The current regulatory climate took center stage at Industry Summit 2015, with at least five sessions dedicated to helping dealers, finance sources and F&I product providers stay off the radars of state and federal regulators. Presenters also called for a change in how dealerships approach the rules of the road, their customers and even their employees — a shift they said could help on the regulatory front and draw dealers closer to the younger generations that represent their future customer base.
Attendees of the magazine’s annual event, held Sept. 8–10 at Paris Las Vegas, heard from the official on the frontlines of the National Automobile Dealers Association (NADA)’s campaign against the Consumer Financial Protection Bureau (CFPB)’s attack on the indirect financing channel. Ally, the first auto finance source targeted by the bureau, also had a representative on hand to take attendees on a deeper dive into the bureau’s examination process.
Also participating in the compliance discussions were F&I trainers, F&I and Showroom columnist “Mad” Marv Eleazer and the Association of Finance and Insurance Professionals (AFIP)’s David Robertson, as well as executives and attorneys from the industry’s leading F&I product providers. While they offered their take on the CFPB and other regulatory issues, their discussions seemed to veer into an even bigger issue facing the F&I industry.
“Ladies and gentleman, it’s time to freshen things up,” said Allstate Dealer Services executive Peter Chafetz during his “Is the F&I Party Over?” session. “It’s not about word-tracks; it’s about thought-tracks. It’s not about trickery; it’s about transparency. Because there is a storm brewing, and it’s not the CFPB. It’s the Millennial buyer. They’re going to revolutionize the way we do business.”
Echoing Chafetz’s take during the conference’s “From the Boardroom” session was IAS senior executive Eric Mélon, who pointed to another looming issue detailed in the Office of the Comptroller of the Currency’s 2015 Semiannual Risk Perspective. The report noted that 60% of auto loans originated in last year’s end-of-year quarter had terms of 72 months or more. It also cited Experian Automotive data from the same period showing that the average loan-to-value ratio for used-vehicle loans was 137% — 150% for consumers with credit scores below 620.
“Right now, business is great. We have the cheapest interest rates ever. But in 2017, they’re saying there’s going to be an interest rate increase of 5%,” Mélon said. “What happens if the loan-to-value [ratio] on used cars goes from 150% to 120%? What happens if they reduce the loan term from 84 months to 60 months again? What happens to a finance manager who, instead of having to bump a customer $30 to sell product, he has to bump it $70 to sell the same stuff?”
But it was the AFIP’s Robertson who got to the core issue plaguing the industry, noting during the event’s “Passing the Compliance Test” session that he can quickly tell how serious dealerships are about compliance and ethics by how they address consumers and employees.
“Do we have customers or do we have ‘flakes’ or ‘skates’? Are salesmen a dime a dozen and we don’t care if they come and go?” he asked. “If you don’t respect the person you serve or you don’t respect the people who work for you, then whatever standards of fairness you wish to apply to those people gains a lot of latitude.”
The Next Chapter
Andrew Koblenz, the NADA’s executive vice president of legal and regulatory affairs and general counsel, focused his remarks on the CFPB’s targeting of dealer participation. He broke down the association’s efforts to protect a key source of dealer income into three chapters.
“The first chapter is where there was an effort to get rid … of dealer-assisted financing in its entirety,” he said. “The second chapter is what I refer to as ‘getting rid of the model — ‘No, we’re not going to get rid of [dealer-assisted financing] … but we don’t like the model of dealer compensation, so we’re going to find a different way of doing it.’ And the third is the chapter I call ‘altering the model’ — ‘No, we’re not going to get rid of it, but we’re going to change it.’”
Koblenz said the industry’s odyssey began in the wake of the 2008–’09 financial crisis and continued through the 2010 discussions preceding the creation and passage of the CFPB-creating Dodd-Frank Act four years ago. There were also the Motor Vehicle Roundtables hosted by the Federal Trade Commission (FTC) in the summer of 2011. The debates centered on the notion that dealers shouldn’t be compensated for helping consumers secure vehicle financing, with consumer-advocacy groups calling dealer markups nothing more than “surcharges” and “dealer kickbacks” during Congressional hearings.
Then there was the report issued by the Senate Banking Committee in 2010. It claimed that dealers “routinely mark up loan rates” above what borrowers would need to pay to qualify for credit. “Think about that. What the [committee] was telling this new agency, if it had gone into effect against dealers, is that what dealers get paid is excess,” Koblenz said. “So that’s what was at stake during the Dodd-Frank debates, and that’s what led to the aggressive lobbying and aggressive education that the NADA and the dealers around the country did. And that’s what led to the exclusion of dealers from Dodd-Frank [under the Brownback amendment].”
The chapter would end with a CFPB official telling attendees of the 2013 Consumer Bankers Association conference that dealers deserve to be compensated. “She actually said it twice,” Koblenz recalled, noting that the bureau even went as far as saying that a solution to its fair lending concerns should be revenue-neutral for dealers.
“So Chapter One ends with the efforts to eliminate the enterprise … off the table,” Koblenz added.
Chapter Two began with the bureau’s March 2013 guidance on dealer participation, a document that made clear the CFPB’s intentions to move the industry toward a flat-fee compensation model. “But we pushed back on this one, too,” Koblenz said. “And we said, ‘… For the government to mandate a particular form of compensation, that’s problematic. And for the government to mandate this particular form of compensation is especially problematic.’”
The NADA’s main argument was that dealers would still have discretion when it came to lender selection, but a move to flat fees would eliminate the incentive for dealers to seek out the lowest buy rate. “You’ve introduced the risk of steering, where you have a perverse incentive to put people in higher cost loans than you would otherwise,” Koblenz explained.
The chapter ended with Ally’s $98 million agreement in December 2013 to settle questions regarding its dealer compensation policies. But Koblenz said Ally’s decision to retain its dealer participation model was a major turning point. “That really spelled the end of the realistic effort to get the world to move to flat fees as a government-mandated policy matter,” he said. “That brings us to Chapter Three. … Now we’re moving into a situation where they’re trying to improve the model.”
Koblenz pointed to recent settlements in the powersports and auto finance arenas as evidence of the CFPB’s changed course. The first involved a case brought against Evergreen Bank by the Department of Justice (DOJ) and the Federal Deposit Insurance Corp. (FDIC). They claimed that Evergreen’s dealer compensation model resulted in 2,200 minority borrowers paying higher interest rates than non-Hispanic white borrowers over a three-year period starting in January 2011. But the settlement, announced this past May, gave the powersports finance source, which voluntarily adopted a flat-fee model in 2014, the option to maintain dealer participation if it significantly lowered its dealer markup caps.
Then there was American Honda Finance Corp.’s July settlement with the CFPB and DOJ regarding its dealer participation model, which Koblenz said recognized for the first time that beating a competing offer, which often leads to discounts for consumers, should be part of the solution. The downside of the $24 million ECOA settlement was the captive agreed to lower its markup caps from 2.25% to 1.25% above the buy rate for loans with terms of five years or less, and from 2% to 1% on loans with longer terms.
“The Honda settlement is a step forward, and it contains very good elements, but there’s still more to be done,” Koblenz said, noting that budget constraints are another consideration the CFPB needs to recognize. “We need to ensure that the discount zone is large enough and we need to be able to ensure that all of the relevant competitive considerations are present.”
The Discount Zone
Ally’s Courtney Hennessey revealed why the CFPB now favors reduced markup caps during her compliance workshop. The F&I trainer said the agency’s examination team looked at a dealer’s book of business where markups of 200 and 250 basis points were allowed, as well as a book of business where dealers limited markups to 100 basis points.
“They found a considerable reduction or effective elimination of markup disparities when … there was only a 1% availability of markup across the board,” she said. “What that means is if you have a stricter policy in place — and it doesn’t have to be 1% — but if you have a stricter policy in place than a 2%, 2.5% spread, you’re less likely to have a disparity on a prohibited basis.”
Hennessey also took attendees through the CFPB’s examination process, including how it uses the controversial Bayesian Improved Surname Geocoding proxy methodology to isolate deals with negative disparities involving protected classes. Weeded out are nonincentivized and nonlease finance deals, as well as deals for which protected classes received a lower or equal rate.
Ally’s trainer used two $20,000 finance deals with identical 60-month terms to illustrate how the CFPB would raise claims of disparate impact — a legal theory that says a policy can be deemed discriminatory if it has an adverse impact on a protected group, even if it’s unintentional. In her example, Hennessey said the CFPB would call on a finance source to take action if one customer received an APR of 2.9% and the other 3%. “That’s not a lot in my eyes, personally, but this 10 basis points is what the CFPB is using as a marker of when a finance source should take corrective action,” she said.
Hennessey also touched on the bureau’s inclusion of F&I products in the updated examination procedure manual it released in June. She said the 54-page guide stressed the need for F&I protections to be presented as optional. “This is why I like the menu, because with the menu topper, you have the opportunity to say, ‘Mr. or Mrs. Customer, you have the opportunity to take this vehicle home today at the price and the payment that was agreed upon,’” she said. “So we need to ensure, whether you’re using a menu or not, that those products are presented to the customer as optional.”
F&I Product Pricing
Choosing his words carefully so as not to provoke the bureau, Koblenz said it remains unclear whether the CFPB can regulate product pricing since there isn’t a rule like the Equal Credit Opportunity Act (ECOA) governing F&I product sales. He speculated that the bureau would have to link F&I product sales to deceptive or unfair acts or practices claims, “… which really takes them into the merits of the product,” Koblenz noted.
“Not only would they be approaching the edge of the envelope of their jurisdiction, they may be exceeding the envelope,” he said.
The CFPB’s interest in F&I products was also discussed during the conference’s “From the Boardroom” panel session, with panelist Tim Blochowiak of Protective Asset Protection sharing details of a recent discussion between his compliance team and that of an indirect finance source.
“One of the takeaways is our products do land on the finance contract. And what [could be] the discriminatory practice within that? Pricing, right?” he said. “One of the things we’re trying to promote is really for dealers to establish, just like the car, an MSRP on the pricing — establish a floor and then work within that.”
“Price your products reasonably” was listed at No. 6 on Allstate’s Chafetz list of recommendation for how dealers can stay off regulators’ radars. He noted that several product providers, including his, have instituted pricing guidelines designed to give dealers a defensible base should their pricing strategy be questioned by regulators.
“Can you sell a $3,000 etch benefit for $4,500? If you are, you’re a hell of a salesman, and I promise we’ll send someone out to visit you in prison,” Chafetz quipped. “It just doesn’t make sense. The CFPB has not really caught on to this part of our business yet, and I’m going to do everything I can to make sure there’s no reason for them to do so.”
Speaking during the “Passing the Compliance Test” session, attorneys from Safe-Guard and GSFSGroup tossed around the idea of product providers moving to a fixed pricing system. Safe-Guard executive and general counsel Damon Wiener said it’s a discussion taking place in many provider boardrooms, but he noted the first company to do so would put itself at a competitive disadvantage. Such a move would also be problematic from a legal standpoint.
“Who’s to say you’re coming up with the correct MSRP? And now you’re actually taking a position that the regulator may take issue with,” the attorney said. “But I wouldn’t be surprised that once you see some orders come out that have to do with the actual retail prices of the products that you will see some people start to list MSRPs.”
The consensus was that finance sources — feeling the pressure of regulators — would be the ones to set max retail prices that they would advance for a product; Weiner noted that some already do.
In May, US Bank notified dealers that its dealer-monitoring program would include the examination of how F&I products are priced and sold. If the program discovers unexplained differences in pricing or excessive add-on product pricing, the bank would request additional information from the dealer explaining the disparity. Further action would be taken if a dealer can’t produce a reason and if the unexplained difference persists.
Lewis Kuhl, senior counsel and director of regulatory compliance for GSFSGroup, said the key is for dealers to price products in line with what their competitors charge for a similar product. But a dealer’s responsibility doesn’t stop there, he said.
“The customer needs to be getting some type of value for the price they’re paying,” he warned. “If a product only costs the dealer $50 and they’re selling it for $750, I think a regulator is going to look at whether the customer gets value for that product.”
Robertson confirmed the CFPB’s interest in getting into a good cost-benefit analysis of F&I protections, but said there’s an even more basic question dealers need to consider. “Is gouging making too much or is it selling customers things they really can’t afford?” he asked. “If you charge me a little too much and I can make the payment easily, that’s one thing. If gouging means I’ve loaded somebody up who’s a gullible buyer that is spending more money than he can effectively pay, then I think the test of gouging becomes a more acute point to ponder legally or morally.”
So far, the bureau has only addressed the way F&I products are marketed and presented to customers, the most notable example being the bureau’s June 2013 consent order with US Bank and its nonbanking partner, Dealers’ Financial Services, regarding their now-defunct Military Installment Loans and Education Services (MILES) auto finance program. Among the issues the regulator raised was how the companies marketed the program’s associated service contract and GAP waiver.
The order was terminated in November 2014 after the bank fulfilled its obligations under the consent order, but the case did force a shift in how product providers market their offerings.
“One of the things we started doing on some of our brochures … is adding in some of the exclusions — the more commonly used exclusions. Because when we looked at them, we realized, OK, from a CFPB perspective, we need to be as transparent as possible,” Wiener said. “But a lot of these exclusions are things that make sense to the customer. If you’re talking about GAP, and it’s a waiver, well, if you refinance your agreement, there’s no longer coverage. We want the customer to know that upfront.”
Ally’s Hennessey said F&I managers also need to do their part by making sure F&I product buyers understand what the protections do. Not only will it reduce the likelihood of buyer’s remorse, she said, it will stop buyers from heading to the Internet for advice that might not be factual. “When I was creating this presentation, I went on a fact-finding mission and Googled the different ancillary products,” she said. “The only thing that was out there was customers complaining about the products and the experiences they had.”
One solution discussed at the conference was for dealers to populate the F&I sections on their websites with product information — an idea consumers would embrace, according to a study released earlier this year by Cox Automotive’s MakeMyDeal ecommerce site.
The study indicated that 63% of the 500 vehicle buyers and shoppers surveyed would be more likely to purchase F&I products if they had the option to learn about them before finalizing their vehicle purchase. Fifty-five percent said they would be more likely to buy if the dealer’s website helped them understand the value of the products offered. But GSFSGroup’s Kuhl said the idea isn’t without its pitfalls.
“I think the one pitfall a dealer or a provider is going to fall into is the disclosure online,” the attorney said. “If you’re just using a generic, 50-state approach to a disclosure of a service contract or a GAP waiver, a dealer in Georgia using this canned provider script may not properly disclose the product as required by the state of Georgia.”
Safe-Guard’s Wiener agreed, noting that his company is in the midst of developing product videos and beefing up the company’s site with more descriptive product information. But the AFIP’s Robertson said there’s an even more critical need providers can fulfill.
“Part of the problem when we train F&I managers is they’ve never read any of the documents they’ve asked the customer to sign. And I’m talking a percentage I would never say in this room,” he said. “There has to be a strong effort on the part of the providers to make sure [F&I managers] have a working knowledge of what it is they’re trying to sell.”
The Road Ahead
The NADA’s Koblenz used the conference to debut a video the association developed as part of an online campaign designed to show the value of dealer-assisted financing. It contains testimonials from real customers telling real stories, including one family’s story of how a dealer saved them approximately $2,000 over the life of their loan.
The video is expected to aid the association’s efforts to drum up lawmaker support for a bill awaiting a vote by the House of Representatives. Passed by the House Financial Services Committee in July by a 47-10 bipartisan vote, the bill, H.R. 1737, would repeal the CFPB’s March 2013 guidance on dealer participation and add a few more steps to its guidance-writing activities if approved by Congress. In the meantime, Koblenz urged attendees to consider the association’s Fair Credit Compliance Policy and Program, which calls for dealers to document any deviation from a preset compensation amount included in consumer credit offers.
“It does two things: It addresses fair credit concerns. It does so by utilizing a model that was developed, not by us, but by the Department of Justice in a case involving dealers in 2007,” Koblenz said, noting that the program has been endorsed by 12 of the industry’s leading fair lending and dealer lawyers, including former CFPB official Rick Hackett. “But equally important, it allows the flexibility in negotiations that will result in the kind of outcomes that you saw in the video.”
But there are other challenges, many of which can be linked to today’s regulatory pressures. As noted in a study Autotrader released this past March, only 17 out of 4,002 consumers surveyed said they prefer the current car-buying process. But not everyone was in agreement with the study’s ultimate conclusion, which is that dealers need to speed things up by moving more of the process online.
“Now we got product providers trying to come up with a way to rush [the process] — to try to shorten the wait time,” said F&I and Showroom’s Eleazer during the “Passing the Compliance Test” session. “But my question is why do we want to rush something that is so important? There are so many legal loopholes for the F&I manager to jump through. We shouldn’t be trying to rush that.”
While the questions facing the industry have no clear answers, Safe-Guard’s Weiner said the good news is product providers, dealers and agents are clearly aligned from a compliance standpoint. “Just the fact that we have so many sessions on compliance, it shows that it’s at the forefront of everybody’s thoughts,” he said, adding, “I’ve seen less resistance over the last few years when talking with dealers selling the product, agents marketing it and even our own internal sales and marketing teams.”