Distressed Debt Restructuring in the Presence of Credit Default Swaps

Abstract

The availability of credit insurance via credit default swaps has been closely associated with the emergence of empty creditors. We empirically investigate this issue by looking at the debt restructurings (distressed exchanges and bankruptcy filings) of rated, nonfinancial U.S. companies over the period January 2007–June 2011. Using different proxies for the existence of insured creditors, we do not find evidence that the access to credit insurance favors bankruptcy over a debt workout. However, we document higher recovery prices following a distressed exchange in firms where empty creditors are more likely to emerge.

Shareholder bargaining power and the emergence of empty creditors

“…Danis (2017) provides further evidence of the empty creditor problem showing that creditors of CDS firms are less likely to vote in favor of distressed exchange offers. By contrast, Bedendo, Cathcart, and El-Jahel (2016) do not find any evidence that distressed CDS firms are more likely to file for bankruptcy.…”

Credit Default Swaps: Past, Present, and Future

“…Such views are echoed by Arentsen et al (2015), who document that the loan delinquency rate for subprime loans underlying mortgage-backed securities that were subject to CDS coverage increased during the financial crisis and that the existence of CDS increased the supply of lower-quality subprime securities. There is also evidence that the existence of CDS had an influence on corporate restructuring outcomes (as documented by Bedendo, Cathcart & El-Jahel 2016, Narayanan & Uzmanoglu 2012, which could stem from a reduced interest in voting participation as a consequence of the availability of credit insurance (Danis 2013).…”

Half-full or half-empty? Financial institutions, CDS use, and corporate credit risk

“…Saretto and Tookes (2013) suggest that borrowers have improved access to credit markets due to sellers being able to hedge their credit risk to bond exposure. Bedendo et al (2016) and Danis (2016) analyze debt restructuring in bond markets in the presence of CDS markets. Subrahmanyam et al (2014) do not find any differences in firm bankruptcy filings based on differences in capital structure complexity.…”

“…The lack of detailed transaction-level information on CDS use renders tests of how CDS affect the debtor-creditor relationship indirect. In fact, many empirical studies on CDSs explicitly state this limitation (see , Bedendo et al (2016), and Streitz (2017), to cite a 1 A CDS is a contract between two counterparties for the transfer of a reference entity's credit risk. Typical reference entities in the corporate CDS market are either single firms, a basket of firms, or a large group of firms that comprise an index.…”