The Consumer Financial Protection Bureau sent a multimillion-dollar message Thursday to banks: your relationships with vendors can do more harm than good.
Not only do U.S. Bancorp (USB) and a third-party service provider have to refund $6.5 million for allegedly hiding fees and committing other violations in auto loans to U.S. military members, but CFPB officials strongly hinted that other banks that use the same vendor could get in hot water, too.
"It's our understanding that while U.S. Bank has been, up until this point, by far the largest partner in [this] program, there are other entities that are utilizing" the vendor's program, Kent Markus, the CFPB's assistant director of enforcement, told reporters.
Banking regulators have repeatedly cautioned bankers to monitor the operations of its vendors in recent years. But the two-year-old CFPB has taken the toughest stance, industry sources say.
"We are involved in many other investigations involving the CFPB that have not yet seen the light of day," said Alan Kaplinsky, who heads the consumer financial services group at law firm Ballard Spahr. The CFPB has "a laser-like focus on vendor management. We're telling our clients all the time that they've got to do whatever they can to focus on that area."
As part of a settlement announced Thursday, U.S. Bancorp in Minneapolis and Dealer Financial Services in Lexington, Ky., agreed to repay more than 50,000 service members who used a car loan program the two companies established more than a decade ago. The program hid fees and used illegal marketing tactics, the CFPB says.
The program, called the Military Installment Loans and Educational Services program, or MILES, offered subprime auto loans to service members and required them to make payments through the military allotment program a long-standing system for service members to automatically direct their paychecks to certain accounts or bill payments.
But the MILES program required service members had to pay a $3 monthly fee for the service, which was not properly disclosed to users, the CFPB says. It totaled $180 over the term of a typical five-year loan, the CFPB says.
Service members were also misled about a bi-weekly payment schedule that created a lag between the timing of deductions and loan payments. The delay caused borrowers to incur as much as $75 in additional interest over the terms of their loans, the CFPB says.
U.S. Bancorp has to refund $3.2 million to service members who had to pay the extra fee. The remainder of the refund, to be repaid by DFS, is primarily for misleading borrowers into buying add-on products.
Despite regulators' warnings, banks are more and more turning to vendors to reduce operating expenses as compliance costs skyrocket. But the increase in third-party relationships makes it harder for banks to keep an eye on everything.
"Third-party programs are absolutely huge and they continue to become bigger," Kaplinsky says. "And part of the problem is being able to control them and exercise the kind of oversight that CFPB expects. The banking regulators have also required banks over the years to have oversight of third-party relationships, but the CFPB has kicked it up a notch."
In many ways, several controversies that have plagued banks for years coalesced the settlement Thursday: the threat of the CFPB, conduct of auto lending, treatment of military customers and veterans and vendor relationships.
"These coordinated enforcement actions were made possible because Congress gave the bureau authority to examine and enforce consumer laws regarding both banks and nonbanks," Markus said during a call with reporters. "The bureau's ability to examine both business partners in the MILES program led to the bureau holding the banks and nonbank businesses involved in this program accountable for their violations of federal consumer financial laws."
In particular, the CFPB said Dealer Financial Services used "deceptive marketing" to promote two add-on products for car repair insurance and gap insurance.
The "brochures claimed the insurance contract would add just a few dollars a month to the cost of the loan, but in fact the average cost of a service contract was over $40 a month," Markus said.
Though U.S. Bancorp did help create the program and is on the hook for nearly half the refund, Markus said DFS was "handling a substantial" amount of the marketing to facilitate the program.
A spokesperson for DFS could not immediately be reached.
U.S. Bancorp's spokesperson, Tom Joyce, said in an emailed statement that the bank has a "very strong track record" of supporting the military, noting the Defense Department gave it the highest honor for supporting members of the National Guard and Reserve just two days ago.
"We take seriously the CFPB's concerns regarding these disclosures and certain marketing materials used in conjunction with the MILES program," said Joyce, adding that they would exit the program. "At U.S. Bank, we have high expectations for ourselves and our company's product offerings, and we apologize for any confusion this program may have caused our customers."
The settlement also raises the question as to whether the government and regulators should change how the military allotment program works.
The program was created well before banks were offering free direct deposits or automatic withdrawals, so service members could allocate portions of their paychecks to certain accounts or set up automatic payments for bills while being deployed. It also made it easier for banks to extend credit to young military members still trying to build up their credit because the direct withdrawal adds assurance that loans will be paid on time.
But Holly Petraeus, assistant director for the CFPB's service-member affairs, said the allotment program has generated numerous concerns as vendors and banks began profiting from the program through hidden servicing fees or higher percentage yields.
The settlement "shines a spotlight on potential problems with the use of the military discretionary allotment system as a way to pay off consumer debt," Petraeus said on the call with reporters.
In response to overarching concerns about the allotment program, Defense Secretary Chuck Hagel separately announced Thursday that it would create a working group of federal officials, including from the CFPB, to look at the program.
"This group will include representatives from enforcement agencies and bank regulators and will report back to me within 180 days on steps the department can take to ensure our discretionary allotment system no longer creates an opportunity for unscrupulous businesses and lenders to take advantage of those who serve in the armed forces," Hagel said in an emailed statement.
U.S. Bancorp and DFS must submit a remedial plan to the agency within 30 days and refunds should go out to service members soon after, Markus said. The refund each person receives "vary quite dramatically," he said, but average less than $100 each.
Brian Browdie contributed to this article.