December 8, 2023

Car Auto Finance

Car Auto Finance FOR Everyone

CFPB lawsuit seen as warning shot to subprime auto lenders

A federal lawsuit against the subprime auto lender Credit Acceptance Corp. is making waves, posing existential questions for the company and potentially upending some corners of the auto finance industry.

Consumer advocates hope the suit will curtail lending practices they consider predatory. They point to the Consumer Financial Protection Bureau’s allegations that Credit Acceptance deceives subprime borrowers into taking out inflated loans they can’t repay, ultimately leading to their cars being repossessed and harming their already low credit scores.

The company is fighting the lawsuit in a case that some observers see as a warning shot to other subprime auto lenders. CFPB critics say the agency’s push to overhaul lending practices could ultimately hurt lower-income consumers by drastically limiting their access to auto loans.

Used car lot
Credit Acceptance Corp.’s borrowers had median yearly gross incomes of $35,000 and median FICO scores of 546, the Consumer Financial Protection Bureau said in a recent lawsuit.

Adobe Stock

The case, which is in its early stages, has captured the attention of some investors, who are evaluating their legal exposure and whether their investments in Credit Acceptance could suffer. But they also worry that heightened regulations — or changes the CFPB is strongly hinting it wants to see in the industry — could force subprime lenders to pull back from making auto loans.

“That’s really what they’re really concerned about. What does this mean for the future of the industry?” said Joseph Cioffi, a partner at the law firm Davis & Gilbert.

Southfield, Michigan-based Credit Acceptance makes indirect auto loans to consumers through its network of more than 10,000 dealers. It is one of the largest subprime auto lenders in the country, and its annual report says that most of the loans it buys from dealers are to customers who have “impaired or limited credit histories.”

In its lawsuit, the CFPB said the company’s borrowers had median yearly gross incomes of $35,000 and median FICO scores of 546, numbers that are in “deep subprime” territory.

Between roughly 2016 and mid-2021, Credit Acceptance made nearly 2 million loans nationally, and a majority of its borrowers became delinquent, according to the lawsuit. The company repossessed over 25% of the vehicles it financed nationally and 44% of those it financed in New York, where the CFPB and the state’s attorney general filed the suit.

The agencies say the loan defaults are part of a business model that encourages dealers to “sell cars at inflated prices,” resulting in large “hidden finance charges” that set borrowers up for failure. “Over and over, repossession, garnishment, and bankruptcy result,” the lawsuit alleges, adding that “despite the significant human toll borne by consumers,” the company “continues to profit.”

Credit Acceptance declined to comment for this story, but it said in a statement earlier this month that it “operates with integrity and believes it has complied with applicable laws and regulations.”

“We believe the complaint filed is without merit and we intend to vigorously defend ourselves in this matter,” the statement read.

Since the lawsuit was filed on Jan. 4, the company’s stock price has recouped its losses. 

While investors are attuned to the lawsuit, some are viewing it as a “buying opportunity” since past complaints against Credit Acceptance haven’t dealt a fatal blow, said Vincent Caintic, an analyst at Stephens. In 2021, the company settled a lawsuit with the Massachusetts attorney general’s office for $27 million over similar claims.

“There’s this skepticism that because this is nothing new, that nothing’s really going to happen,” Caintic said. 

But if the CFPB wins the case, Credit Acceptance would have to drastically overhaul its business model, since it would be “unprofitable” to operate, Caintic said. He argued that the same would be true for other subprime auto lenders.

The CFPB declined to comment on potential broader implications of the lawsuit, with an agency spokesperson saying its action is “targeted at the specific illegal practices of this lender.”

The American Financial Services Association, a trade group whose members include auto lenders, said the lawsuit is a “prime example of regulation by enforcement,” or forcing changes in the industry through lawsuits rather than formal policy proposals. 

“If creditors changed their practices based on the principles in the lawsuit, that are unmoored to any established law or regulation, it would substantially limit credit availability, and likely eliminate subprime credit,” Celia Winslow, senior vice president at the trade group, said in a written statement.

Chuck Bell, advocacy program director at Consumer Reports, expressed an opposing view, saying that a “highly predatory” business model that results in severe customer harm should be eliminated. If Credit Acceptance were no longer able to operate, other lenders would step in to “provide safe and sustainable credit,” he said.

“This type of lending that these companies are doing is really a disaster,” Bell said. “They’re pricing the loans so aggressively. They don’t really care whether the customer can afford it or not because they know they can get the car back and that they can make their money back in other ways by selling the car again.”

The definition of a “finance charge” figures to feature heavily in the case. The CFPB argues that the money that dealerships get for selling loans to Credit Acceptance is a proxy for what they would have accepted from an all-cash buyer. Any amounts above that level are finance charges, the CFPB alleges, even if they are not explicitly called interest. 

In New York, Credit Acceptance typically discloses annual interest rates of just below 25%, the maximum rate allowed in the state, according to the lawsuit. But the company’s loans often exceed that cap, the CFPB alleges, thanks to what isn’t explicitly stated as an interest charge: the “inflated” prices that dealers charge so they can get more money from Credit Acceptance.

That theory is an “incredibly aggressive” approach, said Scott Pearson, a partner at the law firm Manatt. It suggests that the CFPB believes secondary market transactions — the sale of the original loan — need to be taken into account in disclosures to consumers.

“If they win, then investors in secondary markets are going to have less of an appetite for purchasing loans,” Pearson said. “When that happens, then companies that are making loans in the first place are going to make fewer of them.”

The CFPB also alleges that Credit Acceptance does not assess borrowers’ “ability to repay” their loans. In its lawsuit, the agency notes that the lender requires proof of income for borrowers, and it generally doesn’t approve loans if monthly payments exceed 25% of the borrowers’ gross monthly income. But it doesn’t consider other debts, rent payments, mortgage payments or other critical expenses like food, healthcare or childcare.

Specific ability-to-repay requirements are not currently in place for auto lenders — and efforts to implement them for payday lenders have stalled in the face of industry-backed litigation.

The CFPB doesn’t want auto lenders to just “look at income and FICO and say: ‘OK, that’s good enough,’ ” said Ed Groshans, an analyst at Compass Point Research & Trading. But rather than writing an ability-to-repay rule for auto lenders, the agency appears to be taking an “iron first” approach toward certain lenders, Groshans said.

“If there’s a lending model out there where there’s elevated defaults and collections, their view is that is harm to the consumer,” Groshans said.