U.S. auto lending is still booming, but those in the industry are not smiling as widely as you might expect.
Shares in the nation's largest auto lender, Ally Financial, are down about 2% since the firm's initial public offering in April. Santander Consumer, a leader in subprime auto finance, has seen its stock price fall 22%since its debut last January.
Those price declines happened despite the fact that industrywide loan balances have climbed to an all-time high. Late payment rates, while on the rise, are fairly normal by historical standards.
Some of the angst among investors is likely the result of caution ingrained after the subprime mortgage boom, when handsome profits masked longer-term peril.
But there's also another factor at play: unlike in the mortgage saga, when heavy regulatory scrutiny arrived only after the market cratered, the high-flying auto finance market has already begun to attract lots of unwanted attention from state and federal authorities.
Stock analysts who follow auto finance say that the government's watchful eye is hurting investors' perception of the industry. It's not that investors are overly worried about any particular government probes; rather, it's a feeling that heightened regulatory scrutiny likely spells trouble in the long run.
"My concern for any company under a regulatory microscope is that some uncomfortable email might be found," said Christopher Donat, an analyst at Sandler O'Neill. "I think there's a risk if you dig through enough people's emails, you might find something bad, or inappropriate or embarrassing, when it's leaked."
When the nation's large auto lenders report their fourth-quarter earnings later this month, analysts will view their profits through the prism of a steady flow of securities filings in which the firms have disclosed their exposure to numerous government probes.
What follows is an overview of the top regulatory threats facing the auto finance industry today.
This long-standing issue remains the most pressing regulatory challenge for the auto finance industry, according to several observers.
For the last couple of years, the Consumer Financial Protection Bureau has been using the threat of enforcement actions to pressure lenders to stop compensating auto dealers based on the terms of the agreements the dealers strike with consumers.
The CFPB has pursued the issue as a fair-lending matter, in light of research showing that minority groups tend to pay higher interest rates under the current system. In December 2013, the agency reached a $98 million settlement with Ally; since that time, no other settlement agreements have been made public.
Today, bank industry lawyers say that the CFPB appears to be stepping up its efforts to reach settlements with lenders.
Late last year, the CFPB and the Justice Department threatened enforcement actions against American Honda Finance Corp. and Toyota Motor Credit over their pricing practices, according to securities filings. The two companies expressed interest in cooperating with the agencies in order to reach a settlement.
The stepped-up pressure on auto lenders precedes a Jan. 21 Supreme Court hearing, which could have big implications for the government's legal theory with respect to dealer markups.
Although the Supreme Court case involves housing, not auto lending, bankers are hopeful that the court's decision will allay their fears about being held liable for lending practices that have a disparate impact on minority groups, even if there's no intentional discrimination.
Some bank industry lawyers said that the Supreme Court case could upend the current landscape with respect to auto finance probes. "It would seem to make sense to not enter into a settlement right now," one industry lawyer said.
Auto lenders are reluctant to switch to the flat-fee pricing model CFPB prefers because of fears that it will result in a loss of market share at car dealers. The lenders find themselves stuck in the middle of what's essentially a fight between the CFPB and the dealers, according to Jason Stewart, an analyst at Compass Point Research & Trading.
During a recent conference call with clients, Stewart recounted a conversation with an auto lender who said, "If we could just grab a bag of popcorn and a beer and watch from the sidelines, we would. But we can't."
Other Consumer-Protection Issues
Regulators, led by the CFPB, have also begun to scrutinize auto-industry practices involving debt collection and the sale of add-on products, such as extended warranties, insurance and rustproofing.
Last June, the consumer agency forced U.S. Bancorp to reimburse military service members who were customers of an auto lending program that allegedly misled customers about the cost of certain add-on products. In November, the bureau imposed an $8 million fine on DriveTime Automotive Group and its financing arm over debt collection and credit-reporting practices.
States are also getting in on the action. Last year, Condor Capital, a small subprime lender, was forced to stop accepting new loan applications following accusations by New York state authorities that the firm refused to provide refunds to customers who overpaid for their loans.
The regulators' focus on consumer protection in the auto-lending sphere is still in its early stages. But industry sources expect the CFPB and other agencies to become more aggressive as they gain more expertise in auto lending, and as consumer advocates continue to make the case that abuses are widespread.
"I haven't seen anything that indicates that a lot has changed in the marketplace," said Chris Kukla, senior counsel for government affairs at the Center for Responsible Lending.
In a reprise of the subprime mortgage era, federal and state authorities have been scrutinizing the assurances that subprime auto lenders have been making to investors in their securitizations.
The Securities and Exchange Commission has opened an inquiry of Ally's subprime auto finance business. The Justice Department has sent subpoenas to GM Financial and Santander Consumer. The Massachusetts Attorney General's Office is also reportedly scrutinizing Santander Consumer looking at the credit histories of the firm's borrowers and how it described risk to investors in its securities.
It's unclear whether these inquiries will lead anywhere. Bank industry sources note that prosecutors have broad leeway to issue the subpoenas. And they point out that the subprime auto securities that are at issue have generally performed well so far, in contrast to subprime mortgage bonds.
"No one appears to have lost any money," one industry lawyer said.
Still, once investigators start digging around, there's no telling what direction their probes might turn. Right now, that uncertainty is working against the auto-lending industry.