As the summer comes to a close, many credit unions turn their attention to planning for next year and what lending programs need attention.
If your credit union has an indirect auto lending program, then it should be at the top of your list to revamp.
Even if you don’t follow the Consumer Financial Protection Bureau’s (CFPB) every move, you have probably heard chatter in the industry that preventing fair lending violations in indirect auto lending programs is a top priority for the agency.
For those of you who haven’t been following this issue step-by-step, here’s a quick recap.
In March 2013, the CFPB issued a bulletin to “hold auto lenders accountable for illegal discriminatory mark-up.”
The agency explained dealer discretion to offer auto buyers a higher rate than the lender’s buy rate (often called a dealer “mark-up” or “reserve”) presents a real risk of discriminatory practices toward protected classes of consumers.
Of course, dealers have long enjoyed the widespread practice of allowing dealer mark-ups because most agreements allow the dealer to keep a portion of the profit from the inflated rates.
The issuance of the bulletin has brought forth a flood of criticism from both members of Congress and the auto dealer lobby. The critics highlight everything from the statistical analysis the CFPB used to diagnose the problem to whether the agency should have the power or influence to regulate auto lending in dealerships in the first place.
Despite the heavy criticism from Congress, the CFPB shows no signs of backing down. On the contrary, it has charged ahead with enforcement actions against indirect lenders.
The most publicized action was the consent decree entered into by Ally Bank agreeing to cap dealer discretion in its indirect program and pay almost $100 million in restitution and penalties.
It’s clear from the CFPB’s actions and effort on this issue that it is not a question of if the agency will act on this issue, only a question of when.
How should CUs respond?
So what should a credit union with an indirect auto lending program do? The CFPB offers two alternative paths for lenders, but both ignore the competitive market in which credit unions compete for indirect dealer relationships.
The first option, according to the CFPB, is for credit unions to develop hard and fast policies constraining dealer discretion in marking up rates and to conduct regular monitoring of loan data to ensure dealer compliance with the policies.
Unfortunately, credit unions will lack the leverage to impose restrictions on dealer discretion and impose additional compliance costs. If the credit union’s competitors are not imposing the same restrictions, the credit union will risk damaging its relationship with the dealer.
The second option is fraught with the same challenges. The CFPB suggests that the only other option is to eliminate all dealer discretion in offering rates and pay the dealer a flat fee for each loan transaction.
This is a fantastic option in theory, as it eliminates the need to impose additional policies and monitoring costs on the dealer. However, as with the first option, credit unions will not have the leverage to make this change unless competitors in the same market follow suit.
Even though competition among lenders may prevent credit unions from abandoning dealer mark-up programs in the short term, we may be approaching a tipping point where the market deems mark-up programs too risky to continue.
One sign that time is approaching is some large lenders exiting programs with dealer discretion. Bowing to the proverbial writing on the wall, BMO Harris Bank, a large indirect lender, declared earlier in the year that the bank would no longer allow dealer mark-ups.
Judging by CFPB director Richard Cordray’s public statements praising BMO’s decision, we can all assume this was the CFPB’s desired result all along.
The tipping point for the elimination of dealer mark-ups is likely on its way, but it may not arrive at the same time in every market. Credit unions will be well served to keep a close eye on indirect lending news from both the CFPB and the local indirect market while planning for 2015.