Wednesday, October 22, 2008

Nokia prices loans according to CDSs

(FT) Nokia has become one of the first European corporates to link the pricing of some of its loans to its credit default swaps as banks look for new ways to ensure they are being paid enough for the risk they are taking lending to companies.

Typically, a borrower will arrange a so-called revolving credit facility, like an overdraft facility, with a bank at a fixed margin over the London interbank offered rate, the rate at which banks lend to each other.

However, since the start of the credit crunch, banks’ funding costs and the cost of corporate credit have soared.

A potential headache for banks is that many such facilities will have been agreed before the recent worsening in credit conditions at a fixed rate over Libor – a rate that may now be lower than a bank’s all-in cost of funding that facility.

If the company decides to draw down on that loan, it could leave the bank nursing losses.

Nokia has agreed terms of a financing with its banks that will link the rate of interest it will pay for such a facility to the level at which its credit default swaps trade.

CDSs represent a form of insurance against a borrower defaulting on its debt, and vary according to how risky the market perceives the borrower.

This form of “market-based pricing” has been used for several US companies this year as a number of companies looked to renew their facilities with banks.

Until now it has been unclear how much success bankers have had using this pricing tool for European corporates. However, bankers expect there will be more such deals as the rate of companies looking to renew their facilities accelerates next year.

For a borrower it can have several benefits: it provides liquidity at a time when banks have been unwilling to lend and can allow borrowers to benefit from price differentials if market conditions improve.

“Nokia feels that for a strong company with solid credit ratings and good access to the commercial paper markets this is the best solution,” the company said.

“It optimises the undrawn cost of a facility which is used as a backstop for commercial paper issuance.”

David Slade, European head of leveraged finance at Credit Suisse, said the deal could potentially be very significant.

“I expect it to be used more often as a way for banks to reflect the cost of company credit at the time the facility is drawn,” said Mr Slade.

“The moves reflect bankers’ expectation that markets will remain volatile.”

However, the Association of Corporate Treasurers said: “In making their business plans companies seek certainty so that any trend towards CDS-based pricing would be unhelpful”.

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