CarMax 2010 Annual Report Download - page 63

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various reserve accounts, required excess receivables and retained subordinated bonds, as described below. As of
February 28, 2010, on a combined basis, the reserve accounts and required excess receivables were 4.3% of
managed receivables. The interest-only strip receivables, reserve accounts and required excess receivables serve as
a credit enhancement for the benefit of the investors in the securitized receivables.
The fair value of the retained interest was $552.4 million as of February 28, 2010, and $348.3 million as of
February 28, 2009. Additional information on fair value measurements is included in Note 6. The receivables
underlying the retained interest had a weighted average life of 1.5 years as of both February 28, 2010 and 2009. The
weighted average life in periods (for example, months or years) of prepayable 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.
Interest-Only Strip Receivables. Interest-only strip receivables represent the present value of residual cash flows
we expect to receive over the life of the securitized receivables. The value of these receivables is determined by
estimating the future cash flows using our assumptions of key factors, such as finance charge income, loss rates,
prepayment rates, funding costs and discount rates appropriate for the type of asset and risk. The value of interest-
only strip receivables could 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 and credit markets; therefore, actual
performance could differ from these assumptions. We evaluate 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.
Reserve Accounts. We are required to fund various reserve accounts established for the benefit of the securitization
investors. In the event that the cash generated by the securitized receivables in a given period was insufficient to
pay the interest, principal and other required payments, the balances on deposit in the reserve accounts would be
used to pay those amounts. In general, each of our term securitizations requires that an amount equal to a specified
percentage of the original balance of the securitized receivables be deposited in a reserve account on the closing
date. An amount equal to a specified percentage of funded receivables is also required in our warehouse facility.
Any excess cash generated by the receivables must 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, the
excess is released through the special purpose entity to us. In the term securitizations, the amount required to be on
deposit in the reserve account must equal or exceed a specified floor amount. The reserve account remains funded
until the investors are paid in full, at which time the remaining balance is released through the special purpose entity
to us. The amount on deposit in reserve accounts was $47.4 million as of February 28, 2010, and $41.4 million as of
February 28, 2009.
Required Excess Receivables. The total value of the securitized receivables must exceed the principal amount owed
to the investors by a specified amount. 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.
Any remaining cash flows from the required excess receivables are released through the special purpose entity to us.
The unpaid principal balance related to the required excess receivables was $129.5 million as of February 28, 2010,
and $139.1 million as of February 28, 2009.
Retained Subordinated Bonds. Between January 2008 and April 2009, we retained some or all of the subordinated
bonds associated with our term securitizations. We receive periodic interest payments on certain bonds. The bonds
are carried at fair value and changes in fair value are included in earnings as a component of CAF income. We base
our valuation on observable market prices of the same or similar instruments when available; however, observable
market prices are not consistently available for these assets. Our current valuations are primarily based on an
average of three non-binding, current market spread quotes from third-party investment banks. By applying these
average spreads to current bond benchmarks, as determined through the use of a widely accepted third-party bond
pricing model, we have measured a current fair value. The fair value of retained subordinated bonds was $248.8
million as of February 28, 2010, and $87.4 million as of February 28, 2009.
Key Assumptions Used in Measuring the Fair Value of the Retained Interest and Sensitivity Analysis
The following table shows the key economic assumptions used in measuring the fair value of the retained interest as
of February 28, 2010, and a sensitivity analysis showing the hypothetical effect on the retained interest if there were
unfavorable variations from the assumptions used. These sensitivity analyses 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
interest is calculated without changing any other assumption; in actual circumstances, changes in one factor could
result in changes in another, which might magnify or counteract the sensitivities.