Bond traders are rapidly losing faith in Sears’ ability to stay alive.
The price to insure $10 million of Sears bonds against default has risen to $4.6 million a year, meaning that holding the bond insurance—called a credit default swap—for a little more than two years will actually cost more money than the principle is worth, according to research firm IHS Markit. Over the full five-year term, it would cost $23 million to insure $10 million in bonds, meaning very few traders who are buying up the bond insurance think the company will last nearly that long. The cost per year was $3.3 million as recently as September, and was less than half a million dollars in mid-2013.
The implication of this wacky math coming from the obscure CDS corner of the bond market: Sears won’t make it much past Jan. 2019.
The bonds pay about $660,000 a year. So it would take an additional four months to wipe out the interest after the principal is gone, a total of about 29 months. But the most likely scenario is that the CDS traders expect the company to enter default even sooner than that since traders wouldn’t invest in the credit protection just to break even on the deal. CDS pays out when a borrower defaults, or doesn’t make a bond payment on time.
Sears has been in trouble for several years as its revenue has dropped and debt has piled up, but the company has managed to keep itself afloat by divesting its holdings. Since 2011, the company has lost $8.2 billion as it experienced a nearly $40 drop in sales. To counter the massive losses, Sears raised $12 billion since 2012 by selling off real estate and spinning off assets such as Lands’ End and Sears Canada, according to Fitch Ratings. The strategy has worked to keep the lights on, but it can only last so long. At some point, Sears will have no more brands to sell or companies to spin off.
The company’s shaky-looking future has made Wall Street abandon its stock in droves. As recently as May 2015, the company’s stock price sat at $44.31, but shares of Sears (SHLD) have dropped to all-time lows in recent weeks, sitting at $6.36 in midday trading. But that 86% drop in price pales in comparison to the huge difference in stock valuation from late 2006, when shares were trading for over $160.
One thing to consider is that some of these traders may just be viewing the Sears CDS contract as a trading vehicle—they may just be making bets on something that they don’t actually think will happen because they’ve found a market inefficiency they think they can exploit. All they may be trying to do is find someone to flip the contract to for a quick profit, as the prospects of Sears make investors who hold the company’s bonds more and more nervous. But even if that were true, it still wouldn’t change the messy and unsustainable financial situation Sears is in now.
