CFPB-Honda Settlement Gives 3 Options for Fair Lending Compliance

Honda (American Honda Finance Company) recently struck an agreement with the DOJ and CFPB after the regulators identified allegedly discriminatory auto loan pricing. Here are the lessons you need to know, plus three regulator-approved dealer compensation policies, directly from regulatory guidance.

Last week, Honda reached an agreement with the CFPB and the DOJ in response to indications of discriminatory auto loan pricing.

As part of this agreement, Honda was given three regulator-approved options for indirect auto lending. 

The bottom line when it comes to auto fair lending risk: More Discretion = More Controls!

The Model

Honda was employing a familiar indirect lending business model: 

• Auto dealers submit applications to the Bank/Financial Institution/Respondent. 
• Respondent conducts an underwriting process. 
• For approved loans, Respondent sets a specified “buy rate” based on an underwriting and pricing model that evaluates the borrower’s creditworthiness.  The buy rate is the minimum interest rate that the Respondent will finance a retail installment contract from a dealer. 
• Dealers could mark-up the contracts 200-225 basis points depending on the term of the loan (Dealer Mark-Up).

The Exam

The Bureau and DOJ assigned race and national origin probabilities to the applicants using the Bayesian Improved Surname Geocoding (BISG), which determines a probability by employing a combined geography-based and name-based proxy methodology (Census Bureau). 

The Bureau’s and DOJ’s analyses focused on the interest rate difference between the buy rate set by the Respondent and the borrower’s contract rate (dealer mark-up) where dealers had discretion that was not based on objective credit criteria.

The Findings

African-American borrowers were charged 36 basis points more in dealer markup than similarly situated non-Hispanic whites. Hispanic borrowers were charged approximately 28 basis points more in dealer mark-up than similarly situated non-Hispanic whites. Asian and/or Pacific Islander borrowers were charged 25 basis points more in dealer mark-up than similarly situated non-Hispanic whites. 

The higher markups that the Respondent charged to African-American, Hispanic, and Asian and/or Pacific Islander borrowers “are a result of Respondent’s specific policy and practice of allowing dealers to mark-up a consumer’s interest rate above Respondent’s established buy rate and then compensating dealers from that increased interest revenue.” 

Other Related Issues:

• The Bureau claims that the Responent did not monitor whether disparities occured between prohibited basis groups; and
• The Bureau further broadly claims that the Respondent did not employ adequate controls to prevent discrimination.

3 Regulator-Approved Approaches to Dealer Compensation

The regulators offered three options for how to revise Honda's approach to dealer compensation. Below is a quick look at these recommendations:

Revised Approach - Option 1

Limit dealer discretion to 125 basis points (60 months or less) and 100 basis points (greater than 60 months).  Respondent may provide additional nondiscretionary dealer compensation.  Respondent may also provide entirely nondiscretionary compensation to other dealers.  All loans purchased from a parparticular dealer should be compensated using only one of the two compensation systems.

With this program, the Compliance Management System should include:

• Send regular notices to all dealers regarding ECOA compliance and the dealer’s obligation to price retail installment in a non-discriminatory manner, and monitor each dealer’s compliance with Dealer Discretion limits.
• Submit data on the auto lending to the DOJ semiannually.

Revised Approach – Option 2

Limit dealer discretion to 125 basis points (60 months or less) and 100 basis points (greater than 60 months).  Respondent may provide additional nondiscretionary dealer compensation.  Respondent may also provide entirely nondistretionary compensation to other dealers.  All loans purchased from a particular dealer should be compensated using only one of the two compensation systems.   

With this second option, Respondent must require dealers to disclose "Standard Dealer Compensation Rates" to borrower.  Respondent may also allow dealers to include a single, set lower dealer participation rate.  To the extent Respondent allows exceptions to the Standard Dealer Participation Rate, Respondent may allow dealers to lower the standard rate as long as they follow exception policies and maintain required documentation.  Respondent must set exception policies and procedures.

Compliance Management System to Include:

• Training Dealers on exceptions policies and procedures;
• Regular monitoring of exceptions;
• Periodic audit for compliance with policies and procedures; 
• Appropriate correction action for a dealer’s noncompliance; 
• Send regular notices to dealers explaining ECOA and the need for everyone to comply; and
• Monitor for compliance with Dealer Discretion limits.

Revised Approach – Option 3

Respondent will maintain policies and practices that do not allow for any discretion to dealers. 

Compliance Management System to Include:

• Send regular notices to dealers explaining ECOA and the need for everyone to comply
• Dealer will not have to review disparities or maintain a strict compliance management system to monitor dealer exceptions. 

TRUPOINT Viewpoint:  The CFPB has presented three business model options for Honda (and all indirect dealers) to consider.  If you are an active indirect auto lender, the three options are worthy of review and debate.  Equally important, the CFPB and DOJ are sending a strong message regarding the need to maintain an effective compliance management system that includes data monitoring. 

This is a story that has been told by many regulators in regards to all types of lending products: the more discretion in your business model, the stronger the controls you need to manage the risk. 

TRUPOINT Partners can help you assess, analyze and monitor your indirect auto lending risk.