Contributed By Homburger
A transaction structure that is frequently used is the combination of a (funded) credit default swap (CDS) and the issuance of credit-linked notes (CLNs). In such a structure, the protection buyer (eg, a bank holding a loan portfolio) purchases credit protection under a CDS from the protection seller (ie, the SPE). In the CDS documentation, certain events are defined in relation to the underlying portfolio held by the protection buyer that will trigger a compensation payment of the SPE under the CDS. The SPE in turn issues CLNs to investors. Issuance proceeds from the CLNs are deposited with a bank and/or invested in low-risk marketable securities to provide funding for a potential compensation payment under the CDS. As a consideration for the credit risk protection provided, the protection buyer pays a periodic premium under the CDS to the SPE, which is used by the SPE to meet interest payments due under the CLNs.