Feds, Ally reach $98M pact in lending-bias case
Ally reaches $98M pact with feds in lending-bias case

A first strike on dealer reserve

Feds, Ally reach $98M pact in lending-bias case

Cordray: "New attention to this serious problem"
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WASHINGTON -- The federal government is sending a clear message to auto lenders: It's time for them to rethink the way they pay dealers for arranging loans.

The 3-year-old Consumer Financial Protection Bureau and the U.S. Department of Justice last week announced a $98 million settlement with Ally Financial Inc. to resolve claims that Ally's method of compensating dealers had resulted in loans with higher interest rates for minority buyers.

The crackdown on Ally, which finances vehicle purchases at more than 12,000 U.S. dealerships, underscores the fact that regulators are ready and willing to act on concerns about the dealer reserve -- the payment lenders make to dealers for arranging a loan -- despite fierce pushback this year.

"What the CFPB is trying to do is shift the business model," said Michael Benoit, a Washington partner at law firm Hudson Cook LLP, who predicts more such enforcement actions. "And this is the way they're choosing to do it."

Under the settlement, Ally will repay $80 million to affected car buyers and pay an $18 million civil penalty. That amount pales in comparison with the multibillion-dollar settlements the U.S. government reached with banks in the aftermath of the housing crisis, but it's the largest auto loan discrimination settlement in U.S. history.

Fair-lending advocates have long taken aim at the practice of the dealer reserve, in which a lender agrees to finance a car purchase at a certain interest rate but lets the dealer charge a higher rate and pocket the difference. The CFPB says this discretion has led to bias against minorities.

Differences in dealer reserve meant African-American car buyers with loans financed by Ally paid an average of $300 in extra interest over the life of a loan, compared with white car buyers with similar credit profiles, according to a government analysis.

"Too often, these consumers do not know they're paying more or are simply unable to get recourse," CFPB Director Richard Cordray told reporters after announcing the settlement. "Today's action signals new attention to this serious problem."

Disparate impact
The government says it detected discrimination by analyzing 800,000 dealer-originated auto loans that Ally purchased from April 2011 to March 2012. Ally had a limit on dealer reserve of 200 or 250 basis points (2 or 2.5 percentage points), and minorities typically ended up with higher rates than non-Hispanic whites with similar credit profiles, the CFPB found.
• African Americans paid 29 basis points more than whites, or about $300 over the life of a loan.
• Asian Americans paid 22 basis points more, or about $200 over the life of a loan.
• Hispanics paid 20 basis points more, or about $200 over the life of a loan.
Source: CFPB

A cut of the interest rate has become a key profit source for dealers as repair work has dried up and the profit margin on new cars has narrowed. They have fiercely resisted the CFPB's enforcement push, saying dealer reserve lets them haggle with customers -- and sometimes negotiate lower interest rates -- while other payment structures, such as flat fees, do not.

Dealers have stepped up lobbying on the issue since March, when the CFPB released a bulletin saying it had detected discrimination in auto lending and urging lenders to examine their practices.

The National Automobile Dealers Association slammed the action against Ally, saying the CFPB has yet to explain fully the basis for its findings of bias.

"This is an attempt to scare the rest of the auto lending marketplace into changing their auto lending policies," NADA spokesman Bailey Wood said in an interview. "But the fact remains that dealers are still going to be able to discount interest rates for their customers."

A settlement with Ally has symbolic importance because Ally is the largest U.S. auto finance company in terms of the number of car deals. It financed about 6.2 percent of loans and leases on U.S. car purchases in the first quarter of 2013, according to an August report by Experian Automotive.

Ally did not admit fault as part of the settlement, but said it will step up monitoring of dealers and make other policy changes to reduce the perceived disparity.

The company "does not believe that there is measurable discrimination by auto dealers," the company said. "Regardless, Ally takes the assertions by the CFPB and DOJ very seriously and has agreed to the terms" of the settlement.

Experts say this may be just the first in a series of enforcement cases under the Dodd-Frank financial reform law, which gave the CFPB unprecedented authority to supervise the nation's largest financial institutions but exempted auto dealers from direct oversight.

Justice Department officials said at a recent forum in Washington that several auto lending cases have been referred to the agency under the Equal Credit Opportunity Act, which makes it illegal to charge higher interest rates to minorities.

"I expect that we'll see a few more of these in the next few weeks," said Benoit, the Washington lawyer. "They don't generally do these things on a one-off basis."

You can reach Gabe Nelson at gnelson@crain.com.

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