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Swaps Show Energy Future Winning Against Aurelius Default Claim

Derivatives signal Energy Future Holdings Corp. is persuading lenders it didn’t break terms of its credit agreement, a month after Aurelius Capital Management LP claimed the former TXU Corp. defaulted on a loan.

The cost to protect $10 million of Energy Future debt from losses for one year decreased to $1 million upfront, from $1.37 million on March 1, according to data compiled by CMA. That’s in addition to an annual $500,000 for the contracts.

Traders are wagering the Dallas-based power company, subject of the largest leveraged buyout in history, will fend off the assertion. Many larger creditors don’t want to own the debt through a restructuring, even as Aurelius may have encouraged other hedge funds to vote with them, according to Andy DeVries, an analyst for debt-research firm CreditSights Inc. in New York.

“Anyone who owns the CDS wants to force” a default, DeVries said. “But when you’re talking about a $20 billion term loan, you’re going to get a lot of buy-and-hold investors.”

The cost to protect the debt for one year has increased from $350,000 upfront on Feb. 25, when Energy Future disclosed in a regulatory filing that New York-based Aurelius said it’s in default on a $23.9 billion term loan. The debt was taken on to finance the $43.2 billion takeover by KKR & Co. and TPG Capital in October 2007.


Aurelius says loans made to Energy Future Holdings from its Texas Competitive Electric Holdings Company LLC unit weren’t completed at a so-called “arm’s-length basis,” meaning they may not have been made in good faith.

Lisa Singleton, a spokeswoman for Energy Future, and Stephen Sigmund, a spokesman for New York-based Aurelius, declined to comment.

The allegations are “utterly meritless,” Robert Walters, general counsel of Energy Future, said in a telephone interview last month.

Contracts that protect Energy Future debt for five years eased to 41.3 percent upfront from 48.3 percent on March 14, meaning it would cost $4.13 million and an annual $500,000 to protect $10 million of the debt, CMA data showed. The swaps were at 35.8 percent on Feb. 25. Credit-defaults swaps on Texas Competitive debt declined to 51.1 percent, from 58.7 on March 15.

Natural Gas

The prices indicate investors are speculating that Energy Future won’t be able to take advantage of rising natural gas prices and demand for speculative-grade debt to refinance $20 billion of loans coming due in 2014.

The Energy Future contracts priced in 21.7 percent odds that the company will default within one year, and 80 percent odds within five years, based on an expectation that investors would recover 27.5 percent of face value of the company’s bonds if it failed to meet its obligations, CMA data show.

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.

Natural gas for April settled today at $4.374 per million Btu on the New York Mercantile Exchange. The futures touched $4.48, the highest intraday price since Feb. 3, and have gained 13 percent from a year ago.

“This might be your one and only chance to get a default declared, because if gas goes up, things are going to get better,” said Mark Unferth, manager of distressed debt strategies at CQS U.S. LLC, a London-based hedge fund with $9.4 billion under management. “You have a small window here in which to operate.”

‘Search For Yield’

Energy Future’s $571 million of 11.25 percent so-called toggle bonds due in 2017 climbed to 81 from 46 cents in September, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

“The global search for yield sends everyone to TXU,” DeVries said.

Yields on speculative-grade debt fell to 7.41 percent on March 25 and touched 7.29 percent on Feb. 22, the lowest in records extending to October 1986, according to the Bank of America Merrill Lynch High Yield Master II Index.

Energy Future is rated Caa2 by Moody’s Investors Service and CCC+ by Standard & Poor’s. High-yield, high-risk bonds are rated below Baa3 by Moody’s and lower than BBB- by S&P.

Sales of speculative-grade bonds have totaled $85.9 billion this year, 31.5 percent above last year’s $65.3 billion in the same period. Issuance last year set a record of $287.6 billion.

“There is a ton of liquidity in the system looking for a return,” Unferth said in an e-mail.

The cost of protecting U.S. corporate bonds from default rose as stocks fell and concern grew that Japan is failing to contain hazardous materials at its damaged nuclear plant.

Discretionary Spending

The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, climbed 1.1 basis points to a mid-price of 96.1 basis points as of 5:07 p.m. in New York, according to index administrator Markit Group Ltd. The measure falls as investor confidence improves and rises as it deteriorates.

The Standard & Poor’s 500 Index lost 0.3 percent to 1,310.19 at 4 p.m. in New York after climbing as much as 0.5 percent earlier, as radiation levels that can prove fatal were detected outside reactor buildings at Japan’s Fukushima Dai-Ichi plant.

A Commerce Department report earlier showed consumer purchases rose 0.7 percent in February, the most since October. Incomes increased 0.3 percent, and the Federal Reserve’s preferred measure of inflation accelerated.

Disposable Incomes

“Consumer spending increased more than expected driven by higher energy and food prices, not necessarily due to a pickup in unit volume,” Adrian Miller, fixed-income strategist at Miller Tabak Roberts Securities LLC in New York, said in an e-mail. “Consumers will continue to be under pressure and discretionary spending will likely take a hit.”

Disposable incomes fell 0.1 percent after adjusting for inflation, the first decrease since September.

The swaps index rolled to a new series on March 21, replacing companies that no longer had appropriate credit grades, weren’t among the most actively traded or failed to meet other criteria. New versions are created every six months.

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