I have followed your progress on improving railcar liquidity and wanted to advise you and your readers of a potential changes in accounting regulations impacting leasing.

The discussion on the table is a change in when a lease gets off-balance sheet vs. on-balance sheet treatment. If this passes in its present form, there would likely be a drastic reduction in leasing capital, lessees would have a harder time obtaining leases and stock prices could be impacted.

Under current regulations, FASB 13 provides a set of four criteria that determine whether a lease is off-balance sheet (operating) or on-balance sheet (capital). It is not uncommon to have rail equipment leases of 18+ years afforded off-balance sheet treatment.

Therein lies the issue.

An international accounting group commissioned a study that examined the books of a large airline. In a report dubbed "The McGregor Report" the group found several long-term leases that had terms of 20+ years and reasoned that the airline had long-term commitments with lessors and these commitments should be reflected as long-term liabilities and recorded on the balance sheet using an "asset-liability" framework.

The proposal on the table is that every lease longer than one year should be classified as a capital lease on the balance sheet of the leseee. What is up in the air is what goes on the asset side of the balance sheet to make things balance.

As a practical matter, rating agencies are aware of off-balance sheet liabilities such as leases and typically consider them when assigning debt ratings to railroads and shippers. However, it is unclear how many bank and leasing company credit departments actually add the off-balance sheet items back into their financial ratio calculations when evaluating the creditworthiness of a lessee. One lessor told me that this change could cause many lessees to fail minimum financial ratio requirements that are necesssary to get credit approval. Further, another lessor said that if lessees were to demand one year leases to keep things off balance sheet, his firm would leave the market due to the residual risk of one year deals.

The change could also impact reported book values that are widely used by stock analysts. Stock price to book value is a common benchmark measurement. If the asset that is recorded is considered "tangible", then there is probably no impact on book equity. However, if it is considered "intangible", then it falls into the same bucket as the dreaded goodwill and would reduce tangible book value.

We are told by the Equipment Leasing Association that the proposal is most likely two to three years from becoming law and the usual lobbying and revisions will happen throughout the process. On an international basis, The G4 +1 (Australia) seem to be supporting the changes. ELA is going to discuss it with its membership in late March. Alot of companies large and small are likely to be impacted.

Regards,
Richard L. Rockhold
Momentum Leasing Advisors, LLC
San Francisco
rickr@momentumleasing.com

Copyright Richard L. Rockhold. Used with permission.

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