a Better Bubble™
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Wall Street could always bank on used cars. In fact, for years, investors bought bonds backed by auto loans because they reliably produced handsome returns, even amid rocky markets and downturns in the economy.
But now, for the first time in decades, that winning streak appears to be coming to an end, with a half dozen prominent used-auto lenders facing either an avalanche of failed loans — or growing regulatory scrutiny. The Consumer Financial Protection Bureau is currently suing two of those lenders over potentially predatory practices.
Together, experts say, the woes could signal a significant blow to a key pillar of the U.S. economy.
The first warning sign came in late February, when a company called American Car Center, which offered loans to customers with troubled credit histories, abruptly closed its 40 dealerships across the South and filed for bankruptcy protection. Then in April, another lender called U.S. Auto Sales also collapsed, shuttering dozens of dealerships in several states.
Before long, S&P Global Ratings put American Car Center and two other major subprime auto lenders — Exeter Finance and United Auto Credit — on watch for potential ratings downgrades.
Driving much of the concern are delinquencies. Today, the number of subprime borrowers who are behind on their auto-loan payments by 60 days or more is the highest it’s been since at least 2017, according to reports from multiple ratings agencies. Defaults are climbing too.
American Car Center executives did not respond to ProPublica’s interview requests. A representative for York Capital Management, the private-equity firm that has controlled the company since 2016, declined to answer questions about the subprime lender. Neither Milestone Partners, the private-equity firm that owns U.S. Auto Sales, nor Adam Curtin, the executive who oversaw it, responded to requests for comment.
The companies’ closures, as well as Wall Street’s souring financial forecasts, represent what appears to be the end of a hot three-year run in the used-auto sector, a rally driven partly by supply chain problems. With a shortage of new cars, consumers turned to used ones. Spending was fueled by pandemic-era federal aid, which helped American households cover their bills, including monthly car payments.
Lenders then used that steady revenue to fund a massive increase in new loans, particularly to people with low or even nonexistent credit scores. As a result, since 2020, the nation’s auto-loan balance jumped 28% and now totals more than $1.5 trillion, making it the fastest-growing type of consumer debt in the U.S., according to data from the Federal Reserve Bank of St. Louis.
Auto bonds increased in kind, as lenders packaged those loans together and sold them as securities on Wall Street, where ratings agencies labeled them as largely safe investments. According to Bloomberg News, lenders sold bonds containing $76 billion in subprime loans in 2021 and 2022. All of this was predicated on the belief that the vast majority of borrowers would continue to make their monthly payments. “Investors are always thinking they’re protected,” said Joseph Cioffi, a partner at Davis+Gilbert in New York who specializes in finance and corporate insolvency. “And the lenders didn’t seem like there was any concern either.”
Economic conditions, however, changed. Pandemic aid ended, and the Federal Reserve aggressively increased interest rates to combat inflation, meaning more and more people are struggling to pay their expensive loans.
Regulators have also begun looking at the business practices of some subprime lenders, including USASF Servicing, an affiliate of U.S. Auto Sales. In a federal lawsuit, the Consumer Protection Financial Bureau accuses the company of “a host of illegal practices,” like double billing for insurance products and misapplying other payments, costing borrowers millions of dollars. The agency says USASF also wrongly disabled borrowers’ vehicles more than 7,000 times using “kill switches,” devices that prevent the engine from starting.
According to court records, USASF has not filed a formal response in the case, which is ongoing.
Regulators are also taking legal action against a company known as the Credit Acceptance Corporation, which “aggressively markets itself as an alternative for consumers with limited credit options and touts its loans as a way for consumers to build their credit and gain financial freedom,” according to a complaint filed by the Consumer Financial Protection Bureau and the New York attorney general.
“But CAC,” authorities allege, “is often setting up consumers to fail.”
Unlike a traditional lender, which assesses whether a borrower can repay a loan, CAC assumes from the outset that many of its customers will, in fact, default. Authorities accuse the company of charging interest rates so high that they violate New York law, as well as inducing dealers to inflate prices. As a result, “the median selling price for CAC consumers nationwide is over 77% greater” than the wholesale value of the vehicle, according to the complaint. Those prices also dramatically exceed standard retail prices, which include dealer markups.
Profit relies on collecting a certain amount from monthly payments and then selling repossessed cars when people can’t keep up, regulators contend. The lawsuit argues that borrowers and bond investors, who considered the loans safe investments, are both victims of the alleged scheme.
In court filings, CAC has denied the regulators’ allegations, arguing that it is not directly involved in the transactions between dealers and car buyers, and that it works exclusively with sellers to fund loans.
“Credit Acceptance operates with integrity and believes it has complied with applicable laws and regulations,” Douglas Busk, the company’s chief treasury officer, said in a written statement. “We believe the complaint is without merit and intend to vigorously defend ourselves in this matter.”
Depending on the outcome, Cioffi said, the CAC litigation could alter the ways used-auto lenders operate — or reinforce business as usual.
“That case is going to foretell how concerned lenders, sponsors, servicers and investors will be about their practices,” he said. “A lot of folks are watching.”
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Help ProPublica Investigate the World of Used-Car LoansWe plan to continue investigating the used-car-lending industry. If you have insights or tips, please be in touch through this brief questionnaire.
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