just acquired a second lot in Plainfield for its used-car business. Pearson Ford owner John Pearson was unavailable for comment.

The Tom Wood Automotive Group has a buy-here-pay-here lot at 3218 Harper Road on the northeast side, known as Tom Wood Select. Key to running the decade-old venture is having the right people to manage the risk, said Tom Wood executive Roger Keller.

"It's something you watch very closely, and having the right people working for you to make the right decisions" is key, he said.

"You have to micromanage it, not just every day but every minute of the day," said Dowling of the Automobile Dealers' Association.

And buy-here-pay-here is a bit counterintuitive for a car salesman. Tipps steers Pedigo clients to a car he thinks they can make payments on rather than putting them into a vehicle with a fat profit margin.

"I'll tell them, 'Here's what I think you can do'" on payments, he said. Fortunate- ly, "Gary's been good at not pushing me" for volume.

Dealers getting into the business also have to manage collection of payments, unlike for a new car. Tipps is a stickler for communication with customers, requiring them to call him if they can't make their weekly payment.

"The line of communication has to be open," he said.

Usually, a call is all it takes to get customers to comply with terms of the loan, Pedigo said. "That's really a strange psychology of the business."

But Pedigo's slow and steady approach belies a heavy rate of loan default in this segment of the used-car business.

Bentonville, Ark.-based America's Car-Mart Inc., the nation's largest and publicly traded buy-here-pay-here chain, posts annual credit losses as a percentage of sales in the range of 17 percent to 21.3 percent, according to a recent financial report. Still, it earned a 2004 profit of $15.8 million on sales of $176.2 million.

"It's a very intense business. You cannot make a mistake or it can blow up in your face," said the owner of a prominent central Indiana new-car dealership who asked not to be named.

The dangers are evident in the implosion of companies that provided car financing to consumers with blemished credit. One of them, Indianapolis-based Union Acceptance Corp., filed for Chapter 11 bankruptcy protection three years ago.

Why take the chance on customers with the financial equivalent of leprosy? Some dealers say buy-here-pay-here is a hedge against the capriciousness of the new-car business. New-car dealers are in a mature industry with thin margins. They're finding it harder to make as much money in an era when car invoices are available on the Internet, giving consumers a weapon against their wily salespeople.

Many new-car buyers are taking out longer-term loans so they owe too much on their existing car to trade for a new one anytime soon. And finance managers who once could carve out a decent commission on loans from local financial institutions now see business going to the financing arms of car makers.

"It's pretty hard to compete these days with 0 percent financing," said Mark Tarpey, head of the Consumer Credit Division at the Indiana Department of Financial Institutions. "The captive financing companies are taking a pretty big piece of their new car [financing] business."

It also hasn't helped that automakers are "turning the rebates on and off," causing some consumers to sit on the sidelines for the next big rebate, Dowling said.

Most profitable new-car dealers find it hard to reap profit equivalent to 3 percent of revenue, vs. 17 percent to 20 percent of revenue for buy-here-pay-here dealers, according to the National Alliance of Buy Here Pay Here Dealers.

Local dealers are mum about profits, but America's Car-Mart sheds some light on the profit potential in a recent filing with the Securities and Exchange Commission.

The company generally acquires cars for $2,500 to $5,000 and sells them for $5,000 to $8,500. So its markup can be anywhere from $2,500 to $3,500 per car.

Then comes financing. A buy-herepay-here firm making a $5,000 loan at a rate of 21 percent could earn roughly $1,150 in interest on a 24-month loan-not an uncommon term in the business.

Add the markup on the car and the interest collected and the firm makes $3,650 on the sale. That does not factor in the dealer's costs, such as reconditioning the car for sale or the cost of money to loan.

Still, the dealer could break even in just about nine months once it includes a customer deposit that's often the equivalent of two payments-helping mitigate the risks of customers who default.

Byrider's Ackermann doesn't see dealers becoming a threat to his firm, which has 125 outlets in almost 30 states.

"A lot of new-car dealers are [still] afraid to try it," he said.

One reason is the upfront cost. He said Byrider plowed millions of dollars into an underwriting and analytical tool to help franchisees figure out which customers have the best chance of paying and to put them in a car they're most likely to be able to afford.

The Carmel company has spent years researching which cars are least likely to wear out. Many of the cars are 5 or 6 years old with upwards of 80,000 miles.

"We're doing three- and four-year loans now, so those cars have to last," Ackermann added.

The business for buy-here-pay-here also has evolved, requiring further capital costs to stay competitive. Many of Byrider's locations now sport their own repair shops. Some sell warranties. "We've had to evolve our model."

Some buy-here-pay-here dealers have also employed new technology, such as devices that prevent a car from being started if a customer fails to make a payment.

But even tough managers like Pedigo's Tipps won't go that far.

"I have some customers whose wives are pregnant, kids that are sick. I'd hate to be the person to shut down the car on the way to the hospital," he said.
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