Another layer of protection: Even if they were on the hook for all that “non recourse” debt, it’s also secured debt: a car loan is secured against a car. It’s relatively easy for them to repossess a car, particularly as they are ideally placed to sell it again at a profit.
One my of my earlier investing mistake is CPS, now it is trading under CPSS. They finance car loans with a bit bias towards sub-prime. The argument was the prime portfolio is so big, the sub-prime just juices the returns. When the funding gets hit, they got decimated not once but twice.
I am not saying KMX will face the same thing, far from it. But, 100’s of hours of pouring into reading their ABS documents, I was delusional to believe, that I understood. Alas, NO.
Most of these conditions work under 'normal conditions", the “normal” includes funding stress, default stress all following the “model”. When the “model” fails, the losses quickly add up. For ex: KMX “warhouse” has loans with average interest rate of 3.5%, primarily prime, and Fed does 75 basis point hike, I know no one is expecting it, however, there is a funding crisis brewing in the inter-bank market and fed may inject liquidity or not, if it doesn’t the rates move much ahead of FED and fed has to catch up, therefore, fed raises 75 basis point, now, that is not in the “model”, they might have “anticipated 50 basis point hike” and somewhat baked into the model, the 75 basis point hike means when they structure their ABS, they have to structure the ABS trenches to offer 4% or god forbids 4.5% return, suddenly they are starring at a loss on their warehouse. They have to eat that loss, because they need to rotate that facility, they cannot just keep it in their books. Of course, this just impacts that one trench and they will adjust quickly. Most of the time, a gradual increase is something they can quickly adjust the rates of the loans, so the trenches doesn’t suffer much. However, timings can mess up these calculations.
None of this is lethal, probably one to two quarter hit and they will recover. But there are variety of scenario’s where the loans can hurt them.
Yes, KMX has dealership business and generally has a better idea of the value of the car’s they sold, the market is hot due to supply chain issues, etc. Having said that, the funding cost will shake up KMX, I would not be surprised if it revisits $75 or KMX taking some loan loss.