The FASB s upcoming rule change

Transcription

1 The FASB s upcoming rule change Panelists: Rob Royall Partner Financial Accoun5ng Advisory Services - Ernst & Young LLP Ellen Billings North America Controller GM Financial Jim Bass Director of Vendor Compliance First Investors Financial Services, Inc

2 What is the FASB up to? ASU No , Financial Instruments Credit Losses (Topic 326) Why is that important? What should be my plan?

3 Or, we could just relax..

4 In a change to take effect on January 1, 2020 (not that far away) 100% of expected life+me losses on a pool of receivables must be reserved in the same period as originated. So, how does this affect me?

5 This is just an accoun5ng issue, right? I m in sales, credit, collec5ons, etc., why do I care? Because your company must be ever vigilant in selec5ng which receivables go on the books! Drain on Equity could be very large, especially for growing companies

6 Every Dealership and/or Origina5on Partner must be the Best Available. Every Credit Applica5on s underwri5ng has to be more thorough. Every Finance Contract funded has to be very carefully audited. Every pre-funding interview has to be more diligent. Every collec5on effort has to be be_er executed, keeping compliance in mind. Repossession and Recovery Departments have to sharpen their skills and minimize 5me to sale and maximize recovery percentage. Only the most well run, well automated, well capitalized companies may survive. And while protec5ng your company, stay 100% compliant with all the rules of the CFPB, FTC, etc. That s why this Accoun5ng Rule Change affects every one in this industry.

7 6.00% % 5.00% % 4.00% 80.00% 3.00% 60.00% Monthly Cumulative 2.00% 40.00% 1.00% 20.00% 0.00% % Typical lifeume (stauc loss) losses

8 Income Statement Beg Balances Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 New Finance Contracts 25,000,000 28,000,000 30,000,000 35,000,000 40,000,000 50,000,000 Interest Income 16% 166, , ,142 1,301,196 1,767,500 2,321,979 Cost of Funds 5% 83, , , , , ,781 Net Interest Spread 83, , , ,274 1,262,767 1,663,198 Provision for Losses 10% 17,250 60, , , , ,140 Income (Loss) Before Overhead 66, , , , ,987 1,120,058 Overhead 7% 11,667 36,050 62,380 91, , ,539 Net Income (Loss) 54, , , , , ,520 Balance Sheet Cash 100,000,000 95,071,667 69,775,200 42,459,181 13,101,465 (20,616,726) (59,601,869) Receivables 24,625,000 51,835,625 80,089, ,562, ,148, ,669, ,000, ,696, ,610, ,548, ,663, ,531, ,067,849 Line of Credit 20,000,000 22,400,000 24,000,000 28,000,000 32,000,000 40,000,000 Loss Reserve (357,750) (1,087,055) (2,174,356) (3,652,535) (5,552,051) (7,973,425) Equity 100,000, ,054, ,297, ,723, ,316, ,083, ,041, ,000, ,696, ,610, ,548, ,663, ,531, ,067,849 Under Present accounung rules

9 Income Statement Beg Balances Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 New Finance Contracts 25,000,000 28,000,000 30,000,000 35,000,000 40,000,000 50,000,000 Interest Income 16% 166, , ,142 1,301,196 1,767,500 2,321,979 Cost of Funds 5% 83, , , , , ,781 Net Interest Spread 83, , , ,274 1,262,767 1,663,198 Provision for Losses 10% 2,500,000 2,800,000 3,000,000 3,500,000 4,000,000 5,000,000 Income (Loss) Before Overhead (2,416,667) (2,460,417) (2,379,890) (2,579,726) (2,737,233) (3,336,802) Overhead 7% 11,667 36,050 62,380 91, , ,539 Net Income (Loss) (2,428,333) (2,496,467) (2,442,270) (2,670,809) (2,860,958) (3,499,340) Balance Sheet Cash 100,000,000 95,071,667 69,775,200 42,459,181 13,101,465 (20,616,726) (59,601,869) Receivables 24,625,000 51,835,625 80,089, ,562, ,148, ,669, ,000, ,696, ,610, ,548, ,663, ,531, ,067,849 Line of Credit 20,000,000 22,400,000 24,000,000 28,000,000 32,000,000 40,000,000 Loss Reserve 2,125,000 4,135,625 5,915,984 7,701,835 9,430,539 11,466,025 Equity 100,000,000 97,571,667 95,075,200 92,632,931 89,962,121 87,101,164 83,601, ,000, ,696, ,610, ,548, ,663, ,531, ,067,849 Under the new FASB rules

10 FASB vs Current Results 120,000,000 1,500,000 1,000, ,000, ,000-80,000,000 (500,000) Produc5on & Equity 60,000,000 40,000,000 (1,000,000) (1,500,000) (2,000,000) Profit (Loss) Results Current Equity FASB Equity Produc5on Current Profit B4 Overhead FASB Loss B4 Overhead (2,500,000) 20,000,000 (3,000,000) (3,500,000) - Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Axis Title (4,000,000)

11 NAF AssociaUon Non-Prime Auto Financing Conference Rob Royall Partner, EY 1 June 2017

12 Credit impairment: a discussion of the FASB s new standard The Credit Loss Journey Q Exposure drak (ED) Redelibera5ons and 2 nd ED Redelibera5ons on 2 nd ED Q Final standard The financial crisis of 2008 exposed weaknesses in the exis5ng incurred loss model Delay in recogni5on of losses Complexity of and differences among various models The Financial Accoun5ng Standards Board (FASB) and the Interna5onal Accoun5ng Standards Board (IASB) discussed and proposed many approaches to impairment FASB s final standard should accelerate recogni5on of credit losses

13 The FASB s New Credit Impairment Standard The Financial Accoun5ng Standards Board (FASB) issued a new credit loss standard (Accoun5ng Standards Update (ASU) No ) that changes the impairment model for most financial assets and certain other instruments. For loans, held-to-maturity (HTM) debt securi5es, trade and other receivables, and other instruments, en55es will be required to use a new forward-looking expected loss model that generally will result in the earlier measurement of credit losses. For available-for-sale debt securi5es with unrealized losses, en55es will measure credit losses in a manner similar to what they do today, except that the losses will be recognized as allowances rather than reduc5ons in the amor5zed cost of the securi5es. En55es will have to disclose significantly more informa5on, including informa5on they use to track credit quality by year of origina5on for most financing receivables. Credit impairment: a discussion of the FASB s new standard

14 Accoun;ng Models under ASU AFS debt security impairment model (ASC ) AFS debt securi5es Expected credit loss model (Accoun5ng Standards Codifica5on (ASC) ) Financial assets measured at amor5zed cost, including: Loans HTM debt securi5es Receivables (trade, reinsurance and other) Net investments in leases recognized by a lessor Off-balance-sheet credit exposures for loan commitments, standby le_ers of credit, financial guarantees and other similar instruments Model for certain beneficial interests (ASC ) Certain beneficial interests classified as HTM or AFS that are not of high credit quality New approach for the ini;al recogni;on of purchased financial assets with credit deteriora;on (PCD assets) Under this approach, an en5ty will record as the ini5al amor5zed cost the sum of (1) the purchase price and (2) the es5mate of credit losses as of the date of acquisi5on Thereaker, the en5ty will account for PCD assets using the models listed above Credit impairment: a discussion of the FASB s new standard

15 Credit impairment: a discussion of the FASB s new standard Current Expected Credit Loss Model Overview Objec;ve Recognize an allowance for credit losses that results in the financial statements reflec5ng the net amount expected to be collected from the financial asset Core concepts Based on an asset s amor5zed cost Reflect losses over an asset s contractual life Consider available relevant informa5on Reflect the risk of loss

16 Credit impairment: a discussion of the FASB s new standard Current Expected Credit Loss Model Core concepts Based on Based on an asset s an asset s amor5zed amor5zed cost cost Reflect losses over an asset s contractual life Consider available relevant informa5on Reflect the risk of loss Expected loss refers to the por5on of a financial asset s amor5zed cost basis an en5ty does not expect to collect Calcula5on of the allowance depends on the en5ty's approach to measuring it: If using a discounted cash flow approach The allowance should reflect the difference between the amor5zed cost basis and the expected cash flows discounted to a present value at the effec5ve interest rate If not using a discounted cash flow approach The allowance should reflect the expected credit losses of the amor5zed cost basis of the financial assets

17 Credit impairment: a discussion of the FASB s new standard Current Expected Credit Loss Model Core concepts Based on an asset s amor5zed cost Reflect losses over an asset s contractual life Consider available relevant informa5on Reflect the risk of loss Expected credit losses should reflect losses that are expected over the remaining contractual life of an asset The life of an asset generally would not include expected extensions, renewals or modifica5ons unless a troubled debt restructuring of the asset is reasonably expected Expected credit losses should reflect expected prepayments, which mi5gate poten5al loss

18 Credit impairment: a discussion of the FASB s new standard Current Expected Credit Loss Model Core concepts Based on an asset s amor5zed cost Reflect losses over an asset s contractual life Consider available Consider available relevant relevant informa5on informa5on Reflect the risk of loss Expected credit losses should reflect reasonably available informa5on that is relevant to the collectability of cash flows Specifically, en55es should consider informa5on about Past events Current condi5ons Reasonable and supportable forecasts about the future Use informa5on that is reasonably available without undue cost and effort

19 Credit impairment: a discussion of the FASB s new standard Current Expected Credit Loss Model Core concepts forecasung New standard provides li_le applica5on guidance on How to develop a forecast What the forecast should cover For periods in which the en5ty is unable to reasonably and supportably forecast expected credit losses, the en5ty should revert to historical credit loss informa5on that reflects the asset s contractual term Reversion may be immediate, on a straight-line basis or using another ra5onal and systema5c basis Poten5al economic variables Gross domes5c product Infla5on Unemployment Interest rate environment Credit spreads Business confidence metrics House price indices Factory orders Bankruptcies Stock market indices Savings rates

20 Credit impairment: a discussion of the FASB s new standard Current Expected Credit Loss Model Core concepts Based on an asset s amor5zed cost Reflect losses over an asset s contractual life Consider available relevant informa5on Reflect the risk of loss Expected credit losses should include a measure of the expected risk of credit loss, even if that risk is remote Level of aggrega5on Requires a collec5ve or pool-based approach when similar risk characteris5cs exist Allows individual approach when there are no shared risk characteris5cs An en5ty is not permi_ed to es5mate a zero loss simply because the current value of the collateral exceeds the financial asset s amor5zed cost basis

21 Contractual life Embedded prepayments example The en5ty has the following historical informa5on about losses for a porsolio of loans that were originated in one specific year and had a contractual maturity of 3 years: Year following origina5on Beginning amor5zed cost Prepayments Losses (e.g., charge-offs) Ending amor5zed cost Total losses experienced to date Life5me cumula5ve loss rate 3.2% (32/1,000) Credit impairment: a discussion of the FASB s new standard

22 Effec;ve Date and Transi;on Type of en;ty Effec;ve date Early adop;on? Public business en55es (PBEs) that are SEC filers Annual periods beginning aker 15 December 2019, and interim periods therein Other PBEs Annual periods beginning aker 15 December 2020, and interim periods therein All other en55es Annual periods beginning aker 15 December 2020, and interim periods within annual periods beginning aker 15 December 2021 An en5ty will apply the new guidance using a modified retrospec5ve approach Recognize a cumula5ve-effect adjustment as of the beginning of the first repor5ng period in which the guidance is effec5ve Transi5on relief provided for: Purchased financial assets currently accounted for under ASC Debt securi5es for which an other-than-temporary impairment has already been recognized Credit impairment: a discussion of the FASB s new standard Yes, annual periods beginning aker 15 December 2018, and interim periods therein

23 Implementation of ASU Financial Instruments Credit Losses Presentation to NAF Association 2017 National Non-Prime Auto Financing Conference June 1, 2017 Ellen Billings, North America Controller

24 CECL Adoption: Assessing the Impact Current accounting requires an allowance to cover only incurred losses New accounting will require an allowance to cover all expected losses Adoption will require a cumulative adjustment to retained earnings Going forward, the monthly provision expense will increase based on monthly origination activity Counter-intuitive impact to earnings: Earnings will drag during periods of growth in origination volume Earnings will have tailwinds during periods of pullback in origination volume 24 24

25 Implementation Timeline Implement Identify impacted business areas Form Steering Committee Build models Parallel modeling Refine & Monitor Educate stakeholders Design project plan Validate models Test internal controls Evaluate modeling alternatives Design internal controls Identify accounting policy issues Track impacted processes 25 25

26 Step 1: Forming an Implementation Committee Forming a Committee CECL implementation has broad crossfunctional impacts Strive for senior level representation Define Roles of the Committee Set objectives and timelines Determine responsibilities and scope out resource requirements Provide regular updates to senior management and the Board Create a Project Plan Assess capabilities and practical solutions Accounting Economist CECL Committee Ensure regular progress to meet established timelines 26 CFO Information Technology Chief Risk Officer Internal Audit 26

27 Defining Roles for the Committee Additional Considerations Need insight into bandwidth of the organiza5on, and any needed resources CFO Strive to iden5fy a solu5on that meets the requirements, but is also prac5cal, operable, well-controlled, and can be used to our strategic benefit Assump5ons used for the ALLL under CECL will need to be consistent across other func5ons and models (ALM, stress tes5ng) Accounting CECL Committee Chief Risk Officer An ac5ve commi_ee will create a system of checks and balances Economist Internal Audit Ideally, CECL should be viewed as an opportunity to improve the ALLL process Information Technology 27 27

28 Factors for the Committee to Consider Methodology Data Requirements Capital Adjustment Communication There is not one right way to implement CECL: Historical Losses Migration Analysis Probability of Default / Loss Given Default Vintage Analysis Defining economic cycles Reasonable and supportable forecast, revert to historical loss information Model validation Internal controls Projected Impact 28 28

29 Factors for the Committee to Consider Methodology Data Requirements Capital Adjustment Communication Projected Impact Utilize our 20+ years of data Determine key data necessary for the methodology we select Identify and plan to obtain any missing data Data validation process Report building process Gather industry data Gather economic data 29 29

30 Factors for the Committee to Consider Methodology Data Requirements Capital implications Timing considerations Management and Board Education Capital Adjustment Communication Projected Impact 30 30

31 Factors for the Committee to Consider Methodology Data Requirements Capital Adjustment Communica;on Projected Impact Training and education of CECL with the Board and Senior Management Communication with auditors Document new policies and procedures Periodic meetings Documents read into the Board minutes SAB 74 disclosures Investor Relations 31 31

32 Factors for the Committee to Consider Methodology Data Requirements Capital Adjustment Communica;on Projected Impact Run scenarios to test initial model(s) Perform during the years leading up to the effective date for CECL Refine model(s) based on results Net income projections due to changes in provision Peer comparisons will change ALM impact Stress testing Loan pricing Underwriting guidelines 32 32

33 For more information, visit gmfinancial.com