Protect Your Clients’ Banking Relationships by Adhering to New Lease Accounting Standards

By Ane Ohm and Chris Marschka.

If the failures of Silicon Valley Bank, Signature Bank, and First Republic Bank illustrate anything, it’s the fragility of trust that both bank customers and regulators are experiencing as a result of downturn fears. While a new era of regulatory scrutiny was dawning well before the collapse of SVB and Signature Bank in March, these incidents brought into sharp focus the impact of rising interest rates and economic slowdown on banks and their customers from a risk perspective.

As the industry drives toward greater compliance, banks will scrutinize agreed-on covenants and reporting requirements. Therefore, filing for exceptions on financial statements could bring your clients oversight ramifications and put their bank relationships at risk.

Adhering to financial statement standards, like the new GAAP lease accounting standards that went into effect January 2022 for many private companies, is one way you can help your clients stay compliant and avoid additional scrutiny while ensuring the stability of their bank relationships.

If your clients do need GAAP exceptions for this year’s financial statements, it’s best to first ensure the bank is aware and has approved their use. Even if a bank accepts an exception this year, it will likely want customers to work toward compliance and keep it apprised of when compliance is expected. Bank regulators won’t look kindly on too many exceptions for a bank’s customers, particularly in this economic environment.

Adhering to the new GAAP lease accounting standards on your clients’ financial statements reduces risk for your clients and their banks.

As the economy constricts, banks look more closely at their own risk profile than they would in times of growth and expansion. This means examining financial statement delays and exceptions – all the little things that banks must measure and track which become very important on the cusp of a slowdown.

Banks want their clients to adhere to GAAP standards, which includes standards for lease accounting, in order to minimize risk. To ensure timely delivery of financial statements, clients should prioritize submitting them early.

It’s important for your clients to communicate proactively with their bank if there are any significant differences between their financial statements and their loan agreements or covenants. If they’ve chosen not to follow the new lease accounting standard and have issued statements with a GAAP exception (which is not recommended), it’s crucial to have a conversation with the bank.

Following the new GAAP lease accounting standards will alleviate scrutiny.

A full analysis and report on what officially happened at Silicon Valley Bank is going to undoubtedly lead to new standards and tighter regulations and restrictions. Banks are going to see exceptions or filing delays as potential symptoms of greater issues. Having the heads-up that you as the auditor are close to a draft of your financial statements even if they are behind schedule will go a long way to alleviating concerns on the part of a client’s bank.

Staying in the bank’s good graces all comes down to communication: proactive, frequent outreach. GAAP exceptions become important if they are material enough to change the bank’s view of a company’s risk profile and if they are ongoing for multiple periods in a row. In itself, needing an exception isn’t problematic if the client’s bank can get enough information to understand the material impact of it.

With respect to exceptions to lease accounting standards: larger, more sophisticated banking institutions have been incorporating off-balance-sheet leases into credit risk analysis for some time. Smaller banks have historically taken a simpler approach to analysis and enforcing covenant structures and may face greater scrutiny as a result.

When the level of risk goes up, businesses with weaker credit are going to need to take extra steps to safeguard their relationship with their bank. This may include restructuring credit agreements, collateral, covenant definitions or filing additional forms of support like guarantees.

Do banks care about client compliance with covenants? Absolutely. Regulators are going to look to see whether banks are following their own policies when underwriting loans and if customers are being held to the terms of their credit agreements, including reporting compliance and timeliness.

To maintain trust with their banking institutions, it’s imperative that clients provide a thorough report that includes details of the exceptions and the buckets they fall into. By doing so, they are going to demonstrate transparency and help their banking institutions better understand the nature of the exceptions.

Remember that banks want to be your clients’ trusted advisor. Bankers should be helping your clients understand what their peers are doing and what the bank is doing to help them adhere to their covenants.

Although applying the new GAAP lease accounting standards to your clients’ upcoming financial statements may appear intimidating, you don’t have to handle it by yourself. Software tools and consulting services are readily available to aid in the transition. Encourage a transparent conversation with banking institutions about the state and future of your clients’ financial reporting. Getting your clients ahead of the transition will save them the costly pain of tightening scrutiny on GAAP exceptions.

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Ane Ohm is co-founder and CEO of LeaseCrunch, a cloud-based lease accounting software company. Chris Marschka is SVP of Commercial Banking.