Feds eye finance reserve
Several lenders get warning letters
Cordray: Stats tell the tale.
For more than two years, dealers have been bracing for possible actions by the Consumer Financial Protection Bureau, formed after the financial crisis of 2008.
Now the federal agency has taken its first auto-related action, and it appears to be aimed at a longstanding auto-lending issue: whether minorities are hurt unfairly by car dealers keeping a point or so of the interest rate on a car loan.
Beginning in the late 1990s, a string of lawsuits alleging discriminatory or predatory lending tied to the finance reserve were filed against various banks and the captive finance arms of Nissan, Ford, General Motors, Honda and other automakers. Most were settled by 2003, with the lenders agreeing to cap the finance reserve at two or three percentage points. That cap became the industry standard.
Now the CFPB is taking another look at the finance reserve and possible unfair lending practices.
This month the bureau put several auto lenders on notice after bank examinations turned up evidence of what the agency considers violations of the Equal Credit Opportunity Act, said Chris Stinebert, CEO of the American Financial Services Association, a Washington lobbying group.
Stinebert, whose group represents banks, captives and other lenders, said he doesn't know how many lenders received the letter. Bloomberg reported that the CFPB sent letters to "at least four" banks.
"We don't believe these investigations and these letters are warranted," Stinebert told Automotive News. "We are very concerned the CFPB is viewing this in a very selective, isolated way."
The National Automobile Dealers Association, in a statement, said, "Dealers are committed to ensuring that all categories of consumers are protected and treated fairly."
Dealership-assisted financing, or an indirect loan, "provides overwhelming consumer benefits," NADA said. Last year, NADA experts testified to the Federal Trade Commission that consumer interest rates for indirect loans are often cheaper than direct-to-consumer loans, even though dealerships are compensated for being a middleman on indirect loans, as a result of competition among lenders for dealers' business.
The CFPB declined to comment.
For most auto loans, dealerships tack an additional amount, called finance or dealer reserve, onto the interest rate the customer will pay. Today it's typically less than 2.5 percentage points and sometimes less than a single point.
That's the dealership's cut for negotiating the loan, finding the customer a lender and handling the paperwork. The lender, which typically prices the loan knowing that the dealership will add the finance reserve, returns most of the profit from the markup to the dealership.
Lobbyist Chris Stinebert: “We don’t believe these investigations and these letters are warranted.”
Stinebert said the CFPB's case for discriminatory lending is based on the theory of disparate impact.
Disparate impact is what happens if legally protected classes, such as minorities or women, are charged more than other borrowers with similar qualifications. It doesn't matter whether the lender or the dealer intended to discriminate. Under the disparate impact theory only the results matter, based on statistical analysis, as CFPB Director Richard Cordray affirmed last week without talking about specific cases.
"From the perspective of a consumer disadvantaged by policies that have a discriminatory effect, it makes no practical difference whether a lender consciously intended to discriminate," he told the CFPB's Consumer Advisory Board last week. "Lenders whose policies provide incentives for brokers or loan officers to negotiate higher rates have often been shown to result in African-American and Hispanic borrowers paying more for mortgages and auto loans."
Lenders can't say the CFPB didn't warn them, at least in general terms. Without singling out auto lenders or dealers, the CFPB said last April it would employ disparate impact to go after discrimination.
Lawyer Michael Benoit, a partner at Hudson Cook in Hanover, Md., said consumer-advocate groups wonder whether auto lenders observe the industry rate standards. He said his clients include several large auto lenders.
The lenders he's aware of have stuck with those limits, and in fact actual finance reserve is much lower on average, Benoit said. He said the legal theory being advanced by the CFPB today is a "rehash" of the earlier discrimination lawsuits.
When the CFPB was created in 2010, dealerships were excluded from its jurisdiction -- except for buy-here, pay-here stores, which collect their own loans -- but not auto lenders.
A CFPB spokesman made it clear at the AFSA Vehicle Finance Conference in Orlando this month that the CFPB expects lenders to take "remedial action" with dealers when necessary.
"Lenders need to have a compliance program that includes the effects of their compensation system," said Rick Hackett, CFPB assistant director for installment and liquidity lending markets. "And where that compensation system has the effect of causing a disparate impact, the lender needs to consider whether a dealer interaction or other means are necessary."
Tyler Corder, CEO of Findlay Automotive Group in Henderson, Nev., has been warning dealers and lenders that tougher regulation for finance reserve was only a matter of time.
Corder's solution to the lost finance-reserve revenue is to sell more finance and insurance products, such as extended-service contracts, to make up the difference. The Findlay group has 27 locations, mostly in and around Las Vegas.
"I've been de-emphasizing finance reserve for several years," he said. "My guess has been that it would be more highly regulated, and now it looks like that's going to happen."
You can reach Jim Henry at firstname.lastname@example.org.