Accounting Rules Could Impact Equipment Lease Volume

Accounting rule changes, in the works for several years, are likely to have a mixed effect on the market for securitization of equipment leases. They could curtail leasing of new, large equipment, but lessors may have additional incentives to securitize the leases that they do make.

The second version of the Financial Accounting Standards Board’s proposal to update accounting for leases may be less controversial than the first. A major bone of contention around the FASB’s 2010 proposal was its complex requirements for real estate leases, such as factoring in whether a lease would be renewed or not. Those elements have largely been smoothed over, but the proposal nevertheless could significantly change how lessees recognize their lease-related expenses and affect their equipment-sourcing decisions, potentially impacting the volume of leases available to securitize.
Lessors, on the other hand, would be able to move securitizations of leases for big-ticket items off-balance sheet, which is not possible under current accounting rules.

“Now, virtually all equipment leases would look like direct finance leases and they’re going to be ready to securitize and go off-balance-sheet,” said Bill Bosco, president of consultancy Leasing 101 and a former Citibank executive specializing in leases.

That means lessors of aircraft, rail cars, shipping containers and other costly equipment that tend to have longer lease terms and are now accounted for as operating leases would be able to free up capital to originate more leases.

“Operating lessors may be more likely to feel the effect than what I would describe as financial lessors” who provide direct-finance leases, said Joe Turfler, chief financial officer of GreatAmerica Leasing Corp., which focuses on leasing out “small-ticket” equipment such as copiers and printers.
Turfler said the proposal would likely have little direct effect on GreatAmerica’s business because its direct-finance leases typically have tenors between 48 months and 60 months, in which time the lessor recoups most of the purchase price. Under current accounting rules those direct-finance leases are already reflected on a lessees’ balance sheet.

Although the proposal would benefit lessors seeking off-balance-sheet treatment, their clients’ operating leases would have to move onto the balance sheet.

“Lessees that now have operating leases may see the greatest impact. Some may get favorable accounting treatment under today’s rules and they could lose that under the new rules,” Turfler said.
Such a change could affect lessees’ decisions about how much equipment they source. In doing so, the proposed rule would potentially influence the types and quantity of leases available to be securitized. For example, the proposal would allow off-balance-sheet treatment for leases with tenors of less than 12 months and that may prompt lessees to shorten their leases. Real estate leases as well as equipment leases under 12 months would be classified as Type B leases, and most other equipment leases would fall under the Type A category.

FASB’s proposal would have a more direct impact on lessors that today provide operating leases. Those lessors securitize leases because it’s a cost-efficient form of financing, even though the deals must be reported on their balance sheets. The proposal would give them cheaper financing and off-balance-sheet treatment, freeing up capital.

An additional benefit for the lessor, said Dave Mirsky, co-founder and CEO of Pacific Rim Capital, a major forklift lessor, is that operating leases require depreciating the asset and paying more interest at the beginning of the lease, creating a book loss and a drag on earnings early on. Direct-finance leases, instead, incur straight-line expense recognition.

“So under the new proposal, leases won’t throw off losses in the early months and instead will provide earnings,” Mirsky said.

This benefit may prompt some lessors to consider securitization as an option, but it’s unlikely to create a surge in new issuers of lease ABS.

Mirsky said the costs involved in “creating a bond” mean that securitization tends to make the most sense for public lessors originating high volumes of leases.

Sectors today where lessors regularly tap the securitization market include rail cars and shipping containers. In an August report, Fitch Ratings said that $2.5 billion in asset-backed bonds were issued last year in nine transactions, and the first half of this year saw six deals totaling $1.7 billion.

ASR’s Scorecards Database includes at least two rail car equipment lease deals this year as well as three offerings of  equipment trust certificates from airlines, including American Airlines and US Airways.