CFPB lets lenders decide the fate of auto dealer rate mark ups but outlines its expectations

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1 CFPB lets lenders decide the fate of auto dealer rate mark ups but outlines its expectations April 2013 A joint point of view by PwC s Financial Services Regulatory Practice and Consumer Finance Group

2 CFPB ends the suspense On Thursday March 21st, the CFPB ended the suspense for many banks and captives that lend into the consumer auto finance space when it issued CFPB Bulletin This Bulletin outlines the Bureau s intent to hold indirect auto lenders responsible for compliance with fair lending requirements of the Equal Credit Opportunity Act related to dealer interest rate mark ups, participation and reserves. Going forward, lenders that elect to offer their dealers programs that allow for buy rates to be marked up to the consumer will have to implement fair lending controls and monitor the dealers behavior for potential disparate practices. The CFPB has implemented these requirements due to the significant risk that they will result in pricing disparities on the basis of race, national origin and potentially other prohibited bases. 1 The Bulletin was released on the heels of a recent statement made by CFPB Director Richard Cordray that auto lending is within our jurisdiction and we are examining institutions around auto lending just as we are looking at them on mortgage, credit cards and student loans. 2 With this bulletin the CFPB has made it clear that they have supervisory authority over banks, non-banks and auto lenders to oversee how their dealer partners mark up loans and whether they discriminate against certain borrowers. The Equal Credit Opportunity Act that is the focus of the Bureau s Bulletin, commonly referred as the ECOA or Reg. B, makes it illegal for a creditor to discriminate in any aspect of a credit transaction because of race, color, religion, national origin, sex, marital, status, age (provided the applicant is of legal age to contract), receipt of income from any public assistance program, or the exercise, in good faith, of a right under the Consumer Credit Protection Act. 3 While some indirect lenders may argue that the dealer is the creditor and they are merely assigned the security instrument after consummation, the CFPB makes it clear that the ECOA definition of creditor expressly includes an assignee, transferee, or subrogee. 4 Furthermore, indirect auto lenders are considered creditors under the ECOA and Reg. B, if in the ordinary course of business they regularly participate in a credit decision and information gathered by the CFPB suggests that the standard practices of indirect auto lenders likely constitute participation in a credit decision under the ECOA and Reg. B. Although the Bureau did not altogether ban the practice of dealer mark ups, it did recommend lenders consider fairly compensating dealers using alternative methods, such as a flat fee per transaction, which do not result in discrimination disparities. The Bulletin pointed out that disparities could occur within individual dealer s transactions or across different dealers within the portfolio and that a lender s mark up and compensation policies 1 CFPB Bulletin Credit Union Conference Call, February 5, U.S.C. Section 1691(a) 4 12 C.F.R. Section (l) The fate of auto dealer rate mark ups 1

3 alone may result in lender liability under the legal doctrines of both disparate treatment and disparate impact if its policies result in discrimination. When recently asked at the annual Consumer Bankers Association conference whether there is a specific threshold below which the CFPB would not pursue fair-lending cases involving dealer mark ups, Assistant Director of Fair Lending and Equal Opportunity Patrice Ficklin, would not comment. 5 We believe this indicates indirect lenders must be prepared to carefully monitor, review, and if necessary, defend the manner in which dealers mark up buy rates across the board. Both the National Automobile Dealers Association (NADA) and the National Association of Minority Automobile Dealers (NAMAD) have expressed concern about the Bureau s Bulletin and the potential that it may actually weaken the consumer s ability to secure financing at the lowest possible cost. Further, they believe the CFPB should have solicited the full participation of the Federal Reserve Board and Federal Trade Commission, the two agencies with regulatory authority over auto dealers, before issuing this guidance which has put indirect auto finance lenders in the middle of the CFPB and the professional associations representing their dealers. 6 While the recent Bulletin should not cause indirect lenders to panic and eliminate legacy mark up practices, we recommend they consider the following practical action items below as they continue to navigate the waters of increasing fair lending regulation and align their business strategies to a changing regulatory landscape. Areas to address Fair lending policy and governance Practical impacts Fair lending policy enumerating the institution s commitment to fair treatment of customers and that allow the institution to prevent, detect and correct instances of unfair treatment. Comprehensive training tailored according to roles and responsibilities which informs bank or captive employees of fair lending requirements. New tracking to monitor dealer pricing as part of the credit approval process and prior to funding of auto loans. Additional post acquisition quality control and compliance reviews. 5 American Banker, March 15, Credit Union Times, March 22, 2013 The fate of auto dealer rate mark ups 2

4 Areas to address Dealer reserve policy Credit and pricing models Data requirements Credit decision process Funding Practical impacts Clear dealer reserve/participation policy including rate caps, terms and good faith, competitive reasons for allowable adjustments consistent with the ECOA. Internal controls to monitor, detect and address potential fair lending and pricing disparities by dealers for protected classes. Routine audits at the dealer, product and portfolio level to test dealer reserve program and loan pricing compliance with federal fair lending regulations, disparate treatment and disparate impact. Monitoring and testing program that evaluates transactions for areas of potential discrimination in underwriting decisions or pricing practices. Model validation process that ensures applicable credit scoring and/or automated underwriting sy stems are empirically derived and statistically sound. Development of new pricing models/strategies which give the aggregator more control over pricing, documentation and disclosure. Adaptable data collection and retention capabilities to support the loan-level data requirements for potential disparities on a prohibited basis in pricing or underwriting. Impose controls on credit policy and process to ensure subjective underwriting does not result in pricing disparities or adverse credit decisions on a prohibited basis. Adjust credit underwriting controls to ensure rate/price negotiations with the dealer are aligned with dealer reserve policy and do not result in pricing disparities or adverse credit decisions on a prohibited basis. Approved transactions not contracted as approved should be re-underwritten and decisioned through the credit scoring/pricing engine. The fate of auto dealer rate mark ups 3

5 Areas to address Dealer considerations/ oversight Strategic decisions Practical impacts Fair lending/ecoa training program conducted by an independent qualified person or organization for all sales and finance dealer personnel. Public notices including a notice of nondiscrimination and a notice that each APR may be negotiable should be prominently posted on the showroom floor and in each sales or F&I office. Provide prospective buyers a copy of Understanding Vehicle Financing published by the FTC, NADA and AFSA Educational Foundation. Dealer document retention requirements concerning buy rates, dealer reserves and customer APRs for approved and contracted files. Periodic self-audits by dealer personnel who has not participated in the transactions. Clearly defined quality standards leading to exclusion of dealers from indirect lending programs. Forecast the impact on product and pricing strategies, dealer production and risk-tier blends for flat fee or adjusted dealer participation levels. Consider reputational risks involved with dealer participation alternatives and requisite controls to mitigate risk. The fate of auto dealer rate mark ups 4

6 For more information on the impacts of these new requirements please contact : Peter Pollini Principal (207) peter.c.pollini@us.pwc.com Jeff Lavine Partner (202) jeff.lavine@us.pwc.com Ric Pace Principal (703) ric.pace@us.pwc.com Doug Roeder Managing Director (571) douglas.w.roeder@us.pwc.com Tony Ricko Managing Director (978) anthony.ricko@us.pwc.com Doug Ekizian Senior Manager (949) douglas.c.ekizian@us.pwc.com Follow us on 2013 PricewaterhouseCoopers LLP, a Delaw are limited liability partnership. All rights reserved. Pw C refers to the US member firm, and may sometimes refer to the Pw C network. Each member firm is a separate legal entity. Please see for further details. This content is for general information purposes only, and should not be used as a substitute for consultation w ith professional advisors. This publication has been prepared for general guidance on matters of interest only, and does not constitute professional adv ice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, Pricew aterhousecoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.