Auto financing’s reserve system is misunderstood and maligned by many. Dealers need to do their part to explain why it benefits all parties.
What do you call it when people who know little about an industry insist on telling those who know a lot how the industry should operate?
In the federal government, it is called business as usual, and it’s exactly what is going on with the Consumer Financial Protection Bureau’s efforts to regulate dealer financing.
With alarming frequency, we are seeing stories that the CFPB is intent on taking action to eliminate dealer finance reserve opportunities. CFPB’s enabling legislation exempted franchised dealers and some independent dealers from the agency’s direct regulatory oversight. However, that has not discouraged it.
According to news reports, the CFPB is taking steps to sue some banks over auto loans and what dealer critics like to call “mark ups.” Those critics have long hated the reserve system, in which dealers one or more percentage points to the lender’s interest rate as compensation for arranging customer financing.
Critics argue finance reserves are the same as yield-spread premiums for brokers who sold home mortgages, a practice that is widely blamed for the financial crisis.
That is a false comparison since brokers walked away after placing the home mortgages, while finance reserves are created as a result of financing a customer’s purchase of a vehicle from a dealer who remains involved and dedicated to solve problems that may arise.
Nevertheless, because of years of negative publicity about “mark ups,” vehicle financing with reserves has gotten a bad rap by many who do not or choose to not understand the process.
CFPB attorneys and their anti-dealer allies apparently want to determine what dealers may make on the sale of financing. They also apparently believe that embroiling a few finance sources in expensive litigation and bad publicity with charges of lending discrimination is the road to that destination.
Proponents of these lawsuits apparently hope for what lawyers call an “in terrorem effect.” Sue a few banks, and this will scare other lenders into demanding that dealers accept flat fees for financing.
Unfortunately, no one truly understands the fallout of eliminating the tried and true reserve system and replacing it with a flat-fee system. The result is likely to be negative for vehicle sales as finance and insurance personnel will have less incentive to help buyers find the right financing alternative and to fight to get tough deals done.
So what does this mean to dealers?
Let your finance sources know of your preference for the present reserve system. Make sure they know you do business with them because you can be adequately compensated through reserves for the work you do creating accounts for them.
Understand the importance of the present system. There is a widespread misunderstanding of how the reserve system works. It benefits vehicle buyers and finance sources.
It works for consumers because it provides adequate compensation to F&I professionals to provide information on the best options, to help buyers understand the options, to package transactions so that they can be adequately considered by finance sources, and to fight when necessary for financing approval for customers.
It works for finance sources because dealers create accounts with no infrastructure costs. Dealers should be properly compensated for their work.
Adopt strict policies for F&I personnel to avoid charges of discrimination in rates. There are several ways to do this, such as rate sheets depending on credit tiers or pre-set reserve targets across credit tiers. Deviations from that for non-discriminatory reasons such as the need to meet competition should be permitted. Notes on the reasons for deviation should be kept in every deal.
If you are asked to help, do it. It is easy for those unfamiliar with the car business to condemn the present system as a dealer money grab. It requires hard work (and more important an open mind) for someone not conversant in industry matters to take the time to understand why the system works for everyone – buyers, dealers, and finance sources.
Regulators, political leaders, and media opinion shapers should understand the benefits of the present system. If you are ever asked to assist in explaining the benefits, make the time to do it. It is important for your business.
Michael Charapp is a lawyer who represents auto dealers. Based in McLean, VA, he is at 703 564-0220 and firstname.lastname@example.org.