Oi's Vexing Credit Mess: How to Deal With $14.2 Billion of Swaps

  • Brazilian company explores triggering credit derivatives
  • Phone operator hopes to ease process of restructuring its debt

Struggling Brazilian telephone company Oi SA is concerned that some bondholders who bought credit protection may try to push it into default, according to people with knowledge of the matter. So it’s looking for ways to take them out of the equation, the people said.

Oi’s lawyers are exploring whether they could orchestrate a payout for the $14.2 billion of derivatives known as credit-default swaps, the people said, asking not to be identified because the discussions are private. They may create an event that would trigger payments on the derivatives without sparking a default on the rest of the company’s nearly $17 billion of debt, the people said. No decision has been made and the company may not pursue the strategies currently being analyzed by its lawyers, they said.
 
The telephone operator is weighing its options because it’s worried that creditors who have purchased the derivatives may have little incentive to give the company breathing room by, for example, agreeing to ease terms on some of its bonds or loans, the people said. Such a debt restructuring usually entails money managers accepting short-term losses in exchange for the borrower surviving longer-term.

Oi, which operates a mobile network and landlines in Brazil, has been trying to fix its finances after its revenue has shrunk. A merger deal that would have pumped $4 billion into the company failed in February. 

It’s Complicated

Oi would need to find a way to trigger the derivatives without creating a wide-scale default, one of the people said. One possibility could be to skip an interest payment on a single bond that wouldn’t spark a cascade of defaults on other debt. The company’s discussions with lawyers underscore how many borrowers still view credit derivatives as a murky product that can muddy markets.

“Oi’s debt and capital structure is one of the most complicated I’ve ever seen and all those CDSs make it even more difficult," said Carlos Gribel, the head of fixed income for Andbanc Brokerage LLC in Miami, which trades Oi bonds.

The cost of a one-year credit-default swap on Oi unit Portugal Telecom International Finance BV rose to 63.5 percentage points upfront on Wednesday, or $6.35 million for every $10 million of principal protected, from 62.11 percentage points the day before.  

A representative for Oi declined to comment.

Credit derivatives have given investors unexpected incentives before. In 2013, GSO Capital Partners, a credit fund manager owned by Blackstone Group LP, lent money to Spanish gaming operator Codere, with terms that guaranteed that the investor’s credit-default swaps would be triggered. In 2014, RadioShack Corp. was kept afloat by credit derivatives traders who had sold protection against the company defaulting on its debt. 

“Creditors who hold credit default protection well in excess of its bonds would have far less incentive than a traditional creditor to work with a troubled borrower to help it stay out of bankruptcy," said Henry Hu, a professor at University of Texas School of Law. Hu helped create the theory of the “empty creditor," or an investor that holds a company’s bonds but has an incentive to push the borrower into bankruptcy to collect on an even bigger derivatives bet.

A Telephonic Millstone

Oi, whose name means "hi" in Portuguese, is the fourth-biggest mobile phone operator in Brazil. It also operates part of the country’s landline phone system, which has proven onerous-- the company has a legal commitment to expand and maintain the obsolete network. It had about 5 billion reais ($1.4 billion) of interest expense in 2015, far more than the roughly 2.7 billion of operating income it had available to pay those costs, according to data compiled by Bloomberg.

The credit derivatives outstanding on Oi are almost equal to its debt on a gross basis, but excluding offsetting trades such as those that banks complete with one another to reduce risk, the net outstanding positions are closer to $1 billion.

Restructuring Oi’s debt won’t be easy. The company issued bonds from at least three entities, some of which have guarantees from other Oi units. It has more than 200 different investors globally, said one of the people. The company issues and borrows in U.S. dollars, euros, and Brazilian reais, and has lenders and investors ranging from European banks to Brazilian individuals.

The company’s efforts to restructure its debt have already proven to be complicated. Oi is in the process of negotiating with a committee of international bondholders represented by Moelis & Co., two people with knowledge of the matter said last week. A group of bondholders is talking to adviser Houlihan Lokey Inc., in an effort to create another group to negotiate with the company, said the people. Oi hopes to only negotiate with Moelis, the people said.

The telecommunications carrier said last month it hired PJT Partners Inc. to advise on how to manage its debt.

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