The U.S. Consumer Financial Protection Bureau has told at least four banks that it may sue them over vehicle loans and interest-rate markups by auto dealers that appear discriminatory, according to three people briefed on the matter.
The banks received letters from the CFPB last week giving them 15 days to provide an explanation of the practice, said the people, who asked not to be identified because the plans aren’t public. The letters indicate the bureau believes the banks may have violated the Equal Credit Opportunity Act, a 1974 law that bars discrimination in lending.
The letters, sent as vehicle loan originations are on the rise, demonstrate that the CFPB may be willing to sanction banks over mark-ups by auto dealers, which were excluded from the bureau’s supervision in the 2010 Dodd-Frank Law. As the economy has improved, auto and truck loan originations climbed to $85.8 billion in the third quarter of 2012, according to the Federal Reserve.
“Auto lending is within our jurisdiction,” CFPB Director Richard Cordray in a conference call with credit unions on Feb. 5, without referencing any enforcement plans. “We are examining institutions around auto lending just as we are looking at them on mortgage, credit cards, student loans.”
Moira Vahey, a CFPB spokeswoman, declined to confirm the existence of the letters or comment on possible enforcement matters.
The market for auto loans is fragmented, with no lender controlling more than 6 percent of the market in the third quarter of 2012, according to data compiled by Experian Plc. (EXPGY) Wells Fargo & Co. (WFC) had 5.9 percent at that time, while Ally Financial Inc. (ALLY) had 5.54 percent and JPMorgan Chase & Co. (JPM) had 4.94 percent.
Other banks that are among the top 20 auto lenders include Bank of America Corp., Fifth Third Bancorp (FITB), U.S. Bancorp (USB), SunTrust Banks Inc. (STI) and PNC Financial Services Group Inc. (PNC), according to Experian.
“There is always a demand for autos,” Melinda Zabritski, director of automotive finance at Experian, said in an interview. “You also have banks with money to lend.”
The regulation of auto lending was one of the hardest- fought provisions of Dodd-Frank. Auto dealers overcame opposition from the Obama administration to gain an exclusion from oversight by the CFPB, with Congress giving regulatory power to the Federal Trade Commission instead.
Cordray said on Feb. 5 that the agency is fielding “a number” of complaints on vehicle financing through its consumer response system. Dealers often provide financing by giving buyers loans backed by banks and other lenders, a process known as indirect lending.
CFPB has the authority to supervise banks with more than $10 billion in assets.
The agency also has the authority to issue a regulation that would allow it to supervise the larger players in the field of auto lending that are not traditional banks. Those could include some in-house financing companies owned by the major auto manufacturers, said Leonard Chanin, the former head of regulation-writing at CFPB.
“I think ultimately the bureau will want to establish their supervisory authority over auto loans,” Chanin, now a partner at the law firm Morrison & Foerster LLP, said in an interview. “It’s a matter of time and priorities.”
Vahey, the CFPB spokeswoman, said in an e-mail: “As in all market-wide issues, if action is needed, we want to act in a way that promotes a level playing field for all lenders, both banks and nonbanks.”
CFPB has the power to enforce ECOA, the 1974 law banning discrimination in lending. Last year, the agency indicated it would apply a legal doctrine known as “disparate impact” to consumer financial products. The doctrine states that lenders can be sanctioned for actions that have a discriminatory effect -- as demonstrated by statistical analysis, for example -- even if they didn’t intend to discriminate.
“From the perspective of a consumer disadvantaged by policies that have a discriminatory effect, it makes no practical difference whether a lender consciously intended to discriminate,” Cordray said in a speech yesterday to the CFPB’s Consumer Advisory Board. “Every consumer, regardless of race, gender or other characteristics protected by federal law, should have equal access to credit.”
Fees collected by auto dealers “have historically been found to affect people of color more than others,” said Vahey, the CFPB spokeswoman.
Bailey Wood, a spokesman for the National Automobile Dealers Association, declined to comment on any potential CFPB action. He defended the dealers’ role in vehicle finance across racial and economic categories.
“At the end of the day, dealer assistance does more to expand access to credit than anything else,” Wood said in an interview. “We make sure that people can get car loans.”
The Supreme Court has signaled interest in a case on disparate impact involving a separate law, the Fair Housing Act.
The possible CFPB lawsuits concern a practice in the indirect lending process that consumer groups call the “dealer markup,” and whether it is applied in a discriminatory way, according to the people. Industry lobbyists refer to the practice as “dealer participation” or “dealer-assisted financing.”
Under this practice, buyers receive a loan that is costlier than the one the bank gave the dealer. The industry says the difference is a reasonable price for dealers’ services, and that buyers can negotiate that spread down.
“It’s a very competitive marketplace, and consumers can negotiate the cost of car and financing,” Chris Stinebert, head of the American Financial Services Association, a trade group, said in an interview.
The Center for Responsible Lending, a Durham, North Carolina-based consumer advocacy group, has estimated that buyers who bought cars in 2009 paid $25.8 billion in interest over the lives of their loans due to dealer markups. They also argue that buyers have limited chances to negotiate the price of the loan, and are unaware that dealers are compensated through the financing, not only the vehicle sale.
“This creates a perverse market incentive where the dealer’s incentive is to sell the loan that provides the most compensation for the dealer, which by definition is not the loan that provides the most competitive rate for the consumer,” the center wrote in a March 30 comment to the FTC.
The center has compared dealer markups to the yield-spread premium, which compensated mortgage originators through the interest rate on a home loan. The Federal Reserve banned the yield-spread premium for mortgages in a 2010 regulation.
Stuart Rossman, director of litigation at the Boston-based National Consumer Law Center, said any action by the agency to address auto lending would now have to occur through its authority to examine banks.
“In a general sense, CFPB can only cover the banks,” Rossman said in an interview.
The consumer law center litigated a series of cases on discrimination in auto lending about a decade ago. The cases resulted in settlements valued at more than $100 million and changes to lending practices in auto finance, according to the NCLC website.
Stinebert, of the financial services trade association, said that the cases also led bank and non-bank auto finance businesses to limit the dealer markup.
“Those voluntary caps on dealer participation agreed years ago are still in place,” Stinebert said.
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