CDS growth may increase corp bankruptcy risk-Moody's

NEW YORK, June 8 (Reuters) - Companies at risk of failure may be more likely to succumb to bankruptcy than in previous downturns because bondholders who also own credit default swap protection could be less amenable to debt restructurings, Moody's Investors Service said on Monday.

A global recession is crimping the earnings of companies at the same time as their access to capital markets is also being curtailed, forcing some to launch distressed debt exchanges as a means of reducing their obligations and avoiding bankruptcy.

Unlike previous downturns, when bondholders were faced with the choice of taking a hit outside of bankruptcy or risking even greater losses if the company filed, credit default swaps allow investors to recoup their investment even in bankruptcy.

"Bondholders with CDS protection have financial incentives to be less accommodating in their workout negotiations with issuers than those without CDS protection," Moody's said in a report.

Bondholders that also own protection on a company would be repaid losses from the debt by the seller of protection on the CDS, which are contracts used to protect against a borrower defaulting on their debt.

There is no data on how many bondholders in specific companies own the debt only, and how many also own credit default swap protection.

However, "to the extent that holders of CDS will act differently in dealing with a distressed issuer, the magnitude of this effect should be far greater in the current period of elevated defaults," Moody's said.

Global volumes in credit default swaps have risen to around $39 trillion from $2 trillion in 2002, which marked the last large wave of U.S. defaults by companies including WorldCom.

Offsetting the impact of CDS players on corporate defaults, however, are looser terms in credit agreements than in previous downturns, which has allowed more companies to avoid bankruptcy, Moody's said.

The scarcity of "debtor-in-possession" (DIP) financing, which is needed to fund a company's operations as it restructures in bankruptcy, also may make bankruptcy a less attractive option to bondholders, Moody's added.

Without DIP loans a company is more likely to need to liquidate, which typically leads to lower recovery rates on their debt. (Reporting by Karen Brettell; Editing by Chizu Nomiyama)