Effective December 15, all financial institutions including BHPH dealerships, are required to adhere to the new CECL accounting changes. For those dealerships with aggressive plans for growth, these changes could prove burdensome. For all dealers, you’ll need to get your accounting ducks in a row to comply with the new changes.
What is CECL?
CECL stands for Current Expected Credit Losses. It’s an accounting standard that affects the way dealers must report expected losses on their loan portfolios. Currently, losses show up on financial statements over the time periods in which they occur. For example, on a $10M loan portfolio with lifetime losses that average 10%, or $1M, those losses will be spread over the lifetime of the loans in the portfolio.
With the new CECL change, dealers must estimate the total amount they expect to lose over the life of the loans and report all of it in the month they originated. So, continuing with our example, instead of spreading $1M in losses over the life of the loans, the dealer will have to report a $1M dollar loss in the month the loans were originated.
Why is this happening?
This change is a reaction to the mortgage crisis in 2008-2010 where many mortgage lenders — in the opinion of the Federal Accounting Standards Board (FASB) and Securities Exchange Commission (SEC) — understated their losses and overstated their equity. CECL is an attempt to drive more accurate reporting.
The ramifications of CECL
Under Generally Accepted Accounting Principles, or GAAP, the new CECL accounting standard will affect how you report income on your financial statements. It’s a paper change only — it will have no impact on the cash flow coming into your business. Still, since you need to show financial statements to banks and other lenders when applying for loans and credit lines, you need to be aware of how that paper change will look. Be advised: It will look significantly different.
In the example below, the only thing that changes between the two income statements is how the loss provision is recorded. Yet, under CECL, your dealership looks like it made $792,388 less.
Month One Income Statement (Current)
Interest income (15% APR) $125,000
Loss provision (7 months) $207,612
Cost of funds $41,667 $249,279
Gross profit (loss) ($124,279)
Month One Income Statement (CECL)
Interest income (15% APR) $125,000
Loss provision (lifetime) $1,000,000
Cost of funds $41,667 $1,041,667
Gross profit (loss) ($916,667)
Accounting with current standards.
Under CECL the “hit” is $792,388 worse.
As you adapt to the CECL standard, your P&L statements and equity in the balance sheet are going to look ugly — just get ready for it. If you’re planning to grow and need cash to do so, be prepared to walk the lender through your financial statement while explaining the CECL changes and their effects. Don’t assume they’ll know about them, especially if you’re working with a smaller lender. (At Agora Data, we’re fully up to speed on CECL and can look at those ugly first months through the right lens.)
Here are some other things to consider:
- Are you able to pull up historical data to make accurate loss predictions? If you’re using a DMS that includes a collection system, you should be able to recover that history.
- You’ll need to make a special one-time adjustment to your pre-CECL loans. That means going back to every pool of open loans and recalculating the expected losses.
Indeed, CECL is a large pill to swallow. To make it go down as easy as possible, consulting with a CPA is highly recommended. And the sooner the better! Remember: Your year-end books need to be aligned by December 15 and current to reflect CECL accounting requirements.