On Aug. 31, the Consumer Financial Protection Bureau rule that enables the CFPB to supervise the biggest nonbank automobile finance companies will take effect, subjecting the auto finance industry to new and unprecedented regulatory scrutiny. Finance companies across the country are bracing for their first CFPB examinations. Given the recent CFPB settlement with one of the biggest finance companies, nonbank auto lenders should pay special attention to fair lending risk as they build out their compliance functions.
Background Dodd-Frank expressly authorized the CFPB to supervise by, for example, conducting supervisory exams on very large banks (i.e., those with more than $10 billion in assets), nonbank residential mortgage lenders, brokers and servicers, payday lenders, and private student lenders. It also authorized the CFPB to supervise nonbank “larger participants of a market for other consumer financial products or services,” once the CFPB had defined such “larger participants” by regulation. In September 2014, the CFPB issued a proposed rule defining auto finance companies that, with their affiliates, finance at least 10,000 loans annually as larger participants in the auto finance market. The final rule, which the CFPB released in June, sets the same threshold. According to the CFPB, this threshold will cover the top 34 nonbank auto finance companies, which together originate 90 percent of nonbank auto loans and leases.
Nonbank Auto Finance Companies Are Gearing Up for Supervision, with a Special Focus on Fair Lending We know from working with some of the 34 companies that are subject to routine CFPB examinations that the past year has seen a flurry of improvements to compliance management systems. Nonbanks that were not previously supervised suddenly have to implement policies and procedures comparable to those of banks. Many of the companies have hired additional staff or rearranged organization charts to ensure that compliance receives more attention. And law firms have been busy helping out, too. The finance companies have done all this work in the hope that when the CFPB knocks on their doors, their compliance teams will not be surprised by what examiners find.
One of the areas where we have seen nonbank auto finance companies spending significant resources concerns fair lending and the Equal Credit Opportunity Act. This is because of a March 2013 CFPB Bulletin (No. 2013-02), which declared that the CFPB would hold nonbank auto finance companies (and the banks they compete with) responsible for any disparities along racial, ethnic or gender lines in the amount of interest-rate markup (i.e., dealer markup) that dealers were charging. The CFPB has alleged that any such disparities violate ECOA because the markup is added on top of the lender’s risk-adjusted “buy rate.”
The finance company (or bank) typically allows the dealer discretion to mark up the buy rate by up to 2 percent (or 2.25 percent for loans with terms of five years or less), and the dealer’s compensation from the finance source varies in proportion to the size of the markup. Even though the finance company has no control over the size of an individual loan’s markup, the CFPB reasoned that the finance source could reduce or eliminate the disparity by reducing the discretion it gives dealers.
Under pressure from the CFPB, most large finance companies have instituted programs to monitor for disparities at the dealer and portfolio level, and to implement remediation if necessary. Lenders are sending dealers letters when they identify dealer-level disparities. If a dealer fails to reduce or eliminate the disparities, lenders will restrict the dealer’s discretion or even stop buying loans from the dealer. Lenders are frustrated because the CFPB has not provided guidance on what exactly the lender’s monitoring program should look like or how remediation should be calculated. Lenders want to comply with the law, but they don’t want to impose more onerous terms on the dealers than they have to, because dealers can just take their business to another indirect lender.
CFPB Actions Have Already Cost Indirect Lenders $178 Million Since the CFPB released its bulletin, the CFPB and U.S. Department of Justice have been investigating several nonbank auto finance companies and have issued two consent orders, the first with a bank in December 2013, and the second with a nonbank in July 2015.
These consent orders cost the bank $98 million and the nonbank $24 million. Additionally, the CFPB has examined several banks’ auto finance programs and has ordered an additional $56 million in redress based on disparities identified in examination. This redress was paid through nonpublic supervisory action, which means the institutions paid a large price but avoided the embarrassment of a public enforcement action.
The CFPB’s public and nonpublic actions in this area underscore the importance for indirect lenders (bank and nonbank alike) to have rigorous systems in place to monitor their loans and remediate for disparities. Any that have not yet implemented such systems are taking a big risk, since it seems likely the CFPB will closely scrutinize fair lending programs during its early examinations. Unfortunately, the CFPB has not provided any details on how the $56 million in nonpublic redress was distributed; were it to do so, lenders would have a better sense of how to design their own remediation programs.
"Buy Here, Pay Here" Dealers Dodged a Bullet Notably, the larger participant rule does not cover automobile dealers – even if they originate more than 10,000 loans – because Congress granted most automobile dealers a blanket exemption from the CFPB’s authority in section 1029 of Dodd-Frank. Under that exemption, the CFPB “may not exercise any rule-making, supervisory, enforcement or any other authority ... over a motor vehicle dealer that is predominantly engaged in the sale and servicing of motor vehicles, the leasing and servicing of motor vehicles, or both.” 12 U.S.C. 5519. The exemption for dealers, however, is not universal.
The final rule takes the same approach as Dodd-Frank in exempting certain dealers, with one wrinkle – it exempts even those dealers that are otherwise subject to CFPB authority because they extend retail motor vehicle credit or leases to consumers without routinely assigning them to unaffiliated third parties (typically known as “Buy Here, Pay Here” or “BHPH” dealers). The CFPB in the final rule stated that the primary reason for exempting BHPH dealers is that dealers engaged in both buying and financing automobiles “are typically much smaller in asset size and activity level than the entities included in [the final] rule.” However, it left the door open for a “separate larger-participant rulemaking” covering BHPH dealers.
FTC Retains Primary Authority over Dealers at the Federal Level Dodd-Frank’s exemption for auto dealers, and the final rule’s exemption for BHPH dealers, means that the Federal Trade Commission retains primary enforcement jurisdiction over them.1 The FTC regularly takes enforcement actions against dealers, and it coordinates closely with the state attorneys general, with whom it shares enforcement authority. In March, for example, the FTC announced six new actions, totaling $2.6 million in monetary judgments, against dealers found to have engaged in deceptive practices in their sales and finance agreements.
Interestingly, as part of the negotiations over Dodd-Frank’s dealer exemption, Congress (in 12 U.S.C. 5519(d)) granted new authority to the FTC to write rules prohibiting unfair or deceptive acts or practices by exempt auto dealers. Because the FTC’s authority over dealers is broader than the CFPB’s, the agency could use its rule-making power to prohibit any practice it deems to be a UDAP by dealers, regardless of whether the practice is related to the financing of a car. But thus far, the FTC has given no indication that it plans to use this rule-making authority. We would be surprised if the FTC ever uses its authority to write rules for dealers because the agency is much less inclined than the CFPB to take risky positions, and taking on the auto dealers is always a risk given the power they wield with Congress.
This month marks a critical milestone for the auto finance world. For the first time, all of the biggest finance companies will be subject to federal supervision. With the CFPB’s heavy focus on fair lending compliance, this means most dealers will face scrutiny from the indirect lenders with whom they do business. For lenders to stay competitive, they will need to successfully navigate the pressure from the dealers to continue offering discretionary markups, and the pressure from the CFPB to police the dealers to prevent disparities.