On a recent trip to Sam’s Club, I began thinking about how efficient their business model is, and how it relates to my long career in the auto finance industry.
Pushing my flatbed cart through the massive store, stocking up on cases of wine (this business makes me drink plenty of it) and other items that I usually buy in bulk, it occurred to me that I had transitioned my business to the Sam’s Club model more than 20 years ago.
Like many of you, I was the CEO of a traditional indirect auto lender buying non-prime auto loans from car dealers one contract at a time. For 10 years, I watched thousands of credit applications spit out of our “wall of fax machines” from hundreds of dealers. Out of the 100,000 or so dealers in the United States, it seems many of us did business with the same few thousand. We measured active dealers as a dealer that sent us one or more contracts per month. Our “look-to-book” ratios were low single digits, and that drove me crazy.
As technology progressed and new platforms hit the market, my look-to-book ratio did increase, but was still far too low. I had to do something to become more efficient. Instead of trying to reinvent the wheel, I chose to imitate the Costco and Sam’s Club model, incorporating what they do best in their business into mine. The answer?
Buy in bulk!
A short time later, I had outlined an entirely new business plan. Instead of competing for one loan at a time, I would buy hundreds of loans at a time from the same counterparty. With my new strategy in place, my risk manager began writing models so that, instead of underwriting guidelines, I had pricing guidelines. Suddenly, there was “no such thing as a bad loan, just a bad price.” My look-to-book ratio was now in the high double digits, far better than the single-digit ratios I had during my first 10 years in auto finance.
Anticipating many obstacles along the way, I tasked our senior managers to help me identify and solve several issues. How would we re-amortize thousands of loans; review collections notes and payment histories; calculate LTV and build loss curves for seasoned loans; change our static pool methodology as acquisition month may be contractually month 12 in the loan due to seasoning; and getting our senior lender comfortable with buying guidelines versus underwriting guidelines. We would also need to perform due diligence on the counterparty and create new campaign strategies for loan servicing. Finally, we would have to draft a solid purchase and sale agreement. With the analysis and processes in place, we decided to go for it.
As models evolved, the seller could take advantage of the efficiencies of selling in bulk, and the buyers of buying in bulk.
As my company grew 10, 20, and 30 percent, year over year, I wondered why most mid-sized to large finance companies were not adopting portfolio acquisitions as part of their core business strategy. I watched mid-sized indirect finance companies attempt to buy market share (never a wise choice) to get scale, only to suffer from credit and performance problems. Problems that eventually put them out of business.
Those shops should have taken the time necessary to develop bulk pricing models, a comprehensive due diligence process, and a marketing strategy. Had they done so, they might have discovered they could get scale quickly without sacrificing credit quality. After all, when buying seasoned accounts, you have the advantage of reviewing the payment transaction history on the actual loan you’re buying.
Isn’t that the crystal ball you need in indirect lending?
Today, a large number of indirect finance companies and banks have specialized groups buying loans from dealers and finance companies in bulk. That number continues to grow as technology makes it more predictive and efficient. The use of machine learning and artificial intelligence has helped companies navigate the “there is no such thing as a bad loan, just a bad price” mantra.
If buying in bulk is something you’re interested in, I recommend finding an external partner, software, SaaS, or hire experienced people to help you understand the differences between indirect and bulk. To be self-serving, in 2017, I began my quest to change the landscape in the secondary market and came up with the Agora platform.
Buying paper in bulk in the secondary market will positively change your bottom line more significantly than any other lever you can pull.
Check out bulk. It’s worth it!