Troubled Debt Restructuring (Explained: All You Need To Know)

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What Is Troubled Debt Restructuring

In business, troubled debt restructuring is a type of debt restructuring where creditors grant a company certain concessions allowing it to avoid bankruptcy.

In other words, troubled debt restructuring is a process that company creditors can approve to minimize their losses in the event a company (the debtor) is unable to pay off its debt.

For example, a public company having financial difficulties is recently delisted from the stock exchange.

In this context, a creditor may offer certain concessions to the company so it can better manage its debt and avoid bankruptcy.

To be in the presence of troubled debt restructuring, you must have a troubled borrower who is experiencing financial difficulties and a concession by the creditor.

Creditors will often grant concessions when they believe that the concession will represent a smaller “loss” than a company completely defaulting on its debt.

The objective here is to modify the original loan terms to provide payment relief to borrowers who are financially struggling.

Keep reading as I will further break down the meaning of troubled debt restructuring and how it works.

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Identifying Troubled Debt Restructuring

You need two elements to be in the presence of troubled debt restructuring: a troubled borrower and a creditor concession.

Borrowers and creditors should carefully assess whether or not they are in the presence of troubled debt restructuring so they can properly account for it in their books and for tax purposes.

A troubled borrower or a debtor experiencing financial difficulties can be manifested in many ways:

• The borrower is in default on its debt obligations
• The borrower has filed for bankruptcy 
• The borrower is delisted from the stock exchange
• The borrower is unable to get funding from other sources
• The borrower expects that it cannot adequately service its debt
• The borrower has serious reasons to doubt the viability of the business 

It’s important to mention that a borrower does need to actually default on its debt for it to be considered a troubled debtor.

A creditor concession essentially represents a modification to the original loan terms that the creditor would not have accepted in the normal course of business.

Creditor concessions can include things like:

• Reduction of the loan rate of interest
• Extension of the loan maturity date
• Reduction of the face value of the debt 
• Reduction of accrued interest
• Payment in forms other than cash 

The creditor’s main objective is to help alleviate the debtor’s financial burden in the short-term so it can use its cash to fund its business operations.

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Troubled Debt Restructuring Accounting

Companies and creditors should carefully assess loan modifications to determine whether it should be reported as troubled debt restructuring or not.

Loans that are modified because the creditor granted concessions to a troubled borrower are considered impaired loans.

As a result, there are accounting rules that require companies to measure the loan for impairment.

There are various accounting and reporting guidelines issued to help companies measure their loan impairment.

Companies have different impairment measurement methods that they can use to measure their loan impairment, such as the discounted cash flow method, fair value of the collateral method, and others.

It’s also important to remember that you can only be in the presence of troubled debt restructuring (or impaired loan) if you have a borrower having financial distress and a creditor giving concessions that it would not have ordinarily accepted to give.

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Takeaways 

So there you have it folks!

What does troubled debt restructuring mean?

In a nutshell, troubled debt restructuring is a type of debt restructuring referring to certain concessions made by creditors to a company that it would not have given in normal business circumstances.

The reason why creditors may agree to offer debtors concessions is to avoid the debtor from going into bankruptcy or defaulting on its debt where the creditor can potentially lose more money.

The creditor’s objective here is to reduce risk and potentially recover its money rather than risk having the debtor go into bankruptcy and 

Companies tend to renegotiate their loan terms, increase their borrowings, exchange one loan for another, extinguish some loans, or make changes to their debt structure for various business reasons.

However, when such an operation takes place when you have a troubled borrower and a modification or extinguishment of a loan that creditors would not have otherwise considered, you fall within the definition of troubled debt restructuring.

Now that you know what troubled debt restructuring means and how it works, good luck with your research!

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