Carvana’s success rides on used-car loans

https://www.wsj.com/articles/carvanas-success-rides-on-used-car-loans-11629019801

by bookofjoe • 5 years ago

60 132 5 years ago

bookofjoe• 5 years ago

"When Carvana makes a car loan to a buyer, it packages it with other loans and sells the debt to investors. While other auto lenders also sell loans to investors, they typically keep the debt on their books, recording gains and losses over time. Carvana, on the other hand, doesn’t retain the debt and immediately books gains on the cash sales."

This is precisely [edit: precise is to strong. "analogous to"] what happened in the financial crisis almost 15 years ago: https://en.wikipedia.org/wiki/Bank_of_America_Home_Loans#Sub...

"When Countrywide finances mortgage loans, they usually packaged them for sale to large investors as mortgage-backed securities. Fannie Mae or Freddie Mac can only buy loans which conform to the standards of government-sponsored enterprises. Non-conforming mortgages securities must be sold in the private, secondary market to alternative investors."

I don't know auto loan based securities (size, participants) but this should be a huge red flag to anyone with any sense of history.

dayofthedaleks• 5 years ago

Yes but the federal government will go to the mat for any of the Big Three automakers while everybody knows REITs can go dangle.

throwaway57527• 5 years ago

I don't understand your point. The big three (do you still count Chrysler/Stellantis?) make things and produce jobs. Carvana is not a REIT and is substantially a financial services company per this article.

eigen• 5 years ago

well, by definition the Big Three are 3 large car companies that employ thousands. a particular REIT employs far less and has far less impact on the market. I guess the lesson is, for govt to bail you out, get too big to fail. but we already knew that.

laweijfmvo• 5 years ago

Can someone explain why this is bad practice?

If I loan someone $100 with 10% interest, and immediately sell the loan to someone else for $102, why should I care about anything other than $2 profit?

compiler-guy• 5 years ago

The seller works out great until the buyers decide they no longer want the product. In the housing crisis this was because the sellers of the security had them rated far higher than they should have been. Will these be rated properly? Very hard to m know.

But the seller ends up I trouble if they can’t sell the security because they are relying on the cash flow to finance the rest of the business.

It all works fine as long as the pipeline flows.

Spooky23• 5 years ago

Your question is the answer. The incentive is to get your $2, and you don’t care about the $100.

So the business process has an incentive to just write loans, period. It sounds like in this cases there is a compromised relationship with the lender as well.

adeelk932• 5 years ago

Skin in the game, forces you to consider the quality of the loan. In theory.

HarryHirsch• 5 years ago

why should I care about anything other than $2 profit?

That's the point, right? Securitization serves individual short-term interest, at the cost of stability of the system. We saw that in 2008, and even then the politically connected players made out like bandits.

beerandt3• 5 years ago

Car debt is a very different thing than real estate debt.

No one is expecting cars to hold or appreciate value, even if some have in the past year.

And no one buying used car debt has any delusions about the potential rate of defaults. Not to mention that default recovery is much cheaper and easier than mortgage foreclosures.

adrr• 5 years ago

I am sure they are tranching the debt and selling the senior tranche as investment grade.

adeelk932• 5 years ago

I thought 5% vertical slice retention was a Dodd-Frank requirement for originators in ABS (I’m not an Auto guy though, maybe that’s not true in this sector)

ralph84• 5 years ago

There are some differences too, though.

- There is no expectation that a car should increase in value over time (except for collectibles), whereas there was and still is an expectation that houses should increase in value over time.

- Because of that, there is no such thing as interest-only, negative-amortization, or option ARM car loans. Those products were the worst-performing mortgage loans from the financial crisis.

- For a lot of Americans the biggest component of their net worth is the equity in their house, so a house price crash wiped out most of their net worth. Most Americans have little to no equity in their cars, so a car price crash would help more Americans that it hurt.

Will a lot of these loans default if there's an economic downturn? Of course, but as long as there isn't a "repo man moratorium", investors will still recover most of their principal.

Now, if Goldman Sachs is selling derivatives on these car loans, that's a whole different story.

throwaway57527• 5 years ago

This is not about the asset class, it's about the business model of selling X, packaging loans for X, and the reselling the loans for securitization.

X can be anything. When the income stream for the financial product becomes large in comparison to the income stream for underlying purchase, it doesn't bode well.

throwawayboise2• 5 years ago

IDK how much principal can be recovered. For used cars, depreciation is slower, but most cars purchased with financing are upside down immediately. You would recover a fraction of the principal after paying the repo man and then reselling the car at a wholesale auction.

rootsudo5• 5 years ago

Price crash wouldn't help, it would hurt as many people overleverage to purchase a car - and that asset, while on a financial point of view DOES depreciate, many people are very well unaware at what rate, and most likely traded in an underwater loan, to get another car (negative equity) and are more and more overleveged.

With the past year, most cars appreciated in value on paper, only because of supply and demand and money inflation - that's it.

There is also very much a housing crisis and a huge population that do not have a house, and need to juggle the rent payment, the car payment, the insurance payment and well it seems unsustainable.

tl;dr you assume that the price of the asset is the same when repo'd, that is not true, very much the asset itself can be worthless if there's default across because it means there's no demand or need for cars.

gnicholas3• 5 years ago

There is no expectation that a car should increase in value over time (except for collectibles)

Except for the last 18 months.

geoduck142• 5 years ago

This comment is spot on.

Also, there were "NINJA" mortgages before the 08 recession (No Income No Job/Assets).

adventured• 5 years ago

this should be a huge red flag to anyone with any sense of history.

It's a small red flag and not at all concerning as a macro risk. In the scale of the US economy and US household finances (including disposable income vs debt service payments), Carvana & pals could hardly be more meaningless. Overall the subprime car loan industry is a modest rounding error sized problem (ie it can't cause even a small fraction of the damage the housing implosion did, that you're referring to re sense of history). For the auto industry subprime is around 7% of new vehicles and a quarter of used vehicles (both figures have decreased over the past year as the employment picture has improved). In a very bad outcome scenario, only a minority share of those subprime loans will go bad. The subprime sector risk is, realistically, measured in the tens of billions of dollars, not trillions (as the housing market risk was). Tens of billions of dollars is as close to meaningless as non-trivial things get against $137 trillion in US household assets and the US income figures.

People get overly paranoid up as a matter of routine, looking for the next financial crisis. Every year there are typically a few items that the financial media will run headlines with in terms of clickbait doom, blaring about how x y z is the next impending financial crisis doom-cause agent. Subprime auto loans are not a big threat to the US economy.

If you want to be worried about something, there are only two primary financial categories domestically to pay serious attention to: housing and the stock market. Nothing else much matters by comparison, those are the two giants, by a very dramatic margin (subprime auto loans, student loans and credit card debt are each trivial compared to housing & stocks, in terms of risk to the US economy).

swiley• 5 years ago

Yikes!! What are they going to do when the shortage ends? They'll have a bunch of loans with little collateral.

refurb• 5 years ago

While other auto lenders also sell loans to investors, they typically keep the debt on their books, recording gains and losses over time.

How do you sell a loan but keep it on your books? That makes no sense.

throwaway0a5e2• 5 years ago

I don't know auto loan based securities (size, participants) but this should be a huge red flag to anyone with any sense of history.

I agree but there are far less pesky regulations surrounding the repo and sales of cars than of houses so that does a lot to cap the downside. You also can't generally be in debt for a few times your annual gross income on a car.

vmception2• 5 years ago

2008’s issue was leverage and redundant ownership

(A bank that originated the loan and sold a CDO may have bought essentially an ETF of CDOs which contained its own original loan. When the individual stopped paying, nobody know who was on the hook for the car property or who to ask about)

Having better lending standards, ownership data and less leverage allows this to flourish to much greater heights

throwaway57527• 5 years ago

My gut feel is we can tuck this away for future financial crisis reporting: "Carvana uses a related party, Bridgecrest Acceptance Corp., for loan servicing. Bridgecrest is owned by DriveTime Automotive Group, a Tempe, Ariz.-based used-car dealer. Carvana was spun out of DriveTime, which is owned by Ernie Garcia II. He owns around 45% of Carvana and is the father of its CEO."

mmcconnell1618• 5 years ago

Good call out. You have to wonder if Bridgecrest is really doing full risk reviews of the loans they are buying from Carvana or if the DriveTime/family connection is influencing the process. If Carvana could sell those bundles to other buyers at the same price, maybe everything is legit. On the other hand, if Bridgecrest is purchasing bundles that Carvana would have a difficult time selling to others, then Bridgecrest would be artificially propping up the financial performance of Carvana.

ssharp2• 5 years ago

I was given a rate by Carvana without having any credit pulled. You just give them your income and they'll start quoting you rates and the rates aren't particularly attractive if you have good credit.

If people are actually taking those loans, there seems to be a decent amount of excess risk at play. I'm assuming Carvana eventually does pull your credit but I doubt they're lowering rates after doing so.

adventurer• 5 years ago

Used car companies buying up all the inventory during a shortage and Zillow buying up properties in cash over their own online estimates. Regulation anyone?

jjeaff3• 5 years ago

Used car market in the US is valued in the $150B range. So something like that could possible have some affect.

The housing market in the US though is on a different level. $8-9 trillion, so I don't think any one player is going to even make the smallest of differences unless they are focusing in specific markets and maybe manipulating just that area.

J253• 5 years ago

Zillow buying up properties in cash over their own online estimates

A discussion around this probably deserves its own entire page, but as I am currently looking for a home as a first-time buyer, seeing “Zillow owned home” labels all over the area in which I’m looking (as if it’s some sort of positive thing) has been infuriating. All they do is use their scale and data science to push me out of the market several times over!

I present no evidence, to prove this, but from what I can tell, this is what they seem to do:

First, they use scale and data science to find what they consider under-priced homes and buy them for cash. If I happen to find the same home for sale at the same time, what seller is going to go with a traditional loan over a full cash offer who could easily offer more if needed? I can’t compete with that.

Secondly, they don’t do anything to the house (aside from clean it up and taking nice pictures—no value added) and then resell it for multiple tens of thousands more than what they just paid. If this house was originally at the high end of my budget, bought by Zillow, then re-listed for more, I can no longer afford it.

Third, if that house DOES sell for more to someone else, it just drives up the rest of the prices in the neighborhood. A lose-lose all around for me and my family. I don’t see how Zillow being able to flip houses is good for anyone. And by flip, I don’t mean fix up—-I have yet to find a Zillow-owned home that has anything of substantial value added to it—-and saving 1% of closing costs or whatever their incentive is by owning a Zillow house is not enough value add.

FWIW, I’ve spent a LOT of time of the past few years trying to get a hold of reliable MLS market data to do my own sort of analysis to try and find affordable enclaves or diamonds in the rough or whatever and that data is damn near impossible to get free access to. So the fact that Zillow has this data and also has unlimited pockets and FTEs who work on this stuff all day…it doesn’t feel right to me.

And it’s not like they’re driving up prices of arbitrary goods or services—these are single family homes (in probably the most popular price range) they’re inflating when we’re already in the middle of a national housing crisis!

/rant

Edit: spelling/clarification

ryankupyn• 5 years ago

I think it'd be risky for Carvana if they tried "cornering the market" on used cars - unlike houses, used cars fall in price pretty quickly and new-car production has the potential to increase as car manufacturers respond in a way that housing production does not. If Carvana buys up all the inventory to drive up prices they'll need a plan to unload as well - while keeping prices high.

ineedasername5• 5 years ago

The Zillow thing seems to work pretty well for home sellers-- fast sale, cash, over asking price. That's pretty much a seller's dream.

Although the sleazier part might be people shopping homes on Zillow, which can then promote its own listings above those not owner by Zillow.

toomuchtodo2• 5 years ago

Wow! I did not know that relationship existed, but it makes sense as both concerns are subprime financing plays.

rootsudo5• 5 years ago

Now that I did not know! Wow!

vyrotek• 5 years ago

I led dev teams at DriveTime and Bridgecrest and worked regularly with Carvana devs. The relationships between everything legally and technically is definitely tighter than most people realize.

That said, The folks I worked with were all really great people. There's just a lot of interesting history. Fun fact, DriveTime used to be Ugly Duckling Car Sales.

dpifke• 5 years ago

Same Ugly Duckling whose sign is one of my favorites at the Neon Museum in Las Vegas?

https://www.reviewjournal.com/local/local-las-vegas/ugly-duc...

poulsbohemian7• 5 years ago

I'm in the middle of a transaction with Carvana, so I guess in some ways I'm somewhat surprised by this.... sure it would have been easier to have them as the loan provider, but their rate was more than double what I was able to find elsewhere. Would be very interesting to know if the buyers who are accepting their financing are doing it because its the only option available. Because I went with outside financing, the transaction has definitely been a longer and more complicated process than I expected, but Carvana has overall been responsive and good to work with. Their customer-facing site and app were a better experience than their competitors. That said, it's clear there are aspects of their back office that aren't as polished as the store window makes it appear.

tmp_anon_222• 5 years ago

Carvana puts a ridiculous mark-up on used cars - I'm talking several thousand more then the same car brand NEW in some cases. Further their inspection process leaves a lot to be desired, and best practice is to take the car for inspection after receiving it for how often they "miss" things.

It just does not make sense to throw thousands of dollars away to save a couple hours at a dealership.

xfitm32• 5 years ago

Used car prices are skyrocketing. It's a function of the market. Compare apples to apples - used prices are higher on other sites, too.

tmp_anon_222• 5 years ago

Used car prices are skyrocketing

Yup, any car buying right now is going to cost extra - but even in that context Carvana overcharges (and offers laughable financing). IMO - I spent the past 3 months researching this topic for my own purchase, limited mostly to sedans and cross-overs.

throwawayboise2• 5 years ago

Best to avoid dealerships altogether. They all have their markups. Have cash in hand and shop private sellers on local CL or Facebook.

An exception might be if you live in a rust belt area where they salt the roads in the winter. Then you might need to go to a dealer who sources southern cars.

jcims2• 5 years ago

Private sellers around here are even more optimistic about what their used stuff is worth. It's bad with cars and trucks, even worse with off road vehicles.

rootsudo5• 5 years ago

Yep, they do value add on and make it "zero" fees and then want you to use their financing option so they can sell your financing among others in a contract very similar to a CDO that has an expected depreciation curve (with high APR)

jseliger• 5 years ago

Six months ago, I was considering buying a car from Carvana or similar, and their prices didn't seem outrageous: the market was also much more liquid than any other I was aware of. The difference wasn't just a "couple hours" at a dealership—it was all in time and attention.

I wound up with a new Tesla, partially because used car prices were so high. The amount of time and attention buying cars still commands, in most cases, is ridiculous, and the efforts of Carvana to lower both, however imperfect, is commendable.

Grazester• 5 years ago

I was searching Carnava also a month ago for a Crossover and their prices were better than the used car lots in my area. The price difference was about $3000 cheaper for lower mileage of the same year vehicle.

ineedasername5• 5 years ago

That's not necessarily Carvana. Near me dealerships are calling up people halfway through their lease asking to buy them out at a profit to the leasee, and are then selling those cars at a higher price than new cars-- because the have almost no new cars to sell.

That's just the market we're in right now. I recently sold my car on a trade-in for 2x the price it was worth 2 years ago when I've looked at things.

jonnycomputer• 5 years ago

Where I am, If I want to buy an EV then either I'm going to have to make a long trip, or I'll buy from Carvana. Other options?

hans-moleman• 5 years ago

Most dealerships will deliver a car if you ask.

andrewmcwatters• 5 years ago

I'm buying a car right now. I own two German cars that have both been on the road for over a decade. Great cars, but they're at the end of their life now. I want one of the most common possible sedans you can purchase today to replace them: the Toyota Corolla. Should be an easy process, no brainer, in and out in less than half an hour.

And yet, the whole experience with dealerships and Carvana-likes is utter dogshit. It is a 1000% ripe market for any small shop who wants to own the entire experience Amazon-world-domination style.

And it will happen. There's too much free capital in the world right now.

jcims2• 5 years ago

I sold an S5 to Carvana, got $1-2k over trade in offers, it had a broken windshield and bad brakes and there were zero issues with the process. They showed up, had to bring a specific person b/c it was manual lol, and wrote me the check right there. It was as painless a process as I've ever had with a vehicle transaction.

missedthecue2• 5 years ago

I sold a car to carvana and had the exact same experience. I thought for sure that there was going to be some kind of catch because it took just 15 minutes and they did all the work and hauled it away from my house. It was too easy it seemed unreal.

throwaway57527• 5 years ago

It is one of Tesla's underappreciated innovations.

sokoloff6• 5 years ago

Decade-old cars is around the midpoint of where I’m usually buying them, not when they’re end-of-life.

missedthecue2• 5 years ago

Not German cars I hope...

alistairSH2• 5 years ago

Where are you shopping? I bought a new Honda in March and it was dirt simple. Traded a few text messages with salesman to agree on price, show up at dealer, sign a pile of pre-printed paperwork (mostly loan related, Honda had better rates than my CU at the time), and on my way. I was there maybe 30 minutes.

poulsbohemian7• 5 years ago

That’s awesome! I walked into a highly regarded area dealer, ready to buy, and the guy pulled out pre-printed four-square sheets. Took about five minutes of that before I walked out and got online, coincidentally with Carvana, where I found exactly the trim I wanted at a better price than any of the local dealers.

ssharp2• 5 years ago

I've recently bought two used cars -- one from Carvana (about 2 years ago) and one from a dealer (in the last month).

In both instances, I paid with a certified check, so financing complications did not come up.

In my experience, Carvana was a substantially easier process. I picked the car out online, "ordered" it, and they showed up a few days later with a flatbed and put the car in my driveway. I signed some paperwork and we were done in less than an hour at my house.

The dealership took almost 3 hours to get me out of the door even though we had done a fair amount of work up-front to avoid having to spend time at the dealership. I suspect a lot of this could have been mitigated by the dealership if they were better with paperwork and interfacing with the DMV or doing some work ahead of time.

In the end, however, I'd rather not buy from Carvana again. You have no room to negotiate and their customer service is not great. Their prices generally aren't better than the dealer's prices BEFORE you negotiate with the dealers. If you're buying a newer used car (I usually buy cars that are 2-3 years old), the certified warranties that the car manufactures offer are a really nice bonus that Carvana can't offer.

For example, I just picked up a certified 2019 with around 19k miles. It's basic warranty will now run until 2025 or 100k miles. And the manufacturer warranties, in my experience, are substantially better than after-market warranties since the dealers' service departments work directly with the manufacture on servicing them and the dealers are more aligned with your interests than the manufactures' since they make a lot of money off doing repairs. Whereas third-party warranties are more like insurance and you better have your ducks in a row if you actually need to make a claim and expect to have it paid.

closeparen• 5 years ago

I expect it is not actually profitable to let a customer out the door for the same price that brings him in the door. If a dealership shifted their pricing from last minute upsells into the advertised price, would anyone come?

zitterbewegung• 5 years ago

Car Loans in the US are a part of all car companies whether they sell new or used. So this like a good ad for Caravana. Most people in the US expect to buy a car with some kind of financing but as people get price out of more and more homes you can see the Used car market growing more and more.

dougSF70• 5 years ago

Car dealer makes money from financing loans....no surprises!

rossdavidh• 5 years ago

Any article on anything to do with used cars at this point in time, should include the caveat that (in the US at least) this is a very strange year for used cars.

That said, I bought a car from Carvana a couple years ago, and the process was much better than one associates with buying a used car, generally. I think they have created an actually improved process/business, rather than just sucked up a lot of VC money to undercut on price. They are getting lucky with being in the used car business during a time when that is the hottest thing going, but they are also just better at it from the consumer's point of view, and it's not mostly about price.

josephorjoe• 5 years ago

i bought a car from them three years ago and was very pleasantly surprised w how smoothly everything went (fwiw i did not get financing from them).

it was definitely not about price for me. it was about selection and minimizing hassle. i’m still reluctant to buy a guitar online but had no problem w buying a car that costs 15x as much online.

i’ll definitely buy my next car online too.

jws• 5 years ago

I’ve sold a car to carvana and I have to say it was the easiest it could possibly have been.

Fill in a web form, get a number (higher than the other guys), set a meeting and their person comes out, does paper work and trades you a check for the keys and title. (Later someone comes to get the car.)

So I’d say at least part of their success is developing a really nice input side.

cirrus3• 5 years ago

Duh

ramesh31• 5 years ago

Something is very very wrong with the used car market right now. I purchased a brand new 2021 Tacoma 3 months ago for 33k, and the average listing price for an identical used model with ~10k miles is $38k. Surely no one is buying these things when that's the case, so what gives?

fortran77• 5 years ago

For years GM's financing division provided most of its profits. (They were hit hard during the housing bubble because they also got into home loans)

https://www.wsj.com/articles/SB108371503435402235

milanify• 5 years ago

I bought a BMW i8 through Carvana recently. Having gone through the full purchasing flow (and afterward re-financing their loan because their rate was insane) this makes total sense to me.

vmception2• 5 years ago

Collateralized debt objects are lucrative, just dont leverage up 50x like the investment banks in 2008 did

Carvana’s success rides on used-car loans

Related Stories