Limitation on Subsidiary Debt: Definition

Limitation on subsidiary debt is a bond covenant that restricts how much debt the issuer’s subsidiaries — especially those that do not guarantee the bonds — may take on, protecting bondholders from structural subordination.

What it means

Most bonds are issued by a parent or holding company, while the group’s assets and cash flows sit in operating subsidiaries. If those subsidiaries borrow in their own name, their creditors get paid from the subsidiaries’ assets first; the parent’s bondholders only receive what is left after climbing the corporate ladder. This disadvantage is called structural subordination, and it exists even when the parent’s bonds are labeled “senior.”

The covenant tackles the problem at its source. A typical clause caps debt at non-guarantor subsidiaries — through a basket sized as a fixed amount or a percentage of assets — or requires any subsidiary that incurs debt above the threshold to also guarantee the bonds, so bondholders are not left behind.

Why it matters for bond investors

Two bonds from the same group can have very different recovery prospects depending on where in the structure the debt sits. A holding-company bond without this covenant leaves the issuer free to shift borrowing down to its operating companies, quietly pushing existing bondholders further from the assets. Checking for a limitation on subsidiary debt — and how large its baskets are — is a core part of assessing where a bond truly ranks.

This definition is for general information only and is not investment advice. Bond investing involves risk, including possible loss of principal.

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