CarMax 2004 Annual Report Download - page 38

36 CARMAX 2004
below. The cash reserves and excess receivables are generally 2%
to 4% of managed receivables. The special purpose entities and
the investors have no recourse to the company’s assets. The
company’s risk is limited to the retained interests on the
company’s consolidated balance sheets. The fair value of the
retained interests may fluctuate depending on the performance
of the securitized receivables.
The fair value of retained interests was $146.0 million as of
February 29, 2004, and $135.0 million as of February 28, 2003.
The retained interests had a weighted average life of 1.5 years as
of February 29, 2004, and 1.6 years as of February 28, 2003. As
defined in SFAS No. 140, the weighted average life in periods
(for example, months or years) of pre-payable assets is calculated
by multiplying the principal collections expected in each future
period by the number of periods until that future period,
summing those products, and dividing the sum by the initial
principal balance. The following is a detailed explanation of the
components of retained interests.
Interest-Only Strip Receivables. Interest-only strip
receivables represent the present value of residual cash flows the
company expects to receive over the life of the securitized
receivables. The value of these receivables is determined by
estimating the future cash flows using management’s
assumptions of key factors, such as finance charge income,
default rates, prepayment rates, and discount rates appropriate
for the type of asset and risk. The value of interest-only strip
receivables may be affected by external factors, such as changes
in the behavior patterns of customers, changes in the strength
of the economy, and developments in the interest rate markets;
therefore, actual performance may differ from these
assumptions. Management evaluates the performance of the
receivables relative to these assumptions on a regular basis. Any
financial impact resulting from a change in performance is
recognized in earnings in the period in which it occurs.
Restricted Cash. Restricted cash represents amounts on
deposit in various reserve accounts established for the benefit
of the securitization investors. The amounts on deposit in the
reserve accounts are used to pay various amounts, including
principal and interest to investors, in the event that the cash
generated by the securitized receivables in a given period is
insufficient to pay those amounts. In general, each of the
company’s securitizations requires that an amount equal to a
specified percentage of the initial receivables balance be
deposited in a reserve account on the closing date and that any
excess cash generated by the receivables be used to fund the
reserve account to the extent necessary to maintain the
required amount. If the amount on deposit in the reserve
account exceeds the required amount, an amount equal to that
excess is released through the special purpose entity to the
company. In the public securitizations, the amount required to
be on deposit in the reserve account must equal or exceed a
specified floor amount. The reserve account remains at the
floor amount until the investors are paid in full, at which time
the remaining reserve account balance is released through the
special purpose entity to the company. The amount required
to be maintained in the public securitization reserve accounts
may increase depending upon the performance of the
securitized receivables. The amount on deposit in the restricted
cash accounts was $34.8 million as of February 29, 2004, and
$33.3 million as of February 28, 2003.
Required Excess Receivables. The warehouse facility and
certain public securitizations require that the total value of the
securitized receivables exceed, by a specified amount, the
principal amount owed to the investors. The required excess
receivables balance represents this specified amount. Any cash
flows generated by the required excess receivables are used, if
needed, to make payments to the investors. The unpaid
principal balance related to the required excess receivables was
$28.8 million as of February 29, 2004, and $13.4 million as of
February 28, 2003.
Key Assumptions Used in Measuring Retained
Interests and Sensitivity Analysis
The following table shows the key economic assumptions used
in measuring the fair value of the retained interests at February 29,
2004, and a sensitivity analysis showing the hypothetical effect
on the retained interests if there were unfavorable variations
from the assumptions used. Key economic assumptions at
February 29, 2004, are not materially different from
assumptions used to measure the fair value of retained interests
at the time of securitization. These sensitivities are hypothetical
and should be used with caution. In this table, the effect of a
variation in a particular assumption on the fair value of the
retained interests is calculated without changing any other
assumption; in actual circumstances, changes in one factor may
result in changes in another, which might magnify or counteract
the sensitivities.
Impact on Impact on
Fair Value of Fair Value of
Assumptions 10% Adverse 20% Adverse
(In millions) Used Change Change
Prepayment rate 1.45%–1.55% $5.4 $10.5
Cumulative default rate 2.00%–2.50% $4.1 $ 8.1
Annual discount rate 12.0% $2.1 $ 4.2
Prepayment Rate. The company uses the Absolute
Prepayment Model or “ABS” to estimate prepayments. This
model assumes a rate of prepayment each month relative to the
original number of receivables in a pool of receivables. ABS
further assumes that all the receivables are the same size and
amortize at the same rate and that each receivable in each
month of its life will either be paid as scheduled or prepaid in
full. For example, in a pool of receivables originally containing
10,000 receivables, a 1% ABS rate means that 100 receivables
prepay each month.
Cumulative Default Rate. Cumulative default rate or
“static pool” net losses are calculated by dividing the total
projected future credit losses of a pool of receivables by the
original pool balance.