David Paul Morris/Bloomberg *** Local Caption *** Kyle Jones

RadioShack’s Almost-Defaulted Bonds Gain as Swaps Warp Bids

As RadioShack Corp. prepares for a bankruptcy filing this week, traders are doing something that seems counterintuitive -- trying to buy more of the retailer’s soon-to-be-defaulted bonds.

That’s because about a month after the court filing, credit-default swaps traders will need to settle a net $531 million of derivatives wagers with $325 million of the company’s bonds. The simple math suggests a scarcity of deliverable securities may drive up their price.

“If I told you that in a week, we’re going to run out of water, you’re going to buy water,” Eric Gross, a credit strategist at Barclays Plc in New York, said by phone. “The buyers believe there is going to be a large demand for these bonds at some future day.”

RadioShack’s 6.75 percent notes that mature in May 2019 traded Monday at 15.6 cents on the dollar after falling to 12.5 cents last month.

Traders are offering to buy the bonds for 16 cents, yet there’s little interest in selling from those who already own them, according to two investors who trade the debt. They asked not to be named because the conversations are private.

Bond owners are reluctant to part with their securities because when credit-swaps dealers hold an auction of RadioShack bonds to settle the derivatives wagers after bankruptcy, demand will probably increase.

Trading Rush

A spurt of trades on Monday boosted the price of the securities by 3.1 cents, according to the Financial Industry Regulatory Authority’s trade-reporting system known as Trace. About $4 million of the debt exchanged hands, the highest volume in almost a month.

After a company defaults, a two-part auction is held among swaps dealers to determine the value of its bonds -- and, thus, how much investors who bought swaps insurance will ultimately get. Those who sold the insurance deduct the bond value from the amount they agreed to insure.

RadioShack had about $23.4 billion of gross amount of swaps outstanding as of Jan. 30, according to the Depository Trust & Clearing Corp. Accounting for offsetting positions, the net amount was $531 million, still more than 1.6 times the face value of the company’s bonds.

Sprint, Amazon

While the auctions were created to curb the effect such swap-to-debt imbalances can have on bond prices, demand can still be exaggerated. Dealers collect orders to buy or sell the bonds in the auction process, which are known as physical settlements.

The auction should, in theory, “stop the buying spree for the bonds,” Gross said. “But the bond price might go up if a lot of the sellers” of credit-swaps insurance “request physical settlements where there isn’t a lot of bonds,” he said.

It’s not the first time the credit-swaps market has influenced RadioShack’s standing in the bond market. Hedge funds that had sold insurance against default by the company were among a group of lenders that provided rescue financing in October to stave off a bankruptcy, people with knowledge of the matter said at the time. That helped to at least delay a payout on the contracts.

RadioShack is preparing for a bankruptcy filing imminently that would see as many as 2,000 stores sold to Sprint Corp. and RadioShack’s largest shareholder, Standard General, people with knowledge of the discussions said Wednesday, asking not to be identified because the talks are private.

The bankruptcy deal doesn’t preclude other bidders from taking over some of the store leases. Amazon.com Inc. has held discussions about acquiring RadioShack locations as part of a push into traditional retail, people with knowledge of the matter said this week.

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