Article

A Primer On Delinquency

August 2006, Auto Dealer Today - WebXclusive

by Chuck Bonanno - Also by this author

Dealers, Vendors, Industry Analysts, Bankers, Lawyers and Accountants have their opinions about the significance of delinquency rates. Some say that delinquency is a critical measurement of the value and strength of a portfolio while others are not nearly so concerned. The second group measures portfolio strength using cash flows and loss analysis. Are dealers with low delinquency rates more profitable than those with high rates? Not necessarily. I have yet to encounter any dealership whose delinquency rate is substantially different than the delinquency goals of that dealer. Why is that? Because you, the dealer, has the ability to arbitrarily set your delinquency rate to any level you choose whether it be through the repossession and charge off of delinquent accounts or through the manipulation of the loan itself through rewrites, due-date changes, extensions, graces, deferrals and allowable delinquency levels. If you cannot and should not compare delinquency rates and they do not necessarily equate with profitability, why should a dealer even care about delinquency? The reality is that you should all care about your levels of delinquency and not worry about other dealers.
Delinquency is not a financial event. The payment on an account is a financial event. That is a good event. The repossession of a vehicle is not a financial event. The charge off of an account is a financial event. That is a bad event. Contractual delinquency is an industry standard measure of the “relative” health of the loan portfolio. Your delinquency rate is much like your blood pressure or body temperature. High or low measurements may not by themselves mean serious consequences. Delinquency measurements outside normal parameters certainly require investigation and, in most cases, a plan of treatment. You MUST review your own loan portfolio’s delinquency on a regular basis (daily) to track changes in the health of the portfolio. This is the only way to take proactive measures in curing delinquency issues. Nobody wants to find out they have high blood pressure after suffering a stroke!

To discuss delinquency intelligently and compare apples to apples with other dealers, we must first define delinquency in a standard form. The Finance Industry defines contractual delinquency as the balance of the delinquent accounts divided by the balance of the entire accounts receivable (it is not the number of delinquent accounts divided by the number of active accounts receivable method. That does not weigh the individual loans by the dollar value of the delinquent account). Do you look at a $500 balance account the same way you look at a $5,000 balance account? These two accounts would carry the same weight under the accounts divided by accounts method. The second method some dealers use to measure their delinquency is to take the dollar value of payments that are in arrears and divide them by the balance of the entire accounts receivable. This method is only focusing about the actual payment amount due. The flaw here is that the payments are not the only portion of the loan that are in jeopardy. The entire balance of the loan is in jeopardy. The amount of contractually due payments and total past due payments due is a number that must be tracked. It is not, however, the standard for describing delinquency. The same flaw as the “account divided by account” method occurs when two accounts are $100 in arrears (payments due) and are given the same weight and yet the balances due on those two accounts may differ by thousands of dollars.

As a dealer, you put policies in place about when to repossess a car and when to charge off an account. Some dealers have very low delinquency rates because they choose to repossess vehicles very quickly. I have some clients who actually repossess when the accounts reach 30 days contractually past due. These dealers make no exceptions and therefore, by definition, have essentially no accounts 30 days plus past due. That is easy to do and certainly will keep delinquency under control but you have to wonder, “how much money has been left on the table” in those situations. We can probably all agree that the majority of our customers will not pay exactly as contracted and we can probably all agree that unforeseen things will happen to our customer during the life of the loan. When you implement policies that give no leeway for these occurrences, you will needlessly charge off good accounts. This is exactly the drawback with “payment devices”. They can obviously lower delinquency but they cannot lower charge off and may, in fact, increase frequency of repossessions. What dealers must understand is that they live and die by customers making payments, not by levels of delinquency. The ultimate goal is to keep customers in their cars and paying. The customer is the asset in this scenario, not the vehicle. It goes right back to the winning philosophy of selling ten cars to every customer.

Before you compare delinquency rates with fellow dealers, you must also be aware of the manipulation tricks employed by many dealers. Many dealers boast of delinquency rates under ten percent. Some companies even promote this as a magic number to achieve as if something wonderful occurs at this level. Many of these dealers performing at or below the ten percent delinquency level are manipulating their loan portfolios. They rewrite or “refinance” past due accounts, they change customer’s due dates and they give deferrals or graces. Some actually set their computer systems to treat partial payments as whole payments. Dealers who employ such tactics are not fooling anyone but themselves. Another interesting theory I’ve come across is one where dealers don’t count repossessed accounts, bankruptcy accounts or pending insurance claim accounts when calculating their delinquency rates. These dealers claim that these are not “active” accounts. To accurately calculate contractual delinquency you must include all active accounts. (Active accounts are defined as all accounts with a balance more that one dollar that have not either paid out or been charged off.) The best policy is to avoid these tactics and collect your accounts to the best of your ability regardless of the customer’s contractual delinquency level. If you feel you must employ one or more of these tactics, it is advisable that you create policy about the use of these procedures. Never allow anyone but the dealer to make the decision to manipulate an account. Never allow anyone but the dealer to do the actual manipulation. Be sure that the manipulation assists the customer, not the collector or the collection manager. Have all customers sign an affidavit acknowledging they are aware of and accepting of the procedure. And lastly, track these procedures to ensure strict adherence with the policies.

Most dealers quote their delinquency rate using the “one-day, one-dollar” method. They quote the entire amount of all delinquent accounts and compare that balance to the total outstanding balance of the portfolio. Table I illustrates the trappings in looking only at one number when discussing delinquency.
 
TABLE I
A B
Current Accounts 71.4 percent 70.4 percent
1-29 Days Past Due 17.6 percent 22.6 percent
30-59 Days Past Due 5.4 percent 4.8 percent
60-89 Days Past Due 3.3 percent 2.0 percent
90 Days Plus Past Due 2.3 percent 0.2 percent
Total 30 Days Plus 11.0 percent 7.0 percent
Total 1-Day: 1-Dollar 28.6 percent 29.6 percent
In Table I, portfolio A has 28.6 percent delinquency rate and portfolio B has a 29.6 percent delinquency rate based on the one-day, one-dollar method. But when you dig deeper you find that 11 percent of portfolio A is contractually past due 30 days or more while portfolio B is at 7 percent. That represents $100,000 in balances 30 days or more past due in a $2,500,000 portfolio. In this case, portfolio B is much healthier than portfolio A. In Table II, let us compare the month end of the same company to determine the collection effort.

 
Table II
Month 1 Month 2
Current Accounts 70.4 percent 71.4 percent
1-29 Days Past Due 22.6 percent 17.6 percent
30-59 Days Past Due 4.8 percent 5.4 percent
60-89 Days Past Due 2.0 percent 3.4 percent
90 Days Plus Past Due 0.2 percent 2.2 percent
Total 1-Day: 1-Dollar 29.6 percent 28.6 percent

In Table II, it would appear that delinquency reduced from one month to the next. Overall they did reduce delinquency, but the reality of the situation is the collection team was only able to improve collection of the one -29 days past due accounts and essentially collected nothing on the 30 days plus accounts. So, although they reduced 1-day, 1-dollar delinquency by 1.0 percent the 30 days past due accounts increased from 7.0 percent of the portfolio to 11.0 percent of the portfolio. How months can you stay in business with that trend?

What all this means is that you must track your contractual delinquency every day and every week and every month. Take measurements at regular intervals and look for changing trends in your rates. These changes will prompt immediate action and will put you in a proactive mode of collections. Do not be concerned with other dealer’s delinquency rates because you have no idea how they calculate it or what they do to manipulate it. Actively track your delinquency trends and motivate your collection team to continually lower delinquency rates. Do so through cash collections, not repossessions and charge-offs and I can guarantee that you will be more profitable.

Vol 1, Issue 3

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