Heightened scrutiny of potentially discriminatory auto lending practices by the U.S. Consumer Financial Protection Bureau (CFPB) will likely raise lender regulatory costs in 2014, according to Fitch.
The CFPB started investigating the auto finance industry last year concerning allegations that it may be discriminating against consumers based on race and violating the antidiscrimination provisions of the Equal Credit Opportunity Act. Fitch believes the CFPB is currently in discussions with various auto finance players, including banks, captive finance arms of auto manufacturers and independent finance companies regarding their lending practices.
The regulatory actions pertain to the auto lending industry's widely used practice of making indirect loans through dealers, rather than direct lending (whereby a consumer enters a dealership with a qualified loan from a bank). The indirect lending system allows dealers to mark up the interest rate submitted by the lender.
In December, Ally Financial Inc. (Ally) became the first lender to enter into consent orders with the CFPB and the U.S. Department of Justice regarding the allegation of disparate impact in the auto finance business. Despite reaching an agreement, Ally maintains that it does not make loans to consumers, but rather, it purchases installment contracts originated by auto dealers. Ally has further stated that its underwriting process does not include information on a consumer's race or ethnicity, but rather, is based solely on a consumer's creditworthiness and contract characteristics.
As part of the consent orders, Ally agreed to a $98 million settlement (an $18 million civil penalty fee and an $80 million contribution to a settlement fund). The order also requires Ally to implement a compliance program to monitor dealer markups in order to prevent future discrimination or eliminate dealer markups altogether.
Fitch believes Ally's acceleration of the settlement ahead of its competitors may be partly due to the lender's desire to allay investor concerns ahead of a potential IPO.
Fitch also notes that CFPB does not have jurisdiction over auto dealers and their practices. Actions taken against lenders could be an indirect way to regulate dealers.
We expect this issue to receive considerable attention in 2014, with more banks and finance companies subject to fines and settlements. This could ultimately lead to changes in established business practices, including an elimination of the dealer markups altogether in favor of flat dealer fees.
Regulatory scrutiny from the CFPB is expected to remain elevated for the foreseeable future. Moreover, increased regulatory costs and compliance requirements are expected to continue to weigh on operational flexibility and the financial performance of auto lenders in 2014.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
- Auto Loans
Mohak Rao, CFA, +1-212-908-0559
Bill Warlick, +1-312-368-3141
Fitch Ratings, Inc.
70 W. Madison
Chicago, IL 60602
Brian Bertsch, New York, +1-212-908-0549