Objects in the mirror are closer than they appear - Auto finance industry keeps its sights on impending regulation
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Objects in the
mirror are closer
than they appear
Auto finance industry keeps its
sights on impending regulation
December 2013
FPO
Contents Is your organization ready for increased regulatory scrutiny? 1 Six areas of focus: Working together to meet regulatory requirements 6 How PwC can help 16 Contacts 17
Is your organization ready
for increased regulatory
scrutiny?
Although most auto dealers are What’s on the horizon?
exempt from the Consumer Financial
Protection Bureau’s (CFPB’s) Auto loans in today’s marketplace
supervisory authority, CFPB’s oversight are most often executed indirectly,
of automobile finance transactions is between the consumer and an
expanding. In the upcoming months, automobile dealer, rather than directly,
auto lenders and dealers are likely with a bank, captive automotive
to see increased regulatory scrutiny finance entity, or private finance
around consumer protection matters, company. And depending on the
and this could mean significant channel in which the financing is
changes for the industry. For the auto conducted, regulatory oversight could
finance industry and those entities that impact the industry mainly in two
help consumers with financing options ways: it could be directly enforced by
for automobile purchases and leases, the CFPB (i.e., for a supervised lender
now is the time to assess the changing subject to CFPB oversight), or the CFPB
regulatory landscape, evaluate may influence the lender through its
where the stress points will be, and relationship with other regulatory
prepare for an increase in oversight agencies (i.e., related to a lender’s
and attention from the CFPB or other interactions with a dealer).
supervisory or enforcement agencies.
Auto lenders and dealers are likely to see
continued increased regulation – and
this could mean significant changes for
the industry.
Objects in the mirror are closer than they appear 1
Meanwhile, many leaders in the consumer protection concerns. In With greater regulation
automotive finance industry expect 2012, for instance, a credit card issuer
that auto lenders will bear significant was ordered to refund tens of millions
on the horizon, dealers
responsibility for helping dealers of dollars for what were described and lenders should work
adhere to the evolving framework of as illegal credit card practices. Some together to enhance their
federal consumer lending regulations. of the violations cited included
For example, in a recent bulletin, the deceiving consumers who had signed regulatory compliance
CFPB encouraged auto lenders to up for certain credit card programs frameworks.
review whether they have appropriate and misleading consumers about the
controls in place to comply with the benefits of paying off old debt.
federal fair lending laws in connection
with dealer markups and dealer These rulings go to the heart of the
compensation policies.1 CFPB’s mission, to make markets for
consumer financial products and
Another example of the impact of the services work for Americans. The
CFPB’s oversight can be found in its actions taken to date by the CFPB
recent enforcement action against auto against auto lenders and credit card
lenders for deceptive marketing and issuers are evidence that unfair or
lending practices. In this enforcement misleading sales, marketing, pricing,
action, the CFPB ordered refunds of and collection tactics will continue to
over $6 million for borrowers subject be a focus for federal regulators across
to financial protections given their consumer lending.
status as military service members.
According to the CFPB, the lenders But for the auto finance industry, the
had failed to properly disclose all traditional fair lending considerations
fees charged to program participants relating to prohibited basis pricing
disparities are just the tip of the
and misrepresented the true cost and Prohibited basis –
coverage of after-market products regulatory iceberg. The CFPB, Federal
Trade Commission (FTC), and other Under the Equal Credit
financed by these borrowers.
regulators are likely to continue to Opportunity Act,
Such actions are not without precedent, scrutinize many legacy sales and creditors aren’t allowed to
and we are seeing dramatic increases marketing practices related to auto
in the amounts of penalties and finance and after-market product discriminate in any aspect
customer reimbursements required sales to be certain that consumers are of a credit transaction
by the CFPB and other regulators for treated fairly. based on certain
prohibited factors.
1 CFPB Bulletin 2013-02, “Indirect Auto Lending and
Compliance with the Equal Credit Opportunity Act”
2 PwC Consumer Finance Group
The road ahead: • Limit CFPB oversight to only those And despite not having direct
dealers that make direct loans with regulatory authority over most dealers,
Prepare now
consumers and that generally don’t the CFPB can influence dealer behavior
Although it’s not yet clear how these transfer those loans to third parties by restricting these lenders’ abilities to
agencies intend to regulate these (i.e., “buy here, pay here” dealers). contract and do business with dealers
practices and the broader auto finance that do not follow CFPB or other
• Give the CFPB supervisory authority
industry, one thing is certain: with regulatory requirements. The CFPB is
over certain auto lenders, such as
greater regulatory scrutiny on the also addressing specific components of
large banks participating in auto
horizon, dealers and lenders should traditional dealer transactions, such as
lending.
begin to work together to enhance their dealer reserves and add-on products,
regulatory compliance processes and • Give the CFPB the power to issue demonstrating that the CFPB is able
controls. This paper explores important rules to larger industry participants to serve as a de facto regulator using
ways in which increased oversight as a way to supervise these lenders, indirect means.
could impact the industry in the near such as captive auto finance
companies. The CFPB is also working with other
future, and six areas that lenders and
enforcement agencies that have
dealers should begin focusing on now
Large banks and captive finance influence or jurisdiction over lenders
to prepare for the road ahead.
entities, supervised by the CFPB, and dealers, such as the FTC and the
Provisions contained within the typically make up the primary source Department of Justice (DOJ). Lenders
Dodd-Frank Wall Street Reform and of consumer funding for nearly every and dealers should actively monitor
Consumer Protection Act (Dodd-Frank) auto dealership. It’s the growing CFPB, FTC, and DOJ regulations
generally2: regulation of these entities that has and adapt as necessary. (For more
captured the attention of auto dealer information about potential regulatory
association and trade groups. impact, please see the following table).
2 Dodd-Frank Act Title X, Subtitle B, Section 1029(b) Objects in the mirror are closer than they appear 3
At a glance: DOJ enforcement actions
2007 2007 2008 2009
Auto dealer Regional bank Auto financing Regional bank
company
Entered into Consent Entered into Consent Entered into Consent Entered into partial
Order related to allegedly Order related to allegedly Order related to allegedly Consent Decree related
charging higher interest discriminating against refusing to finance to allegedly charging
rate markups to certain individuals based on car loans to certain higher markups to certain
borrowers. marital status. borrowers. borrowers.
Terms of settlement: Fine, Terms of settlement: Fine, Terms of settlement: Fine, Terms of settlement: Fine,
changes to practices changes to procedures, changes to policy, and investment in consumer
related to markups, and and training. training. financial education,
training. and various additional
requirements.
4 PwC Consumer Finance Group
A snapshot of regulatory considerations
Regulatory subject Comments and considerations
CFPB Bulletin 2013-02: • Lenders should confirm that they are operating in compliance with the ECOA and Regulation B as
Indirect Auto Lending applied to dealer markup and compensation policies.
and Compliance • Lenders should be certain that dealer markup and compensation policies are appropriately
with the Equal Credit controlled and monitored to guard against prohibited basis pricing disparities. Remediation policies
Opportunity Act (ECOA) for addressing unexplained pricing disparities should be implemented.
• Another important tool for limiting fair lending risks in indirect auto lending is the development and
implementation of a robust fair lending compliance management program.
CFPB Bulletin 2012-03: • Lenders are expected to have an effective process for managing the risks of service provider
Service Providers relationships; in the auto finance industry, this would include dealerships assigning retail sales
finance contracts and leases to the lenders.
• To limit the potential for statutory or regulatory violations and related consumer harm, lenders
should make certain their business arrangements with service providers do not present
unwarranted risks to consumers.
• As a result of the service provider relationship between lenders and dealerships, lenders should
verify that the dealer understands and is capable of complying with all aspects of federal consumer
financial laws.
Dodd-Frank Act: FTC’s • Dodd-Frank authorizes the FTC to use the same rulemaking procedures for dealers as other
improved powers federal agencies use.
to regulate dealer • The Administrative Procedure Act (APA) will help reduce FTC rulemaking to approximately one
financing year, rather than an average of seven years, which may have discouraged rulemaking in the past.
CFPB/FTC • Agencies have agreed to meet regularly to coordinate upcoming law enforcement, rulemaking,
Memorandum of and other activities that may increase the CFPB’s indirect influence with other regulatory agencies.
Understanding • Consumer complaints may be shared between the CFPB and FTC. With the CFPB’s complaint
website operational, dealer-related complaints may be made available to the FTC.
• The CFPB has agreed that it may provide examination reports from its supervision of non-banks
to the FTC, if requested to do so.
CFPB/DOJ • Outlines three primary areas of cooperation between the agencies: 1) information sharing and
Memorandum of confidentiality, 2) joint investigation and coordination, and 3) referral and notice procedures.
Understanding • Reiterates that both agencies have ECOA enforcement authority.
• The DOJ has a history of initiating enforcement actions against dealers, which has resulted in
multiple consent orders and settlement payments (see At a glance: DOJ enforcement actions).
CFPB joins Federal • FFIEC is an interagency body empowered to prescribe uniform standards for the examination of
Financial Institutions financial institutions by the Board of Governors of the Federal Reserve System (FRB), the Federal
Examination Council Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA), the
(FFIEC) Office of the Comptroller of the Currency (OCC), and the CFPB.
• The Council also makes recommendations to promote uniformity in the supervision of financial
institutions.
Objects in the mirror are closer than they appear 5
Six areas of focus:
Working together to meet
regulatory requirements
Just as lenders will now face additional Front-line dealer employees are The six areas of focus include:
regulatory scrutiny of their dealer the “regulated” lenders’ primary
• Maintain high standards of
monitoring, the dealers themselves will connection to the potential consumer.
transparency with customers
be under more pressure from lenders to Dealers are also heavily involved
monitor and adjust their own practices in executing specific fair lending • Keep after-market products above
to help lenders meet regulatory responsibilities related to the fair board
requirements. Given that lenders and treatment of customers. Even if the
• Apply lessons learned from other
dealers have a common interest in ultimate regulatory responsibility is
industries
preparing for increased oversight, it placed on lenders, they are reliant
only makes sense to work together on the dealers’ actions to remain • Examine current policies for
toward this mutual goal. in compliance. Front-line dealer adherence to fair lending guidance
employees should be capable of
Dealer groups should adjust their risk • Pay close attention to discretion
complying with all regulatory
assessment and monitoring practices throughout the transaction
requirements when originating
over their dealerships so that they can transactions, and lenders will need • Keep an eye on regulatory action
demonstrate compliance to lenders. to educate their dealers on their regarding credit origination and
Dealers may have to adjust their sales compliance obligations to help them pricing
and underwriting processes to meet comply as well.
the requirements being enforced
by their lender partners or their It’s clearly in the best interests of both
primary regulators. Because the CFPB lenders and dealers to create a strong
ultimately holds lenders responsible partnership focused on compliance
for their dealers’ actions, lenders may with regulatory requirements,
choose to a) stop doing business with collaborative support of the regulatory
dealers that can’t demonstrate their and legal issues facing each of them,
compliance with fair lending and other and achieving a lower risk profile
regulatory standards, b) limit flexibility for both organizations. To help the
with these dealers for pricing or credit auto finance industry prepare for the
exceptions, or c) restrict these dealers possibility of enhanced regulatory
in other ways, such as exclusion from requirements, we’ve identified six key By addressing the CFPB’s
special programs. areas of focus that will help develop
regulatory oversight, avoid costly
concerns and providing
This is a very significant change, and penalties, and manage reputational effective monitoring and
many dealers are still discovering risks. compliance documentation,
its full implications. Conversations
with dealer groups reveal that many dealers and lenders can
customer-facing sales and finance work together to satisfy
(F&I) personnel are largely unaware regulators and develop
of the CFPB’s recent bulletin on dealer
markups. effective relationships that
manage both of their needs.
6 PwC Consumer Finance Group1
Maintain high Preventing deceptive practices Training and monitoring programs
should begin with the areas that
standards of To further underscore the need for typically involve the greatest potential
transparency lenders and dealers to work together, for customer complaints and, therefore,
with consumers consider the Dodd-Frank definition exposure to UDAAP violations. Dealers
of “deceptive.” An act or practice is should aim for transparency in five
UDAAP (unfair, deceptive, or abusive deceptive when3: primary areas:
acts or practices) is the federal
regulatory consumer protection 1. It misleads or is likely to mislead • Vehicle sales price. Present the
requirement that’s currently receiving the consumer; price of the vehicle separately from
significant regulatory focus. It’s the price of any other additional
2. The consumer’s interpretation equipment, such as custom upgrade
applicable to lenders’ and dealers’
is reasonable under the packages and audio, entertainment,
advertising, sales, credit origination,
circumstances; and or navigation systems. Clearly
and other activities.
explain to the borrower state sales
3. The act or practice is material.
Preventing unfair practices tax, title, and required licensing
That is, an individual doesn’t have fees.
“Unfair” acts or practices are those that to intend to deceive or mislead a • After-market products.
can result in harm to a consumer that consumer for an act to be considered Negotiate the price of extended
the consumer cannot reasonably avoid. deceptive. To mitigate UDAAP risk, service contracts, guaranteed asset
Recent examples in mortgage servicing lenders should be sure their dealers protection (GAP) insurance, and
include mishandling of paperwork receive recurring, appropriate training other additional products typically
that resulted in failures to consider all and implement routine compliance sold by the dealer’s finance and
applicable information in connection monitoring and oversight programs for insurance offices separately from
with requests for loan modifications, all sales, finance, and other customer- the price of the vehicle. Clearly
and failing to notify borrowers that the facing dealer employees. disclose product terms, conditions,
address for sending payments changed,
limitations, and restrictions as part
resulting in late fees. Therefore, it is
of the negotiation.
important to handle all aspects of each
transaction competently and to focus
5 areas to focus • Vehicle trade-in value. Clearly
on maintaining a high standard of transparency efforts: explain the equity from a vehicle
transparency with consumers. • Vehicle sales price trade-in applied toward the down
payment of the new purchase. The
• After-market products “gross allowance” for the trade-in
• Vehicle trade-in value should be supported with NADA,
Kelley, or Black Book calculations
• Truth-in-lending disclosures or comparable auction valuations.
• Payment amount
3 CFPB Bulletin 2013-07, “Prohibition of Unfair, Deceptive, or Abusive Acts or Practices in the Collection of
Consumer Debts”
Objects in the mirror are closer than they appear 7Consistently calculate the allowance Preventing abusive practices Powerful mitigation tools:
for the trade-in and keep it complaints management
independent of the sales price of the Recently, Dodd-Frank added the
and training
vehicle or “gross of the deal.” concept of “abusive” practices into
UDAAP. Abusive acts or practices are Credit analysts and other dealer-
• Federal truth-in-lending defined as those that4: facing employees, and even a lender’s
disclosures. Give borrowers
• Materially interfere with the ability customers, are often the first to
a clear, concise summary of the
of a consumer to understand a term identify high-risk behaviors, so it is
amount financed calculation and
or condition of a consumer financial critical to leverage those resources
the manner in which the annual
product or service, or to prevent enforcement actions. In
percentage rate and total finance
September 2013, for instance, the
charges affect the total of payments • Take unreasonable advantage FTC accepted agreements containing
and the total price of the vehicle. of: 1) a lack of understanding on proposed consent orders from two auto
• Payment amount. Because the part of the consumer of the dealerships charged with deceptive
many consumers in effect purchase material risks, costs, or conditions advertising involving discounts off the
vehicles as “payment buyers,” they of the product or service; 2) the MSRP for certain vehicle models. And
should understand the monthly inability of the consumer to protect in 2012, the FTC filed administrative
payment calculation. Extending the their interests in selecting or using complaints against five dealerships
term to lower the monthly payment a consumer financial product or for alleged deceptive conduct by
is a common practice to make the service; or 3) the reasonable reliance advertising to consumers that “we’ll
payment more affordable. But the by the consumer on a covered pay off your trade no matter how
consumer should be made aware person to act in the interests of the much you owe.” In reality, the dealer
of potential drawbacks, such as consumer. was rolling the negative trade equity
additional finance charges they into the new transaction and may not
Since the concept of abusive acts
could incur and the additional time have completely disclosed these facts
and practices is relatively new,
it may take to establish equity in to consumers, implying instead that
there are few practical examples
the vehicle. consumers would have no further
for lenders and dealers to reference
obligation on the previous loan.
Another common industry practice or to use as a guide for building
that’s being closely watched by the operating practices. However, the If the auto dealers had leveraged key
FTC is “spot delivering” vehicles. Spot CFPB Examination Manual suggests personnel in the lending process, they
delivery is when the consumer signs that consumer complaints may play might have been able to prevent the
the sales and financing agreement and a role in identifying abusive, unfair, conduct that led to the enforcement
takes delivery of the vehicle before and deceptive acts and practices. actions. For example, implementing a
financing is approved. This creates a For example, the manual notes that multi-channel complaints management
disadvantage for the consumer if the complaints regarding consumers’ lack program that allows customers to
lender either declines the application of understanding about a product’s easily raise concerns will help identify
for credit or approves the application or service’s terms may indicate a risky behaviors early and maintain an
with less attractive terms. Because need to conduct a detailed review of open line of communication and a high
it could take several days for the the relevant practice.5 Both lenders standard of transparency within the
dealer to exhaust all lending options, and dealers should have an effective industry. Similarly, a dealer-monitoring
the consumer may not be notified of monitoring framework for customer program that provides incentives to
a problem for a week or more after complaints and should collaborate employees to report such activities, and
taking possession of the new vehicle regarding complaints that could be a framework that follows through with
and, in many cases, after the dealership viewed as abusive under UDAAP. investigations, can also go a long way
has sold their trade-in. toward avoiding regulatory sanctions.
4 Dodd-Frank Act Section 1036(a)(1)(B) and 12 U.S.C. section 5536(a)(1)(B)
5 CFPB Supervision and Examination Manual, Version 2, October 2012
8 PwC Consumer Finance Group2
Keep after-market • Product restrictions. Advise • Product cost. Marketing material,
customers of limitations that product literature, and verbal
products above board
could impact the value or terms descriptions or “sales pitches”
When it comes to after-market of a product. Examples include should accurately disclose the true
products, parallels can be drawn requirements to perform regularly and complete cost of the product.
between auto lending practices and scheduled maintenance or routine Avoid general cost descriptions that
the recent enforcement actions against oil changes for extended warranties, could be subject to interpretation,
credit card issuers. In one instance, payout or frequency limits on and clearly disclose additional fees
the bureau required a refund of more claims, and restrictions on service or product options that could result
than $100 million to customers who center locations for repairs and in a higher cost to the consumer.
were allegedly misled into buying inspections. Present a separate,
• No strings attached. Sales
credit card “add-on” products, citing executable disclosure document
of after-market products should
such deceptive marketing practices outlining these restrictions.
stand on their own, regardless of
as misleading consumers about the • Product value/benefits. the vehicle purchase or financing.
benefits and nature of the products. Customers want value from the Customers shouldn’t be told that
Lenders and dealers should prepare products they buy, and certain credit approval or qualification
for additional scrutiny around after- products, such as discounted for a manufacturer’s incentive is
market products (such as extended pre-sale oil changes, generally contingent on the purchase of any
service warranties and GAP insurance provide value. Companies after-market product or service.
policies), how they disclose and sell should embed customer benefit Companies should clearly disclose
them, and the products’ benefits to considerations in new product that the product or service is
consumers. design and approval processes, and optional, subject to the customer’s
implement policies to prevent the cancellation, and that the customer
sale of insurance or other products isn’t required to finance it.
Five policies to enact now
that are unlikely to add value to the
To begin, put robust policies and consumer. A consumer would not Don’t ignore activation of after-
procedures in place governing the likely benefit from GAP insurance, market products
advertising, sale, and disclosure for instance, if they financed less
requirements of after-market products, than 50% of the value of the vehicle. Don’t limit your focus to only the
including: Similarly, an extended service advertising and selling of after-market
contract sold to a lease customer products. Lenders have also received
• Product description. Give the whose scheduled agreement will regulatory inquiries about how they
customer a clear and unexaggerated terminate within the manufacturer’s handle the activation of these products
description of the primary benefits warranty period may not provide and how they account for any refund
of the product. Many dealers are value to the customer. These due to the consumer for an unused
turning to an electronic product examples could be viewed as unfair insurance premium when vehicles are
menu option to help efficiently acts. returned or repossessed.
increase penetration rates while
minimizing compliance risk. This
offers a consistent, unbiased,
and auditable presentation of the
product to every customer. Prepare for additional scrutiny around how
you disclose and sell after-market products,
such as extended service warranties and GAP
insurance policies.
Objects in the mirror are closer than they appear 9A customer does not have to
buy an after-market product
in order to purchase or
finance a vehicle.
It’s critical that they
understand after-market
products are optional.
When a dealer sells an insurance Both the lender’s and dealer’s the product’s expiration. This
product, such as an extended service compliance and audit frameworks need refund should not only include
warranty or GAP insurance, the to address two critical areas on behalf the unused, prepaid percentage of
consumer is typically charged the of the consumer in this scenario: the wholesale premium but also
retail price of the product, which is the corresponding portion of the
included in the sales and financing 1. The dealer must remit the funds dealer’s profit.
agreement funded by the lender. The in a timely manner to the product
dealer is responsible for activating the provider so the product is properly Strong governance and ground rules
product with the provider by remitting activated without significant lag regarding each after-market product,
the product agreement, required time. robust training and supervision of
documentation, and payment for the the sales and finance professionals
2. Both the dealer and lender offering these products and services,
wholesale cost of the product. The should have controls in place so and a compliance and/or internal audit
difference between the retail price any unused prepaid insurance oversight plan can help mitigate the
paid (or financed) by the customer and premiums are promptly refunded regulatory, litigation, and headline
the wholesale price paid to the service to the borrower if the vehicle is risks associated with after-market
provider is the profit retained by the returned or repossessed prior to products.
dealer.
10 PwC Consumer Finance Group3
Apply lessons learned
from other industries
It’s not always necessary to create The following table summarizes actions
new processes from the ground up. taken in the credit card industry and
Regulators have already been working their potential parallels in automotive
with the credit card industry, and these finance.
experiences can provide useful insights.
Allegation Credit card industry Auto finance industry ―
Misled about Consumers were sometimes led to • Clearly disclose limitations on the scope of coverage or exclusions
the benefits of believe that the product would improve from coverage.
the product their credit scores and help them • Don’t represent extended warranty programs as a manufacturer
increase the credit limit on their credit warranty unless approved by the manufacturer.
card. Additionally, they may have been
misled into thinking that the product or • Make consumers aware of routine maintenance requirements to keep
service was required, not optional, or the product activated/valid.
to believe it was an included feature in • Fully disclose limitations on the number or aggregate amount of
the original transaction, which they then claims.
paid extra for.
Deceived about Consumers were not always told that • Clearly disclose that products are optional and cancellable on
the nature of the buying the products was optional. In marketing materials and service agreements.
products other cases, consumers were wrongly • Lenders and dealers should create policies and processes for product
told they were required to purchase cancellation.
the product to receive full information
about it, but that they could cancel the • Disclose repair facilities that are limited to a preapproved list of
product if they were not satisfied. Many providers that may not be in convenient, close proximity to the
of these consumers later had difficulty customer.
canceling. • Replacement parts may be generic or overhauled rather than new and
manufacturer certified.
Misled about In some cases, call center • Disclose limitations on the scope of coverage or exclusions from
eligibility representatives marketed and sold coverage.
products to ineligible, unemployed, • Take steps to be certain that both the borrowers and the vehicle
and/or disabled consumers. Despite financed qualify for the service warranty sold.
paying the full fees, they could not get
all the benefits of payment protection.
Misinformed Consumers were sometimes led to • Disclose all fees and costs in advertisements and marketing material.
about cost of believe they would be receiving a free • Disclose deductible amounts.
the products product rather than making a purchase.
• Disclose requirements for consumers to pay for repairs up front and
then request reimbursement.
Enrolled without Some call center vendors processed • Be certain dealers’ after-market sales processes are clear and
consent add-on product purchases without the transparent.
consumer’s consent. Consumers were • Implement a process to promptly cancel the warranty and refund all
then automatically billed for the product unearned fees if a cancellation is requested by the consumer.
and often had trouble canceling it.
Objects in the mirror are closer than they appear 11It’s not enough to act in good faith. Instead,
lenders and dealers should have an exhaustive
knowledge of fair practice regulations and take
proactive steps to avoid regulatory penalties.
4
Examine current any creditor to discriminate against • Ongoing monitoring for compliance
a loan applicant in any aspect of a with fair lending policies and
policies for adherence
credit transaction on the basis of race, procedures
to fair lending rules color, religion, national origin, sex,
• Ongoing monitoring for compliance
While it may sound like a simple marital status, or age. The ECOA also
with other policies and procedures
concept, fair lending includes an prohibits creditors from discriminating
that are intended to reduce fair
entire continuum of trade practices, based on the fact that all or part of an
lending risk (such as controls on
some of which might not be obvious. applicant’s income is derived from a
loan originator discretion)
Discrimination and preferential public assistance program, or that an
treatment, for example, might seem applicant has in good faith exercised • Review of lending policies for
like clear practices to avoid, but any right under the Consumer Credit potential fair lending violations,
they’re often nuanced and may be Protection Act. including potential disparate impact
committed inadvertently, making • Regular assessment of the marketing
lenders and dealers that have acted A fair lending framework of loan products
without malice potentially subject
The CFPB and other bank supervisory • Meaningful oversight of fair lending
to significant regulatory penalties
agencies expect financial institutions compliance by management and,
and litigation risk. Moreover, lenders
to have a compliance framework in where appropriate, the financial
and dealers, although close partners
place to manage fair lending risks, institution’s board of directors
in the financing realm, bear joint
and the CFPB provided guidance on
responsibility for adhering to fair • Depending on the size and
its expectations for institutions’ fair
lending requirements, making lenders complexity of the financial
lending programs in its Fall 2012
vulnerable to the practices of dealers institution, regular statistical
Supervisory Highlights.6 The guidance
even though there may be no other analysis of loan data for potential
states that every financial institution
legal relationship between the two. disparities on a prohibited class basis
should establish fair lending policies,
In short, to adhere to fair lending in pricing, underwriting, or other
procedures, and internal controls so
requirements, it’s not enough to act in aspects of the credit transaction,
they’re operating in compliance with
good faith. Instead, lenders and dealers including both mortgage and
the ECOA in all of their relevant lines of
should have an exhaustive knowledge non-mortgage products such as
business. The guidance also identifies
of fair lending regulations and other credit cards, auto loans, and
common features of well-developed
requirements and take proactive steps student loans
fair lending compliance programs.
to implement fair lending compliance
These features include: • Oversight of third-party service
processes and controls to mitigate risk.
• An up-to-date fair lending policy providers’ compliance with laws and
Implemented by Regulation B, the statement regulations, including fair lending
Equal Credit Opportunity Act (ECOA) requirements
contains fair lending requirements for • Regular fair lending training for
auto financing in the United States. all officers, board members, and Considering the recent spate of
The ECOA makes it unlawful for employees involved with any interest from regulators on fair lending
aspect of the institution’s credit compliance, lenders and dealers should
transactions examine their fair lending frameworks,
processes, and controls for adherence
with the guidance.
6 Consumer Financial Protection Bureau, “Supervisory Highlights: Fall 2012,” http://files.
consumerfinance.gov/f/201210_cfpb_supervisory-highlights-fall-2012.pdf, accessed Oct. 7, 2013.
12 PwC Consumer Finance GroupCFPB Bulletin 2013-02 announced that
lenders will be held accountable for illegal,
discriminatory markups, even though the markup
may be at the sole discretion of the dealer.
5
Pay close attention to the opportunity to mark up the rate • Monitor and address the effects of
to cover the incremental cost of markup policies as part of a robust
discretion throughout
acquiring another similar vehicle for fair lending compliance program
the transaction its inventory. Because the factors that
• Eliminate dealer discretion to
In auto finance, the most common fair go into pricing a transaction may be
mark up buy rates and fairly
lending risks are the by-products of inherently subjective and dependent
compensate dealers using a different
credit analyst discretion and the use on unique facts and circumstances
mechanism that does not result in
of subjective characteristics to decide at the individual dealer level, there’s
discrimination, such as flat fees per
on and price individual consumer the risk that the discretion permitted
transaction
transactions. And the risks regarding a by these markup policies may result
dealer’s discretion to mark up interest in pricing differences on the basis Fair lending responsibility doesn’t rest
rates has been the subject of the most of race or national origin, or on only with lenders, however. The ECOA
discussion, largely because of the another prohibited basis. Although defines “creditor” broadly to include “a
attention generated by the CFPB’s dealer markups are a current area of person, who, in the ordinary course of
March 2013 Bulletin 2013-02 on the regulatory focus, it’s also important business, regularly participates in the
subject. to assess underwriting and pricing decision of whether to extend credit.”7
practices for potential fair lending Also, the Commentary to Regulation
Typically, dealer markups come into compliance risk. B provides that a “creditor” “includes
play within the indirect lending all persons participating in the credit
channel for auto finance lenders Lenders and dealers are decision,”8 implying that the ECOA
and involve a loan that’s originated both accountable for illegal, applies to dealers as well as lenders.
through a dealer. While the lender discriminatory markups
may establish a specific permissible Dealer trade groups contend that
range for the markup, usually between The CFPB Bulletin 2013-02 says that changing the way lenders compensate
200 and 250 basis points, lenders lenders may be liable for its dealer dealers without examining the effect
don’t typically guide the dealer on the markup and compensation polices of this change could adversely affect
specific markup or rate to charge an if these policies result in pricing the cost and availability of credit
individual customer. differences on a prohibited basis, even for consumers. They also say dealer
though the markup may be at the sales could be impacted if they can’t
For example, if the dealership is able discretion of the dealer. The bulletin recover their inventory and overhead
to sell the customer a vehicle that’s also indicates that indirect auto lenders costs, which are partially recaptured
been in their inventory for a long time within the CFPB’s jurisdiction should through dealer markups. However, the
or gain additional revenue through take steps to maintain compliance with CFPB acknowledges a dealer’s right
the sale of an extended warranty, the fair lending laws as they apply to dealer to compensation and maintains that
dealer may be less likely to mark up markup and compensation policies. a change to “flat fee” reserve pricing
the interest rate. But if a customer These steps may include: is only one option. An alternative is
purchases a highly sought-after imposing proper controls and closely
vehicle and is indifferent to price, • Impose controls on dealer markups,
monitoring dealer markup and
the dealer may take advantage of or otherwise revise dealer markup
compensation activities to address
and compensation policies
unexplained prohibited basis pricing
7 15 U.S.C. Section 1691a(e)
8 12 C.F.R. pt. 1002, Supp. I, Section 1002.2, Paragraph 2(l)-1
Objects in the mirror are closer than they appear 13disparities. All of these considerations Recent fair lending examination and to be exploring an improved proxy
underscore the need for a collaborative enforcement authority has been driven method, but it hasn’t yet released
effort among dealers and lenders to by this “disparate impact” theory. details on the methodology.
mitigate fair lending risk. This controversial legal approach
does not require specific evidence of In addition to enhanced processes
and controls around fair lending,
Defining disparate treatment discriminatory intent by the lender;
instead, enforcement actions are lenders should consider proactive
and impact
driven primarily by observed statistical statistical analysis of loan pricing
Disparate treatment in its purest differences in lending outcomes and underwriting practices to
form occurs when a lender bases a between protected and non-protected understand current fair lending risks
lending decision on one or more of the groups.9 and replicate analyses conducted
prohibited bases as defined by the fair by the regulators. Lenders should
lending laws. But it doesn’t require To be certain a lender isn’t applying also consider developing a dealer
proof of intention to discriminate. disparate treatment or that its monitoring program and consider
For example, in 2009 the Justice origination practices aren’t resulting monitoring pricing differences in
Department filed a lawsuit against in disparate impact, the CFPB will metropolitan statistical areas (MSAs)
two auto dealers and a bank. The suit generally apply statistical analysis to as well as dealer-level differences. Any
maintained that the organizations determine whether there are disparities monitoring program should include
violated the ECOA by charging certain within a dealer’s transactions and processes for corrective action, such
borrowers, predominantly those of across the lender’s portfolio of all as dealer disciplinary actions and
Latino descent, higher interest rate dealers’ transactions. The portfolio’s borrower remediation.
markups than other borrowers with aggregation of contracts assigned by
numerous dealerships further creates The scope of fair lending extends
comparable qualifications.
the possibility that the CFPB will find beyond approved transactions,
Disparate impact can occur when a discrimination to exist collectively, however; it also includes borrowers
group of customers on a prohibited even if an individual dealership did not who have been denied a loan
basis are disproportionately excluded engage in discriminatory conduct. altogether. In the eyes of a regulator,
or negatively affected by a policy if there’s evidence that a certain
or practice even though the policy Since lenders don’t collect demographic group of customers has a much higher
or practice applies consistently to information for auto loans, the approval or rejection rate than another
all customers across the board. CFPB uses proxies to determine or group of customers (even though both
For example, a lender may have approximate the age, gender, racial groups have the same risk profile),
a policy of not making auto loans background, etc. of borrowers and uses this may be evidence of a fair lending
for less than $10,000. This policy these proxies to determine whether violation. Lenders who use subjective
might disproportionately exclude evidence of fair lending disparities underwriting criteria and who depend
applicants who are members of a exists. Proxies are typically based on an underwriter’s discretion to
protected class who have lower on Census Bureau surname lists as make a decision on an application
income levels or lower collateral well as demographics of borrowers’ should have additional safeguards and
values than the rest of the applicant home addresses (i.e., census tract oversight in place to avoid inconsistent
pool in the areas in which they live. demographics).10 The CFPB appears customer treatment.
9 Office of the Comptroller of the Currency, http://www.occ.gov/topics/consumer-protection/fair-lending/index-fair-lending.html, accessed Oct. 7, 2013.
10 Consumer Financial Protection Bureau, Letter from Richard Cordray to Chairman Bachus, August 2, 2013.
14 PwC Consumer Finance Group6
Keep an eye on by the dealer (the interest rate quoted
by the dealer to the consumer minus
regulatory action
the ‘buy rate’).”11 It’s possible that the
regarding credit CFPB could begin to look more broadly
originations at pricing considerations across the
and pricing transaction, examining factors such as
the buy rate, price of the vehicle, and
In addition to subjective underwriting add-on products. Also, the CFPB has
criteria, lenders may also use risk- not specified their exact methodology
based pricing, which may lead to for their analyses of price variances
pricing variances among customers. or set a specific threshold for the level
As long as the variance is explained of variance that will be considered
by a business justification (such as to constitute a violation. In order to
competitive landscape, cost of funds, prepare for the CFPB’s potential review,
or cost of operations) that is not related lenders should carefully evaluate their
to any of the protected characteristics pricing practices and their monitoring
covered by fair lending laws, pricing of pricing and dealer markups in order
variances are allowed and are a to demonstrate that they have effective
common practice across asset classes, controls in place to consistently price
from mortgages to auto finance. customers with the same risk profile.
Lenders with subjective discretion
in their pricing process should have
additional safeguards and oversight
so that customers with the same risk
profile are priced consistently.
The CFPB could begin looking more broadly at
pricing considerations. Factors such as the buy
It remains to be seen how the CFPB
will evaluate pricing variances. A letter
rate, price of the vehicle, and add-on products
addressed by CFPB Director Richard may come under scrutiny.
Cordray to members of Congress noted
that “A typical fair lending examination
of an indirect auto lender would
include a review of credit denials,
interest rates quoted by the lender to
the dealer (called ‘buy rates’), and any
discretionary markup of the buy rate
11 Consumer Financial Protection Bureau, Letter from Richard Cordray to Rep. Sewell, June 20, 2013.
Objects in the mirror are closer than they appear 15How PwC can help
With deep experience in the auto For lenders: For dealers:
finance, regulatory compliance, and
• PwC can help establish and review • PwC can assist in developing
fair and responsible lending areas, PwC
compliance management systems material and providing training to
can assist lenders and dealers in the
(CMS) and conduct assessments of finance officers at dealerships on the
development of regulatory compliance
fair lending, UDAAP, and vendor UDAAP and fair lending regulatory
and fair lending policies, processes,
management programs and requirements and expectations
training, and monitoring capabilities.
processes against industry practices relating to UDAAP and fair lending.
Because regulators will hold lenders
and regulatory requirements.
and dealers jointly responsible for • PwC can help dealers develop
compliance, alignment of the activities • PwC can help lenders develop fair or strengthen their own internal
and consistency in the robustness of lending statistical models and dealer compliance policies, practices, and
the execution are critical. Lenders monitoring programs. monitoring tools.
will serve as the key connection
• PwC can conduct independent third-
point across multiple dealers and can
party statistical analyses and other
facilitate collaboration and knowledge
reviews to determine current fair
sharing to give dealers perspective
lending risks and the state of fair
on what other dealers within their
lending controls.
network have implemented, and to
maintain consistency in the collective
approach. PwC can help lenders and
dealers at any stage in the process,
bringing our knowledge of industry-
leading practices and experiences to
enhance the collaboration between
lenders and dealers.
16 PwC Consumer Finance GroupContacts
Sam May Michael Stork
Consumer Finance Group Leader Partner Other reading material
(213) 356-6203 (612) 596-6407 of interest
samuel.may@us.pwc.com michael.stork@us.pwc.com
www.pwc.com
Rick Hanna Martin Touhey
Global & US Automotive Leader Principal
(313) 878-8754 (206) 790-8751 Spotlight
Lessee Accounting–
richard.hanna@us.pwc.com martin.e.touhey@us.pwc.com Automotive Industry
July 2013
Eva Ziegler Anthony Ricko Transformational change
Considering the impact
of the proposed new lease
US Automotive Finance Leader Managing Director
accounting guidance on
lessees in the automotive
industry
(312) 298-3736 (978) 985-1749
eva.ziegler@us.pwc.com anthony.ricko@us.pwc.com
Ric Pace Doug Ekizian
Principal Senior Manager
(703) 624-3314 (949) 517-8220
ric.pace@us.pwc.com douglas.c.ekizian@us.pwc.com
Peter Pollini Wade Hampe Lessee accounting: Transformational
Principal Senior Manager Change - Considering the impact of the
(207) 450-9036 (404) 915-4682 proposed new lease accounting guidance
peter.c.pollini@us.pwc.com wade.d.hampe@us.pwc.com on lessees in the Automotive Industry.
Follow us on Twitter @PwC_US_FinSrvcs
Objects in the mirror are closer than they appear 17www.pwc.com/auto www.pwc.com/consumerfinance www.pwcregulatory.com © 2013 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the US member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. PwC US helps organizations and individuals create the value they’re looking for. We’re a member of the PwC network of firms in 158 countries with more than 180,000 people. We’re committed to delivering quality in assurance, tax and advisory services. Tell us what matters to you and find out more by visiting us at www.pwc.com/us.
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