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Special Business Report

Opportunity knocksASIC changes to finance rules could see big increase in

dealers’ share of car loans

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ASIC CHANGES: CAR FINANCE SPECIAL REPORT - JANUARY 2018

Big car loan opportunity

What’s changing?

The role of financiers

Clearing the mists of confusion

Changes to dealer revenues

The role of dealers in making the transition

Why did ASIC feel the need to act?

New treatment for the origination fee

The changing role of business managers

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1 Big car loan opportunity

2 Clearing the mists of confusion

3 Why did ASIC feel the need to act?

4 What’s changing?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

n NEW rules governing the sale of car finance, that will become mandatory on November 1, 2018, could see car dealers come to dominate the funding of the cars they sell and place greater competitive pressure on credit unions, banks and finance brokers.

An examination of the rules, and the likely response by auto finance companies and their intermediary dealers, reveals that while dealers are likely to make less commission on many of the loans they write, if approached in the right way they have the potential to sell far more loans.

This special GoAutoNews Premium business report prepared by GoAutoMedia publisher, John Mellor, says that, due to the changes enforced by ASIC, dealers will see their finance offerings become far more appealing to car buyers.

The report says that in order to generate the sort of revenue they have traditionally enjoyed from selling car finance where generating commission revenue was a focus, dealers will have to concentrate less on commission and more on increasing the penetration and total volume of loan sales.

To do this they will have to work with their financiers to take on the other players selling car loans in order to increase dealer conversion rates of customers buying cars from them.

Dealers will need to work with their financiers to enhance the variety of finance products on sale and to change to more convenient processes for customers.

Fortunately for Australian dealers, a potential window exists for them to achieve growth in conversion rates.

This is because Australian dealers have, by global

standards, extraordinarily low finance conversion rates on the cars they sell. In fact Australia stands out as a very poor provider of finance at the point-of-sale compared with other markets.

It is common for Australian dealers to sign up a car loan on only one in five cars they sell from their showrooms even though, from a convenience perspective, they are in the best position to help buyers pay for their cars. Many dealers achieve even less than a 20 per cent finance conversion rate.

Continued next page

ASIC changes to finance rules could see big increase in dealers’ share of car loans

Big car loan opportunity

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1 Big car loan opportunity

2 Clearing the mists of confusion

3 Why did ASIC feel the need to act?

4 What’s changing?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

Continued from previous page

Indeed, industry benchmarks like those from KPMG and Deloitte say dealers should strive for at least 35 per cent. Dealers selling loans on more than 45 per cent of the cars they retail are seen in the industry as superstars.

But in the United States and the United Kingdom, the penetration of finance written by the selling dealer is often more than 80 per cent – four in every five cars sold.

One explanation is that in the US and the UK private buyers are keen to lease their cars and this accounts for a large chunk of the finance

deals done in those markets.But in Australia, leases tend

to be confined to buyers with an ABN or ACN. And, while there have been consumer lease products available in

Australia, Australians still like to own their cars.

However, GoAutoNews Premium has been told that buyers can expect to be increasingly offered a variety of consumer loan and lease products by dealers as the new

ASIC rules come into effect.Another factor in the low

conversion rate in Australia is that it is a symptom of the business structure within Australian car dealerships

where dealers faced with slim margins on the sale of each individual car come to rely heavily on commissions from the sale of car finance.

Numbers from Deloitte suggest some dealers are earning the equivalent of 100 per cent

of their annual profit in finance and insurance commissions.

The necessity to build profits into the sales of car loans means that dealers have been setting interest rates to a point where they have come to be regarded by some car buyers as uncompetitive.

Over time, this focus by dealership owners for revenue from finance sales as a substitute for low or non-existent profit margins in vehicle sales attracted the attention of the regulator – ASIC – which has stepped in with new rules regarding the use of flex commissions.

Continued next page

“Buyers can expect to be increasingly offered a variety of consumer loan and lease products by dealers as the new ASIC rules come into effect”

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1 Big car loan opportunity

2 Clearing the mists of confusion

3 Why did ASIC feel the need to act?

4 What’s changing?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

Continued from previous page

ASIC’s intervention has taken issue with the connection between interest rates charged on car loans and the level of commissions dealers could achieve. Among other things, it saw this structure as a potential conflict of interest detrimental to buyers.

That is why ASIC has placed the setting of interest rates and commissions firmly in the hands of the financier offering the loan.

Now, in less than 10 months’ time, dealers will have no choice but to reset their

business model.By mandating an end to

the present system, which has often resulted in dealers being at a competitive price disadvantage when selling car finance, it means the slate can been wiped clean for all auto retailers.

All dealers will be in the same boat and all dealers, in working with their financiers, can begin focusing on providing more competitive and enhanced loan products to help them achieve higher finance conversions on the cars they sell.

n MOVES by ASIC to change the way dealers sell car finance could be seen as timely for dealers because the current system for selling loans to car buyers in dealer showrooms was heading for trouble.

The fact is that Australian dealers, in spite of having very low finance sales penetration rates by world standards, were already seeing their conversion rates falling further and were beginning to lose their share of the car finance market.

The traditional dealer finance sales model was also coming under increased threat from technology.

Car buyers can already use their mobile phones to compare interest rates while sitting in the business manager’s office in the dealership, which effectively means they could see if the dealership was pushing the envelope on pricing.

This type of online price comparison shopping is becoming more commonplace and is readily available to all car buyers.

Positive credit reporting, where buyers have a much

wider knowledge of their credit scores, is also on its way to Australia.

This means that the Australian model should move much closer to the US model where consumers can learn a lot more about their credit history, both negative and positive, as can lenders.

In the US a FICO score is provided so both the financier and the consumer know their credit risk rating and, as a result, roughly what their interest rate should be.

If a consumer’s interest rate is part of their walk-around knowledge, then why would they accept a rate of 10 per cent when they know they should be at seven per cent?

With positive credit reporting, customers using their mobiles to check interest rates and the possibility of new, disruptive competitors entering the market to offer loans directly, these sorts of changes were already on the way and were going to work against the traditional finance model that has been in place.

So the current model really had an end date anyway.

Dealer finance was set to evolve anyway

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

4 What’s changing?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

2 Clearing the mists of confusion

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

n THE car industry is now finally in a position to understand the full implications of the legislative instrument introduced by ASIC after years of confusion about what the rules would mean for dealers and their businesses.

There has been widespread speculation as ASIC worked through the process over the past six years during which the regulator completed a number of different drafts in the process of discovery and consultation with the industry.

Now the final draft is released.Macquarie Leasing division

director, Russell Bryant, told GoAutoNews Premium: “The good thing is that we can now finalise the position.”

Mr Bryant has just completed a national roadshow with OEMs and dealer clients to explain what the changes mean for them.

He said that the question everyone wanted answered immediately was the effect the changes will have on revenue for dealers.

But he said it was important for the Macquarie team to take its OEM and dealer clients back to basics because, “once everyone understands the

fundamentals of the changes then the effects on their revenue become apparent”.

The first step Macquarie has taken is to explain:

• What drove ASIC to make the changes

• What measures ASIC has put in place to address its concerns

• What will actually change for dealerships once the new legislation is in place

Mr Bryant said that once dealers get a grip on these changes in a general sense they can then investigate internally how the changes will specifically impact the operations of their businesses.

“This involves, for example, understanding the actual process of signing up a buyer for a car

loan because the interaction between the business managers and the financiers will change significantly.”

Once they understand the fundamentals, dealers will need to consider in that context:

• What does this mean for sales staff throughout the dealership?

• What does it mean for their OEMs?

• What does it mean

for the way F&I and sales staff deal with car buyers?

Mr Bryant said: “Once dealers see that the new rules will require some process changes within dealerships, as well as within financiers, they will see that the extent to which these changes are

implemented in their own business will impact on their revenue position.”

Mr Bryant said of dealers: “Doing nothing is not an option. Implementing new procedures like automation of certain processes can have a really positive impact on a dealer’s business and customer experience in this new world and that’s what we are supporting our clients to do; embrace these changes and build on the opportunities that can come as a result.”

The question of everyone’s mind is how will these changes affect their bottom line

Clearing the mists of confusion

“The interaction between the business managers and the financiers will change significantly”

Russell Bryant

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

4 What’s changing?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

2 Clearing the mists of confusion

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

Why did ASIC feel the need to act?

n ASIC took the view that the long-standing way of selling finance involving so-called “flex commissions” left many car buyers open to potential financial disadvantage compared with another car buyer with similar creditworthiness paying the same amount for the same car.

ASIC went so far as to say that there was potential that using flex commissions, which is the most common form of commission arrangement, could possibly be in breach of the National Consumer Credit Protection Act because it saw “flex” as likely to be inconsistent with the obligations and expected standards of a credit license holder.

For those not familiar with “flex”, here is how it works.

In general, a base rate of interest is set by the financier (it could be six per cent, for example) on car loans sold at the dealership.

This base rate would attract a relatively modest commission

for the dealership (maybe $200 to $300).

But dealers have been able to “flex” the interest rate by increasing the level of commission they wanted to earn on a given deal, which led to the interest rate being increased above the base rate. In certain circumstances they occasionally ‘flexed’ the rate

lower as well.What worried ASIC was

that it was the business managers in dealerships, once a buyer had set their heart on a car, who effectively negotiated the interest rates;

not the finance company because of how interest rates were linked to the level of commission.

ASIC concluded that the financier should be setting the interest rate being offered to the buyer for a given purchase and the level of commission, not the loan introducer.

Under the flex commission

arrangement dealers’ commissions were based on the interest rate to buyers.

In its announcement, ASIC said that sometimes 80 per cent of the “flex” interest income generated by a loan was being paid as commission to the dealer.

Of course, within the interest rate was a mix of factors designed to cover risk based on the buyer’s credit profile.

Some finance companies provide business managers with a matrix of guidelines; a risk-price plan that may revolve around the age of the car, new or used, whether the customer was a homeowner or not, credit record and the loan-to-valuation ratio of how much was being loaned against the value of the car.

Continued next page

“ASIC concluded that the financier should be setting the interest rate being offered to the buyer for a given purchase and the level of

commission, not the loan introducer”

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

4 What’s changing?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

2 Clearing the mists of confusion

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

Price of car Interest rate Interest charge Commission Difference

$45,000 7.99 $9818 $453 -

$45,000 12.74 $15,212 $3332 $2879

Base rate Contract rate Commission at base rate

Commission at contract rate

Difference

8.24 10.95 $303 $1549 $1246

8.24 12.99 $316 $2488 $2172

7.99 10.45 $354 $1717 $1363

6.24 13.04 $346 $3173 $2827

6.24 8.99 $209 $897 $688

Above: ASIC said that under these “flex” arrangements it was possible for dealers to receive commission four to seven times higher than the commission generated at the base rate

An example of a “flexed” rate as published by ASIC

ASIC gave these examples of “flexed” rates from its research

Continued from previous page

Those factors all combined into a matrix which would give the business managers in dealerships a rate that went up as those risk indicators went up.

It was then left up to the finance manager to flex the level of commission and interest rate up or down.

Some dealerships would try to control the degree of flex quite tightly while others

would rely on the experience of the business manager. This resulted in variation.

Not all finance companies use a risk matrix to determine base rates.

Some financiers operated much more simplistic models that only varied between new or used cars, or maybe the loan amount. They often didn’t get a lot more complicated than that. But in these simple models, the financier has

to build additional margin into the base interest rate to cover for the various risk levels of every type of customer, thus undermining competitiveness.

Under this one-size-fits-all policy the low-risk loans were effectively subsidising the high-risk customers. With the addition of flex, the comparatively higher interest rate could cause dealerships to lose out on the most ideal

type of customers.Under those traditional

ways of doing things, some dealers encouraged their business managers to strive for higher levels of commission and interest rates in order to earn significant commissions but others were happy to sell more loans by taking a lesser stance on commission levels and interest rates.

Continued next page

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

4 What’s changing?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

2 Clearing the mists of confusion

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

Continued from previous page

ASIC said “the percentage of the flex amount retained by the intermediary (dealer) varied significantly from lender to lender and from plan to plan but some dealers were getting commissions as high as 80 per cent of the additional interest income”.

ASIC said that under these arrangements it was possible for dealers to “flex” and receive commission four to seven times higher than the commission generated at the base rate.

The regulator also reviewed 25,000 finance contracts

written by seven lenders in May 2013 which it regarded as a typical month.

The numbers revealed that

roughly 15 per cent, or 3800 car buyers, were charged an interest rate that was 700 basis points (ie. seven percentage points) or more above the base rate.

ASIC made the point that these people could be presumed to be less sophisticated buyers and more financially

vulnerable than the 85 per cent of borrowers which achieved contracts at lower rates.

It believed that those signing up at high interest rates were potentially financially

challenged with few loan options elsewhere or not familiar with the nuances of car loans and swept along in the process of buying a new car.

In short, ASIC thought that having the dealer’s business managers setting the interest rate and level of commission created a potential conflict of interest that it could not countenance.

And that is why the role of setting the interest rate and levels of commission to be offered to car buyers will now rest with the finance company and not the dealers.

“ASIC indicated that having the dealer’s business managers setting the interest rate and level of commission was a potential conflict of

interest that it could not countenance”

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

2 Clearing the mists of confusion

4 What’s changing?

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

• Financiers set the interest rate and the level of commission not the dealership business managers

• If a flex commission is to be paid, business managers are permitted to REDUCE (within a limit of 200 points) interest rates from the rate set by the financier. This allows dealers to compete at the point-of-sale to secure a loan sale over an alternative finance provider

• It will be prohibited for a business manager to attempt to negotiate an interest rate higher than the rate set by the financier

• Commission calculations must be set in advance and can be paid based on rates within the window of 200 points below the interest rate set by the financier

• If the customer’s interest rate is a rate lower than that window, commission must be paid at the rate being paid at 200 basis points below the interest rate set by the financier

• The financiers will manage the risks and the rate• Commissions are likely to be lower because

commission plans (which go into interest rate setting) will need to be set such that they are competitive to a greater number of customers in

a given risk band, otherwise they may become uncompetitive in that risk band and not support dealers with securing sales

• The finance companies will bear the brunt of the law. It is the financiers who will be penalised for breaches of the rules (including criminal penalties) – not the dealers

• Origination fees, sales incentives and sales bonuses can remain but must be divorced totally from anything to do with interest rates

• Origination fees cannot be increased to cover for the loss of commissions

• As dealers change their focus, the number (less so the size) of origination fees becomes more crucial to revenue

• Dealers may be encouraged by their financiers to reassess their loan sales costs to be better reflected in the origination fees

• Records justifying origination fees must be kept for seven years. These will be used by ASIC to study any undesirable trends emerging down the track (potential loopholes, for example) which, ASIC assures the industry, it will move to close down if they surface.

Summary of what’s changing

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

2 Clearing the mists of confusion

4 What’s changing?

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

n THE new legislative instrument makes rate-setting an obligation of the financier.

So the financier now sets the rate offered to the borrower. The dealer, as the intermediary, can only put to the buyer a rate no higher than the rate offered by the financier.

The role of the dealer as the intermediary is to qualify the customer and work to get the customer buying the right finance for their needs from that financier through that dealership – preferably at the rate offered.

But it is the role of the finance company to assess the borrower and set a competitive interest

rate. The dealers’ business managers are not allowed to take part in that process (other than providing information about the customer).

But there is some wriggle room to close the deal.

Once the financier responds with a rate, the business manager can reduce that rate. Commissions can then be paid based on rates within the window of 200 points below the interest rate set by the financier.

But if the customer’s interest rate ends up lower than that window, commission must be paid at the same rate as 200 basis points below the interest rate set by the financier.

Given the fixed rate of commission at any interest rate below the 200 basis point window, financiers will control whether interest rates below the window will be offered and if so, in what circumstances.

The reason for allowing the dealer to reduce interest rates is to give the dealership the ability to compete for the loan business of a buyer who might have a better offer from another financier.

But a key point is that the dealer business managers cannot increase the interest offered by the financier, they can only come down.

For example: a customer

is looking for finance and a finance company offers a rate of 6.0 per cent. But the customer requests 5.5 per cent before they will consider the loan. Then the dealer can come down to 5.5 per cent. However, that variability within the 200 point window would also result in a reduction in the commission income generated for the dealer.

The new rules are strict when it comes to business managers in dealerships attempting to negotiate a higher interest rate in order to generate a higher commission. The business manager simply cannot urge the financier to set a higher rate than was originally offered.

Interest rate setting now firmly the role of the financier

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

2 Clearing the mists of confusion

4 What’s changing?

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

The financier directly manages the loan risk and sets the interest rate based on the information on the consumer gathered by the dealer’s business manager (as well as its own sources).

Accurate risk-based pricing will change the competitiveness of dealer finance very much in

favour of the customers – improving competitiveness for dealers.

This change requires the providers of the finance to set customer rate and commission, then provide the introducer of the finance some competitive movement to move that rate downward if required, in order to close the deal.

Risk-based pricing is the key to volume sales

In the past the customers with good risk tended to subsidise the customers with poor risk. This was especially the case with financiers which had very few parameters to draw on when setting price other than perhaps if it was a new or used car and maybe a couple of other factors.

That has tended to make dealer finance generally more attractive to high credit risk customers and less attractive to low credit risk customers.

So, a positive customer experience and obvious convenience, a move to risk-based pricing should change the competitiveness of car finance in favour of the dealers.

It is important to realise that the financier or lender can still make a call to charge borrowers interest rates higher than the current base rates in order to generate higher margin on the loan for the financier as a margin for higher risk and profit.

In turn, a higher rate should still provide an opportunity for dealers to continue to earn significant commission revenues if they can provide a very positive customer experience to increase their finance penetration

and optimise their business operations.

But this will involve a balance between the combined effects of:

• Return for the financier;• Built-in risk margin to

cover for customer and transaction risks; and

• The level of commission in the commission plan between financier and dealer.

Further to these inputs, market forces also come into play as the interest rates offered by other financiers

and lenders competing to win the buyer’s business in the new environment will be more readily available and will raise competitiveness.

This is significant because pencils are going to have to be sharper in setting loan rates if dealers are going to win the increased market share on car loans.

On the flip side, there is no reason in the new rules to stop a financier setting a very high interest rate with equally generous commission for the dealer, but it is very doubtful

those loans will ever be sold at the high rates as they would be very uncompetitive.

Also, with only 200 points to negotiate the price down, the dealer would miss a huge proportion of their sales opportunities.

Dealers selling at less than the rate offered by the financier within the 200 point window might also find they are squeezed on commissions because the lower rate will come with a lower level of commission. It will be important for dealers to monitor and manage this.

The role of risk-setting in determining interest rates

How commissions will work under the new rules

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

2 Clearing the mists of confusion

4 What’s changing?

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

n ONE factor of considerable importance that is not generally understood is that if a dealer negotiates to the bottom of the 200 point window and yet, for some reason, they need to discount further, they may be able to. But if they do, the regulation will require that only a commission equal to the level that would be paid at the bottom of the 200 basis point window can be paid.

Here is how that might look based on commission rates used in ASIC examples:

• Commission at 12.95 per cent = $1200

• Commission at 10.95 per cent = $800

If the window is between 12.95 per cent ($1200 commission) and 10.95 per cent ($800 commission) and the dealer drops the rate another 100 basis points below the window, to say 9.95 per cent, the financier must pay the commission that applies at 10.95 per cent ($800).

This might seem like good news for dealers but the effect is that it leaves the financier getting lower interest income on the deal. And if the dealer wants the

rate to go down even further, the commission will always remain at $800.

So the financier gets less income and, in these circumstances, the financier will most likely reject the deal, leaving the dealer without a loan sale.

The constraint is the amount payable in commission has to be the same amount as the rate at the bottom of the 200 basis point window.

This is the device put together by ASIC to prevent financiers from providing dealers with large initial or

“starting point” interest rates.In theory, under the new

ASIC regime a financier could inform dealers that its rates are always going to start at 13 per cent and go down to 11 per cent and that it will pay commission of $2500, or $1500 at the bottom of the 200 points range. While the dealer would be attracted to this, it would make the dealership uncompetitive in the marketplace.

In this way, ASIC has used competition to stop the rate and commission window being pushed to a high level.

Minimum commission rule

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

2 Clearing the mists of confusion

4 What’s changing?

5 Changes to dealer revenues

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

n MANY dealers are saying that, when the ASIC rules come into effect, their financiers will come to the party and make sure that overall dealer finance revenues are protected.

But in the new environment, the fact is dealers will be required to increase their loan sales penetration rates to maintain the total commission revenues they achieve at present.

The negative effect on revenues for those dealers that consistently strive for high interest rates, and set generous bonuses for business managers who achieve their targets, will be very significant.

So, under the new rules,

a dealer which in future is signing up loans at between six per cent and nine per cent when they may have previously averaged 12 to 15 per cent will require a huge focus on increasing penetration to cover

for the lost revenue.However, there is a hidden

danger in the fallout from the new rules that many dealers don’t recognise.

Even a dealer who generally operated down at the competitive end and provided rates of, for example, six per cent and eight per cent;

sometimes they would have a customer come in who has ‘fallen in love with the car and want it now’ and they may sign them up at 10 per cent or 11 per cent.

The revenue they would

generate from that specific deal is very significant compared to their normal deals and if they had one or two of those deals a month then, those one or two deals would make up a reasonable proportion of their total commission revenue.

But those deals are not going to exist anymore under

these new rules.This is one of the areas

where dealers will see a significant impact and some may be caught unawares.

A dealer may look at their average margin and think

they are fine because the average is based on a large number of relatively low rate deals. But those

deals are only generating a small amount of income while the small number of higher-rate deals are generating significant income. The loss of those higher-rate deals will have a significant impact.

ASIC has said that it wants the changes to eliminate the outlier interest rates.

Changes to dealer revenues – is there an upside?

“There is a hidden danger in the fallout from the new rules that many dealers don’t recognise”

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

2 Clearing the mists of confusion

4 What’s changing?

5 Changes to dealer revenues

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

Scenarios of possible effects on dealer revenues

A generic business model can be used to show the level of increased penetration in car loan sales that various dealers will have to achieve to recover the potential lost commission revenue from the new rules compared with the present rules.

The data shows that if they do nothing, dealers are likely to suffer losses in commission revenue of between 20 and 45 per cent

under the new rules.The data suggests that

to recover their position, dealers will need to sell more loans generating lower commission revenue per loan, but will generate increased overall revenue, because they are increasing the total number of loan deals they are closing.

The big question is: what increase in finance penetration will be needed in a dealership

to generate the same total finance income under the new rules that is being achieved today under the old rules?

Additionally, remembering that any increase in the origination fee is not allowed to cover the reduced commission, where customer service and process improvements have added additional cost, it may be possible for a dealer to increase their DOF. Under this scenario, it may be possible to

prove to the finance company that costs to support arranging the finance are higher than the present origination fee suggests.

The inference from that would be that the $700 is less than it should be because the dealer is not really covering their costs properly at the moment.

Next page: How will a dealer selling $1 million in loans a

month be affected?

DEALER A

Sales of new and used cars per month = 100

Low finance penetration = about 20 per cent

Margins are lower = 10 per cent of deals are greater than two per cent flex

Dealer origination fee (DOF) penetration

= 90 per cent

DOF charged = $600

Likely impact of ASIC changes on commission revenue = minus 20 per cent

Finance penetration required to achieve status quo - about 24 per cent

Increase in finance penetration required = only four percentage points

DEALER B

Sales of new and used cars per month = 100

Medium finance penetration = about 30 per cent

Margins are moderate = 25 per cent of deals are greater than two per cent flex

Dealer origination fee (DOF) penetration = 90 per cent

DOF charged = $650

Likely impact of ASIC changes on commission revenue = minus 30 per cent

Finance penetration required to achieve status quo - about 39 per cent

Increase in finance penetration required = only nine percentage points

DEALER C

Sales of new and used cars per month = 100

Finance penetration is higher = about 40 per cent

Very strong margins = 50 per cent of deals are greater than two per cent flex

Dealer origination fee (DOF) penetration = 90 per cent

DOF charged = $700

Likely impact of ASIC changes on commission revenue = minus 40 per cent

Finance penetration required to achieve status quo - about 59 per cent

Increase in finance penetration required = 19 percentage points

Here are three notional dealers:

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

2 Clearing the mists of confusion

4 What’s changing?

5 Changes to dealer revenues

ASIC CHANGES: CAR FINANCE SPECIAL REPORT Interest rate* Commission* Current Scenario 1 - Negative Scenario 2 - Breakeven Scenario 3 - Growth

Loans sold Income Loans sold Income Loans sold Income Loans sold Income6.24 200 5 $1,000 5 $1,000 15 $3,000 25 $5,0008.24 600 15 $9,000 15 $9,000 20 $12,000 25 $15,000

10.95 1550 6 $9,300 6 $9,300 6 $9,300 6 $9,30012.99 2500 2 $5,000 0 $0 0 $0 0 $013.04 3200 2 $6,400 0 $0 0 $0 0 $0

Total Commissions $30,700 $19,300 $24,300 $29,300DOF** $700 30 $18,900 26 $16,380 41 $25,830 56 $35,280

Total income $49,600 $35,680 $50,130 $64,580Variation to current -$13,920 $530 $14,980

* Interest rates and commissions are based on data used by ASIC in its report. Commissions are rounded.** Dealer Origination Fees @ 90 per cent penetration

GoAutoNews Premium, based on commissions outlined by ASIC, has calculated the possible effects the new rules might have on a dealer selling 100 new and used cars a month with a 30 per

cent loans penetration – about a million dollars in loans.

Scenario: How will a dealer selling $1 million in loans a month be affected?

CURRENT

The dealer in the table is selling and delivering 100 new and used cars a month.

While most of the sales are at the lower end of interest rate range, the dealer has one third of the 30 loans priced at higher rates and generating two-thirds of the commission revenue. This scenario illustrates the “hidden issue” for dealers under the new rules.

SCENARIO 1 - NEGATIVE

It is anticipated that many dealers will see a significant drop in loans sales under the news rules unless they are well prepared to adjust their finance business sales model.

In this example, the dealer has only lost six loan sales but these are the ones generating the majority of the revenue. The total origination fees revenue has suffered as well due to fewer loans written.

In all, the dealer is more than $13,000 off the current pace in that month.

SCENARIO 2 - BREAKEVEN

Dealer and financier have increased focus on offering customers improved product and service, including lower interest rates in order to generate more deals.

The position is recovered by selling 10 more low-priced loans and five more lower-medium priced loans – lifting penetration from 30 per cent to 41 per cent.

Note the multiplier effect in restoring revenue. This is why it is so important for dealers to refocus on loan sales to more customers and less on margins.

SCENARIO 3 - GROWTH

This illustrates a dealer that is really working hard to provide what customers want in terms of product, service and price, and get low-interest loans in front of car buyers while still achieving a handful of loans with comparatively stronger commissions.

At 56 per cent penetration, which should be achievable with a high volume, low margin focus in the dealership, the business is nearly $15,000 a month ahead of current.

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

2 Clearing the mists of confusion

4 What’s changing?

5 Changes to dealer revenues

6 New treatment for the origination fee

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

New treatment for the origination fee

n A MAJOR and significant change involves the origination fee.

It must not be forgotten that the dealers are a sales channel for the financiers and are entitled to a return on the investment they make in the sales activities, facilities, personnel, IT systems and training that they undertake on behalf of the finance companies.

But ASIC has said it does not wish to see dealers use fees to make good for any loss of revenue suffered by

any of the changes in the flex commissions. The origination fee falls into this area.

However, there may be some scope to adjust (up or

down) origination fees going forward if they do not at present reflect the real cost and value of dealers operating their finance sales activities.

Historically the origination

fee was set many years ago by one of the financiers to lure dealers away from competitor finance companies and, once introduced, other financiers

followed. The origination fee today

is effectively a pre-delivery charge by the dealer to cover the cost of setting up loans and is included in the amount

financed by the car buyer.ASIC identified the

origination fee to be around $700 to $900 but it ranges down from that – to zero in some circumstances.

ASIC has said that the financier must be responsible for setting the maximum origination fee for each dealer.

ASIC has stipulated that the basis for the origination fee must be recorded by the financier and held for seven years.

Continued next page

“ASIC has said it does not wish to see dealers increase origination fees to make good for any loss of revenue

suffered by any of the changes in the flex commissions”

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

2 Clearing the mists of confusion

4 What’s changing?

5 Changes to dealer revenues

6 New treatment for the origination fee

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

n DEALERS will need to focus closely on the accuracy of their origination fees under the new rules because they are important to their overall finance revenues and play a significant part in covering the investment in and overheads of running the finance sales operations.

So dealers will have to take a hard look at the true value and costs of those operations because making sure those are accurate and accounted for becomes crucial under the new rules.

The origination fee is the sleeper; not because it will go up by a huge amount (because it cannot) but if dealers double their penetration they double their origination fee revenue.

This seriously adds

up as dealers grow their penetration.

So instead of getting 30 origination fees per month at, say, $600 (totaling $18,000) a dealer might get 40 (totaling $24,000).

This is one of the areas that dealers could expect some interaction with and assistance from their financiers. If there is a justification, a dealer may ask the financier to increase the DOF, particularly where their costs can be shown to be higher.

But the finance companies will have to be careful with this because they are the ones who are responsible for following the rules, documenting what they have done and holding it for seven years.

Origination fee is a sleeper

Continued from previous page

The commission recognises that, given that this is a fee for the dealer setting up a loan, one dealer could have a significantly different business, provide significantly different services and value to customers and, as a result, have significantly different costs than another dealer.

For example, their business managers might talk to a smaller number of customers (higher cost per loan) or they do a lot more advertising than other dealerships. One dealer could readily provide different services or value and have costs that are higher or lower, than another. This

means that the origination fee should be appropriate to each given dealer.

Documentation of the fee, and the basis on which it was determined, has to be retained by the lender for seven years so that ASIC can check for trends.

ASIC will be on the alert for any financiers setting origination fees that are out of kilter with the provided service value and market position.

On its website the regulator talks about monitoring the industry and, if its officers see they are not achieving the goals they require, then they will introduce further changes.

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

8 The role of dealers in making the transition

9 The changing role of business managers

2 Clearing the mists of confusion

4 What’s changing?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

n THE financiers will be playing an important role in supporting the dealers to improve processes and procedures in their businesses as well as supporting dealers to enhance the end customer experience.

Mr Bryant said that financiers and dealers will need to work together to make it simpler, more efficient and more effective to write finance within the dealership.

“It will definitely be part of our role to assist with the improvement of processes;

to make it more digital and to drive innovation in that space,” he said.

“At the moment there is a lot of retyping involved for the business manager, for example. There is quite a lot of paperwork and we need to improve that side of it for the benefit of the end customer, the dealer and the financier.

“There is also a lot of applicable digital innovation that can improve how we interact with customers as part of that process.”

The biggest opportunity is

in improving the customer’s experience.

“The customer’s experience should change to bring finance forward to become embedded as part of the purchase process of the vehicle,” Mr Bryant said.

“As the interest rate becomes much more transparent the customer will be better informed and more confident in the dealership. This should also make the whole process more attractive to them.

“It is important for the processes to become more efficient and effective, but also

to offer improved products, such as dealership-only products for example. These would be specific to dealers and not available elsewhere.”

Existing examples of these include guaranteed future value under Toyota Access, Mercedes Agility or BMW Full Circle. These are only available from a dealer.

Mr Bryant said that as part of the process of adjusting to the new rules, Macquarie Leasing was developing dealer-only products.

Continued next page

The role of financiers

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

8 The role of dealers in making the transition

9 The changing role of business managers

2 Clearing the mists of confusion

4 What’s changing?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

Continued from previous page

“We are looking into products that associate an ownership experience with a loan like a fully-maintained or partially-maintained style of loan. Those are the sorts of things that are being investigated so we can continue to meet end-customer needs through dealers.

“However dealers will also need to participate with some adjustments. For example, at the moment they tend to shy away from putting rates on their websites, but this is actually

what customers will want.“Those dealers who

embrace these opportunities, drive changes and make improvements, will be able to meet customer needs and

successfully achieve more loan relationships as a result.”

“For example, when a dealer advertises a car at $X a week it requires an interest rate to have been established on that

car, which is clearer and more transparent for the buyer and brings the loan discussion forward to when the buyer is considering the affordability of the vehicle.

“Customers are already investigating their finance options before going to the dealership and yet the current process confines the finance conversation to the

dealership only, and often to the end of the dealership sales process.

“Including more finance information earlier, through the website for example,

delivers a better customer experience that supports them in their research process.

“To support dealers we need to help them to make sure the processes

in their dealerships are efficient and effective to help manage costs in the business and ensure they can focus on delivering a great customer experience,” Mr Bryant said.

“Those dealers who embrace these opportunities, drive changes and make improvements, will be able to meet

customer needs and successfully achieve more loan relationships as a result”

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

9 The changing role of business managers

2 Clearing the mists of confusion

4 What’s changing?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

The role of dealers in making the transition

n MACQUARIE Leasing is currently working with dealers to develop strategies to manage the transition to the new ASIC rules and the primary message is to start preparing now.

The implementation date is November 1, 2018.

ASIC will introduce changes that will affect the industry in the same way across all providers and suppliers at the same time.

But that does not mean everyone can keep running the old system until the end of October 2018.

Mr Bryant told GoAutoNews Premium: “Due to the scale of the changes and scale of the dealership network, financiers will need to implement changes over a period of time. The focus is on the start

date of the regulation but, in reality, the changes will start a lot earlier.”

Mr Bryant said: “Over the next 10 months dealers we work with will be invited to be involved in various change programs.

“We want to take dealers through the steps that we believe are needed to help them to adjust and embrace the changes. Some might need to change their sales processes more than others, for example.

Macquarie Leasing has developed a modelling tool for its client dealers that uses all their data and helps them work through the likely outcome.

“So this helps dealers understand what it means for them,” Mr Bryant said

“The modelling shows that

for most dealers there is the probability of a dip in finance revenue as dealers adjust to the changes.

“To mitigate this, we can work with dealers using our modelling so they can look at their sales processes dynamically, measuring impacts of changes as they are implemented between now and November.”

Macquarie Leasing is working to step the dealers through the various processes and increase their levels of understanding to help them address questions like:

• What are my current sales processes?

• What might they look like in future?

• What will be the impact? • How can I pre-plan?

• What should I be changing – each month?

“Some dealers are telling us they plan to put interest rates on their websites as well as monthly repayments on vehicles. They are working on their quoting systems to ensure they quote the right price, right at the start.

“In these circumstances, the dealers will need to talk to their customers about affordability before they can even talk about cars.

“Potentially that actually leads to the customer buying a different car because their affordability may change once they work out the best loan structure for their needs.

“So there is definitely a lot of change but there is also plenty of opportunity.”

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

2 Clearing the mists of confusion

4 What’s changing?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

The changing role of business managers

n THE change is likely to see an end to some of the larger incomes of dealership business managers who have been generating significant revenues for dealerships.

But finance sales specialists will still be required in dealerships.

This refocusing of dealer finance sales procedures and emphasis on volume is expected to result in a very

substantial indirect saving to dealerships because, most likely, while business managers will still earn a good salary, the bonuses for business managers at the top end will be reduced.

Dealers are already reporting that packages for business managers are being changed and their remuneration being re-focused and reduced.

Some dealers have started

trialing sales systems where the staff selling the cars are also organising the finance with the buyer as part of the process.

While early signs are positive, it is still generally believed that there remains a need for someone who is a finance specialist who can assist finance buyers and be capable of negotiating with the buyer.

Of course the revenue

impact of that role is less than the revenue generated in the current model so it is expected that a different kind of person will be needed to handle finance sales.

In effect, the speed of sale is likely to increase and the reduced level of remuneration to business managers across the dealership may save the business many hundreds of thousands of dollars a year.

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1 Big car loan opportunity

3 Why did ASIC feel the need to act?

2 Clearing the mists of confusion

4 What’s changing?

5 Changes to dealer revenues

6 New treatment for the origination fee

7 The role of financiers

8 The role of dealers in making the transition

9 The changing role of business managers

ASIC CHANGES: CAR FINANCE SPECIAL REPORT

Finance companies effectively to ‘police’ dealer behaviour

Wording is very comprehensive

n IT IS not generally realised that this legislation – which includes significant fines and even penal provisions for transgressors – is actually a control on credit licence holders – the financiers – not the dealers themselves.

Dealers generally operate under the point-of-sale exemption in the National Consumer Credit Protection regulations.

So the prohibitions within the new rules apply to the financiers and requires them to put in place processes and procedures to ensure compliance with the

legislation. For example: a business

manager would not be allowed under these new rules to influence a financier (to set a higher interest rate than the one offered, for example) but under the rules the penalty would be on the finance company for allowing that to happen and not on the business manager for attempting to do it.

The penalties work on the basis of a number of penalty points which, added up, convert to a dollar amount which is quite significant; and can include criminal penalties.

With the onus on the financiers to make sure the new legislation is adhered to, it will become increasingly important for financiers to ensure business managers in the dealerships they work with are well educated on the rules and are acting in the right way.

This is likely to mean stricter practices come into effect like formal accreditation processes (with removal of accreditation for non-compliance), thorough training on the dos and don’ts and ongoing close monitoring of the activity.

ASIC has gone to great lengths to ensure the regulation is effective and prevents dealers finding loopholes in the legislation.

It has been through a lot of iterations to make it holistic and ASIC has received a lot of feedback.

For example, they do not just use the word commission, they use the word benefit. And they define benefit as monetary or non-monetary.