RadioShack Kept Alive by $25 Billion of Swaps Side Bets

RadioShack Corp. (RSH) is finding an unlikely ally in its efforts to stay out of bankruptcy: credit derivatives traders who amassed more than $25 billion of trades speculating how much longer it can keep paying its bills.
After a 60 percent surge this year, the amount of credit-default swaps tied to RadioShack is 28 times its debt, more than any other U.S. company. When the retailer’s biggest shareholder arranged $585 million of funding in October to help it survive the holidays, much of the money came from hedge funds wagering on the company to avoid default, said people with knowledge of the trading. Those included DW Investment Management and Saba Capital Management, the people said.
The derivatives are amplifying the stakes on a company with less than $1 billion of debt that’s running out of cash and struggling to compete with online competitors. By injecting the 93-year-old electronics retailer with new money, swaps traders, more often blamed for pushing companies toward bankruptcy, have been preserving big payoffs if they can delay or prevent a default.
“The sellers of the protection built up quite a large war chest, and it took a relatively small amount of money to keep the company going,” said Peter Tchir, a former credit-swaps trader who is now head of macro strategy at Brean Capital LLC in New York. “They have huge incentives to keep the company alive to not trigger the swaps.”

Motivated Lenders

That provided RadioShack’s biggest shareholder, Standard General LP, a potential pool of lenders when it arranged the loans in October. The financing gave the retailer enough cash to stock up for the holiday season while negotiating with other creditors that are blocking a plan to close underperforming stores. RadioShack has struggled to keep up with a migration of sales to the Internet, losing money for 11 straight quarters.
As part of the October funding, DW Investment, run by David Warren, bought more than $100 million of a $275 million first-lien loan, the people with knowledge of the deal said this month. Saba, founded by former Deutsche Bank AG credit-trading head Boaz Weinstein, also bought a piece of the debt, they said. Both firms have swaps investments that would benefit from RadioShack’s solvency, the people said.
Representatives of DW Investment, Saba Capital, Standard General and Fort Worth, Texas-based RadioShack declined to comment.

Rare Situation

Among U.S. non-financial companies, only one has more swaps tied to its debt than RadioShack: casino operator Caesars Entertainment Corp., according to the Depository Trust & Clearing Corp. The $28.3 billion of contracts on that company’s biggest unit is 1.5 times its $18.4 billion of obligations.
The potential to profit from swaps trades swelled this year as concern mounted that the company would run out of cash sooner than investors expected.
In September, a swaps trader could have sold RadioShack default insurance through Dec. 20 for an upfront payment of $3.65 million on every $10 million of protection. Contracts protecting the same amount through March would have paid $5.3 million, while swaps lasting a year paid about $6 million. As long as the company keeps paying its obligations through the contract’s expiration date, the swaps traders pocket the fees.
The upfront payment on a one-year contract climbed to a record $7.45 million this week after the company reiterated to investors on Dec. 12 that it’s running out of cash and may have to file for bankruptcy protection.

Seeking Payouts

The derivatives are usually blamed for pushing a borrower into default, not keeping them solvent.
Firms that bought protection on a RadioShack default sought to collect this month after a lender claimed that the company breached the terms on a $250 million loan.
The request, made to an industry committee that governs the market, sought a so-called credit event and cited concern that Standard General’s funding deal was “structured with a purpose to manipulate the CDS market” by preventing a default long enough to avoid triggering swaps that expire at the end of this week. The committee ruled last week that no credit event occurred.
Swaps on RadioShack have long overshadowed the company’s debt because dealers included the retailer in indexes that are used to wager on the health of U.S. companies. That can generate more volume than normal as investors set up trades to profit from price anomalies between the indexes and individual swaps, as well as to hedge against losses.
While such trading makes the amount at risk appear bigger than it is, even after subtracting offsetting positions, the net amount wagered on RadioShack surged to as much as $1.1 billion in February before falling to about $600 million this month, Depository Trust data show.
“Pumping in enough money for the swaps to roll off makes the most sense if the seller’s position is large and the amount of debt is limited,” said Henry Hu, a law professor at the University of Texas who’s studied the effect of swaps on lender behavior.
To contact the reporter on this story: Jodi Xu Klein in New York