Editor’s note: This commentary is the second in a series compiled by Joel Kennedy, who is the current president of the National Automotive Finance Association and board adviser at TruDecision, looking at the intricacies of repossessions and recovery. The first segment is available here.

I founded an auto-finance business during the peak of the Great Recession in early 2009. I knew credit, risk, analytics, finance, compliance — you name it. But when it came to loan servicing and managing delinquent borrowers, skips, recoveries, asset disposal — it was a trial by fire.

Despite our team’s collective naiveté, we did a decent job of handling these activities early-on. In fact, we did well enough to get through multiple rounds of funding and “servicing retained” deals. After the second round of funding (the “big” round) the loan portfolio really grew, and along with that growth came a lot of new issues and problems to manage. The hallmark of these issues was that they were largely centered on finding borrowers and collateral that we had lost our grip on, and these problem accounts have a way of hiding from you, so you really run the risk of missing some big things.

In hindsight, there were choices to be made on how to manage these operational components that I should have outsourced entirely from day one. The problem was that my partner and I put too much stock in building all of these capabilities internally, and we viewed outsourcing them as dilutive to our brand. We figured that building a finance company that is nothing more than a bunch of outsourced systems, vendors, etc. cobbled together, can that really be unique and create enterprise value? We certainly got a passing grade in Management Hubris 101.

I now reflect on the opportunities from my auto-finance company with a much better understanding of all of the moving parts operationally and how they manifest in the financials. Nowadays, it doesn’t matter to me who does an activity — just is that activity optimized and maximized — or am I at least getting the best possible service or result. My time embedded with Flying A Information Resources, a skip/locate and recovery company really opened my eyes to the full power and scope of outsourcing in a way that eliminates a lot of the pain, friction, and knee-jerk management that I self-inflicted.

Top 8 challenges

Through my experience, I identified what I believe to be eight primary challenges.

Challenge No. 1: Lagging repossession, skip, and recovery rates

For non-prime banks and finance companies (mostly small-to-mid-sized), repossession rates generally run in the low-to-mid teens, but have been rising in recent years. Similarly, the unrecovered skip rate (as measured by the number of unrecovered repos in the current year / number of repossessions for the prior year) runs on the lower side of the mid-teens as well. Recovery rates (net post-charge off deficiency) for the non-prime segment generally run in the mid-to-high teens. So, now that we have the general benchmarks, how does your institution stack up? If you are outperforming, then you probably already know that, and have a good thing going. For underperformers turning the tides on lagging performance can be tough – there are a lot of moving parts with systems, process and people, which can make diagnosing the problem a substantial undertaking.

Challenge No. 2: Days to recover are increasing

The longer the days to recover, the worse your collateral recovery will be. Plain and simple. And the reasons for nonperformance can come from a number of prior actions that resulted in misses. Did you start off with good customer contact and get ahead of delinquency and roll rates? Were there misses along the way where your collectors decided to wait rather than advance an account to assignment for repo? Do you have a solid process that is followed consistently on which accounts need to be skip-traced or assigned? All of these misses add up to a huge hit on your bottom line because when cars are missing for too long, the more busted up they become, and the less you have to recover at auction if and when you get it. Even worse, you end up recovering a total bomb that you should have just abandoned.

Challenge No. 3: Poor / declining collateral sale proceeds

Poor collateral sale proceeds can be a function of many things. For example, just as automotive retailers look to match the collateral they carry to their local clientele, auctions have some differences that are worth noting. A vehicle that does well at a larger, higher volume auction may not do well at a smaller auction, and vice-versa. It is a good idea to be constantly evaluating your auction returns, and looking for ways to improve the top line and reduce your recovery and reconditioning costs. Do you have someone representing you at auctions? Do you have good lane placement and time of day for your cars to roll through? At the end of the day, the CFO’s question on this one is a good one; what was our expectation for collateral sale proceeds versus what we are actually recovering?

Challenge No. 4: Volume of recoveries and agent management is unmanageable

When delinquency and roll rates increase or even spike, regardless of whether it was weaker credit quality for a particular vintage, seasonal / exogenous factors, or poor collections performance, you have a bubble that needs to be addressed. This is often the time that outsourced options are seriously considered and deployed, and for good reason; you have a bump in volume that you don’t want to staff to, you just want to solve it. In my opinion, this is the time when a longer-standing relationship with an outsourced vendor gets crucial. The lender knows that the accounts were mismanaged, but most will look to hold the vendor to a standard that is more suitable to a well-managed account. If this understanding gap can be overcome, then chances are that vendor becomes strategic.

Challenge No. 5: I am not confidently managing specialty accounts

Specialty accounts can quickly eclipse a finance company’s abilities. Military, BK, Non-self-help states, and sovereign nation reservations all have particulars that if not properly managed can equate to serious legal, regulatory, and reputational risks, along with the risk of losing recoveries, or even the lender’s claim to pursuing the deficiency balance. It has been my observation that most finance companies fall into two camps on this: one that relies on the most expensive and comprehensive legal guidance they can buy, and those that ignorantly apply their normal process to these accounts. To shed further light on the issues involved with the most prevalent categories, I interviewed some experts.

• Military: Kelly Blankenship of KRB Partners, a regulatory compliance consultancy provides some caution in handling military recoveries, said, “Make sure you have policies and procedures in place to verify the military status of your borrowers before your company begins the repossession process. A best practice would have checks and balances in key places along the repossession process, for ex., at the time the vehicle is categorized as eligible for repo and prior to assigning it for repossession agent or forwarder. As a reminder, protected service members are people who have made an installment payment (one payment is enough) prior to entering military service and were in the military at the time of repossession.”

• Bankruptcy:  Brad Cloud of National Bankruptcy Services (NBS), a bankruptcy administration and management firm serving lenders and loan servicers, said, “Our clients who have built up internal bankruptcy management functions know the pain of having to manage multiple different law firms across the country to assist in the management of bankruptcies. The cost of court filings can really add up, and it is not always easy to staff bankruptcy teams with experienced administrators. In general, NBS can deliver results for half the cost of doing the same internally. And, when you consider that bankruptcy files generally represent between 50 and 100 basis points in a portfolio, even the captives (who have the capacity to do it themselves) choose to outsource this work.” Cloud adds that the first step for them is to audit what the client has done, and what he sees are that debtors and their attorneys tend to err on the side of less (in terms of validating assets, and their values) and it is on the lender to identify this, call it out and correct it – with real financial impacts.

• Sovereign nation reservations: Gabriel Garcia of Flying A Information Resources has been working specialty accounts for some time. According to Garcia, “Each reservation has their own laws, so if an agent is not fully familiar with the tribal laws, it is better to check in with the tribal police before going to make contact with the borrower or touch the collateral. It is actually best to have a native of the reservation to act as an agent while performing the recovery and performing any contact with the borrower.” Garcia had some interesting tidbits on the stickiness of a recovery that pertained to the use of a GPS (can be sticky on a reservation), and the fees (legal fees + access fees + native lawyer fees) that can quickly add up when you don’t even have eyes on the car and you have no idea of the vehicle’s current condition. Another interesting fact is that geography can be an issue in the recovery of a vehicle when it is recovered outside of tribal lands. You can end up recovering a vehicle just outside of tribal land, yet the only road back to the tow yard requires that you re-enter tribal land on your way back home. In many cases, the agent can be forced to surrender the vehicle to tribal police unless they have a signed surrender form from the customer.

• Non-self-help states: On the topic of non-self-help states, Garcia continues, “It is important that the self-help laws are written into the contract. Lenders that do not put that verbiage on their sales contract are not able to use self-help. If self-help fees are approved and available to the client, then the repossession agent has to file paperwork and pay fees to both the parish and the local sheriff’s office. There are always two fees paid, one to each municipality.” Garcia sites a specific example, with the state of Louisiana, “You approach the customer with a voluntary surrender form, and if they sign, you can repossess the vehicle. If they refuse, you can pay a fee to the sheriff then you can do a self-help repossession.”

Challenge No. 6: Loan and payables associated with recovery and sale activities are unmanageable

Some auctions provide transport, and reconditioning and net those charges out of your disposal proceeds, while others invoice you directly for these services. When contemplating a skip that flips to a deep skip, then moves to recovery, is then stored for some time, transported, reconditioned and sold, you could have quite a lot of invoices tied to that single account. Further, if you do a good bit of business with any of these vendors along the process, chances are they will invoice you for all the services and then you have to break it all out and assign it to each unit. And, this assignment of all recovery, reconditioning, transport costs is super-important, and must be correct on the deficiency balance notice, and in many states the issuing of that notice must be timely. This is just one of the reasons why you want to stay far away from the accounting team during month’s close activities. They are literally ripping their hair out (and for good reason).

Challenge No. 7: Immature skip and recovery operations

Loss mitigation is a tough game. You need to apply a significant amount of rigor and structure to keep things organized and not drop any balls. At the same time, it requires a great deal of financial intelligence / intuition, and the more analytic your team the better. Unfortunately for most small-to-mid-sized operators if they have one good person that fits this bill, they are lucky. Grit and determination are great, but they should not overshadow the higher-level skills that need to be present as well. You can hire a “hammer” to do the job (perhaps someone that used to work in skip / recovery for a repossessor), or you can hire a “hand” that will provide more guidance and analytical leadership. The fact is that you need both, and they both need to be gritty since they are always cleaning up someone else’s mess. The reality is that many operators hire out of immediacy and desperation, often thinking that they can develop excellence internally, only to be disappointed.

Challenge No. 8: Managing non-auto recoveries

Similar to the specialty accounts, non-auto recoveries can be problematic for lenders or holders of these different accounts. Let’s say that you picked up a few portfolios of boats, farm equipment and RVs. These are vastly different collateral types that would be housed, stored and even hidden in a variety of ways. So, the real issues don’t start at the point of repossession — they start prior to that in the skip phase. The farmer hides his farm equipment on a friend’s farm, the boat owner hides their boat in dry-dock, and the RV owner is never in one place (or state) for long. If the majority of your holdings are in auto and these other assets make up a smaller number in the portfolio, you may find yourself spending significant time and effort simply lining up vendors to help you.

In summary, managing collateral recoveries is an entire process that can be mapped out, but managing the process tree can be difficult given that there are very few “vanilla” involuntary recoveries. This can often result in these accounts not being worked, or perhaps outsourced to a specialist that understands the legal and regulatory aspects but may not be so great at operationalizing the solution.

Possible solutions

When it comes to managing collateral recoveries, the fact is that there is a baseline level where we all use outside vendors to get the job done; recovery agents, and auctions to name just two. I support a strategic, and financially-driven decision to guide the structuring of this function either internally or outsourced. So, while I admitted bias and hubris on my part at my last finance company (where we outsourced the minimum), I have seen the value of a more exhaustive outsourcing arrangement for everything from skip through recovery and disposition, and I have changed my tune accordingly.

The short answer is that there are organizations out there that do a very good job of specializing this skill-set and function, takes care of the accounts, hires people, handles sub-contractor payment and performance, possesses workflow, and can even share some resources across a variety of lenders that can save you significant money. To me, it is no different than me listening to Spotify and not buying CDs, and buying movies in the cloud and abandoning DVDs, and purchasing cloud space for my digital photos instead of buying photo boxes. Be open to the changes and you may find better results and fewer headaches.

Evaluating what is right for you

When evaluating options of insourcing / outsourcing, I offer a basic framework for assessing:

• Results: Is your team outperforming or underperforming on key metrics such as recovery rate, skip rate, collateral recovery $? If you are underperforming is it because your back-end team is underperforming or is it because your collections team is underperforming and letting too much flow through, or is it because the underlying loans (customer, asset, structure) are poor?

• Cost of achieving results: How much does it cost you to staff, train, and equip your skip, recovery, asset disposition team? Are replacement resources readily available in your locale? Take the time to add up the cost of all the skip tools (e.g. license plate recognition, PACER, information sources, etc) and the success rate associated with your staff employing these tools. Is there a better option available to you?

• Capabilities: Do you have access to an abundance of highly skilled resources that specialize in these activities? Do you have legal and regulatory expertise in the specialty areas such as military, BK, non-self-help states? Is your loan accounting function highly performing, or do they seem all frazzled every month-end?

Joel Kennedy is a consumer finance executive, advisor, and consultant. He has a passion for growing and improving auto finance ecosystem. He has over 24 years’ experience helping big banks down to start-up finance companies to build, grow, improve, and repeat. He is the current president of the National Automotive Finance Association, and a board adviser to TruDecision. He can be reached at (240) 308-2169 or joelkennedy1@outlook.com.