The Handwriting Is on the Wall
The Future of Dealer Compensation from Retail Installment Sales Contracts
Several things have happened recently that would make you not want to “read the handwriting on the wall”—the future of dealer participation, as a percentage of finance charge generated by a retail installment sale contract, is on the way out.
Not only do we hear about this from anecdotal sources (dealer chat at industry meetings), but we also see what the federal regulators have done to regulate perceived “steering” and to prohibit compensation in the form of yield spread premium in the home mortgage lending business.
Captive finance companies and banks that purchase dealer paper have used, as a primary means of compensating dealers, a split on the finance charge generated by the terms of the retail installment sale contract. In the old days, that split—the amount of the finance charge on the contract over the “buy rate” the captive or bank offered—was earned by the dealer over the life of the contract. As the buyer paid on the contract, the percentage earned by the dealer would be placed in a reserve account to ensure against charge-backs, and at a certain point the dealer would receive a check for the amount over the reserve.
As time went by, dealers who didn’t want to wait to be paid would agree to split the mark-up over the “buy rate” and take theirs up-front, with a limited right of charge-back, typically three months of payments on the contract. Such compensation practices encouraged some dealers to charge as much finance charge at the highest annual percentage rate on the contract that the deal would bear, often to the detriment of the most vulnerable buyers. Years of class action litigation tempered the practice somewhat, but did not eradicate it. Disclosures in the contract forms, brought about as a condition of settlement of the litigation, would advise the buyer that “the APR is negotiable” and that the dealer “may retain or receive part of the finance charge.” That split was also limited as a condition of settlement of the litigation, and over the years has found its way into buying practices as a custom, but certainly not a safe harbor against potential claims of discrimination.
In the home mortgage lending business, the Federal Reserve Board’s Final Rule prohibiting yield spread premium as a method of mortgage broker compensation in connection with closed-end residential mortgage loans became mandatory on April first. The method of lenders paying brokers a portion of the interest generated on a home mortgage loan over the wholesale or “buy rate” has met its demise. The Final Rule is to “protect consumers in the mortgage market from unfair or abusive lending practices that can arise from certain loan originator compensation practices.” Public hearings on consumer protection issues in the mortgage market preceded the Final Rule by about four years.
In February, the Federal Reserve announced that it will conduct a Survey of Finance Companies as part of an effort to “paint a complete and continuing picture of the sector in the aftermath of the financial crisis.” Chairman Ben Bernanke sent a letter to approximately 2,500 companies urging their participation. While this survey is part of a regular effort to collect data about the non-depository lending industry, other announcements reflect additional oversight is on the way. In April, the Federal Trade Commission began a series of roundtables around the U.S. to gather information on consumers’ experiences when buying or leasing motor vehicles. The roundtables are designed to explore consumer protection issues related to the sale, financing, and leasing of cars, SUVs, and light trucks.
The increase in the amount of covered consumer credit transactions is due to go into effect on July 21st. Part of Title X of the Dodd-Frank Wall Street Reform and Consumer Financial Protection Act was to increase the dollar amounts for the Truth in Lending Act and the Consumer Leasing Act, up from $25,000 to $50,000. The Consumer Financial Protection Bureau is authorized to engage in rule-writing and has been actively hiring and staffing lawyers to get going. An avalanche of new federal rules is expected, and one of those is sure to be a limit on the way dealers get paid for originating retail installment sale contracts.
My partner, Tom Hudson, has been expecting “the other shoe to drop” for years. I look down and see one shoe on the pavement, with the sole of the other one about to touch down.
Elizabeth A. (Liz) Huber is a partner in Hudson Cook’s Orange County office. She writes and speaks frequently on consumer credit compliance matters. Liz can be reached at 310-686-5050, or email her at email@example.com.