Carvana holders brace for the worst with growing credit risk and losses

It took only a few years for Carvana Co. to grow from a startup to the second largest used car seller in the United States.

Its fall may be even faster. The company burned through $2 billion in cash in the six months ended March 31 by one measure, and some analysts predict it will be out of business by the end of 2023. Used car prices are falling at the fastest rate in decades, squeezing Carvana’s potential revenue from automobiles he planned to sell. And borrowing to keep going is getting harder as interest rates rise and fund managers become more selective about who they lend.

Investors are worried: Carvana shares have plunged 96% this year. Its bonds fell this month after the company posted a bigger-than-expected loss and are now trading below 50 cents on the dollar, reflecting fund managers’ belief that there is a high risk of default.

The company slowed its pace of cash burn, consuming about $188 million in the quarter ended Sept. 30 based on the free cash flow measure. A spokesperson said Carvana had $2.3 billion, between cash and its line of credit, and another $2.1 billion in additional cash. S&P Global Ratings said last week that the company has enough cash to last through the end of 2023, which Carvana agrees with. It continued to gain market share in the third quarter, the spokesperson said.

But the car salesman’s troubles are a dramatic turn for a company that was the darling of hedge funds just a few years ago, with its vending machine-style glass towers a sight to behold along highways in major cities. Americans.

winner of the pandemic

Few companies have benefited from the pandemic economy as much as Tempe, Arizona-based Carvana. When Covid fears car dealerships across the country will close in 2020, consumers could go online to select a vehicle from Carvana and have it delivered to their doorstep.

Carvana’s annual revenue has surged, topping $12 billion last year, more than triple 2019 levels. But like many tech companies, Carvana has prioritized growth over profits. He bought competitors and spent a lot on marketing and other sales expenses. It has generated a net profit in just one quarter since its IPO in 2017.

“The company grew too fast and now we see the ramifications of that,” said John Kerschner, head of US securitized products at Janus Henderson Group.

Carvana needs regular funding to operate, as do many companies. He has sold nearly $6 billion in corporate bonds over the past two years. It makes auto loans to car buyers and sells those loans to other businesses or bundles them into bonds called asset-backed securities.

But financing is increasingly difficult. The company’s corporate bonds trade between about 37 and 48 cents on the dollar, making it virtually impossible for the company to borrow economically in this market.

‘say default’

Many investors dumping corporate bonds from Carvana now fear the car salesman will borrow even more, this time backing the loans with durable assets, including its real estate or inventory. The value of this security to other lenders is unclear, as the company did not detail the assets in filings.

But these types of secured financings would hurt existing bondholders, as they would stand behind new lenders if the company actually went bankrupt. And current bond prices imply that this is a real possibility.

“Carvana debt prices indicate default,” said Eric Rosenthal, senior director of leveraged finance at Fitch Ratings. “Debt prices in the secondary market are one of the best indicators of what you’re going to see happen with the company.”

Debt swap?

One avenue the company could take to reduce its indebtedness would be to ask noteholders to surrender their unsecured notes in exchange for a smaller amount of secured debt. Such a swap would amount to default by the criteria of bond raters like Fitch, which said it expects Carvana to default next year.

The company has other assets against which it can borrow. The real estate acquired from Adesa, a car auction company that Carvana bought in May, is likely worth around $1 billion, chief executive Ernie Garcia III told investors on a conference call. The struggles are personal for Garcia and his father, Ernie Garcia II, who hold about four-fifths of voting control, the younger of the two having fallen from the billionaire ranks with the plummeting stock.

Major holders of its most recent bonds are Apollo Global Management, Pacific Investment Management Co., and Franklin Resources Inc. These bonds are backed by Adesa’s assets and consistently trade at higher prices than others. But generally, the company’s securities recently trade at about the same price whether they mature soon or in a decade, known as a bond pile collapse.

The collapse signals that “debt restructuring is inevitable,” said John Dixon, managing director and bond trader at Dinosaur Financial Group, a brokerage. “The question is whether it will be out of court or in court, consensual or adversarial.”

Car loans

Another way the company finances itself is by bundling auto loans into bonds. But its financing costs in this market are also increasing.

In August, Carvana sold asset-backed securities with average maturities of around one year at a yield of 4.471%. That’s more than five times what he paid in December, when the roughly one-year portion of an ABS offering returned just 0.83%.

Since September, asset-backed asset yields have risen sharply for auto lenders, especially for bonds backed by subprime loans. More auto loan borrowers are falling behind on their bills, making many investors more concerned about buying bonds backed by that debt.

“There are so many cheap bonds out there. You don’t want to be a hero,” Kerschner said.

Carvana may have to find other ways to sell its subprime loans. One of the avenues the company has taken this year is to sell the debt to Ally Financial through a running deal through early 2023. There is no indication yet that it will extend or renew the contract, according to Jory Eisenberg, senior research analyst at CreditSights, and Ally has already purchased more than 60% of the $5 billion in loans it agreed to buy from Carvana. Ally declined to comment.

Companies like Ally are being inundated with loans from used car dealerships and other lenders as asset-backed market financing dries up. They will likely seek better terms from sellers instead of renewing deals, said Jennifer Thomas, portfolio manager at Loomis Sayles & Co, in an interview.

“The ability of auto lenders to sell their loans is going to dry up at some point,” Thomas said.

Losing that funding avenue could be the deathblow for Carvana, said Eisenberg of CreditSights.

“If it’s not renewed, it’s kind of catastrophic for them,” Eisenberg said.

–With help from Mary Biekert and Dayana Mustak.

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