It’s unlikely to be news to dealership owners, but floorplan expenses – always a significant cost for any dealership – are on the rise. As floorplans are short-term loans used to purchase high-cost inventory, financing costs are already high, even under the best market circumstances. With rising interest rates and changing consumer trends, the auto retail industry is undergoing changes that could impact floorplan loans in the future. Dealers can overcome these challenges by reviewing their current floorplan strategies.
What Almost Happened Last Year
Late last year, an early version of the Senate Finance Committee’s tax reform bill (the “Tax Cuts and Job Act,” or H.R. 1) included a provision that would have reduced the existing 100 percent deduction of floorplan interest to just 30 percent of adjusted taxable income, essentially treating the floorplan as general business interest, and dealerships — which are often family businesses — the same as large corporations.
Fortunately, the National Automobile Dealers Association (NADA) stepped in to engage in some heavy lobbying for both the Senate and House drafts of the bill, and was successful in its efforts to effect change in the legislation. Later versions of the bill released in December restored the 100 percent deductibility of the floor plan, which was a big win for dealers.
Floorplan Loans Themselves Haven’t Changed Much
With the legislative hurdle cleared, there are other challenges ahead that may not be alleviated by Internet lending or new loan models the way some business-to-business and business-to-consumer lending has, according to Tom Kolski, senior vice president at Ally Financial Inc.
“Floorplan loans are probably one of the few products that have remain entrenched in the traditional foundations of what we’ve known forever,” Kolski told Dealer News Today. “On the retail side, there are banks, like Ally, and Internet startups that allow consumers to borrow money directly at 2:00 am from their living rooms. In the commercial space, for floorplan loans, there has not been much change in the past 50 years, and Internet lending hasn’t really impacted this space yet. It’s still considered to be a very traditional type of financing.”
Floorplan lending is currently provided by two different types of lenders: money center banks such as Ally and the captive lenders such as Ford Motor Credit Company or Toyota Financial Services. Ally – which until 2010 was General Motors Acceptance Corp. (GMAC) — has the widest breadth and depth of automotive products in the industry, according to Kolski, and in recent years has been helping dealerships expand with real estate and working capital loans. The company today has 18,000 dealership relationships in the U.S. covering nearly 4,000 floor plans.
“Since we’ve come out of the great recession, most of the OEMs have started requiring dealers to make facility enhancements and even add new buildings,” he said. “We introduced a product in 2014 called acquisition loans that are actually credit facilities to assist dealers in acquiring new stores and blue-sky acquisitions. In the last three years, we’ve assisted dealers with over $14 billion for new commercial floor plans as well as capital loans. Some captive lenders want to work with their OEM only. Other banks may have limits on what they’ll provide to a single lender. We thrive outside those limitations. We don’t have these types of requirements, and this allows us to support dealers with the financing they need, regardless of size or the brands they sell.”
While The Loans Don’t Change Much, the Market Will
While dealers have access to many options for financing, new challenges in the market – and changes in the way dealerships will sell in the future – should induce caution, particularly as dealership profitability peaked in 2015 and is on a slight descent. (NADA figures predict that 16.7 million new cars and light trucks will be sold in 2018, representing a small decline from 2017’s 17.1 million.)
“We have been in a robust period of growth, but things have started to come down slightly from 2015,” Kolski told Dealer News Today. “Until 2015, as dealers grew, they quickly added expenses such as more staff and inventory, but some dealers were caught off guard by the slowdown.”
With federal fund rate increases, the costs to finance floorplans have gone up, and some dealers have seen their inventories grow as well. Kolski noted that consumer tastes are shifting to trucks and SUVs, which is driving up inventory costs. Dealerships that normally carried 75-day supplies were seeing their inventories approach 100 days. These changes have put pressure on dealerships and escalated costs.
Fixed Rate or Floating Rate?
Changes coming to the auto sales market are also inducing dealership owners to reconsider the benefits of fixed-rate loans versus floating rate loans. The right choice isn’t always obvious to dealerships.
“Dealers need to be very strategic when they are deciding between fixed-rate or floating-rate loan offers,” Kolski told Dealer News Today. “It’s the dealer’s choice, but the Fed is certainly going to continue to raise rates, and if the Fed increases rates three or four times, the payments for a floating-rate loan could become more expensive. Regardless of the Fed’s actions, dealers need to carefully evaluate the financing option that is right for their business, which is why some are still choosing floating rates. Dealers are attracted to the floating rate loans because they usually have lower starting points, or they’re betting that interest rates won’t continue go up. In contrast, other dealerships are taking a more cautious approach and converting from floating rates to fixed rates to lock in their expenses.”
For some dealers, the prepayment penalties that typically come with fixed-rate options may be unworkable. If the dealer plans to pay off the loan early or flip it to someone else, the penalties could undermine benefits of a fixed-rate plan.
There’s No Internet Lending for Floorplans
Kolski re-emphasized that while Internet lending may have made borrowing more flexible for some business loans, it’s unlikely to make a big dent in floorplan borrowing in the near future due to complexity and scale.
“There are some tech solutions for underwriting transactions, but they still need people to that make things churn,” he said. “We have a very large commercial department with business development managers that just work on these transactions. Using the knowledge gained from years of supporting dealers across the country, we sit with clients to develop a proposal that is tailored to their needs.”
Evaluate the Requirements of the Loan
With the challenges facing the auto retail industry, dealerships need to be mindful when evaluating floorplan loan products, particularly with regard to lender stipulation and loan covenants that may be difficult to manage. It’s not uncommon to find loans that require dealerships to maintain a certain level of capital or move all their accounts to the loan bank, for example. Another important factor to check in advance is the fee structures that some lenders will introduce with loan advances. On first glance, loan offers might appear to have a low interest rate, but added fees can quickly offset the rate. Always ask the lender about these types of stipulations, cautioned Kolski.
“Make sure you understand all the covenants, requirements and stipulations before you sign,” he said. “Do your due diligence on the offers you received to see which is most workable, and choose products that is complimentary to the way you operate.”
Going forward, what’s really important for dealerships, according to Kolski, is thinking about the future of the industry and planning for it. With a good plan, a dealer can overcome most challenges.