TOOL F1
This tool provides questions to establish if, in the stress scenario, a credit exposure could be subordinated with regard to that exposure’s claim on the company’s assets, cash flows and /or contracts.
1. Questions to Ask
- Where are the Legal Counterparties(LCPs), debt, assets, contracts, profits and cash flows in the group?
- Is the credit base accurately presented by the group’s consolidated financial statements?
- Ascertain the strength of the LCPs relative to the rest of the group
- Assess the exposure’s debt priority position visa-a-vis other creditors in the group.
- Can support be expected from other entities within the credit base in a stress scenario?
2. Detailed Checklist
| 1. Subordination /Holding Company Risks | Structural subordination will be a risk if: • The exposure is at HoldCo level= (LCP) • HoldCo is a pure holding. And there is significant subsidiary debt • There is other secured debt in the group Cash flow • Is up-streaming of cash from subsidiary to HoldCo restricted? • Is cashflow diverted through guarantees or collateral to other parties? | • Check the LCP’s asset profile to see if it lends to or invests in subsidiaries • Undertake horizontal analysis and compare consolidated/ unconsolidated debt and guarantees • Check covenants for restrictions to upstream cash |
| 2. Intra-group Assets & Liabs | If a large part of the LCP’s assets / liabilities are intra-group: • Assess the nature and quality of assets • Assess the reliability and priority of claim of the funding • Have any of the LCPs issued intra-group guarantees? • Intra-group loans given by the LCP should not be subordinated • Intra-group loans received by the LCP should be subordinated • Compare consolidated / unconsolidated contingent liabilities to determine the level of intra-group support given by any LCP. Are there other related party off-balance sheet liabilities? | • Lower quality assets mean a higher LCP risk profile • Intra-group guarantees issued by LCP’s risk dilution of one’s own debt position |
| 3. Transfer Pricing | • Is the LCP’s financial position determined by the group? • If the LCP benefits from transfer pricing, is this likely to change? • Are intra-group transactions commercial, financial, or synthetic? • Are intra-group transactions commercially and fiscally justifiable? • Where are profits / cash being generated and diverted to • Is the LCP supporting / likely to support weaker parts of the group? | • Compare profit margins in the consolidated group figures and the unconsolidated figures of the LCP. |
| 4. Change of ownership | The bank/ investor faces possible risk if: • The parent sells the LCP and the credit base changes • The LCP sells key assets or investments • The LCP sells a key cash generating subsidiary • Ownership or control of the parent company changes | |
| 5. Change of Group Structure | The bank/ investor faces possible risks if: • Assets can be transferred to another (new) company • An intermediate or sub-holding company can be created • A subsidiary is deconsolidated • Associated companies are consolidated • There are related parties that are not part of formal groups | • Remember when there is no holding company; group structure will still be relevant where there is a common owner such as in family groups |
