Toys ‘R’ Us Caught Credit Traders Completely Off Guard

Toys “R” Us Inc., once the go-to store for parents looking for that must-have holiday gift for the kids, is now reorganizing its $5 billion of debt in bankruptcy court. But just two weeks ago, credit markets were giving little indication it was coming.

The day after the U.S. Labor Day holiday, credit-default swaps that allow traders to hedge against losses on the toy merchant’s debt were pricing in a low probability of a near-term default -- about 10 percent based on contracts expiring in June. You could insure $10 million of debt on Sept. 5 for an upfront payment of about $300,000. By the end of that week, the upfront cost had surged to $2.5 million. By Monday, the eve of the bankruptcy filing, it was $7.7 million.