Credit-Default Swaps on J.C. Penney Rise on Concern Over Credit Profile
By Mary Childs - Oct 12, 2010 6:19 PM CT
Credit-default swaps on J.C. Penney Co. jumped to the highest since April 2009 on concern that recent stake purchases by Pershing Square Capital Management LP and Vornado Realty Trust could change the company’s credit profile.
The cost to protect against losses on J.C. Penney bonds jumped 36.5 basis points to a mid-price of 279.8 at 5:03 p.m. in New York, according to data provider CMA. The contracts surged 50 basis points on Oct. 7 and Oct. 8 as activist investor William Ackman’s Pershing Square disclosed its stake, according to George Ashur, managing director of credit strategy at Societe Generale.
“There’s a lot of anticipation, a lot of speculation: what does he want, what’s he going to do,” Ashur said of Ackman. “The CDS have moved out rather significantly, reflecting the market uncertainty concerning where debt levels will settle, what strategy might be adopted that might change the profile of the company that might adversely affect the credit.”
Pershing Square disclosed a 16.5 percent stake in Plano, Texas-based J.C. Penney on Oct. 8. The hedge-fund firm plans to engage in talks with J.C. Penney’s board and managers regarding the company’s performance, according to a filing with the U.S. Securities and Exchange Commission. In a separate filing, Vornado said it acquired a 9.9 percent stake.
‘Rarely Good News’
“As bondholders recently saw with the Pactiv buyout, leveraged acquisitions are rarely good news for holders of high grade bonds,” Adam Cohen, founder of Covenant Review LLC, wrote in a note Oct. 8. Covenant Review is an independent credit research firm that analyzes corporate bonds’ investor safeguards.
Pactiv, the maker of Hefty trash bags, is being purchased by Rank Group Ltd. for about $4.5 billion and the assumption of $1.5 billion in debt. Its 7.95 percent bonds due in December 2025 traded at 96 cents on the dollar before Pactiv agreed to the takeover in August and ended today at 89 cents, according to Trace, the bond price reporting system of the Financial Industry Regulatory Authority.
Swaps on Fortune Brands Inc. also jumped, climbing 18.9 basis points to 188.1, the highest since Sept. 2009, according to CMA. Pershing Square took an 11 percent stake in Fortune Brands.
Ackman buys stock in companies he deems undervalued, particularly in the retail, restaurant and real estate industries, and urges changes he says will boost shareholder returns. He pushed for a share buyback at Target Corp. in 2007 and lobbied restaurant chain Wendy’s International Inc. to sell land after acquiring a 9.3 percent stake. Shares in J.C. Penney, whose sales fell 45 percent in the past decade, have lost more than half their value since peaking at $86.35 in February 2007. The Standard & Poor’s 500 stock index is down 12 percent on a total-return basis over that span.
Right Place, Right Time
“Whether it’s by good fortune or good management, Penney’s has been at the right place in the right time,” Ashur said. “Now they’re being viewed as an undervalued asset.”
Contracts protecting debt issued by Sara Lee Corp. jumped 5.2 basis points today and 63.6 basis points on Oct. 4 amid speculation the company is a potential target for a leveraged buyout, according to a report by Moody’s Capital Markets Research Inc. director Daniel Coker.
“Sara Lee may only be interested in selling a business or brand, but its active engagement -- with parties who have the potential to buy the whole firm -- raises the risk that the event could happen,” Coker wrote in the note, dated today.
Conducive Environment
The macroeconomic environment is conducive to mergers and acquisitions, according to Coker.
“Companies that hoarded cash during the financial crisis, and have been unable to find a path to growth amid the recession, may be looking at acquisitions to put excess cash to work,” he wrote. “Adding fuel to the fire are exceptionally low interest rates which offer cheap financing to private equity firms.”
Credit-default swaps protecting Avon Products Inc.’s debt also jumped, adding 9.9 basis points to 70 after a report that L’Oreal SA may make a takeover offer for the world’s largest door-to-door cosmetics seller.
A benchmark indicator of overall U.S. corporate credit risk climbed for the first time in a week as stocks fell after minutes of the Federal Reserve’s last meeting showed the central bank was prepared to buy more government debt to stabilize the recovery. Swaps on banks climbed, led by JPMorgan Chase & Co., which increased 8.5 basis points to 83.2, while those on Bank of America Corp. rose 10.1 basis points to 162.4, according to CMA.
Broad Index
Credit-default swaps on the Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, increased 0.5 basis point to a mid-price of 97 basis points, according to index administrator Markit Group Ltd. The index, which typically rises as investor confidence deteriorates and falls as it improves, touched the lowest in more than five months yesterday at 96.5 basis points.
Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point, 0.01 percentage point, equals $1,000 annually on a contract protecting $10 million of debt.
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