CECL Considerations for Dealerships

The ECL will be reported in current earnings as an allowance for loan and lease losses (ALLL) in your entity’s financial statements. Because this new methodology could adversely affect a BHPH dealer’s net worth on financial statements, dealers will need to factor in CECL considerations and how adjusted financial statements could impact existing bank loan covenants or other credit agreements.

Banks will be aware of potential changes among their customers, but proactive communication will be important to ensure that relationships and access to credit remain intact.

Besides big changes in accounting methodologies for RFCs, it remains to be seen what this FASB standard means for established BHPH dealers seeking future access to traditional capital. BHPH loans, by their nature, are short-term loans with a high risk of default. Dealers rely on strong relationships with financing arms to purchase inventory and maintain operations through the ebb and flow of customer transactions and variable payment plans. As banks and other third-party financing arms adopt some form of CECL model for their portfolios, they will weigh the expected risk of loans even more heavily than before — which may limit their participation in financing higher risk industries like BHPH.

Well-managed BHPH dealerships can maintain strong cash flow by keeping customers in cars, collecting payments consistently, diversifying sources of revenue and reinvesting in a variety of inventory. As we have discussed in , there are ways to improve the scale and structure of your dealership to add value to the loan portfolio. We focus on your relationship with financing, your tax returns and operational changes to improve profits.

Download the Whitepaper: The Impact of New Credit Loss Standards on the BHPH Industry

In light of this new federal accounting standard for monitoring and calculating expected credit losses, BHPH operators of all sizes will likely require additional professional support. A CPA knowledgeable in BHPH operations can help you determine the standard’s impact on your current accounting methods, monitoring and reporting. Talk to the audit group at Cornwell Jackson to start planning for internal and external finance changes in the next few years.

Mike Rizkal, CPA is the lead partner in Cornwell Jackson’s Audit and Attest Service Group. He provides advisory services, including financial audit and attest services, to privately held, middle-market businesses. Contact him at mike.rizkal@cornwelljackson.com

BHPH dealers may need to consider data collection in ways they haven’t before, or ways of collecting data that weren’t required before, to develop forward-thinking estimates of credit loss.

For example, our clients will often review data on all the loans issued in a given month, and then analyze how those loans are performing as a gauge of how all loans are performing for the year (static pool analysis). They might see that 10 percent of loans defaulted in the first six months and another 10 percent defaulted in the next six months. Using that static pool of loans, the dealers will then calculate a discount rate before selling the portfolio to the RFC.

With the new standard, tracking average default rates for a short time period is not enough. Analysis will have to go deeper to determine “potential loss” over the life of loans. The final risk-based calculation will be reported in the dealer’s current earnings as an “Allowance for Loan and Lease Losses (ALLL)” on financial statements.

If the ALLL increases — as many think it will under this new standard — it will impact the net worth of a financial institution on its financial statements. That’s why it’s so important to collect the right data and make sure it is accurate. Incomplete or inaccurate historic data — such as data that has not historically been audited — will affect the accuracy of the final calculation

Operators may need to track data such as expected timing and extent of projected cash collections of the loan portfolio as well as projected losses and an estimate of future principal losses. In order to estimate future losses, it may also be helpful to track:

• Actual cash value and type of vehicle sold
• Customer risk assessments, including credit scores
• Underwriters approving each contract
• Collectors assigned to which loans
• Loan performance data

The level of risk estimated also correlates to the amount of cash reserves an entity may be required to hold to support these expected losses over the life of the loan portfolio. Known as your entity’s “reserves for credit losses,” this amount may need to increase under the new accounting standard if you find that “expected credit losses” over the life of the loan portfolio are higher than the real incurred losses that previously guided reserves.

Continue Reading: CECL and Loan Portfolio Analysis

In light of this new federal accounting standard for monitoring and calculating expected credit losses, BHPH operators of all sizes will likely require additional professional support. A CPA knowledgeable in BHPH operations can help you determine the standard’s impact on your current accounting methods, monitoring and reporting. Talk to the audit group at Cornwell Jackson to start planning for internal and external finance changes in the next few years.

Mike Rizkal, CPA is the lead partner in Cornwell Jackson’s Audit and Attest Service Group. He provides advisory services, including financial audit and attest services, to privately held, middle-market businesses. Contact him at mike.rizkal@cornwelljackson.com

Following the global financial crisis of 2007 and 2008, the Federal Accounting Standards Board (FASB) has taken steps to mitigate risk among financial institutions. One of the newest standards is a change from the “incurred loss” accounting model used to evaluate financial portfolios to an “expected loss” model known as the Current Expected Credit Loss model (CECL). For BHPH dealers, CECL will require changes in loan and lease loss recording, which in turn requires changes in the type of loan data collected and how it’s analyzed. This article outlines what BHPH dealers can do to prepare for this sweeping change and why it’s important to start planning now.

At a recent TIADA conference, BHPH dealers and related experts were discussing the impact of the Current Expected Credit Loss (CECL) model on their industry.

New Credit Loss Standards

CECL was announced in 2016 as part of a new Federal Accounting Standards Board (FASB) update, and it “represents the biggest change to bank accounting ever,” according to Mike Gullette, vice president, Accounting and Financial Management, for the American Bankers Association. The implementation deadline is by 2021 for all financial institutions. The deadline for SEC filers is 2020, and these entities will likely set a course that non-SEC filers will use to develop their own standards methodology.

This new standard impacts any financial entity with the following assets, including Related Finance Companies (RFCs):

• assets subject to credit losses and measured at amortized cost;
• certain off-balance sheet credit exposures, including
  • loans
  • held-to-maturity debt securities
  • loan commitments
  • financial guarantees
  • net investments in leases
  • reinsurance and trade receivables.

In essence, CECL is designed to make financial institutions examine the future risk to their portfolios, not based on actual incurred losses in the portfolio but on expected loss. This expected loss isn’t reliant on annual loss rates, but on expected “life of loan” data or life of portfolio loss rates.

In future blog posts we will drill down on some immediate impacts to the BHPH industry — specifically on loan portfolio data collection, analysis and loan covenant considerations.

Continue Reading: Current Expected Credit Loss Model and Data Collection

In light of this new federal accounting standard for monitoring and calculating expected credit losses, BHPH operators of all sizes will likely require additional professional support. A CPA knowledgeable in BHPH operations can help you determine the standard’s impact on your current accounting methods, monitoring and reporting. Talk to the audit group at Cornwell Jackson to start planning for internal and external finance changes in the next few years.

Mike Rizkal, CPA is the lead partner in Cornwell Jackson’s Audit and Attest Service Group. He provides advisory services, including financial audit and attest services, to privately held, middle-market businesses. Contact him at mike.rizkal@cornwelljackson.com