CFPB goes on the offensive in auto finance. Or did they?

With several rulings and actions, the CFPB’s recently released Summer Supervisory Highlights and subsequent field hearing in September 2014 may seem to be yet another attack from the CFPB. But a closer look reveals that the release of the Summer Supervisory Highlights and subsequent field hearing may signal a softening of the agency’s harsh 2013 Auto Finance Guidance. Nevertheless, in the report, and at the hearing, the CFPB took five key steps that will most certainly impact automotive lending practices:

1. Larger participant supervisory authority: Issued a proposed rule to assert “larger participant” supervisory authority over approximately 38 nonbank automotive finance companies, including most captives. The new supervisory threshold for nonbanks is whether they originate, refinance or acquire 10,000 or more sales contracts or leases in any calendar year. This should bring approximately 90 percent of the nonbank auto finance market under the CFPB’s authority.
2. Confidential supervisory resolutions: Announced new confidential “supervisory resolutions” with several large banks in which collectively $56 million will be paid as remuneration to approximately 190,000 consumers in protected classes who the CFPB found to be victims of “disparate impact” credit discrimination. The banks may pay out additional compensation over time based on further CFPB audits. Despite this, it’s reasonable to believe these banks will continue to offer rate participation to dealers and consider any additional payments to consumers a cost of doing business.  
3. Proxy methodology: Issued a white paper explaining its proxy methodology for determining who is in a protected class. The CFPB uses a proxy called the Bayesian Improved Surname Geocoding (BISG). Criticized by statisticians, even the CFPB concluded that BISG is not entirely accurate by overstating black and Hispanic Americans, up to 30 percent of the time. 
4. Open source software: Promised to release an open source software model of how it runs its statistical analysis to banks and finance companies. It will be interesting to see if the software regresses out any transactions; the cynic in me suggests it does not, making the CFPB analysis even further flawed. 
5. Consumer automotive lease law: Finally, the CFPB made up its own law by including consumer automotive leases among consumer financial products or services. The definition of “leases” under the Dodd-Frank Act limits leases to the functional equivalent of purchase finance arrangements, such as a quasi-lease where the consumer is able to buy the vehicle for a nominal amount at conclusion of term. That is not the kind of closed-end leases that dealers use in automotive financing. The CFPB has no authority to make up the law, but that doesn’t appear to stop them from doing so.

What does this mean for dealers?

Despite the new rulings, read the Supervisory Highlights closely. The CFPB actually seems to be backing off some of its mandates in the 2013 Guidance. Yes, banks are still required to have comprehensive Compliance Management Systems, and to train and monitor dealers. And yes, the absurd notion of “portfolio level discrimination” (1) continues to get lip service. But the CFPB may be softening. There is no mandate for flats, and the CFPB seems to be giving dealers a lighter compliance option IF they lower the permissible dealer rate markup range:

• Examination teams observed that indirect automotive lenders often limit discretionary dealer markup to between 200 and 250 basis points.
• Teams found that indirect automotive lenders often do not otherwise engage in significant monitoring and internal control of the fair lending risk.      
• Supervisory activity identified some products that limit, by policy, discretionary dealer pricing adjustment. 
• Supervisory experience suggests that where these limits on discretionary pricing have been in effect, they may result in considerable reductions or the elimination of markup disparities for the product. It also suggests that significant limits on markup, such as a limit of 100 basis points, may reduce fair lending risk and reduce the need for certain compliance management activities.

So if a lender limits the rate markup allowance to 100 basis points (1 percent) instead of 200-250 basis points (2-2.5 percent), it gets an administrative break on the need for certain compliance management activities. Compliance lite, if you will.  Nowhere does the CFPB state what a “statistically significant rate differential” is, but I suspect many lenders may seize on the “compliance lite” administrative burden that apparently comes with lowering permissible markups to 100 basis points.

The solution for dealers

The CFPB’s recent activities make it more essential than ever to adopt and implement a program such as the NADA Fair Credit Compliance Policy and Program. The program works as follows: Your dealership adopts a standard rate markup and deviates downwards (but never upwards) if a significant, nondiscriminatory legitimate business purpose exists to reduce the standard markup. The NADA program lists seven legitimate business purposes:

1. The rate cap imposed by the lender is lower than the standard dealer rate markup.
2. The monthly budget payment constraint documented by the customer requires a reduction in the rate markup to make the deal workable for the customer.
3. Another dealer or lender quoted a lower rate that your policy indicates you will meet or beat.
4. The dealership is conducting a promotional rate campaign for customers.
5. A manufacturer or financing source is buying down the interest rate to customers.
6. A description of how the vehicle attached to the indirect financing transaction satisfies inventory reduction criteria stated in your fair credit compliance policy.

Companies like Dealertrack have digitized NADA’s Rate Participation Certification Form as a part of its justification program, so you can complete and store the form electronically and integrate it within your operations flow. This form should be completed for all deals, both where you employ the standard rate markup and where you deviate downwards for one of the seven reasons. Speak with your local counsel about other reasons that may apply. Remember, the reason does not have to be necessary or essential, only significant, nondiscriminatory, and legitimate to your business.

The Department of Justice has effectively endorsed this program and even CFPB Director Richard Cordray called it “encouraging.” The CFPB’s moves away from requiring flats is an encouraging sign that the NADA Program – or something close to it – may be the ultimate solution to “disparate impact” credit discrimination. If you adopt the NADA Program, when you are questioned by a lender or a regulator, you can show you do not discriminate. The NADA Program also removes an element of dealer discretion that flat fees do not.

You will no doubt be hearing from lenders looking to monitor your contracts and possibly limiting your markups to 100 basis points (1 percent). With the NADA program, you are best positioned to present an effective response. Now more than ever.

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Randy Henrick is associate general counsel and lead compliance counsel for Dealertrack Inc. This article is intended for information purposes only and does not constitute the giving of legal or compliance advice to any person or entity. Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on your particular situations from a knowledgeable attorney or compliance professional licensed to practice in your state.

(1) Portfolio Level Discrimination: Where there is no discrimination at the dealer level but because the lender buys contracts from hundreds or thousands of dealers, rate differentials occur at the lender’s portfolio level and create an alleged “disparate impact” credit discrimination claim.