The perceived risk of owning bonds of forest-products maker Domtar Inc. fell to the lowest in a year and a half as the company agreed to sell its stake in its Norampac containerboard venture, according to traders betting on corporate creditworthiness in the credit-default swap market.
The offered price on credit-default swaps based on $10 million of Montreal-based Domtar's bonds fell 17 percent to $188,000, from $226,000 yesterday before the announcement, according to data compiled by London-based Credit Market Analysis. A decrease in price indicates an improvement in the perception of credit quality; an increase in price suggests deterioration.
Domtar, Canada's biggest forest-products company by market value, is trimming debt as it prepares to merge with a unit of Weyerhaeuser Co. (WY), North America's largest lumber producer. The sale of its half of Norampac for C$560 million ($488.4 million) to Cascades Inc. (CAS) should help Domtar cut debt and achieve a higher credit rating, CreditSights Inc. analyst Chris Ucko said.
The Norampac sale and the Weyerhaeuser deal ``appear structured to accelerate a return to investment grade'' credit- rating status for Domtar, Ucko, who is based in London, wrote in a research note to clients yesterday.
Domtar bonds are rated B2 by Moody's Investors Service, five levels below investment grade. Standard & Poor's rates the debt BB-, three levels below investment grade.
Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. Credit-default swaps based on Domtar bonds have fallen 44 percent since the company announced Aug. 23 that it would merge with Weyerhaeuser's paper unit. The contracts had been as high as $600,000 in February, Credit Market Analysis data show.
Today's contract prices are the lowest offered since May 2005, according to the data.
The Norampac venture reported third-quarter earnings of $23 million on $165 million in sales, according to Domtar's most recent financial statement on Oct. 31.
The earnings lost from the sale ``is more than offset by the expected reduction in debt,'' Dominion Bond Rating Service analysts led by Tom Fitkowski, said in a report yesterday.
The combination of Domtar and Weyerhaeuser's paper unit will create North America's largest maker of paper used in facsimile and copying machines. The merger will generate annual savings of as much as $200 million, the companies estimate.
The Norampac sale and the refund of U.S. softwood lumber duties may cut the debt of the merged company by about C$645 million and trim original estimates of the company's debt to $2.5 billion from $3.1 billion, the analysts wrote. Dominion rates Domtar debt BBL, three levels below investment-grade.
Moody's boosted its outlook on Domtar's debt ratings after the Weyerhaeuser unit announcement in August.
Credit-default swaps based on Domtar may ``slowly grind tighter'' in the next six months to a year as ratings companies react to the improved credit quality, Ucko wrote in his note.
Credit-default swaps, the fastest growing derivatives market, have become the best gauge of shifts in credit quality. The market for credit-default swap contracts doubled the past year to $26 trillion, the International Swaps and Derivatives Association said in September.
The contracts were conceived to protect bondholders against default and pay the buyer face value in exchange for the underlying securities should the company fail to adhere to its debt agreements. Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.