Dealers and buysiders met at the midtown office of BlueMountain Capital Management last Thursday and moved a step closer to hammering out the framework and ground rules for loan-deliverable credit default swaps, or LCDS. Jeff Kushner, managing director and head of execution at BlueMountain, said he anticipates a Dec. 1 meeting and is optimistic that a document will be ready to present to the Loan Syndications & Trading Association and the International Swaps and Derivatives Association after a Dec. 15 meeting. He stressed, however, that these dates are not set in stone. "I'm really excited that expectations are positive, but much like any other product, it is an evolutionary process," Kushner said. "I don't think we are going to solve this issue on day one."
One of the key challenges the group wrestled with last week was how to define "secured" as it applies to LCDS. One determination made around secured deliverables is that it would include any of the tranches within a single facility. For example, rather than one specific term loan or revolver of a company being deliverable, the idea would be for any of the company's similar term loans or revolvers to be deliverable.
The issue of what is secured is a key for sellers of protection and the rating agencies. "They need the language to be tight, but not tight enough to not allow you to get into a new contract," one trader said. The group also discussed settlement issues, and how to deliver on distressed documents.
The group has been sifting through the myriad of issues presented by private corporate loans. "Voting rights, amortizations and fees are other examples of loan characteristics built into the credit agreement that may not be able to be incorporated into a CDS contract," explained Jeremy Vogelmann, a loan CDS trader at Lehman Brothers and involved in the talks. "These and other issues are currently being discussed within the working group."
The group has so far agreed to make loans not cancelable, which differs from current practices in Europe. "The callable nature of loans (by the issuer) affects the way in which they trade and price," Vogelmann explained regarding the decision to allow deals not to be cancelable. "This call option is difficult to replicate in a product whose value is dependent on the ultimate maturity of the trade. For simlicity's sake, and in the interest of getting the most participants on board, we made this aspect of the product following existing CDS conventions."
Kushner explained LCDS would have mass appeal. "The dealers who have large loan portfolios would like to be able to hedge and as market makers also would like another product to trade," he said, adding that shops such as BlueMountain would use the product to increase the universe of the credits they can trade and expand arbitrage opportunities.
"One thing important to note is the willingness of everyone involved to compromise has just been fabulous," Kushner said. "I can't say enough. Everyone has their own vested interest from one side or another, but everyone has taken the approach not to create perfection, but to create a working product that has a lot of liquidity with the core belief being that if it is liquid."
The original group included Lehman Brothers, Credit Suisse First Boston, Morgan Stanley, Wachovia Securities, Goldman Sachs, Merrill Lynch and the Royal Bank of Scotland. Since the initial talk the group has grown to about 20 participants, including Bear Stearns, Deutsche Bank and Toronto Dominion. On the side of investors looking to buy protection to hedge their risks, individuals from Bank of America, JPMorgan, Citigroup and CSFB have joined in. Other groups are also involved including Anchorage Capital.
