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Tech-driven Carvana delivers 1st auto loan securitization

The car-buying process is not the only area in which auto retailer Carvana Co. seeks to distinguish itself from its peers.

Perhaps best known for an e-commerce-centric buying process where vehicles are delivered through vending machines in select cities, the company is about to make its securitization market debut with auto loan collateral that has some unique attributes relative to rival used-vehicle retailer CarMax Inc. and peers that lend to customers indirectly through third parties.

Carvana Auto Receivables Trust 2019-1 plans to issue $338.8 million in notes on March 28, according to a Kroll Bond Rating Agency presale report. The notes will be backed by $309.1 million in auto loans extended to borrowers with a weighted average FICO score of 635.

The company employs a vertically integrated model, selling and financing vehicles. To underwrite loans, it employs machine-learning techniques as part of proprietary algorithms that generate customer credit scores and risk-adjusted pricing options. Carvana has historically sold loans to third-party finance partners once the seven-day return period on the vehicles it sells has elapsed. It is party to a forward-flow agreement with Ally Financial Inc. under which the auto finance company committed to purchase $1.25 billion of Carvana-originated loans through Nov. 1, 2019.

CarMax also originates loans in-house, but it outsources that function to third parties for customers categorized into lower credit tiers. Traditional franchised dealers typically outsource the origination process in its entirety to third-party lenders.

"The innovation that exists in our retail platform flows into our finance platform, allowing us to generate higher-quality loans," Carvana Chairman, President and CEO Ernest Garcia III said during a recent conference call.

The company said in a recently published paper that its loans have performed "meaningfully better" than traditional securitization market issuers, based on cumulative net losses. To reach that conclusion, it analyzed performance data from five large lenders that fund fixed auto loan pools in the ABS market: CarMax Auto Finance; two of Santander Consumer USA Holdings Inc.'s platforms; Exeter Finance Corp.; Westlake Services LLC; and American Credit Acceptance LLC. Carvana noted that the latter four companies serve as external lending partners for CarMax's Tier 2 or Tier 3 loans. Additionally, the company said, its loans achieved what it characterized as improving performance, even during a period of rapid growth.

"This differs from many historical examples of fast-growing finance companies who, because they must compete for the loan, lowered standards or signed up new, unknown dealers over time," Carvana said. "In contrast, we primarily compete for the vehicle sale, and once we get the sale, we operate in our own controlled environment for the loan."

The company's origination volumes increased at rates of more than 135% in each of the last two years, reaching $1.26 billion in 2018.

In breaking down the finance business, Carvana divided its 2018-vintage originations into three "Deal Score" bands. The highest band had a weighted average borrower FICO score of 702, and it constituted 53% of the company's production. The middle and lower tiers had weighted average scores of 567 and 508, respectively, and accounted for 37% and 10% of 2018 originations.

When analyzing the historical performance of loans originated from 2014 through 2017, Carvana concluded that its "Deal Score" has been "a strong predictor of loan performance." However, it cautioned that there is limited data available about the "outer years" for its originations.

Rating agencies also listed the limited performance history of Carvana's loans among the potential weaknesses of the securitization. But they found no shortage of positives about the company and its inaugural transaction.

Kroll Bond Rating Agency said Carvana's management has "extensive" auto finance experience and the pool benefits from "robust underwriting and risk analytics." While Carvana is vertically integrated from an originations standpoint, it engages an affiliate of DriveTime Automotive Group Inc. for loan servicing functions. DriveTime, a highly seasoned ABS sponsor, launched Carvana in 2012, and the two companies maintain a variety of business relationships.

The company did not rule out revisions to its underwriting standards, given the flexibility afforded by its overall strategy, insofar as they increased the value of its business. Additionally, Carvana said it does not believe its loans must continue to outperform to the extent they have to date for it to achieve its financial goals.

But Garcia is optimistic that the company's overall approach to selling and financing vehicles puts its customers in a position to succeed and, in turn, default with less frequency.