Rate Markup, the CFPB, and Common Sense

Auto industry finance experts agree that the Consumer Financial Protection Bureau will eventually turn its focus to rate markup on dealer arranged finance contracts. Consumer advocates bring up anecdotes of what they refer to as “rate gouging” as proof regulation is needed. David Robertson, President of the Association of Finance and Insurance Professionals, points out, “There is no empirical evidence that consumers who use auto dealer arranged financing pay higher interest rates than other auto loan borrowers.” But Dodd Frank has already imposed similar legislation on the mortgage business capping rate markup and broker compensation.

The threat that the CFPB may take away the opportunity for dealers to make “rate spread” is an emotional issue, if only for the sake of principle. According to Terry O’Loughlin, director of compliance for Reynolds and Reynolds Co. (www.reyrey.com), “The CFPB would more effectively advance consumer interests if it identified serious problems to police. It is attempting to provide a solution to a problem which doesn’t exist. There is nothing preventing consumers from shopping rate. In fact, it has never been easier for them. Often, dealers are able to gain financing for consumers they couldn’t arrange for on their own.”

Despite the fact that auto industry is dug in against regulation of rate markup, there is another way of looking at the issue. Highly respected Finance and Insurance trainer, George Angus, training director for Team One Research and Training, provides perspective. According to George, and others who agree with him, myself included, making excessive rate mark-up is counterproductive, perhaps even “stupid.” In fact, George used that exact word to describe the consequences of excessive rate markup to an enthralled group at last summer’s F&I conference held in Las Vegas. It is dealer compensation plans for their F&I producers that are the problem.

Why is excessive rate markup “stupid?” Increasingly there are companies like Rate Genius, who contact borrowers with an offer to pay off their “unnecessarily high interest rate” auto loan and replace it with a more “market rate” contract, thereby reducing the consumer’s monthly payment. They represent the market at work. Rate Genius, and the others, have every right to do what they do. Depending on how long after the original bank contract has been signed by the consumer at the dealership, and the dealership’s underlying agreement with their lender, the dealership may or may not receive a charge back to their interest reserve. The lender certainly takes a hit. It is quite likely that the dealership experiences a chargeback on other products sold and added on to the contract being paid off by Rate Genius and the others, and replaced with their own products.

The real damage is done to the relationship between the consumer and the dealership. What are the chances the consumer will return to the dealer for another vehicle? What are the chances the consumer will speak well of the dealer who charged them the “excessive rate” to their friends and associates?

Paying the F&I department based on income PVR (Per Vehicle Retailed) encourages charging higher than market rates that can end up in premature borrow payoffs, chargebacks, and hard feelings on the part of the dealer’s customers. Angus suggests paying F&I producers based on finance penetration and a formula based on the number of products sold per deal.

Our industry needs to tend to this issue for reasons of common sense, before the CFPB gets involved.


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NVLA Update

Guest Post: Jeff Cook

The first day of this year’s conference wrapped up with a reception hosted by association President Ben Carfrae of Ruan Leasing. The dual Independent Leasing Company and Lease Here Pay Here tracks were well attended everyone had great things to say about the venue and the largely unknown vitality of downtown Fort Worth.

To kick off the day, we were treated to a presentation by Richard Shing – a retired Texas Ranger (Law Enforcement Officer not a ballplayer!). Dressed in cowboy boots and a Silver Belly Stetson, Sergeant Shing used his dry Texas wit to describe the role he and fellow Rangers have played in the state’s storied history. He also shared some insight into then Governor Bush during the months he was assigned to the future president’s security detail in 1999 and 2000.

Attendees were also presented with economic insight from Manheim’s Tom Webb and Black Book’s Ricky Beggs. Both had largely positive forecasts for automotive dealers and lessors. Beggs remains particularly bullish on trucks and SUV‘s even in the face of this summer’s forecasts of $4 per gallon gasoline.

The biggest bombshell of the day was presented by Phil Clements of Cathedral Consulting. And Clements is no lightweight. He’s one of the founding partners of Price Waterhouse and is an expert in tax law. Clements compared and contrasted President Obama’s tax plans with those presumptive republican nominee Mitt Romney and how each would impact vehicle lessors. The bottom line: if you hold title on a large fleet of vehicles and have previously taken Bonus Depreciation, get ready to cut a big check to the IRS in 2012 and 2013 – no matter who wins the presidency.

The afternoon saw a marketing workshop presented by David Blassingame of AutoFlex leasing. Blassingame shared insight on how he turned a massive North Texas hailstorm into a successful marketing event and how he used customer feedback to redesign AutoFlex’s website.

Lastly, there was an eye-opening workshop conducted by Jim Satterfield of the crises management firm Firestorm. Most attendees, including the author, had no idea just how vulnerable and unprepared our businesses are to social media risk and negligent liability.  He conducted an interactive exercise demonstrating just how real the risk is. It included business continuity, communications and disaster preparedness plans too.

This has been a great event so far and it wraps up today.



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NVLA From Afar

Guest Post: Jeff Cook

The NVLA Annual Conference kicked off last night – albeit without Ruggles. He’s resting comfortably in Las Vegas after a mild heart attack last week. Prognosis is for a full recovery and he’ll be back on the conference circuit in no time. He asked that I send his regards to all.

That said, the vibe here in Fort Worth is outstanding and we anticipate a great conference. We’ve got Chamber of Commerce weather and a group of us hit the legendary Joe T. Garcia’s last night after the opening reception.

Attendance is up 50% over last year and there is a new Lease Here Pay Here (LHPH) track garnering attention. Tom Webb from Manheim and Ricky Beggs from Black Book are here, as is the association’s new business development partners Cathedral Consulting.

I’ll report back tomorrow with more details. In the meantime, if  you’d like to drop Ruggles a line or comment here, I know he’d love to hear from you.



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A Look Back At The 2008 Gas Crunch & A Look Ahead To Next Month’s NVLA Annual Conference

With US gas prices approaching $4 per gallon, we thought it would be good to revist Ruggles’ column published in January 2009. As you may expect, he nailed much of it – including the inevitable “Accordian Effect” of consumer pull-back and oil company over-production.  Will we see the same this summer or will market forces and a pre-conditioned driving public align to set record highs?  The attached column is re-printed as it was originally published with comments and thoughts in red-line. Click here to view: Ruggles_Report_2012_A_Look_Back_At_2009

In other news, the National Vehicle Leasing Association’s Annual Conference will be held in Fort Worth next month April 23-25 in Fort Worth, Texas.  Take a look at the number of banks and financial services firms that will be in attendance. This is great news and bodes well for leasing in 2012!

Admiral Leasing
Advanced Lease Systems, Inc.
Advantage Funding
Alliance Inspection Management
Allstate Leasing
Capital One, N.A.
Cathedral Consulting Group, LLC
Centennial Leasing Inc.
Crawford & Company
Credit Union Leasing of America
CyberCalc / AutoBidsOnline
Eastern Auto Motor Corp.
Ellis Brooks Leasing, Inc.
Financial Services of Mississippi, Inc.
GM Commercial & Fleet
Hudson Cook LLP
Interstate Fleets Inc
LHPH, Inc.
MidWestern Leasing
Moritt Hock & Hamroff LLP
Nissan North America Commercial Vehicles Div.
PDP Group, Inc.
Sovereign Bank
Texas IADA
Tom Bell Leasing
Total Resource Auctions
V A Leasing Corp
VCI Mobility
Wilmar, Inc
Zeemac Vehicle Lease Ltd.


Jeff Cook
Editor / Publisher

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Bush 43 and NADA 2012

The annual National Auto Dealer Association convention was recently held at the Las Vegas Convention Center.  This year’s conference was indicative of the vigorous rebound of the industry as a whole.  Attendance was brisk and the exposition hall was packed full of vendors.   Spirits were upbeat and optimism abounded.  

Ex President George W. Bush was the last to present and he packed the hall.  The President began with a 25 minute presentation followed by Q&A with outgoing NADA Chairman Stephen Wade asking the questions.  The President showed his human side with a liberal mix of applause lines and humor.  He cracked up the room on numerous occasions with spontaneous “off the cuff” remarks. He devoted some time to trying to sell his book, “Decision Points,” which is highly recommend.  But every time Bush mentioned “Decisions Points” he added with a wry expression and a twinkle in his eye, “We still have plenty of inventory.”  The line became funnier every time he said it.  “Did I mention, we still have plenty of inventory?” 

Despite the fact that the room was primarily Republican, based on informal polling, there was no booing or hissing for the fact that President Bush authorized the advance of a bridge loan of $17.4 million from TARP funds to GM and Chrysler in December of 2008 after having been turned down for a bailout package by Congress.  TARP and the auto “bridge loan” this was the second topic Bush addressed after first spending some time on his own battles with alcohol. 

So given the audience, it made perfect sense for him to dwell on his part of the auto industry rescue.  In fact, it might as well be termed the rescue of the North American industrial base, since that is what was at stake.  Bush spoke glowingly of the advice and support of Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke.  He cited them as perfect examples of when a leader needs to surround himself with people who know about that which the leader doesn’t. 

Speaking of the massive government support by his administration during the economic collapse of late 2008 Bush says, “In a normal environment, the free market would render its judgment and they could fail.  I would have been happy to let them do so.  As unfair as it was to use the American people’s money to prevent a collapse for which they weren’t responsible, it would have been even more unfair to do nothing and leave them to suffer the consequences.  The consequences of inaction would have been catastrophic.” 

Regarding the economic crisis he said, “If we’re really looking at another Great Depression, you can be damn sure I’m going to be Roosevelt, not Hoover. Wall Street got drunk, and we got the hangover.”

In his book, Bush says he opposed the Carter/Reagan bailout of Chrysler. “The economy was extremely fragile, and my economic advisors had warned me that the immediate bankruptcy of the Big Three would cost more than a million jobs, decrease tax revenues by $150 million, and set back the country’s GDP by hundreds of billions of dollars.” 

President Bush refrained from getting involved in the current politics other than to say he understands the immense pressures of the job and that it would be counter productive for him to weigh in.  Despite the occasional malapropism, he conducts himself with class and grace with a large dose of Texas one-liner humor.  While history may judge him harshly on some issues it seems clear that the decisive action he authorized saved the economy, and in particular the auto industry, from a catastrophic meltdown.

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Residual Values To Remain High – Even In Face Of High Gas Prices

I have been privileged to discuss residual values and the pre-owned market with a number of industry experts over the years.  An idea that was born in a late 2008 discussion over a beer with Matt Traylen, then Chief Economist for Automotive Leasing Guide, has since become full blown reality.

At the time, the stock market was tanking, new vehicles sales had slowed to a crawl, the auto manufacturers were begging for money before Congress, the acronym TARP had just been coined and the economy and our lives were looking bleak and uncertain.

Most lenders had announced in previous weeks that they were getting out of the leasing business, or dramatically “pulling in their horns.”  The asset backed securities market had disappeared, pulled down by the mortgage backed securities market and we were hearing unpleasant terms like “toxic assets.”  This reminded me of some earlier dark days in the auto industry when a dealer or leasing company might take particular vehicles to auction and they wouldn’t even draw a single bid, a particularly difficult position when one had a payroll due.

It was easy to understand how a bank holding a lot of “toxic assets” but little cash could become a “zombie bank,” a term invented to describe the Japanese banks after their own real estate bubble burst. That is a bank with a “strong” balance sheet but no cash to loan or to return to depositors who arrive “electronically” at the bank to make a withdrawal.  Marking these assets to market was impossible because values could not be established as no one would bid on these mortgage backed securities or their “first cousin,” auto loan backed securities. Regardless, “mark to market” it would have rendered the U.S. banking system insolvent and caused a complete meltdown.

After acknowledging that most of the major players had announced their exit from the leasing business, the collapse of available financing for fleet and daily rentals, and the dramatic drop off in overall new vehicle sales volume, Traylen and I asked, “Where will pre-owned inventory come from down the road?”

While used vehicle sales plunged from a high of about 44 million units in a single year to about 35 million units in 2009, it became apparent that once demand began to trend upward toward historical volumes, there would be an acute shortage of available inventory.

Within a few months, GM and Chrysler went through bankruptcy and Cash for Clunkers plucked another 600,000 potential pre-owned vehicles out of the system and fed them to the crusher.  The Buy Here Pay Here business was really crushed as what the government called a “clunker,” they called “inventory.”

Today, there is considerable pent up demand for pre-owned vehicles and the banking system has recovered to the point that ready financing is available again.  There are still serious issues to be resolved in the economy, not the least of which is high unemployment, but demand is building.

Other than unemployment, the biggest impediment to full economic recovery is the fact that 25% of American mortgages are in negative equity territory.  The large numbers of foreclosures have left empty and/or abandoned houses in neighborhoods across the country further depressing home values.  Few neighborhoods, regardless of affluence, are immune from this.

Economist Alan Greenspan, past chairman of the Federal Reserve Bank, recently stated that he did not believe the economy could reach full recovery momentum until the real estate market experienced at least a 10% increase in home values.  It just is not clear how long it will take for home real estate to become stabilized, let alone regain value.  On the other hand, the rebound of the stock market has restored almost 16 trillion dollars of mostly American wealth.

Against this mixed backdrop of economic news and general economic uncertainty, there is much more demand than available pre-owned inventory, which is driving wholesale pre-owned prices ever higher.  We see pent up demand in the new vehicle business by the steady increase in sales results.

New vehicle incentives have a considerable impact on pre-owned values.  If incentives lower the true transaction price of new vehicles, the value of same make/model pre-owned vehicles drop a commensurate amount.

Restraint of late on the part of auto manufacturers to refrain from over production is keeping dealer inventory levels in line with demand.  It is likely that OEM restraint on overproduction and incentives will be ongoing as they have new policies and labor agreements in place. The fact that dealer floor plan arrangements with lenders are much more restrictive than before has also helped maintain this equilibrium.  Few dealers have the liberal floor plan arrangements these days that once allowed for the massive stocking of vehicles on behalf of a manufacturer looking to “force the market” with incentives.

But now that financing for leasing has recovered, OEM captive finance arms are focusing on shorter terms to try to create additional supplies of pre-owned inventory.  Financing for the daily rental business has allowed rental companies to begin to return to more traditional replacement cycles.  The same is true for fleets.  So what is the outlook going forward and how will it impact residual values?

Experts say we will continue to experience pre-owned shortages for at least as long as 5 years.  Some niches will be more acute in this respect than others, and segment values could change with fuel prices and other issues.

But the tremendous shortfall in pre-owned inventory supply will take years to balance out as demand increases in line with economic recovery.  In talking to experts like Tom Webb, Chief Economist for Manheim Auctions, Tom Kontos, Chief Economist for Adesa Auctions, Ricky Beggs, Managing Editor and Vice President for Black Book, Rene Abdalah, Vice President of Residual Value Insurance Group, Eric Ibara, Director of Residual Value consulting at Kelly Blue Book and Traylen who is currently head of M.A.T. Consulting, the consensus is that the shortage will be with us for at least 5 years.  Residuals are expecting to stay quite strong!

However, in projecting residual values, there is a somewhat different outlook between Abdalah of RVI and Ibara of KBB and their counterparts at Automotive Leasing Guide.  Both companies are convinced that as long as fuel prices increase gradually, American consumers will adapt without drastic short term consequences.  Consumers will tend to buy the largest vehicles they can afford.

Other than “early adopters,” most consumers will only pay a technology premium for “electrics” and hybrids if the government pays it for them through tax credits or other subsidies.  When fuel prices suddenly spike, as they did in 2008, fuel economy becomes the consumer’s primary motivator. However, experience shows this is a short term circumstance.

As we have seen repeatedly, and as recently as the price spikes in 2008, high fuels prices are followed by oil gluts and extreme fuel price declines as oil producers rush oil to market to capitalize on the high market prices, creating over supply.  In 2008, the cycle began in April when the price threshold broke $4./gallon.  By the time January 2009 arrived, a gallon of regular was $1.90.

So while there may be some price spikes along the way, Ibarra and Abdalah expect the overall fuel price trend will be gradual.  As a consequence, manufacturers will have to deal with substantial Corporate Average Fuel Economy (CAFÉ) fines if consumers do not naturally purchase a product mix that lends itself to the auto manufacturer’s, and the government’s, CAFE objectives.

In the past we have seen manufacturers prefer to pay significant consumer incentives to move vehicles they need to move to avoid the CAFÉ fines.  With CAFÉ requirements at extremely high levels, it is logical to expect the focus of OEM incentives to be on fuel efficient vehicles. The CAFÉ standard for 2016 for cars is 39 mpg ad 30 mpg for trucks. This will drive down the values of like make/model pre-owned vehicles. Lessors need to consider this very real possibility looking down the road.

At the same time, manufacturers can be expected to raise the price of larger less fuel efficient vehicles and reduce incentives to try to make more gross profit per unit, while somewhat depressing volume to enhance their CAFÉ calculation.  As a consequence, Kelly Blue Book and RVI Group residual projections are higher for “heavies” than ALG’s projections while ALG’s projections are higher for smaller fuel efficient vehicles.

If a cataclysmic event takes place and oil goes to $200. plus per barrel, and stays there, all bets are off anyway.

Lenders, fleet operators, and private capital leasing companies will have to make their own overall residual setting decisions and come to their own conclusion about each size and fuel economy segment.  However, there is no doubt that overall residual values will stay historically strong in the years to come as strong demand for pre-owned vehicles overwhelms the available supply.

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Turning Oil Into Salt – A Review

Turning Oil into Salt, a review of the new book by Gal Luft and Anne Korin

If you believe in global warming, you believe we need to get off of fossil fuel.  Conversely, if you believe we need to reduce the strategic value of oil, it is a different calculation.  People get these issues confused they result in similar outcomes.

Reducing our dependence on fossil fuel is generally considered the province of “Green Liberals,” “Al Gore Disciples,” “Tree Huggers,” “Global Warming Alarmists,” etc. However this is certainly not the case.  An example would be the following video made by unlikely partners, Newt Gingrich and Nancy Pelosi:


But reducing the strategic value of oil is something everyone should be able to agree on, even for those who are skeptical that a global warming hazard even exists.  The following video was made by ex CIA head James Woolsey:


So why are you reading this in an auto publication?  Because according to Gal Luft and Anne Korin, the authors of Turning Oil Into Salt, MORE government intervention into the auto industry is required to reach a solution.  Many of us are rolling our eyes at even the thought, but the stakes couldn’t be higher.  We ARE engaged in a war against fundamentalist Islam, and we ARE paying for both sides of the war.

Today, roughly two-thirds of the world’s oil is used for transportation, and most vehicles are able to run on nothing but traditional gasoline. As such, oil’s strategic status stems from its virtual monopoly over fuel for transportation, which underlies the global economy and our way of life.

To understand the implication of an over dependence on a strategic commodity we can look at history.  At one time, salt had a virtual monopoly on food preservation.  Wars were fought over salt.  Finally, Napoleon, whose army “traveled on its stomach,” had enough and offered a significant sum of money to the person to eliminate his army’s reliance on salt.  Within a few years, a French chef invented food “canning.” After canning, electricity, and refrigeration, salt has lost its strategic status and we no longer go to war over salt.

How can this be accomplished with oil?  According to Luft and Korin it only requires Congress to mandate that from a specific date forward, all or most vehicles sold in the U.S. must be manufactured as a “flex fuel” vehicle, capable of running on gasoline and/or a variety of alcohols and blends.

This has already been done in Brazil where 80% of new vehicles purchased in 2008 were flex fuel.  The additional cost to produce a flex fuel vehicle is about $100, which includes the cost of premium fuel system components, a fuel sensor and computer chip reprogramming.

The first Model T Fords ran on gasoline OR alcohol, so the concept is not new.  There are also a variety of alcohol fuels available.  Alcohol does not mean just ethanol, and ethanol does not mean just corn, a particularly bad fuel feed stock.  Other alcohol based fuels include methanol made from coal and ethanol from almost anything.

According to the authors, the average vehicle in the U.S. is in service for 16.7 years.  Once 15% – 20% of the total vehicles on the road are flex fuel, the market will take over.  Refueling infrastructure will develop and additional alcohol production will come to market with coal/methanol probably eclipsing corn as a feed stock, much to the chagrin of Midwestern farmers and Senator Charles Grassley.

Add in additional vehicles operating on compressed natural gas and electricity, plus additional conservation based on increased fuel efficiency, and dependency on oil could be reduced 35% in 10 years, the exact amount we currently import from OPEC.  We would also be less dependent on oil in general and all of our oil could be sourced from North America, including Mexico and Canada.

There is even a “Drill Baby Drill” component to the Luft/Korin plan, although we have some disadvantages in the USA.  It costs OPEC less than a dollar per barrel to lift their oil from the ground, while it costs us almost $10.   They have about 78% of the world’s known reserves, but only produce 40% of the world’s supply, as they work to maximize the price of each barrel they sell.  OPEC produces less now than they did in 1973.

In the meantime, we have less than 5% of known reserves but consume 25% of the world’s production.  And the lower the American price at the pump, they more we’ll consume and the more pressure we put on the world market price of oil to rise.  Unfortunately, we don’t get a discount for our volume purchases.

OPEC also has the nasty habit of flooding the world market with supply to drive down the price any time a new but more expensive technology threatens their dominant position.  This is another reason government involvement might need to be involved before flex fuel begins to make oil a less strategically important commodity.

A bill called the “Open Fuel Standard” is pending before both the House and the Senate.  The bill ensures that 50% of new vehicles sold in the U.S. with an internal combustion engine would be warranted to run on gasoline, ethanol, or methanol.  Diesel vehicles would also be warranted to run on bio-diesel.

In 2009 there were no fewer than 33 Make/Models warranted to run on up to 85% ethanol, but no warranty for methanol.    Expanding this to more models and including blends of methanol should be easy.  Brazil has done it and at one time, auto manufacturers considered using methanol as an octane booster, but chose lead instead.

There are currently 8 million flex fuel vehicles on the road out of 200 million total vehicles but we have not yet reached the critical mass necessary for the market to respond with refueling infrastructure and additional investment in alcohol production.

Some say the expansion of alcohol fuels is being held hostage by agribusiness lobbying efforts.  For some reason, we place a 54 cent per gallon tariff on imported Brazilian sugar cane ethanol.  A barrel of oil is 42 gallons.  You can do the math.

Turning Oil into Salt is must reading for auto industry professionals and for all U.S. citizens.  And it’s a quick read, making its points in only 138 pages.

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