Energy Future Holdings, Texas Competitive CDS show severe stress

Fri Sep 6, 2013 2:30pm EDT

NEW YORK, Sept 6 (IFR) - Interest in purchasing credit protection has resurfaced in Energy Future Holdings Co after another rating agency recently underscored the plausibility it may be headed toward a credit event sooner, rather than later.

Moody's late August downgraded Energy Future Intermediate Holding and its ultimate parent company, Energy Future Holdings Corp to Caa1 from B3 citing "the likelihood EFIH will be affected by the restructuring contagion at Energy Future Competitive Holdings Co and despite attempts to disentangle the legal entities."

EFH, a Texas power company, is considered a volatile name in CDS. Its subsidiary, Texas Competitive Electric Holdings Co is a constituent of the CDX.HY index. Its spreads are also highly distressed. The latter's CDS has sharply widened in the wake of the downgrade.

It was the second time this year Moody's downgraded the two entities and as a result, based on recent disclosures, Moody's thinks EFIH and ultimate parent holding company, Energy Future Holdings Corp are likely to be included in any bankruptcy restructuring events, which could come as soon as the next quarter.

Fitch has also downgraded the entities twice in the last eight months. In its latest ratings action, EFH and EFIH were lowered to CC from CCC. Fitch cited the potential for a voluntary Chapter 11 filing by some or all of EFH's subsidiaries, except the ring-fenced Oncor Electric Delivery, as per the company's 10-Q regulatory filings from August 2.

In that filing, EFH said its liquidity was USD1.7bn versus USD3bn for the comparable year ago period.

EXCHANGES BIDE TIME

Since 2009, EFH and its subsidiaries have attempted to meaningfully reduce its significant debt load brought on by its LBO in 2007. The efforts are aimed at extending maturities via a liability management program.

Earlier this year, EFIH exchanged USD1.3bln of new 10.00% senior secured notes due 2020 for various senior secured EFH notes maturing 2019-2020.

The exchanges had a substantial tightening effect on EFH's spreads during that time frame as roughly 99% of the bonds were tendered. The market has a built in expectation there would be further debt exchanges to extend maturities and buy more time.

Since 2007, EFH has completed seven distressed exchanges. Despite these efforts, out of all the CDX.HY20 names, EFH subsidiary Texas Competitive Electric Holdings is the worst of all the underperformers.

Its CDS credit curves are heavily inverted in the short- and intermediate-term and have been for a prolonged period.

Aside from the distressed nature of the company, reflected in its CDS, there are growing expectations the entity will not able to make its forthcoming November bond coupon payments as emphasized by Moody's as well as market opinion.

While the inversion of the CDS credit curve takes this event risk into account, it can also reflect what bond investors are beginning to think of recovery in case of default.

When looking at the yield-to-maturity on the 6.55% due November 15 2034, it is 12.955%. It is equal to the current yield of the bond at 12.955% which is priced at USD54.

The price of the bond at USD54.00 has declined from USD73.50 in early June. In some cases, when CDS credit curves are heavily inverted the yield-to-maturity can become skewed and an investor would look at the price of the bond.

For the time being, it appears that the bond investor has a more resilient opinion of the company, since the bond is priced below par, but the yield-to-maturity and yield are 12.955% which remain higher than the coupon rate of 6.55%. It is worth noting, the yield-to-maturity is currently at a three-month high.

However, the synthetic market is less optimistic on the overall company's future.

TXU's CDS in the five-year maturity is currently trading at roughly 92 points upfront. If an investor were to buy protection on a bond, for example, a USD100 bond, you would pay a USD92 premium upfront, which is implied in the pricing by the CDS market of a 92% haircut on the bond.

Meanwhile, TXU parent, EFH's CDS is quoted at 56 points upfront, which is indicative of a 56% haircut on the hypothetical bond in the example.

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