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?