A proposed change in a FASB accounting standard will likely have the effect of eliminating one of the reasons corporations choose to use debt exchanges in liability management. Transactions once considered debt modifications, bankers tell NeuGroup Insights, would henceforth be deemed debt extinguishments. That means corporates could no longer spread losses incurred by paying premiums for old bonds over the life of new, lower-coupon bonds, forcing companies to account for the entire loss at the time of the debt exchange. - Nor would companies that pay less than par for bonds they’re exchanging be able to spread the resulting gain over the life of new bonds; that’s a less common scenario that may come up more in the current rate environment. Either way, “the change could lead to instances where relatively insignificant modifications generate significant upfront accounting events,” said one banker involved in debt exchanges.
- This could potentially steer companies away from using debt exchanges instead of tender offers and new bond issuances. AT&T, Broadcom, Comcast and Verizon are among corporates that have done exchanges in the past.
- “If the issuer’s preference is to avoid upfront impacts, that’s going to become more challenging because both legally separate transactions—tenders and new issues—and legally linked transactions—debt exchanges—would now result in the upfront loss/gain,” the banker explained.
FASB comment letter. A comment letter from one bank said the FASB change “could almost completely deter U.S. GAAP issuers from choosing exchange offer structures in the future.” It goes on to say the proposed amendments will eliminate the ability of issuers retiring bonds at a premium “to amortize P&L charges from refinancing high-coupon/long-dated existing debt,” one reason for choosing an exchange instead of a tender and new issue.
- As a result, the letter adds, issuers would have fewer options in their capital markets tool kit, and the “knock-on effect could be increased funding costs” for companies that decide against retiring expensive legacy debt to avoid a large P&L charge.
The cash flow test. At the center of this issue is something known as the “10% cash flow test” that has been used to determine if a transaction is accounted for as a debt modification or extinguishment. According to the accounting and consulting firm Crowe, it “compares the present value of the cash flows of the new debt to the present value of the remaining cash flows of the old debt. If the difference is 10% or more, the exchange is accounted for as an extinguishment; otherwise, it is treated as a modification.” - Under the proposed changes, bankers say, the test would no longer apply to most transactions, and exchange offers would usually be accounted for as extinguishments, according to the interpretation of Big Four accounting firms. Banks are working together to get more information from FASB and the firms as well as persuade corporate issuers to make FASB aware of what the bankers say are unintended consequences.
- The irony, bankers say, is the original intent of the Big Four in 2024 was to get FASB to clarify for accountants that contemporaneously refinanced tender offers should be treated as debt extinguishments and not as modifications. But after a process that included consideration of nuanced terms and issues like whether the contemporaneous exchange of cash is on a gross or net basis and the removal of the phrase “customary marketing process,” the treatment of debt exchanges, not tender offers, has become an issue of concern for corporates.
A call to action. “Issuers that have used liability management in the past and believe a materiality standard for exchange offers is broadly sensible should consider speaking with their accountants and consulting with FASB about implementation of these changes,” one banker told NeuGroup Insights.
- “We’re asking our clients to potentially reach out to FASB themselves,” another banker said. “Large corporate borrowers reaching out to FASB is going to be more powerful than a bunch of banks.” He added that while bankers may be seen as acting out of self-interest, companies can make a strong case that FASB “is taking away a beneficial structure that issuers use and potentially hurting a borrower’s ability to manage their outstanding debt maturity profile.”
- The comment period for the FASB change is officially over, but bankers acting on behalf of treasury teams are not giving up hope. The standards will not be finalized until Q1 of 2026 and only go into effect at the end of next year. “So there’s still some time potentially to at least get some clarity,” one banker said.
- “They may not rewrite anything but they at least could give clarity to the market that adding certain language to this tentative decision won’t affect regular debt exchange offers in the future, and companies can continue to have modification accounting if they meet the 10% test.”
