Ally won't be a 'Trojan horse'

Lender sticks with dealer reserve, defies CFPB

NEW ORLEANS -- The Consumer Financial Protection Bureau wants Ally Financial and other auto lenders to switch from dealer reserve to flat fees or some other new compensation plan for dealers.

But Ally will stick with dealer reserve.

"We are not going to be the Trojan horse for driving industry change," Ally CEO Michael Carpenter told Automotive News at the National Automobile Dealers Association convention here.

Dealer reserve is at the heart of allegations of discriminatory auto lending that led to the $98 million consent order Ally signed Dec. 20 with the CFPB and the U.S. Department of Justice.

"We are not going to go to flats," Carpenter said. "That is obviously not what the CFPB wanted to hear. They thought we were going to cave" and set an example for other auto lenders that would reverberate through the industry.

Chicago lawyer Ken Rojc, a specialist in auto finance law, said: "This sends a huge signal to the industry."

Ally was the largest auto lender in the United States in 2011 and 2012. Its share slipped in 2013, but Ally remains among the top five, according to Experian Automotive.

Through a spokeswoman, the CFPB declined to comment for this report.

Carpenter acknowledged that profits are at stake: Dealers would simply take their business elsewhere if Ally dropped dealer reserve and other lenders didn't. But he insists that Ally's stand is partly the result of what Carpenter called "nonnegotiable principle."

In fact, Ally was standing its ground even as it negotiated separately with the Federal Reserve for a change in its legal status that was critical for continuing its insurance and online auction operations.

Dealer reserve, also known as dealer participation or dealer markup, is the added interest lenders allow a dealership to tack onto an auto loan as compensation for acting as a middleman. The amount of that additional interest, generally up to 2 percentage points, is set at the dealer's discretion.

The CFPB maintains that dealer discretion in setting dealer reserve results, whether intentionally or not, in higher interest rates -- a so-called disparate impact -- for legally protected classes of borrowers such as minorities or women.

The CFPB analyzed about 800,000 contracts, excluding ones that included automakers' incentives, which Ally had purchased from dealerships between April 2011 and March 2012. The study, which was the basis for the consent order, found that African-American borrowers paid an average of 0.29 percentage point, or about $300 over the life of the loan, more than similarly situated non-Hispanic whites.

Hispanic borrowers paid an average of 0.2 percentage point more, or about $200. Asian or Pacific Islander borrowers paid an additional 0.22 point, which also worked out to about $200, the consent order said.

Those price differences are statistically significant, the CFPB says. According to its analysis, the differences are not related to creditworthiness or risk. The bureau maintains that any creditworthiness concerns are priced into the loan by the lender before the dealership adds the dealer reserve.

Under the consent order, Ally agreed to pay $80 million in restitution and another $18 million in penalties for what the CFPB said was past discriminatory lending. Who is eligible for restitution and in what amount remain to be determined. In January, Ally said it will book a $98 million pretax charge to fourth-quarter earnings due to the consent order, but still expects net profits of $90 million to $110 million.

To eliminate discrimination, the CFPB wants lenders to switch to what it calls nondiscretionary compensation for dealers, such as a flat fee or a fixed percent of the amount financed, whereby dealerships in theory wouldn't have any discretion over their own compensation.

Flat fees or ...

The consent order Ally signed in December with the CFPB and the U.S. Department of Justice says Ally "may" submit a nondiscretionary compensation plan for the CFPB's review, but doesn't require Ally to do so. In other words, Ally had a choice going forward, with one option being a switch to flat fees.

Ally probably could have satisfied the government simply by adopting flat fees. Instead, by exercising its option to stick with dealer reserve, Ally is accepting several potentially onerous new analyses and reporting requirements spelled out in the consent order.

For starters, Ally will have to analyze loans originated at dealerships for variations in dealer reserve at least quarterly. The analysis must be performed on both a dealership-by-dealership basis and a portfoliowide basis, with all dealerships added together. To be in CFPB compliance, Carpenter said, the variation in rates between, say, minority and nonminority consumers must be within 0.1 percentage point.

Ally also must submit a compliance plan for CFPB approval, which must include provisions for appropriate corrective action for dealerships for what the CFPB calls disparities on a prohibited basis.

Specifically, those corrective actions are to include restricting or eliminating an offending dealership's ability to exercise discretion in setting dealer reserve, providing refunds to affected consumers, and, when necessary, terminating dealers responsible for statistically significant disparities in dealer markup on a prohibited basis.

Rojc, the Chicago lawyer, said other lenders and dealers were watching closely for Ally's next move. "This is a huge development," he said of Ally's decision to stay with dealer reserve. Rojc (pronounced Royce) is the managing partner in charge of the auto finance group for Nisen & Elliott, whose auto lender clients include several major banks and captive finance companies, but not Ally.

Tom Hudson, a partner at the law firm Hudson Cook in Hanover, Md., said Ally's decision to stick with dealer reserve was not surprising. That's because Ally would lose share if it changed dealer compensation, Hudson said.

John Casesa, senior managing director for investment banking for Guggenheim Securities in New York, said Ally's decision is a vote for market forces over government regulation.

"Ally's commitment underscores it's a robust, efficient, competitive wholesale market for auto finance," he said. "Supporting a government-regulated environment over a competitive market is never going to yield lower prices."

Ally agreed to the consent order even though it said at the time it didn't agree with the CFPB's conclusions. In a statement last month, the company said: "Ally does not engage in or condone violations of law or discriminatory practices, and based on the company's analysis of its business, it does not believe that there is measurable discrimination by auto dealers."


So why did Ally go along with the consent order?

Carpenter said Ally was motivated in part by a desire to get the consent order behind it so it could move forward on other urgent business.

At the time, Ally had a request pending before the Federal Reserve to move up to financial holding company status from bank holding company status, Carpenter said. The CFPB was one of a number of regulators that had input on the Federal Reserve's decision on financial holding company status.

Ally needed the change in status to retain its insurance, including automotive finance-and-insurance products, and used-car remarketing operations -- businesses that are important to Ally's future as an independent auto lender. The change also makes it easier for Ally to make acquisitions and to pay dividends, Carpenter said.

"It was important for us to put the CFPB thing in the mirror," he said.

The Fed approved that request on Dec. 23, just three days after the CFPB consent order was announced and just as a deadline for approving the request was about to expire.

"That was a critical step to becoming a more independent company," he said. "No investor publically was going to invest in us unless we got financial holding company status. And we could not do that without coming to terms with the CFPB."

You can reach Jim Henry at

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