The Warehouse Guarantee That Looked Like a Loan
A mid-sized distributor, Halvard Foods, guarantees a supplier's bank facility of EUR 4.0m so the supplier can keep delivering during a cash crunch. The guarantee sits off-balance-sheet and the risk register lists it as 'low - contingent'. Meanwhile Halvard's largest customer, representing 31% of receivables (EUR 2.6m), has just been downgraded two notches and is negotiating 120-day terms instead of 45. The CFO argues the guarantee is not a credit exposure because 'we have never had to pay on one'. The board risk committee meets in ten days and wants a single counterparty-risk view. Collateral is limited to a second-ranking charge over the supplier's aging refrigeration equipment, independently valued at EUR 0.9m. Halvard's total equity is EUR 7.5m and its internal single-name limit is 25% of equity.
1. Assess whether the guarantee and the customer concentration together breach the single-name limit, and explain the reasoning the risk committee should follow.
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A guarantee is a credit exposure: Halvard is obliged to pay EUR 4.0m if the supplier defaults, so the exposure should be treated as a direct, contingent claim rather than excluded because it is off-balance-sheet and has never been drawn. The correct comparison is exposure at default, not accounting classification.
Step 1 - measure each name. Supplier exposure = EUR 4.0m guaranteed amount less realisable collateral. The second-ranking charge over equipment valued at EUR 0.9m is weak: second-ranking means another lender ranks ahead, and equipment values erode under distress, so a prudent haircut (say 50% or more) leaves roughly EUR 0.45m of mitigation, giving an exposure near EUR 3.55m. Customer exposure = EUR 2.6m of receivables, with the downgrade and 120-day request signalling rising probability of default and longer exposure.
Step 2 - apply the limit. 25% of EUR 7.5m equity = EUR 1.875m per name. Both names individually exceed it: supplier at ~EUR 3.55m and customer at EUR 2.6m. This is a breach on two names, not one aggregate issue, because limits are single-name.
Step 3 - recommend action. The committee should (a) reclassify the guarantee as a material credit exposure in the register, (b) require collateral strengthening or a cash margin from the supplier, (c) cap or insure the customer receivable and shorten terms, and (d) escalate the breach with a dated remediation plan. The 'we have never paid' argument confuses historical frequency with exposure size and must be rejected.
2. The CFO proposes simply netting the supplier guarantee against payables owed to that supplier. Evaluate this mitigation.
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Netting is only valid where a legally enforceable right of set-off exists in all relevant jurisdictions, including insolvency, and where the amounts are due between the same parties in the same currency. Here the guarantee runs to the supplier's bank, not to the supplier, so Halvard's payable to the supplier is owed to a different counterparty than the beneficiary of the guarantee. Set-off against the bank is generally unavailable.
Even if a close-out netting agreement existed, netting reduces exposure at default only if it survives the supplier's insolvency. A guarantee called by the bank during a liquidity crisis is precisely when enforceability is tested, and the bank will demand payment independently of Halvard's trade payables.
Therefore the proposed netting should be rejected for limit-monitoring purposes. The committee can note it as a possible commercial lever in negotiation, but exposure measurement must assume gross EUR 4.0m less eligible collateral. This is a classic trap: legal form (payable) does not offset contingent obligation (guarantee) without a documented, enforceable netting opinion.