Following an investigation by the Consumer Financial Protection Bureau (“CFPB”) and the Department of Justice (“DOJ”), a captive indirect auto lender agreed on February 2, 2016, to change its pricing policies and compensation systems to limit dealer discretion and financial incentives to mark up interest rates for auto purchases.
The investigation of the lender’s policies stemmed from the CFPB and DOJ’s increased joint focus on fair lending risk in the indirect auto lending arena. Beginning in April 2013, the agencies launched an investigation to determine whether the lender’s indirect lending activities violated the Equal Credit Opportunity Act, which prevents lenders from discriminating against potential borrowers on the basis of race, national origin, and other characteristics unrelated to creditworthiness. Larger nonbank auto finance companies, which include indirect auto lenders, are now subject to the CFPB’s supervisory authority since the agency’s implementation of a new rule in June 2015 (see here for a discussion of the rule).
The CFPB and DOJ used a proxy methodology to assess the probability that a borrower was of a certain race or national origin, and then estimated whether differences in dealer markups based on race or national origin existed.
Based on their findings, the agencies alleged that the lender’s pricing and compensation practices caused African-American borrowers to pay, on average, 27 basis points (or a total of $200 over the full loan term) more than non-Hispanic white borrowers, and Asian and Pacific Islander borrowers to pay, on average, 18 basis points (or a total of $100 over the full loan term) more than non-Hispanic white borrowers.
Under the CFPB’s order, the lender must:
• Pay $19.9 million in restitution to minority borrowers for paying higher interest rates than white borrowers between January 2011 and February 2, 2016, due to dealer markups;
• Pay up to $2 million to compensate minority borrowers impacted by these policies from February 2, 2016, until the lender puts in place its new policies;
• Limit dealer discretion in markups to 1.25 percent above the interest rate for loans with terms of five years or fewer and 1 percent for loans with longer terms;
• Choose among three options for managing the fair lending risk associated with dealer discretion: (1) allow dealer discretion in markups and monitor for fair lending compliance; (2) allow dealers to choose a pre-set markup rate, but require documentation to justify exceptions to the same; or (3) eliminate dealer discretion; and
• Provide funds to hire a settlement administrator to contact and distribute funds to the affected borrowers.
The lender also agreed that it would not fund additional nondiscretionary dealer compensation by quoting higher interest rates to dealers. Interestingly, the agencies did not require the lender to pay penalties because of the “proactive steps” it has taken to address the fair lending issues raised.
Since December 2013, the agencies have reached three other public resolutions regarding fair lending risks in dealer discretion and financial incentives (see here; here; and here for a discussion of these resolutions). This resolution indicates a continued focus by the CFPB and DOJ on investigating lending practices by indirect auto lenders.