Despite NADA’s landmark victory in getting most auto dealers exempted from direct oversight by the Consumer Financial Protection Bureau (CFPB), it looks like the agency has found a back-door way to make life more difficult for dealerships. The Bureau recently announced that lenders that offer auto loans through dealerships will be held responsible for “unlawful, discriminatory pricing at the dealership level”. The Bureau has indicated that it sees a potential for discriminatory pricing caused by the policies of some indirect auto lenders that allow auto dealers to mark-up lender-established buy rates and that compensate dealers for those markups in the form of reserve. Their rationale is that because of the incentives these policies create, and the discretion they permit, there is a significant risk that they will result in pricing disparities on the basis of race, national origin, and potentially other prohibited bases. A central issue is that lenders traditionally leave it up to dealerships to set the final interest rate customers pay on their indirect auto loans arranged by dealerships. The CFPB guidance calls for additional compliance burdens on lenders who purchase Retail Installment Contracts from dealers and expects those lenders to take “remedial action” with dealers when necessary. As the old saying goes, “stuff” rolls downhill.
Here’s the problem: the CFPB is citing the concept of “disparate impact” - which is purely a statistical analysis - in evaluating potentially discriminatory dealer rate markups. Only the numbers matter, not the intent or even the knowledge of the creditor. So, even if a lender or dealer didn't intend to discriminate, they may still be held liable for perceived discrimination against protected classes. You can be doing everything completely neutral or unbiased but if there is a statistically significant adverse impact on a protected class, you can still be held responsible under the Equal Credit Opportunity Act (ECOA).
The CFPB further recommends that indirect auto lenders take steps to ensure that they are operating in compliance with fair lending laws as applied to dealer markup and compensation policies. These steps may include revising dealer markup policies, eliminating dealer discretion to markup buy rates, and compensating dealers using a different mechanism that does not result in discrimination, such as flat fees per transaction.
As a result of these announcements, at least one major bank has already sent a letter to dealers indicating that it will “periodically review dealer portfolios, addressing indications of potential discrimination”. The letter also stated in part “if you are unable to provide any explanation for the pricing differences, or if we continue to identify unexplained differences in your pricing to protected classes on a prohibited basis, we will consider taking further action”.
Who knows what these “actions” could include - perhaps disruptive audits or even demands for repurchase of a dealer’s entire portfolio?
While it remains to be seen whether this will ultimately affect how dealerships get compensated for arranging financing, it’s clear that the government intends to carefully scrutinize dealer loan-pricing practices.
Now that’s not to say that any of this makes sense. It certainly seems like a stretch that dealers are discriminating against consumers. But keep in mind that while it’s quite likely that allegations of pricing discrimination in connection with dealer participation are questionable at best, the potential liability is real and dealers should pay close attention. Consumer advocates have been pushing the idea that dealer participation is evil for quite some time and the government is obviously buying into it. Keep in mind that while the CFPB may not have direct jurisdiction over dealers, they have working partnerships with the DOJ, FTC. and state attorneys general and could refer matters to those agencies for action against the dealerships. As if that’s not bad enough, plaintiff’s attorneys will almost certainly be on the watch for potential claims of Unfair and Deceptive Acts and Practices (UDAP).
So if your bank, regulator, or an attorney sent you a letter, how would you respond? Following are suggestions on policies and processes that may help favorably position your dealership in the event of a fair lending inquiry.
Implement a desking and fair lending policy at your dealership that addresses how payments are quoted. Dealership personnel need to be careful that the processes they use to quote payments avoid any impression of discriminatory practices. The key is consistency.
· If the dealership runs credit before presenting the first pencil, a good best practice can be to quote all payments initially with a standard (maximum) rate markup. So, for the first pencil, all customers will be quoted the buy rate for the tier they qualify for plus the established markup (e.g. two points) with variances only allowed for competitive and non-discriminatory purposes. If the rate is lowered in negotiations, the reason for the variance should be documented in writing (e.g. to match a rate offered by the customer’s credit union, or to bring the customer within budget, etc.). This way the dealership can show that their practices are consistent, fair, and non-discriminatory and justify why certain rates were higher than others even though the consumers were in the same tier. All exception notices should be kept in the deal jacket and care should be taken not to state the same reason on every deal where there is an exception made.
· If the store doesn’t run credit before the first pencil quote, there can be a “store rate” that is used for all customers. This rate could be based on an average rate of sold deals over the last 90 days. Keep in mind that establishing an accurate store rate is difficult due to the wide range of credit tiers, so running credit before quoting rate is a safer fair lending practice. Another reason why pulling a credit report before quoting a payment reduces risk is that in doing so every quote will be based upon the actual credit-worthiness of the consumer. By “guessing” what rate the customer qualifies for, the possibility of making a mistake is greatly enhanced and it becomes more difficult to document a consistent, non-discriminatory process. In cases where you can’t pull credit before quoting a payment, a best-practice can be to inform those consumers that you are quoting a payment based upon their qualifying for “A” tier credit and that they may not qualify. Any exceptions to quoting rate based on actual credit standing should be documented.
· Always use a good faith effort in quoting the rate that you think the customer will qualify for. You shouldn’t rely on only the finance department to know rates and program guidelines; the desk needs to know as well.
Use full disclosure when quoting payments. Customers should be given all the necessary deal terms, including the selling price, trade allowance, payoff, down payment, rebates, the amount financed, payment, term and rate. This will also help eliminate the potential for payment packing or UDAP claims. Avoid using payment ranges, especially after credit has been run.
Make sure everyone is on the same page. If rates are quoted at the sales desk, that rate should not change in the F&I office unless there’s a valid reason. Practices such as lowering rates to encourage product sales should be avoided (this can also lead to other compliance issues as well). If there is a legitimate reason to adjust a rate in F&I, there should be written documentation. Everyone in the dealership tasked with quoting payments should be trained on your desking policies and the same payment-quoting practices should be used in all departments, including internet, fleet, and special finance.
Train, monitor, and enforce compliance. Many dealership employees are promoted to management positions based solely on their ability to sell cars, and are provided with little or no training. As a result, there is often a lack of loan underwriting knowledge at the desk & F&I level. Managers should have a high-level understanding of credit bureau interpretation, loan underwriting guidelines, and deal structuring in order to produce consistent, logical pencils and structures that are not potentially discriminatory. Traditional sales and F&I training typically don’t provide those forms of education and curriculum. An investment in comprehensive training will go a long way towards protecting the dealership. In addition, regular audits should be performed and all employees should be held accountable for strict adherence to company policies.
Of course, this entire discussion may be moot if the consumer advocates somehow get their way and are successful in outlawing dealer rate markups. Let’s hope that doesn’t happen, but if it does I’m sure the industry will overcome adversity as it always has and continue to prosper. That said, I believe the suggestions above are good business practices whether the current dealer compensation system remains the same or we move to flat fee- only compensation. Well-thought-out and consistent processes, transparency, and education are always recipes for success.