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WASHINGTON, D.C. — Legal experts and industry associations weighed
in as the Consumer Financial Protection Bureau released a bulletin Thursday
that targeted dealer reserve and potential discriminatory practices.

Tom Hudson told SubPrime Auto Finance News that he expected
to see the guidance the bulletin contained as the CFPB took its first
regulatory move aimed solely at the auto finance industry.

"There wasn't anything in the bulletin that the bureau hadn't
been signaling for weeks," said Hudson, chairman of Hudson Cook, the Hanover,
Md., firm that specializes in auto finance law. "The bureau representatives
have been out to industry conferences and giving presentations where they've
essentially signaled that this was coming.

"The problem with the guidance they've put out is the banks
and finance companies that are going to have to try to comply with the guidance
aren't being given an awful lot of direction on how to do so," Hudson
continued. "We're going to go through an interesting and difficult period for
the next couple of years while banks and finance companies try to figure how
they're going to operate in the indirect auto space.

"The dealers are likely the ones to put up the biggest fight
here," he added.

Hudson's projection came to fruition as both the National
Automobile Dealers Association and the National Association of Minority
Automobile Dealers refuted the CFPB's position.

The CFPB explained its bulletin was directed at indirect
auto lenders that permit dealers to increase consumer interest rates and that
compensate stores with a share of the increased interest revenues, better known
in the F&I office as dealer reserve or dealer participation.

The agency said it made the notice to provide guidance about
compliance with the fair lending requirements of the Equal Credit Opportunity
Act (ECOA) and its implementing regulation, Regulation B.

CFPB director Richard Cordray said on Thursday that lenders
that offer auto loans through dealerships are responsible for unlawful,
discriminatory pricing, and the bulletin was intended to provide guidance to
indirect auto lenders within the CFPB's jurisdiction on how to address fair
lending risk

Cordray noted the guidance applies to all indirect auto
lenders within the jurisdiction of the CFPB, including both depository
institutions and nonbank institutions.

The head of the CFPB believes potentially discriminatory
markups in auto lending may result in tens of millions of dollars in consumer
harm each year.

"Consumers should not have to pay more for a car loan simply
based on their race," Cordray said. "Today's bulletin clarifies our authority
to pursue auto lenders whose policies harm consumers through unlawful
discrimination."

Meanwhile, NADA and NAMAD took exception to the CFPB's
assertion, insisting how dealers provide critical assistance in the vehicle-financing
process.

"The guidance issued by the CFPB 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," association officials said. "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," they continued. "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," they went on to say.

Both NADA and NAMAD emphasized that they strongly oppose any
form of discrimination in auto lending and agreed how 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," the associations said. "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," officials continued. "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."

Indirect Auto Lenders as Creditors Under the ECOA

The CFPB pointed out the ECOA makes it illegal for a
"creditor" to discriminate in any aspect of a credit transaction because of
race, color, religion, national origin, sex, marital status, age, receipt of
income from any public assistance program, or the exercise, in good faith, of a
right under the Consumer Credit Protection Act.

The ECOA defines a "creditor" to include not only "any
person who regularly extends, renews, or continues credit," but also "any
assignee of an original creditor who participates in the decision to extend,
renew or continue credit."

Regulation B further provides that "creditor" means "a
person, who, in the ordinary course of business, regularly participates in the
decision of whether or not to extend credit" and expressly includes an
"assignee, transferee, or subrogee who so participates."

"The commentary to Regulation B makes clear that an assignee
is considered a ‘creditor' when the assignee participates in the credit
decision," CFPB officials said. "The commentary provides that a ‘creditor
includes all persons participating in the credit decision' and that ‘this may
include an assignee or a potential purchaser of the obligation who influences
the credit decision by indicating whether or not it will purchase the
obligation if the transaction is consummated."

Even as assignees of the installment contract, the CFPB
insisted indirect auto lenders are creditors under the ECOA and Regulation B
if, in the ordinary course of business, they regularly participate in a credit
decision.

"The CFPB recognizes that there is a continuum of indirect
lender participation in credit decisions, ranging from no participation to
being the sole decision maker with respect to a particular transaction, and
that a lender's practices and conduct may place it at various points along this
continuum," officials said.

"The CFPB also recognizes that credit transactions in
indirect auto lending take many forms. However, information gathered by the
CFPB suggests that the standard practices of indirect auto lenders likely
constitute participation in a credit decision under the ECOA and Regulation B,"
they continued.

For example, the CFPB explained that an indirect auto lender
is likely a creditor under the ECOA when it evaluates an applicant's
information, establishes a buy rate, and then communicates that buy rate to the
dealer, indicating that it will purchase the obligation at the designated buy
rate if the transaction is consummated.

In addition, the agency said that when a lender provides
rate sheets to a dealer establishing buy rates and allows the dealer to mark up
those buy rates, the lender may be a creditor under the ECOA when it later
purchases a contract from such a dealer.

"These two examples are illustrative of common industry
practices; indirect auto lenders may also be creditors under other
circumstances," officials said.

Liability of Indirect Auto Lenders for Discrimination
Resulting from Markup & Compensation Policies

The CFPB went on to highlight that an additional
consideration for auto lenders covered as creditors under the ECOA is whether
and under what circumstances they are liable for pricing disparities on a
prohibited basis.

"When such disparities exist within an indirect lender's
portfolio, lenders may be liable under the legal doctrines of both disparate
treatment and disparate impact," officials said.

"An indirect auto lender's markup and compensation policies
may alone be sufficient to trigger liability under the ECOA if the lender
regularly participates in a credit decision and its policies result in
discrimination," they continued. "The disparities triggering liability could
arise either within a particular dealer's transactions or across different
dealers within the lender's portfolio.

"Thus, an indirect auto lender that permits dealer markup
and compensates dealers on that basis may be liable for these policies and
practices if they result in disparities on a prohibited basis," they went on to
say.

The CFPB believes some indirect auto lenders may be
operating under the incorrect assumption that they are not liable under the
ECOA for pricing disparities caused by markup and compensation policies because
Regulation B provides that "a person is not a creditor regarding any violation
of the (ECOA) or (Regulation B) committed by another creditor unless the person
knew or had reasonable notice of the act, policy, or practice that constituted
the violation before becoming involved in the credit transaction."

"This provision limits a creditor's liability for another
creditor's ECOA violations under certain circumstances," the CFPB said. "But it
does not limit a creditor's liability for its own violations — including, for
example, disparities on a prohibited basis that result from the creditor's own
markup and compensation policies.

"Additionally, an indirect auto lender further may have
known or had reasonable notice of a dealer's discriminatory conduct, depending
on the facts and circumstances," the agency added.

Limiting Fair Lending Risk in Indirect Auto Lending

Officials recommended that institutions subject to CFPB
jurisdiction, including indirect auto lenders, should take steps to ensure that
they are operating in compliance with the ECOA and Regulation B as applied to
dealer markup and compensation policies.

The agency indicated these steps may include, but are not
limited to:

—Imposing controls on dealer markup and compensation
policies, or otherwise revising dealer markup and compensation policies, and also
monitoring and addressing the effects of those policies in the manner described
below, so as to address unexplained pricing disparities on prohibited bases.

—Eliminating dealer discretion to mark up buy rates and
fairly compensating dealers using another mechanism, such as a flat fee per
transaction that does not result in discrimination.

Officials mentioned another tool for limiting fair lending
risk in indirect auto lending – developing a robust fair lending compliance
management program.

The CFPB said it recognizes that the appropriate program
will vary among financial institutions.

In its most recent Supervisory Highlights, the CFPB set out
the following features of a strong fair lending compliance program, which the
agency said are applicable in the indirect auto lending context:

—An up-to-date fair lending policy statement.

—Regular fair lending training for all employees involved
with any aspect of the institution's credit transactions, as well as all
officers and board members.

—Ongoing monitoring for compliance with fair lending
policies and procedures.

—Ongoing monitoring for compliance with other policies and
procedures that are intended to reduce fair lending risk (such as controls on
dealer discretion).

—Review of lending policies for potential fair lending
violations, including potential disparate impact.

—Depending on the size and complexity of the financial
institution, regular analysis of loan data in all product areas for potential
disparities on a prohibited basis in pricing, underwriting, or other aspects of
the credit transaction.

—Regular assessment of the marketing of loan products.

—Meaningful oversight of fair lending compliance by
management and, where appropriate, the financial institution's board of
directors.

For some lenders, the CFPB noted that additional
compliance-management components may be necessary to address significant fair
lending risks.

"For example, indirect auto lenders that retain dealer
markup and compensation policies may wish to address the fair lending risks of
such policies by implementing systems for monitoring and corrective action,"
officials said.

The CFPB explained that lenders could achieve this level by
implementing four procedures:

—Sending communications to all participating dealers
explaining the ECOA, stating the lender's expectations with respect to ECOA
compliance, and articulating the dealer's obligation to mark up interest rates
in a non-discriminatory manner in instances where such markups are permitted.

—Conducting regular analyses of both dealer-specific and
portfolio-wide loan pricing data for potential disparities on a prohibited
basis resulting from dealer markup and compensation policies.

—Commencing prompt corrective action against dealers,
including restricting or eliminating their use of dealer markup and
compensation policies or excluding dealers from future transactions, when
analysis identifies unexplained disparities on a prohibited basis.

—Promptly remunerating affected consumers when unexplained
disparities on a prohibited basis are identified either within an individual
dealer's transactions or across the indirect lender's portfolio.

"The CFPB will continue to closely review the operations of
both depository and non-depository indirect auto lenders, utilizing all
appropriate regulatory tools to assess whether supervisory, enforcement, or
other actions may be necessary to ensure that the market for auto lending
provides fair, equitable, and nondiscriminatory access to credit for
consumers," officials said.

What Could Be Ahead for Dealer Reserve

With such a list of recommendations, Hudson offered an
assessment of where the outlook for dealer reserve might be headed.

"If you read between the lines, I think you would conclude
that the bureau would just as soon see dealer participation go away, but they
stopped short of banning it," Hudson said. "In effect, what they've done is
make dealer participation programs awfully time consuming and bothersome for
banks and finance companies because what they've done is put the banks and
finance companies in the business of policing the dealers they deal with.

"So the banks and finance companies are going to have the
choice of going to just a flat rate participation or else really getting into
the operations of the dealer they buy paper from," he added.

Nick Zulovich can be reached at nzulovich@subprimenews.com. Continue the conversation with SubPrime Auto Finance News on LinkedIn and Twitter.