One of the Last Big Buyouts Is Now Haunting the CDS Market

  • iHeartMedia triggers credit event with foregone payment
  • ‘Significant’ deficiency may be seen in CDS product: Barclays

Some 20 years after their invention, credit default swaps are still going through growing pains.

Late last month, the International Swaps and Derivatives Association ruled that the decision of iHeartMedia Inc. to forgo payment on $57.1 million of bonds due to an affiliate constituted a “Failure to Pay Credit Event.” That would trigger payouts on as much as $749 million of swaps linked to the U.S. radio broadcaster’s debt.

The decision is causing consternation among some participants in the CDS market, which has been struggling to revive volumes in the aftermath of the financial crisis. According to Barclays Plc analysts, it’s the “first instance that we can recall of CDS being triggered by a company’s failure to pay itself.”

It also means one of the last so-called “jumbo” leveraged buyouts of the pre-crisis era -- iHeartMedia racked up about $21 billion of debt thanks largely to a 2008 buyout by Bain Capital and Thomas H. Lee Partners -- is now haunting the CDS market. iHeart forewent payment on bonds due Dec. 15. to its affiliate, Clear Channel Holdings, in a move likely aimed at maintaining control over some key collateral, according to analysts.

‘Significant Deficiency’

The ISDA ruling “was consistent with both past decisions and the definitions as they are written, but we think this outcome will be viewed as a significant deficiency of the CDS product,” said the Barclays analysts led by New York-based Vincent Foley. “Investors may be less inclined to sell CDS protection, especially as the iHeartMedia situation could provide a road map for other distressed issuers to do similar, particularly if they are involved in contentious negotiations with basis holders and seeking to restructure their balance sheets.”

Such basis trades generally see investors attempt to arbitrage differences between cash bonds and CDS spreads, and have been a source of tension between companies and investors.

The ruling could put a powerful tool in the hands of companies seeking to clear out basis holders who want to profit from corporate defaults, some analysts say. Others argue the association may eventually alter its definition of credit events to prevent future repeats of the radio saga.

“An issuer can purchase its own notes through an unrestricted subsidiary, decide not to pay its own note holdings at maturity, and trigger a CDS credit event,” Philip Brendel, a credit analyst at Bloomberg Intelligence in Skillman, New Jersey, told Bloomberg News last month. “The effects on the company itself may be minimal since no outside creditors or suppliers are directly affected -- just the side bets in the CDS market.”

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