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.
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 firstname.lastname@example.org