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Fitch: Lessors Challenged by Proposed Lease Accounting Changes

July 18, 2013, 06:59 AM
Filed Under: Regulatory News

Fitch Ratings expects lessors to face significant challenges in applying the new rules, but the impact on economic fundamentals in the leasing industry will be limited.

Off-balance sheet treatment, which would end for most lessees under the terms of the exposure draft, is only one of many current incentives for leasing assets, as opposed to purchasing them outright. Other key benefits of leasing, such as reduced capital outlays, lower residual risk and portfolio management flexibility will remain in place.

Since economic effects on lessors will likely be small, no rating actions are anticipated. However, Fitch says it will evaluate any changes in market dynamics that result from the new rules.

The new accounting rules would increase the level of management judgment used by lessors to determine lease asset and discount rates. Additional disclosure around the residual value and interest rates used in the calculations should enhance analytical comparison across issuers.

As noted in a recent Fitch Wire comment ("Accounting Rules May Encourage Short-Term Leases" published May 21, 2013), the new accounting rules may encourage some lessees to shift to short-term leases (less than 12 months) or structure lease agreements as service contracts. Fiitch believes this outcome would be a modest negative for lessors, as short-term leases generally diminish the predictability of cash flows for a lessor and reduce flexibility in aligning the duration of funding.

In commercial fleet leasing, the biggest effects are likely to be seen on the lessee side. Lessees may be forced to make changes to their treatment of "right of use" payments on nonproperty leases with terms of more than one year. Still, Fitch does not expect the changes to fundamentally alter customer decisions on whether to lease assets.

The new standard will generally make lessor accounting more complex. Both income statements and balance sheets will likely require numerous adjustments to analyze the true economics of the business.

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