John Pappanastos on The Economy, the Automotive Industry and the F&I Market
Q. Where do you see the economy going in 2017, and the automotive industry in particular?
A. I think the U.S. economy is on solid footing. Interest rates remain low. Gas prices remain low. Unemployment is below five percent. And, there’s no over-supply of housing.
However, I believe that the increase in bond yields that we’ve seen since the presidential election reflects increasing inflation expectations and interest rates, which will slow economic growth a bit. This makes sense given President Trump’s proposed policies. For example, lower taxes, higher government spending, and more tariffs will put upward pressure on prices, especially in light of the fact that the U.S. economy is operating at close to full employment.
As for the auto industry, I agree with the experts and expect marginally lower new light-vehicle sales, as this segment is driven by growth in employment and personal income. We’re near full employment and inflationary pressure on wages will take some time to build.
Q. What trends will you be watching in the automotive industry as a whole – and specifically within F&I?
A. First, we will watch how consumer credit will tighten in the coming months. This couldn’t come at a better time. According to J.D. Power, the percent of car loans with negative equity rolled-in has reached a 10-year high, exceeding 31 percent, and the average amount of negative equity is over $4,800 per loan.
Wide-spread loose credit across the auto finance industry has resulted in skyrocketing GAP loss ratios. GAP claim frequency is highly correlated to consumer credit scores, and the increasing frequency of GAP claims suggests that credit is being extended to consumers who shouldn’t be able to secure financing. The increasing severity of GAP claims is attributable to the fact that higher levels of negative equity are being absorbed in consumer auto debt by extending loan terms.
We’re also closely watching manufacturer incentives. The OEMs have made incentives so rich that auto dealers are foregoing front-end margins to chase them. We’re encouraging our clients to be careful with this model because it will be difficult to instill operating discipline when the OEMs take these incentives away.
With a new President and Republican-held congress, it will be exciting to watch the changes in regulations, especially compliance changes in the auto finance space.
Lastly, we’re watching is dealership consolidation. We expect to begin seeing an acceleration in public company consolidation, with a focus on acquiring 8-12-store groups.
Q. What F&I products do you believe will be big sellers and why?
A. At EFG, we work to integrate F&I products into the dealership’s overarching objectives. The role of F&I products extends well beyond current-period profit. F&I-like products are being used more often to create market differentiation and drive traffic to the showroom. For example, EFG has built a program called Power X2 to enable our clients to win “same brand competition”. This powertrain coverage mirrors the terms of the original manufacturer warranty, but doubles the term and miles. If the car comes from the factory with a five-year, 50,000-mile warranty, our program extends the coverage to 10 years and 100,000 miles. Think about the differentiated marketing message that this program provides dealers to compete with stores of the same brand: “Same car. Same price. Twice the warranty. You decide if it’s worth the drive!”
Another overarching objective for dealers is to cultivate long-standing repeat business. So, I think you’ll see more emphasis on F&I products that drive customers back to the store’s service drive. These would include loyalty programs and discounted, prepaid maintenance programs.
Q. Do you foresee any changes in processes or technology in the F&I office?
A. Consumers have made it clear that they want a new, online car-buying process. The majority of consumers begin their vehicle buying process online and, depending on which study you rely on, at least three-quarters of consumers would consider conducting the entire car buying process online. I think you’ll see dealers continue to increase their effectiveness in transacting business online. We are already seeing a move to place F&I product descriptions online, and I think you’ll see more of the finance process move online.
Q. With Donald Trump in the White House, how do you see the rules and regulations landscape developing?
A. Between the election and developments with the CFPB, 2016 was a whirlwind for the automotive industry. With the CFPB’s structure being ruled unconstitutional in November, everyone has been wondering if President Trump will significantly limit the scope or altogether eliminate the CFPB. The CFPB is appealing the ruling that would allow President Trump to fire Director Cordray, which could delay the final decision into 2018.
The bigger, more likely possibility for 2017 is the ratification of the “Reforming CFPB Indirect Auto Financing Guidance Act”. This act passed in the House with a bipartisan vote of 332-92. Considering the widespread approval of this act, it is highly likely to be ratified in 2017, especially with a Republican-held Senate. This could essentially nullify the CFPB’s bulletin instructing lenders to either eliminate or constrain dealer pricing discretion by monitoring dealership practices and using “controls” to force dealerships to adjust their practices.