RLPC: JC Penney bonds, CDS shrug off default notice

NEW YORK Tue Feb 5, 2013 2:11pm EST

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NEW YORK Feb 5 (Reuters) - Pricing on JC Penney's unsecured bonds and credit default swaps today remain relatively unchanged after the company filed disclosures regarding a potential bond default.

At issue is whether the pledging inventory as collateral to the company's $1.75 billion asset-backed credit facility violates a bond indenture written in 1994. A default, if found true, could be addressed in 90 days but would add another headache to the company's attempts to turn around its struggling top line.

Dealers are quoting JC Penney's 7.4 percent unsecured bonds due 2037 at 85 this morning, down about a quarter point from yesterday and a point from a week ago. Meanwhile, the company's credit default swaps tightened, which tends to signal a lower risk of default, this morning to 18.5 points upfront from 20.5 yesterday.

This means investors would need to pay $1.85 million upfront and $500,000 annually to protect $10 million of unsecured debt from default for five years.

Holders of the unsecured bonds due 2037, represented by Brown Rudnick LLP, believe that granting inventory liens violate a covenant that prohibits such a pledge unless unsecured bonds receive the same.

"The merits of the bondholder argument depends on whether inventories fall under the scope of the Principal Property definition", said Adam Cohen, founder of Covenant Review, an independent credit research firm. "Even if it does, JC Penney can argue that inventory is being pledged to secure debt that finances the acquisition of that inventory, which should be allowed under the bond indentures."

The principal property definition includes all "real property and tangible personal property" attached to certain types of company buildings. One could argue that the transient nature of retail merchandise at JC Penney means that inventories would not qualify as being part of such buildings.

The indenture further includes a material threshold of 0.25 percent of shareholders' equity for qualifying inventory. JC Penney reported shareholders' equity of $3.5 billion at the end of last October.

In addition, the company has disclosed the credit line remains undrawn, so not actual debt outstanding has a claim on the pledged inventories.

JC Penney has filed a complaint in the Delaware Courts seeking a judgement declaring that the company has done nothing wrong.

Market analysts seem to have shrugged off the severity of the bondholders allegations for now. One sell-side analyst wrote in a note to clients, "We do not believe the intent of the definition was to include inventory but instead related to real property and believe the definition reads as such.... We believe if JCP loses, it could be forced to renegotiate its credit agreement and/or collateralize more of its assets."

Calls to Brown Rudnick were not returned by press time.

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