Credit Traders Bet on Worthless Insurance on U.K. Debt Collector

(Bloomberg) -- U.K. debt collector Lowell is sowing confusion in the credit insurance market as traders anticipate the company’s upcoming debt refinancing will render its existing contracts worthless.

The firm is marketing 1.6 billion pounds ($2.1 billion) of new bonds this week and plans to issue all of the notes out of a unit called Garfunkelux Holdco 3, according to a statement Wednesday. The move could nullify almost $400 million worth of credit insurance traders hold on the company’s debt because the contract covers a different holding company which will be left empty with the refinancing.

When credit derivatives become worthless with no debt to insure the situation is known as orphaning. These events don’t happen often in the $10.5 trillion market. But when they do, they can sow confusion for traders trying to place a value on a contract that may be worth anywhere between nothing or much more than its currently traded price.

The price of Lowell credit insurance plummeted Wednesday from 566 basis points to a record-low of 143 basis points, according to ICE Data Services, indicating traders see less value in the contracts.

Once the refinancing completes, there will be no debt left at Garfunkelux Holdco 2, a spokesperson for Lowell said in a response to questions. That’s the unit the CDS references. While no decision has been made to wind down this entity, the new refinancing allows the parent to release its guarantee, the spokesperson said.

“The market sees the CDS as almost having no value,” said Jochen Felsenheimer, the Munich-based managing director of XAIA Investment GmbH, which invests in credit derivatives but doesn’t have any holdings in Lowell swaps. “Situations like this are pretty rare.”

Stonegate Confusion

Investors will be keen to dodge a repeat of a debacle earlier in the year when credit swaps on U.K. pub company Stonegate lost their value only to spike up again.

Traders had bet heavily that the firm’s credit insurance would prove worthless due to a 1.35 billion pound debt offering. But the company surprised them by saying it would use an existing funding vehicle to guarantee at least some of the financing, indicating the swaps were still relevant.

Read more: Pub Firm’s Credit Swaps Show Pitfalls of $10 Trillion Market

Stonegate swaps fell to a record low of 80 basis points in January when traders were speculating on an orphaning. The contracts are now quoted at about 930 basis points, among the most distressed in the high-yield benchmark.

Some analysts haven’t ruled out another whiplash scenario at Lowell. Credit-default swap buyers, whose trades are hurt by the huge fall in prices, may try to influence the company’s decision, CreditSights analysts wrote in a note to clients.

Still, “there does not currently appear to be a path to continued life” for the existing CDS, the analysts wrote.

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