Credit-loss rule could spur Harley-Davidson Financial to tighten lending standards

The Financial Accounting Standards Board’s new credit-loss accounting rule could spur tighter underwriting standards at Harley-Davidson Financial Services, according to a report UBS provided Powersports Finance.

While it’s too early to tell how the adjustments will play out long term, medium-term expectation are “primarily negative,” requiring the captive to make “consistent additions to loan-loss reserves, increasing provision expense and decreasing net income,” Analyst Robin Farley wrote in the report.

The rule, called Current Expected Credit Losses (CECL), is a new accounting regulation that mandates how companies reserve for credit losses. Under CECL— which goes into effect Jan. 1, 2020, for larger banks and finance captives — lenders need to reserve for the lifetime of a loan’s losses upon origination. The previous standard allowed lenders to reserve against losses over time.

“The average motorcycle loan made by HDFS is for a six-year term,” Farley said. “[With CECL], all of the expected loss over those six years is now expensed upfront and, in addition, all loans that Harley has made must now be retroactively adjusted for the new accounting. Further, each time Harley makes an adjustment to its future loss expectations, it must retroactively apply this change to its entire legacy loan book, not just to new originations.”

HDFS accounts for more than 40% of the total operating income of parent company Harley-Davidson, compared with less than 15% of total income 10 years ago, according to the report.

In response to the shift to fair-value accounting, HDFS may seek to reduce losses by buying fewer subprime deals, shortening loan terms or raising interest rates. However, tighter guidelines could pressure retail sales as fewer consumers receive financing.

“CECL is most challenging for lenders that have high loss content and those with a long duration, like Harley’s six-year loans,” Farley explained. “So HDFS sits at the intersection of those two factors, although this is partially mitigated by the loan’s shorter effective duration, which is only two years.”

The regulation could also impact other key areas of business. For example, Harley will need to make an adjustment to its balance sheet, which could reduce equity. Additionally, higher expenses would reduce earnings and hamstring forecasting on earnings per share. There’s also uncertainty around how CECL will affect Harley’s credit rating and ability to securitize.

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