“Bondholders are saying that they’re hedged and that they basically want the company to die.”
If you want it in a nutshell, that’s the import of a fascinating (and lengthy) piece about Gannett in The Big Deal by Richard Morgan.
Not so long ago, Gannett possessed one of the sprucest balance sheets in the newspaper industry. In 2007, its debts were 2.1 times EBITDA, compared with an average of 4.4 for its publicly-traded peers.
Two years of horrible declines in profitability have made Gannett’s debts loom larger relative to its profits. No-one expects that trend to go into reverse.
Credit default swaps insure a lender against loss or default, just as a buildings insurance policy insures you against the possibility of your home collapsing into a pile of rubble.
According to Morgan, demand for Gannett-related debt insurance has grown so large that the company — like AIG and General Motors before it — has become a ‘CDS magnet”. While Gannett owes net debts of $3.7bn, the notional value of CDSs referencing the company is a remarkable $30.9bn.
This suggests the existence of speculation on an epic scale. According to University of Texas Law School professor Henry Hu, it also raises the prospect of so-called ’empty-creditor phenomenon”. As Morgan puts it:
An empty creditor may have started out as a traditional lender by making loans and buying bonds. But somewhere along the line, he began supplementing his basic credit transactions with CDSs or other instruments. . .
Hence, the ability of the empty creditor to render himself less economically sensitive to the fate of his debt issuer, who in earlier eras he would have wanted to stay out of bankruptcy.
In a recent Wall Street Journal article, Professor Hu states the proposition more directly: “Let’s say a creditor lends $100 million but then buys $200 million in CDS protection. . . In this extreme version of an empty-creditor pattern, the lender would actually have an interest in seeing his borrower fail.”
This, Morgan suggests, is precisely what is happening to Gannett.
Gannett may have been laid low by structural changes in its markets. Yet on this evidence, the killer blow may yet be struck by the speculators and financial engineers who have already played such a visible role in the global financial crisis.
In turn, of course, this raises the question of what the market for credit default swaps looks like in relation to Johnston Press, Trinity Mirror, ITV and Independent News & Media.
In the latter case, Denis O’Brien seems perfectly well aware of the potential impact of CDS speculation on bondholders’ negotiating position. . .