The Situation: Following a recent court
decision holding that Windstream Services, LLC
("Windstream") failed to pay hundreds of millions of
dollars in accelerated debt in 2017, the Credit Derivatives
Determinations Committee ("DC") was asked to determine
whether a Failure to Pay Credit Event had occurred on Windstream
credit default swaps ("CDS").
The Result: Apparently locked in by its own prior
decision in 2017, and the amount of time that had elapsed since
bondholders had purported to accelerate Windstream's debt, the
DC concluded that no Failure to Pay Credit Event had occurred under
Windstream CDS.
Looking Ahead: Windstream's bankruptcy filing
should allow holders of current CDS protection to collect on their
contracts after the upcoming Bankruptcy Credit Event CDS auction,
but buyers whose credit protection expired prior to the occurrence
of that Credit Event are unlikely to be helped by it.
In January 2013, Windstream issued $700 million of senior
unsecured notes ("Notes"). The indenture for the Notes
("Indenture") prohibited Windstream and its subsidiaries
from entering into a "Sale and Leaseback Transaction"(as
defined in the Indenture). After issuing the Notes, Windstream
formed a new parent holding company ("Holdings") and a
real estate investment trust it planned to spin off as a separate
publicly traded company ("Uniti"). In 2015, Windstream
sold assets to Uniti, and Holdings entered into a master lease with
Uniti subsidiaries ("2015 Transaction").
Following the 2015 Transaction, Aurelius Capital Master, Ltd.
("Aurelius") built up a substantial positon in the Notes
and in September 2017 it delivered a default notice claiming the
2015 Transaction constituted an impermissible Sale and Leaseback
Transaction. In October 2017, the trustee for the Notes
("Trustee"), at the direction of Aurelius, sued
Windstream in the Southern District of New York ("Court")
in connection with the alleged Indenture violation, and Windstream
filed counterclaims against the Trustee and Aurelius the following
day. Windstream also engaged in a series of exchange offers and
consent solicitations in October and November that were aimed at
obtaining the requisite consents to waive the alleged default.
Notwithstanding Windstream's efforts, upon expiration of the
cure period for the alleged default, Aurelius delivered a notice of acceleration which purported to
declare the Notes immediately due and payable on December 7,
2017.
On December 15, 2017, an anonymous CDS market participant submitted a request to the DC asking it to
either: (i) find that a Failure to Pay Credit Event had occurred
based on Windstream's failure to pay the Notes upon the
purported acceleration; or (ii) toll its decision, leaving current
CDS contracts outstanding, pending the outcome of the litigation.
The DC did neither. Based on the information available to it, the
DC unanimously determined that no Failure to
Pay Credit Event had occurred.
Following a July 2018 trial, the Court issued a decision on February 15 ("Court
Decision") finding that: (i) the 2015 Transaction constituted
a default under the Indenture, (ii) the notices of default and
acceleration were valid and effective; and (iii) all principal and
accrued and unpaid interest on the Notes became immediately due and
payable on December 7, 2017.
On February 20, two anonymous CDS market participants again requested that the DC determine whether a
Failure to Pay Credit Event had occurred in light of the Court
Decision. The DC unanimously resolved six days later that
"on the basis of the Publicly Available Information submitted
... no Failure to Pay Credit Event has occurred." This may
seem like a counter-intuitive outcome but, while the DC did not
elaborate on its rationale, the outcome is consistent with the
concept of the Credit Event Backstop under the CDS Definitions.
This "backstop" increases fungibility among CDS by
"erasing" alleged Credit Events that occur prior to a
60-day lookback period from the date of any given DC request,
irrespective of the trade date for individual transactions. The
Court Decision held that the Notes became due and payable in
December 2017, about a year prior to the Credit Event Backstop Date
for the February 2019 requests.
The DC also rejected another Failure to Pay Credit Event request it received on February 26 which asked
the DC to reverse its December 2017 resolution. Fortunately for
current CDS protection holders, the DC did find that a Credit Event occurred when
Windstream filed a chapter 11 bankruptcy petition on February 25.
But the Bankruptcy Credit Event will do nothing to help those whose
credit protection expired worthless prior to the bankruptcy filing
date.
This situation highlights the unique role the DC plays in the CDS
market. The DC, which is made up of 10 dealer and five buy-side
representatives (who may have their own positions that will be
impacted by the determinations they make) are charged with making
quick decisions based on limited information in order to aid the
efficient functioning of the market. Litigations, on the other
hand, can play out over years and involve fulsome discovery.
Whenever a party enters into a CDS it is effectively putting its
faith in the hands of the DC, which will ultimately decide whether
or not a Credit Event has occurred, regardless of whether a court
later decides the DC's determination was wrong.
Three Key Takeaways
- The DC and the Court have issued seemingly contradictory decisions regarding whether Windstream failed to make an accelerated debt payment in December 2017.
- While current holders of Windstream credit protection should get paid on their CDS based on Windstream's recent bankruptcy filing, those parties whose CDS protection expired prior to the bankruptcy filing are unable to collect on their contracts.
- The situation illustrates the unique role the DC plays and the faith that parties place in it every time they enter into a CDS.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.