In new accounting rules proposed by key regulators, businesses may have to start putting leases on their balance sheets. Corporations are howling already because many are up against debt limits right now.
The Economist discusses the “shocking new accounting rules” in You gonna buy that?
WHEN you lease something—a boat, a warehouse, a machine for making ball-bearings—you agree to pay for it bit by bit over time. So it is like incurring a debt, say the International Accounting Standards Board (IASB) and America’s Financial Accounting Standards Board (FASB). Therefore, it should be on your balance-sheet. This new rule, proposed on August 17th by the two regulators, has shocked companies everywhere. It is up for public comment until December, but could be enacted as soon as June next year.
A survey by PricewaterhouseCoopers, an accounting firm, found that it would add about 58% to the average company’s interest-bearing debt. Not only new leases but also existing ones would immediately be subject to the new rules. On the other hand, since rents will no longer be a running expense, operating earnings could see a bump upwards. But since the downturn, many companies are close to their maximum debt limits, and the new rules could push them over the edge. Small wonder they are howling.
The new rules’ effects will vary widely. Retailers, who often lease prime property, will take a beating. Airlines, which seldom own their jets, will suffer too. Some businesses, such as utilities, will barely notice. But others will see their apparent return on capital plunge. Many firms will see their debt-to-equity ratio rise and their ability to borrow fall.
How much Corporate Debt Is There?
I picked this story up from Bruce Krasting on ZeroHedge who asks How Much Debt Does the S&P; 500 Have?
The list of companies with Operating Leases is endless. I would imagine that most of the S&P; 500 will be impacted one way or the other.
Watch for a big fight over this issue. Look for GE to be the biggest opponent to any changes. I think they have the most to lose in this.
Off the Radar
This is one of those off-the-radar kinds of things, very easy to miss. It also sheds a new light on the question Are Corporations Sitting on Piles of Cash?
Here was my answer.
So, in spite of what most are saying, corporations are not really holding tons of cash, ready at any moment to go on an investment or hiring spree.
Instead, corporations burnt by inability to raise cash during the 2008 credit bust are simply taking advantage of market conditions to raise cash levels now, at attractive rates, while they can.
Corporations raise cash in two instances
1. When they can
2. When they have to
After the corporate bond blowup in 2008, companies are wisely focusing on #1, while they still can. How much longer the market is willing to allow debt financing at favorable rates remains to be seen. When it stops, equities are likely to get clobbered.
Raising Cash While They Still Can
Putting two-and-two together I cannot help but wonder if some of this recent corporate “cash raising” exercise is directly related to the proposed new accounting rules. Certainly rule #1 above applies, and for some corporations the window might close in a year.
Thus, it is highly likely some corporations are “raising cash” now, just to be safe, while they still can. That is one plausible explanation for at least a part of the massive corporate debt issuance as of late.
On the other hand, since when has there been any meaningful changes in accounting rules that were not discarded, ignored, or put on the back-burner for years or decades?
Regardless, we have yet another solid reason for stating that “high” corporate cash levels are nothing but a mirage.
Mike “Mish” Shedlock
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