It’s a question of “when, not if,” federal regulators will force auto lenders to switch to flat fees from dealer reserve, says John Pappanastos, CEO of EFG Companies, a major F&I administrator based in Dallas.Flat fees for F&I products could follow, he says. If that happens, dealerships likely will reap lower revenues per vehicle and try to make up for it by selling F&I products to a greater share of customers, he says.
So far only one sizable U.S. bank has switched to a flat fee as its method of compensating dealerships for arranging car loans, BMO Harris Bank in Chicago, which began paying a flat in April.
Pappanastos spoke about regulation and F&I products recently with Automotive News Special Correspondent Jim Henry.
The Consumer Financial Protection Bureau says dealer discretion in setting interest rates can lead to discrimination in the form of higher prices for legally protected groups like minorities or women. Do you think the CFPB also has F&I product pricing on its agenda?
Ever since BMO Harris said it was switching to flat fees, everybody’s standing back and saying, “Now is there going to be a domino effect with other lenders following suit over time?” The next question becomes: What’s the next focus of scrutiny that could leave the door open for discrimination?
It’s a matter of when, not if. “When?” is probably the biggest question out there. How long for flat fees to come from a lender standpoint.
And that next focus of scrutiny will be F&I products?
When you’re financing a deal, certainly VSCs [vehicle service contracts] come to mind as a point for potential scrutiny and potential flat fee pricing.
The public dealership groups say they’re already getting about two-thirds of their F&I revenue per vehicle retailed from add-on products as opposed to dealer reserve. Is that typical?
We do monthly compliance audits with every dealership we work with. We recommend no more than 35 percent in finance reserve. The higher you get in finance reserve, the more likely a contract is to be refinanced. That customer goes home and they end up refinancing with their credit union, and then you have more chargebacks, to the detriment of the dealer.
From a dealer standpoint, it becomes a question of margin vs. volume. From a dealer profitability standpoint, it’s either “I’m going to get a giant amount per transaction” or it’s the penetration rate.
So if a giant amount per transaction is out, then it’s all about penetration rate, right?
Obviously, there’s always a trade-off between margin and volume. What’s going to happen if you go to flats is pricing is going to find the lowest common denominator.
There may be a lower margin on the front end, but VSCs drive customers back to the dealer, so you really want that. What we see happening is we see that if the market goes to a flat-rate model, we think that there will be pressure to drive product penetration on F&I product.
The next step will be dealers will say, “I need lower prices from our providers.” That’s the inevitable impact on F&I product providers from the CFPB.