Troubled debt restructurings in the current economic environment

Apr 05, 2023
Financial reporting Audit Debt & equity

As the news of bank failures and bank bailouts dominates the financial headlines, many wonder whether loan defaults in the commercial real estate industry will be next. Recent media reports have noted mortgage defaults by several companies that are prominent landlords in the commercial real estate market. Worries about the future of commercial real estate first made headlines in 2020, when COVID-19 restrictions did not permit many employees to work from offices. Today, even without those restrictions, many firms and their employees continue to embrace hybrid or work-from-home arrangements.

Current economic and business conditions may require entities in the commercial real estate industry and other industries to think about factors that they have never significantly considered before. Macroeconomic factors such as inflation, rising interest rates and tighter credit, together with business specific factors such as reduced cash flows from operations, or in the case of commercial real estate, increased vacancies and/or rent holidays or reductions. These factors may indicate that when loans are being renegotiated, a lender may grant a concession. If a concession is granted to a borrower experiencing financial difficulties, the refinancing would be considered a troubled debt restructuring (TDR) for a borrower.

Accounting Standards Update (ASU) 2022-02, Financial Instruments – Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures, eliminated the accounting guidance for TDRs by creditors in Subtopic 310-40, Receivables – Troubled Debt Restructurings by Creditors. However, ASU 2022-02 did not eliminate or amend the guidance in Subtopic 470-60, Debt - Troubled Debt Restructurings by Debtors. As a result, borrowers still need to determine whether their loan modifications or restructurings represent TDRs.

While some TDRs result in assets or equity being transferred to the lender to settle the debt, many TDRs are simply agreements to modify the terms of the debt and may not involve a partial payment of principal. The accounting for a TDR varies based on the terms of the agreement and may result in the recognition of a gain by the borrower. TDRs also have specific disclosure requirements.

Further guidance on accounting and disclosure requirements for debt modifications and restructurings can be found in Section B.2 of our publication, A guide to accounting for debt modifications and restructurings.

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