As CFPB retreats, what's next for dealer reserve?

Just a few years ago, some industry watchers were predicting that automotive lenders would widely adopt a flat-fee model in place of dealer reserve to steer clear of enforcement actions by the Consumer Financial Protection Bureau.

But now, two major auto lenders that implemented a flat fee a few years ago, BB&T and BMO Harris Bank, have changed their policies. The revisions come as new leadership at the bureau has signaled a pullback from aggressive enforcement actions.

Meanwhile, dealerships' finance and insurance operations increasingly drive their profits from the sale of products, such as extended service contracts, rather than from helping to arrange financing for customers.

A few years ago, the CFPB said that dealerships' discretion to vary the amount of dealer reserve — the retail margin that dealerships earn for arranging a car loan — resulted in minorities being charged higher interest rates for auto loans than nonminority borrowers with similar credit, even if no discrimination was intended. The bureau urged auto lenders to switch to paying dealerships a flat fee to eliminate the risk of discrimination.

BB&T Dealer Finance will end its flat-fee program in March in favor of a traditional retail pricing plan.

The unit of BB&T Dealer Financial Services — which is part of BB&T Corp. in Winston-Salem, N.C. — began offering dealers a flat fee for arranging auto loans in 2015.

The bank's new program will include a maximum dealer reserve rate spread of 2 percentage points on loans up to 75 months and a maximum dealer reserve amount of $5,000, spokesman Brian Davis told Automotive News.

After the switch to the flat fee in 2015, BB&T's vehicle-loan volume decreased, Davis said. In the fourth quarter, BB&T's auto loan balance fell about 6 percent from a year earlier to $13.4 billion.

"To provide our dealer clients with more options and better flexibility, we will introduce a more traditional auto pricing program," Davis said. "BB&T remains firmly committed to the auto finance industry and to the fair and equal treatment of all consumers."

BMO Harris implemented a flat-fee payment method before BB&T's move, but adjusted its model last year.

In 2014, BMO Harris offered dealers a 3 percentage-point flat fee on loans of 36 months and longer. The bank did not pay dealerships a fee for loans shorter than 36 months, a spokesman said at the time.

In 2017, however, the Chicago bank adjusted its plan to a three-tier model. It began offering its U.S. dealership clients a 1 percentage-point flat fee for loans of 36-59 months, a 3 percentage-point flat fee for loans of 60-72 months and a 5 percentage-point flat fee for loans of 73-84 months.

Enforcement

Over the past several years, major auto lenders, including Ally Financial, Toyota Motor Credit, American Honda Finance and Fifth Third Bancorp, settled with the CFPB and the Department of Justice for potentially discriminatory auto lending practices. The lenders agreed to pay between $18 million and $98 million to resolve the regulators' claims.

Part of the settlements reached with Honda Finance, Toyota Motor Credit and Fifth Third in 2015-16 required the lenders to cap dealer reserve at 1.25 percentage points above the lender's wholesale buy rate for loans of 60 months or fewer and at 1 percentage point for loans longer than 60 months.

At the time, those settlements were seen as reshaping the landscape of auto lending.

But that was then.

Today, under Acting Director Mick Mulvaney, who simultaneously serves as director of the Office of Management and Budget in President Donald Trump's administration, the CFPB is taking a notably less activist stance.

The bureau — which some previously criticized as aloof, over-reaching and uninterested in listening to the views of Corporate America — has issued four calls so far for comments and feedback, including on its supervision and enforcement processes. At least eight more are expected, which will allow consumers and affected companies and industries to comment, among other topics, on its external engagement, rulemaking processes and inherited rules.

On Monday, Feb. 12, when the bureau issued a five-year strategic plan, Mulvaney said in a statement, "If there is one way to summarize the strategic changes occurring at the Bureau, it is this: we have committed to fulfill the Bureau's statutory responsibilities, but go no further."

The previous strategic plan, for 2013-17, listed as the first of four goals: "Prevent financial harm to consumers while promoting good practices that benefit them."

Under the new strategic plan, the first of three goals is "Ensure that all consumers have access to markets for consumer financial products and services."

Profit mix

In anticipation of continued elimination or reduction of dealer-reserve profits, many dealerships placed a greater focus on F&I product sales and a lesser focus on reserve.

Today, many dealerships' F&I profits are split 70 to 75 percent products and 25 to 30 percent dealer reserve.

That's compared with the roughly 50-50 model some of them had before the CFPB began its campaign scrutinizing dealer reserve.

But dealerships' F&I profit mix shift is driven by more than lenders' changed policies.Many stores value F&I product sales more than a one-time profit from dealer reserve, in part because the products come with more lasting benefits for customers and in part because those products aid in customer retention in the service lane. James B. Treece contributed to this report.