Neiman Marcus Struck ‘Devil's Bargain’ With CDS Traders, Fund Says

Neiman Marcus Talks With Debt Holders Said to End in Stalemate

Photographer: David Paul Morris/Bloomberg

Neiman Marcus Group’s proposal to take more time to pay back its debt is tantamount to a deal with the devil, according to one hedge fund.

The Dallas-based retailer said last week it had reached a preliminary agreement with a majority of its bondholders and lenders giving it three additional years to pay them back and allowing the struggling retailer more time to turn itself around. As part of that agreement, the company would swap current borrowings for new obligations.

That exchange will end up helping some investors that made side bets against the company in the credit derivatives market, according to a letter from Dan Kamensky, founder of hedge fund Marble Ridge Capital. The investment firm is a Neiman Marcus bondholder that is suing the retailer over a subsidiary that it transferred.

“This seemingly innocuous provision is a spectacular ‘Devil’s Bargain,’ presumably struck by the company at the behest of the sponsors to create a massive windfall for a subset of creditors betting against the company,” Kamensky wrote, referring to Ares Management LP and Canada Pension Plan Investment Board, the investors that own the retailer.

The proposed debt swap is the latest example of how the $10 trillion credit derivatives market can play a key role in debt restructuring negotiations. In recent years, traders seeking to profit from derivatives bets have helped prop up grocers, ailing newspaper chains, homebuilders and even bankrupt Sears Holdings Corp.

A representative for Neiman Marcus said, “This is a small holder that clearly regrets it has refused the company’s repeated invitations to join creditor groups that reached an agreement in principle with Neiman Marcus last week. Far from increasing default risk, this deal will help support the Company’s long-term success.”

CDS surged after proposed agreement added new co-borrower

Without an exchange, players that used derivatives to buy protection against Neiman Marcus defaulting might not get much of a payout. Most of the retailer’s debt was borrowed by Neiman Marcus Group Ltd LLC. But only the debt borrowed by a different entity, Neiman Marcus Group LLC, can be delivered to settle the derivatives if the company fails. Because there’s so little debt from that issuer, the payouts on the derivatives would likely be relatively low.

Under the debt exchange, the current debt from Neiman Marcus Group Ltd LLC would become obligations of both that entity and Neiman Marcus Group LLC. That would create a lot more debt tied to the credit derivatives, which would in turn make payouts on the credit default swaps higher. Prices on the CDS contracts linked to Neiman surged after the deal was announced Friday. With those rising CDS levels, the market’s implied probability of the company defaulting over the next five years surged to around 80 percent, according to Kamensky’s letter.

The Neiman exchange would be a boon for roughly $255 million of CDS wagers against the retailer’s debt. A similar predicament last year sparked a hedge fund war over derivatives tied to Sears. Investors that had nothing to do with the credit derivatives market are now having assets stripped from them, in particular Neiman’s MyTheresa online retail business, because of side bets in the derivatives market, according to Marble Ridge’s letter.

“We will not stand idly by as the sponsors use their leverage over the company to retain the valuable MyTheresa assets in exchange for enabling the activities of speculators in the derivatives market,” the hedge fund said.

CDS Jump

After Neiman announced its tentative agreement with creditors, the cost to insure its debt against default for five years more than doubled to $3.3 million per $10 million of debt, according to data provider CMA. Such a jump typically indicates that traders are growing more wary about a company’s credit quality, but the retailer’s bonds rallied Friday, suggesting the opposite.

A tweak Goldman Sachs made last year to help complete a struggling buyout loan got the investment bank sued. United Natural Foods Inc., which issued the loan, accused the bank of raking in fees while exposing it to hedge funds betting against the retailer.

In the letter, Kamensky also drew parallels to Windstream Holdings Inc., which filed for bankruptcy last month after losing a court battle with New York hedge fund Aurelius over whether Windstream defaulted on its bonds by spinning off Uniti Group Inc.

“We see no legitimate reason for Neiman to suffer a similar fate as Windstream,” Kamensky wrote.

Kamensky said in the letter that Marble Ridge has never held CDS contracts to bet against the company. Marble Ridge took issue with the retailer’s financial plans in September, when the company first transferred a stake in MyTheresa to a unit owned by its equity sponsors. The hedge fund wrote a letter that month questioning whether that transaction constituted a debt default by the company, and followed up with a lawsuit in December.

Neiman Marcus returned with its own suit, in which it’s seeking damages tied to statements from Marble Ridge about the transactions that the retailer characterized as false.

— With assistance by Katherine Doherty

( Updates with implied probability of default in eighth paragraph.)