Where loan origination is fragmented, payments get made to intermediaries for the services provided. In some cases, those payments are clearly disclosed to borrowers as fees on the loan. However, most of the time the cost of paying the intermediary is built into the borrower’s interest rate. In the mortgage world, this is called yield-spread premium (YSP). In auto and recreational lending, it is called dealer reserve. In home improvement lending, it is most often called dealer participation.
In the aftermath of the market crash and the Great Recession, the Consumer Financial Protection Bureau (CFPB) was created and they took a close look at mortgage originations. An end result among many was the elimination of the yield-spread premium method of compensating originators. Why? To move origination charges out of their “hidden” location in the interest rate, and to eliminate incentives to charge the consumer more in order to increase the originator’s compensation.
Lending industry folks might have thought that was the end of the story. I don’t know about you, but I’ve never met a powerful regulatory agency that doesn’t like the feel of flexing its muscles. After spending some time on credit cards, the CFPB’s attention turned to auto dealers and the dealer reserve. In March of 2013, the CFPB fired a shot across the bow of auto finance. Though the Bureau does not have a specific rule addressing auto dealer compensation, they decided to use anti-discrimination laws to enforce their will. This is a very effective approach in that it ropes in the lenders and makes them responsible for dealer practices. Oh, and just in case you were thinking that intention matters when discrimination is alleged, the CFPB made it clear in August that intention is irrelevant.
“Lenders should not assume that they may be liable only when they have actual knowledge of discrimination by a particular dealer.”
That’s a serious threat.
If you’ve been around the block a couple times, you know that auto dealers carry a lot of political weight. After some agitation in the halls of power, Congressional leaders challenged the CFPB to explain their actions. Well, the CFPB responded and they aren’t showing signs of backing down. Like savvy poker players, they’ve even doubled down, announcing that they’ve referred four lenders to the Justice Department over discriminatory practices by auto dealers.
I’m no Nostradamus, but I can’t imagine this is going to turn out well for auto dealers or lenders. In order to reign in the CFPB on this front, they may have to be reigned in altogether. Does anyone think this Congress is prepared to do that, especially so close to the crisis that spawned the agency?
Probably not. Frankly, if I were a home improvement contractor relying on participation, I’d find a way to eliminate it. Like railroads at the advent of mass airline travel, it appears interest rate-based payments to dealers may be living on borrowed time.