6. Finance Receivables

HDFS provides retail financial services to customers of the Company’s independent dealers in the United States and Canada. The origination of retail loans is a separate and distinct transaction between HDFS and the retail customer, unrelated to the Company’s sale of product to its dealers. Retail finance receivables consist of secured promissory notes and installment loans. HDFS holds either titles or liens on titles to vehicles financed by promissory notes and installment loans.

HDFS offers wholesale financing to the Company’s independent dealers. Wholesale loans to dealers are generally secured by financed inventory or property and are originated in the U.S. and Canada.

Finance receivables, net, including finance receivables held by VIEs, consisted of the following (in thousands):


	July 1,			December 31,			June 26,
	2012			2011			2011
Retail	$	5,225,779		$	5,087,490		$	5,374,055
Wholesale		905,038			824,640			733,789

		6,130,817			5,912,130			6,107,844
Allowance for credit losses		(114,248	)		(125,449	)		(144,404	)

	$	6,016,569		$	5,786,681		$	5,963,440

At July 1, 2012, December 31, 2011 and June 26, 2011, the Company’s Condensed Consolidated Balance Sheet included finance receivables, net of $2.05 billion, $2.86 billion and $2.51 billion, respectively, which were restricted as collateral for the payment of debt held by VIEs and other related obligations as discussed in Note 7. These receivables are included in retail finance receivables in the table above.

A provision for credit losses on finance receivables is charged or credited to earnings in amounts that the Company believes are sufficient to maintain the allowance for credit losses on finance receivables at a level that is adequate to cover losses of principal inherent in the existing portfolio. The allowance for credit losses on finance receivables represents management’s estimate of probable losses inherent in the finance receivable portfolio as of the balance sheet date. However, due to the use of projections and assumptions in estimating the losses, the amount of losses actually incurred by the Company could differ from the amounts estimated.

Changes in the allowance for credit losses on finance receivables by portfolio were as follows (in thousands):


	Three months ended July 1, 2012
	Retail			Wholesale			Total
Balance, beginning of period	$	112,857		$	9,646		$	122,503
Provision for credit losses		(3,681	)		(1,578	)		(5,259	)
Charge-offs		(17,054	)		—			(17,054	)
Recoveries		14,058			—			14,058

Balance, end of period	$	106,180		$	8,068		$	114,248


	Three months ended June 26, 2011
	Retail			Wholesale			Total
Balance, beginning of period	$	141,704		$	17,980		$	159,684
Provision for credit losses		(2,596	)		(4,194	)		(6,790	)
Charge-offs		(22,903	)		(330	)		(23,233	)
Recoveries		14,743			—			14,743

Balance, end of period	$	130,948		$	13,456		$	144,404


	Six months ended July 1, 2012
	Retail			Wholesale			Total
Balance, beginning of period	$	116,112		$	9,337		$	125,449
Provision for credit losses		5,023			(1,269	)		3,754
Charge-offs		(42,906	)		—			(42,906	)
Recoveries		27,951			—			27,951

Balance, end of period	$	106,180		$	8,068		$	114,248


	Six months ended June 26, 2011
	Retail			Wholesale			Total
Balance, beginning of period	$	157,791		$	15,798		$	173,589
Provision for credit losses		843			(2,027	)		(1,184	)
Charge-offs		(58,094	)		(330	)		(58,424	)
Recoveries		30,408			15			30,423

Balance, end of period	$	130,948		$	13,456		$	144,404

Included in the $106.2 and $130.9 million retail allowance for credit losses on finance receivables is $41.9 and $62.1 million, respectively, related to finance receivables held by VIEs.

Portions of the allowance for credit losses on finance receivables are specified to cover estimated losses on finance receivables specifically identified for impairment. The unspecified portion of the allowance for credit losses on finance receivables covers estimated losses on finance receivables which are collectively reviewed for impairment. Finance receivables are considered impaired when management determines it is probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement.

The retail portfolio primarily consists of a large number of small balance, homogeneous finance receivables. HDFS performs a periodic and systematic collective evaluation of the adequacy of the retail allowance for credit losses. HDFS utilizes loss forecast models which consider a variety of factors including, but not limited to, historical loss trends, origination or vintage analysis, known and inherent risks in the portfolio, the value of the underlying collateral, recovery rates and current economic conditions including items such as unemployment rates. As retail finance receivables are collectively and not individually reviewed for impairment, this portfolio does not have finance receivables specifically impaired.

The wholesale portfolio is primarily composed of large balance, non-homogeneous loans. The Company’s evaluation for the wholesale allowance for credit losses is first based on a loan-by-loan review. A specific allowance for credit losses is established for wholesale finance receivables determined to be individually impaired when management concludes that the borrower will not be able to make full payment of the contractual amounts due based on the original terms of the loan agreement. The impairment is determined based on the cash that the Company expects to receive discounted at the loan’s original interest rate or the fair value of the collateral, if the loan is collateral-dependent. Finance receivables in the wholesale portfolio that are not considered impaired on an individual basis are segregated, based on similar risk characteristics, according to the Company’s internal risk rating system and collectively evaluated for impairment. The related allowance for credit losses is based on factors such as the specific borrower’s financial performance and ability to repay, the Company’s past loan loss experience, current economic conditions, and the value of the underlying collateral.

Generally, it is the Company’s policy not to change the terms and conditions of finance receivables. However, to minimize the economic loss, the Company may modify certain finance receivables in troubled debt restructurings. Total restructured finance receivables are not significant.

The allowance for credit losses and finance receivables by portfolio, segregated by those amounts that are individually evaluated for impairment and those that are collectively evaluated for impairment was, as follows (in thousands):


	July 1, 2012
	Retail		Wholesale		Total
Allowance for credit losses, ending balance:
Individually evaluated for impairment	$	—	$	—	$	—
Collectively evaluated for impairment		106,180		8,068		114,248

Total allowance for credit losses	$	106,180	$	8,068	$	114,248

Finance receivables, ending balance:
Individually evaluated for impairment	$	—	$	—	$	—
Collectively evaluated for impairment		5,225,779		905,038		6,130,817

Total finance receivables	$	5,225,779	$	905,038	$	6,130,817


	December 31, 2011
	Retail		Wholesale		Total
Allowance for credit losses, ending balance:
Individually evaluated for impairment	$	—	$	—	$	—
Collectively evaluated for impairment		116,112		9,337		125,449

Total allowance for credit losses	$	116,112	$	9,337	$	125,449

Finance receivables, ending balance:
Individually evaluated for impairment	$	—	$	—	$	—
Collectively evaluated for impairment		5,087,490		824,640		5,912,130

Total finance receivables	$	5,087,490	$	824,640	$	5,912,130


	June 26, 2011
	Retail		Wholesale		Total
Allowance for credit losses, ending balance:
Individually evaluated for impairment	$	—	$	3,031	$	3,031
Collectively evaluated for impairment		130,948		10,425		141,373

Total allowance for credit losses	$	130,948	$	13,456	$	144,404

Finance receivables, ending balance:
Individually evaluated for impairment	$	—	$	4,676	$	4,676
Collectively evaluated for impairment		5,374,055		729,113		6,103,168

Total finance receivables	$	5,374,055	$	733,789	$	6,107,844

There were no wholesale finance receivables at July 1, 2012 or December 31, 2011 that were individually deemed to be impaired under ASC Topic 310, “Receivables.” Additional information related to the wholesale finance receivables that were individually deemed to be impaired under ASC Topic 310, “Receivables,” at June 26, 2011 includes (in thousands):


	June 26, 2011
							Three months ended				Six months ended
			Unpaid				Average		Interest		Average		Interest
	Recorded		Principal		Related		Recorded		Income		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized		Investment		Recognized
Wholesale:
No related allowance recorded	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Related allowance recorded		4,676		4,441		3,031		4,932		—		5,050		—

Total impaired wholesale finance receivables	$	4,676	$	4,441	$	3,031	$	4,932	$	—	$	5,050	$	—

Retail finance receivables are contractually delinquent if the minimum payment is not received by the specified due date. Retail finance receivables are generally charged-off at 120 days contractually past due. Retail finance receivables accrue interest until either collected or charged-off. Accordingly, as of July 1, 2012, December 31, 2011 and June 26, 2011, all retail finance receivables were accounted for as interest-earning receivables, of which $14.8 million, $27.5 million and $18.7 million, respectively, were 90 days or more past due.

Wholesale finance receivables are delinquent if the minimum payment is not received by the contractual due date. A specific allowance for credit losses is established once management determines that the borrower does not have the ability to repay the loan in full. Interest continues to accrue on past due wholesale finance receivables until the date the collection of the finance receivables becomes doubtful, at which time the finance receivable is placed on non-accrual status. The Company will resume accruing interest on these wholesale finance receivables when payments are current according to the terms of the loan agreements and future payments are reasonably assured. While on non-accrual status, all cash received is applied to principal or interest as appropriate. There were no wholesale receivables on non-accrual status at July 1, 2012 or December 31, 2011. The recorded investment of non-accrual status wholesale finance receivables at June 26, 2011 was $4.7 million. At July 1, 2012, December 31, 2011 and June 26, 2011, $0.6 million, $0.9 million, and $1.2 million of wholesale finance receivables were 90 days or more past due and accruing interest, respectively.

An analysis of the aging of past due finance receivables, which includes non-accrual status finance receivables was as follows (in thousands):


	July 1, 2012
							Greater than				Total
			31-60 Days		61-90 Days		90 Days		Total		Finance
	Current		Past Due		Past Due		Past Due		Past Due		Receivables
Retail	$	5,101,847	$	84,858	$	24,247	$	14,827	$	123,932	$	5,225,779
Wholesale		902,891		1,125		468		554		2,147		905,038

Total	$	6,004,738	$	85,983	$	24,715	$	15,381	$	126,079	$	6,130,817


	December 31, 2011
							Greater than				Total
			31-60 Days		61-90 Days		90 Days		Total		Finance
	Current		Past Due		Past Due		Past Due		Past Due		Receivables
Retail	$	4,915,711	$	107,373	$	36,937	$	27,469	$	171,779	$	5,087,490
Wholesale		822,610		777		344		909		2,030		824,640

Total	$	5,738,321	$	108,150	$	37,281	$	28,378	$	173,809	$	5,912,130


	June 26, 2011
							Greater than				Total
			31-60 Days		61-90 Days		90 Days		Total		Finance
	Current		Past Due		Past Due		Past Due		Past Due		Receivables
Retail	$	5,205,300	$	115,163	$	34,860	$	18,732	$	168,755	$	5,374,055
Wholesale		730,476		816		387		2,110		3,313		733,789

Total	$	5,935,776	$	115,979	$	35,247	$	20,842	$	172,068	$	6,107,844

A significant part of managing HDFS’ finance receivable portfolios includes the assessment of credit risk associated with each borrower. As the credit risk varies between the retail and wholesale portfolios, HDFS utilizes different credit risk indicators for each portfolio.

HDFS manages retail credit risk through its credit approval policy and ongoing collection efforts. HDFS uses FICO scores, a standard credit rating measurement, to differentiate the expected default rates of retail credit applicants enabling the Company to better evaluate credit applicants for approval and to tailor pricing according to this assessment. Retail loans with a FICO score of 640 or above at origination are considered prime, and loans with a FICO score below 640 are considered sub-prime. These credit quality indicators are determined at the time of loan origination and are not updated subsequent to the loan origination date.

The recorded investment of retail finance receivables, by credit quality indicator, was as follows (in thousands):


	July 1, 2012		December 31, 2011		June 26, 2011
Prime	$	4,181,527	$	4,097,048	$	4,313,863
Sub-prime		1,044,252		990,442		1,060,192

Total	$	5,225,779	$	5,087,490	$	5,374,055

HDFS’ credit risk on the wholesale portfolio is different from that of the retail portfolio. Whereas the retail portfolio represents a relatively homogeneous pool of retail finance receivables that exhibit more consistent loss patterns, the wholesale portfolio exposures are less consistent. HDFS utilizes an internal credit risk rating system to manage credit risk exposure consistently across wholesale borrowers and capture credit risk factors for each borrower.

HDFS uses the following internal credit quality indicators, based on the Company’s internal risk rating system, listed from highest level of risk to lowest level of risk for the wholesale portfolio: Doubtful, Substandard, Special Mention, Medium Risk and Low Risk. Based upon management’s review, the dealers classified in the Doubtful category are the dealers with the greatest likelihood of being charged-off, while the dealers classified as Low Risk are least likely to be charged-off. The internal rating system considers factors such as the specific borrowers’ ability to repay and the estimated value of any collateral. Dealer risk rating classifications are reviewed and updated on a quarterly basis.

The recorded investment of wholesale finance receivables, by internal credit quality indicator, was as follows (in thousands):


	July 1, 2012		December 31, 2011		June 26, 2011
Doubtful	$	9,467	$	13,048	$	12,386
Substandard		5,902		5,052		21,088
Special Mention		7,897		14,361		12,887
Medium Risk		808		3,032		12,861
Low Risk		880,964		789,147		674,567

Total	$	905,038	$	824,640	$	733,789