FORT WORTH, Texas -

SubPrime Auto Finance News, our sister publication, was on hand at the NAF Association’s 17th annual Non-Prime Auto Financing Conference last month.

On the docket of SubPrime’s extensive coverage was a keynote session that included a question-and-answer dialogue between Hudson Cook chairman Tom Hudson and Rick Hackett, the then-assistant director at the Consumer Financial Protection Bureau.

Below is a condensed recap of the exchange, which took place on June 6. (About two weeks later, Hackett announced he would be leaving the bureau at the end of the month; more details on that can be found here.)

How does the bureau expect to apply disparate impact theory to indirect auto finance companies? Different economic factors affect a customer’s history and account for different rates, reflecting different levels of risk. Credit score, credit history and employment history have no racial or ethnic element to it. Does the CFPB expect all customers to be offered the same rate for funds?

Hackett: It’s a great question that I believe reflects the basic misunderstanding of the issue. When a lender offers a buy rate to a dealer, they’ve already factored into the buy rate differences in credit worthiness and collateral risk. Our concern as we expressed in the bulletin is not with the buy rate, but the discretion permitted to dealers to then add on to the risk-based rate, an add-on that has no relationship to the risk of the transaction. The result is consumers with the exact same risk profile may receive different financing deals. We’re focused only on that additional rate markup, a process that takes place after the lender’s underwriting. It’s the discretionary pricing unrelated to risk that creates the fair-lending risk.

Do you see the dealer’s role in auto financing similar to that of a mortgage broker?

Hackett: With certain exceptions such as buy-here, pay-here, the CFPB has no authority over automobile dealers, whereas we do regulate mortgage brokers. We have direct authority from Dodd-Frank to regulate the brokering of mortgage loans in addition to the making of mortgage loans. The context is very different. Both auto dealers and table-funded mortgage brokers are similar in that they facilitate indirect financing. But there are important differences. An auto dealer might have an ongoing service or sales relationship with the customer that the mortgage broker doesn’t.

Does the CFPB think that permitting dealer discretion in setting rates is per se discriminatory? If the bureau does feel that way, why doesn’t it ban discretionary pricing?

Hackett: It’s the one quick answer I can give: No. We don’t think discretionary pricing is per se illegal. It simply creates and exacerbates the risk that there may be unfair lending outcomes across a large pool of transactions that are originated in that way. In our historical experience with other agencies suggests that this practice creates a measureable risk of discrimination. At the end of the day, the actual effect of discretionary pricing is what matters for regulatory purposes. If a lender has in place controls for these issues and appropriately addresses the risk, you may not have a problem.

If discretionary pricing is not illegal, what do you expect finance companies to do in order to monitor pricing for fair-lending concerns? Should they monitor participation rates? Contract rates? Both?

Hackett: In an overall effective fair-lending compliance program, you monitor lots of stuff. What you’re trying to monitor for this particular issue and what you’re looking for is disparities in pricing of similarly situated persons, meaning FICO and other aspects are the same, that result from the dealer has the discretion to charge one a markup of 300 basis points and another 500 basis points.

What corrective actions do you expect auto creditors to take when their price-monitoring programs shows a large enough pricing disparity? Should they send warning letters to dealers? What would you expect creditors to tell individual dealers?

Hackett: Rate discretion is not per se illegal, but another way to look at it is that the risk it creates is work. Lenders and the market as a whole might decide that work exceeds its value. That’s entirely up to the market. There isn’t any one alternative solution. I’ve seen people talk about flat rates, volume incentives, objective markdowns. One thing we try not to be in the business of is telling the market what to do but rather have the market which is much smarter than we are discern sometimes in a less than precise fashion, what the right answer is.

To me the right answer will always be to monitor the situation. If it’s monitoring the situation with continued discretionary pricing, then what do you do? Again, you need to look at your portfolio and your finance proxies and see what’s going on to make sure you are aware. Given what’s been done in past activities, is it high enough to worry about at all?

We highlighted several things in the bulletin such as communicating with dealers so they understand their obligations and your expectations as a finance company supporting them. If you have an issue on the dealer level, focus your efforts on education, having a system of corrective action for dealers who are creating issues for your portfolio, including possibly restricting the scope of markup.

Yes, we do believe if there are identifiable consumers who have been directly affected by a disparate pricing regime that’s inappropriate; there could be adjustments to their contracts.

The CFPB defines complaints as submissions that express dissatisfaction with or communicates suspicion of wrongful conduct by an identifiable entity related to a consumer’s personal experience with a financial product or service. If that is the definition of a complaint and I am a buy-here, pay-here dealer, and my customer calls in and says, ‘My transmission is broken and that makes me unhappy.’ That’s not a complaint, is it?

Hackett: The context you gave makes it difficult because in a buy-here, pay-here transaction the purchase of the vehicle and the financing activity are so intimately interwoven that it’s hard to separate them. It’s a hard question. I think an easier one might be a complaint might be that says, “I have a loan with this finance company, and the dealer told me the vehicle had four-wheel drive but it’s two-wheel drive.’ That to me, that is a transaction where most of the problem is with the dealer.

 

Editor’s Note:  This article appears in the July 15-31 print and digital editions of Auto Remarketing, as well as the July/August print edition of SubPrime Auto Finance News. Check out both magazines to see more guidance on how to make sure you are CFPB compliant.