FORD\'S DEBT TRANSFERS An advantage when one corporation controls another is tha

Question

FORD'S DEBT TRANSFERS

An advantage when one corporation controls another is that the controlling entity's management has the
ability to transfer resources between the two legal entities as needed. For example, the controlling corporation
may make loans to or borrow from the other entity when cash is short. The borrower often benefits from
lower borrowing rates, less-restrictive credit terms, and the informality and lower debt issue costs of
intercompany borrowing relative to public debt offerings. The lending affiliate may benefit by being able to
invest excess funds in a company about which it has considerable knowledge, perhaps allowing it to earn a
given return on the funds invested while incurring less risk than if it invested in unrelated companies. Also,
the combined entity may find it advantageous for the parent company or another affiliate to borrow funds for
the entire enterprise rather than having each affiliate going directly to the capital markets. Ford exercised this
option in 2009.
Between January 2003 and January 2008, the U.S. economy underwent one of the biggest booms in its
history. The NASDAQ, S&P 500, and Dow Jones Industrial Average all increased by at least 60 percent, with
the NASDAQ jumping almost 100 percent. However, such unprecedented growth could not continue
indefinitely. Beginning in early 2008 and continuing through 2009, the economy made a complete
turnaround. The housing bubble burst, Lehman Brothers closed its doors, and the great behemoth, General
Motors, was forced into bankruptcy. However, during this time of economic turmoil, Ford was able to wisely
use intercompany debt transactions to its advantage.
During the first quarter of 2009, Ford Motor Credit (a wholly owned subsidiary of Ford Motor Company)
paid $1.1 billion to purchase a portion of Ford Motor Company's senior secured term loan debt. Ford Motor
Credit then distributed the debt to its immediate parent, Ford Holdings LLC, which in turn forgave the debt.
By carefully managing its business, in part through a savvy application of debt transfers, Ford was able to
avoid much of the turmoil many other companies experienced during this turbulent period. This chapter
introduces accounting for debt transfers.

Question: How can intercompany indebtedness arm a corporation to successfully battle a financial crisis – as this type of intercompany activity did for Ford Motor Company?

Explanation / Answer

In intercompany indebtedness, the two parties of the debt instrument belong to same parent.

In the event of finanical crisis, generally the company which defaults the payments tends to lose its existence for the time being or forever in the capital market.

But in case of intercompany indebtedness, the parent company or any affiliate which has lend the money can easily forfeit the loan to make the financially unstable company to recover from the crisis and in the above example, Ford Motors done the same.

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