Anyone who has dealt any length of time with financial instruments will increasingly notice the similarities to other areas of life. While this is sometimes not particularly pleasant – try bringing up the subject at a party – it does help us to recognize that there are some topics that recur seasonally.
One of these topics is the increased occurrence of refinancing. Even though it is, by nature, an perennial topic – after all, everyone has to deal with the issue when their current loan agreement expires – there are still times when the refinancing activity increases significantly. And this phenomenon is not a coincidence, because just as the days get longer in the summer, companies react to changes in interest rates.
With this in mind, it is important to keep an eye on the regulations governing value-related matters in general and the requirements for refinancing in IFRS financial statements in particular. What is particularly value-related in this context is the conclusion of contracts and the change in expectations.
Typically, external financing is secured well in advance and the new financing agreement is signed. It is interesting to note that in some cases the new loan agreement only comes into effect after a certain date (“closing”). The signature represents the conclusion of a new contract that is provisionally valid until it comes into effect. At the same time, the date of signature is the latest point in time at which it can be assumed that the currently active contract will continue to run as before until maturity. However, it is very likely that the repayment period under the active contract will be shortened well before that.
This is precisely why it is important to check on the day of signing whether the original financing has been removed from the balance sheet (IFRS 9.3.3.1) because it has been significantly modified (IFRS 9.3.3.2 f.). Any material modification has an immediate effect on the balance sheet, which may therefore result in a change in the income statement even before the “effective date”. Following a material modification, all original transaction costs are derecognized together with the original financing, and the new financing is recognized at fair value. If there are significant modifications, it is no longer safe to assume that the conditions are in line with the market, and a fair value will usually have to be formally demonstrated (calculated) (KPMG Insights into IFRS 7.6.370.20). On top of that, it will rarely be possible to defer new transaction costs (IFRS 9 B3.3.6).
Alternatively, where the original financing has a short remaining term, one can usually show that it is simply a completely new financing and not an amended existing financing. However, even these cases have a fair amount of potential for complications. For example, if the original financing includes a right of termination, this will usually be exercised in order to be able to carry out the refinancing. This right of termination also has an impact if it has not been separated, valued and recognized as a separate derivative. Where the right to terminate is not separated, this usually results in significant expense. Because even if the original financing is not considered to no longer apply, the changed repayment expectations are contractually enforceable and must therefore also be taken into account in the presentation of the amortized cost of the current financing (IFRS 9 B5.4.6). When implementing the new expected repayment flows, they must be discounted using the original effective interest rate. In these cases, the upcoming repayment is hardly discounted at all and a large portion of the deferred transaction costs, discounts and any additional penalties for early repayment are recognized directly in profit or loss. This once again shows that the term “amortized cost” under IFRS can be somewhat misleading, as the basis for the calculation is the adjusted cash flows and not the amortized carrying amount.
Both a significantly modified financing agreement and an entirely new financing arrangement will also have an impact on an existing interest rate hedge designated in hedge accounting, beyond the aspects outlined above. In the case of a significantly modified financing agreement, the original underlying transaction will usually have been disposed of. Along with the changed repayment expectation on which the value is based, no further interest payments can be made after the planned repayment, and consequently the hedged underlying transaction no longer exists.
The only way to maintain hedge accounting in such circumstances is to have carefully drafted hedge documentation. Otherwise, hedge accounting is usually terminated (IFRS 9.6.5.5 f. in conjunction with B6.5.15) and any deferred amounts are reclassified to profit or loss (IFRS 9.6.5.7 in conjunction with 6.5.12 (b)).
Likewise, in the event of a non-material modification, the new carrying amount is calculated as soon as the contract is signed. When this happens, there are a number of rules that determine whether and to what extent the effective interest rate must or may be adjusted (IFRS 9 B5.4.5) or whether, alternatively, the carrying amount must be remeasured (IFRS 9 B5.4.6) and whether such a difference will therefore immediately affect the interest result. The rules applicable here are very complex and take into account, for example, whether the interest rate is changed from fixed to variable or vice versa, and whether there is a special right of termination without significant penalty (a good description can be found in the Insights into IFRS 7.7.350 ff.).
We recommend that you discuss refinancing and its implications with us well ahead of time, so that you don't end up with a windfall loss in your interest income and avoid any unpleasant surprises in your balance sheet.
Source: KPMG Corporate Treasury News, Edition 145, July 2024
Authors:
Ralph Schilling, CFA, Partner, Head of Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG
Felix Wacker-Kijewski, Senior Manager, Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG
