Unveiling Companies' Massive Hidden Debts
Starting in 2019, new accounting standards will reveal the true extent of companies' off-balance sheet debts, transforming how financial obligations are reported.
In just a couple of years, U.S. corporations will appear significantly more indebted on their balance sheets, thanks to upcoming changes in accounting regulations. Presently, firms hold approximately $3 trillion in off-balance sheet liabilities, primarily through operating lease commitments. However, with the introduction of new accounting rules effective in 2019, these operating leases must be recognized directly on the balance sheet, according to Bloomberg.
Unmasking Hidden Liabilities
Petrobras leads the pack with $97.8 billion in operating lease obligations, followed by Sinopec at $54 billion, Walgreens Boots (WBA) at $34.1 billion, AT&T (T) and Petrochina each at $29.7 billion, and CVS Health Corp (CVS) with $27.2 billion. Bloomberg's analysis reveals that, for these companies, operating leases amount to roughly 25% of their long-term on-balance sheet debt.
Many businesses utilize operating leases to finance assets like real estate, aircraft, or equipment with long lifespans. These leases function as rental agreements, allowing lessees to use assets without recording the asset or related rent liabilities on their balance sheets. Despite this, rent obligations represent future payment commitments, effectively mirroring debt in financial terms. (For further insights, see: Uncovering Hidden Debt.)
Impact of New Accounting Standards
For those who seldom examine the footnotes in financial statements, these lease liabilities often go unnoticed. However, with the implementation of IFRS 16 in 2019, companies will be required to report operating leases transparently on their balance sheets alongside other debts and assets.
This change will cause many firms to appear considerably more leveraged overnight. While sectors like healthcare, telecommunications, and airlines will see notable impacts, the retail industry faces the most profound shift, with median indebtedness nearly doubling due to the new rules.
Although this shift does not increase actual financial obligations or affect creditworthiness—since rating agencies already factor in operating leases—the visible inclusion of this debt will empower investors to better assess company risks and make more accurate comparisons. (See also: Soaring Debt Risk for Retailers After Bruising Web Wars.)
Armed with this clearer financial picture, investors may soon mirror the strategies of hedge funds that have recently taken bearish positions against U.S. retailers. Bloomberg reports that short positions on some of the riskiest commercial mortgage-backed securities (CMBS) have surged by 50% compared to the previous year.
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