A year after the Consumer Finance Protection Bureau issued guidelines on discretionary loan pricing by automobile dealers, lenders who buy loans from them are still wrestling with the best ways to comply with that edict.
The main difficulty: Lenders are being required to act as a “policeman” over the actions of their dealer clients—who are not regulated by the CFPB—and risk alienating those relationships even if the dealers haven’t violated any fair lending laws.
In March 2013, the CFPB released a bulletin telling lenders who offer auto loans through dealerships that they are responsible for unlawful, discriminatory pricing that may result from dealer “discretion.” Indirect auto lenders often allow dealers the leeway to charge consumers a higher interest rate than the rate the lender gave the dealer, called the “dealer markup.” According to CFPB research, markup practices may lead to African Americans and Hispanics being charged higher markups than white consumers .
The bureau is taking the matter very seriously. Last December, the CFPB and the U.S. Department of Justice ordered Ally Financial Inc., the largest auto lender in the country, to pay $80 million in damages and $18 million in penalties for alleged violations of fair lending laws, the largest auto loan discrimination settlement in history. The agencies alleged that 235,000 black, Hispanic, and Asian borrowers paid higher interest rates for auto loans because of what they said were Ally’s discriminatory pricing system.
In its March 2013 bulletin, the CFPB recommended that auto lenders take steps to ensure that they are operating in compliance with fair lending laws as applied to dealer pricing, including imposing controls on dealer markups, monitoring their markup policies, and eliminating dealer discretion in pricing and replacing it with flat fees.
However, putting those recommendations into action is not as easy as the CFPB makes it sound. Indeed, lenders—and the attorneys who advise them—still aren’t sure what’s the best method of compliance while remaining on good terms with their dealers.
“It’s a little difficult to give precise guidance on exactly what dealerships should do,” says James M. Golden, a litigation and compliance attorney at the Dykema law firm in Los Angeles. “I think lenders are still having a tough time figuring out what to do. I don’t know that a lot of final decisions have been made.”
On the other hand, “If you sit on your hands and do nothing, I think you’re going to be worse off. Clients need to have a game plan,” he says.
Leonard N. Chanin, a partner at Morrison & Foerster in Washington, DC, agrees.
“A number of lenders are uncertain how to proceed, simply because it’s not clear what the best or compliant approaches are in terms of following the guidance,” he says. “People are still trying to figure out what the best approach is…(including) where they can continue to purchase loans (and) do so in a way that minimizes or tries to eliminate fair lending risk.”
The easiest way to comply is to follow the CFPB’s recommendation of eliminating dealer discretionary pricing outright and replacing it with a flat-fee structure. However, Golden says that would make both dealers and lenders unhappy. “We are seeing a lot of hesitation in doing that,” he says.
“Indirect financing is a big profit maker for the automotive companies; it’s a bigger profit maker than selling the automobiles, in my understanding,” he says. “There’s going to be a lot of resistance to making these kinds of changes. On the other hand, $98 million (the Ally fine) is a pretty big number.”
“You could eliminate discretionary pricing or try to contain it by going to a flat percentage or flat dollar amount, but then dealers are going to go to lenders who pay more, and you’re not solving the problem,” notes Chanin.
Monitoring dealer pricing behavior is another option recommended by the CFPB. In its December 20, 2013, statement on the CFPB-DOJ consent order, Ally said it was “enhancing dealer monitoring and reducing the perceived disparity for the protected classes outlined in the order.”
But that approach also has problems.
Chanin notes that unlike mortgage lenders, who are required by federal law to ask for the borrower’s race or ethnic identity, auto lenders are prohibited from doing so. In its statement, Ally notes that its “long-time process for evaluating auto installment contracts from dealers does not include information on a consumer’s race or ethnicity.” As a result, he believes lenders will have to “guesstimate” each customer’s race and ethnic group using a variety of information, such as surname, address and the like.
“Once you pass that hurdle—which is no small hurdle—then becomes the difficult task of what to do with that information,” he says. The dealer would then have to determine a reason for any discrepancy in rates. Besides, he says, “monitoring is always after the fact, and in that sense it’s already too late.”
“There’s a risk in finance companies becoming too much of a policeman, because finance companies are not dealers,” Golden says. Monitoring dealer pricing “is kind of a double-edged sword. You don’t want to make the case against yourself. If you go out and analyze the data and discover that there’s a problem, then what are you going to do? Are you going to cut off relations with that dealer? Are you going to change your compensation mechanisms just for this dealer? But if you don’t do anything, the CFPB will be on you, and if you get sued the plaintiffs’ lawyers are going to make a field day out of it.”
Golden says he is not aware if any of his lender clients are doing a lot of that analysis right now.
For now, Chanin says, “lenders are likely to adopt different approaches to try to figure out exactly how best to deal with the fair lending issues, but also to stay in the market.”
“I do think clients want to do the right thing. But there’s going to be a lot of pushback if they’re told to end dealer markups, because they don’t think they’re doing anything wrong, and I’m not sure they’re doing anything wrong, either,” Golden says. “But the CFPB is a true believer in this disparate impact theory, and the Ally settlement shows they’re taking this very seriously.”