Auto Lenders Face More Scrutiny in Move to End Loan BiasCarter Dougherty
The U.S. Consumer Financial Protection Bureau is set to expand supervision of auto-finance companies even after making little headway in a campaign to get banks to change how they lend for new and used cars.
The agency, which already supervises consumer finance products at banks with assets over $10 billion, plans to propose a rule paving the way for oversight of non-bank car lenders at a field hearing in Indianapolis tomorrow, two people briefed on the matter said.
Such an action would bring the auto-finance units of manufacturers such as Ford Motor Co. into the bureau’s purview, along with firms such as Consumer Portfolio Services and Credit Acceptance Corp.
During its four-year existence, the consumer bureau has changed industry practices in mortgage lending, credit cards and other products through a mixture of supervision and regulation. In all, the agency said Sept. 15, it has recovered about $4.7 billion in relief for more than 15 million consumers harmed by illegal practices.
The bureau has been less successful in auto finance, an industry it targeted in March 2013. It has issued guidelines, demanded data from banks and filed an enforcement action to alter a system officials say lets auto dealers charge higher rates to minority buyers.
Nearly 18 months later, the market isn’t a lot different. Ally Financial, one of the top four auto lenders, refused to overhaul its business after paying $98 million to settle claims of unfair lending by the agency and the Department of Justice.
While one firm, Chicago-based BMO Harris Bank, changed its practices, settlement talks between the consumer bureau and other banks have slowed or stalled. And this week, more than 400 auto dealers lobbied Congress for a bipartisan bill that would stop the agency from targeting their finance methods.
“They may have overestimated their ability to get change in the market,” Alan Kaplinsky, head of the consumer financial services group at the law firm of Ballard Spahr LLP, said of consumer bureau officials. “All the big players are going to be reluctant to be the first ones to make a move because it has a dramatic competitive impact.”
Sam Gilford, a spokesman for the bureau, said the agency has made progress, including by recovering millions of dollars in the Ally settlement.
“Our explicit goal from the beginning has been to root out illegal auto-lending discrimination,” Gilford said. “There is still more work to do.”
The consumer bureau can’t simply order dealers to change how they finance cars. In the 2010 fight over the Dodd-Frank Act that created the consumer bureau, the dealers successfully lobbied Congress for an exclusion from the agency’s oversight.
Instead, the bureau is attacking the matter indirectly through lenders.
The consumer bureau’s 2013 guidelines take aim at a practice the agency calls “dealer markup” and auto dealers term “dealer participation” or “dealer-assisted finance.” Banks function as indirect lenders, allowing dealers to add to the interest rate the banks charge and pocket the difference.
Consumer groups say the practice gives dealers too much leeway to move certain buyers into more-expensive loans. Dealers say the markup is a reasonable price for their services, which include bringing in customers and handling paperwork, and that buyers can negotiate the spread.
U.S. officials say the system often results in higher payments by members of minority groups. The consumer bureau has said lenders should monitor spreads to prevent discrimination, or switch to a flat markup so all buyers get the same deal.
At the Indianapolis hearing tomorrow the bureau will outline its methodology for determining whether discrimination is occurring, according to the people briefed on its plans, who spoke on condition of anonymity because the discussions aren’t public. Officials also plan to disclose how they have settled disagreements with some banks behind the scenes.
Banks haven’t been eager to abandon the markup system because they don’t want to lose their piece of the booming auto financing business. Outstanding auto-loan volume reached $839 billion in the second quarter of this year, up 12 percent from a year earlier, according to Experian Plc, a research firm that analyzes auto finance.
Ally Financial, the former General Motors Co. lending arm, settled with the government after the bureau and Justice Department compiled data showing that more than 235,000 minority borrowers paid higher rates due to a discriminatory pricing system. The deal announced Dec. 20 included an $18 million fine and $80 million in borrower restitution.
About six weeks later, Ally Chief Executive Officer, Michael Carpenter said that the bank refused the agency’s demands that it abolish dealer markup and that it wouldn’t be the “Trojan horse” that introduced flat fees to the industry.
“We are not going to go to flats,” Carpenter told Automotive News on Feb. 3. “That is obviously not what the CFPB wanted to hear. They thought we were going to cave.”
Ally spokeswoman Gina Proia confirmed his comments by e-mail.
Chris Kukla of the Center for Responsible Lending, said that there is a “first-mover problem” in obtaining the changes to the overall system that consumer officials seek. He said lenders who don’t revamp the system will have “an ongoing dialogue” with the bureau. Ally, under the terms of its settlement, will have to report to the agency each quarter on what it’s doing to avoid discrimination.
The banks’ determination to stick with the system is “going to depend on the lenders’ appetite for regulatory risk” when they’re trying to avoid it, said Kukla, who is senior counsel for government affairs at the Durham, North Carolina-based group.
The bureau’s tool for pressuring the banks is a legal doctrine known as “disparate impact,” which the agency has been applying to a range of consumer financial products. The doctrine holds that lenders can be sanctioned for actions with a discriminatory effect -- as demonstrated by statistical analysis, for example -- even if they didn’t intend to discriminate.
Consumer officials have been collecting information about lending patterns by sending civil investigative demands, a form of subpoena, to at least 10 lenders, according to four people briefed on the actions.
“We know that they are currently at the doorstep of quite a number of the major banks in the auto finance area, as well as the doorstep of regional banks,” said Kenneth Rojc, the managing partner of the auto finance group at Nisen & Elliot LLC in Chicago.
The U.S. financing arms of Toyota Motor Corp. and Honda Motor Co. have received such requests from Justice and the consumer agency, they disclosed in regulatory filings. Fifth Third Bancorp., based in Cincinnati, disclosed a Justice Department query in May.
Wells Fargo & Co., Ally, Capital One Financial Corp. and JPMorgan Chase & Co., the top four lenders, together had 19 percent of the auto-loan market at the end of the second quarter of this year, according to Experian. Fifty-two percent of loans came from banks and credit unions, while 27 percent originated with financial companies controlled by car manufacturers.
The fragmentation means dealers have many options for financing, and will likely send their business to banks that give them discretion, said Michael Buckingham, senior director in the auto finance practice at J.D. Power & Associates.
BMO Harris Bank, which dropped the old system, had less than 1 percent of the U.S. auto loan market at the end of 2013, making it the 28th-largest lender, according to Experian. That didn’t stop Richard Cordray, the director of the consumer bureau, from publicly praising it for switching to flat fees.
“It is encouraging to see BMO Harris taking this proactive step to protect consumers from discrimination,” said Cordray. “When people go to buy a car, they should not have to worry whether they’ll pay more for their auto loan because of their race, gender, or ethnic background.”
Talks between the agency and auto lenders to settle claims of discrimination have stalled at times because the bureau wanted a public commitment that banks will eliminate the discretion of dealers to change loan costs, according to four people briefed on the discussions.
The lenders have instead aimed for confidential agreements with a promise to monitor how dealers mark up loans to minority borrowers, something most of them are doing anyway, these people said, requesting anonymity to discuss private negotiations.
“We are not mandating one specific path to compliance,” the bureau’s Gilford said. “We have been very clear that there are a number of different approaches lenders can take.”
The consumer bureau could sue a bank rather than reach a negotiated settlement, but the methodology for determining discrimination is controversial and has already been the subject of Supreme Court cases. That has emboldened the lenders to resist the bureau’s pressure, said the people, since a lawsuit would likely take years, and could deliver a legal victory to the banks.
“From a legal standpoint, they are managing that risk in doing business with dealers,” said Rojc, the auto finance lawyer. “And until we see more enforcement action from CFPB, that approach will continue to hold.”
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