Two loan-only credit default swap contracts may soon be canceled as the underlying loans are taken out by the issuers, a first in the continually growing LCDS market. Market players speculate that LCDS contracts referencing Jean Coutu Group's term loan "B" and Georgia-Pacific's second lien will be the first contracts subject to cancelability in either the next few weeks or the first quarter of 2007. "It will prove to people that they don't always go for their full five years," a dealer said, noting the cancellation underscores some of the risk of LCDS. "A company may sell assets and the contract is up everyone knows that going into a contract."
LCDS contracts are non-callable in the event of a refinancing, but a contract is cancelable by either party if a deliverable loan, which is syndicated secured, ceases to exist. Georgia-Pacific's LCDS contract could be canceled as soon as Dec. 23, when the second lien is due to be taken out. Georgia-Pacific sought $1.25 billion in financing in late November to repay part of its $2.25 billion second lien (CIN, 12/4). The rest will be paid back with $1 billion in senior notes. A trader said the LCDS contract on the second lien would be cancelable because it has no other syndicated deliverable security of that priority.
LCDS for Georgia Pacific's first lien will continue to trade. A trader said that while LCDS on Georgia's first lien was one of the first to trade in big bites, the second lien is not actively quoted because of its limited duration. The LCDS is trading in the 95-105 context; the second lien is trading in the 100 1/4-1/2 range.
A trader said Jean Coutu's term loan will likely be taken out in the first quarter of next year. There is speculation the company will use Canadian banks to replace the term debt with an unsecured bank loan. The term loan will be taken out in connection with a new debt financing backing Rite Aid's acquisition of Jean Coutu's Brooks and Eckerd stores. Citigroup leads the financing for the $3.4 billion acquisition. As part of the deal, Rite Aid will assume $850 million of Jean Coutu's 8 1/2% senior subordinated notes (8/25). Rite Aid will carry the loans for the acquisition financing on its balance sheet.
In August, investors seeking to capitalize on a yield to call play bought into Jean Coutu's term loan "B" on the expectation the loans would be taken out at par in three to six months (9/1). The $1.1 billion term loan, priced at LIBOR plus 2 1/2%, is led by Deutsche Bank, Merrill Lynch and National Bank of Canada (LMW, 7/5/04). A trader said the term loan has traded down to 100 1/4 from 100 5/8-7/8 on the expectation the loan will be taken out a par. Calls to spokeswomen at Jean Coutu and Georgia Pacific were not returned.
Elliot Ganz, general counsel of the Loan Syndications and Trading Association, expects the cancellation of the contracts will not cause much of a blip. "It is definitely contemplated and addressed in the documentation," he said.
The issue of cancelability has been at the forefront of LCDS discussions both in the U.S. and in Europe. The U.S. chose a non-cancelable document--unless there is no replacement security, or another special situation--to help promote liquidity, traders said at the time of the decision (CIN, 11/18/05). In Europe, the LCDS contract terminates if the reference obligation goes away. European dealers are leaning toward a contract that would allow for trades in both cancelable and non-cancelable forms in the near term with many hopeful it will move to non-cancelable later (11/20). The International Swaps and Derivatives Association has been working with banks to develop a European confirm that would include a non-cancelable provision (11/3). An ISDA spokesman declined comment.
