Leasing Industry Update: Expectations for 2018
With less than 12 months to go before IFRS 16 — the new lease accounting standards that require lessees to recognise almost all lease contracts on their balance sheets — is enforced on 1 January 2019, it makes sense to do a leasing industry update.
What did leasing industry performance look like in 2017 and, more importantly, what is predicted for 2018 – the year in which companies will be forced to make a number of drastic changes and possibly far-reaching processes to their accounting practices?
At this stage, we know that the majority of companies worldwide are still far from ready for one of the biggest changes the leasing and asset finance industry has seen in decades. Innervision’s research shows that less than 10% of companies are prepared today for the new lease accounting standards and that only 7% of companies have started an inventory of their current leases. What’s more, 75% expect to have significant or moderate difficulty developing policies, processes and internal controls, as well as getting through their first post IFRS 16 launch date audit.
Across the globe, virtually every company uses rentals or leasing agreements as a way to obtain the use of assets that might not be immediately accessible otherwise. According to the White Clarke Group (WCG), global annual leasing volumes reached an overall milestone of $1 trillion in 2017. “Growth in the industry is now outperforming that of the overall economy,” they note in their 2017 Global Leasing Report, which was released early in 2017.
North America, Europe and Asia remain the leaders in the leasing industry, with countries on these continents accounting for more than 90% of total leasing volumes worldwide. The United Kingdom is positioned as the third largest leasing market in the world and remains one of the dominant players in Europe. As Brexit negotiations develop, it will be interesting to see if the change inspires further lease industry growth. Short-term agreements and lack of ownership responsibility make sense in a potentially turbulent period, which may increase lessee interest.
PwC’s Market Study on the Asset Finance Software Market report notes that growth in the European asset finance market is being driven by increases in penetration and easy borrowing conditions. But, the professional services network suggests that Brexit’s backdrop of uncertainty makes it difficult to predict exactly how the industry will perform in the next few years.
Overall, however, it looks like the global economy is improving. In the words of Investec’s Philip Saunders, we appear to have achieved “escape velocity” from the Global Financial Crisis stagnation – good news indeed for the asset management and leasing industries.
The global car leasing market, in particular, is predicted to grow at a compound annual growth rate of 12.61% during the period 2017 to 2021, thanks to an increased demand for new and luxury vehicles, market research company Technavio reports.
One of the main factors driving the leasing market in the luxury car segment is increased interest among millennials. “A new generation of drivers that have grown up with Netflix and mobile phone contracts see a car as just another device to be paid for monthly and upgraded on a regular basis,” reads an Industry Outlook Report by the British Vehicle Rental and Leasing Association (BVRLA). But vehicle rental and leasing companies will face an increasingly complex challenge in specifying and managing vehicles with a huge variety of connected attributes and services.
The healthcare equipment leasing market is also set to grow during the next three years. Technavio reports that the demand for leasing equipment from cash-strapped facilities is on the up-and-up thanks to benefits such as the easy tax return that’s offered on leased equipment. “The growing demand for medical equipment leasing from the low-budget healthcare facilities will be one of the major factors that will have a positive impact on the growth of the market,” they note in their Global Healthcare Equipment Leasing Market 2017 - 2021 report.
Impact Of New Accounting Standards
But how is the run-up to the enforcement of the IFRS 16 lease accounting standards impacting the leasing industry’s performance?
Companies with large operating leases are likely to be most affected. Listed companies are estimated to have around $3.3 trillion of leasing commitments, of which about 85% do not appear in their balance sheets, says the International Accounting Standards Board (IASB). Implementing the new leasing standards will have a massive impact on these companies’ books.
The IASB predicts that bringing leases onto the balance sheet will increase debt, earnings before interest, taxes, depreciation and amortisation (EBITDA) by 10%. With the new definition of a lease, the focus will shift from risk and reward to the control of the asset. In practice, this may result in agreements formerly known as leases being defined as services, and vice versa.
Reported cash flows will be affected, and most companies will show an increase in net debt once they’ve successfully implemented IFRS 16. Research by Deloitte, conducted among 50 publicly listed companies in The Netherlands, indicates that the companies’ combined net debt will grow by an estimated EUR 45 billion. This, says Deloitte, represents an increase in net debt of approximately 30%.
In other instances, companies will show increased revenue. One such example is Microsoft, which adopted IFRS 16 in July 2017. Revenues for 2016 and 2017 are expected to rise by about $6 billion each year for the company, which has adopted the full retrospective method. “The assets for those two years will rise by about $9 billion, while liabilities will fall by about $6 billion and $2 billion, respectively,” CFO Magazine reports.
In the US, industry experts expect very little impact on the demand for leasing from the introduction of the new lease accounting standards, according to a State of the Industry report by the Equipment Leasing and Finance Foundation. As companies have been aware of the new standards for many years, executives feel that firms will be prepared for the change.
A difficult Task Ahead
While the new lease standards will no doubt bring lease accounting into the 21st century, ultimately assisting the industry in becoming more transparent, companies that aren’t complying yet shouldn’t underestimate the task ahead. “It may take a substantial effort to identify all lease agreements and extract all relevant lease data,” writes KPMG’s global IFRS leases leadership team in their Lease Definition document.
The problem facing the majority of financial executives and large corporations is that often they do not have a full understanding of how many active leases they have. Unless they are currently using lease management or administration software to manage and maintain their lease portfolios, often, large organisations do not have enough data relating to their leases to actively respond to this compliance deadline. This means that they not only have to collect and consolidate the relevant lease contracts and find the assets, they also need to extract the required lease information at the appropriate level of detail before reporting on the data in accordance to the new standards.
But, even though 2018 is predicted to be a tough year in terms of implementing new processes in order to comply with IFRS 16, the industry seems to be on the right track for growth. In the UK, recent figures released by the Finance and Leasing Association (FLA) show that asset finance new business (primarily leasing and hire purchase) grew by 7% in October 2017, compared with October 2016.
“Growth in the asset finance market was broad-based in October, with most of the main asset sectors reporting increases in new business,” an FLA press release states. “The industry is on course to report a record level of annual new business in 2017 of around £32 billion.”
In the US, the future is also looking bright: “Persistently strong business optimism, stable credit conditions, and robust global demand are expected to be key drivers of economic growth, while the primary headwind will be a rising interest rate environment,” reads a report by the Equipment Leasing and Finance Foundation. Overall, however, investment in most equipment verticals should be strong in 2018.
Take Action Now
If you haven’t started the IFRS 16 adoption process, PWC recommends the following steps to ensure compliance by 2019:
- Determine the current state. Figure out what your leasing portfolio looks like and assess the potential impacts of applying the standards, which will help your company understand the volume and nature of leases you have, as well as potential complexities. This assessment can help you begin planning.
- Begin data effort. In addition to data collection, your company should plan to close data gaps and remediate any data quality issues. Don’t wait too long to assess your data as accumulating this information can be a lengthy process.
- Select a system to conduct the accounting. Many companies already have a system in place to manage real estate leases, but additional needs may exist for accounting and reporting requirements, as well as accommodating large volumes of non-real estate leases. System implementation can vary greatly so it is important to leave enough time to identify and implement the right system to match your company’s unique needs.
Is your company ready for IFRS 16 compliance? Download Innervision’s 7 Step Guide to Lease Accounting Compliance – it’s free. Simply register and download the guide, practical and useful information on implementing the new standards.