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RadioShack Credit Swaps Surge to Record After Unexpected Loss

The cost to protect against a default by RadioShack Corp. (RSH) jumped to a record after the electronics retailer reported an unexpected second-quarter loss.

Credit-default swaps on Fort Worth, Texas-based RadioShack climbed 4.8 percentage points to a mid-price of 37.3 percent upfront, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. The increase means the cost to protect $10 million of the company’s debt jumped to $3.73 million initially and $500,000 annually for five years, from $3.25 million upfront yesterday.

Fitch Ratings downgraded RadioShack’s long-term issuer default grade to CCC from B-, citing a decline in profitability that “has become progressively more pronounced over the past four quarters.” The company’s net loss of $21 million, or 21 cents a share, in the three months ended June 30 compared with a $24.9 million profit a year earlier. Analysts on average had estimated the retailer would have a profit of 4 cents a share, data compiled by Bloomberg show.

“There is a lack of stability in the business and no apparent catalyst to stabilize or improve operations,” Fitch analysts led by Philip Zahn in Chicago and Monica Aggarwal in New York wrote in a statement today. “Sharp declines in cash flow, together with the expected repayment of the $375 million of convertible notes maturing in August 2013, will materially reduce the company’s financial flexibility.”

Best Buy

RadioShack swaps jumped even as the cost to protect against defaults by speculative-grade companies fell from the highest in almost a month. The default premium on the Markit CDX North America High Yield Index fell 2.3 basis points to 613 basis points after earlier rising to as high as 618.4, according to prices compiled by Bloomberg. The measure, which rises as investor confidence deteriorates and falls as it improves, had reached the highest since June 29.

Investors use the benchmark to hedge against losses on junk debt or to speculate on creditworthiness.

Credit-default swaps tied to Best Buy Co. jumped, adding 1.7 percentage points to 15.4 percent upfront, CMA data show. The world’s largest electronics retailer is struggling to compete with the likes of Amazon.com Inc., Apple Inc. and Wal- Mart Stores Inc. In March, Best Buy reported a $1.7 billion fourth-quarter loss and said it would close 50 big-box stores.

Dividend Suspended

Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

RadioShack will reduce its debt-to-equity ratio by refinancing about half of its $375 million of 2.5 percent convertible notes due August 2013, “with the balance paid down with excess cash,” Jim Gooch, RadioShack’s president and chief executive officer, said in the statement. The company suspended its dividend to free up cash, he said. RadioShack had $517.7 million of cash at the end of the quarter, $392.5 million available under a revolving credit facility and $679 million of long-term debt, according to the statement.

“We were disappointed in our gross margin rate performance, as the initiatives we have under way have not yet generated enough momentum to improve the trend,” Gooch said in the statement. “Our primary operating focus continues to be on stabilizing gross margins and aggressively managing our cost structure.”

Margin Pressure

RadioShack’s $324.8 million of 6.75 percent bonds maturing in May 2019 dropped 8.75 cents to 65.75 cents on the dollar at 4:27 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. They’ve fallen from 90.25 cents in January.

Gross margin, the percentage of sales left after costs of goods sold, narrowed to 37.8 percent from 45.9 percent a year earlier. Costs of goods rose 16 percent from a year ago as sales gained 1.2 percent.

Selling more lower-margin smartphones contributed to the decline in gross margin, including a higher mix of Apple’s iPhone, and will continue to pressure margins in the third quarter and, “to a lesser extent,” the fourth quarter, Gooch said in a conference call with investors and analysts.

A gauge of U.S. investment-grade debt fell after earlier climbing for a fourth day amid comments by European Central Bank council member Ewald Nowotny that sparked speculation the region’s permanent bailout fund would be given more firepower to fight Europe’s debt crisis.

Investment Grade

The Markit CDX North America Investment Grade Index fell 1.1 basis points to 115.4 basis points after earlier rising to as high as 117.3, Bloomberg data show.

Investors are concerned the European Stability Mechanism may not have enough cash to aid Spain or Italy if a bailout’s required, accelerating financial turmoil in global markets and hampering companies’ ability to repay debt. Nowotny said yesterday there are arguments in favor of giving the fund access to European Central Bank lending.

The ESM currently has access to 500 billion euros ($607 billion) in funds. Spanish 10-year bond yields surged this week to a euro-era record above 7.6 percent, prompting concern that the country may need a full-scale rescue in addition to as much as a 100 billion-euro bailout already granted to its banks.

To contact the reporter on this story: Mary Childs in New York at mchilds5@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

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