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RALEIGH, N.C. — Consolidated Asset Recovery Systems is often asked how lenders can address escalating charge-offs and losses. You may find the answer surprising.

Basically, CARS provides managed repossession and remarketing services. The company is at the forefront of an industry that has been greatly impacted by the recent economic crisis and is seeing dramatic changes as a result.

It is funny how the more things change the more they remain the same.

Lenders have been looking at repossession costs for years. Focused on controlling costs, several approaches were deployed that tried to lower the servicing costs of portfolios. Many of these tactics are commonplace today, such as direct drop to auction, flat fee structures or contingency based pricing for repossession services.

When we started CARS five years ago we looked at repossession and remarketing as a supply chain problem. Our backgrounds were in supplier management for the aerospace industry; we did not come from the repossession services business. Accustomed to managing thousands of tasks to a budget, collaborating between tens of thousands of suppliers, and optimizing supplier performance for multibillion-dollar programs that could span over 30 years, we knew that proper focus and being aligned with key processes had the greatest impact on program/supplier performance and costs.

With this understanding we set out to change how recovery services were executed. Much like with the aerospace industry, servicing a portfolio of non-performing assets requires coordination with many suppliers. Supplier performance is critical to the success of recovering an asset and liquidating that asset at auction. Unnecessary steps in the process, poor performance and poor collaboration directly impact success rates and add costs to the recovery process.

What we discovered was that by increasing the recovery rate for repossession, lenders can dramatically reduce losses. A 3-percent increase for example compared to the industry average recovery rate of 50 percent would deliver a 53-percent repossession recovery rate.

By applying the increase in recovery rate to a portfolio that assigns 1,000 cases for repossession in a month, the lender would net an additional 30 vehicle recoveries a month. If we assume an average value of $10,000, that represents $300,000 not charged off each month to the bottom line.

Of course the question is how can we change agent behavior, optimize supplier performance and increase recovery rate?

Agent behavior is directly related to compensation. Balancing compensation against performance is essential. When we cap fees for repossession agents, we have in effect dictated how much time and effort will be applied to the recovery of that asset.

This is also true with contingency based fees. There are hard, fixed costs that agents incur when they execute a repossession effort, such as insurance, vehicle maintenance, facilities, taxes, labor, fuel, etc. As a businessman, an agent must assess the potential profit/loss of each assignment he receives.

In order to control risks against performance based fees — contingency — an agent must limit his expense. This means that the agent will only work an assignment for so long, including running the address, performing skip efforts, etc., before he must abandon the chase and move on. This can lead to "cherry picking" accounts and lower recovery rates.

It is therefore important to understand how to compensate suppliers for maximum performance and then be able to have transparency in the process to validate supplier metrics. When executed properly these two components work together to improve recovery rate.

Traditional thinking looks at controlling just the costs of repossession and recovery efforts. If we compare this practice using the same metrics as we did above, we can evaluate recovery rate versus costs to determine the impact.

Let's assume that our repossession service charge is $350 and we currently do not pay a close fee for assets not recovered. This means that with our current recovery rate we would not have costs for 500 of the vehicles that we never recovered. For the 500 we did recover, the costs would be $175,000.

Now let's suggest that one factor for increasing recovery rate is increasing the repossession service fee to $375, and secondly, paying a close fee of $50 on accounts worked satisfactorily, but not recovered. Assuming this resulted in an increased recovery rate from 50 to 53 percent, the costs would look like this:

—Increased costs for the recovery of 530 cars to a total of $198,750.

—An additional cost for the close fee of $50 for the 470 vehicles not recovered of $23,500 for a total of $222,250 for the month.

These costs would generate an additional $300,000 — 30 addition assets at $10,000 — in revenue to the bottom line, compared to our current costs for a lower recovery rate of $175,000.

Our additional cost to secure the $300,000 in revenue is $47,250 ($222,250 adjusted costs minus $175,000 traditional cost). This means we recognize net revenue of $252,750, calculated by taking $300,000 additional assets recovered and subtracting $47,250 in additional cost each month.

Over 12 months, this results in $3.03 million in additional revenue to offset against losses.

Now we start to see the impact of focusing on supplier management versus focusing on costs only. Controlling agent behavior and managing suppliers provides the greatest impact on losses. Not only do we control behavior, we obtain the mindset of the supplier who willingly works our assignments first, knowing these pay out better than other clients fixated on below market pricing or performance based models which present potentially higher risks and costs.

Compensation is one answer to improving supplier management and performance. When leveraged with other supplier optimization techniques and processes, true improvements in recovery rate can be realized. It is not uncommon that our clients see increases of 10 percent or more over current industry results.

Rethinking costs and focusing on supplier management requires managing the natural resistance to change that exists in many organizations. Often with limited resources and high operational demands, it is easier to do nothing. It takes a change agent to question the status quos. We find that management needs to lead the charge. Operational resources can be compensated incorrectly creating resistance to change. Often we see compensation tied to costs reinforcing a myopic view of recovery processes continually focused on driving costs down and then questioning why losses continue to escalate.