IFRS-9 Fair value of restructured liability

[Muzammil Korai]

On 01-01-20x1, ABC Ltd. defaulted on a bank loan carrying a markup rate of 17%. The bank restructured the loan by extending the maturity date by 5 years, along with the following changes:
- Future mark-up rate would be only 2% (Far below the original and market interest rate of 17%)
- Mark-up accrued so far would be payable at the end of 5 years. And no further interest would be charged on that amount.

Assuming that the change in liability is more than 10%, at what amount should the loan be recorded at the date of modification? i.e how to calculate the value at which modified liability should be recorded?

[JakobLavrod]

Hi!
When you write "markup rate" is that the EIR, APR or an addon to these? That will matter in order to be able to carry out the calculation. How long was the orginal loan from present date supposed to be?

[Muzammil Korai]

The loan originally had a 17% coupon rate, which matched the market rate at the time. However, following the default, this has been significantly reduced to just 2%. My question is, how are loans typically treated when their interest rate falls far below the market?

Additionally, the change in the liability under IFRS-9's 10% rule exceeds the 10% threshold.

[JakobLavrod]

What you are supposed to do is to calculate the market rate for this customer (in this case it could be the 17 %, or some other rate if that is applicable) and use that for the discounting of the future cash flows to get a fair value of the loan. That is the fair value you will recognize as the new gross carrying amount, so there will be a difference between the derecognized amount and the new gross carrying. I am little more unsure where that difference exactly ends up on the PnL however, maybe someone else knows more here.

[Marek Muc]

The difference between the liability derecognised and a new liability assumed goes directly to P/L under IFRS 9.3.3.3
Regarding the FV of the loan with the new terms, it should consider the borrower's creditworthiness. If the borrower has a poor credit standing, the discount rate used in the FV calculation might be significantly lower than the rate used for a company with good credit standing.

[Muzammil Korai]

@Marek Muc Can you please provide me further guidance on that or tell me some reference material so that I can research it myself?

[JakobLavrod]

I think the point Marek is making (and which I agree with) is that if you lend to someone, you typically charge interest rate = risk free rate + credit spread + liquidity spread + ... + profit margin. In other words, when one derecgonize the loan and originate a new one, you need to assess how these components would be priced. If the borrower has low creditworthiness, the credit spread part will be higher. The good news is that since it is a loan you have on book, the credit risk should already be measured by the internal IFRS 9 assessment, so that should serve as an input.

[Muzammil Korai]

@JakobLavrod I agree with you. For a company with a poor credit rating, a higher spread is charged. However, @Marek Muc has mentioned otherwise. As per Marek, . If the borrower has a poor credit standing, the discount rate used in the FV calculation might be significantly lower than the rate used for a company with good credit standing. That's what basically confused me.

[Marek Muc]

I meant lower fair value, i.e. higher discount rate, my bad, I'm sorry!