Module 3 · Chapter 8

The First Winter: Events of Default, Cross Default and the Two Hats

A breach of a loan covenant can also put the borrower in default under its hedge. This chapter shows how that happens, what the bank may then do, and how one letter waives both defaults.

≈ 14 min read 8-question test

In this chapter

  • How a default on the loan becomes a default on the swap
  • What the bank may do while the default lasts, and why it chose not to
  • Why a waiver of the loan must also waive the swap

8.1A default on the loan, and on the swap

Atlas’s loan requires its debt to stay at or below three times its yearly earnings. At the first test date, 31 December 2026, the debt was higher. The loan gives no time to put that right, so Atlas was in default under the loan at once.

One limb of the Master Agreement, the cross default, carried that default into the swap. The bank could then stop paying, take more collateral and end both trades. It did none of these, and one letter later waived both defaults.

Key point

A default under the loan can be a default under the hedge, with nobody doing anything. The bank’s rights are real whether or not it uses them. So advise the client on what the paper allows, not on what the bank has done so far.

Also in this chapter

  1. Two notices for one breach
  2. The eight Events of Default
  3. How the cross default caught the loan
  4. The collateral Threshold is a different number
  5. What the bank reserved, and why it still paid
  6. Why the bank did not end the trades
  7. One bank, two waivers
  8. Termination Events, the no-fault family
  9. Your job

Preview

The rest of this chapter opens with a free account. Every edition is free to read until 31 January. Open a free account by the end of that day and keep every edition published by then, for good. Open it from the edition home →