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CFPB, FRB, and DOJ Webinar on Fair Lending in Indirect Auto Finance
On August 6, 2013, the Federal Reserve sponsored a webinar entitled “Indirect Auto Lending – Fair Lending Considerations,” in which presentations were given by Patrice Ficklin, Fair Lending Director, Consumer Financial Protection Bureau (CFPB), Maureen Yap, Special Counsel/Manager, Fair Lending Enforcement, Federal Reserve Board (FRB), and Coty Montag, Deputy Chief, Housing and Civil Enforcement Section, Civil Rights Division, U.S. Department of Justice (DOJ). During the webinar, each of the speakers provided a perspective on the examination and enforcement activities of their respective organization, followed by a Question and Answer session.
Ms. Ficklin began by providing a summary of the CFPB’s supervisory and enforcement authority, followed by a discussion of CFPB Bulletin 2013-02. In discussing the bulletin, Ms. Ficklin addressed the specific guidance provided in that Bulletin, with a particular emphasis on how the “standard practices” of indirect auto financial institutions “likely constitute participation in a credit decision” resulting in their being deemed “creditors” under the ECOA. That was followed by a discussion of the way in which the existence of dealer discretion and markup presents fair lending risk and ways in which financial institutions may comply with fair lending requirement. Ms. Yap then presented the FRB’s authority for and purpose in examining for fair lending risk in indirect auto finance, making particular note of the FRB’s referral of the Nara Bank case to the DOJ. Ms. Yap emphasized that FRB personnel rely on the 2009 Interagency Fair Lending Examination Procedures in determining the scope of an examination, including indirect auto financing practices, including as it relates to pricing which presents the “area of highest risk”. After discussing some of the FRB’s key risk factors, Ms. Yap then discussed methods used by the FRB to code loans and test for disparities. Ms. Yap also provided additional resources that may be of value to indirect auto financial institutions, including the FRB’s “Step-by-Step Guide to Coding for Gender and Ethnicity,” “Example: Hypothetical Loan Data with Lookups and Formulas,” and “Female and Hispanic Names List (U.S. Census).” The last two items may be found here. Ms. Yap concluded her remarks by discussing what to expect if the FRB finds evidence of pricing disparities, and ways that market participants may mitigate their fair lending risk.
Ms. Montag opened her remarks with a review of ECOA’s framework and the DOJ’s recent enforcement activities in indirect auto finance, with particular attention given to both the 2009 partial Consent Decree and the recent “Agreed Order” with Union Auto and the default judgment against the final defendant. The Pacifico Ford, Inc. and Springfield Ford, Inc. cases were also discussed at some length, emphasizing the consent orders that limited the amount of dealer reserve in each matter and the circumstances under which the amount of such reserve may be modified. Finally, Ms. Montag provided an overview of ongoing enforcement efforts in the indirect auto market, with particular focus on (i) potential race-based targeting by “buy here, pay here” dealers; and (ii) discretionary dealer markups and fees, including “several” ongoing joint investigations with the CFPB.
The presentations were followed by a Question & Answer session in which the panelists addressed particular requests submitted by attendees. Of particular interest were the following:
- To the extent exceptions are made to match competitive offers or otherwise, Ms. Yap suggested that all such instances should be “well documented” and include specific information that is maintained by the institution to help explain potential disparities as the need arises;
- Ms. Ficklin stated that in general, when determining fair lending violations, the CFPB relies on statistical evidence at “the 95th per cent confidence level, or greater,” though she noted that the CFPB may look at data of a lower confidence level when providing supervisory guidance regarding potential fair lending risk or when acting in its supervisory capacity;
- In discussing whether a dealer agreement should address the obligation of the dealer to ensure the accuracy of data submitted in an auto finance transaction, Ms. Yap opined that it is important to address this issue and any other fair lending risks within such an agreement. Ms. Yap suggested that dealer agreements should be explicit about fair lending expectations and learning about and resolving complaints to help mitigate fair lending risk;
- In discussing controlling for variables in analyzing whether disparities may be explained through permissible criteria, Ms. Yap acknowledged the FRB wants to look at “the variables that the bank actually uses”; but they nonetheless want to make clear distinctions between the “buy price” and any markup. The “buy price” would take into consideration characteristics related to a borrower’s credit, such as credit score or income; but since markup is not usually based on such characteristics, they might take into consideration factors such as new car financing offers, or the month in which a purchase is made (based on any sensitivities related to purchases made in certain seasons); and
- In response to whether the CFPB’s approach to indirect auto exams is the same as that of the FRB, Ms. Ficklin stated that the evaluation of whether an indirect auto lender is in compliance with the ECOA requires “multiple steps.” She advised that a typical CFPB examination would include: a review of credit denials, interest rates quoted by the lender to the dealer (“buy rates”), and any discretionary markup of the buy rate by the dealer. Ms. Ficklin further stated that determining whether discrimination has occurred is both case-specific and fact-intensive and like the FRB, the CFPB’s analysis “considers appropriate analytical controls” in reviewing data to determine if a specific policy results in unlawful differences, on a prohibited basis. Ms. Ficklin then added that “consistent with the approaches of other federal regulators” including the FRB, the Bureau has previously indicated that it uses surnames, and geographic location data “to estimate protected characteristics” where direct evidence of protected characteristics is unavailable. She explained that the CFPB conducts its proxy analysis by using publicly available data from the Social Security Administration, and the Census Bureau, and that the CFPB is aware that some lenders are currently using various forms of proxy analysis for their own internal fair lending analyses. Finally, she noted that Bulletin 2013-02 encourages lenders who are not doing such analysis to select “a reasonable proxy method that is suitable for their nature, size and complexity” and to monitor their data for “fair lending risk.”
Though the webinar may not have covered a significant amount of new ground, it nonetheless provides some additional clarity around the expectations of the CFPB, FRB and DOJ when looking into fair lending matters in the indirect auto finance market as it relates to pricing and some useful resources from the FRB. As such, institutions participating in the indirect auto finance market may be well served to listen to the archived copy of this presentation.
CFPB Publishes ECOA Baseline Review Modules
Yesterday afternoon, the CFPB released its ECOA baseline review modules, which supplement the recently updated ECOA examination procedures. Completed baseline modules will be included in an institution’s examination work papers and may be considered in conjunction with any fair lending statistical analysis to assess an institution’s fair lending compliance and risks.
The baseline review procedures provide examiners with a series of questions in six modules to assess the following:
- Fair lending supervisory history;
- Fair lending compliance management system – management participation, policies and procedures, training, and internal controls and monitoring;
- Mortgage lending - policies and procedures for mortgage underwriting and pricing, including frequency of deviations, compensation structures, third-party involvement, and marketing practices;
- Mortgage servicing - policies and procedures as they relate to fair lending;
- Auto lending – policies and procedures for direct and indirect auto lending, including information related to pricing, underwriting, referrals, origination, and third-party compensation; and
- Other products – policies and procedures with respect to any additional products selected for review, e.g. secured and unsecured consumer lending, credit cards, add-on products, private student lending, payday lending, and small business lending.
The CFPB baseline review differs from the CFPB’s targeted review process, during which a supervised institution can be subject to an in-depth look at a specific area of fair lending risk, and is separate from the CFPB’s HMDA review, which includes transactional testing for HMDA data accuracy.
CFPB, Federal Reserve Board, DOJ Plan Indirect Auto Fair Lending Compliance Event
On July 15, the Federal Reserve Board announced that it will co-host an upcoming consumer compliance webinar with the CFPB and the DOJ entitled “Indirect Auto Lending – Fair Lending Considerations.” The event, which will be held August 6, 2013, 11:30 a.m. – 12:30 p.m. (ET), will feature Maureen Yap, special counsel and manager of the Federal Reserve’s Fair Lending Enforcement Section; Coty Montag, deputy chief of the DOJ’s Housing and Civil Enforcement Section of the Civil Rights Division; and Patrice Ficklin, assistant director of the CFPB’s Office of Fair Lending and Equal Opportunity. The panelists plan to discuss (i) the CFPB’s indirect auto lending bulletin and compliance with ECOA; (ii) supervisory guidance; (iii) examination procedures; (iv) public settlements; and (v) “emerging issues.” Following their presentations, the panelists will take audience questions, which may be submitted in advance.
Congress, CFPB Trade Letters on Fair Auto Lending Guidance
On June 20, 35 Republican Members of the U.S. House of Representatives sent a letter to CFPB Assistant Director of the Office of Fair Lending and Equal Opportunity, Patrice Ficklin, questioning the manner in which recent CFPB guidance regarding lending practices in the auto lending industry was rendered and requesting details concerning the process of analyzing potential fair lending violations. The letter comes on the heels of a similar inquiry made by 13 Democratic Members of the House Financial Services Committee to CFPB Director Richard Cordray on May 28, 2013. The CFPB guidance at issue, contained within CFPB Bulletin 2013-02, advised bank and nonbank indirect auto financial institutions about compliance with federal fair lending requirements in connection with the practice by which auto dealers “mark up” the financial institution’s risk-based buy rate and receive compensation based on the increased interest revenues.
The Republican letter takes issue with the CFPB “initiating [a] process without a public hearing, without public comment, and without releasing the data, methodology, or analysis it relied upon to support such an important change in policy.” The letter notes that “allegations of disparate impact do not involve intentional conduct, but instead consist solely of statistical analysis of past transactions” and that any model assessing such impact must be reliable and accurate. Because the guidance fails to disclose the model for assessing fair lending violations, Congress requested the CFPB provide all pertinent details regarding its methodology to evaluate whether the statistical model supports its supervision and examination of financial institutions.
In addition to taking issue with the CFPB’s statistical analysis, the Republican letter also characterized the ECOA compliance controls suggested in the CFPB bulletin as “onerous and unrealistic,” noting that “restricting consumer choice is highly problematic.” To support the controls prescribed by the guidance, the Republican letter requested that the CFPB provide “all studies, analysis, and information it relied upon in developing its guidance document.” Specifically, the two congressional letters requested the analysis conducted by the CFPB on the impact of these prescribed controls on the auto lending industry and any coordination activities undertaken with other agencies in developing the guidance. The House members, like many in the auto industry, are concerned the guidance will have an adverse impact on competition, result in increased overall costs for consumers, and potentially exclude lower-income customers from the credit market entirely.
Amid these growing concerns regarding the CFPB’s guidance and inquiry into auto finance practices, on June 20, Director Cordray provided a response to the May 28 Democrat letter. Mr. Cordray’s response essentially reiterates both the CFPB’s authority to supervise and investigate financial institutions engaged in auto finance and the CFPB’s concerns that pricing discretion may create a significant risk of discrimination. In responding to the issues of the Democrat letter, Director Cordray indicated that the CFPB uses a proxy methodology to analyze disparate impact in the auto lending industry, though it is short on the specifics behind the methodology used. The CFPB response acknowledged that ECOA fair lending analysis is more complex than mortgage lending analysis given the absence of data similar to that collected in the mortgage context under the Home Mortgage Disclosure Act. Director Cordray also posited that the use of proxies for unavailable data is a widely accepted mathematical and systematic approach in various arenas, including for marketing in the auto industry itself. According to Director Cordray, the CFPB uses both surnames and geographic location as proxies for unavailable characteristics. The proxy analysis is then conducted through publicly available data from the Social Security Administration and Census Bureau.
Notwithstanding the information provided regarding the CFPB’s methodology for analyzing potential discrimination within the auto finance industry, it appears that both Members of Congress and industry participants remain skeptical of the accuracy of such an approach and continue to call for increased transparency from the CFPB regarding its due diligence in creating this proxy methodology and disclosure of the methodology itself. Opponents also question the manner in which the guidance was released and absence of public hearings or public comment periods. The most recent Republican letter raised these precise issues and requested a response from the CFPB within 30 days.
CFPB Director Affirms Mortgage Rule Effective Dates, Acknowledges Potential Secondary Market Impacts
On Wednesday, CFPB Director Richard Cordray delivered remarks at an Exchequer Club luncheon in Washington, DC. During a brief question and answer segment, Mr. Cordray confirmed that the Bureau does not intend to delay the effective date of the mortgage rules and fully expects institutions to be in compliance when the rules take effect in January 2014. Financial institutions and their trade associations have expressed concern about implementing certain aspects of the myriad rules in the short time allowed by the CFPB and the potential impact on credit markets. Most recently industry representatives highlighted specific challenges at a House Financial Services Committee hearing that focused on the potential effects of the ability-to-repay/qualified mortgage (ATR/QM) rule.
Mr. Cordray generally downplayed the potential market impact and cost of compliance with the CFPB’s mortgage rules, with a particular focus on the ATR/QM rule. Mr. Cordray explained the CFPB expects that the spread between QM and non-QM loans, if passed to the consumer, should be only 10 basis points, and that, as a result, concerns over the significant cost of compliance with the ATR/QM rule’s requirements are overblown. Some market participants believe this estimate may be overly optimistic and not in line with the factors they are considering in making pricing decisions on non-QM loans. These observers believe that the underlying CFPB economic analysis for the estimate includes a series of critical assumptions based on limited data, such as the probability that a borrower will allege a rule violation and estimated repurchase and litigation costs.
Mr. Cordray reiterated the agency’s promise to provide further guidance on the interplay of fair lending compliance and QM lending although, given his expectations that QM and non-QM loans will not vary significantly from a pricing perspective, he expressed the view that the issue is not a major concern. He also downplayed concerns that changes to FHA premium requirements will cause more QM loans to exceed the APR threshold required for QM safe harbor status, an issue recently addressed by FHA Commissioner Galante.
In response to an observation from BuckleySandler Partner Jerry Buckley that the assignee liability provisions of the ATR/QM rule may act as an impediment to private capital re-entering the secondary market -- an issue that could become more critical since the Federal Reserve Board has signaled it may soon begin to taper its quantitative easing activities, which have buoyed secondary market liquidity -- Mr. Cordray acknowledged that the provision could possibly serve as a brake on secondary market liquidity. He also noted the CFPB’s ongoing work with the FHFA to develop a national mortgage database, which is intended to allow the agencies to monitor, among other things, the health of the secondary market.
House Democrats Raise Concerns about CFPB Auto Lending Enforcement
On May 28, a group of 13 Democratic Members of the House Financial Services Committee sent a letter to CFPB Director Richard Cordray seeking “any and all background information about . . . [the CFPB’s] investigation into alleged practices within the auto lending industry.” As has been reported, earlier this year the CFPB issued guidance to bank and nonbank indirect auto lenders about compliance with federal fair lending requirements, and the CFPB has spent the past several months implementing that guidance through supervision and examination of lenders. In particular, the CFPB is focused on the practice by which auto dealers “mark up” the indirect lender’s risk-based buy rate and receive compensation based on the increased interest revenues. In their letter to Director Cordray, the Members of Congress remind the Director that vehicle ownership can be critical to a consumer’s ability to obtain and maintain employment and find affordable housing, and raise concerns about the impact of the CFPB’s auto lending enforcement activity on consumers’ access to affordable credit for vehicle purchase. The Members ask the Director to provide specific information about allegations stemming from investigations of auto lenders and the methodology the CFPB is employing to determine whether fair lending violations exists. They also seek additional information about the CFPB’s compliance expectations for indirect auto lenders with regard to dealer compensation policies. The letter asks the CFPB to respond by June 7, 2013.
CFPB Issues Third Semiannual Report
On March 29, the CFPB released its third semiannual report, which covers the Bureau’s activities from July 1, 2012 through December 31, 2012. The report reviews, among other things, the CFPB’s supervision, enforcement, and rulemaking activities over the subject period. With regard to fair lending, the report confirms that the CFPB is developing a fair-lending focused component of its Compliance Analysis Solution system that collects, validates, and analyzes loan portfolio data, and highlights previously reported fair lending activities, including those in its December 2012 fair lending report. The report also touches on many other familiar topics – it again reviews the CFPB’s complaint handling process and summarizes complaints received to date, discusses challenges consumers have reported with regard to student loan obligations, and highlights “shopping challenges” allegedly present in small dollar lending. Finally, the report provides vague timeframes for rulemakings, including the CFPB’s plan to (i) “accelerate work on” amendments to HMDA to require creditors to collect and report additional lending data, and (ii) propose a prepaid card rule in 2013.
Insights Into The Financial Fraud Enforcement Task Force Priorities for 2013
On March 20, 2013, Michael Bresnick, Executive Director of DOJ’s Financial Fraud Enforcement Task Force gave a speech at the Exchequer Club of Washington, DC highlighting recent accomplishments of the Task Force and outlining its priorities for the coming year. He began by discussing a number of areas of known focus for the Task Force, including RMBS fraud, fair lending enforcement, and servicemember protection. He then outlined three additional areas of focus that the Task Force has prioritized, including (i) the “government’s ability to protect its interests and ensure that it does business only with ethical and responsible parties;” (ii) discrimination in indirect auto lending; and (iii) financial institutions’ role in fraud by their customers, which include third party payment processors and payday lenders.
The third priority, which was the focus of Mr. Bresnick’s remarks, involves the Consumer Protection Working Group’s prioritization of “the role of financial institutions in mass marketing fraud schemes -- including deceptive payday loans, false offers of debt relief, fraudulent health care discount cards, and phony government grants, among other things -- that cause billions of dollars in consumer losses and financially destroy some of our most vulnerable citizens.” He added that the Working Group also is investigating third-party payment processors, the businesses that process payments on behalf of the fraudulent merchant. Mr. Bresnick explained that “financial institutions and payment processors . . . are the so-called bottlenecks, or choke-points, in the fraud committed by so many merchants that victimize consumers and launder their illegal proceeds.” He said that “they provide the scammers with access to the national banking system and facilitate the movement of money from the victim of the fraud to the scam artist.” He further stated that “financial institutions through which these fraudulent proceeds flow . . . are not always blind to the fraud” and that the FFETF has “observed that some financial institutions actually have been complicit in these schemes, ignoring their BSA/AML obligations, and either know about -- or are willfully blind to -- the fraudulent proceeds flowing through their institutions.” Mr. Bresnick explained that “[i]f we can eliminate the mass-marketing fraudsters’ access to the U.S. financial system -- that is, if we can stop the scammers from accessing consumers’ bank accounts -- then we can protect the consumers and starve the scammers.”
Mr. Bresnick stated that the Task Force’s message to banks is this: “Maintaining robust BSA/AML policies and procedures is not merely optional or a polite suggestion. It is absolutely necessary, and required by law. Failure to do so can result in significant civil, or even criminal, penalties under the Bank Secrecy Act, FIRREA, and other statutes.” He noted that banks should endeavor not only to know their customers, but also to know their customers’ customers: “Before they agree to do business with a third-party payment processor, banks should strive to learn more about the processors’ merchant-clients, including the names of the principals, the location of the business, and the products being sold, among other things.” They further should be aware of glaring red flags indicative of fraud, such as high return rates on the processor’s accounts: “High return rates trigger a duty by the bank and the third-party payment processor to inquire into the reasons for the high rate of returns, in particular whether the merchant is engaged in fraud.” (See BuckleySandler’s previous Spotlight on Anti-Money Laundering posts here, here and here.) Mr. Bresnick underscored this point by mentioning a recent complaint filed by the DOJ in the Eastern District of Pennsylvania.
With respect to the financial institutions’ relationships with the payday lending industry, Mr. Bresnick stated that “the Bank Secrecy Act required banks to have an effective compliance program to prevent illegal use of the banking system by the banks’ clients.” He explained that financial institutions “should consider whether originating debit transactions on behalf of Internet payday lenders – particularly where the loans may violate state laws – is consistent with their BSA obligations.” Although he acknowledged that it was not a simple task for a financial institution to determine whether the loans being processed through it are in violation of the state law where the borrower resides, he suggested “at a minimum, banks might consider determining the states where the payday lender makes loans, as well as what types of loans it offers, the APR of the loans, and whether it makes loans to consumers in violation of state, as well as federal, laws.”
In concluding, Mr. Bresnick said, “It comes down to this: When a bank allows its customers, and even its customers’ customers, access to the national banking system, it should endeavor to understand the true nature of the business that it will allow to access the payment system, and the risks posed to consumers and society regarding criminal or other unlawful conduct.”
The agenda outlined by Mr. Bresnick reinforces ongoing efforts by FinCEN and the FDIC, and adds to the priorities recently sketched out by CFPB and the OCC. Together they describe an ambitious, and increasingly aggressive, financial services enforcement agenda for federal regulators and enforcement authorities.
NCUA Issues Fair Lending Guide, Plans Fair Lending Webinar
On March 19, the NCUA released a letter to credit unions to introduce its new fair lending guide and announce other fair lending tools. The fair lending guide includes (i) an overview of fair lending law and regulations, (ii) credit union operational requirements, (iii) fair lending compliance policy considerations, and (iv) checklists for testing compliance with laws and regulations, or developing a fair lending policy for compliance. The letter also explains that the NCUA’s determinations about which credit unions will be examined for fair lending are based on (i) HMDA outliers, (ii) recent fair lending findings or violations identified in safety and soundness exams, (iii) general risk compliance ratings, and (iv) other factors such as volume, types, and complexity of products and services offered, types of communities served, and customer fair lending complaints. The NCUA also announced its plans to hold a fair lending webinar on April 4, 2013.
New Study Claims Mortgage Lenders Discriminate against Women
On March 12, the Chicago-based Woodstock Institute released research claiming that mortgage lenders discriminate against female applicants. The research is presented in a “fact sheet” and previews a longer report the group plans to publish later this year. The study reviewed 2010 HMDA data on first lien single-family home purchase and refinance mortgage applications in the Chicago area and purports to show that (i) female-headed joint applications are much less likely to be originated than male-headed joint applications and (ii) this disparity holds true across all racial categories and is most pronounced for African American women. The Woodstock Institute further claims that these disparities are more pronounced for refinance loans. Based on its conclusions, the group urges federal regulators and enforcement authorities to conduct further investigation, including through enforcement of HUD’s recently finalized disparate impact rule. It also recommends that the CFPB prioritize enhancing the HMDA rules to make public more information to better identify discriminatory lending practices.