Owners of credit protection on Cendant Corp. have been saved from holding worthless contracts--a phenomenon known as CDS orphaning. In what traders say is a market first, a group of influential investors last week contrived to stop the company buying back all outstanding debt as part of its spin-off into Avis. In doing so they have ensured there are bonds available for delivery for holders of credit-default swaps.
It was unclear who comprised the group or exactly how they managed to halt the buy-back, but traders speculated it is most likely leading investment banks and hedge funds that Cendant/Avis will target for future bond issues. "They obviously want to keep these investors in good favor; it's like an informal give and take," said one trader. In an email to DW, Kelli Segal, spokeswoman for Cendant in New York, said the company was not persuaded to leave debt in the market and bought back all bonds maturing between 2008 and 2015 that were tendered.
The play-out of events was closely watched by a market which insiders say is spooked by succession and deliverability worries. "This is undermining the whole CDS market," said one London-based trader. It follows the unsuccessful attempt by CDS players in March to persuade Cendant to guarantee debt under Avis (DW, 3/24).
Ahead of the investor-intervention, which saw 3% of Cendant bonds remain the market, there was dramatic CDS spread volatility. "Spreads tightened artificially when the buy-back was tendered because of fears there would be a shortage of deliverables," said another trader, who continued, "When only 97% of bonds were bought back, however, spreads widened back out again."
One trader from a top-tier firm declined to say if his house was involved, but noted CDS orphaning will continue to plague the market until a cash-settlement procedure for CDS is agreed. "Although this has left deliverables, there is still a skew of debt compared to notional outstanding and there will be a squeeze if an event occurs."
The cost of five-year protection on CDS was 105 basis points Tuesday, widening out from around 50 bps in March when the buy-back was announced.
