Credit Default Swap based loan pricing

This briefing note suggests some points for treasurers to consider before contemplating such a basis for loan pricing.

Borrowers are advised

  • to recognise the nature of CDS prices/spreads
  • to be cautious in using CDS based pricing, especially for lines which may be drawn
    - to consider, for example, a pricing grid (ratings or ratio driven pricing grid) with modest increments as an alternative

Where it seems CDS based pricing is either unavoidable or appropriate, probably for lines intended as standby lines and unlikely to be required to be drawn, borrowers will generally seek,

  • not to accept CDS based loan pricing with the margin un-capped or with a formula which might increase the cost of debt by more than a modest amount
  • to pay particular attention to
  • - the fraction of CDS price/spread to be added to the rate index
    - the method of determining the CDS price to be used in the calculation

  • to ensure that alternative pricing mechanisms are available if CDS prices are unavailable or seem to unreliable at any particular rate setting

The usual concerns of any company negotiating any loan still apply, of course.

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