Automobile dealers who three years ago won an exemption from direct oversight by the U.S. Consumer Financial Protection Bureau have found that it still has a lot of clout over how they finance car sales.
Under pressure from the agency, large banks that routinely buy auto loans have been reviewing records to ensure the dealers they work with aren’t discriminating against customers on the basis of race or gender. When firms including Bank of America Corp. find evidence of possible unfair treatment, they are sending warning letters to the dealers.
The situation is a turnabout from the industry’s lobbying victory in 2010, when it won a carve-out in the Dodd-Frank financial regulatory law from the consumer bureau’s authority.
Dealers are learning a “painful lesson,” said Richard Hunt, head of the Consumer Bankers Association, which represents large institutions. “If you provide a financial product to consumers, you will be under the oversight of the CFPB -- one way or another.”
The vehicle loan market, measured by outstanding volume of lending, was $751 billion at the end of June, according to Experian Plc. (EXPN) Of that, 58 percent came from banks and credit unions, with another 28 percent from finance companies controlled by car manufacturers. The major banks involved in auto finance, which besides Bank of America include Wells Fargo & Co. (WFC), JPMorgan Chase & Co. (JPM) and Ally Financial Inc. (ALLY), are examined directly by the consumer bureau.
When Tyler Corder, finance chief for Henderson, Nevada-based Findlay Automotive Group, meets with his bank lenders, the “top item on their list” has been the pressure they are getting from the consumer bureau, Corder said in an interview.
In addition to the banks, finance companies owned by vehicle manufacturers including Toyota Motor Corp. (TM) and Honda Motor Co. Ltd. have been producing data on auto-dealer lending at the request of the agency, according to regulatory filings.
The consumer bureau may soon propose to directly supervise the manufacturer-owned finance firms as well as large non-bank lenders including Credit Acceptance Corp. (CACC) and Consumer Portfolio Services Inc. (CPSS), people briefed on the agency’s plans said.
In the meantime, the bureau’s pressure on the banks could lead dealers to do more business with lenders who don’t fall under the agency’s direct purview. Smaller banks, credit unions and non-bank lenders could pick up the slack, said Melinda Zabritski, director of automotive finance at Experian.
“From a dealer standpoint, there are more options,” Zabritski said in an interview.
Samuel Gilford, a spokesman for the consumer bureau, declined to comment.
The bureau’s tactics surprised an industry that had celebrated its exemption. “Thanks to our successful grass-roots campaign in 2010, dealer-assisted financing was saved from additional federal oversight under the Dodd-Frank law,” Stephen Wade, then chairman of the National Automobile Dealers Association, told the group’s members in a newsletter in 2011.
Dealers now face “de facto” supervision from the bureau, said Thomas Hudson, a partner at Hudson Cook LLP, which represents auto dealers. The agency will “make the banks police the dealer marketplace since the CFPB can’t do it itself,” Hudson said in an interview.
Bailey Wood, a spokesman for the National Automobile Dealers Association, said the carve-out still shields his members from much of the agency’s power. “The exemption does protect us from the CFPB walking through the doors, the way they do with the banks,” he said in an interview.
The consumer bureau’s initiative began in March, when it issued a formal letter of guidance on auto lending, saying that banks it supervises -- those with assets above $10 billion -- face lawsuits if they buy discriminatory loans made by dealers.
The guidance takes aim at a practice the agency refers to as “dealer mark-up” and auto dealers call “dealer-assisted financing” or “dealer reserve.” Under the system, banks function as indirect lenders, allowing dealers to add points to the interest rate and pocket the difference. The consumer bureau said that one way for lenders to comply with guidance would be to pay flat fees to dealers instead of varying interest rates.
Consumer groups, including the Durham, North Carolina-based Center for Responsible Lending, charge that the financing practice gives dealers an incentive to move buyers, including members of minority groups, into more-expensive loans.
In a statement issued after the bureau’s guidance, the dealer association said indirect lending is “convenient and competitive” for consumers and said the agency was basing its theories about discrimination on unreliable statistical methods.
Dealers say the mark-up is a standard practice in wholesale-retail transactions and represents a reasonable price for their services, which include bringing in sales and handling paperwork. It also gives them the discretion to cut rates for customers to beat competing offers, dealers have said.
If the consumer bureau finds that discrimination exists, even without evidence it was intentional, a lender could face sanctions under the concept of disparate impact, which the consumer bureau has embraced in its work on fair lending.
As a result, major banks are telling some dealers their portfolios show evidence of discrimination, according to documents and people involved with the work who spoke on condition of anonymity because the discussions aren’t public.
In an April 30 letter to one dealer, whose name was redacted in a copy provided to Bloomberg News, Bank of America cited differences in loan pricing that “are not explained by credit-related characteristics.” The data suggests that “for similar transactions, African-Americans, Hispanics, or female applicants paid more compared to White and/or male applicants,” according to the letter.
“If we find similar results, we may take further action, which may include termination of our dealer agreement,” or moving to a flat-fee payment for loans, the letter reads.
Betty Riess, a spokeswoman for Bank of America, declined to comment on specific letters. She said the firm and its dealers “are committed to fair lending and work to advance that commitment.”
San Francisco-based Bank of the West is also running statistical analyses on its portfolios of auto dealer loans to “be ahead of the regulator,” said Andrew Harmening, a senior executive vice president who is also chairman of the consumer bankers’ group.
Most banks, in their letters, are telling dealers they’ll continue to monitor lending practices, according to Arthur Baines, vice president of Charles River Associates, a Boston-based consultancy.
“We are at the front end of what I’d describe as a tidal wave of new lender controls and communication about loan pricing,” Baines said in an interview.
Corder, head of finance for Findlay, a chain of about 30 dealerships that sell more than 20 makes, said his company hasn’t received any notices from its lenders, though he said he knows of others that have.
He said the consumer bureau’s approach of working through the banks breeds uncertainty among the dealers and the lenders.
“We are in the stage where the banks are covering their tails,” Corder said. “They really don’t have an answer as to what we do if we do get a nastygram.”
Through its scrutiny of auto lending, the consumer bureau is also examining how consumers fare with ancillary products, such as theft protection and service contracts, which are sold by dealers on behalf of third-party vendors and financed with the car loans.
Dealers have expanded their sales of such products in recent years and scrutiny of that business could be “a good deal more disruptive” than the regulators’ interest in dealer mark-up, Baines said.
American Honda Finance Corp. warned investors in an Aug. 19 regulatory filing of a “material adverse effect” on its finances if the bureau cracks down on such activities.
“If the CFPB concluded that we are not in compliance with applicable rules and regulations, we may be required to cease or alter certain of our business practices,” it stated.
The agency’s queries have created uncertainty among vendors of ancillary products, which aren’t regulated by the consumer bureau. The agency hasn’t contacted the vendors, said Dave Robertson, executive director of the Association of Finance and Insurance Professionals, which trains and certifies sales staff.
“We can’t really dance with the CFPB if we don’t know what music is playing,” Robertson said in an interview.
The consumer bureau may also propose this fall a regulation that would allow it to have the same direct supervision authority over non-bank lenders that it does over banks, according to two people briefed on its plans. Some non-bank lenders involved in auto loans already have received civil investigative demands, a type of subpoena requesting information that can mark the start of an enforcement action, according to a person briefed on the issue. The person didn’t name the lenders.
All that activity will spur dealers to be more careful with their loan business, said Chris Kukla, senior counsel for government affairs at the Center for Responsible Lending.
“The lenders see some potential for liability here, and that’s a good thing,” Kukla said.
Still, Matthew Stover, an analyst with Guggenheim Securities LLC in Boston, predicted that the indirect pressure from the consumer agency wouldn’t fundamentally alter the auto-lending market.
“If there is simply increased vigilance and guidance, you’re not going to get durable change,” Stover said in an interview. “It’s like you wait until mom and dad fall asleep, and then do what you were doing.”
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