IFRS 9 and Loan Holidays

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smitpay
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IFRS 9 and Loan Holidays

Post by smitpay »

Hello everyone!

I have an interesting question regarding financial asset modifications under IFRS 9. After a whole load of research, it appears there's little or no comment on the loan restructure I'm looking at. I'm very interested in any thoughts the community may have if a fully drawn fixed rate term loan is restructured such that principal is repaid today and the borrower is committed to redraw at a future date (say, in two years). All other terms remain the same, there are no changes to the contractual obligations (no new covenants, no collateral terms changed etc). My view is that this should be considered under the 10% test (so we calculate the present value using the original loan's effective interest rate but now include any break costs paid upfront by the borrower, the principal repayment and future drawdown cash flows, and not include the cancelled interest payments over this 'holiday' period. I can empathise with the view that this is extinguishment as the loan has been fully repaid, but as it's temporary and the borrower is contractual committed to redraw the loan fully in 2 years (and all other terms remain exactly the same, existing loan documentation remains in place but with an amendment for the holiday) and it passes the 10% test, isn't this just non-substantial modification?

I can't imagine this kind of loan holiday (i.e. not just interest holiday, but principal holiday as well) is that common, but also surely not that unusual?!

Thoughts most welcome!!
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Marek Muc
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Re: IFRS 9 and Loan Holidays

Post by Marek Muc »

The principal is repaid upon entering into this restructuring arrangement, and what happens with interest accrued and unpaid at that date?
smitpay
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Re: IFRS 9 and Loan Holidays

Post by smitpay »

Any interest accrued would be settled as well... in reality, the holiday would start on the next coupon date and hence avoids any messy accrued interest noise...
pub_acco
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Re: IFRS 9 and Loan Holidays

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It reminds me of the discussion with my colleagues about an agreement (not an option) to draw/provide a loan at a future date. Our conclusion at that time was that it was a derivative that reflects the difference between the agreed interest rate and the effective interest rate as of the future date. Usually, an agreement to exchange two things doesn't give rise to a "gross" liability because the future outflow of economic resource is offset by the value of the thing to be received. Only the difference between the fair values of the two is considered an asset or liability.

If this logic applies, the FV of the gross loan repaid and the FV of the net new liability should be substantially different in value, and the restructuring will pass the 10% test. Also, I think we can also apply B3.3.2 by analogy, which says bond buyback constitutes derecognition.
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Marek Muc
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Re: IFRS 9 and Loan Holidays

Post by Marek Muc »

I agree with pub_acco, and this discussion would be even more complicated as loan commitments are generally scoped out of IFRS 9

@smitpay, even if you kept the gross amount of liability in the balance sheet, then you would have to recognise some kind of financial asset representing the loan (cash) to be received in the future, have you thought about this?
smitpay
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Re: IFRS 9 and Loan Holidays

Post by smitpay »

Thanks pub_acco and Marek, these are really useful points! I think this is a really interesting debate, although I risk being too excited about the finer details of IFRS 9! If I may take a few of the points in turn (and acknowledging my bias towards no derecognition)…

I completely agree that loan commitments are outside scope for IFRS 9 (although they are in scope for ECL). If this wasn’t a restructure, the forward loan commitment certainly not be on balance sheet.

I also agree that bond buy backs necessitate derecognition. But I do think this isn’t relevant for two reasons: buying back a tradeable security in a liability management exercise, thereby defeasing all future cash flows, fully nets to zero and therefore the position is economically nullified. There’s no contractual commitment to sell the bond back to the market in the future. However, in our case, we have the complete contractual commitment to redraw the loan in 2 years. For that reason, I think this is very different. The modified loan is completely connected to the original loan.

Pub_acco’s point regarding a forward loan is, in my view, outside the scope of IFRS 9 (as it’s a loan commitment)… unless it’s a derivative… which would require net settlement ("Loan commitments that can be settled net in cash" - IFRScommunity Forum). Not the case here.

So I keep going back to the fact that it passes the 10% test (i.e. the difference in present value is less than 10%). It’s actually the case that the existing loan’s break cost is huge (as it’s rate is far higher than today’s market) and the break cost for the holiday period is very small. Almost all of the economic value in the loan is transferred into the modified loan (hence the 10% test is passed).

My final argument focused on how this would be treated if only part of the loan was temporarily repaid. Let’s say $1m out of a loan of $50m? What about $25m? What about $49m?
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Marek Muc
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Re: IFRS 9 and Loan Holidays

Post by Marek Muc »

what entries (debits and credits) would you recognise if the loan is repaid but not derecognised?
smitpay
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Re: IFRS 9 and Loan Holidays

Post by smitpay »

Let's say it's a holiday on the full loan amount $50m with a rate of 5%, and the fee paid by the borrower for the holiday is $3m (to compensate the lender for them losing the 5% coupons for the next 2 years, when today's market is 2%).

Let's also assume it passes the 10% test as the present value of all cash flows, including principal repaid and fee, is $51m (so it’s within 10% of the original loan’s $50m b/s value)

Let’s do this from the lender’s point of view.

I would say:

Dr Cash $50m / Cr Financial Assets $50m – to reflect the repayment of principal
Dr Cash $3m / Cr Financial Assets $3m – to reflect the fee received
Dr Financial Assets $2m / Cr P&L $2m – to reflect the gain on modification

So the lender now has a liability of $1m. An effective interest rate calculation would be needed, and this would reflect all future cash flows (both the future drawdown in 2 years, interest coupons thereafter, and repayment at maturity). At the first drawdown date, it would be Dr Financial Asset $50m Cr Cash $50m… leaving a b/s asset of £49m. This would increase back to $50m at maturity using an EIR calculation. I’ve ignored a bit of EIR cost on the $1m liability during the holiday period.

Perhaps this seems unusual (in particular, the $1m liability over the holiday period). And presentationally you might prefer part repayment so the asset remains an asset, if you see what I mean. But it still passes the 10% test and nothing has changed except the timing of cashflows!
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Marek Muc
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Re: IFRS 9 and Loan Holidays

Post by Marek Muc »

the 10% threshold applies to financial liabilities only, so let's start with borrower's accounts - what entries do you have in mind?
smitpay
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Re: IFRS 9 and Loan Holidays

Post by smitpay »

Agreed that IFRS 9 only explicitly links the 10% test to liabilities, and judgement is required to apply it to assets. From the borrower’s perspective:

Dr Financial Liabilities $50m / Cr Cash $50m – to reflect the repayment of principal
Dr Financial Liabilities $3m / Cr Cash $3m – to reflect the fee paid
Dr P&L $2m / Cr Financial Assets $2m – to reflect the loss on modification

Would you agree that it’s very common for the lender to approach the modification considerations on the basis of the 10% test?
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Marek Muc
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Re: IFRS 9 and Loan Holidays

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Dr Financial Liabilities $50m / Cr Cash $50m – to reflect the repayment of principal
so you just derecognised this loan :)

for derecognition of financial assets, there is a specific decision framework:

https://ifrscommunity.com/knowledge-bas ... al-assets/
smitpay
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Re: IFRS 9 and Loan Holidays

Post by smitpay »

Hahaha! I beg to differ but see your point! The entries below do reflect that the loan's b/a value has now switched to ~zero for the next 2 years... but the implications of derecognition go beyond the carrying value. If it's derecognised, the modified loan will need to be valued again once it's drawn. Given it's high coupon vs. market, this would be valued well above par and you'll need an EIR calc again. The gain should be amortised over the remaining life, given it's a level 2 instrument under IFRS 13. It seems counter intuitive to me to allow the lender to take a extinguishment gain (equal to the fee paid for the holiday period), when the majority of the economics has been transferred into the modified instrument. Surely the whole point of the 10% test is to check for the significance of this, and avoid derecognition if the value is almost entirely transferred? One other point, let's say that 50% of the loan is repaid (as opposed to 100% holiday), then surely we can't derecognise the whole loan? I guess I find the modification treatment more attractive because it recognises that most of the value is transferred into the new loan and the new EIR calc achieves a sensible smoothing of the value, without large day 1 gains/losses etc.
pub_acco
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Re: IFRS 9 and Loan Holidays

Post by pub_acco »

Btw, I'm actually skeptical if the lender is obligated to provide a loan after two years. I know the borrower has to commit to draw a loan to compensate for the lost profit, but from the lender's point of view, it really depends on the credit standing of the borrower two years later. If the borrower's condition gets better, the lender wins, but if it gets worse, the lender is likely to give up the money that is just collected today. This doesn't really make economic sense under this low-interest-rate market. Does the lender retain the option not to provide a loan? If it does, I think the nature of the borrower's liability is substantially different than that before restructuring.
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