Carvana’s success is based on used car loans

Online used car dealer

Carvana Co.

CVNA 0.01%

, known for its machine towers, has a secret sauce for its business success: a revenue-increasing auto loan processing system.

The company has become a market favorite during the pandemic and is benefiting from great demand and high prices for used cars. Its existence has shot up by more than 1000% since the depth of the Covid-19-related sell-off in March 2020 and is now rated at over

Ford engine Co.

at about $ 63 billion.

Part of the appeal to investors: Selling cars is only part of what makes Carvana cash. In the second quarter, approximately 36% of the company’s gross profit per unit came from the sale of loans that customers had given to purchase the cars. Retail sales represented 39% of gross profit per unit, Carvana’s preferred earnings metric. The rest was made up of other income, including from vehicle maintenance contracts.

Last quarter, the credit boost helped Carvana generate its first quarterly profit.

The company had a setback last week when North Carolina suspends Carvana from sales of cars in the Raleigh area to January after it was found not to be delivering titles to the automotive division and selling cars without government inspections. Carvana said it was pleased to find a solution after the state motor vehicle division conducted an investigation.

When Carvana grants a car loan to a buyer, it bundles them with other loans and sells the debt to investors. While other auto lenders also sell loans to investors, they usually keep the debt on their books, making gains and losses over time. Carvana, on the other hand, does not keep the debt and immediately takes profits on the cash sales.

For the time being, this will boost income. Critics warn the practice could leave the company vulnerable if conditions in the debt market change or the loans Carvana grants turn sour.

This summer, it’s harder than ever to rent a car in the U.S., especially in popular vacation destinations. To find out what’s behind the rise in rental car prices, WSJ spoke to an industry analyst and WSJ’s Nora Naughton. Photo: Luke Sharrett / Bloomberg News

Indeed, loan sales revenues fell when the securitization markets closed in the first half of 2020. A linchpin of the deal is that Carvana can sell its auto loans to investors at a premium to their face value.

“If credit goes wrong, investors will no longer be willing to pay the same premium in the future and profitability will be affected,” said Seth Basham, an analyst at Wedbush Securities.

So far, Carvana has defied skeptics. Rising car prices and low interest rates have strengthened the ability of borrowers to repay the loans.

Rating firm KBRA upgraded five of Carvana’s public securitisations in June, citing lower-than-expected loan losses. Losses in a 2019 transaction are around 3.77%, better than expectations of 6.18%, the agency said.

Ernie Garcia III, the company’s chairman and CEO, said its financing business was just one of several reasons the company did well, including website design and the way it buys trade-in cars from customers.

“Our goal is to always give our customers the best experience, choice and value they can get when they buy a car,” he said.

Carvana was founded in 2012 with the aim of revolutionizing the used car industry. Instead of haggling a lot, Carvana sells vehicles online and delivers them to consumers’ homes.

Sale of cars increased during the pandemic also thanks to Carvana’s socially distant business model. In the three months to June, sales almost doubled compared to the previous year to over 100,000 vehicles.

Along with auto sales came a similar surge in auto loans. It sold $ 3.1 billion in loans to securitization trusts and other investors in the first half, doubling in 2020 from the same period.

Car loan securitization is huge business. Consumers borrow money from auto dealers, automakers, and banks, who bundle the loans into bonds from trusts. Investors looking for a stable income, such as pension funds and insurance companies, buy the bonds. The companies that sell the loans to the trust are required by the post-financial crisis rules to maintain at least 5% exposure to any deal.

Most of the auto industry uses a different accounting approach than Carvana.

Unlike many other car dealers, Carvana does not service its loans.


Patrick T. Fallon / Bloomberg News

CarMax Inc.

said it does not make a profit when it transfers its loans to securitization trusts because it has an ongoing exposure to the loans. The company operates a loan service business and collects owed funds from borrowers. It also maintains its 5% exposure by keeping the riskiest part of its securitizations, which gives it potential and control.

By keeping the loans on the balance sheet, CarMax achieves interest income over the term of its loan portfolio in order to “achieve more profit in life” according to a spokesman.

General Motors Financial Co. and Ford Motor Credit Co. include trusts in their financial statements, according to the companies.

Santander Consumer USA Holdings Inc.

keep most loans on their books, but book certain securitisations as sales, a spokesman said.

Carvana, on the other hand, does not service its loans. And instead of keeping the riskiest part, it buys parts of every bond issued by the trusts for its 5% commitment. Those two factors mean that accounting rules require the loans to be off-balance sheet, the company said.

Carvana uses a related party, Bridgecrest Acceptance Corp., to process its loan. Bridgecrest is owned by the DriveTime Automotive Group, a used vehicle dealer based in Tempe, Arizona. Carvana has been spun off from DriveTime, owned by Ernie Garcia II. He owns around 45% of Carvana and is the father of the CEO.

According to S&P Global Ratings, Carvana is the only car company he knows that does not service the loans in its securitisations.


What websites do you search for used cars? Join the conversation below.

There are tradeoffs in booking profits on loans in advance. Profits can be episodic and depend on the markets being open and investors paying a premium, accounting professors said.

“It would make profitability lumpier,” said Bob Herz, former chairman of the Financial Accounting Standards Board and now executive in residence at Columbia Business School.

Carvana’s auditor Grant Thornton recorded the profits on loan sales in Carvana’s 2019 and 2020 annual reports as a critical examination matter, These are points in an audit that are considered particularly sensitive. Critical audit matters are not intended to be indicative of potential misconduct.

To determine whether the transfer of loans to the trusts qualifies as a sale would require “complex judgments” and legal opinions, Grant Thornton said. The company declined to comment beyond the auditor’s report.

The loan sales have caught the attention of short sellers who they cite as a potentially unsustainable source of income.

“If the market softens a little so that people are paying face value for these new loans – God forbid a discount – well, you will get rid of 30% of Carvana’s revenue right away,” said Jared Rose. an investor at Gravity Partners Capital Management Inc. in Toronto who said he had options on the falling stocks.

Carvana says there is no known evidence that profits from loan sales are unsustainable.

More about cars

Current WSJ stories about the automotive industry, selected by the editor

Write to Kristin Broughton at [email protected] and Margot Patrick at [email protected]

Copyright © 2021 Dow Jones & Company, Inc. All rights reserved. 87990cbe856818d5eddac44c7b1cdeb8

Comments are closed.