Photo of John Chamberlain and Fred Schacknies, Hilton Worldwide.

Hilton’s story is noteworthy in the degree of turnaround relative to the original problem. They had a large, complex portfolio of intercompany loans, maintained in multiple databases and without a policy governing associated transactions. It had no comprehensive visibility to aggregate positions or exposures. Hilton had no prospective sense of potential FX risk to earnings or cash flow. Lacking that information, it had no ability to mitigate either risk. Today, Hilton’s intercompany loan portfolio has been reorganised and dramatically simplified. Read how they did it.

The challenge

On 26th February 2016, the President and CEO of Hilton Worldwide announced the company’s intention to spin off its real estate and timeshare businesses as independent companies. Aligned with the objective of capital efficiency, the residual operating company would need a sharper focus on financial risk management. In anticipation of this, the treasury, tax and accounting teams were busy wrapping up a multi-year initiative to rationalise, reduce and mitigate FX risk.

As a natural by-product of its growth through acquisitions, Hilton had accumulated a large and complex portfolio of intercompany loans. Any cross-border loans in the portfolio created FX volatility to different degrees in earnings and cash flow, and whilst the effect on net income was material it did not always reflect the underlying cash flow.

There were numerous options available to the team. Hedging the entire loan portfolio with derivatives would have neutralised the earnings volatility, for instance, but at considerable cost and with real implications for liquidity, as not all loans were associated with the underlying cash flow.

Winning this award is a great recognition of the efforts of many individuals across treasury and other parts of the organisation over several years, and a standard to live up to in future endeavors.

“A ‘Gordian knot’ solution of simply writing off all loans would have also eliminated the FX noise in earnings, but would have materially impacted the statutory results and capitalisation of many legal entities in different jurisdictions,” says Fred Schacknies, VP & Assistant Treasurer at Hilton Worldwide.

Hilton therefore needed a solution that would provide visibility across the portfolio and one that had the ability to mitigate both cash flow risk and earnings risk, without the adverse ancillary consequences for the legal entities involved.

The solution

At first, the company needed to gain control and visibility over the transaction data by capturing all intercompany loans in a single system. With a single, comprehensive data-set in hand, it could then assess the earnings and cash flow characteristics of each loan in the portfolio, with input from individuals in the treasury, tax, accounting and operations finance teams.

As a result, risk could be measured in terms of notional exposure, simple factor sensitivity and probabilistic models (value-at-risk), which could then be calibrated with the benefit of historical results data. With this information:

• Any new and existing loans with cross-currency cash flow impact were targeted for hedging under the umbrella of a new in-house bank structure.
• Any loans deemed to be of a long-term nature were designated as such per ASC 830 (US GAAP).
• Remaining loans were flagged for restructuring under a rationalisation plan.

Best practice and innovation

Most multinationals engage in intercompany lending and many struggle with the cross-currency implications, which can be clouded by byzantine considerations of accounting, statutory reporting, tax planning and financial markets.

Hilton’s approach demonstrates best practice and innovation by:

• Incorporating diverse inputs from a multi-functional team.
• Clearly defining and differentiating its objectives with respect to FX risk to both earnings and cash flow.
• Incorporating robust data management and advanced risk measurement techniques. These views of risk allowed Hilton to measure potential impacts to earnings and to cash flow, at various levels of aggregation, from individual transactions to legal entities, countries, regions and the consolidated corporate parent.

Moreover, by segregating the investor optics of GAAP earnings from the underlying economics of cash flow risk, Hilton was able to achieve meaningful improvements on both fronts. By routing all cash-impacting intercompany activity through an FX hedging programme, Hilton has been able to reduce FX cash flow risk to a negligible level.

Schacknies concludes: “Our intercompany loan portfolio has been reorganised and dramatically simplified. All data is in one place and subject to a common policy. We have clear visibility to the FX impacts to both earnings and to cash flow and the ability to measure potential future risk to each.”

Key benefits

• Improved risk management.
• Reduced below-the-line FX earnings volatility by over 80%.

Key takeaways

For other organisations undertaking similar projects, key principles to consider are:

• Start with clean and comprehensive data.
• Ensure centralised controls over transactions.
• Consider independent impacts to cash flow and earnings and appropriate solutions for each.