Contingent Capital

Funds that would be available under a pre-negotiated agreement if a specific contingency (such as a natural disaster) occurs or a threshold (such as the maximum price of a raw material or the minimum price of product) is crossed. In this off balance-sheet arrangement, a party pays a capital commitment fee to a second party which undertakes (in advance) to extend a loan or purchase debt or equity security of a certain amount in case a stated situation occurs. Thus, the first party does not transfer its risk (as in insurance, which affects the income statement) and does not have to show a liability on its books (as for a loan, which affects the balance sheet), but receives a critical capital injection exactly when it is needed without having to negotiate from a position of weakness. Contingent capital arrangements take several forms, such as a catastrophe equity put option, contingent surplus note, or standby loan.