On December 21, 2016, the International Swaps and Derivatives Assocation, Inc. (ISDA) announced that its Americas Credit Derivatives Determinations Committee (the DC) had unanimously resolved that a Failure to Pay Credit Event occurred in respect of iHeart Communications, Inc. (iHeart). Of particular interest, the DC subsequently released a statement summarizing the anaysis underlying its decision - an elaboration of its voting results that the DC seldom provides to the market.1
The DC is comprised of sell-side, buy-side and other market partcipant representatives who decide whether (among other things)2 an event or set of circumstances reating to a Reference Entity constitutes a Credit Event under commonly-traded credit default swaps (CDS). A DC finding that a Credit Event has occurred is binding universally on standard CDS contracts made on any such Reference Entity, and, generally speaking, triggers the obigaton of CDS protection sellers to make payments to protection buyers as compensation for losses incurred in respect of various debts of the Reference Entity.
When the DC convened in late December, the Reference Entity at issue was iHeart, a borrower under various unsecured credit facilities and the issuer of certain senior notes, some of which became due on December 15, 2016. On that due date, iHeart paid $192.9 million of the outstanding principal balance owed to most of its noteholders. It did not, however, repay the remaining $57.1 million of the notes held by one of its wholly-owned subsidaries, Cear Channel Hodings, nc. (Clear Channel).
iHeart's reason for its selective repayment of the notes was explained in public filings and court documents prior to the due date. On December 12, iHeart petitioned the District Court of Bexar County, Texas for a declaratory judgment that the notes held by Clear Channel should be deemed outstanding until their repayment or cancellation. A contrary finding would, according to iHeart's submissions, trigger onerous "springing lien" provisions under its credit facilities and other indentures, which require outstanding loans and bonds thereunder to become secured by additional collateral once the aggregate outstanding principal amount of the notes (among other iHeart debt securities) drops below $500 million. iHeart also stated in public filings that its subsidiary did not intend in the foreseeable future to collect on the notes or request that the note trustee exercise remedies with respect to any nonpayment by iHeart.
Because iHeart paid all principal due on notes held by third-party noteholders, any creditor that held the notes to maturity would not have experienced a loss on the notes themselves. Nonetheless, iHeart's ultimate non payment of the notes held by its subsidiary raised the question in the CDS market as to whether these circumstances constituted a Credit Event under the relevant ISDA Credit Derivative Definitions (Credit Definitions).
According to Section 4.5 of the Credit Definitions3, a Failure to Pay Credit Event is triggered by:
after the expiration of any applicable Grace Period (after the satisfaction of any conditions precedent to the commencement of such Grace Period), the failure by the Reference Entity [e.g., iHeart] to make, when and where due, any payments in an aggregate amount of not less than the Payment Requirement under one or more Obligations, in accordance with the terms of such Obligations at the time of such failure.
At least one credit protection seller, represented by the law firm of Linklaters, argued to the DC that no Failure to Pay occurred with respect to the notes held by Clear Channel. Linklaters grounded its argument on the fact that such notes were not truly "due" as a result of iHeart's and Clear Channel's arrangement whereby Clear Channel would not seek to collect on outstanding note amounts until some date in the future. Rather, iHeart and Clear Channel had effected a de facto deferral of the due date.
This position was challenged in another memorandum filed by the law firm of Paul Weiss, in which it argued that the non-payment of Clear Channel notes was a Failure to Pay by virtue of iHeart's non-payment of obligations when due "in accordance with the terms oi" the notes' indenture. The Paul Weiss memorandum also cited prior DC decisions as precedent to support its position that any creditors' "forbearance from exercising remedies upon a default does not affect the determination of a Failure to Pay." It further noted that many market participants and at least one ratings agency (S&P Global Ratings) already viewed the non-payment as a default.
Ultimately, all 15 voting members of the DC agreed that a Failure to Pay Credit Event had occurred. Typically, DC resolutions are released without commentary or reasoning. In this case, however, all of the members also agreed to publish a post-decision statement. That statement describes a close and conservative parsing of the wording of Section 4.5 - without any discussion of economic realities or policy concerns - to arrive at the conclusion that iHeart's non-payment of some of the outstanding notes constituted a Failure to Pay.
We believe the statement communicates the DC's intention to hew closely to the text of the Credit Definitions. Accordingly, when analyzing a potential Credit Event, market participants should continue to give heavy weight to the precise wording of the relevant Credit Definitions, even when adherence to the text yields counterintuitive outcomes which may be at odds with the economic realities of the situation or where countervailing policy considerations are at play. Arguably the iHeart determination, which requires credit protection sellers to pay protection buyers even though investors who held the notes suffered no loss, creates an unexpected outcome for certain CDS market participants. For those familiar with the Credit Definitions at a technical level, however, the result is uncontroversial given the clear contractual language governing CDS transactions.