BMO warns on impact of new accounting rules

An interesting note in Bank of Montreal’s financial statements Wednesday points out that the new International Financial Reporting Standards that public companies have to adopt could impact the bank’s capital ratios.

This is an issue that markets should be keeping an eye on, because the new rules could ultimately require Canadian banks to park many loans that are currently held off-balance sheet (because they’ve been sold or securitized) on their balance sheets.

It’s been a long haul for big banks as they prepare to adopt IFRS. The preparation has been costly and time-consuming, bankers say. BMO’s statements give some clues as to why.

Canadian public companies are required to start preparing their financial statements inline with IFRS for fiscal years beginning on or after January 1, 2011.

In order to get ready, BMO set up a bank-wide project led by a new executive steering committee to implement a three-phase transition plan. (The bank will adopt IFRS effective Nov. 1, 2011, the start of its fiscal year. So its first quarter reporting under the new rules will be the first quarter that ends Jan. 31, 2012).

The bank says the “implementation activities” have been organized into 25 individual work streams based on key areas that the new rules could affect, such as leases and stock-based compensation. (The rules will require companies to account for leases in a way that more closely resembles the way they account for mortgages, a change that could have a big impact on retail chains and other businesses with substantial leases). BMO has nearly finished seven work streams, and so far it hasn’t found any major differences to the way it’s already accounting for these items.

But “based on our analysis to date, the main accounting changes due to adopting IFRS are expected to be in the areas of asset securitization, consolidation, and pension and other employee future benefits,” the bank said. In those areas, the changes to the bank’s accounting regime are expected to be significant enough that they could change the bank’s financial results and capital ratios, it warned. (When it says “consolidation,” it’s referring to the potential need to include results from variable interest entities with its own statements).

It noted that the banking regulator is giving banks some leeway on their asset-to-capital multiple by allowing them to keep mortgages that were sold through CMHC programs (such as the Canada Mortgage Bonds program) before March 31, 2010 off their balance sheets as they adopt the changes. The regulator is also giving them some other relief, allowing them to phase in certain changes to their retained earnings over five quarters.

Interestingly, bankers say that corporate loan departments have also been helping clients determine the impact that IFRS will have on their financial statements. That’s because the new rules could potentially impact debt to equity ratios, triggering loan covenants.