Carvana’s success relies on used car loans


Online used car dealer Carvana Co., known for its vehicle vending machine tricks, has a secret sauce to its business success: a revenue-boosting vehicle loan management.

The company became a market darling during the pandemic, benefiting from huge demand and high prices for used vehicles. Its stock has climbed more than 1,000% since the depth of the Covid-19-related liquidation in March 2020 and is now valued at over Ford Motor Co. at around $ 63 billion.

Part of the attractiveness to investors: Selling cars is only part of what makes Carvana money. In the second quarter, about 36% of the company’s gross profit per unit came from the sale of loans it had made to customers to buy the cars. Retail sales accounted for 39% of gross margin per unit, Carvana’s preferred profit measure. Other types of income, including vehicle maintenance contracts, made up the remainder.

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CVNA CARVANA CO. 298.14 +3.68 + 1.25%
F FORD MOTOR CO. 19.77 +0.28 +1.43%

In the last quarter, increased loans allowed Carvana to realize its first-ever quarterly profit.

The company suffered a setback last week when North Carolina suspended Carvana from selling cars in the Raleigh area until January after determining it had not delivered titles to the Department of Motor Vehicles and sold cars without state inspections. Carvana said he was happy to reach a solution, following an investigation by the state’s Motor Vehicle Division.

When Carvana gives a car loan to a buyer, it combines it with other loans and sells the debt to investors. While other auto lenders also sell investor loans, they usually keep debt on their books, recording gains and losses over time. Carvana, on the other hand, does not keep the debt and immediately recognizes gains on cash sales.


For now, this boosts income. Critics warn the practice could leave the company vulnerable if debt market conditions change or if Carvana’s loans start to deteriorate.

Indeed, the income from the sale of loans fell when the securitization markets closed in the first half of 2020. One of the pillars of the transactions is that Carvana is able to sell its auto loans to investors at a higher price. higher than their face value.

“If the loans go badly, investors in the future will not be willing to pay the same premium, and profitability will be affected,” said Seth Basham, 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 their loans.

Rating firm KBRA upgraded five of Carvana’s public securitizations in June, citing lower than expected losses on loans. Losses in a trade from 2019 are around 3.77%, higher than expectations of 6.18%, the agency said.

Ernie Garcia III, chief executive officer of the company, said his fundraising activity is just one of the many reasons the company has been successful, including the design of its website and the way it buys. trade-in cars to its customers.

“Our goal is to always offer our customers the best experience, the best selection and the best value for money that they can get when buying 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.


Car sales have jumped during the pandemic thanks in part to Carvana’s social distancing business model. It nearly doubled sales to more than 100,000 vehicles in the three months to June compared to the previous year.

Along with car sales, there has been a similar wave of auto loans. It sold $ 3.1 billion in loans to securitization trusts and other investors in the first half of the year, double the level from the same period in 2020.

Securitization of automatic loans is a massive activity. Consumers borrow money from car dealerships, automakers, and banks, which bundle the loans into bonds issued by trusts. Investors looking for a stable income, such as pension funds and insurers, buy the bonds. The companies that sell the loans to the trust are required by post-financial crisis rules to maintain at least 5% exposure to each trade.

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

CarMax Inc. said it does not recognize a gain when it transfers its loans to securitization trusts because it maintains an ongoing involvement in the loans. The company operates a loan service business, collecting money owed by borrowers. It also retains its 5% exposure by keeping the riskiest part of its securitizations, which gives it upside and control potential.


By keeping loans on its balance sheet, CarMax earns interest income over the life of its loan portfolio, to “capture more lifetime profits,” according to a spokesperson.

General Motors Financial Co. and Ford Motor Credit Co. include trusts in their financial statements, according to the companies. Santander Consumer USA Holdings Inc. keeps most of the loans on its books, but records some securitizations as sales, a spokesperson said.

Carvana, on the other hand, does not service its loans. And instead of keeping the riskier part, he buys chunks of each bond issued by the trusts for his 5% exposure. Both of these factors mean that, according to accounting rules, it doesn’t need to keep the loans on its balance sheet, according to the company.

Carvana uses a related party, Bridgecrest Acceptance Corp., for loan servicing. Bridgecrest is owned by DriveTime Automotive Group, a used car dealership based in Tempe, Arizona. Carvana was created out of DriveTime, which is owned by Ernie Garcia II. He owns around 45% of Carvana and is the father of its CEO.

S&P Global Ratings said Carvana is the only auto company it is aware of that does not manage loans in its securitizations.

There are tradeoffs to accounting for loan profits up front. Gains can be episodic and depend on market opening and investors paying a premium, accounting professors have said.

“It would make profitability more lump-sum,” depending on how often a company securitizes its loans, said Bob Herz, former chairman of the Financial Accounting Standards Board, who is now an executive in residence at Columbia Business School.

Carvana auditor Grant Thornton noted the gains on loan sales in Carvana’s 2019 and 2020 annual reports as a critical audit question, which are elements of an audit that are considered particularly difficult to sort out. Critical audit questions are not meant to be an indication of potential wrongdoing.


Determining whether the loan transfer in the trusts meets the criteria to be considered a sale involves “complex judgments” and legal opinions, Grant Thornton said. The cabinet declined to comment beyond its auditor’s report.

Loan sales have caught the attention of short sellers, who describe them as a potentially unsustainable source of income.

“If the market eases up a bit, so people only pay face value – heaven forbids a discount – on these new loans, well, right off the bat you’re getting rid of 30% of Carvana’s income. Said Jared Rose, an investor with Gravity Partners Capital Management Inc. in Toronto, who said he put options on the stock down.

Carvana says she is unaware of any evidence that the gains on loan sales are unsustainable.

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