Auto lenders, dealers draw more scrutiny after pandemic-era boom

Auto dealers and lenders have had quite a party over the last two years as sky-high demand prompted record levels of sales activity and drove up prices.

But now comes the hangover, as federal and state regulators put more scrutiny on their practices, clamping down on some companies and seeking to impose major changes that are expected to reshape the industry for years to come.

The auto finance industry is facing regulatory pressure on several fronts, with the Consumer Financial Protection Bureau, the Federal Trade Commission and various state regulators all taking action. The scrutiny is wide-ranging, covering pricing discrimination, "add-on" products that make cars more expensive and lenders' handling of car repossessions.

Luke Sharrett/Bloomberg

The agencies' renewed focus on the sector is drawing praise from consumer advocates, who say that shoddy practices at dealers and lenders have long needed stronger policing. But the industry is pushing back, arguing that the regulators' more aggressive approach could impede consumers' access to car purchases.

"The vehicle finance industry is highly competitive, and consumers have many choices when it comes to financing their vehicles," Celia Winslow, senior vice president at the American Financial Services Association, said in an emailed statement. "Because of the industry's ability to price for risk, consumers can get the loans they need to get the vehicles they want."

Though industry lawyers say scrutiny of the sector is normally high, they also acknowledge that their clients are getting more questions from regulators, and more issues are being flagged for formal enforcement actions.

"There's just a whole lot of activity going on from all quarters of the regulatory front in auto finance right now," said Chris Willis, a lawyer at Troutman Pepper who advises banks and other consumer lenders.

The industry is facing "more collaboration and communication" across the various agencies responsible for overseeing the auto industry, said Jody Porter, a partner at the law firm Nelson Mullins. "We expect to see that continued coordination throughout 2023."

In one closely watched case, the CFPB and New York state attorney general sued the subprime auto lender Credit Acceptance Corp. for what the CFPB says is deceiving borrowers into loans they can't afford. The company says that it "operates with integrity" and that it intends to "vigorously defend ourselves in this matter."

A major area of concern for regulators is discriminatory pricing. The scrutiny is similar to the CFPB's crackdown on auto lenders under the Obama administration, which died down after the agency imposed fines on a few companies. Republican lawmakers also clipped the CFPB's wings in 2018 by repealing the agency's guidance on the issue.

Today, other agencies are pursuing similar cases. The FTC, which regulates auto dealers, reached a $3.3 million settlement with a Washington, D.C.-area dealership that it says charged Black and Latino customers higher financing costs than white ones.

The FTC and the state of Illinois also settled a similar dealer-focused case in April for $10 million. Other state agencies taking action against dealers or lenders include the Massachusetts Attorney General's Office and New York's state banking regulator.

And in December, a top fair lending official at the Federal Deposit Insurance Corp. said during a webinar that the agency has recently referred some auto cases to the Department of Justice for potential violations of fair lending laws.

Regulators are also scrutinizing so-called add-on products, such as extended warranties, dealership service contracts and guaranteed asset protection, or GAP, products. GAP products can help consumers whose cars are stolen or damaged, since the product covers the "gap" between what insurance companies pay for the vehicle and the remainder of an auto loan.

Last year, a CFPB report on issues that supervisors are seeing included a section on GAP products. It found shortcomings in the refunds that consumers may receive if their cars are repossessed, since the products do not offer benefits when the consumer no longer has the car.

In a $3.7 billion order against Wells Fargo in December, the CFPB cited GAP refunds as an issue. The agency said that until July 2021, the megabank didn't ensure that all affected customers received the refunds to which they were entitled.

The FTC is also focusing on add-on products under a major rule that sets new standards for dealers. The agency has described its proposed rule as one that seeks to "eliminate the tricks and traps that make it hard or impossible to comparison shop" for cars and "leave consumers saddled with thousands of dollars in unwanted junk charges." 

The proposed rule has drawn heavy criticism from the industry, with the National Automobile Dealers Association calling it "ill-conceived, ill-supported, ill-coordinated, untested, and unlawful."

The auto dealers' trade group wrote that if the rule is finalized, it will "inject massive costs into the auto retailing process, greatly extend transaction times, greatly confuse consumers, and impede efficiencies aided by technological innovations that have significantly improved — and continue to improve — the customer experience."

The FTC rule targets add-on products that the agency says are applied in a "deceptive" manner, noting that the "paperwork-heavy vehicle-buying process can make it difficult" for consumers to spot add-on charges. Other add-on products include emergency road services, theft protection devices and vehicle undercoating.

The FTC's proposed rule prohibits add-on products that are "fraudulent," such as rustproofing services that don't work or GAP insurance products that exclude the car owner from the service. It also would bar dealers from charging for add-on products without getting explicit consent from buyers, and would require dealers to post their add-on charges at the dealership.

Reforms are necessary in light of "aggressive car sales tactics," which became more visible due to auto shortages during the pandemic, giving dealers a bigger advantage in bargaining, said Erin Witte, director of consumer protection at the Consumer Federation of America. She said some car dealers lead consumers to believe that add-ons — including for more cosmetic products like rims — aren't optional.

"There's really no question that auto-related issues plague consumers nationwide, and that this increased action and scrutiny by these enforcement agencies is warranted," Witte said, noting that auto sales and repairs topped the group's annual report on complaints for the sixth year in a row.

NADA, the dealer trade group, said the FTC failed to gather data showing "widespread misconduct that requires or justifies this action," despite comments from agency officials saying they were seeking such data. Only three of the agency's 37 enforcement actions against dealers over the last 10 years have involved add-on products, the group noted.

Similarly, the American Financial Services Association said lenders' GAP insurance "can be a very useful product that can save consumers a significant amount of money." The group pointed to a recent academic paper showing about 90% of GAP purchasers were satisfied and would recommend a similar product to their friends or family.

Despite its focus on dealers, the FTC rule also has implications for auto lenders, which often partner with dealerships by buying their loans under "indirect financing."

The proposed rule would require dealers to maintain a broad array of records to demonstrate their compliance. Lawyers view that requirement as a way for regulators to force lenders indirectly to monitor the records and keep better track of dealers so that bad actors get weeded out.

"The rule itself does not say that, but my suspicion is that that may evolve," said Willis, the Troutman Pepper lawyer.

That aim would line up with an FTC action last year, which increased the legal liability for auto lenders in cases where dealers defrauded consumers.

The CFPB, meanwhile, is looking to bolster its own record-keeping on the auto finance sector. In November, the agency announced that it wanted to "develop a new data set to better monitor the auto loan market," noting that there's limited information on the sector compared with student loans and mortgages.

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The CFPB has also sent warnings to lenders about their repossession practices, just as increased strains on consumer finances lead to more borrowers falling behind on their payments.

In a compliance bulletin last year, the agency said that its supervisors have identified cases of loan servicers incorrectly listing consumers as delinquent and failing to halt repossession orders after receiving payments. The CFPB also pointed to instances of repossession companies failing to confirm their orders were still active just before taking a car.

"No American ever wants to wake up to see their car stolen," CFPB Director Rohit Chopra said at the time. "Auto loan servicers need to ensure that every repossession is lawful."

Winslow, the AFSA official, said that repossessions are "always a last resort" and that lenders lose several thousand dollars when they repossess a car.