How Financial Regulation Reform Will Affect Car Dealerships

Includes: ABG, AN, GPI, KMX, PAG, SAH
by: Steve Hosaflook

Recently, the United States Senate has been in serious discussion about Financial Regulation Reform. Financial reform has passed the House (December 2009) and the Senate (May 2010), and now awaits the negotiation process between the two legislative bodies.

There are several topics that this legislation is attempting to address, including: derivatives, proprietary trading, the size of financial institutions, and new consumer protection initiatives. Any reform in these areas will have major impacts on a diverse group of companies and industries.

In this article, I will focus solely on the consumer protection aspect of financial regulation, and how it relates to the profitability of private and public automotive dealerships.

On Monday May 24th, the US Senate passed a non-binding vote encouraging the two parties involved in the negotiation process to exempt the loan operations of car dealerships (automotive financing) from oversight by the new consumer protection agency that will be formed by the financial regulation reform. Car dealers have successfully argued that they are only mediators between the banks and the customer.

While it may seem strange that the financing of a consumer’s second largest purchase wouldn’t be covered by consumer protection legislation, the current political clout of car dealerships can’t be ignored. Car dealerships are significant employers across every political district in this country, and the last three years have been extremely difficult for the dealerships that have remained open. Most dealerships are considered a “small business,” and politicians from both parties love to praise America’s small businesses every opportunity they are in front of the media.

It is still too early to determine what will come out of this negotiation process and if the lobbying efforts of car dealers have been successful. Several powerful organizations, including the White House and the Pentagon, are lobbying the negotiation efforts to include dealership’s financing operations under the consumer protection agency. The recent non-binding vote in the Senate was meant to persuade the negotiation committee against the wishes of the White House and the Pentagon.

If dealership financing is exempt from the new regulations, will it be impactful? It will absolutely make an impact on a dealership’s profitability. Having the ability to maximize profits in the financing process is extremely important to the profitability of any dealership. In other words, It will be a huge win for both private and public dealerships - CarMax (NYSE:KMX), AutoNation (NYSE:AN), Penske Automotive Group (NYSE:PAG), Sonic Automotive (NYSE:SAH), Genuine Parts Company (GP), Asbury Automotive Group (NYSE:ABG). It will be a big win for both the new and the used car industry.

Dealer groups have been extremely concerned about this legislation. According to the nonpartisan Center for Responsive Politics, car dealers have made over $3 million in campaign donations to national politicians this election cycle alone. At this moment, it appears their lobbying efforts have been successful. However, the negotiation process between the House and the Senate could swing in either direction. Further, trying to guess the outcome of any legislative negotiation process is nearly impossible to do. The process is compared to sausage making for a reason.

However, once financial regulation is finalized, analysts will quickly try to determine which industries and companies are winners and which are losers. With items like derivatives, the winners and losers will be a more nuanced subject, but this piece of the financial regulation is very clear. If automotive financing through an automobile dealership is exempt from the consumer protection guidelines, then it is a big win for private and public car dealerships. If automotive financing does fall under the consumer protection initiative, it will be a significant loss for both private and public dealerships. This will be a binary outcome and investors and traders should proceed accordingly.

Disclosure: Author long KMX through call options