Notes Receivable and Allowance for Losses

The Company has provided financing to franchisees in support of the development of properties in strategic markets. The Company utilizes the level of security it has in the notes receivable as its primary credit quality indicator (i.e., senior, subordinated or unsecured) when determining the appropriate allowances for uncollectible loans. The Company considers loans to be past due and in default when payments are not made when due. Although the Company considers loans to be in default if payments are not received on the due date, the Company does not suspend the accrual of interest until those payments are more than 30 days past due. The Company applies payments received for loans on non-accrual status first to interest and then principal. The Company does not resume interest accrual until all delinquent payments are received. Interest income associated with these notes receivable is reflected in the accompanying consolidated statements of income under the caption interest income.

The Company assesses the collectibility of its senior notes receivable by comparing the market value of the underlying assets to the carrying value of the outstanding notes. In addition, the Company evaluates the property’s operating performance, the borrower’s compliance with the terms of the loan and franchise agreements, and all related personal guaranties that have been provided by the borrower. For subordinated or unsecured receivables, the Company assesses the property’s operating performance, the subordinated equity available to the Company, the borrower’s compliance with the terms of the loan and franchise agreements, and the related personal guaranties that have been provided by the borrower.

The Company considers a loan to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. All amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement. The Company measures loan impairment based on the present value of expected future cash flows discounted at the loan’s original effective interest rate or the estimated fair value of the collateral. For impaired or restructured loans that are provided a concession, the Company establishes a specific impairment reserve for the difference between the recorded investment in the loan and the present value of the expected future cash flows or the estimated fair value of the collateral. The Company applies its loan impairment policy individually to all notes receivable in the portfolio and does not aggregate loans for the purpose of applying such policy. For impaired loans, the Company recognizes interest income on a cash basis. For restructured loans that are provided a concession, the Company recognizes interest as earned as long as the borrower is in compliance with the restructured loan terms. The Company assesses the adequacy of its loan reserves on a quarterly basis. If it is likely that a loan will not be collected based on financial or other business indicators, it is the Company’s policy to establish a valuation allowance with a corresponding charge to SG&A expenses in the accompanying consolidated statements of income in the quarter when it is deemed uncollectible. Recoveries of impaired loans are recorded as a reduction of SG&A expenses in the quarter received.

The following table shows the composition of the Company's notes receivable balances:



	December 31,
	2018		2017
Credit Quality Indicator:	(in thousands)
Senior	$	94,349	$	73,700
Subordinated	28,100		18,647
Unsecured	2,435		3,182
Total notes receivable	124,884		95,529
Allowance for losses on receivables specifically evaluated for impairment	4,426		1,647
Allowance for losses on non-impaired loans	259		490
Total loan reserves	4,685		2,137
Net carrying value	$	120,199	$	93,392
Current portion, net	$	36,759	$	13,256
Long-term portion, net	83,440		80,136
Total	$	120,199	$	93,392

The Company classifies notes receivable due within one year as current assets.

On February 5, 2019, the Company restructured one of its loans with senior and subordinated tranches and provided a concession to the borrower. This event represents a recognized subsequent event, resulting in the establishment of a $2.8 million loan valuation allowance with a charge to SG&A expense in the fourth quarter of 2018. The total amount of the recorded investment in the restructured loan is $50.4 million, with total unpaid principal balance of $50.1 million. The Company continues accrual of interest for this loan as the borrower is in compliance with the restructured loan terms.

The Company determined that approximately $1.7 million and $1.8 million, respectively, of its unsecured notes receivable were impaired and recorded an allowance for credit losses of $1.6 million for both the years ended December 31, 2018 and 2017, respectively. For both the years ended December 31, 2018 and 2017, the average notes receivable on non-accrual status was approximately $1.8 million. The Company recognized approximately $44 thousand of interest income on impaired loans during both years ended December 31, 2018 and 2017, respectively, on the cash basis.

The Company provided loan reserves on non-impaired loans totaling $0.3 million and $0.5 million at December 31, 2018 and 2017, respectively.

The Company has identified loans totaling approximately $12.9 million and $2.1 million, respectively, with stated interest rates that are less than market rate, representing a total discount of $1.5 million and $0.1 million, respectively, at December 31, 2018 and 2017. These discounts are reflected as a reduction of the outstanding loan amounts and are amortized over the life of the related loan.

Past due balances of notes receivable by credit quality indicators are as follows:



	30-89 days Past Due		> 90 days Past Due		Total Past Due		Current		Total Notes Receivable
As of December 31, 2018	(in thousands)
Senior	$	—	$	—	$	—	$	94,349	$	94,349
Subordinated	—		—		—		28,100		28,100
Unsecured	—		—		—		2,435		2,435
	$	—	$	—	$	—	$	124,884	$	124,884
As of December 31, 2017
Senior	$	—	$	—	$	—	$	73,700	$	73,700
Subordinated	—		—		—		18,647		18,647
Unsecured	—		—		—		3,182		3,182
	$	—	$	—	$	—	$	95,529	$	95,529

Variable Interest through Notes Issued

The Company has issued notes receivables to certain entities that have created variable interests in these borrowers totaling $114.3 million and $35.2 million at December 31, 2018 and 2017, respectively. The Company has determined that it is not the primary beneficiary of these variable interest entities. Each of these loans have stated fixed and/or variable interest amounts.

The following table summarizes the activity related to the Company’s Notes Receivable allowance for losses for the years ended December 31, 2018 and 2017:



	December 31,
	2018			2017
	(in thousands)
Beginning balance	$	2,137		$	2,417
Provisions	2,779			—
Write-offs	(231		)	(280		)
Ending balance	$	4,685		$	2,137

Transfer of Interest

On September 12, 2017, the Company entered into an agreement to transfer $24.2 million of a $49.1 million outstanding note receivable with a maturity date of November 30, 2019 to a third party. In the first quarter of 2018, an additional $0.2 million was transferred for a total of $24.4 million of a $50.1 million outstanding note. The transaction did not qualify as a sale and therefore the outstanding note receivable was not derecognized on the balance sheet. The one-time cash proceeds were recorded as unrestricted cash and the future obligation to transfer principal and interest received under the note has been recorded within Other Long-Term Liabilities. In addition, the proceeds from the transfer of the interest in the note receivable have been reflected on the statement of cash flows as a financing activity. The Company retains responsibility for collecting and distributing cash received on the note and interest paid to the participant is reflected as interest expense in the Company’s consolidated statements of income. At December 31, 2018 and 2017, Other Long-Term Liabilities includes $24.4 million and $24.2 million, pursuant to this transaction, respectively. Refer to Note 24 for additional information regarding the Company's repurchase in February 2019.