CFPB Turned High Beams on Auto Lending. Will Lenders See the Light?

The Department of Justice (DOJ) and the Consumer Financial Protection Bureau (CFPB) announced a recent consent order with Fifth Third Bank regarding the bank’s indirect auto lending. The consent order resolved allegations that the Bank’s pricing policies and practices discriminated against African American and Hispanic borrowers. This is the third recent settlement where the regulators have signaled how they would like lenders to approach Indirect Auto Lending. Below, we share the regulator’s preferred approach to indirect lending.

With recent settlements, the regulators have turned on the high beams for indirect auto lending compliance. But will financial institutions see the light, and make the necessary adjustments? Here's a quick overview of the Fifth Third consent order, as well as regulatory guidance:

Fifth Third Consent Order Overview

Fifth Third is the 17^th largest auto loan lender in the United States. The Bank has historically set an initial risk-based “buy rate” that it shared with the Bank’s network of auto dealers. The bank gave auto dealers the discretion to mark-up the buy rate.

According to the CFPB, these “mark-ups generate compensation for the dealers while giving them the discretion to charge consumers different rates regardless of their creditworthiness.”

The consent order stated that Fifth Third allowed dealers to mark-up the buy rates by as much as 250 basis points with variation based on term, geography, and time period.

According to the government’s analyses discussed in the consent order, African-American borrowers were charged approximately 35 basis points more in dealer mark-up and Hispanic borrowers were charged approximately 36 basis points more. The government’s analyses uses a proxy methodology to assign race and national origin to retail contracts. The higher mark-up resulted in each borrower paying, on average, $200 more in interest expense compared to non-Hispanic white borrowers.

The Fifth Third consent order is structured in a similar fashion compared to the orders associated with American Honda Finance Corporation (July 2015) and Evergreen Bank Group (May 2015).

Regulatory Guidance on Dealer Compensation

Through the recent consent orders, the DOJ and the CFPB have provided auto lenders consistent guidance in regards to the government’s preference on the structure of Dealer Compensation Policy and associated Fair Lending Compliance Management Systems.

Here are the three “dealer compensation policies” options the CFPB appears to be consistently endorsing:

Option 1: Capped Dealer Discretion Model

• Overview: Under this model, auto lenders would give auto dealers a capped dealer mark-up (e.g., up to 125 basis points). This model would not preclude lenders from offering additional flat dealer compensation. Lenders would also be allowed to offer entirely nondiscretionary dealer compensation to some dealers, while offering the discretionary compensation to others, as long as all loans purchased from a particular dealer are compensated used one of the two compensation systems.
• Compliance Management System: Lenders would need to comply with all consumer financial laws, including ECOA. Financial institutions would also:
  • Send annual notices to dealers explaining ECOA and dealer’s obligation
  • Monitor for compliance with Dealer Discretion limits
  • Regular data analysis and monitoring (e.g., semiannually)

Option 2: Capped Dealer Discretion Model – Standard Dealer Participation Rate with Exceptions

• Overview: Under this model, auto lenders would give dealers the same cap and offer the same “flat” option mentioned above. In this model, the lender would set a “Standard Dealer Participation Rate” for all borrowers. Dealers could also set a lower Standard Dealer Participation rate for particular loan types and/or channels. Finally, dealers could lower the Standard Participation Rate(s) based on a lawful exception pursuant to the lenders fair lending policies and procedures.
• Compliance Management System: Lenders would need to comply with all consumer financial laws, including ECOA. Financial institutions would also:
  • Send annual notices to dealers explaining ECOA and dealer’s obligation.
  • Monitor for compliance with Dealer Discretion Limits.
  • Effectively manage exceptions. Financial institutions would:
    • Set Policies and Procedures for Exception Management
    • Require Loan-By-Loan Exception Documentation
    • Maintain document retention consistent with Regulation B.
    • Train dealers on exception policies and procedures
    • Monitor Exceptions to Standard Dealer Participation Rate
    • Conduct Audits for Compliance with Policy and Procedure
    • Appropriate Correction Action for Non-Compliance

Option 3: No Dealer Discretion Model

• Overview: Auto lenders would not allow any dealer discretion. The borrower’s contract rate would be set by the bank.
• Compliance Management System: Lenders would need to comply with all consumer financial laws, including ECOA. Financial institutions would:
  • Send annual notices to dealers explaining ECOA and dealer’s obligation.

Additional Regulatory Takeaways

Auto lending is the third largest source of outstanding household debt in the United States, after mortgages and student loans. Recognizing the size and importance of this debt market, the CFPB has turned on the high beams to illuminate auto lending. They have shined the light on the path they would like to see auto lenders follow. The regulators have outlined the three models for lenders to consider. Here is what they have also stated:

• Understand Your Auto Lending Models and Approach: Business Managers, Executive Management and Compliance need to have a clear understanding of your indirect lending model. There needs to be transparency and alignment on the approach. What are the business model(s) you currently have employed? What types of lenders are you currently working with? How are the dealers being compensated and monitored? Based on all the guidance provided (e.g., bulletins, press releases, consent orders, webinars, etc.), you cannot afford to ignore the regulatory concern about dealer discretion.   
• Align Your Compliance Management System with the Discretion Allowed: With more discretion (e.g. bigger caps and exceptions) comes the need for more controls and structure in your Compliance Management System.
• Assess Both the Quantitative and Qualitative Risks: To appropriately assess your organization’s risk, you have to consider both types of risks:
  • Qualitative Risks: Review of your Business Models, Dealer Networks, Application Flows and the corresponding Compliance Management System (policies, procedures, training, audit to ensure compliance, etc.).
  • Quantitative Risks: If your approach to auto lending includes any dealer discretion, there is a regulator expectation that you are analyzing your data for disparities between groups. Review your lending data to look for disparities between prohibited basis groups and control group. Review the data at the aggregate level and at the dealer level. [RELATED: 9 Essential Steps of Indirect Auto Fair Lending Analysis]

TRUPOINT Viewpoint: TRUPOINT Partners can help you manage both your qualitative and quantitative auto lending risks through risk assessments and data analytics. 

To help your team understand the recent consent orders, we have assembled a side-by-side comparison.

To get it, just click here!

Read More:

• Fifth Third 
  • CFPB Press Release
  • CFPB Consent Order
  • Fifth Third Complaint
• Honda:
  • DOJ Press Release
  • Honda Complaint
  • Honda Consent
  • Honda Press Release
• Evergreen Bank – Motorcycle Lending
  • DOJ Press Release
  • Evergreen Complaint
  • Evergreen Consent Order
• Ally Auto
  • CFPB Press Release
  • Ally Complaint
  • Ally Consent Order
• CFPB Methodology – Indirect Auto and Proxies
  • Indirect Auto Lending Bulletin
  • Using Proxies
  • Supervisory Highlights & Indirect Auto