In the absence of a legally binding obligation when having an exposure to a subsidiary
TOOL F2
This tool outlines a structured approach for assessing potential parent company/ group support, when a credit exposure exists to a subsidiary company without a legally or commercially enforceable guarantee. The steps are:
Step 1: Ability to Support
- What is the standalone credit strength of the parent?
- What is the credit risk correlation between the parent, the subsidiary, and the rest of the group?
- Can the parent afford to support without placing itself or the rest of the group in danger?
Step 2: Willingness to Support
- What is commercial / self-interest of the parent/ group in supporting the subsidiary?
Step 3: Implications for both parent & subsidiary credit assessment
- To what extent will this implicit support improve/ weaken the PD of the subsidiary and parent
- To what extent will the implicit support reflect in external ratings and the Bank’s internal PD ratings?
Note that “Support” can work both ways. If a subsidiary company is expected to support its parent or another group company, then this “negative support” leads to dilution and intra group risks
ANALYTICAL APPROACH
1. Ability to Support
- Intrinsic credit strength of the parent?
- Parent / subsidiary default correlation?
- Legal / regulatory support mandate?
- Legal / regulatory / debt covenant / support restrictions?
- Does the parent company give guarantees?
- Are unconsolidated contingent liabilities greater than consolidated?
- Cross-border impediments against support (e.g. withholding taxes, central bank permission)?
- Expected / likely changes to any of the preceding points?
2. Willingness to Support
| A. Parent / Subsidiary Relationship | • Percentage ownership of parent in subsidiary? • Identity of other shareholders if less than 100% ownership? • Likelihood of the other (minority) shareholders to support? • Level of parental control / voting power not reflected by % ownership. Is the subsidiary consolidated? • Year established / acquired? • Shared legal domicile and / or place of business? • Level and subordination of equity / loan injections from parent and minority shareholders into subsidiary? • Current and future distribution policies? • Is there a change of ownership / control clause? |
| B. Importance of the Subsidiary for the Parent / Group | •Type / nature of subsidiary business vis-à-vis parent / rest of the group: • Is the subsidiary part of the group’s core business / strategy for the future? • Interdependency between subsidiary and parent / group (as supplier, patent holder, distribution channel)? • Is local management independent or tightly controlled by the parent company management? • Existence of formal intra-group commercial arrangements? • Subsidiary earnings and / or cash as % of group? • Estimated cash / funding requirement? • Expected return to parent of additional support? • Impact on the credit worthiness of the parent in case of additional major subsidiary support? • Are major group relationship banks lending to both subsidiary and parent company? • Ability of the parent to insulate its own position without material adverse consequences to its own operations? • Shifting industry trends / technology? |
| C. Financial independence of the subsidiary | • Operations / capital expenditure • Ability to generate cash flow? • Debt (subsidiary raises its own debt, finances its own Capex, etc)? • Difference in debt pricing and covenant structures between parent and subsidiary? • Does the subsidiary influence distribution policy? |
| D. Parent Track Record & Integrity | • Parent support policy: formally / informally disclosed or stated? • Past track record of support? • Tangible evidence / commitment to support? • Shared corporate name / brand identity? • Management / company integrity and cultural? • Reputational risk to franchise value (incl. customers, suppliers, etc)? |
3. Implications for both Parent and Subsidiary Credit Assessment
| A. Implications for Subsidiary credit risk Assessment & PD ratings | • Weak subsidiary: to be assessed at or close to its intrinsic stand-alone credit position. There should be a general understanding with the parent that the subsidiary’s financial position will improve backed up by a step-up stand-alone covenant structure • Strong, business-critical subsidiaries: could receive an up-lift over and above stand-alone credit position. Check support given to other debt providers and extent of dilution risk |
| B. Implications for Parent credit risk Assessment & PD ratings | • Support probability low and / or relatively small: little or no impact on parent stand-alone credit position • Support probability high and / or substantial: Check support given to other debt providers and consider reflecting part or total support assumption in parent’s credit assessment. |
