CFPB Nears Landmark Victory Against Three Large Auto Lenders

WASHINGTON — Three of the nation's largest indirect auto lenders are poised to limit discretionary pricing for dealers after regulators accused them of allowing partners to mark up loans at higher rates to minorities, according to confidential documents.

In proposed consent orders obtained by American Banker, the Consumer Financial Protection Bureau is planning to cite American Honda Finance Corp., Toyota Motor Credit Corp. and Nissan Motor Acceptance Corp. beginning as early as July for unintentional discrimination.

If approved and signed, the orders would require all three firms to pay renumeration to affected consumers, but could forgo civil money penalties in return for changing how much flexibility they give dealer partners to mark up the cost of an auto loan. Though the CFPB cannot directly supervise auto dealers, it has been scrutinizing indirect auto lenders' policy of allowing price discretion to partners, arguing it often results in minorities paying more.

Under the proposed deals, Honda, Toyota and Nissan's financing arms would agree to cut the price discretion that they offer dealers by roughly half of their current rates. While sources caution that the orders could still change because they are not yet finalized, such an agreement would be a significant victory for the CFPB, which until now has struggled in its efforts to curb pricing discretion.

"If the CFPB can get the lenders to cut the caps — as unpalatable as that may be from a business perspective — you address what the CFPB sees as the systemic problem. It basically gets them closer to the fixed-rate option that the agency has pushed for," said Joe Rodriguez, of counsel at Morrison & Foerster, who formerly worked in the CFPB's fair-lending group.

A CFPB spokesman declined to comment for this article, citing the confidentiality of the enforcement process. A spokesperson for Nissan did not comment by deadline. Spokespersons for Honda and Toyota confirmed they are in discussions with the CFPB and Justice Department over the issue, but said they could not provide further details.

"We take seriously our commitment to diversity and inclusion, and that commitment extends to fair and responsible lending practices," a spokesman for Toyota added. "In keeping with this deeply held commitment, it is important to note that as an indirect lender TFS [Toyota Financial Services] has no visibility into the race or ethnicity of our customers or credit applicants, and these factors never influence our credit or pricing decisions."

Though the settlement amounts are still pending approval, Honda is facing $24 million in consumer redress on allegations that its dealers charged higher rates to more than 164,600 minorities because of its dealer price discretion policy. Under the deal, it would not pay an additional civil money penalty in return for limiting dealer discretion going forward to 125 basis points on contracts that are 60 months or less, and 100 basis points for contracts longer than 60 months, among other stipulations. That is roughly half the 200 to 225 basis point range it currently allows.

The exact redress amounts for Toyota and Nissan were not yet set by mid-June, according to the obtained documents. But based on initial recommendations made by CFPB staff in November, Toyota will have to pay between $14 million to $102 million to consumers to settle allegations it charged higher rates to 127,285 minorities. Nissan is facing $8 million to $75 million in redress for an affected 74,405 minority borrowers.

Under settlement terms discussed in November, Nissan and Toyota are facing a cap of 100 basis points on contracts that are 60 months or less and a 75-basis-point cap on contracts longer than 60 months, or another alternative structure to be determined. Those same caps appear to have once been a part of the negotiations with Honda, however, and it is probable the Nissan and Toyota agreements will ultimately be similar in nature to the proposed Honda deal.

According to the documents, the CFPB had said it might forgo civil money penalties depending on the price discretion restructuring. In the case with Honda, it appears the CFPB dropped a proposed $30 million civil money penalty if Honda agreed to lower its dealer price discretion cap going forward.

"The significant limitation of dealer discretion, which in turn reduces fair lending risk, is one of the goals we have been seeking with respect to the indirect auto matters, and this settlement proposal attains that goal," wrote Jeffrey S. Morrow, Jane M.E. Peterson and Rebecca J.K. Gelfond, in the CFPB's office of fair lending and equal opportunity in a June 16 memo to CFPB Director Richard Cordray laying out the terms of the proposed deal.

CFPB is likely to take a similar approach in negotiations with Toyota and Nissan, based on the documents.

The proposed orders against Honda, Toyota and Nissan would be significant considering they are among the top 10 indirect auto lenders in the country. Observers said it may also leave them at a disadvantage in bidding for contracts with dealers if these three lenders have a lower cap than their competitors.

Cutting the caps in half "is a big difference and these lenders are essentially cutting themselves out of the higher end of the market," Rodriguez said. "Because it is already such a fragmented market, other competitors will step in. It will definitely impact the decisions of where dealers go and it definitely will impact the volume that those three lenders do."

The CFPB has encouraged lenders to adopt a flat-fee structure with dealers which the agency says would prevent them from giving higher rates to minorities. But the auto dealers have resisted, arguing that giving them pricing flexibility is a key part of the process. The dealers and allies in Congress have also heavily questioned the agency over its methodology in determining discrimination.

The proposed deals with Honda, Toyota and Nissan represent a compromise of sorts. It would not make them move to a flat-fee structure, but instead would limit how much dealers could mark up a loan from the wholesale purchase rate. Moreover, the settlement would "provide for ongoing monitoring by the Bureau and the Department of Justice," the CFPB officials wrote in their memo to Cordray.

"Should the agencies identify ongoing disparities despite the reduced discretion, the Bureau can reevaluate the lower caps and take forward looking action as appropriate after the termination of the proposed consent order," they wrote.

All three investigations began in 2013 after the CFPB released a controversial bulletin saying it would cite lenders for disparate impact, a legal theory that says lenders and others can be penalized if their processes showed statistical disparities in their loan portfolios, regardless of intent.

The Honda investigation started jointly with the Justice Department on April 25, 2013, a month after its indirect auto bulletin was released. That bulletin led to an outcry from lenders and auto dealers, who argued that the CFPB was trying to eliminate price discretion in the marketplace.

The CFPB denied that was its intent, but encouraged lenders to adopt options like a flat fee or a cap on dealers. On April 30, 2014, the CFPB hailed a decision by BMO Harris Bank to become the first indirect auto lender to move to a flat-fee system. Since then, BB&T announced a similar flat-free approach that launched July 1. Yet no other lenders have publicly announced a flat-fee structure.

The CFPB said in its settlement offer with Honda that the price structure being negotiated would reduce fair-lending risk and "may lessen any possible resistance of the resolution from NADA [National Automobile Dealers Association]."

Though the NADA was not given any details of the proposed settlements, it's likely the group will continue to resist the CFPB's push to lower the caps.

"It is naïve to think that it will result in any savings or produce any benefits for consumers," said Paul Metrey, chief regulatory counsel of the NADA, in response to a question on any push to lower price discretion. "Finance sources currently set the rate caps and compete on the payment terms that they offer to dealers, and NADA has no opinion on the individual decisions of market participants on these matters. However, their decisions should not be the product of CFPB pressure that will only serve to disrupt today's highly competitive financing market without effectively addressing fair credit risks to consumers."

In its investigation of Honda, Toyota and Nissan, the CFPB looked at loans for a three-year period beginning January 2011.

The action against Honda appears to be the furthest along based on the proposed consent order, which shows that the agreement is slated to be completed by July 14. In the proposed order, the CFPB claims that Honda charged higher interest rates to an estimated 164,641 African-Americans, Hispanics and Asian and/or Pacific Islander borrowers when compared to white borrowers from January 2011 through December 2013. The CFPB estimates that each minority borrower paid on average $252 to $417 more than white borrowers, depending on their race, over the life of the loan.

In the citations for all three lenders, the highest amount charged was $562 per borrower to African-Americans who were given higher rates on Lexus loans through Toyota.

The CFPB used a 10-basis-point difference as the market for when a lender should take corrective action. In Honda's case, it allegedly charged African-Americans 36 basis points more than white borrowers, while Hispanics were charged 28 basis points more. Asian and/or Pacific Islanders were charged 25 basis points more, the documents said.

"During the relevant time period, respondent [Honda] did not monitor whether discrimination on a prohibited basis occurred through the charging of markups across its portfolio of retail installment contracts and did not employ adequate controls to prevent discrimination," the CFPB said in its proposed consent order.

The proposed CFPB deals come after the Supreme Court last week upheld the use of disparate impact by regulators under the Fair Housing Act. Though the CFPB is applying disparate impact under the Equal Credit Opportunity Act instead, observers said the high court's decision will embolden regulators to use disparate impact theory, regardless of which law is applied.

"With the Supreme Court affirming the disparate impact doctrine, the reality is that the CFPB is likely to continue an aggressive push against dealer markups through increased supervisory scrutiny and targeted enforcement actions against indirect auto lenders," said Isaac Boltansky, an analyst at Compass Point Research & Trading. "If additional indirect auto settlements are ahead, it will be interesting to see whether the CFPB's actions will result in dealer behavior being altered even though the bureau does not have direct oversight of the industry. I think the lenders will be fine with lessening dealer pricing discretion. It's the auto dealers who will continue pushing back against the CFPB and my sense is that they will likely find some support on Capitol Hill given the statutory limitations on the bureau's oversight."