London - The financing of Tata Steel's planned acquisition of Corus Group is wreaking havoc in the derivatives market.
Tata blindsided traders when it decided to borrow $6.17 billion (R48 billion) through a non-investment-grade Corus subsidiary to fund the takeover of the largest UK steel maker. Tata, whose debt is rated investment grade, is using high-yield, high-risk loans and bonds, prompting Fitch Ratings to change its assessment of the proposed merger to negative, and warning it may downgrade the securities of Corus.
Many traders who sold credit default swaps on the assumption that a takeover would be completed with investment-grade financing are losing money on the deal. Since Friday, credit default swaps based on $2 billion of Corus debt have climbed 21 percent. An increase indicates a worsening in the perception of credit quality. The contracts, based on bonds and loans, are used to speculate on a company's ability to repay debt.
"It's clear that this came as a surprise to a certain part of the market," said Graham Neilson, a fund manager at Credaris in London.
Fitch said the plan to make Corus responsible for the additional borrowing might prompt a cut in its senior unsecured credit rating from B+, four levels below investment grade. High-yield debt is rated Ba1 or lower by Moody's Investors Service and BB+ or lower by Standard & Poor's or Fitch.
"The combination of the two businesses at first seemed positive for Corus; now it's not clear what kind of access Corus will have to financial support to service the debt and to Tata's stronger operations," said Peter Archbold, a London-based analyst at Fitch.
Tata is seeking to create the world's fifth-largest steel maker through its $8 billion acquisition of Corus. The deal would be the industry's second biggest this year, behind Mittal Steel's $38.3 billion Arcelor purchase.
"The proposed financing ensures financial flexibility of Tata Steel" to fund projects, "while addressing the issues of risk", said Koushik Chatterjee, Tata Steel's vice-president of finance.
Credit default swaps based on Corus debt were quoted today at E162 000 (R1.6 million), higher than the E133 800 last week. The prices are based on E10 million of debt. The five-year contracts, conceived to protect bondholders against default, pay the buyer face value in exchange for the notes should the company fail to adhere to its debt agreements.
The debt included a £1.35 billion (R19.5 billion) high-yield loan that would be repaid with a bond once Corus shareholders approved the deal, sources said. - Bloomberg