Restricted vs Unrestricted subsidiaries

@diya – your first statement sounds contradictory to @vincentt’s. The other way around?

My thinking is:

1. The difference between restricted vs. unrestricted subsidiaries is that restricted ones are tied to the debt covenants of the parent issuer, whereas unrestricted one is not. So the debt at parent (issuer) level is pari passu to the restricted subsidiary. This is done to reduce credit risk for bond holders (and thus borrowing cost for issuer) as there are more assets that are governed by the debt covenants, and if all fails, bondholders have access to assets of the restricted subsidiary. This is normally done when the parent company is a holding company and has various subsidiaries, but the debt is to be issued at “parent/Hold Co level” – so bond investors want to ‘ringfence’ more assets as this Hold Co is just an empty holding company.

2. Not necessarily, parent company can use cash from unrestricted subsidiaries through other arrangements such as inter-company loans etc. But debt covenants only covers HoldCo and its restricted subsidiaries.

3.Not necessarily, restricted subsidiaries can be of any choice structured during the debt issuance, but usually it’s worth a lot (or going to be) in terms of asset, to reduce credit risk of the issuer. If a subsidiary is unrestricted, it is not bound by the rules under the debt covenants, which for example may impose certain interest coverage ratio, or have a maximum borrowing % in the capital structure etc – all limitations/restrictions done to protect the interest of the bondholders.

1. The main difference between restricted and unrestricted subsidiaries is that in a restricted subsidiary the subsidiary debt is structurally subordinate to the parent’s debt. Or in plain English when a subsidiary is restricted the parent’s debt ranks above the subsidiary’s debt.

2. I’m not totally sure about that because I recall reading somewhere that the parent can move subsidiaries from restricted and unrestricted category. It would depends on the bond’s indenture and how the relationship is stipulated between the parent and subsidiary. But from my understanding the parent can’t use cash flow from the unrestricted subsidiary if it will adversely affect the subsidiary’s bondholders.

3. The benefit of being unrestricted is that subsidiary’s debt is NOT structurally subordinate to the parents and may be able to command a higher credit rating and therefore the borrowing cost is lower.

@Sophie thanks. I need to re-read my explanations more carefully!

I think all 3 points are best understood by looking at what restricted and unrestricted subsidiaries are.

Restricted and unrestricted subsidiaries are terms that are defined by a specific loan agreement or indenture, whereby restricted subsidiaries are subsidiaries identified by the agreement that need to comply with certain covenants, pledge collateral and so on. Unrestricted subsidiaries are ‘outside of the system’ and have nothing to do with the loan agreement.

So when you refer to ‘service the debt’ here, you’re actually talking about a very specific loan, not just any debt.

Hence to your point 2, it’s not that the parent company isn’t allowed to use CF and assets from unrestricted subsidiaries to service the (specific) debt. They probably can achieve that by using intercompany loans and other agreements. It’s more the point that the restricted subsidiaries are required to service the debt by agreement.

Point 3 – when drafting terms of the agreement, usually the subsidiaries you’d want to list as restricted are the large significant ones (as they have a better chance of guaranteeing the debt properly). Again, it’s down to the specific agreements and there isn’t a strict rule on what ‘should’ be restricted or not. To that end, I suppose the benefit of being unrestricted is as @diya says – better credit rating and generally need not adhere to the covenants as stipulated by the loan agreement.