Notes Receivable and Allowance for Credit Losses

3 Months Ended

Mar. 31, 2020

Accounts and Financing Receivable, after Allowance for Credit Loss [Abstract]

Notes Receivable and Allowance for Credit Losses

The Company has provided financing in the form of notes receivable loans to franchisees to support the development of properties in strategic markets. As of March 31, 2020 and December 31, 2019, the Company had $140.0 million and $133.0 million, respectively, in notes receivable loans outstanding.

The Company has developed a systematic methodology to determine its allowance for credit losses across our portfolio of notes receivable loans. The Company monitors the risk and performance of our portfolio by the level of security in collateral (i.e., senior, subordinated or unsecured). As each of the Company’s notes receivable loans has unique risk characteristics, the Company deploys its methodology to calculate allowances for credit losses at the individual notes receivable loan level.

The Company primarily utilizes a discounted cash flow ("DCF") approach to measure the credit allowance, influenced by the key economic variables of each note receivable loan. The Company identified the key economic variables for these loans to be loan-to-cost ("LTC") or loan-to-value ("LTV") ratios and debt service coverage ratio ("DSCR"). The LTC or LTV ratio represents the loan principal relative to the project cost or value and is an indication of the ability to be re-paid principal at loan maturity. The DSCR represents borrower net operating income as a percentage of the interest and principal payments incurred (i.e., debt service) on all debt of the borrower and is an indication of the ability of the borrower to timely pay amounts due during the term of the loan. The LTC or LTV ratios and DSCR are considered during loan underwriting as indications of risk and, accordingly, we believe these factors are the most representative risk indicators for calculating the allowance for credit loss. Loans with higher LTC or LTV ratios and lower DSCR ratios generally are representative of loans with greater risk and, accordingly, have higher credit allowances as a percentage of loan principal. Conversely, loans with lower LTC or LTV ratios and higher DSCR ratios generally are representative of loans with lesser risk and, accordingly, have lower credit allowances as a percentage of loan principal.

The following table shows the composition of the Company's notes receivable balances based on the level of security credit quality indicator:



(in thousands)	March 31, 2020		December 31, 2019
Senior	$	104,924	$	98,545
Subordinated	32,643		32,153
Unsecured	2,455		2,316
Total notes receivable	140,022		133,014
Total allowance for notes receivable losses	13,102		4,556
Total notes receivable, net of allowance	$	126,920	$	128,458
Current portion, net of allowance	$	24,161	$	25,404
Long-term portion, net of allowance	$	102,759	$	103,054

Amortized cost basis by year of origination and level of security credit quality indicator are as follows:



(in thousands)	2020		2019		2018		Prior		Total
Senior	$	—	$	23,570	$	20,546	$	60,808	$	104,924
Subordinated	—		2,270		11,492		18,881		32,643
Unsecured	—		—		629		1,826		2,455
Total notes receivable	$	—	$	25,840	$	32,667	$	81,515	$	140,022

As disclosed in Note 1, Topic 326 requires a cumulative-effect adjustment to the consolidated balance sheet as of the beginning of the first reporting period in which the guidance is effective. As of the adoption date of January 1, 2020, the Company established a credit allowance on its notes receivable loans of $12.9 million, an increase from a previous loan allowance of $4.6 million as of December 31, 2019. The cumulative-effect adjustment of adopting Topic 326 of $6.8 million, net of tax impact, is recorded in the consolidated balance sheets in the Retained earnings line item.

The following table summarizes the activity related to the Company’s Notes Receivable allowance for credit losses, including the impacts of adopting Topic 326:



(in thousands)	March 31, 2020		December 31, 2019
Beginning balance	$	4,556	$	4,685
Reserves established from adoption of Topic 326	8,348		—
Provisions	198		—
Write-offs	—		(129		)
Ending balance	$	13,102	$	4,556

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 to principal. The Company does not resume interest accrual until all delinquent payments are received. The amortized cost basis of notes receivable on non-accrual status was $1.7 million at both March 31, 2020 and December 31, 2019.

The Company has identified loans totaling approximately $14.2 million and $16.3 million, respectively, with stated interest rates that are less than market rate, representing a total discount of $1.2 million and $1.3 million as of March 31, 2020 and December 31, 2019, respectively. 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:



(in thousands)	30-89 days Past Due		> 90 days Past Due		Total Past Due		Current		Total Notes Receivable
As of March 31, 2020
Senior	$	—	$	—	$	—	$	104,924	$	104,924
Subordinated	—		—		—		32,643		32,643
Unsecured	—		—		—		2,455		2,455
	$	—	$	—	$	—	$	140,022	$	140,022
As of December 31, 2019
Senior	$	—	$	—	$	—	$	98,545	$	98,545
Subordinated	—		—		—		32,153		32,153
Unsecured	—		—		—		2,316		2,316
	$	—	$	—	$	—	$	133,014	$	133,014

The Company evaluated its off-balance-sheet credit exposure for loan commitments and determined the likelihood of having to perform is remote as of March 31, 2020. Refer to Note 12.

Variable Interest through Notes Issued

The Company has issued notes receivables to certain entities that have created variable interests in these borrowers totaling $124.9 million and $126.5 million as of March 31, 2020 and December 31, 2019, respectively. The Company has determined that it is not the primary beneficiary of these variable interest entities ("VIEs"). These loans have stated fixed and/or variable interest amounts.