CFPB Examination Procedures Auto Finance

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CFPBExamination ProceduresAutomobile FinanceExamination ProceduresAuto FinanceExam Date:Prepared By:Reviewer:Docket #:Entity Name:Event e][Click&type][Click&type]These Automobile Finance Examination Procedures(Procedures) consist of modules covering thevarious elements of the automobile life cycle,including the origination and servicing processes. Each module identifies specific matters forreview. Examiners will use the Procedures in examinations of automobile lenders, lessors, andservicers. Before using the Procedures, examiners should complete a risk assessment andexamination scope memorandum in accordance with general CFPB procedures. Depending onthe scope, and in conjunction with the compliance management system review, includingconsumer complaint review, each examination will cover one or more of the following modules.Module 1Company Business ModelModule 2Compliance Management SystemModule 3Advertising and MarketingModule 4Application and OriginationModule 5Payment Processing, Account Maintenance, and Optional ProductsModule 6Collections, Debt Restructuring, Repossessions, and Accounts in BankruptcyModule 7Customer Complaints and InquiriesModule 8Credit Reporting, Information Sharing, and PrivacyModule 9Examiner Conclusions and Wrap-upExamination Objectives1. To assess the quality of a supervised entity’s compliance management system forpreventing violations of Federal consumer financial law in its automobile loan or leaseorigination business or automobile servicing business.2. To identify acts or practices that materially increase the risk of violations of Federalconsumer financial law, and associated harm to consumers, in connection with an entity’sautomobile loan or lease origination business or automobile servicing business.3. To gather facts that help determine whether a supervised entity engages in acts or practicesthat are likely to violate Federal consumer financial law in connection with its automobileloan or lease origination business or automobile servicing business.CFPBJune 2015Auto Finance 1

CFPBExamination ProceduresAuto Finance4. To determine, in accordance with CFPB internal consultation requirements, whether aviolation of a Federal consumer financial law has occurred and whether further supervisoryor enforcement actions are appropriate.BackgroundThis section of the Procedures provides background on the automobile finance business and theFederal consumer financial law requirements that apply.The Dodd-Frank Act (12 U.S.C. 5514(a)(1)(B)) gave the Consumer Financial Protection Bureau(CFPB) supervisory authority over “larger participants” of certain markets for consumerfinancial products or services, as the CFPB defines by rule. In June 2015, the CFPB finalized itslarger participant regulation in the market of automobile financing. The rule appears in 12 CFR1090.108 and is effective 60 days after publication in the Federal Register. It provides that anonbank covered person that engages in automobile financing is a larger participant of theautomobile financing market if the person has at least 10,000 aggregate annual originations.Under the regulation, “automobile financing” generally includes grants of credit for the purchaseof an automobile, refinancings of such obligations (and any subsequent refinancings thereof) thatare secured by a vehicle, automobile leases, and purchases or acquisitions of any of the foregoingobligations. The rule provides that certain auto dealers do not qualify as larger participants 1.Consumers can acquire a vehicle using cash, financing the vehicle with an auto loan (indirect ordirect), or leasing the vehicle for a defined period of time. Auto loans are closed-end (nonrevolving) amortizing consumer installment loans used for the purpose of acquiring a vehicle,usually a car, sport utility vehicle (SUV) or light-duty truck. Loan terms vary by the channel(indirect/direct), type of vehicle sought (new/used), and the credit profile of the consumer (creditscore, debt-to-income ratio, bureau attributes). Leasing is acquiring a vehicle for a fixed periodof time at an agreed amount of money.Indirect Lending ChannelWith indirect lending, dealers rather than consumers typically select the lender who will providethe financing. Upon completion of the vehicle selection process, the dealer usually collects basicinformation regarding the applicant and uses an automated system to forward that information to1Under section 1029 of the Dodd-Frank Act, the Bureau may not exercise its authority over certain auto dealers, asoutlined in that section. The final larger-participant rule also excludes certain dealers that extend retail credit orretail leases directly to consumers without routinely assigning them to unaffiliated third party finance or leasingsources, even though such dealers are not subject to the statutory exclusion of section 1029. Specifically, the largerparticipant rule excludes those motor vehicle dealers that are identified in section 1029(b)(2) of the Dodd-Frank Actand are predominantly engaged in the sale and servicing of motor vehicles (as that term is defined in 12 U.S.C.5519(f)(1)), the leasing and servicing of motor vehicles, or both. Thus, a typical Buy-Here-Pay-Here dealer wouldnot be subject to the larger-participant rule, but a Buy-Here-Pay-Here finance company could a larger participant ifit has at least 10,000 aggregate annual originations.CFPBJune 2015Auto Finance 2

CFPBExamination ProceduresAuto Financeprospective indirect automobile lenders. Most consumers who finance the purchase of anautomobile use the indirect channel.After evaluating the applicant, indirect auto lenders may provide the dealer with purchaseeligibility criteria or stipulations, including but not limited to a risk-based “buy rate” thatestablishes a minimum interest rate at which the lender is willing to purchase a retail installmentsales contract executed between the consumer and the dealer for the purchase of the vehicle. Afranchised dealer often can choose from a selection of funding sources. However, a franchiseddealer that is affiliated with a manufacturer can be incentivized to use a captive finance company(captive) through mechanisms such as promotional discounts or limited-time financing offers thatcan be used to attract consumers. A captive is usually a subsidiary of the parent organization (inthe auto market, the parent is usually the manufacturer) whose purpose is to provide financing toconsumers buying the parent company’s products.With the relevant eligibility criteria and stipulations, the dealer selects the indirect lender thatwill provide the financing and extends the credit through a retail installment sales contract thatthe indirect lender purchases or acquires. The dealer is typically compensated for arrangingindirect financing. In the indirect lending model, the indirect automobile lender typicallybecomes responsible for servicing the retail installment sales contract and consumers will thenmake payments to the lender.Most dealers use a standardized platform such as Dealer Track, Route One, or CUDL to collectcredit application information in a single system. In turn, these platforms route the creditinformation to lenders based on the criteria provided, and the lenders make a preliminarydecision to offer or not offer credit and provide approval terms to the dealers’ finance andinsurance (F&I) departments. This method allows dealers to match customers with a lender whowill accept the loan.Direct Lending ChannelConsumers seek out and negotiate their loan terms with a finance company or bank of theirchoosing, either before or after shopping for a vehicle. Consumers typically use their pre-existingrelationships with a bank or finance company to obtain financing through the direct channelmethod.Auto LeasingDepository institutions have long engaged in auto leasing activities, and nonbank entities are amajor player in the leasing sector. It is an important and growing part of the auto financingmarket for consumers. While the auto financing market is largely made up of purchase loans, inrecent years, consumers have begun to migrate more towards leasing agreements.Unlike the purchase of a vehicle, the consumer does not actually own the vehicle with a lienagainst a title. Instead, the consumer makes payments for the lease term. Auto leases aretypically 12 months to 48 months in length, and include a “money factor” rather than an annualpercentage rate (APR). An APR can be calculated by dividing the money factor by 2400.CFPBJune 2015Auto Finance 3

CFPBExamination ProceduresAuto FinanceAt the end of the lease term, a consumer has the option to purchase the vehicle for a prenegotiated balloon payment that is based on the residual value. The residual value is the dollaramount the consumer’s leased vehicle is estimated to be worth at the end of the lease. The lenderbears the risk that it has estimated the residual value correctly.For consumers, leasing a vehicle requires an application process and an ongoing contractualobligation that are both financial in nature and similar to entering into a financial arrangement topurchase a vehicle. Like a consumer seeking to qualify for a loan to purchase a vehicle, aconsumer seeking to lease a vehicle must provide basic financial information such as income andcredit history. Though a consumer who leases an automobile need not finance the entire cost ofthe vehicle, the consumer still undertakes a major financial obligation in the form of acommitment to make a stream of payments over a significant period of time. The consumer mustconsider how much cash to use, if any, for a capitalized cost reduction (similar to a downpayment), the preferred lease term, and the affordability of monthly payments and other costs,including maintenance, insurance, and state registration fees.Buy Here Pay HereBuy Here Pay Here (BHPH) finance companies are similar to captives in that they are associatedwith certain BHPH dealers. While BHPH dealers are mostly independently-owned entities thatserve as the primary lender and receive payments directly from consumers, some larger BHPHdealers will sell or assign their contracts to specific BHPH finance companies once the contracthas been consummated with the consumer. However, these BHPH finance companies do notfocus on a particular auto manufacturer, unlike captives whose primary purpose is to extendcredit to consumers who want to purchase or lease a specific manufacturer’s vehicles.Ancillary Products and ServicesIn addition to the actual vehicle, auto dealers and auto financers offer ancillary services andproducts at the time of vehicle purchase. These products can be distinguished by their associationto either the vehicle purchase or the financing relationship. GAP Insurance: Also known as Guaranteed Auto Protection or Guaranteed Asset Protection,it is an insurance policy that covers the amount on a financing obligation that is thedifference between the asset value and the amount covered by another insurance policy. Inthe event of total vehicle loss, the insurance policy covers the deficiency between theinsurance settlement and the balance still owed. This insurance coverage is usually marketedfor financing with small down payments, high interest rates, and/or extended terms (usuallyover 60 months). Extended Warranty: An extended warranty or vehicle service contract covers the costs ofsome types of repairs in addition to the manufacturer’s warranty or after the manufacturer’swarranty ends. These contracts typically exclude routine maintenance such as oil changesand tire replacement.CFPBJune 2015Auto Finance 4

CFPBExamination Procedures Auto FinanceVehicle Add-Ons: Also known as back-end products, these add-ons are other pieces ofequipment or finishing items that can be purchased with the vehicle such as Lo-Jack systems,vehicle identification number etching (anti-theft precaution),and paint protection.Applicable Laws/RegulationsRegardless of the channel or business model used by lenders to conduct business, the followingFederal consumer financial laws may apply to an entity’s auto financing activities: The Truth in Lending Act (TILA) and its implementing regulation, Regulation Z, requirelenders to disclose loan terms and annual percentage rates. Regulation Z also requires lendersto provide advertising disclosures, credit payments properly, process credit balances inaccordance with its requirements, and provide periodic disclosures. The Electronic Fund Transfer Act (EFTA) and its implementing regulation, Regulation E,protect consumers engaging in electronic fund transfers. Among other things, Regulation Eprohibits lenders from requiring, as a condition of loan approval, a customer’s authorizationfor loan repayment through a recurring electronic funds transfer (EFT) except in limitedcircumstances. The Fair Debt Collection Practices Act (FDCPA) governs collection activities conducted bythird party collection agencies, as well as servicer collection activities if the servicer acquiredthe loan when it was already in default. The Fair Credit Reporting Act (FCRA) and its implementing regulation, Regulation V,require that furnishers of information to consumer reporting agencies ensure the accuracy ofthe data placed in the consumer reporting system. Additionally, the FCRA prohibits the useof consumer reports for impermissible purposes, and it requires users of consumer reports toprovide certain disclosures to consumers. The FCRA also limits certain information sharingbetween affiliated companies. The Gramm-Leach-Bliley Act (GLBA) and its implementing regulation, Regulation P,require entities to provide privacy notices and limit information sharing in particular ways. The Equal Credit Opportunity Act (ECOA) and its implementing regulation, Regulation B,set forth requirements for accepting applications and providing notice of any adverse action,and they prohibit discrimination against any borrower with respect to any aspect of a credittransaction:o On the basis of race, color, religion, national origin, sex or marital status, or age(provided the applicant has the capacity to contract);o Because all or part of the applicant’s income derives from any public assistance program;orCFPBJune 2015Auto Finance 5

CFPBExamination ProceduresAuto Financeo Because the applicant has in good faith exercised any right under the Consumer CreditProtection Act. 2If examiners identify concerns related to ECOA, they should consult with the Offices ofFair Lending and Supervision Policy, as those issues, except as specifically describedherein, are beyond the scope of these procedures. The Consumer Leasing Act and its implementing regulation, Regulation M, require lessors toprovide specific disclosures prior to the consummation or delivery of the consumer product,including disclosures in advertising. To carry out the objectives set forth in the Examination Objectives section, the examinationprocess also will include assessing other risks to consumers that are not governed by specificstatutory or regulatory provisions. These risks may include potentially unfair, deceptive, orabusive acts or practices (UDAAPs) with respect to lenders’ or servicers’ interactions withconsumers. 3 Collecting information about risks to consumers, whether or not there arespecific legal guidelines addressing such risks, can help inform the CFPB’s policymaking.Generally, the standards the CFPB will use in assessing UDAAPs are as follows.o A representation, omission, act, or practice is deceptive when: the representation, omission, act, or practice misleads or is likely to mislead theconsumer; the consumer’s interpretation of the representation, omission, act, or practice isreasonable under the circumstances; and the misleading representation, omission, act, or practice is material.o An act or practice is unfair when: it causes or is likely to cause substantial injury to consumers; the injury is not reasonably avoidable by consumers; and the injury is not outweighed by countervailing benefits to consumers or tocompetition.o An abusive act or practice:2The Consumer Credit Protection Act, 15 U.S.C. 1601 et seq., is the collection of federal statutes that protects consumers whenapplying for or receiving credit. The Act includes statutes that have dispute rights for consumers, such as the Fair CreditReporting Act. The ECOA prohibits discriminating against an applicant who has exercised a dispute right pursuant to one of thestatutes outlined in the Act.3Section 1036 of the Dodd-Frank Act, PL 111-203 (July 21, 2010).CFPBJune 2015Auto Finance 6

CFPBExamination ProceduresAuto Finance materially interferes with the ability of a consumer to understand a term or conditionof a consumer financial product or service; or takes unreasonable advantage of – a lack of understanding on the part of the consumer of the material risks, costs, orconditions of the product or service; the inability of the consumer to protect the consumer’s interests in selecting orusing a consumer financial product or service; or the reasonable reliance by the consumer on a covered person to act in the interestsof the consumer.Refer to the examination procedures regarding UDAAPs for more information about the legalstandards and the CFPB’s approach to examining for UDAAPs.The particular facts in a case are crucial to a determination of UDAAPs. As set forth in theExamination Objectives section, examiners should follow the CFPB internal consultationrequirements to determine whether the applicable legal standards have been met before aviolation of any Federal consumer financial law is cited, including a UDAAP violation.General ConsiderationsCompleting the examination modules, as applicable, will allow examiners to develop a thoroughunderstanding of a regulated entity’s practices and operations. To complete the modules,examiners should obtain and review, as applicable, each entity’s: organizational charts and process flowcharts; board minutes, annual reports, or the equivalent, to the extent available; relevant management reporting; policies and procedures; compensation structure and bonus programs for origination and servicing personnel; rate sheets; fee sheets; loan/lease applications and verification of information relied on in determining ability torepay; loan/lease account documentation, notes, disclosures, and all other contents of underwritingand closing files;CFPBJune 2015Auto Finance 7

CFPBExamination ProceduresAuto Finance operating checklists, worksheets, and review documents; relevant computer program and system details; dealer agreements, due diligence and monitoring procedures, and origination (lending orleasing) procedures; underwriting guidelines; compensation policies; servicing related policies and procedures, such as those related to payment posting andpayment allocation; service provider due diligence and monitoring procedures and service provider contracts; audit and compliance reports; management’s responses to findings; training programs and materials; advertisements; and complaints.Finally, examiners should obtain access to or a walkthrough of the entity’s online originationinterface and online applications; a walkthrough of the origination process to test the timeliness andcompleteness of disclosures; and a walkthrough and overview of the systems used for the servicingand collection of payments for automobile loans and leases, including any consumer interfaces.Depending on the scope of the examination, examiners should perform transaction testing usingapproved sampling procedures, which may require use of a judgmental or statistical sample.Examiners also should conduct interviews with management and staff to determine whether theyunderstand and consistently follow the policies, procedures, and regulatory requirementsapplicable to automobile financing and servicing; manage change appropriately; and implementeffective controls. Exami

Consumers can acquire a vehicle using cash, financing the vehicle with an auto loan (indirect or direct), or leasing the vehicle for a defined period of time. Auto loans are closed-end (non-revolving) amortizing consumer installment loans used for the purpose of acquiring a vehicle, usually a car, sport utility vehicle (SUV) or light-duty truck.

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