By now, you’ve probably heard of the new lease standard about to become effective (beginning after December 15, 2021). However, have you thought about the impact it will have on your loan customers?
How Financial Ratios will be Impacted
The new lease standard effectively puts all leases (operating and/or financing) on the balance sheet with a right-of-use asset and corresponding liability being booked at adoption. At first glance, one might not realize the implications this standard will have on the financial health ratios that some loan covenants are dependent upon. With this new standard, the following financial ratios will be impacted:
- Debt to equity = increases
- Current ratio = decreases
- Return on assets = decreases
- Debt service ratio = decreases
- Interest coverage = decreases
- EBITDA = increases
Ultimately, there is a risk of non-compliance with loan covenants that are tied to these financial health ratios. So, what should you do now?
Actions for Banks Ahead of Changes
- Talk with your loan customers to get an understanding of the number of leases they have in effect.
- Discuss their implementation plan and make sure all parties involved understand the impact it will have on their loan covenants.
The further in advance you can plan for this change, the better. If loan covenants need to be re-written to account for ASC 842, the better off your loan customers will be come 2022.