Bond Bears Dust Off Debt Insurance on Wave of Corporate Pain

(Bloomberg) -- Corporate debt insurance that fell out of favor after the financial crisis is returning to vogue as default rates rise and a series of high-profile failures pay off for short sellers.

Credit-default swaps trading increased 7% this year, with average weekly volumes of $58 billion, according to the latest data from the International Swaps & Derivatives Association. Payouts on contracts linked to French retailer Rallye SA and U.K. fashion chain New Look Retail Group Ltd. have boosted the value of derivatives, while investors are buying up others on expectation of further windfalls.

The contracts are regaining popularity with investors looking to hedge or short some of the most stressed situations as the European Central Bank withdraws stimulus that triggered an unprecedented rally. As the tide goes out, fund managers in Europe are hiring traders specialized in distressed debt and credit derivatives.

“There are many people now focusing on single-name distressed situations rather than doing plain-vanilla index trades,” said Jochen Felsenheimer, the Munich-based managing director of XAIA Investment GmbH. “There are lots of idiosyncratic situations rather than systematic triggers.”

Distressed situations are increasing as companies struggle to manage the debt piles they built up during years of largesse. The cost of insuring such companies is surging, with swaps on some of Europe’s riskiest names costing thousands of basis points compared to about 300 basis points for the region’s high-yield benchmark.

Investors are paying up for protection amid speculation they’ll cash out when companies collapse. Moody’s Investors Service forecasts the speculative-grade default rate in Europe will nearly double to about 2% next year from 0.9% in April.

“Defaults are still quite low, but swaps are definitely more relevant today than they were a few years ago,” said Justin Jewell, senior portfolio manager at BlueBay Asset Management in London. “For funds that have the flexibility, these tools are becoming effective again.”

Swaps Triggered

Rallye’s swaps were triggered on Tuesday after the parent of French retailer Casino Guichard-Perrachon SA was placed in creditor protection. Buyers of insurance on New Look are preparing for payouts in an auction next week after the company completed a debt restructuring.

Contracts on U.K. travel agent Thomas Cook Group Plc are signaling distress as the company struggles with dwindling bookings and attempts to sell its airline. The swaps are quoted at the equivalent of more than 5,300 basis points, signaling a 92% probability of default within five years, according to ICE Data Services.

Swaps on Boparan Holdings Ltd., owner of some of Britain’s best-known food brands, jumped above 2,500 basis points this week after the company took out a loan secured on a business that it plans to sell.

Pizza Express reached a record of 3,500 basis points amid concern that the restaurant chain will struggle to expand internationally and withstand weakening consumer confidence in the U.K., where Jamie Oliver’s restaurant business collapsed into insolvency last week.

“In an environment where everything appreciates, single-name CDS is a difficult game to play,” said Louis Gargour, chief investment officer of London-based LNG Capital, an alternative investment-management firm. “Now they’re proving their worth because we’re late in the credit cycle and companies are running into difficulty. This is where CDS shorts come into their own.”

To contact the reporter on this story: Katie Linsell in London at klinsell@bloomberg.net

To contact the editors responsible for this story: Vivianne Rodrigues at vrodrigues3@bloomberg.net, Abigail Moses

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