Sears's Latest Hope for Cash: Bidding War Among CDS Traders
(Bloomberg) -- Sears Holdings Corp.’s latest attempt to raise cash and stave off liquidation is hinging on a complex -- and perhaps shrewd -- maneuver to create a bidding war among derivatives traders who wagered hundreds of millions of dollars on the retailer’s failure.
The bankrupt department-store chain asked a judge to let it auction off about $900 million of notes that are essentially loans from one Sears unit to another. Normally, the company would likely find few takers for the debt. But because of arcane rules in the credit-default swaps market, the notes are proving to be a key factor in determining how much hedge funds and other investors get paid on some $400 million of default insurance they purchased before the bankruptcy.
The potential sale is the latest example of how the $10 trillion market for credit derivatives can influence the fate of the companies they are tied to. In the last year, traders seeking to profit from bets on derivatives have extended financing to companies including food distributor United Natural Foods Inc., homebuilder Hovnanian Enterprises Inc. and newspaper publisher McClatchy Co., Bloomberg News has reported.
Sears is looking to sell the notes to the highest bidder before the CDS market settles their wagers in an auction now expected on Nov. 26 or later. The retailer is seeking an emergency hearing now scheduled for Thursday to win approval for the note sale, and it said it hired investment bank Jefferies Financial Group Inc. to run the process.
The retailer has been trying to line up fresh cash as it seeks to keep its doors open and reorganize in bankruptcy. When it filed for Chapter 11 protection last month, the retailer said it had lined up only part of the funding it needed to stay in business.
The note sale could mean a windfall for hedge funds that faced the prospect of getting paid only a small amount on their swaps trades. That’s because they are linked to a part of Sears that now has little debt outstanding. With a scarcity of bonds issued by that unit, Sears Roebuck Acceptance Corp., there’s more CDS wagers to settle than available debt.
That is, unless the notes end up in the hands of CDS traders who could then use them to settle their derivatives contracts. Sears said it asked a committee that governs the CDS market to include the notes on a preliminary list of obligations that can be used to settle the swaps. A sale of the notes would unleash a wave of cheaply priced debt that could drive up the payout for CDS buyers.
Brigade Capital Management, Omega Advisors and Och-Ziff Capital Management Group are among fund managers that bought CDS against a Sears default and have been awaiting a payout, people with knowledge of the matter said last week.
A spokesman for Och-Ziff declined to comment, while representatives for Brigade and Omega didn’t respond to a request for comment on Friday. A representative for Sears declined to comment on Friday.
The CDS holders would be able to deliver the debt into the separate credit derivatives auction. The results of that auction will determine the payout rate on the derivatives. A committee of CDS market participants must still make a final determination on whether the notes are deliverable into the auction.
The CDS trades are giving market participants reason to buy notes that might otherwise not attract much interest. While the securities would sell at a huge markdown, they may still fetch 20 or 25 cents on the dollar, handing the estate tens of millions of dollars, one of the people with knowledge of the discussions said.
A sale of the notes could set up a bidding war among the hedge funds, banks or other investors who bought insurance and others who sold the CDS protection. The approximately $900 million of notes that Sears is looking to sell are a subset of $2.3 billion of medium-term notes, with the other $1.4 billion held by Sears Reinsurance Co. Ltd., which is not part of the bankruptcy proceedings.
Sears has been trying to line up at least $300 million of additional bankruptcy financing to stay open through the crucial holiday shopping season. The retailer was inching closer to a loan last week, a person with knowledge of the matter said, while declining to name the prospective lender.
Sears Chairman Eddie Lampert, the company’s biggest shareholder, had been in talks to provide at least some of the financing, but wasn’t involved in the latest negotiations, the person said. Sears previously has said it was in discussions with hedge fund Cyrus Capital Partners to help fund the lifeline.
Sears’s financial adviser reached out to Barclays Plc, Credit Suisse Group AG, Jefferies, Morgan Stanley and Goldman Sachs Group Inc. to gauge their interest in running the note sale, according to the filing. It received proposals from every bank except for Goldman Sachs. Jefferies will receive fees equal to 2 percent of proceeds of the note sale, the filing said.
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