With the effective date of the Financial Accounting Standards Board’s new lease accounting standard rapidly approaching for nonpublic companies, most community banks are preparing for the standard’s impact on loan covenants and regulatory capital. But it’s also important to consider its potential impact on your institution’s investment in bank premises, such as office space and retail branch leases. For banks supervised by the Federal Reserve, adoption of the new standard may trigger certain obligations under Regulation H, which places limits on such investments. Recently, the Fed issued guidance on this subject.
WHEN DO THE NEW RULES TAKE EFFECT?
The new standard — Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842) — is effective for fiscal years starting after December 15, 2019, and for interim periods in fiscal years starting after December 15, 2020. (The standard is already in effect for many public companies.) Banks may adopt the new standard early. But, if they do, they must apply it in its entirety to all lease-related transactions.
WHAT’S THE IMPACT ON OPERATING LEASES?
The most significant impact of the new standard will be on operating leases. Under current accounting standards, lessees don’t recognize lease assets or liabilities on the balance sheet for operating leases (as opposed to capital leases). But the new standard will require most lessees to record both a right-of-use asset and a lease liability on their balance sheets, based on the present value of minimum payments under the lease (with certain adjustments). After a bank adopts the standard, it will be required to record all of its operating leases (with limited exceptions) on its balance sheet. That includes those entered into before the standard’s effective date.
WHAT ARE THE REGULATION H IMPLICATIONS?
Regulation H implements Section 24A of the Federal Reserve Act. One of its provisions prohibits Fed- supervised banks from making aggregate investments in bank premises that exceed the amount of the bank’s capital stock unless they first obtain the Fed’s approval. For some banks, adoption of the new lease accounting standard will cause the carrying value of bank premises (which includes leases recorded on the balance sheet) to surpass their capital stock. The Fed’s guidance — found in Supervision and Regulation Letter No. SR 19-7 — clarifies that Fed approval isn’t needed when adopting the new standard requires a bank to capitalize premises leased before the standard’s effective date. In other words, if a bank’s investment in bank premises is less than its capital stock before adopting the standard, but adoption causes that investment to increase to an amount that exceeds the bank’s capital stock, it’s not necessary to seek the Fed’s approval. But prior approval will be required for any postadoption leases that cause investments in bank premises to exceed capital stock.
WHAT’S YOUR PLAN?
As you plan your bank’s transition to the new accounting standard for leases, it’s important to evaluate the impact of adopting the standard on your investment in bank premises. Moving existing leases to the balance sheet won’t cause you to run afoul of Regulation H. But if you’re planning any significant new leases of retail branches or other facilities, be sure to consider the timing of those investments in relation to your planned adoption of the standard. Your financial professional can help you assess the impact.