The Next Bubble | By Laura Alix
Car sales are set to accelerate back to pre-recession levels this year, and with them, a new source of revenue for banks and credit unions who do auto financing – that is, of course, if regulators don’t put on the brakes.
New car sales are expected to top 16 million this year, a 6 percent increase over the 15.5 million predicted last year and an effective return to pre-recession levels, the automotive resource website Edmunds.com predicted.
Thank the slowly improving job market and economy, combined with a loosening of credit markets for would-be car buyers, Edmunds.com Chief Economist Lacey Plache said.
That’s not just good news for people who’ve put off replacing the old beater in the driveway. It’s also good news for banks and credit unions who do auto financing, both direct and indirect.
Auto loans have been on a steady uptick. The FDIC reported last fall that auto loan balances had risen 3.2 percent, or $10.6 billion, during the third quarter last year, and auto loans accounted for nearly 49 percent of total credit union loan growth through October, according to CUNA Mutual Group.
But could auto financing be next on the Consumer Financial Protection Bureau’s agenda? All signs point to yes.
Most recently, Ally Financial paid $98 million to settle charges that it discriminated against minority borrowers who were charged more than white customers for auto loans from car dealers.
The consumer protection agency, along with the Department of Justice, alleged that more than 235,000 minority borrowers paid higher interest rates than white customers because of what it characterized as Ally’s discriminatory pricing system.
But Christopher Willis, a partner in Ballard Spahr’s consumer financial services group and chair of the firm’s fair lending task force, said the CFPB signaled its interest in auto financing well before the settlement with Ally Financial.
For one thing, he said, the agency has made numerous public statements to its belief that dealer rate participation creates disparate impact. Then, in March 2012, the agency released a bulletin outlining fair lending guidance to financial institutions that provide indirect auto financing.
Under the indirect auto financing model, the consumer arranges financing through the dealer, who then turns around and sells that loan to a bank, credit union or other finance company that has provided a rate sheet detailing the minimum interest rates it will accept for a customer with a given credit score buying a given age car.
The dealer, however, can increase that interest rate, typically between 2 to 2.5 percent, and the financial institution purchasing that loan will pay the dealer a portion of that interest rate differential.
Semantics are important
While the CFPB has labeled the practice “indirect auto lending,” Willis doesn’t like that term, and instead prefers to say “indirect auto financing.” It may seem like a matter of semantics, but the agency’s choice of words casts financial institutions as creditors under the Equal Credit Opportunity Act, the law that regulators charged Ally Financial with violating.
“I think the most likely thing we’re going to see in 2014 is several more consent orders similar to the ones they just released. They have publicly announced that they have several investigations and it’s no secret that the CFPB does not like this business model,” Willis said.
Willis also predicted the market could move toward more of a flat fee or flat rate environment, in which some customers would end up paying more for a car loan and others would end up paying less – in other words, leaving little, if any, room for savvy customers to negotiate an interest rate with their dealer.
And of course, there’s the cost of compliance, which could wind up being passed onto the consumer.
While the CFPB has outlined a number of steps to limit fair lending risk in indirect auto financing, the most helpful of those might be a statistical regression analysis of your portfolio, Willis said.
“Unless you do that analysis, not only will [the government] think you’re not doing a good job, you’ll be totally in the dark about what they’ll find if they come in and audit you,” he said.
The agency’s legal theory on which it’s based its cases and investigations also leaves some room for doubt, Willis added.
“It is very possible to argue that the [ECOA] only prohibits intentional discrimination and not disparate impact,” he said. The agency has taken the opposite view.
That echoes a similar debate over the Fair Housing Act. The Supreme Court has previously accepted two previous cases – Magner v. Gallagher and Mt. Holly Garden Citizens in Action v. Township of Mount Holly – that argued the act prohibited only intentional discrimination and not disparate impact, but both cases settled before the court could rule on them.■