Many real estate companies have leases, debt, derivative instruments, compensation agreements, and other contracts that are tied to the London Interbank Offered Rate, or LIBOR. In March 2020, the FASB issued guidance to address concerns about the structural risks of interbank offered rates and the risk of cessation of LIBOR.
More specifically, the Accounting Standards Board sought to address stakeholder concerns over ineffective hedging relationships that would result from the markets transitioning to replacement rates once banks cease to offer LIBOR as a benchmark. Enter Accounting Standards Update (ASU) No. 2020–04, Reference Rate Reform (Topic 848) Facilitation of the Effects of Reference Rate Reform on Financial Reporting. ASU No. 2020–04 provides optional guidance to ease the potential burden in accounting for, or recognizing the effects of, reference rate reform on financial reporting. The standard provides optional expedients and exceptions for applying GAAP to certain transactions affected by reference rate reform, if certain criteria are met.
ASU 2020–04 timing and application
For all entities, including real estate organizations, the new ASU applies to modifications starting Jan. 1, 2020, but adoption of the standard must be complete before Dec. 31, 2022.
ASU 2020-04, LIBOR, and real estate debt: What’s the impact?
When amendments are made to relevant agreements updating index-based interest rates (referred to as the Reference Rate in the guidance), the new guidance provides practical means to simplify accounting for the amendment. Any changes to terms of the agreement that are unrelated to the replacement of the reference rate, however, would disallow borrowers from using these practical means and may likely require borrowers to apply modification or extinguishment of debt accounting guidance. Examples of changes unrelated to reference rate replacement include changes to notional amount, changed maturity date, change from a referenced interest rate to a stated fixed rate, and changing from a term loan to a revolver. See ASC 848-20-15-6 for other examples.
Debt modification and extinguishment assessments can be one of the more complex areas in applying GAAP. Similarly, for lease agreements, adding or terminating a right-to-use underlying asset(s), or changing renewal, termination, or purchase option provisions would kick you out of the ASU No. 2020-04 club.
Amending LIBOR-based debt: Time is running out
The time left to amend LIBOR-based debt is dwindling. LIBOR will cease to be a published interest rate benchmark at some point after 2021. The good news is, electing the accounting standard will more than likely simplify financial reporting. Also, putting rate reform on the radar will at the very least give management time to research alternative interest rates options in advance of inevitable lending negotiations.
Banks may offer alternative risk-free rates such as the Sterling Overnight Index Average (SONIA) benchmark, a rate administered by the Bank of England. But the accounting implications of amending interest rate terms may not be front of mind as real estate CFOs negotiate with their lenders. It’s important for real estate companies to fully understand the accounting implications of amending LIBOR-based arrangements before the ink dries. Reach out to our real estate team — we’re more than happy to talk you through it.
