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.
