Original EIR and Revised EIR (modification of financial liabilities)

[Yousaf]

Hi,

On 04 July 2022, ABC entered into a restructuring plan to modify the original terms of a loan with the bank. According to the plan, ABC will make a 30 equal payment of Rs. 920 million till 13 July 2027, instead of originally scheduled payments. The market interest rate at the time of restructuring was 3 LIBOR + 4.5% e.g. 15% per annum.

On the restructuring date, the carrying amount of the original loan was Rs. 500 million, and carry 3 LIBOR + 4.5% e.g. per annum (as at 13 March 2022 interest rate was 11% and as at 04 July 2022, interest rate was 14%). The original loan was repayable on 13 July 2022. No fee was paid for the restructuring plan.

Question is that:

What will be original and revised EIR in case of floating interest rate instrument ?

[JakobLavrod]

When ones solves a problem like this one can either use the spot rate of LIBOR, or a forward curve. The first is simpler, and most used in practices (at least from what I have seen). Hence in that case, the original liability had 15 % EIR. The next crucial assessment is to determine if the modification is substantial, so you discount the payments in the new contract using the 15 % EIR and determines the new value, and how much of a loss one takes. IFRS 9.B3.3.6 stipulates that 10 % change is to be seen as a substantial modification, in which you calculate the EIR of the contract from start, if not, you keep the 15 % rate of the original contract and book the difference in carrying amount as a loss.

However, what consufses me somewhat is that if I read your description correct, the new deal is for a total payment of 920 million spread over 5 years. To get a simple estimate, one can use the continuity approximation (assuming payments are paid continuous over time), and the total effective rate is then R = 5*ln(1.15) = 69.88 %, and the PV is 920/500*(1 - exp(-R))/R = 1.32, so the modified loan is actually worth more then the original loan at 15 %, or do I misunderstand the description?

[Yousaf]

sorry for error in description.

I am re-writing the description as:

On 04 July 2022, ABC Limited entered into a restructuring plan to modify the original terms of a loan with the bank. According to the new plan, ABC Limited will make a 33 equal quarterly payment of $. 5,095,345 till 13 Dec 2027, instead of originally scheduled payments (Originally scheduled payments was as $ 5,095,345 fully settled on 13 July 2022). The market interest rate at the time of restructuring was 3 LIBOR + 4.5% e.g. 7% per annum.

On the restructuring date, the carrying amount of the original loan was $ 5,095,354 (Principal portion only) and carry 3 LIBOR + 4.5% e.g. per annum (as at 13 March 2022 interest rate was 6%). The original loan was repayable on 13 July 2022. No fee was paid for the restructuring plan. Accrued markup on orginal loan as at 30 June 2022 was $ 40,252.

Question is that:

What will be original and revised EIR in case of floating interest rate instrument ?

Is original EIR and Revised EIR are same e.g. 7% in case of floating interest rate?

What will be subsequent treatment of such case ?

Carrying amount of loan will considered as principal portion only ?

[JakobLavrod]

Hi!
Thank you for the clarification. Under the new conditions, R = 5*ln(1.07) = 36.7 %, so the estimates presevent value as a proportion of carrying amount is 1*(1 - exp(-R))/R is 83.7 % (a more accurate discounting calculation looking at discrete payments gives 83.3 %, so the difference is very small), which is less then 90 %, so you should the derecognize the liability and recognize a new one. The challenge here however is that if one looks what you are giving as the new interest, it is an interest free loan, which you are only doing probably due to financial stress of the borrower, hence the fair value of the loan is unlikely to be the full old carrying amount.

It would be interesting to hear what others are thinking, but I would probably start from the EIR, and look at what interest rate I could get by borrowing somewhere else on the market where there is no obligation to extend credit (which is probably going to be quite high due to the risk), use that EIR to discount the payments to compute the fair amount of the new loan, and book the rest as a modification. However, I should say that I exclusively works on the asset side, so much less experience what happens on liabilities.

[Yousaf]

Thanks.

You used the original EIR 7 %, why ?

what will be carrying amount of original loan ?
Remaining cash flows discounted on original EIR ?

[JakobLavrod]

Hi!
For calculating the modification, one use the orginal discount rate (see IFRS 9.B3.3.6). The logic is that if you did not change the cash flows in a way that change the present value with current EIR, there is not really any modification gain / loss.

I based the carrying amount on that you wrote: " the carrying amount of the original loan was $ 5,095,354", or are there some accured interest as well? That should then also be included.