Structured Credit Products: Credit Derivatives and Synthetic Securitisation, 2nd Edition

CHAPTER 11

Syndicated Loans, Loan-only Credit Default Swaps and CDS Legal Documentation1

INTRODUCTION

Loan-only credit default swaps (LCDS) are a later development of the over-the-counter (OTC) credit derivative. LCDS share the purpose of credit default swaps (CDS) in that they allow trading the credit risk associated with some debt obligation. ‘Traditional’ CDS are not intended to reference leveraged loans, an asset class that has become the primary funding source for sub-investment grade companies. In this chapter, we provide a detailed discussion of the characteristics of single-name US and European LCDS, and compare them to those of vanilla CDS. As background, we take a closer look at the differences between leveraged loans and high-yield bonds, as both are typical underlyings in LCDS and CDS, respectively.

The Emergence of LCDS

To raise debt capital, companies may issue bonds or loans (as well as other debt-like instruments not of relevance here), both of which are associated with a certain seniority or ranking. In a credit event, the borrower’s remaining assets are distributed according to a waterfall: obligations with the highest seniority are repaid first, and only if assets remain thereafter are obligations with lower seniorities repaid. Further, debt instruments may be secured or unsecured: if certain of the borrower’s assets are ring-fenced to serve as collateral for the lenders under a particular obligation only, this obligation is called ‘secured’. Together, seniority ...