Lenders Are ‘In Limbo’ Amid Potential Changes to CFPB Fair Lending Policies

The battle over how the Consumer Financial Protection Bureau polices discrimination cases has long been one of the most contentious wars waged between the auto finance industry and its regulators.

This battle had led to multi-million-dollar consent orders, has forced or persuaded several lenders to cap their dealer compensation rates, and has prompted at least two lenders to pursue flat-rate policies that resulted in reduced volume. Now, new leadership at the CFPB seems to be conceding that war, and lenders will have new incentives to raise dealer compensation rates and forego flat-rate policies, lawyers told AFN.

In February, the CFPB reorganized the Office of Fair Lending and Equal Opportunity — the division most directly responsible for enforcing cases of discrimination — under the Director’s Office of Equal Opportunity and Fairness, effectively stripping its powers.

“The fact is, it never made sense to have two separate and duplicative supervision and enforcement functions within the same agency — one for all cases except fair lending, and the other only for fair lending cases,” John Czwartacki, the CFPB’s senior advisor to the acting director, told AFN. “By announcing our intent to combine these efforts under one roof, we gain efficiency and consistency without sacrificing effectiveness.”

Technically, the fair lending office was not moved under the same roof as the more general enforcement office. Rather, it’s housed within the Director’s Office of Equal Opportunity and Fairness, which deals with the bureau’s own cases of discriminatory hiring. While this is largely a symbolic move given that Acting Director Mick Mulvaney was unlikely to approve enforcement recommendations from the fair lending office anyway, it sends a strong signal to the industry, Michael Benoit, partner at Hudson Cook LLP, told AFN.

“[The CFPB has] taken the people who have a background and a history in fair lending enforcement out of the mix,” Benoit said. “It has really neutered their ability to make any fair lending claims going forward because, unless it’s something that’s grossly obvious or blatant, they don’t have the bandwidth now to bring those claims.”

The reorganization of the office stems from a fundamental disagreement between career CFPB staffers and the new leadership over the definition of fair lending, David Gemperle, attorney in the auto finance group at Nisen & Elliott, told AFN. Under former CFPB Director Richard Cordray, the Office of Fair Lending actively pursued cases of disparate impact, a term that has come to be well known across the industry.

Disparate impact describes cases in which a lender’s policies are not intentionally discriminatory, but nonetheless have an adverse effect on minorities and protected classes. Cordray and Patrice Ficklin, head of the now defanged Office of Fair Lending and Equal Opportunity, pursued litigation against lenders whose policies led certain minorities to be charged higher interest rates than their white counterparts of equal creditworthiness. Although lenders do not see information on race or ethnicity when approving loan applications, dealers do.

The CFPB argued that the financial institutions needed to hire statisticians to track disparate impact and lower caps for how much dealers can increase loan interest rates above what the lender approved — a practice known as dealer markup.

The new leadership at the CFPB seems to disagree with this legal theory.

To illustrate their contempt for this concept, one of Mulvaney’s first hires was Brian Johnson, who was named a senior advisor, as well as Kirsten Sutton Mork as chief of staff. Both come from the House Financial Services Committee where they were critics of the CFPB under Chairman Jeb Hensarling (R-TX). During their tenure, the committee issued three successive auto finance reports enumerating the various problems it saw in the CFPB’s disparate impact theory, poking holes in the statistical methodology promoted by the bureau, and questioning whether the CFPB knowingly premised litigation on suspect legal theory.

“The CFPB employs a ‘disparate impact’ theory of discrimination when enforcing the Equal Credit and Opportunity Act (ECOA), despite the lack of a valid legal or statutory basis for doing so,” the committee staff wrote in a January 2017 report. “One searches the text of ECOA in vain for any language giving rise to a disparate impact theory of liability.”

A year later, Sutton Mork and Johnson are now at the CFPB helping to write a new five-year strategic plan released last month. The plan envisions a CFPB that takes a more literal and quantifiable approach to the laws.

“We have committed to fulfill the bureau’s statutory responsibilities, but go no further,” Mulvaney wrote in the preface to the report. “Pushing the envelope in pursuit of other objectives ignores the will of the American people, as established in law by their representatives in Congress and the White House.”

The reorganization of the fair lending office may be somewhat symbolic, but every message the CFPB is sending the industry indicates fair lending enforcement will not be a priority, said Chris Willis, practice leader of Ballard Spahr’s Consumer Financial Services Litigation Group.

“Highly aggressive legal theories relating to fair lending are not going to be something that the agency pursues while Acting Director Mick Mulvaney is leading it,” Willis said.

Lenders Take Notice

The intent of Cordray’s CFPB was to use consent orders against lenders as a measure of what others in the industry should do. Perhaps nowhere was this more effective than in the use of dealer markup.

Consent orders began with Ally Financial Inc. in 2013 with an $80 million fine over claims of a disparate impact on the interest rates minority borrowers were being charged. During the period of analysis, the CFPB found that Ally charged African American, Hispanic, and Asian/Pacific Islander borrowers 29, 20, and 22 basis points more, respectively, than their white counterparts of equal creditworthiness, according to the consent order. Ally declined to comment for this story.

Ally had to make a number of compliance changes and pay remediation costs to affected consumers. However, the lender did not have to lower its cap on dealer markup. Lenders subject to future consent orders were not so lucky.

Later, Fifth Third Bank, Toyota Financial Services, and American Honda Finance Corp. agreed to consent orders for similar infractions of disparate impact, but as part of their agreements had to cap dealer markup at 100 to 125 basis points depending on loan term. The industry standard has been 200 to 250 basis points ever since an early 2000s court case out of Tennessee prompted change in the industry. The consent orders were meant to encourage other lenders to abide by the same 100- to 125-basis-point cap, but with the CFPB pulling back on its fair lending enforcement, lenders will no longer feel pressured to lower the threshold, and those that have may look to raise it again.

“I don’t expect folks will stick to [the CFPB’s standard],” Benoit said. “As long as there are finance sources out there willing to offer 200 to 250 basis points, the industry is naturally going to revert back to that 200- to 250-basis-point standard.”

Per the terms of the consent orders, Fifth Third, Toyota, and Honda don’t have the option to raise those rates until later this year, 2019, and 2020, respectively.

“We continue to focus on compliance, regardless of organizational changes at the CFPB,” a Toyota Financial Services spokesman told AFN. “We revise our compliance policies when changes to laws and regulations require revisions to our policies.” Fifth Third declined to comment, while Honda did not respond to a request for comment.

Smaller lenders, in particular, were not in the CFPB’s sights to begin with and now have even less incentive to make these compliance changes, Nisen & Elliott’s Gemperle said.

“It’s unlikely [smaller lenders] will do anything now as far as paying statisticians and figuring out if there has been some sort of disparate impact,” he said. “Smaller companies have a harder sell now in their compliance department — if they even have one — to [convince their] board that they need to [monitor disparate impact] because the Cordray CFPB expected it. It’s hard to get resources for that.”

However, Gemperle expects larger companies to maintain a status quo on their compliance management systems, despite the CFPB’s shifting focus on enforcement.

“If you’ve implemented policies — or even your overall compliance management — to meet what [former leadership at] the CFPB wants, don’t dismantle that and don’t stop doing your disparate impact testing if you’ve got it in place,” he said. “If the pendulum swings back, you could have someone looking back in five years saying, ‘You should have kept doing what the consent orders were telling other companies to do.’”

One company that has made a change amid all this flux in CFPB priorities is BB&T Dealer Financial Services. The bank is ending its flat-rate dealer compensation model this month and moving to a “traditional” program, a spokesman told AFN.

“While we had some successes with the flat-fee program announced in 2015, BB&T also experienced an overall reduction in volume,” Brian Davis, the bank’s director of corporate communications, told AFN. “So to provide our dealer clients with more options and better flexibility, we will introduce a more traditional auto pricing program in mid-March.”

BB&T’s switch to a flat-rate system in 2015 came amid the CFPB’s mounting fair lending consent orders against auto finance companies and was the bank’s attempt to get ahead of possible enforcement actions.

“The fact that BB&T has gone back to a dealer-reserve model instead of a flat-fee — that’s telling,” Hudson Cook’s Benoit said. “[Flat rate] is not popular with dealers.”

Flat-rate dealer compensation, in part, contributed to BB&T’s drop in total auto outstandings to $13.4 billion in the fourth quarter 2017, compared with $15.1 billion in full-year 2015, according to Big Wheels Auto Finance 2017 and earnings reports.

“The CFPB came in with an iron club and made us change the way we priced our product [in] our indirect auto purchasing [program] through auto dealerships, and that caused substantial runoff in that business,” BB&T Chief Executive Kelly King told investors during a fourth-quarter earnings call in January. [Moving back to a traditional dealer compensation model] will increase that volume into the auto portfolio and the spreads will remain good.”

Despite these changes from BB&T, it is unlikely most lenders will adapt their programs based solely on the tone of the CFPB right now, Ballard Spahr’s Willis said.

“The industry feels like it’s in a bit of limbo right now,” he said. “We have an acting director who is saying, in general, ‘We’re not going to push the envelope,’ but no specific statement has been made about the dealer finance charge cases, that legal theory, or the bulletin. I’m waiting for some statement from the bureau about that issue.”

Even if an official statement is made in the future, there’s no guarantee lenders will expound resources to switch back to a system they had prior to Cordray’s CFPB.

“Even if the CFPB doesn’t push these theories that were pushed at the tail end of the Barack Obama administration, it doesn’t mean those same theories won’t come back in five years,” Gemperle said. “Patrice Ficklin could be the director in that time if there is a change in the election and the subsequent appointment of the director.”