Flat-fee financing: FreedomRoad converts, will others follow?

Publish Date: 
Mar 16, 2014
By Holly J. Wagner

CHICAGO, Ill. - A run-in with regulators has prompted one bank to change its how it compensates dealers for consumer financing from variable rates to a flat-fee structure. If more lenders follow suit, it could change how dealers secure financing for their customers, perhaps putting current F&I practices in jeopardy, some say.

Regulatory pressure tied to community loans and discriminatory lending concerns are prompting banks, including FreedomRoad Financial to opt for the flat-fee structure.

As of March 10, a loan originated through FreedomRoad Financial is now paid on a flat percentage of the contract. Reno, Nev.-based FreedomRoad is the OEM preferred finance company for Husqvarna, KTM, MV Agusta, Triumph and Ural.

"Most of the dealerships we do business with have been very supportive," said Darin Campbell, president and CEO of FreedomRoad parent Evergreen Bank Group. "We started the flat fee-only program on Monday with no dropoff in applications during the first three days of business. We will obviously track this closely over the next few weeks and months."

But some dealers with profitable F&I businesses are crying foul. "This is an existential threat to our industry," said Bob Althoff, principal at A.D. Farrow Co., a three-dealership group in the Columbus, Ohio, area. "Our industry is threatened with extinction... The amount of money we make processing loans is a huge amount of our bottom line."

Read more dealer reactions HERE.

Evergreen's change to a flat fee structure was made in response to a low rating for Community Reinvestment Act (CRA) compliance from the Federal Deposit Insurance Corp. (FDIC). Evergreen disputed the FDIC's allegation that it had violated the Equal Credit Opportunity Act (ECOA) by offering variable pricing, but said it made the change to a flat free structure simply to eliminate the issue.

"If dealerships have no ability to mark up the rates, there is no need for the regulatory bodies to test for dealer markup differentials."

-- Darin Campbell, Evergreen Bank/Freedom Road Financial

As a result, "the bank recently opted to change its variable pricing model to a flat fee pricing model within its indirect dealer lending program, even though variable pricing is the standard in the industry, making the bank one of the first lenders across the country to eliminate discretionary pricing options previously made available to dealerships," Evergreen stated.

Campbell told Dealernews that "the alleged ECOA violation related to the 'disparate impact theory' -- by offering dealerships the ability to mark up our rates -- has been completely addressed with our new flat-fee-only program. If dealerships have no ability to mark up the rates, there is no need for the regulatory bodies to test for dealr markup differentials."

Evergreen is a community bank based in the Chicago area that bought FreedomRoad in 2007. FreedomRoad started as a small part of the bank's business; however, by 2012, it had accounted for 54 percent of Evergreen's total loan portfolio, according to the FDIC assessment. That was good for the bank's bottom line but it pushed the bank out of compliance with community lending requirements for the percentage of loans that must be made to low- and moderate-income borrowers and to borrowers in the bank's Chicago assessment area. The bank made only two loans within its geographic assessment area during 2010 and 2011, the agency noted. 

While drawing scrutiny over CRA compliance makes the Evergreen/FreedomRoad case unusual, regulations made by the Consumer Financial Protection Bureau (CFPB) under the Dodd-Frank Act may push more banks to make a similar switch. Auto industry indirect lender Ally Bank, formerly GMAC, in December agreed to a $98 million settlement -- without admitting to any discrimination.

"The CFPB and DOJ assert that pricing disparity has occurred for certain protected classes of consumers as a result of the auto dealer's ability to mark up Ally's rate at which it buys a retail installment contract.  The CFPB and DOJ also assert that Ally has responsibility for the conduct of its dealer customers and allege that Ally has not sufficiently monitored the pricing practices of its dealer customers," the bank said in a statement. "Ally does not engage in or condone violations of law or discriminatory practices, and based on the company's analysis of its business, it does not believe that there is measurable discrimination by auto dealers."

Nonetheless, Ally agreed to enhance dealer monitoring, reduce the perceived disparity for the protected classes outlined in the order, pay a civil money penalty of $18 million and contribute $80 million toward a settlement fund to be managed by an independent settlement administrator.

Evergreen Bank's Campbell said new regulations may make flat-fee pricing the industry standard, and soon. He said he expects "other lenders to follow suit, due to the overzealous regulatory environment and the substantial risk involved. We believe it's impossible to manage to a few basis points when grouping dealerships across the country and based on a system/test the regulatory bodies won't and/or can't explain."

Lender liability for dealer decisions. The CFPB a year ago issued guidance for indirect lending in the auto market, stating that an indirect auto lender's "markup and compensation policies may alone be sufficient to trigger liability under the ECOA if the lender regulatory participates in a credit decision and its policies result in discrimination."

Disparities triggering liability, CFPB stated, could arise either within a particular dealer's transactions or across different dealers in the lender's portfolio. "Thus, an indirect auto lender that permits dealer markup and compensates dealers on that basis may be liable for these policies and practices if they result in disparities on a prohibited basis," the agency stated.

In response, the National Association of Auto Dealers (NADA) issued a 22-page compliance guide advising auto dealers to document the reason for any markup when originating a loan. NADA suggests, among other possibilities, that dealers establish a preset amount of compensation but allow for downward adjustments to that amount in the event that one or more predetermined conditions exist.

NADA acknowledged that the heavy-handed approach may be the simplest, when it comes to compliance.

"The most obvious way to reduce the possibility of a finding of disparate impact discrimination is for individual dealers to establish a means of compensation in which the determination of the amount of finance income they earn does not vary on a customer-by-customer basis," the NADA advisory states. "Examples of such an approach include charging 1) a fixed number of basis points over the wholesale buy rate (i.e. the rate at which the finance source will purchase the credit contract from the dealer); 2) a fixed percentage of the amount financed; or 3) a fixed dollar amount.

"Of course," NADA adds, "a major drawback to customers [from] such a rigid pricing policy is that it deprives dealers of the ability to meet or beat the most competitive credit offer that the customer has received from another creditor, which in turn limits the customer's ability to reduce thea mount of that the customer pays for credit."