The Consumer Financial Protection Bureau (CFPB) released a bulletin last week warning lenders that offer auto loans through car dealerships that the CFPB will hold them responsible for lending practices by dealers that have a disproportionate impact on protected groups of borrowers.
When a lender allows a dealer to originate auto loans on its behalf, it is referred to as "indirect auto financing." This arrangement is productive for lenders because it allows them to access potential borrowers at the opportune moment (when they are at the dealership and ready to make a purchase) and for dealers because it enables them to facilitate sales at the opportune moment (without the consumer leaving the showroom to make financing arrangements). The appeal of such an arrangement is obvious, and accordingly, indirect and direct auto financing is almost ubiquitous in auto dealerships across the U.S.
The indirect auto financing process usually works in the following way: The dealer collects information from the buyer/credit applicant and shares it with one or more auto lenders, usually electronically. The lender then evaluates the credit applicant and decides whether or not to offer a loan. (Alternatively, a lender may, in some cases, give a dealer underwriting criteria and commit to make loans to qualified applicants or purchase loans made by the dealer to qualified applicants.) The lender will then usually give the dealer a risk-based interest rate (called the “buy rate”) that is the lowest rate at which the lender is willing to make the loan. Sometimes, the dealer has the ability to (a) offer the buyer/credit applicant a higher rate, (b) authorize exceptions to the lender's underwriting criteria, and/or (c) change certain terms of the loan based on negotiations with the buyer/credit applicant.
If a lender regularly participates in credit decisions, even if the loans are closed in the name of the dealer and later sold to the lender, the lender will be deemed a "creditor" under the Equal Credit Opportunity Act (ECOA) and Regulation B. The ECOA and Reg. B prohibit a lender from making a credit decision based on an applicant's race, color, religion, national origin, sex, marital status, age, receipt of income from any public assistance program, and other bases. The CFPB has made clear that it will hold lenders responsible for discrimination resulting from dealers' practices if the lender should have known about them--even if the lender did not know about them.
In order to mitigate the risk arising from indirect auto lending, the CFPB offers a number of suggestions to lenders, including, but are not limited to, the following:
- Ensure the dealers have up-to-date fair lending policy statements;
- Require fair lending training for all dealer employees involved with any aspect of the credit transactions;
- Impose controls on dealer policies and practices, and monitor the dealers' implementation, addressing unexplained pricing disparities;
- Review dealers' marketing of credit products;
- Review dealers' transactions for signs of disparate impact;
- A lender may decide simply to eliminate dealer discretion on interest rates and compensate dealers on a flat fee basis.
The CFPB encourages lenders to take certain immediate steps to address dealers' lending practices. A couple of these comments are particularly concerning:
First, the CFPB expects lenders to take "prompt corrective action" against dealers when "unexplained disparities" are identified. This admonishment arises from the CFPB's position on the disparate impact theory. Disparate impact theory is a legal theory adopted by the CFPB under which a policy or practice that, on its face, seems neutral and fair, but in practice results in a different impact on people of one protected group versus another (e.g., a racial group, women, or welfare recipients). As I have written before, the disparate impact theory operates by shifting the burden of proof from the plaintiff to the defendant-lender so that the defendant-lender must actually prove itself innocent. Good intentions are not a defense. The fact that the CFPB will hold a lender liable for even the unintended consequences of a car dealer's practices should be a matter of serious concern to any indirect auto lender.
In addition, the CFPB expects indirect auto lenders to promptly reimburse consumers when unexplained disparities are identified. Another way of explaining the CFPB's position on this point is that it expects lenders to rapidly begin writing checks to borrowers who voluntarily agreed to enter into transactions on specific terms if the lender finds out that a third-party dealer unintentionally handled lending in a way that seemed to be fair but somehow resulted in different outcomes for a certain group--even before the CFPB or a borrower raises a complaint.
Whether or not the CFPB is being fair to lenders, all lenders and auto dealers should be aware of the CFPB's stance and position themselves to avoid adverse action (or successfully defend against it) by carefully reviewing and documenting ECOA policies and procedures. The writing is on the wall, and auto lenders ignore it at their own peril.