Tag Archive for: loan

Intercompany financing – complying with procedures

| 18-12-2017 | treasuryXL |

Many businesses (not just multinationals) finance the operations of their subsidiaries/affiliates via intercompany loans. During the financial crisis external funding became more difficult to obtain, and more businesses attempted to finance their operations internally. Whilst this can be a good procedure, consideration must be given to the fact that the loans must still be proper loans, compliant with normal market practices. Below we attempt to explain the relevant procedure.

Arm’s length principle

All terms and conditions of the intercompany loan – with special consideration for the interest rate – must be consistent with independent external loan funding. A business can not adopt a more generous approach to funding its subsidiaries than could be obtained externally. The pricing of the loan must reflect the perceived credit risk of the entity that is seeking funding.

Documentation

Just as with external financing, legal documentation needs to be drawn up and signed that clearly shows the terms and conditions of the loan. Standard covenants should be included together with a schedule showing repayment of principal and interest. If a subsidiary is granted an embedded option (early repayment without a penalty) then this must be clearly noted. Whilst the documentation does not have to be as large as that used by banks, it should always contain all relevant clauses, and both parties must adhere to the signed loan agreement. Included within the documentation should be a detailed explanation as to how the price and spread was determined, along with external data proof.

Credit modelling

As most subsidiaries are small and have no independent credit rating, an approach must be taken to attempt to define their creditworthiness. Standard metrics can be used to ascertain an internal rating. Just with a normal external loan, attention should be paid to the ability to repay. Whilst tax authorities may question the integrity of the credit modelling matrix, this can at least be negotiated if a dispute arises. If no matrix is available, then problems can occur.

Pricing

As previously stated, an internal loan should replicate the general conditions of an external loan. That means that when trying to determine the interest rate, full attention should be given to the funding costs of the main company. They need to determine what price they would pay externally to fund the loan and then apply a premium to the subsidiary. Traditionally rates can be fixed or floating with a premium.

Corporate Governance

Internal loans should always be monitored. They should not be a quick substitute for proper due diligence. Problems can easily arise if tax authorities reached the conclusion that the loan is being extended to a loss-making entity that would not receive funding externally.

Debt Compliance – can you make the grade?

| 01-12-2017 | Paul Stheeman |

Debt ComplianceWe welcome a new expert – Paul Stheeman, who immediately brings us an interesting topic that has not been covered in much detail up to now. It goes to show that there are many facets in the role of treasurer and we can constantly find new subjects that have not been approached. Thank you, Paul.

Depending on the financing method chosen, your company is likely to have debt or some kind of financial obligations to third parties. This can be in the form of loans, bilateral or syndicated, or in the form of a bond issue. In each case, the underlying agreement has to be well-documented and could be very extensive with several hundred pages of legal language which, for a non-lawyer, may be very difficult to understand.

In that documentation there will be clauses stating what the debtor is allowed and not allowed to do. Another important part of the agreement will be around financial covenants. These are usually ratios which the debtor has to regularly fulfil. It is commonly the responsibility of the Treasurer to ensure that the terms of the agreements are adhered to and to report the status of the covenants to the lenders and investors. To be able to do this the Treasurer will have to work closely with the company’s lawyers, the accountants and the Controller. He furthermore has to “educate” key internal stakeholders in the requirements, so that they also are aware of any hurdles which may prohibit them in carrying out their day-to-day business. This whole process is commonly known as debt compliance.

A loan agreement will typically have between one and five financial covenants which need to be tested and reported to the lenders on a quarterly or semi-annual basis. One of many examples of financial covenants is a coverage covenant, which requires the debtor to maintain a minimum level of earnings or cash flow relative to certain expenses, e.g. interest or debt service. Typically, such numbers are prepared in the accounting department, but the Treasurer will have to ensure that these figures are prepared timely and are within the thresholds allowed in the financing agreements. If these criteria are not met, then the debtor will be in breach of the covenant(s) and technically will be in default.

Default can also arise when so-called prohibited transactions are entered into or “basket” limits are overdrawn. In many agreements the debtor is not allowed to enter into any other financial obligation. This may in practice prohibit the debtor in carrying out his normal course of business. For example, he may be required to issue a performance guarantee. This would initially not be allowed under the agreement. Lenders therefore establish baskets with a threshold amount up to which the debtor may have a bank issue a performance guarantee. Again here, it will be the Treasurer’s responsibility to ensure that all such transactions fall within allowed business or baskets.

Being in default due to a breach of a covenant or a basket could mean that the outstanding debt becomes immediately repayable in full. This is usually neither in the interest of the debtor or the lender, so that the lender can apply for a waiver. It will depend on the seriousness of the breach, but these waivers are often agreed to by the lenders. However, there will be a fee which the lender will have to pay for the waiver and this can be quite substantial.

To summarize, debt compliance is a very important part of a Treasurer’s role as the consequences of non-compliance can at best weaken the company’s position towards its lenders and at worst be disastrous as lenders call on outstanding debt to be repaid immediately.

 

Paul Stheeman

Owner of STS – Stheeman Treasury Solutions GmbH

 

Treasury ABC Part III

| 29-07-2016 | Jan Doosje |

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For many people Treasury is, as they think, something that is not concerning. Because there are many items that could be mentioned and listed here, I chose to mention the items that have effect on our daily lives, even if we are not aware of the existence of the described item. Last week I published the second part of the treasury ABC which I’ll call the Treasury ABC for normal citizens. 

 

K is for Key Performance Indicators

Similar for almost all type of branches also implementing Key Performance Indicators can be very helpful for goal setting and monitoring your Treasury performance. E.g. a Treasury Key Performance Indicator can be the achieved return on investment, the percentage of invested capital in AAA obligations, the maximum percentage allowed investment in options or the days you can finance your running business compared with your liquidity. Of course, many more examples can be given.

L is for Loan

You can give a loan or receive a loan depending your need for cash/investment means or your “overliquidity”. A loan is the most simple instrument for Treasury purposes and helps you to finance your (temporary) need for cash or, if you are the lucky guy to give the loan, to increase your return on investment (compared to the percentage you get e.g. from banks or national governments). The loan contract defines the sum of money, the interest percentage you have to pay or the counterparty will receive, the repayment schedule and, if applicable, other conditions.

M is for Mortgage

A mortgage is generally spoken involved when you buy a house or another fixed asset (offices, factory, etc.) Not that many people have the financial means to pay for a house at once so a mortgage is then a way to finance the capital needed. It’s not easy to get a mortgage nowadays because there are a lot of regulations and conditions you have to fullfil before you will get the money on a deposit. In far most of mortgages the house you buy will be the security for the bank who provides you with the mortgage. Furthermore, banks will check if you have enough capacity to pay back the mortgage timely, if are a trusted person, the value of the house when you have to sell it unexpectedly when e.g. you become ill or lose your job.

N is for (Treasury) Note rates

A treasury note rate gives you information of the return of investment if you buy notes from a government. The rate depends of course on the time and risk of the note. If you buy a note from the Greek government you will get a higher yield then a note from Germany but the risk if you will lose your money is higher with the Greek note. Furthermore the yield depends on the kind of security (in time) you buy. The yield for long term notes will mostly be higher then a note for a month. So two main ingredients define the yield you will get; risk and the duration.

O is for (Treasury) Officer

In larger organisations you will find one or more treasury officers which are involved in daily operations in Treasury and also in Treasury policy. As Treasury has its own habits and language it’s important to know what you do in the field of Treasury and are aware of the risks. We have seen a lot of organisations gone (almost) bankrupt because they thought they knew what they were doing but it turned out to be, in some cases, exact the other way around. Therefore it is advised to have one or more educated Treasury officers in your organisation.

P is for Pension Fund

For some people the question of the solvency of your pension funds (if you have any) is more relevant than for others. Mostly your own age is an important  “trigger” or awareness around Pension Funds. There are several kinds of Pension Funds e.g. for government employees, employees from a certain branch or a pension fund from a certain private company. Anyway, in all cases, you, as a contributor to the pension fund, want to have certainty to receive a pension when you are entitled to it and that the amount you will get is the same you expected. Nowadays, since the financial crises from 2008, the uncertainty of obtaining your proper pension is bigger because the yields which pension funds achieve are lower than they should be to adhere to long-term achievements.

Q is for Quote

A quote is an offer from a counterparty which they give you when calling them. For instance, if you call the bank and want to buy USD and you ask “Can I get a quote for 1000 USD?” and the answer is “You can buy USD 1000 for € 98.” and you accept it, the deal is done. So take care saying “yes” or “I accept” because you have to buy the USD 1000 for the amount of euros but also the bank has to deliver for that price. A quote is therefore not as “free” as it sounds.

 

Talking to our readers and contributors we have noticed that there are treasury related words with many different understandings. We’ve asked Jan Doosje to kick off a treasury ABC. Of course this is not binding and there are letters which can be connected to several treasury related words We need your input to make a complete treasury ABC. Would you like to contribute to the treasury ABC? Please contact our community manager Stephanie Derkse via [email protected].

Jan Doosje

 

Jan Doosje

Owner of Fimterim Advies & Consultancy