Thursday, October 15, 2009

Thomson auction to inform debate about value of restructuring credit event

Posted on Structured Credit Investor:

The forthcoming Thomson CDS auctions have raised a number of thorny commercial and legal issues, including whether there even should be a restructuring credit event in Europe. However, the market appears to be engaging with these issues and potentially finding solutions to them.

The outcome of the Thomson auctions will inform market debate over whether a restructuring credit event has value to participants, according to one portfolio manager. "The decision post-auction about whether such an event has value will ultimately be price-related," he explains. "If the recovery is extremely high, buyers will question whether the protection is worth having. A distorted settlement with minimal collection will lead to doubts about the whole process."

The auction process is also likely to influence the approach of banks to restructuring negotiations themselves going forward, as well as the drafting of facility agreements at the origination stage to further facilitate any holders of CDS settling their positions in similar circumstances in the future. "Negotiations could shift in favour of lenders and/or potentially limit their participation in restructurings, but they could also result in more clarity around disclosure of CDS positions and transferability of obligations," the portfolio manager agrees.

ISDA announced last week that three auctions will be held with respect to Thomson, with settlement terms still to be published for each of the three designated range of scheduled termination dates - up to 20 June 2012, from 21 June 2012 to 23 October 2014 and from 24 October 2014 onwards. The final list of deliverable obligations has also been published and comprises nine private placement notes and three tranches of the revolving credit facility.

Following the publication of the final list, CDS sellers had two days to trigger their contracts and CDS buyers a further three days. The timing of the auctions will be confirmed once this process has been completed, with 21 October anticipated by many as the likely auction date.

The requirement to choose whether or not to trigger before knowing the details of the auctions was a difficult proposition for some investors, however. Together with concerns about recovery prices being pushed artificially high by a squeeze, other relevant considerations about whether to trigger include the possibility of waiting for a bankruptcy or failure to pay credit event to occur in the future, the potential for any debt held to be deliverable in the auction given the restructuring agreement (and, if so, would the price achievable be greater/less than the auction final price used for settling the CDS) and whether an indemnity would be required in relation to the revolving credit facility.

The likelihood of squeezes in baskets was a major issue for investors, the portfolio manager confirms. But he says that his understanding is that most protection buyers have triggered their contracts.

"This doesn't take anything away from the fact that it was a tough call to make, given the lack of visibility around a potential auction price," the portfolio manager adds. "Triggering means that you lose the value of the protection, so it is a question of weighing the decision to collect now against the potential for prices to rise after the auction or the likelihood of a bankruptcy/failure to pay credit event occurring in the future. Further credit events being called on Thomson look less likely now, however, given that it appears enough lenders have supported the restructuring."

Structured credit strategists at Citi point out that the zero to 2.5-year bucket, in particular, has the potential to see a significant price squeeze if the volume of protection sold is large relative to the volume of unrestricted outstanding deliverable obligations. "For holders of the obligations, though, this represents a sizeable opportunity," they add. "Upon completion of the restructuring, Thomson has stated that all holders will receive a package of restructured securities with the same value."

Looking ahead, there are a number of potential restructuring candidates in Europe, with CIT being the most obvious. CIT is widely traded in CDS indices and is a commonly occurring reference name for US and European CDOs, as well as first-to-default baskets. The Citi strategists note that an awkward auction for Thomson at a time when other restructurings are likely will focus attention on the CDS market - just at the time when it needs to be able to demonstrate reformed efficiency and fairness.

"An unsatisfactory Thomson restructuring CDS auction is likely to be too obscure to cause the market much reputational damage," they observe. "Long-term, however, such issues need to be ironed out. Restructuring events are likely to become increasingly common and more high-profile."

Thomson CDS are now said to be trading at post-restructuring levels of around 9/13, compared to around 19/22 in recent days.

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