Winter · 1998

1997 - Year in Review
Carleton's Online Loan Quoter now available!
From Our Research Dept... Do You Have Reservations about Dealer Reserve Calculations?

To meet the growing needs of our customers we have moved into a larger, custom-designed facility near the Michiana Regional Transportation Center. Our new complex provides an opportunity for expanded service and support to our customers across the nation, Canada, and Puerto Rico.

* 1997 - Year in Review *

A review of changes previously reported in of Interest!

Alabama -- The interest surcharge increased to 6% of the amount financed with a maximum of $120. August 1, 1997

New Prima Facie Credit Life and A&H rates were published. Single Life $1.23/$1000/mo and Joint Life 150% of single. 14 Day Retroactive A&H - $2.70/$100. October 1, 1997

The Banking Department issued an Interpretive Letter that states the amount of the surcharge is "insurable" up to $25.

California -- The dollar limit pertaining to the maximum charge exemption for motor vehicle sales transactions was increased to $2,500 from $1,650. January 1, 1998.

Connecticut -- Small loan maximum increased to $15,000. October 1, 1997.

Florida - The dollar limits in the Florida Consumer Finance Act were increased to the following: 30%/$2,000/24%/$3,000/18%. October 1, 1997.

Kansas - The alternate 18% in the credit sales maximum UCCC structure was removed effectively deregulating credit sales transactions as far as maximum charges. July 1, 1997.

Louisiana - New Prima Facie credit life rates. Single Life $.90/$100/yr. Joint Life $1.35/$100/yr. Further decrease to take place in 1999. January 1, 1998.

"Payday" loan law enacted (Act 41). August 15, 1997

Oklahoma -- Increase in UCCC dollar adjustments to 330% of the original amounts. July 1, 1997.

Attorney General opinion that "B" loans must be refinanced as "A" loans in regards to handling fees and acquisition charges.

Texas - Increase in dollar amount adjustments in the Texas Code to 450% of the original amounts. July 1,1997.

Home Equity Loans allowed. October 1, 1997.

Virginia -- New Prima Facie Credit Insurance Rates Published. Single Life $.6129/$1000/mo. Joint Life 165% of single. 14 Day Retroactive A&H 12 month rate - $2.41/$100.

Loan Quoting on the Internet Available on the Carleton Website!
Follow this link to check out our new online Web Quoter!

The Web Quoter for consumer lending is the first in a series of products Carleton will be offering for handling loan origination on the Internet. Future plans inlcude Web Quoting for Mortgage Lending as presently provided on our PC product. We are nearing completion of a project that quotes loans along with printing loan contracts and insurance certificates, all on the Web.

The Web Quoter contains a surprising amount of flexibility and quoting capability for an open access product. Like all Carleton products, the format, display, and computations can be customized to fit the specific needs of your financing operation.

Also, take time to find out about the following from Carleton and Financial Publishing Company:

PC Loan Origination Software
The Cost of Personal Borrowing
Consulting and "Black Box" Computing Solutions
College 'Scope Online Service

From Our Research Dept.....

Do You Have Reservations About Dealer Reserve Calculations?

Over the years a symbiotic relationship between financing institutions (banks, finance companies etc. hereby referred to generically as the "bank") and auto dealers has evolved where the auto dealer sells a car, which the buyer finances. The dealer then sells the loan to the bank freeing up the cash so the dealer can buy more cars.

The relationship is similar to the primary and secondary mortgage arena where a bank writes a mortgage then sells it to Fannie Mae or Freddie Mac. Fannie/Freddie buy the loan for face value.

There is a difference. In a mortgage loan the bank charges and keeps points. In an auto loan transaction, where there are no points, the bank buys the loan at a lower interest rate than the car buyer is paying. The point spread is paid to the dealer.

The interest rate paid by the car owner is sometimes called the "Sell" rate. The interest rate required by the bank is called the "Buy" or "Bank" rate.

Over the years, various schemes to disburse the spread have evolved. The subject of this analysis is the cash flows and yields of three such schemes, Present Value, True Yield, and Future Value. Bear in mind that Financial Publishing Company, and it's parent company Carleton, Inc. neither condemns nor condones any of these methods.

For the purposes of illustration we will use a simple loan transaction of:

Amount Financed	$10,000.00
Number of Payments	12
Interest Rate ("sell" rate)	10%
Bank Rate ("buy" rate)	8%

11 payments @	$879.16
1 payment @	$879.13

Before we illustrate the various methods that could be used to pay the point spread to the dealer we need to show the amortization of the car owner's loan as originally scheduled.

Original Transaction
10% annually (.0833333 periodic)
Original Principal $10,000.00

No.

Payment

Interest

Principal

Balance

1

$879.16

$83.33

$795.83

$9,204.17

2

$879.16

$76.70

$802.46

$8,401.71

3

$879.16

$70.01

$809.15

$7,592.56

4

$879.16

$63.27

$815.89

$6,776.67

5

$879.16

$56.47

$822.69

$5,953.98

6

$879.16

$49.62

$829.54

$5,124.44

7

$879.16

$42.70

$836.46

$4,287.98

8

$879.16

$35.73

$843.43

$3,444.55

9

$879.16

$28.70

$850.46

$2,594.09

10

$879.16

$21.62

$857.54

$1,736.55

11

$879.16

$14.47

$864.69

$871.86

12

$879.13

$ 7.27

$871.86

$0.00

Totals

$10,549.89

$549.89

$10,000

A.P.R. 9.999729%

Present Value Approach

A dealer reserve situation can be viewed as the bank purchasing a series of future cash flows, in this case the payments the car owner is scheduled to make.

Use of the present value scheme involves computing the amount an investor should pay, in this case the bank, to receive those payments and yield the buy rate. In our example, the buy rate is 8%, and as evidenced by the schedule below, the appropriate amount is $10,106.60 for the given payment stream.

Present Value Approach
8% annually (.0066666 periodic)
Original Principal $10,106.00

No.

Payment

Interest

Principal

Balance

1

$879.16

$67.38

$811.78

$9,294.82

2

$879.16

$61.97

$817.19

$8,477.63

3

$879.16

$56.52

$822.64

$7,654.99

4

$879.16

$51.03

$828.13

$6,826.86

5

$879.16

$45.51

$833.65

$5,993.21

6

$879.16

$39.95

$839.21

$5,154.00

7

$879.16

$34.36

$844.80

$4,309.20

8

$879.16

$28.73

$850.43

$3,458.77

9

$879.16

$23.06

$856.10

$2,602.67

10

$879.16

$17.35

$861.81

$1,740.86

11

$879.16

$11.61

$867.55

$873.31

12

$879.13

$5.82

$873.31

$0.00

Totals

$10,549.89

$443.29

$10,106.60

A.P.R. 8.000071%

The difference between the present value of the future cash flows discounted at the "buy" rate ($10,106.60) and the customer loan amount ($10,000.00) is the "dealer reserve". This amount, $106.60 is disbursed to the dealer immediately, and no further disbursements are made.

True Yield Approach

The True Yield approach can be explained quite simply: the car buyer pays 10% on the principal outstanding, the bank keeps 8% and the dealer gets 2%.

The following chart shows the outstanding balances from the schedule we developed to illustrate the original transaction. Each balance has been outstanding for a month. We then show 10% interest on that balance, 8% on that balance and, finally, 2% on that balance.

10% -- 8% -- 2%

No.

Balance

10% Interest

8% Bank

2% Dealer

1

$10,000.00

$83.33

$66.67

$16.66

2

$ 9,204.17

$76.70

$61.36

$15.34

3

$ 8,401.71

$70.01

$56.01

$14.00

4

$7,592.56

$63.27

$50.62

$12.65

5

$6,776.67

$56.47

$45.18

$11.29

6

$5,953.98

$49.62

$39.69

$9.93

7

$5,124.44

$42.70

$34.16

$8.45

8

$4,287.98

$35.73

$28.59

$7.14

9

$3,444.55

$28.70

$22.96

$5.74

10

$2,594.09

$21.62

$17.29

$4.33

11

$1,736.55

$14.47

$11.58

$2.89

12

$ 871.86

$7.27

$5.81

$1.46

Totals

$549.89

$440.01

$109.88

The amount of dealer reserve with this method would be the total of the 2% column or $109.88.

The Future Value Approach

Another popular method of determining and allocating dealer reserve amounts is to run and compare two transactions. One at the car buyer rate and one at the bank rate. The amount of the loan does not change. The total interest computed on the lower bank rate (hypothetical transaction) is subtracted from the total interest on the higher (actual transaction) car buyer rate.

In our example transaction, the consumer needs to make 11 payments of $879.16 and a final of 879.13 for a total of payments of $10,549.89. That value subtracted from the $10,000 principal leaves $549.89 in interest charges.

If the same $10,0000 principal is computed at an 8% annual interest rate, then 11 payments of $869.89 plus a final payment of $869.81 would amortize the loan amount. The total of payments would be $10,438.60. Subtracting the principal amount of $10,000 would leave $438.60 in interest charges.

Future Value Approach
8% annually
Original Principal $10,000
"Hypothetical" Transaction

No.

Payment

Interest

Principal

Balance

1

$869.89

$66.67

$803.22

$9,196.78

2

$869.89

$61.31

$808.58

$8,388.20

3

$869.89

$55.92

$813.97

$7,574.23

4

$869.89

$50.49

$819.40

$6,754.83

5

$869.89

$45.03

$824.86

$5,929.97

6

$869.89

$39.53

$830.36

$5,099.61

7

$869.89

$34.00

$835.89

$4,263.72

8

$869.89

$28.42

$841.47

$3,422.25

9

$869.89

$22.82

$847.07

$2,575.18

10

$869.89

$17.17

$852.72

$1,722.46

11

$869.89

$11.48

$858.41

$ 864.05

12

$869.81

$ 5.76

$864.05

$0.00

Totals

$10,436.40

$436.40

$10,000.00

A.P.R. 7.999845%

The difference in the interest charge at 10% ($549.89) and interest charges at 8% ($436.40) represents the dealer reserve of $113.49.

Summary of Dealer Reserve Values

Present Value	$106.60
True Yield	$109.88
Future Value	$113.49

As you can see, there are a number of ways to "skin the cat" when it comes to computing a dealer reserve value. Keep in mind that these represent a very basic financing transaction.

Which approach is best for your situation? That probably depends upon a number of variables such as the effect of early payoff by the consumer using any of these approaches and the timing of the payment of the dealer reserve amount.

This article has "set the table" and presented the basics. In our next issue, we will discuss some of the effects of early payoff and timing of payments to the dealer.

As always, we welcome your questions and comments about this, or any other topic, subject. Give us a ring at the Research Department at (574) 243-6047, or e-mail your comments and questions to us.

Winter · 1998

Contents

* 1997 - Year in Review *

Summary of Dealer Reserve Values