7 ms·

"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 investor

"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#Subprime_mortgage_crisis 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 5y 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.
- throwaway5752 5y 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.
  - deleted 5y ago
    [deleted]
  - xfitm3 5y ago
    They are a logistics company, not a financial company. I have no affiliation with Carvana but I am familiar with the market they operate in.
- eigen 5y 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 5y 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?
- deleted 5y ago
  [deleted]
- compiler-guy 5y 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.
  - beerandt 5y ago
    Regardless of the rating, the risk is entirety different, since vehicles almost always depreciate, and do so faster than the debt is paid off, whereas people expect real estate to appreciate long term. Even a highly rated vehicle note is still based on the fact that the asset will fully depreciate somewhat in line with the outstanding debt.
    - imtringued 5y ago
      Faster than usual depreciation would still ruin some loans.
      - beerandt 5y ago
        We're talking packaging the loans into a bundle, so it'd need to be faster than usual depreciation across the market, for some unforseen (aka not priced-in) reason. Otherwise it'd average out.
- 5y ago
beerandt 5y 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 5y ago
  I am sure they are tranching the debt and selling the senior tranche as investment grade.
adeelk93 5y 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 5y 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.
- throwaway5752 5y 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.
  - throwaway5752 5y ago
    Enron (energy), GE (rails, aerospace, industrial), cars (GM/GMAC), homes (Countrywide, IndyMac), home loans (Lehmans Bros, Bear Stearns, AIG and others that repackaged the loans in addition to CDO and other derivative instruments), ad nauseum. The pattern is there. When you get out of the business of selling widgets to people and getting into the business of selling widget loans that you are originating to investors, that inextricably changes the type of company you are. You are going to optimize for the inevitably higher ROE business line of securitization, and you are going to eventually make bad widget selling decisions to prioritize widget loan sales. I have commented more than enough, so just going to tack this on, but people may forget that loan ownership and "zombie debt" was a big problem in 2008. It is not a great sign that Carvana was banned from selling cars in a mid-market due to title delivery issues: https://www.cbs17.com/news/local-news/wake-county-news/ncdmv-revokes-carvanas-dealers-license-in-wake-county-until-2022/ https://www.cbs17.com/news/local-news/wake-county-news/ncdmv...
adventured 5y 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 5y ago
Yikes!! What are they going to do when the shortage ends? They'll have a bunch of loans with little collateral.
refurb 5y 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.
throwaway0a5e 5y 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.
deleted 5y ago
[deleted]
vmception 5y 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

dayofthedaleks 5y 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.

throwaway5752 5y 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.
- deleted 5y ago
  [deleted]
- xfitm3 5y ago
  They are a logistics company, not a financial company. I have no affiliation with Carvana but I am familiar with the market they operate in.
eigen 5y 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 5y 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?

deleted 5y ago
[deleted]
compiler-guy 5y 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.
- beerandt 5y ago
  Regardless of the rating, the risk is entirety different, since vehicles almost always depreciate, and do so faster than the debt is paid off, whereas people expect real estate to appreciate long term. Even a highly rated vehicle note is still based on the fact that the asset will fully depreciate somewhat in line with the outstanding debt.
  - imtringued 5y ago
    Faster than usual depreciation would still ruin some loans.
    - beerandt 5y ago
      We're talking packaging the loans into a bundle, so it'd need to be faster than usual depreciation across the market, for some unforseen (aka not priced-in) reason. Otherwise it'd average out.
5y ago

beerandt 5y 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 5y ago
I am sure they are tranching the debt and selling the senior tranche as investment grade.

adeelk93 5y 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 5y 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.

throwaway5752 5y 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.
- throwaway5752 5y ago
  Enron (energy), GE (rails, aerospace, industrial), cars (GM/GMAC), homes (Countrywide, IndyMac), home loans (Lehmans Bros, Bear Stearns, AIG and others that repackaged the loans in addition to CDO and other derivative instruments), ad nauseum. The pattern is there. When you get out of the business of selling widgets to people and getting into the business of selling widget loans that you are originating to investors, that inextricably changes the type of company you are. You are going to optimize for the inevitably higher ROE business line of securitization, and you are going to eventually make bad widget selling decisions to prioritize widget loan sales. I have commented more than enough, so just going to tack this on, but people may forget that loan ownership and "zombie debt" was a big problem in 2008. It is not a great sign that Carvana was banned from selling cars in a mid-market due to title delivery issues: https://www.cbs17.com/news/local-news/wake-county-news/ncdmv-revokes-carvanas-dealers-license-in-wake-county-until-2022/ https://www.cbs17.com/news/local-news/wake-county-news/ncdmv...

adventured 5y 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 5y ago

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

refurb 5y 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.

throwaway0a5e 5y 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.

deleted 5y ago

[deleted]

vmception 5y 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