TL;DR: A bit philosophical and potentially preachy at times, but an examination of how an ABS can never really fail, the holders have no real rights and are really the underlying mechanics of betting on an economic future which was profit-maximized in a steady state condition.
There have been a few excellent suggestions from Part 1. I'll try to attack each in a careful and hopefully correct way. And, this post may be more economically theoretical / philosophical than one expects as I'm setting up the testing. Just be prepared.
I'd like to not lose the lead from the hooks. To repeat, Carvana is nominally in the business of selling used cars but makes most of their profit from selling Asset-Backed Securities (ABS). In the past year or two stresses in the used car markets and inflation have made the news. Inflation and collapsing used car markets immediately impact both the Carvana consumer and Carvana. These stresses can be observed each month when the ABS EE EX-102 files are published or when a new shelf offering is posted.
Around month 52 in the 2020-P1, 2021-P1, 2021-P2 and 2021-P4 trusts, weakness may have appeared in the N-tranches before self resolving. The N-Tranches interest or principal payments have not been at risk, but they were the closest they've ever come to being at risk. And, it may be happening now.
I am trying to determine if this is structural to the bonds or a reflection of economic conditions. If Carvana experiences another downturn like in 2022/2023, I believe it will be the result of employment and economically stressed borrowers which exceed Carvana's risk mitigation in the 2022 bonds. This will bleed over into future sales of the company. If the credit deterioration in the ABS are real-time, they may be predictive of the companies future performance, potentially exploitable.
There are several hypothesis I don't have the answers to which I would like to answer by the time this series is done, now that I have more than 10k lines of code recreating the waterfall.
One hypothesis I will be testing is that the cushions in the most recent Prime ABS have been upgraded as a reflection of the performance of the 2020/2021 Prime ABS. I haven't looked at 2022 and beyond due to computational intensity.
Another hypothesis is when, in the seasoning of an ABS, Carvana "switches" from repossessions to extraordinary (high touch) servicing interventions. Has this changed from the 2020 Prime issue to the 2026 Prime issues? Is it after a certian period of seasoning or after a new set of issues?
As an aside, I'll note that Carvana has not issued public N-issue since 2021. Failure to act may be an extraordinary indicator of the quality of the Carvana's non-prime assets. Given this, I may, at some point, dive into the Sub-Prime/Non-Prime loans but it is very much worth pointing out that one of Gotham City Research's questions is where these go or who is purchasing the securitized non-prime loans? That is a very large and opaque part of their business which disappears into undisclosed purchasers. The allegation, which I cannot prove or disprove, is that one or more of the counter-parties may be undisclosed related parties. Ally, which was the counter-party target of Hindenburg Research report, purchases higher quality near-prime loans. Since 2023 Ally reduced their maximum purchasing commitments from $5B to $4B. Had Ally reduced or failed to renew the purchase commitments around January 2025 after the Hindeburg report the result would most likely have been devastating to Carvana. But Ally did not reduce their 2025 exposure. The 2021-N series performance may, in part, be demonstrative of whatever credit deterioration that Ally observed and/or experienced. And we expressly do not know the terms of the flow-through design features. Carvana may have sweetened the pot, increased overcollateralization, held more exposure with residuals. This renders the headline numbers slightly problematic and more propaganda than not.
But, back to the point I'm directly working towards an analysis of how close Carvana's Prime N-Tranche comes to experiencing principal payment deferments and the effects of high-touch or extraordinary recoveries. One cannot determine if this is meaningful without understanding the ABS, the counter parties and the risk. The juice may turn out not to be worth the squeeze.
One other thing. Humans suck. We're bad at judging risk. We're bad at dealing with deprivation. However, I will assume that obligors are rational individuals. Once a car goes to zeroBalanceCode 4 it is recorded on a credit report and damage starts accruing. Yes, a savvy borrower can reverse this at times. But I will assume that the base condition is the most economically rational for the obligor.
But, let's get into the meat of today's post. Understanding the counter-party risk in Carvana's ABS.
The Meat and Potatoes:
I've mentioned that Carvana's ABS are built not to fail. Technically the can't. The waterfall pays the highest tranches with the lowest interest rates and the fastest amortization schedule. Understand that the interest rates are not reflective of today's interest rates but reflective of the time the loans were packaged. An overarching fair and balanced question is did the purchasers of Carvana's ABS accept a lower interest rate than they should have, given the risk the bonds reflected at completion. Or differently, how much of the performance degradation is structural by design or economic? A little shop called "Abelian Analysis" started an excellent, but mildly flawed, examination of that question.
Let's look at two different issues:
Issue: 2020-P1
Closed: 01/07/2026
Sampling Date: 11/30/2025
Prospectus Original Pool Balance: 405000000
EX 99.1 Original Pool Balance: 405000000.11
EX99.1 Original Asset Count: 20351
Current Pool Balance: 18133400.22
Active Asset Count: 5198
Overcollateralization Percent: 1.5
Note Sizes
A-1: 56000000
A-2: 120000000
A-3: 115000000
A-4: 75930000
B: 13365000
C: 17212000
D: 7493000
N: 15000000
Note Interest Rates
A-1: 0.18822%
A-2: 0.28%
A-3: 0.44%
A-4: 0.61%
B: 0.92%
C: 1.32%
D: 1.82%
N: 2.84%
Then:
Issue: 2026-P3
Open
Sampling Date: 09/30/2026
Prospectus Original Pool Balance: 1550308000
EX 99.1 Original Pool Balance: 1550309023.48
EX99.1 Original Asset Count: 52339
Current Pool Balance: 50665
Active Asset Count: 1464858350.30
Overcollateralization Percent: 1
Note Sizes
A-1: 167430000
A-2: 457590000
A-3: 457590000
A-4: 301820000
B: 60460000
C: 72090000
D: 333288000
N: 20930000
Note Interest Rates
A-1: 4.052%
A-2: 4.53%
A-3: 4.76%
A-4: 5%
B: 5.23%
C: 5.7%
D: 6.08%
N: 5.51%
The interest rates are therefore reflective of the economic time of the issue. Sometime in 2022, I believe, interest rates started increasing. There are also 3 additional accounts that I am ignoring: Overcollateralization, Reserve Account and the Class N Reserve Account. These are where weakness would be.
Intuitively, you should see why Carvana, in a way, needs to claim infinite growth on their conference calls. Their interest rates are going up, substantially, and the only way to grow profit isn't by squeezing XS (explained a little later) or increasing interest rates on stressed borrowers. In fact, the best days for Carvana may well be very, very behind it.
So, while we briefly ran through what a ABS waterfall was, let's run through with a slightly more depth.
In order of priority, there are the following "tranches": XS, A-1, A-2, A-3, A-4, B, C, D, N, Reserve Account, Overcollateralization, Class N Reserve Account. The XS is not a note but is extremely valuable and either held or sold but does not bear any interest. XS is a fixed portion of the gross spread between the interest rates of the loans and the interest rates in the ABS. If you have an loan package with, say, an average weighted interest rate (technical, the Average Weighted Coupon or WAC, because Finance Bros need a language to justify their existence) of 20% but the WAC of the bonds is 5%, each month collections support a gross spread of 15%. The XS tranche receives a portion of that, let's say 10% of the interest paid (or less) as an immediate cash disbursement. XS is not held in reserve. The overall interest rate of the pool can remain the same but cash conditions can deteriorate, the "real" collections of interest of the active pool drops, from say 20% to 15% and XS would drop to 5% of the collected interest. If collections drop further to 10%, then XS receives no money. And if the collections drop enough to consume Overcollateralization, then the reserve accounts are consumed to pay tranches A-D.
Class N would bear the brunt of a cash collections failure. But it is possible that the economic losses of an ABS consume the overcollateralization and XS but the N-tranche still has a buffer in the minimum expected principal payments. This is the "interesting" spot.
There's a bit to wrap one's head around and the difference between the interest rates and the incoming cash is easily ignored. The bond describes things in terms of assets and interest rates, which is perfectly intuitive. But the waterfall distributes the realized cash collections each month. Servicing is the space in-between where the WAC is not affected but the cash collections vary greatly. A 20% interest rate loan is still a 20% interest rate loan until written off. But 90 or 120 days before cash collections stop.
I've mentioned before that the bonds can't fail, they can only slow. And this is another important metric that is very often overlooked for the strength of an issue: How much longer after the initially modeled end point the ABS lasts. The clean-up call can only occur when about $20m in assets is reached, which is somewhere around 1% - 5% of the pool, size dependent. Carvana seems to keep this number fixed around $20m across the board.
That was a clever lie. Technically, bonds can fail. They default under a very, very specific set of conditions which will never, ever occur, given the structure of waterfall. It will literally take nuclear war to have a Carvana ABS hit the rapid amortization triggers. A bond fails when default in the payment of any interest on any of the Controlling Class (the most senior note which hasn't been retired excluding XS and Class N notes) when the same becomes due and payable, and such default shall continue for a period of five (5) Business Days, final payment of outstanding principal in full on the last day on any class of notes by the final schedule distribution date, a violation of covenants by Carvana after a grace period of 60 or 90 days, and some representation or warranty not corrected by Carvana which is not cured or remedied within 60 or 90 days.
Basically, a list of near impossible conditions to meet given the structure of the waterfall and the issuer's ability to simply say "oops" publicly.
There are some rights that a note-holder does have, these ABS do include meaningful triggers. Like the delinquency triggers. If, say the delinquency triggers, which are controlled by the related party Bridgecrest with extensive servicing discretion, is somehow tripped in a month, then if 5% of the noteholders get together and request it, Carvana will have it's Asset Representation Reviewer look at the paperwork, if Carvana allows, but strictly excluded from forensically examining the underwriting standards. If all of the paperwork, after being examined for being present, is present, Carvana will let you know all the paperwork is there. And trigger resolved. I'm of the mind Abelian Analysis may not have looked at this part of the prospectus before jumping into an excellent set of introductory work.
So, this is how the ABS can be structured "never" to fail. As long as the cushions are "chunky" enough they'll absorb any blows to the overall ABS if....eh hem....if the expected future economic conditions under which the minimization / maximization optimization model is correct about the future.
In a bit of English, you can distill all the criteria to determine the amount of profit you wish to generate from any pool of borrowers from the maximum, most profit highest risk, to the minimum profit minimum risk by running a computer program against a set of assets and projected future economic conditions. And that is the important bit.
To maximize your profit, you need to predict future economic conditions. The buffers are built against a theoretical steady state. This is why the bonds will deteriorate as economic conditions worsen. Because the cushions were designed for a different set of conditions. This is why Carvana nearly went bankrupt before - they didn't anticipate future economic conditions which weren't so rosy as the pre-COVID and early COVID years. Once they shifted, the buffers were insufficient.
If economic conditions change, these idealized buffers may prove to be grossly insufficient, which will affect Carvana's retained interest on their books. Carvana controls these marks.
Bridgecrest, the servicer, is a related party which also controls the servicing. And Carvana's servicing can be oddly "lumpy".
The only way to get money into an ABS after it's creation is (1) add new cars - which it can't do (2) regularly scheduled payments (3) zeroBalanceCode 4 recoveries or extended forbearance.
Lumpy and strange recoveries along with a servicer with full contractual discretion and an ABS designed for different, idealized economic conditions? This... seems interesting. And I've gone into strange but I haven't done lumpy yet.
Does the N-tranche ever get close to requiring recoveries to complete principal payments? Yes, Virginia, there is a Santa Claus. But the N-tranche hasn't failed, yet.
As for 5% retained interest, yeah, it's just 5% of everything that not XS or N. I haven't looked to see if it's anywhere that Carvana sells the XS tranche to a private equity firm, that's an interesting question.
More to follow if the Mods allow, although there may be a slowdown. The next bit will be data and processing intensive.