SAN FRANCISCO -

The concept of starting an in-house auto finance company in 2016 could be viewed as a curious one.

There's the current auto lending regulatory landscape, plus the echoes of the late 2000s auto finance hurdles.

But consider, for a moment, the potential in the peer-to-peer car sales space.

Depending on how you measure it, says Toby Russell of Shift Technologies, there is typically anywhere from $75 billion to $150 billion in peer-to-peer transactions on an annual basis.

But finance isn’t a huge part of that, said Russell, who is Shift’s head of business and product. That’s where Shift hopes to make a difference.

Shift is an online, peer-to-peer car marketplace, one of several similar players to have emerged in this space in recent years. Last week, it launched an in-house auto lending business known as Shift Finance that is offering direct-to-consumer loans.

Customers of Shift will be able to get loans directly from Shift Finance, which is starting out as a pilot program in Virginia with plans to expand throughout all of the Shift’s territory.

“While something like 80 to 90 percent of traditional used-car dealer sales are financed, it’s exactly the opposite for peer-to-peer,” Russell said in a phone interview with Auto Remarketing, SubPrime Auto Finance News' sister publication. “(Approximately) only 10 percent of peer-to-peer sales end up being financed.

“And so what we’re looking to do is add to the Shift platform, really, the ability to facilitate direct financing for the vehicles, so that we change that equation and make it look more like 90 percent of peer-to-peer sales are financed, much as the way they are in the traditional retail model, versus the 10 percent today,” Russell said.

Part of the challenge in peer-to-peer car transactions  — particularly for buyers — has been the lack of being able to know for sure you’re getting a fair price and a quality vehicle, Russell said.  

“Knowledge about the quality of the vehicle has been a traditional barrier,” Russell said. “And as an extension of that … the ability to finance a vehicle has been a major barrier.”

And that, again, is the issue Shift is trying to solve. Russell said the biggest buyer feature request Shift gets is consumers asking if financing is available.

The reason that request comes up is fairly simple, Russell said: when you buy a car, it’s more akin to purchasing a house than your everyday purchase.  Most folks aren’t carrying around $17,000 to $25,000 in cash — and they tend to think of the car purchase in terms of having a monthly payment.

Challenges

Shift Finance, Russell said, runs on a captive vertical financing model. Asked about the legal/regulatory hurdles of setting up a captive finance company, Russell said there are a few legal structures to choose from, but he emphasized that “in a lot of ways, the legal barriers aren’t the hardest part; it’s actually a structural data barrier.”

“Lots of people have tried to do direct-to-consumer peer-to-peer auto finance in the past,” he said, “and the biggest problem that folks will oftentimes cite is, ‘Yeah, we tried that; the problem was, there was tons of fraud.’”

In a nutshell, what opens the door to fraud in this model is challenges surrounding verification, both of asset and buyer — even their very existence. 

One way to think of it:  Buyer tells the lender he wants to buy a car from the seller — both are private individuals.  

Buyer gets a $20,000 loan.

But as it turns out, buyer and seller are actually friends, and there is no vehicle. The two just conspired to commit fraud.  

“The inability to verify the existence and the quality of both the vehicle and the individual — the buyer — has historically been a huge structural barrier to pure online, direct-to-consumer auto finance plays,” Russell said.

Shift Finance aims to combat that in two ways. Russell said that “because we take and inspect the vehicle in a peer-to-peer transaction, we’re able to, one, verify that it’s real (and) two, verify the quality of the vehicle, in part, as saying, ‘yeah, we think this thing is of good enough quality to be sold through the Shift platform.’

“Second, we actually interact in person with the buyer. Because we do an on-demand direct-to-consumer test drive — which nobody else does — we’re able to say, ‘Yeah this is a real person.’ We’re able to see their address and interact with them and actually hand them an iPad to fill out the credit information that they need to,” Russell said.

“That combination of in-person interaction/direct-to-consumer interaction — but also direct-with-vehicle assessment — allows us to gather the data that’s needed to be able to do the underwriting. But we’re doing it in the peer-to-peer space, which no one else has ever done,” he said. “And that means there’s an even bigger ‘goodness,’ and that is, because we’re both facilitating the transaction and taking the risk, we’re incentivized to help the buyer get a fair price, i.e. as low a price as is reasonable, and underwrite that, take the risk on the car.”

Russell said getting a lower price means the company is underwriting a car that has a lower loan-to-value, which drives better risk management.  Thus, this leads to better pricing on the financing and provide better offers for the consumer and Shift as the party taking on the risk, he said.

“In the past, that hasn’t been possible, because no one who’s able to facilitate a car transaction has also had the scale to do financing, with the possible exception of maybe CarMax — albeit they’re in sort of the traditional dealer model, where they actually own the car and they’re selling it,” he added.

Credit tiers, term lengths

As far as credit tiers, Shift Finance will start offering in the near-prime tier, with plans to expand. The company chose to start with near-prime because there’s a strong need among shoppers in that tier for financing in the peer-to-peer space, Russell. Plus, he said “it’s still predictable” in terms of payment performance.

Shift Finance hopes to build out its credit model to be able to offer loans further down the credit spectrum.

As for term lengths, the company will offer 48- to 72-month loans, depending to some degree on the age of vehicle.  Shift Finance is also aiming to set LTV between 90 percent and 100 percent.

Regulatory landscape

The regulatory environment in auto finance certainly can be a challenging one.

To aid in preparing for such a landscape, Russell said Shift has hired people with auto finance backgrounds who have risk management and regulatory experience. Russell himself worked at Capital One for five years

“I personally believe that what regulators want is to optimize for good, fairness for consumers and stability in the banking system. And so, what they don’t want is folks going out and taking advantage of consumers. And they don’t want folks going out and creating risky structures that could have a negative impact on our financial system,” Russell said.  

“And so at its core, our deepest approach to having a good regulatory infrastructure with which to do well is the underlying philosophy of we want to get people low loan-to-value ratio loans, good rates on reasonably low-priced vehicles relative to what they could find elsewhere in the marketplace, thereby doing two things: setting them up for success — and not getting crazy interest rates or crazy loan-to-value, stuff that’s going to lead to them being overstretched or defaulting — and then secondly, it puts the lending in a good risk-management position. And those things go hand-in-hand,” he added.

Essentially, it’s about creating a structure that promotes a healthy outcome for the borrower and financial system, which he says is what regulators want.

But, what if customer defaults?

Russell answered this with a bit of background first.

Shift will own the loan and will have raised debt to be able to offer the financing. At some point, they will likely “securitize that out,” similar to what CarMax has done, he said.

But here’s what Shift is exploring:

The model Shift aims for is to price cars lower than what one might find in the retail market. So, a consumer finds a car via Shift and is paying, say, 10 percent down, Russell said. He or she will have equity from the get-go.

Should the borrower default, Shift’s goal would then be for that person to sell the car peer-to-peer, make back the money to pay is owned on the loan, then get a lower-priced and different car that he or she could afford.

“Our goal is for folks not to default, but instead to be able to have enough equity in their vehicle where they’re able to re-sell, pay off their loan and then buy a different car at a lower price,” he said. “Now, that’s a lot easier in a world where you’re not borrowing against a car with a loan-to-value of 130 percent, where you’re basically borrowing more than your car is worth on the retail market.”