Carvana's Finance GPU and Gain-on-Loan Sale

In Practise Weekly Analysis

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One way to frame Carvana (CVNA) is that of a loan originator that sells cars. Over 50% of CVNA’s gross profit is from finance and other income, of which the majority is driven by the accounting gains from selling the loans originated.

Source: In Practise, CVNA 10-KSource: In Practise, CVNA 10-K

Source: In Practise, CVNA 10-KSource: In Practise, CVNA 10-K

We’ve been studying CVNA’s finance model to understand the potential durability of finance GPU and specifically the gain on loan sales. Over the last few weeks, we've published various pieces of content on CVNA covering different aspects of the business:

  1. CVNA Finance GPU Analysis
  2. In Practise Investor Dialogue: CVNA Liquidity and Finance GPU
  3. CVNA Operations: IRC’s, Trade-ins, and Last Mile Delivery
  4. Carvana, ADESA, and US Auto Wholesale Auctions
  5. IP Analysis on CVNA ADESA acquisition

The CVNA story has moved incredibly fast; the equity has declined ~90% from ATH’s and the company has a completely different capital structure post-ADESA acquisition.

This Weekly Analysis aims to explore CVNA's financing model and provide a balanced view of the potential advantages and future challenges originating profitable loans going forward.

Vertically Integrated vs Indirect Finance Models

Dealers, lenders, and investors all work together to originate loans so consumers can purchase cars. In the indirect finance model, the most common in the industry, dealers outsource the origination of the loan to external lenders like Santander, Exeter, or Westlake who take on the risk of underwriting the loan. Dealers earn most of their margin from selling the vehicle and ancillaries and either pay or receive a fee from the lender to make the economics work for both parties.

The lender typically earns the largest profit in the value chain because they are taking the most risk underwriting the loan. Investors earn a risk-adjusted return determined by traditional credit drivers (rates, spreads, duration, etc).

CVNA's model is different in that it is vertically integrated; it acts as the auto dealer that buys and sells the vehicle and the lender that originates the loan. These loans are then securitised and sold to ABS investors.

Source: In PractiseSource: In Practise

KMX is a hybrid model: it originates prime loans internally but outsources Tier 2 and 3 loans to traditional lenders. This is why comparing Carmax and CVNA’s Finance GPU isn’t apples-to-apples; CVNA is doing more of the work for lower quality but more profitable loans and therefore should earn a higher Finance GPU than KMX. Also, CVNA finances ~80% of retail sales whereas KMX is closer to 40%.

CVNA vs CACC

Comparing CVNA to Credit Acceptance (CACC), the US subprime auto lender, helped us understand CVNA’s loan origination business. CACC’s business model is based on reducing adverse selection in the indirect finance model; put simply, dealers outsource loans to CACC which shares the lending profits with the dealer over time.

This incentivises dealers to sell cars that customers can afford. Typically in the indirect model, dealers may receive a fee for effectively generating leads for lenders and even markup the loan to the customer, but they have no interest in the underlying loan performance.

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Carvana's Finance GPU and Gain-on-Loan Sale(May 24, 2022)

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