Hiding the impact of IFRS 16 is of no benefit to anyone
Some of the more creative souls in corporate debt markets are trying to find ways to gloss over the impact of the IFRS 16 accounting standard. Brought in a year ago, it has driven up some firms’ leverage ratios by forcing them to report leases on their balance sheets, even though their businesses have not changed. But it would be a bad idea to act as if the rules had never changed.
There are plenty of industries that rely upon leasing. Airlines, oil companies and engineering companies all had to report extra liabilities — and suffer a bump in their leverage ratios — overnight when IFRS 16 came into force at midnight on January 1, 2019, despite making no change in their operations.
Just over a year later and the first set of full year earnings reports are emerging and corporate debt bankers are fretting over how to make the rise in leverage more palatable to investors.
Some are trying to encourage investors to believe that, where unrated credits are concerned, four is the new three — that a leverage ratio of four times with IFRS 16 applied should be the new unofficial upper threshold for a firm to be considered equivalent to investment grade, instead of the more traditional three times.
Intuitively, sure, there is a logic to this way of thinking. These businesses are just as reliable as they were before, all other things being equal, and are not worse credits just because of a change in bean counter best practice.
But that ignores the fact that IFRS 16 was brought in for good reason — to make a company’s financial status and obligations more visible. In short, leases matter.
If an airline leased 20 planes that investors knew nothing about because they were not on the balance sheet and then the airline could no longer afford those contracts, it could not just carry on as normal.
Investors need as full visibility of a company’s financial health as can be mustered so they can price risk properly.
By the same token, businesses should be discouraged from hiding those risks off of the balance sheet.
It was not that long ago, after all, that the borrowing of too much money, too cheaply, by people whose true risk was ill considered brought the financial system to its knees.
Investors must stand their ground and not be duped into the idea that IFRS 16 was nothing other than bureaucratic tinkering.