Lease vs debt

[libertango]

"Investors brace for dramatic accounting change. That sounds like a fantasy headline from one of the great geeky professions, but it's almost true."

That was the lead on the Lex column in the FT on Tuesday the 17th, when I started my new job. (We found a way to get a year's subscription to both the FT and the Economist using airline miles, so I'm reading them again.)

It's a fairly big deal. As Lex goes on:

"New rules announced yesterday on lease accounting will increase the average company's debt load by 58 per cent, according to PwC, the professional services firm, and Erasmus University.

The issue: with the right kind of lease contract, companies currently keep assets off the balance sheet that are both durable and vital to operations - for example airlines' aircraft and retailers' stores. But accountants are on the way to banning these operating leases. Almost all leases will see their assets and corresponding discounted present value of future payments put on the balance sheet. The result: the average retailer can expect a three-fold increase in debt levels. For Tesco, an extra £15bn of lease liabilities will be included into a pool barely £200m deep.

The results of the new rule, a joint project of the International Accounting Standards Board and the US's Financial Accounting Standards Board, may surprise many investors. But not lenders and credit rating agencies, which already make similar calculations. They will have to decide whether the new measure of the value of leases is better than their existing rule of thumb, multiplying rental expense by seven. PwC believes the official measure of the liability will be lower in more than nine out of 10 cases.

Uniform lease accounting will make balance sheet comparisons more accurate, but there is a wrinkle. The prevailing interest rate on which each lease's value is based will be set on the day the contract is signed. An unusually low discount rate translates into an unrealistically high liability for the duration of the lease, sometimes 25 years. In big portfolios, the distortions may cancel out. But investors reading financial statements still cannot afford to rest in lease."

There have been few "matchers" out there in the world. That is, few outlets have been picking up the story. One of them was Reuters, with this piece, estimating global impact at "$1.2 trillion in leased assets."

Another was this breathless piece at the Economist, describing the proposed changes as "shocking" in the headline. However they did make the timetable more clear: "(The changes are) up for public comment until December, but could be enacted as soon as June next year."

Why am I telling you all this?

Well, mostly because I can see political implications afoot. Mainly I see the possibility, if these changes take effect, that as corporate debt is then stated on balance sheets to skyrocket, we'll hear the refrain from the Republicans leading into 2012, "Of course Obama's bad for the economy! Look at how corporate debt has soared because of his policies!"

I want to plant my flag here and now, and tell you when you hear that, someone is either lying or misinformed. These changes are being driven wholly by the private sector, and reflect the market giving furtive borrowers their due.

Odds are I'm not exaggerating where I say this: You read it here first.

Comments

[alicebentley]

I have indeed read it here first!

I heard rumors and suppositions about this last year during my MBA classes, but at that point it was still "what they really NEED to do is..." and "if the USA won't agree to something like this, they risk losing credibility world-wide (one instructor felt that US interests were doing all they could to slow or stop this)"

[urlgirl.livejournal.com]

"Of course Obama's bad for the economy! Look at how corporate debt has soared because of his policies!"

Haha! That's good and I'll remember it, thank you.

But... isn't business borrowing supposed to be a good thing and a sign of growth? ;)

[farmgirl1146.livejournal.com]

In some ways this is a return to accounting practices of decades gone by. Will it make companies more "conservative" (in the not political sense)? Maybe. However, corporate off-balance sheet leasing decisions have been dictated by investors, and those who claim that they know investors' minds. I have personally observed that a significant number of early-stage "investors" own leasing companies, and I read that many major investors do, too. Older, privately held companies, ones that never want other people's money (OPM), rarely have leases because it sticks a lot of money in someone else's pocket. In the long-term, debt tends to be less costly than leasing, but not always. This accounting change may slow the economic recovery in real, not Wall St. terms. That may be a good thing, however, if it builds better companies with straight forward accounting practices.

The only debt that indicates true growth in my experience is capital debt, which also places a capital asset on the books, and short-term manufacturing materials debt that is paid off as the product is sold, and is accounted for under COGS.

The private sector must be driving these changes because it does not aid the short-term agenda of any political party. I have a deep and aching fear that this change will cause chaos on Main Street. I am not talking the GMs of the world, but the small companies that do enough to keep 500 or less employed.

I have much more to say on this, but I have my own business to worry about. We are weather driven, and the weather has caused us huge economic and cash flow problems.

Good day and good luck to us all.

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