CarMax to test lending to subprime customers

Subprime borrowers accounted for about 18 percent of CarMax's business in the third quarter.

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(Reuters) -- CarMax Inc. 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 standards.

CarMax 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 Feb. 28, 2013.

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, the nation's largest used-car retailer, said 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 who did not have healthy credit records partly led to the financial crisis of 2008-10 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 prerecession," 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 its lenders went back on the changes they made in the past two years and tightened the terms on down payment and ease of documentation.

CarMax CFO Tom Reedy said it was impossible 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 Aug. 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," CEO Tom Folliard said on a conference call to discuss the company's earnings.

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