The proposed changes in lease accounting standards described in the recent exposure draft from the Financial Accounting Standards Board and the International Accounting Standards Board will significantly alter financial reporting standards for both lessors and lessees, according to Fitch Ratings.

Fitch said Wednesday it 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, Fitch noted. 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 said it plans to 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 (see What's in the Lease Accounting Exposure Draft?). Additional disclosure around the residual value and interest rates used in the calculations should enhance analytical comparison across issuers.

The proposed lease accounting rules may encourage some lessees to shift to short-term leases of less than 12 months or structure lease agreements as service contracts. Fitch said it 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 accounting changes may make it more difficult to compare lessors that have different business profiles or asset types. For example, a newer aircraft lessor with a younger fleet might look more profitable than a more established peer because more income from a lease will be front-loaded under the proposed receivable and residual approach. However, the underlying lease cash flows will not change.

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. Fitch predicted.

Lessors will need to incur additional expenses to analyze, implement and maintain the new accounting standard. While Fitch expects these costs to be manageable, it may put smaller leasing companies at a disadvantage relative to competitors with greater scale and resources. Lessors have plenty of lead time, with the final rules not expected to become effective until 2017 at the earliest.

At a higher analytical level, Fitch said it sees the convergence of international and U.S. lease accounting standards as generally positive, as it will make cross-border peer comparisons much more consistent. The ratings agency also expects that the changes will contribute to enhanced disclosure for lessors, ultimately supporting Fitch’s ability to fine-tune its analysis.

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