Weekend Economists Silent Night Christmas Eve 2014

[antigop]

54. Credit-Default Swaps Get Activist New Look

http://www.wsj.com/articles/credit-default-swaps-get-activist-new-look-1419379954

Hedge-fund managers are putting a new twist on credit-default swaps, using the contracts to fortify bets on troubled companies.

The swaps, which work like insurance policies when companies default on bonds and loans, fell out of favor after Wall Street’s outsize bets on the swaps soured during the financial crisis. Now, investors are increasingly combining credit-default-swaps trades with elements of activist investing to push companies toward default in some cases and away in others.

Swaps buyers pay sellers an upfront fee and a steady flow of premiums in exchange for a guaranteed payout from the seller if default occurs. Historically, the corporate credit-default-swaps market was dominated by bets on giant borrowers with billions of dollars of debt outstanding. But that use has declined, while swaps contracts on the debt of smaller companies in financial distress has surged.
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The debt of struggling department-store chain J.C. Penney Co. has credit-default-swaps contracts valued at $19.3 billion, more than double its $8.7 billion in total debt. Gambling company Caesars Entertainment Operating Co., which is negotiating a debt-restructuring plan with creditors, has $26.9 billion in CDS contracts on its debt, about $8.5 billion more than the company’s outstanding debt.

A big reason for the shift: Event-driven hedge funds manage $555 billion in assets, double what they controlled in 2008, according to HFR, but there are far fewer distressed companies to target as default rates hover near historic lows. Credit-default swaps allow hedge funds to substantially increase the sums they bet on troubled companies.