Bloomberg News

TXU, Dow Chemical Lead Credit-Default Swaps Higher on LBO Talk

February 26, 2007

TXU Corp.'s announcement that it will be acquired in the biggest leveraged buyout ever and speculation Dow Chemical Co. (DOW:US) may be targeted in an even bigger LBO, pushed the perceived risk of owning corporate bonds higher today, credit-default swap trading shows.

Credit-default swaps based on $10 million of bonds (TXU:US) of TXU, the largest power producer in Texas, surged to $157,300 from $84,380, according to CMA Datavision in London. Contracts tied to the debt of Dow, the largest U.S. chemical maker, jumped $29,125 to $44,625, CMA data show. An increase signals deterioration in the perception of credit quality.

Concern about the amount of debt that would be needed to finance the deals helped push an index of credit-default swaps up further from a record low reached last week. The TXU agreement sparked an increase in the perceived risk of owning the bonds of utilities, long considered a haven from leveraged buyouts because of regulatory hurdles.

``The whole utility space is deemed to be somewhat insulated from the public-to-private phenomenon, so it just surprised some people,'' said Gregory Peters, Morgan Stanley's head of U.S. credit strategy in New York.

Dallas-based TXU is being bought for $45 billion by a group led by Kohlberg Kravis Roberts & Co. and Texas Pacific Group, the companies said today. Midland, Michigan-based Dow may get a takeover offer worth as much as $54 billion from private-equity firms within the next few weeks, the London-based Sunday Express reported yesterday, without saying where it got the information.

LBOs are considered bad for bondholders and credit-default swap traders because private-equity firms typically borrow two- thirds of the buyout price to fund the deal and place the debt on the target company's books, leading to lower credit ratings.

Index Rises

An index of credit-default swaps tied to the debt of 35 companies in the U.S. and Canada, including TXU, rose for only the second time in the past nine days. The Dow Jones CDX North America Crossover Index increased $4,500 per $10 million in bonds to $114,750, according to Deutsche Bank AG in New York.

Credit-default swaps tied to the debt of Houston-based Reliant Energy, a Texas power retailer that has posted losses in 12 of the past 16 quarters, rose $27,050 to $183,880 today, CMA data show.

Mirant, Dynegy

The contracts on Mirant Corp., an Atlanta-based electricity producer that emerged from bankruptcy last year, jumped $16,500 to $161,750. They jumped $12,700 to $167,500 on Houston-based Dynegy Inc. (DYN:US), which owns power plants in 10 U.S. states.

``Mirant and Dynegy are the sort of players that could be attractive'' to private-equity firms, said Stephan Truffer, who helps manage the $158 million Energy Utility Fund at EIC Partners AG in Feldmeilen, Switzerland.

Reliant also has an attractive valuation given the potential TXU takeover price, Deutsche Bank AG analysts including John Kiani in Houston wrote today in a note.

Across the broader market, the widening appeared to be relatively contained, Peters said.

The CDX Crossover index, which widened Feb. 23 for the first time in almost two weeks on concerns about a surge in mortgage delinquencies and defaults among the riskiest borrowers, remains near the lowest levels since it was formed in 2004. Investor confidence has been buoyed by the lowest rate of corporate defaults in 25 years and stable U.S. economic growth.

The cost of the index contracts is based on a trading level of 114.75 basis points, or 1.148 percentage points. That's down from 173.75 basis points on Sept. 22.

Fitch Cut

Fitch Ratings today cut TXU's ratings to junk, or non- investment grade, and Moody's Investors Service and Standard & Poor's warned they may lower their ratings on the company.

Fitch cut its ratings to BB+, one level below investment grade, from BBB-. Moody's rates TXU's senior unsecured bonds Ba1, one level below investment grade. Standard & Poor's rates its bonds BBB-, the lowest investment-grade rating. Bonds rated below Baa3 by Moody's are considered junk.

TXU said today it doesn't need approval from Texas regulators to complete the LBO. The law that opened the state's electricity markets to competition limits the Public Utility Commission to assessing the effect of mergers on TXU's regulated business, which operates transmission and distribution lines, TXU General Counsel David Poole said today on a conference call.

Credit-default swaps were conceived to protect bondholders against default and pay the buyer face value in exchange for the underlying securities should the company fail to adhere to its debt agreements.

The contracts are the fastest-growing derivatives market and have become one of the best gauges of shifts in credit quality. As of June, outstanding contracts had more than doubled from the previous year to $26 trillion, the International Swaps and Derivatives Association said in September.

Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.

To contact the reporter for this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net

To contact the editor responsible for this story: Robert Burgess at bburgess@bloomberg.net


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    • $51.2 USD
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