Intercompany receivables and sponsor affordability in the context of COVID-19
Intercompany receivables are often a significant proportion of the assets of DB pension scheme sponsors. They can represent a source of affordability albeit less liquid and reliable than cash. The lower reliability stems from the sponsor’s exposure to the creditworthiness of the receivable counterparty.
In today’s unprecedented economic climate, liquidity – specifically, preserving it until business stabilises in the post-COVID-19 world – is key. This is at the forefront of corporate survival strategies, as shown by cost reductions, creditor deferrals, and dividend suspensions, that have become part and parcel of the COVID-19 landscape.
In this context, a sponsor may find itself with mounting intercompany receivables, as funds are redirected to settle non-deferrable liabilities elsewhere in the wider-Group.
Where a Group (and more importantly, the receivable counterparty) has strong fundamentals and a robust business plan to return to profitability and repay the sponsor, increasing intercompany receivables may represent a relatively liquid and credit-worthy asset on the balance sheet, although intra-group dynamics and governance may impact how willingly these balances are repaid.
Where a Group is not so well-placed, there may be a risk of counterparty insolvency, and non-recovery of the loan. Subject to the sponsor’s own cash generation abilities, affordability and the covenant more broadly may be impacted in this scenario.
No matter the Group’s position, when considering intercompany receivables trustees should review and continually monitor the following:
- The recourse that the sponsor, or the scheme, has to the receivable counterparty;
- Any protections that exist in the event of counterparty distress, such as security / collateral;
- The financial terms attached to the receivable, e.g. interest rates and maturity; and
- The Group and counterparty’s trading performance and core business prospects.
The above will give provide insights into whether the intercompany receivables provide meaningful value to the sponsor, and contribute to affordability. To the extent that cash lent to the Group is not recoverable, trustees should monitor this extraction of value and take actions to protect the covenant of their scheme.
Flo Gracey, Analyst
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