S&P Global Ratings has always viewed lease obligations as debt-like in its credit analysis. While that view remains unchanged with the new lease accounting standard, liabilities and credit metrics have changed from pre-IFRS 16 adoption. Company-specific discount rates used by companies that have adopted the new standard are a major contributor to differences from S&P Global Ratings' legacy calculations (discounted at 7%). Company judgment regarding lease terms and lease payments under the new accounting has also contributed to the variance from our legacy calculations.

To determine the impact of the new IFRS 16 lease reporting on our credit metrics from a lessee perspective, S&P Global Ratings reviewed the 2019 or fiscal 2020 first- quarter (first adoption period) lease disclosures of the Canadian telecom and retail corporate entities that have been the most affected. We have used the first-quarter disclosures even where later quarters are available to isolate the estimated accounting change effect.

The reported lease obligations of the reviewed companies range from C$1.3 billion-C$9.1 billion. In some cases, finance lease liabilities reported in the first post-adoption period varied significantly from amounts we calculated at the last annual pre-adoption period (see chart 1). As discussed below, our previous methodology used a fixed discount rate of 7% to calculate the net present value of operating lease obligations for purposes of our lease adjustment to reported debt.

Chart 1

No Material Leverage Impact For Most Issuers

To estimate the extent of the new standard's impact on our core leverage ratios, debt-to-EBITDA and funds from operations (FFO)-to-debt, we compared our last annual pre-adoption period ratios with pro forma calculations. For these calculations, we removed our previous debt, EBITDA, and FFO lease adjustments and substituted our adjustments for the first post-adoption period based on reporting under the new standard (see charts 2 and 3).

The estimated changes to our debt-to-EBITDA leverage metric have varied from less than 0.1x to about 0.75x. For most of them, the change is not material primarily due to reported interest and depreciation costs for our adjusted EBITDA calculation, partially offsetting the debt impact to various degrees. Sobeys Inc. and Metro Inc. are outliers, with debt-to-EBITDA about 0.75x and 0.6x higher, respectively. The factor behind Sobeys' increased leverage is the significant increase in lease liabilities (due to change in lease term assumptions) compared with our previous lease adjustments to debt, about C$1 billion, or 29% higher. In the case of Metro, it is a combination of both higher lease liabilities (about 38% higher post-IFRS 16 reflecting lease extension options expected to be exercised) and lower total EBITDA (about 37% lower post-IFRS 16 reflecting lower interest and depreciation impact from IFRS 16 compared to our adjustments pre adoption). Changes to FFO-to-debt have been nominal at less than 5%.

Chart 2

Chart 3

Our previous methodology used a fixed discount rate of 7% to calculate the net present value of operating lease obligations for all entities. We will now generally accept the rate used by the company for those reporting under the new standard as we have visibility into the rates used under IFRS 16 and how much the reported lease rates vary from our previous 7% rate. Chart 4 provides a snapshot of the different rates the companies used, and is indicative of the variation from our previously used 7% discount rate. Primary reasons for the variability in discount factors include differences in the nature and location of the assets leased and in companies' credit profiles.

Chart 4

The Bottom Line: No Impact On Ratings

We have generally accepted the reported balance-sheet liability under the new accounting standard, and no ratings actions have resulted from the lease accounting disclosures in 2019. Instead, we have fine tuned our target credit ratios to incorporate the accounting changes following IFRS 16 adoption. For retail companies, the update to outlook triggers reflects the adoption of IFRS 16. For the telecom companies, a combination of our favorable view of the industry structure in Canada and the adoption of IFRS 16 drives the update. The table indicates the updates in our outlook trigger following the implementation of IFRS 16.

Related Research

• Ahead Of The Game: Momentous IFRS 16 Lease Accounting Changes Have Little Effect On Corporate Credit Ratings, Feb. 26, 2020
• Ahead of the Game: New Lease Accounting Brings Little Change To U.S. Corporate Credit Ratings, Feb. 26, 2020
• Metro Inc. 'BBB' Issuer Credit Rating Affirmed; Outlook Thresholds Revised, Feb. 7, 2020
• Sobeys Inc. Affirmed At 'BB+' With A Positive Outlook; Outlook Thresholds Revised, Feb. 7, 2020
• Shaw Communications Inc. Outlook Revised To Positive From Stable On Strong Operational And Financial Results, Nov. 28, 2019
• BCE Inc. Affirmed At 'BBB+' With A Stable Outlook; Outlook Thresholds Revised, Aug. 28, 2019
• Rogers Communications Inc. Affirmed At 'BBB+' With A Stable Outlook; Outlook Thresholds Revised, Aug. 28, 2019
• Telus Corp. Affirmed At 'BBB+' With A Stable Outlook; Outlook Thresholds Revised, Aug. 28, 2019
• Canadian Tire Corp. Ltd. 'BBB+' Rating Affirmed, Outlook Thresholds Revised, Aug. 28, 2019
• Loblaw Cos. Ltd. 'BBB' Rating Affirmed; Outlook Thresholds Revised, Aug. 28, 2019
• George Weston Ltd. Rating Affirmed At 'BBB', Outlook Thresholds Revised, Aug. 28, 2019
• Alimentation Couche-Tard Inc. Affirmed At 'BBB' Despite Increased Leverage Following IFRS Lease Accounting Change, Aug. 28, 2019