December 20, 2013 / 3:30 PM / in 4 years

CarMax unit could lend to subprime customers, shares fall

(Reuters) - CarMax Inc (KMX.N) said it could start lending to borrowers with weak credit records as it seeks to cut its reliance on third-party subprime car loan providers that are tightening their lending norms.

Shares of the largest used-car retailer in the United States fell as much as 10 percent after it also reported a slightly weaker-than-expected profit for the first time in five quarters.

CarMax already has a financing arm that lends to customers with healthy credit records. The business, CarMax Auto Finance, originated about $3.45 billion in loans during the fiscal year ended February 28.

The company pays $1,000 per car to third-party lenders to own the risk of customers defaulting in its subprime business. Subprime borrowers accounted for about 18 percent of CarMax’s business in the third quarter.

CarMax said on Friday it would roll out a pilot project this quarter for lending to subprime borrowers with poor credit history.

Investors are concerned that CarMax’s decision to lend to subprime customers could likely make it too reliant on the risky group to drive sales.

Excessive lending to people that did not have healthy credit records partly led to the financial crisis of 2008-2010 in the United States.

The market, however, was being too hard on CarMax, Stifel Nicolaus analyst Jamie Albertine said.

“This is an opportunistic decision to improve finance profitability (and) I continue to believe that the automotive lending market remains healthy and lacks the overexuberance characteristic of the market pre-recession,” he said.

Shares of auto retailers have risen this year as easier access to credit encouraged customers to buy more cars. Lending to such borrowers had dried up after the start of the credit crisis in 2008.

But Carmax said on Friday its lenders went back on the changes they made in the last two years and tightened the terms on down payment and ease of documentation.

CarMax Chief Financial Officer Tom Reedy said it was not possible to forecast how much more lenders would tighten their terms, but added that its decision to enter the subprime market was not in response to the more difficult standards.

    CarMax said it would lend about $70 million through the subprime program over the next 12 months.

    The company had cash and cash equivalents of $750 million as of August 31, according to a company filing.

    “Customers with challenged credit have become a meaningful part of our overall business ... so we feel like we owe it ourselves to get smarter about this space,” Chief Executive Tom Folliard said on a post-earnings conference call.

    Net income rose to $106.5 million, or 47 cents per share, in the third quarter ended November 30 from $94.7 million, or 41 cents per share, a year earlier.

    Analysts on average expected 48 cents per share, according to Thomson Reuters I/B/E/S.

    Revenue increased 13 percent to $2.94 billion, above the average analyst estimate of $2.89 billion.

    CarMax shares were down 9.7 percent at $47.88 in afternoon trading on the New York Stock Exchange on Friday. They had risen about 41 percent this year to Thursday’s close.

    Editing by Saumyadeb Chakrabarty and Joyjeet Das

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