Follow up on a threat he made in 2018New York State Department of Financial Services (DFS) announcement on October 6, 2022 that it entered into a consent order with Rhinebeck Bank (“Rhinebeck”) to resolve discrimination claims involving discretionary dealer mark-ups on retail installment contracts with minority borrowers. As part of the settlement, Rhinebeck will pay a civil penalty of $950,000, provide restitution to borrowers and develop a compliance plan that includes updates to its automotive policies to cap dealer markups on installment contracts purchased by the bank.
Rhinebeck is a New York chartered bank with fifteen branches serving consumer and commercial customers in New York’s Hudson Valley. As a participant in the indirect automotive financing market, Rhinebeck provides automotive financing through automotive dealerships and has no direct interaction with consumers during the financing application process. As alleged in the consent order, Rhinebeck left auto dealers the discretion to mark up the borrower’s interest rates above the “buy rate” determined by the bank’s underwriting, which is the minimum rate at which the bank would agree to purchase an installment contract issued by the concessionaire. .
Between January 1, 2017 and December 15, 2020, Rhinebeck’s general policy was to allow profit margins ranging from 1.5% to 2.5% (and up to 3%, in a small number of cases) depending on the duration of the contract. Dealer profit margin was capped at 2% after December 15, 2020. A DFS analysis of dealer profit margins on contracts purchased by Rhinebeck during the relevant period found that Black, Hispanic and Asian borrowers paid on average more in discretionary concession. markups than non-Hispanic white borrowers at statistically significant rates ranging from 15% to 39%. Although DFS found no evidence of intentional discrimination by Rhinebeck or its employees, it alleged that the bank’s dealer markup policies and practices resulted in statistically significant disparities in the rates paid to dealers. borrowers who were not based on creditworthiness or other objective risk criteria.
While creditors are permitted to price loans differently based on objective differences in creditworthiness, New York’s Fair Lending Act prohibits discrimination against protected classes in granting, denying, extending, the renewal of credit or the fixing of interest rates, terms or conditions of any form of credit. New York Executive. L. §§ 296-a(1)(b) and (3). Although there appears to be little case law on this point, the DFS considers that the Fair Lending Act prohibits both disparate treatment and practices that have a disparate impact on a prohibited basis.
Rhinebeck released a statement saying he disagreed with the findings and denied the allegations, but wanted to avoid a lengthy legal battle. According to Rhinebeck President and CEO Michael J. Quinn:
This settlement reflects a striking change by DFS from the current approach of virtually all federal and state banking regulators and enforcement agencies on fair lending cases involving a dealer. [markups]. Dealerships, not banks, determine how much markup to charge customers. Banks do not know the racial or ethnic characteristics of borrowers before [contract] comes from. In fact, the law prohibits banks from asking for this information, which means that DFS’s action is based on allegations that the customers concerned are presumed to be only of a particular race or ethnicity, based on their surname and geographic location as an approximation of these borrower characteristics.
Rhinebeck is correct that the installment contracts analyzed by DFS in the action did not contain information about the race or national origin of the borrowers. Instead, the DFS states in the consent order that it “assigned race and national origin probabilities to applicants and used a proxy methodology that combines geography-based and name-based probabilities. , based on public data published by the United States Census Bureau, to form a joint probability using the Bayesian Improved Surname Geocoding (“BISG”) method”. This methodology is commonly used and has served as the basis for similar enforcement actions brought by the DOJ and CFPB against indirect auto finance companies alleging violations of the ECOA through discretionary dealer mark-ups, despite serious concerns about its validity and reliability.
We have challenged these types of enforcement actions in the past, for several reasons. First, banks do not control dealer financing costs, and dealers may choose to sell installment contracts to various assignees. A cap on discretionary markups by a bank may simply mean that a dealer will look elsewhere to sell his installment contracts. Second, actions like this hold the bank or purchaser of an installment contract responsible for the dealer’s discriminatory actions even though the bank was not involved in the negotiation or the discriminatory pricing. Third, as shown, the use of proxy data (here, BISG encoding) may result in disparate impact results that are actually due to coding errors, not actual discrimination. Fourth, a disparate impact analysis is often done at the level of the assignee rather than at the level of each reseller. A hypothetical example we have used in the past illustrates how this may result in a disparate impact finding even when no discrimination has occurred: an assignee buys installment retail contracts from two dealers: one of them always sets the APR of the contract at 2% above the purchase rate of the assignee, and the other always sets the Contract APR at wholesale buy rate with no rate spread increment. If both dealers apply these retail pricing policies consistently, no consumer is ever treated differently by either dealer. But if there is a difference in the demographic composition of the dealerships’ customers, a regression analysis performed at the assignee level will reflect a false “disparate impact”, solely due to the accidental nature of each dealership’s customer base.
This DFS action is a reminder that states continue to take action under state fair lending laws. The CFPB withdrew from applying ECOA in the context of indirect auto loans in 2018 when Congress adopted a joint resolution removal of CFPB bulletin “Indirect Auto Lending and Equal Credit Opportunity Act Compliance”. While New York’s Fair Lending Act is similar to the ECOA, DFS viewed the rollback of federal enforcement as an opportunity to fill the void. By issuing its own guidance on indirect auto credit in 2018then-DFS Superintendent Maria Vullo said “While the federal government fails to protect consumers from fraud and financial abuse, DFS stands up to protect New Yorkers from unfair lending practices.
Of particular note in this settlement is the 2% cap imposed by DFS on dealer profit margins as part of Rhinebeck’s policy going forward and the requirement for a move to a flat-rate model for certain dealers. on a progressive basis. We’ve seen other actions where federal regulators and states have pushed to lower dealer profit margin caps, most recently in a enforcement action brought by the Federal Trade Commission and the Illinois Attorney General which capped dealer profit margins at 185 basis points above the buy rate. Auto finance companies that purchase retail installment contracts that include profit margins greater than 1.5% to 2% should be cautioned that regulators may view this discretion as too permissive and an open door to potential discrimination.
Banks should consult with counsel on the best steps to take to ensure that states do not attack their fair lending compliance in their indirect auto programs. These steps may include setting limits on dealer profit margins, ensuring that annual notices regarding fair lending and compliance with ECOA and lender expectations are sent to all dealers participating in a lending program. indirect automobile, and the engagement of outside counsel to perform periodic portfolio reviews to monitor discrepancies.
