Online car-sales giant Carvana has seen its stock value jump 1,000% since the middle of the pandemic, fueled by high used car prices, low interest rates and its socially distanced business transactions. After consumers click buy, the company delivers the car to their doorstep. 

But the company is also making money by selling its car loans upfront and immediately booking the revenue, rather than keeping the debt on its books and servicing the loans, as other car sellers do. 

The financing technique is generating 36% of the company’s revenue, The Wall Street Journal reported. 

In the first half of this year, the company sold $3.1 billion in loans, double its volume during the same period last year, helping to drive company value to $63 billion, making it more valuable than Ford.

The financial mechanism isn’t all positive. Although it’s making money because investors are willing to buy, at a premium, the company’s loans, after they’re packaged into bonds, that could change if the market experiences a downturn. Should that happen, the company could be forced to sell the loans either at par or a discount, leading to a big drop in revenue.

Even if the market stays strong, the Journal reported, the company is giving up future profit in exchange for the upfront revenue. Other car sellers are positioned to generate higher lifetime revenue from their loans by keeping the debt on their books, after securitization, by retaining the servicing business.

In addition, Carvana’s upfront sales can result in big up-and-down swings, since the revenue stream moves in tandem with the frequency at which its loans are securitized. 

“It would make the profitability lumpier,” Bob Herz of Columbia Business School and a former chairman of the Financial Accounting Standards Board, told the Journal. 

Accounting scrutiny

To make the strategy work, Carvana must rely on relatively tricky accounting to get the loans off its books; while other car sellers also package their loans into securities for sale to investors, as the servicers, they keep the debt on their books for the life of the loans. For Carvana, which doesn’t do that, a certain amount of legal work must go into the way its loans are transferred to the entities that securitize the loans to ensure the transfer qualifies as a sale, the Journal reported.  

The company’s auditor, Grant Thornton, has identified the upfront sales as a critical audit matter, a reference to the transaction’s complexity. In itself, the reference isn’t indicative of any potential misapplication of rules, just something that has a lot of moving pieces to make work, the Journal said.

Meanwhile, to meet a 5% federal skin-in-the-game requirement that was enacted after the 2008 financial crisis to ensure companies don’t pawn off bad loans to investors, the company buys a small piece of each bond in which its loans are sold. 

Eye on volatility

Whatever the direction of the bond market for the loans in the months ahead, investors have the maneuver in their sights and some are willing to bet against the company.  

“If the market gets a little bit softer, such that people are only paying par — heaven forbid a discount — on those new loans, well, right off the bat, you get rid of 30% of Carvana’s earnings,” Jared Rose of Gravity Partners Capital Management told the Journal. He’s placed bets on the stock falling.