Last week, the Consumer Financial Protection Bureau issued a bulletin on what it perceives as the "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. According to the CFPB, 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.
On what are these comments and opinions based?
Well, according to the bulletin, the CFPB's opinion that the finance reserve (the dealer's participation in the difference in the auto lender buy rate and the rate the dealer sells the loan to the consumer) provides incentive to dealers to engage in discriminatory pricing is based on the CFPB's "supervisory experience." Really?
The conclusions in the CFPB bulletin are like a defective complaint filed in court; they are based on mere conclusions and legal analysis, not actual facts. Nonetheless, dealers should take heed. It is clear that the CFPB is targeting the finance reserve, one of the remaining reliable sources of profit in auto sales in light of the ongoing efforts of manufacturers to place emphasis on sales volume and the increased competition fostered by Internet marketing.
The National Automobile Dealers Association (NADA) and the National Association of Minority Automobile Dealers (NAMAD) issued the following statement in response to the guidance from the CFPB:
The guidance issued by the CFPB today attempts to force auto finance sources into changing the way they compensate dealers without any indication that the Bureau has examined the effect this change could have on the cost of credit for consumers. The dealer-assisted financing model (indirect auto lending) has been enormously successful in both increasing access to, and reducing the cost of, credit for millions of Americans. Consumers overwhelmingly choose optional dealer-assisted financing because it’s convenient and competitive. The CFPB’s attempt to eliminate the dealer’s ability to discount the APR that it offers to consumers will only weaken the consumer’s ability to secure financing at the lowest possible cost. This anti-competitive approach is not in the interests of consumers and should not be accomplished through guidance and enforcement actions that lack transparency, the opportunity for public comment, and the benefits of a data driven analysis into the effects they would have on consumers and the automobile financing marketplace. It also should not be accomplished without the full participation of the Federal Reserve Board and the Federal Trade Commission, which are the two agencies that Congress vested with authority over auto dealers engaged in indirect lending.
NADA and NAMAD strongly oppose any form of discrimination in auto lending, and the CFPB guidance appropriately explains that unlawful discrimination has no place in the marketplace. However, it is relying on a theory of discrimination that is based on a statistical analysis of past transactions – not intentional conduct – and the CFPB has not provided any information about how it is conducting its analysis. Without such basic information as how the CFPB is identifying different groups of consumers, how it is controlling for factors that can affect finance rates but are unrelated to the consumer’s background, and what constitutes a finding of disparate impact, one can have little confidence that the CFPB is conducting its analysis in a statistically-reliable manner. Regrettably, no one is well served by such an opaque process. While NADA and NAMAD stand ready to work with all of the federal agencies with responsibilities in this area, NADA and NAMAD encourage the CFPB to approach this issue in a more considered, transparent and coordinated manner.
While it remains to be seen where this most recent attack on the dealer reserve will go, attacks on the finance reserve are not new. Consumer advocates have long targeted the finance reserve, calling it an unlawful practice.
In 2000, several lawsuits were filed in California against numerous automobile dealerships and financing companies. The lawsuits challenged the legality of the “dealer reserve” or “dealer participation” paid by the lender to the dealer when the dealer assigns a conditional sale contract between the buyer and the dealer to the lender. The dealers won in trial court, which resulted in an appeal. But in 2003, in a major victory for dealers, the court of appeal affirmed the trial court, finding that there was nothing unfair or unlawful about the "dealer reserve" or "dealer participation." The case was Kunert v. Mission Financial Services Corp.
Of course, this was only the beginning. Consumer advocates, believing the "dealer reserve" was unfair to consumers, next turned to the California legislature to limit it further. In 2005, consumer advocates initiated the Car Buyer's Bill of Rights to require dealers to disclose the amount of the finance reserve they received in profit and to limit it to $150. That bill was defeated in favor of a competing bill (A.B. 68) that went into effect on July 1, 2006 and capped auto financing fees as follows:
- If a dealer obtains financing on your behalf, the dealer compensation from an institution financing the purchase of a vehicle is limited to no more than:
- 2 percent of the purchase amount for contracts with a term of more than 60 months; or
- 2.5 percent of the purchase amount for contracts with a term of 60 months or less.
The saying goes: "as goes California, so goes the nation." Consequently, several other states faced similar measures. For example, in the 2007/2008 legislative session, 24 Car Buyers’ Bill of Rights and related bills were introduced in Alaska, Arizona, Illinois, Maryland, Massachusetts, Mississippi, New Hampshire, New York, Pennsylvania, Rhode Island and Washington with varying degrees of success.
With only moderate success on this issue in the states, consumer advocates turned to the federal government. On April 19, 2011, the Center For Responsible Lending issued a report called: "Under the Hood: Auto Loan Interest Rate Hikes Inflate Consumer Costs and Loan Losses," which concluded that (1) consumers who financed cars through a dealership will pay over $25.8 billion in interest rate markups over the lives of their loans; (2) dealers tend to mark up interest rates more for borrowers with weaker credit; and (3) rate mark ups are a strong driver of default and repossession among subprime borrowers.
In connection with the FTC Roundtables that occurred in 2011 to address consumer issues in Motor Vehicle Financing and Leasing, areport by Bradley Miller, Associate Director of Legal and Regulatory Affairs at the NADA, debunked these conclusions as a matter of fact.
As we can see, however, the CFPB may have the last word on this debate. For now, dealers should consult with their legal counsel on how to protect themselves from claims of discriminatory pricing. Additionally, several compliance companies, including Auto Advisory Services and Compli and others are hosting webinars on this topic to educate dealers on best practices to avoid specious claims of pricing discrimination in connection with the dealer reserve.