The Consumer Financial Protection Bureau and Department of Justice just took a big bite out of the F&I income Honda dealerships can generate through the financing of vehicle installment contracts by their captive.

CFPB and DOJ officials said on Tuesday that they resolved an action with American Honda Finance Corp. they believe will put new measures in place to address discretionary auto loan pricing and compensation practices.

The agencies indicated Honda’s past practices resulted in thousands of African-American, Hispanic, and Asian and Pacific Islander borrowers paying higher interest rates than white borrowers for their installment contracts, without regard to their creditworthiness.

As part of the order, officials said Honda will change its pricing and compensation system to substantially reduce dealer discretion and minimize the risks of discrimination, and will pay $24 million in restitution to affected borrowers.

According to the consent order, Honda’s captive will limit dealer participation to 125 basis points for installment contracts with terms of 60 months or less. For contracts longer than 60 months, the cap is set at 100 basis points.

Officials maintained that Honda permitted dealers to mark-up consumers’ interest rates as much as 2.25 percent for contracts with terms of five years or less, and 2 percent for contracts with longer terms.

The agencies explained the enforcement action is the result of a joint CFPB and DOJ investigation that began in April 2013. The agencies investigated Honda’s indirect auto lending activities’ compliance with the Equal Credit Opportunity Act, which prohibits creditors from discriminating against loan applicants in credit transactions on the basis of characteristics such as race and national origin.

The investigation concluded that Honda’s policies:

• Resulted in minority borrowers paying higher dealer markups: Honda violated the Equal Credit Opportunity Act by charging African-American, Hispanic, and Asian and Pacific Islander borrowers higher dealer markups for their auto contracts than non-Hispanic white borrowers. These markups were without regard to the creditworthiness of the borrowers.

• Injured thousands of minority borrowers: Honda’s discriminatory pricing and compensation structure meant thousands of minority borrowers from January 2011 through July 14, 2015 paid, on average, from $150 to over $250 more for their auto loans.

Reaction from Honda

In a statement posted on its website, American Honda Finance officials said their consent agreement with federal agencies, “shows our commitment to work together to be part of the solution and to establish the path forward that best supports our Honda and Acura customers and dealers with clear and convenient financing options.

“AHFC strongly opposes any form of discrimination, and we expect our dealers to uphold this principle as well. We firmly believe that our lending practices have been fair and transparent,” they continued.

“AHFC has a difference of opinion with the CFPB and the DOJ regarding the methodology used to make determinations about lending practices, but we nonetheless share a fundamental agreement in the importance of fair lending,” the officials went on to say.

Honda Finance didn’t mention the specific figures regarding dealer participation that the CFPB and DOJ did in the consent order. Rather, officials said, “In cooperation with the CFPB and the DOJ, AHFC will be working closely with our Honda and Acura dealers in proactively adjusting our pricing programs to continue to give our customers the ability to choose the loan that is best for supporting their purchase of Honda and Acura products.

“As part of this new program, AHFC will announce later this year adjustments to our caps for dealers in setting the rate for retail installment contracts lower than the present level,” they continued.

“We will be implementing this change in combination with other adjustments and modifiers in a way that continues to support our Honda and Acura dealers' present business compensation with a full array of financing options,” captive officials added.

American Honda Finance also pointed out that as a result of this settlement, no civil penalties have been assessed.

Along with establishing a $24 million fund that will be used to compensate customers identified by the CFPB and the DOJ, the captive indicated it will continue to enhance our long-standing commitment to support financial literacy education and ensure that the future generation of customers is well informed about the process of financing vehicles.

More details of enforcement action

Officials reiterated the Dodd-Frank Wall Street Reform and Consumer Protection Act, and federal fair lending laws, authorize the CFPB and DOJ to take action against creditors engaging in discrimination.

The CFPB’s order was filed on Tuesday as an administrative action, and DOJ’s proposed order was filed in the U.S. District Court for the Central District of California.

The agencies contend the measures provided in the orders will help ensure that discrimination does not increase the cost of auto loans for consumers on the basis of race and national origin.

Under the CFPB order, Honda must:

• Substantially reduce or eliminate entirely dealer discretion: Honda will reduce dealer discretion to mark-up the interest rate to only 1.25 percent above the buy rate for contracts with terms of 5 years or less, and 1 percent for auto loans with longer terms. Honda also has the option under the order to move to non-discretionary dealer compensation.

“The bureau did not assess penalties against Honda because of Honda’s responsible conduct, namely the proactive steps the company is taking that directly address the fair lending risk of discretionary pricing and compensation systems by substantially reducing or eliminating that discretion altogether,” CFPB officials said.

• Pay $24 million in damages for consumer harm: Officials said Honda will pay $24 million to a settlement fund that will go to affected African-American, Hispanic, and Asian and Pacific Islander borrowers whose auto loans were financed by the captive between January 2011 and Tuesday.

• Administer and distribute funds to victims: Officials said Honda, through American Honda Motor Co., will contact consumers, distribute the funds and ensure that affected borrowers receive compensation. Honda will make reports to the bureau regarding this victim compensation activity.

“The CFPB is committed to creating a fair marketplace for all consumers, and other auto lenders should take note of today’s action,” CFPB director Richard Cordray said. “Honda’s proactive decision to move to a new pricing and compensation system demonstrates industry leadership and represents a significant step towards protecting consumers from discrimination.”

The head of DOJ’s Civil Rights Division, principal deputy assistant attorney general Vanita Gupta, also reacted to Tuesday’s development.

“We commend Honda for its leadership in agreeing to impose lower caps on discretionary markups and for its commitment to treating all of its customers fairly without regard to race or national origin,” Gupta said. 

“We recognize that dealerships perform a valuable service in connecting customers with lenders and that they should be fairly compensated for that service,” Gupta continued. “We believe that Honda’s new compensation system balances fair compensation for dealers and fair lending for consumers. 

“We hope that Honda’s leadership will spur the rest of the industry to constrain dealer markup to address discriminatory pricing,” Gupta went on to say.

In March 2013, the CFPB pointed out that it issued a bulletin explaining that it would hold indirect auto finance accountable for “unlawful discriminatory” pricing. Bureau officials reiterated the bulletin also made recommendations for how indirect auto finance companies could ensure that they were operating in compliance with fair lending laws.

Last September, the bureau also issued an edition of supervisory highlights that explained that the bureau’s supervisory experience suggests that significantly limiting discretionary pricing adjustments may reduce or effectively eliminate pricing disparities.

“Substantial limits on discretionary pricing like those imposed by today’s order can address the type of fair lending risk identified in the CFPB’s bulletin and supervisory highlights,” officials said.

Officials mentioned Tuesday’s action is part of a larger joint effort between the CFPB and DOJ to address discrimination in the indirect auto lending market. In December 2013, the CFPB and DOJ took an action against Ally Financial and Ally Bank that ordered Ally to pay $80 million in consumer restitution and an $18 million civil penalty.