I recently attended the American Financial Services Association’s (AFSA) Vehicle Finance Conference in New Orleans. Despite unseasonably cold weather, there were plenty of reasons for those in the auto finance market to have a spring in their step. The industry is coming off a strong 2013, with forecasts projecting another year of delinquency rates far below levels observed during and just after the recession. Yet much of the discussion at the conference centered on increased scrutiny from the Consumer Financial Protection Bureau (CFPB) and other regulatory hurdles.
Dominating the conversation was the recent consent order issued by the CFPB regarding disparities found in Ally Financial’s dealer reserve compensation, commonly referred to as the “dealer markup.” For those not familiar with this practice, the dealer markup is an amount of interest the dealer can add, at its discretion, to the lender's established rate (the “buy rate”) as compensation for negotiating an auto loan.
While the auto loan contracts purchased by Ally from nationwide dealerships did not contain information on race or national origin, the CFPB and the Department of Justice’s joint investigation used a proxy methodology to allege that Ally’s dealer compensation had a discriminatory impact on a number of minority groups. The agencies found that African Americans, Hispanics and Asian Pacific Island borrowers were obligated to pay a higher interest rate than other similarly situated white borrowers.
Since the publication of the CFPB’s March 2013 bulletin on indirect auto lending, the industry has been discussing the Bureau’s reliance on the legal doctrine of disparate impact (a facially neutral practice that has a disproportionately adverse impact on members of a protected class) in examining the dealer markup. The use of this doctrine is already being disputed in the fair housing context. The Supreme Court twice has been set to weigh in, only to have the cases settled at the eleventh hour. The next disparate impact case, which may eventually make its way to the Supreme Court, currently resides in U.S. District Court in Washington DC.
In the absence of a Supreme Court decision, the CFPB and the auto finance industry continue to be at odds. The CFPB suggests flat fees, or a variation, as a possible remedy for the dealer markup issue. Auto financing sources and dealers have been actively working to demonstrate the value of the existing dealer compensation model, while highlighting the detriment that flat fees could bring to the consumer. Moreover, the industry is examining ways in which proxy methods can be tested and dealer monitoring can be implemented.
This debate continued in New Orleans. The head of the CFPB’s Fair Lending Office, Patrice Ficklin, met with conference attendees and delivered a keynote speech to a packed conference hall. She expressed her ongoing commitment to maintaining a healthy dialogue with the industry, although there were no new revelations regarding a pathway to compliance. Indeed, many at the conference were already preparing for CFPB regulatory scrutiny to intensify in the months ahead.
So what’s next? Non-bank auto finance sources, such as captive finance companies, are expecting the CFPB to issue a Larger Participant Rule (LPR) proposal sometime in the first half of 2014. Under the Dodd-Frank Act, the CFPB was granted the authority to supervise nonbank “larger participant[s]” in certain markets, identified and defined through rulemaking by the Bureau, for consumer financial products or services. When the LPR rule is final, it will mark the first time that large, non-bank auto lenders will be supervised at the federal level. This means an increased emphasis on compliance across the credit lifecycle.
FICO’s work with both auto finance sources, as well as banks large and small, reveals that CFPB examiners will scrutinize areas such as model management, marketing activities, and collections and recovery, as well as furnisher responsibilities related to the Fair Credit Reporting Act. In short, fair lending will be just one area of focus.
While compliance was definitely the talk of New Orleans, the importance of innovation and emerging technologies was also heavily featured. Addressing this theme, FICO’s Chief Analytics Officer—and my fellow blogger—Dr. Andrew Jennings gave two presentations on how predictive analytics can be used with Big Data to drive significant business impacts. In fact, analytics are not only being widely used to improve performance but also to ensure regulatory compliance. This will undoubtedly make them invaluable as the auto finance industry looks to grow while adjusting to a changing regulatory landscape.
