J.C. Penney’s Survival Odds Grow in Credit-Default SwapsSridhar Natarajan and Matt Robinson
J.C. Penney Co., the century-old retailer trying to dig its way out from $2.5 billion in losses over the past three years, is convincing credit swaps traders that it isn’t going away anytime soon.
The cost of protecting against default by the chain within two years has dropped below the price of five-year protection by the most in a year, according to prices compiled by CMA in the privately negotiated market. As recently as April, the relationship was inverted.
J.C. Penney’s outlook is improving as Chief Executive Officer Mike Ullman, who returned to the Plano, Texas-based retailer last year, brings back the retailer’s traditional shoppers while lenders offer $2.35 billion in credit that will provide him with time to undo decisions by his erstwhile replacement. The chain reported rising sales for the first time in three years in the quarter through May 3.
“Essentially they’ve gone back to the old style of business, and it’s probably the best solution in the interim,” said James Goldstein, an analyst at CreditSights Inc., who has an “outperform” rating on the company’s debt that matures before 2018. The new credit line “gives them flexibility. They could’ve gone on without it, but it’s comforting to vendors and to near-term bondholders as well.”
Daphne Avila, a J.C. Penney spokeswoman, declined to comment on the financing beyond a May 19 regulatory filing that announced the commitment from banks for an asset-based revolver and a term loan.
The cost to protect debt with swaps typically rises the longer the term of the contract as investors pay more for the risk of unexpected events. An inverted curve, where short-term protection costs more than longer-term coverage, is indicative of traders betting on a credit event such as a default in the near term.
Contracts protecting against a default for two years decreased to 607 basis points today, according to CMA, which is owned by McGraw Hill Financial Inc. That compares with 851 basis points for five-year protection, the data provider’s prices show. The last time the gap was this wide was July 2013.
The two-year swaps were bid up to the equivalent of 2,135 basis points in February, compared with 1,843 basis points quoted on the five-year CDS. On April 30, two-year swaps were at 1,290, 20 basis points wider than the longer-term protection.
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.
The contracts, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, decline as investor confidence improves and rise as it deteriorates.
The turnaround in sentiment has been sparked by Ullman’s return, according to Evan Mann, an analyst with bond-research firm Gimme Credit LLC. “Ullman laid out a plan to return J.C. Penney to what it was,” he said in a telephone interview.
“In the beginning, people were skeptical. Results have started to improve and he’s delivering on what he’s promised.”
Ullman has cut many of the strategies that almost sank the department-store chain during Ron Johnson’s 17-month tenure, which led to the worst sales in more than two decades.
The company is expected to be unprofitable in the current fiscal year, which ends Jan. 1, and the next, bringing its string to at least five, according to 11 analysts surveyed by Bloomberg.
Sales are forecast to have reached a nadir last year at $11.86 billion, rising to $12.4 billion in fiscal 2015 and then $12.9 billion.
Ullman, whose first term as CEO ran from December 2004 to January 2012, reversed pricing and merchandising decisions, ended a store remodeling plan and reinstated the old logo.
“Under Johnson, there were no promotions. That was like firing their customers,” said Mary Ross Gilbert, a managing director at Imperial Capital LLC in Los Angeles, who recommends buying J.C. Penney’s long-dated debt. “The stores now carry relevant merchandise and are highly promotional, making it more compelling for the consumer that they attract, which is a lower-income consumer looking for value.”
The younger, hipper image that Johnson, the former Apple Inc. retail head, tried to instill with new brands fell flat. J.C. Penney apologized in a 30-second commercial last year that featured clips of women trying on clothes and children hugging as a voiceover says the company made mistakes and asks former customers to come back.
The new liquidity has helped preserve bond ratings. Standard & Poor’s affirmed its CCC+ grade this week, and Moody’s Investors Service maintained its equivalent Caa1. Those ratings indicate a borrower of poor standing with debt that’s vulnerable to nonpayment.
The retailer is seeking a $500 million term loan coming due in 2019 that would pay investors a minimum of about 5.5 percent to 5.75 percent, according to high-yield debt researcher KDP Investment Advisors Inc. of Montpelier, Vermont. The company now pays 6 percent on a $2.2 billion loan it obtained last year.
The rest of the commitment is a $1.85 billion, five-year asset-backed revolver, KDP said in a report yesterday.
“Risk of insolvency in the next couple of years has certainly diminished a lot,” Mann said.