The Consumer Financial Protection Bureau (“CFPB”) has weighed in heavily on the controversy regarding the CFPB’s application of fair lending laws under the Equal Credit Opportunity Act (“ECOA”) to indirect auto lending.
The controversy centers on a guidance bulletin released by the CFPB on March 21, which applies to “all indirect auto lenders within the jurisdiction of the [CFPB]” (the “Bulletin”). The Bulletin primarily focused on the practice of “dealer markups,” which involves auto dealers charging a higher interest rate than the minimum rate (commonly referred to as a “buy rate”) established by indirect auto lenders for purchasing auto loans, and policies which provide compensation to dealers for such higher rates. The Bulletin does not apply directly to auto dealers, as the Dodd-Frank Act contains a provision that explicitly exempts most auto dealers from direct oversight by the CFPB (with very limited exceptions, such as auto dealers that extend credit and do not routinely assign the associated contracts to an unaffiliated third party financing source).
However, indirect auto lenders that purchase automobile finance contracts from auto dealers are subject to CFPB oversight. Lenders are considered creditors under ECOA if they regularly participate in a credit decision in the ordinary course of business. In the Bulletin, the CFPB stated that information it has gathered “suggests that the standard practices of indirect auto lenders” would likely make them creditors for ECOA purposes. More specifically, the Bulletin stated that lenders providing buy rates and allowing dealer markups may be creditors under ECOA, and subject to ECOA liability under a “disparate treatment”/“disparate impact” theory for pricing disparities within the lender’s portfolio. The CFPB explained this position by asserting that such disparities result from the lender’s own markup and compensation policies if such policies provide auto dealers with discretion to set interest rates on the basis of factors other than objective measures of creditworthiness.
In the Bulletin, the CFPB recommended indirect auto lenders take steps to ensure ECOA compliance, such as by imposing controls on dealer markup and compensation policies and monitoring and addressing the effects of those policies to address unexplained disparities, or eliminating dealer markups and instead using an alternative method of compensation such as a flat fee per transaction. A copy of the Bulletin is available here.
The industry response to the Bulletin has been heated, with financial institutions arguing that lenders shouldn’t be liable for actions taken by dealers without their knowledge, and auto dealer advocates warning that the CFPB’s efforts to curtail dealer markups will lead to higher costs for borrowers. Others have argued that lender pricing data is an insufficient basis upon which to base conclusions regarding discriminatory conduct, and that the CFPB’s methods for assessing fair lending compliance (including proxy methods for determining demographic characteristics) are arbitrary.
Response has not been limited to the lending industry, with members of Congress sending a number of letters to the CFPB. One letter dated October 29 from three Representatives stated that this issue required proper Congressional oversight, and that without complete information, it was impossible to know whether the CFPB’s guidance was “unnecessary and counterproductive.”
In a letter dated October 30 (“October 30 Letter”), a bipartisan group of 22 U.S. Senators raised concerns regarding the Bulletin and the CFPB’s position on indirect auto lending, which they indicated was “widely interpreted as pressuring lenders to eliminate or severely limit an auto-dealer’s discretion to negotiate competitive financing for their customers.” The October 30 Letter indicated the view that providing dealer discretion frequently results in consumers obtaining lower costs of credit, and states that the CFPB has “yet to explain its basis” for the assertion that disparate impact discrimination is present in the indirect auto financing market. The October 30 Letter also requested “greater transparency” from the CFPB, and particularly information on the statistical methodology employed by the CFPB in determining the presence of disparate impact in an auto lender’s portfolio and whether the CFPB employed a basis point threshold for determining when statistically significant disparities existed.
In a reply to the October 30 Letter dated November 4 (“November 4 Reply”), the CFPB stated that “[c]ertain policies and practices that allow discretion in pricing” create a significant risk of discrimination and the failure to “properly and consistently monitor such policies and practices for compliance” has (in “historical experience”) been a contributing factor in discrimination in auto lending. The CFPB stated this historical experience has been documented by scholars and reflected in case law and Department of Justice (“DOJ”) enforcement actions, though no citations were provided.
Responding to the request for more details on the statistical methodology used by the CFPB to detect disparate impact, the CFPB noted that demographic information such as race is not collected by non-mortgage lenders, and proxy methods are used for assessing fair lending compliance. The CFPB explained that such proxy methods assign a probability that applicants fall into specific demographic categories based on the distribution of the population across these demographic categories for applicant information that is available (e.g., first name for gender, surname for race and national origin). The CFPB stated that its proxy methods rely solely on public data “so that lenders can replicate our methods” and that the CFPB expects lenders “to choose a proxy method that will support a compliance management system commensurate with their size, organizational complexity, and risk profile.”
The CFPB declined to provide a basis point threshold for determining the existence of statistically significant disparities, and instead stated that the CFPB uses “case-by-case assessments of whether to pursue supervisory or enforcement activity in response to statistically significant disparities.” The CFPB also stated that it considered "analytical controls which are appropriate to each particular entity” being examined, with such controls being “dependent upon the particular lender’s policies, practices, and procedures.” A copy of the November 4 Reply is available here.
The CFPB’s efforts have not been limited to issuing guidance and correspondence. Various auto lenders associated with auto manufacturers (including Toyota and Honda) have confirmed in regulatory filings that the CFPB and the DOJ are probing their lending practices and have sought information from them and other auto finance providers about auto lending pricing practices. In addition, Ally Financial recently disclosed in a regulatory filing that the CFPB has told Ally it has failed to take adequate steps in fulfilling Ally’s obligation to prevent auto dealers from engaging in financing practices that violate fair lending laws. Also, a recent American Banker article reported some auto lenders under CFPB investigation for potential fair lending violations are being referred to the DOJ, and that at least three lenders have been given notice by CFPB regarding such referrals.
Depository institutions and nonbank institutions that engage in indirect auto lending need to keep themselves well-informed of any obligations imposed on them by the CFPB as part of the CFPB’s effort to indirectly regulate the lending practices of auto dealers.