Credit default swaps tied to the UK’s largest pub operator have plunged in value as investors fear the company’s recent debt refinancing has left the contracts worthless, meaning bondholders have no way to hedge.

The contracts have fallen in value since Stonegate Pubs - owner of the Slug & Lettuce and Be At One chains - closed on a refinancing last week, selling more than £2 billion ($2.54 billion) of bonds at double-digit yields. The legal entity cited in the CDS paperwork as the so-called reference entity for the protection against default isn’t included among the vehicles that are guaranteeing the new bonds, according to a document seen by Bloomberg News, paving the way for a potential “orphaning” of the swaps.

Orphaned swaps have no underlying debt they would pay out on in case of a default, effectively making them worthless.

The price of Stonegate’s five-year credit default swaps has more than halved since the launch of the refinancing deal and are now quoted at 199 basis points, according to ICE data. Meanwhile, the price of one year credit default swaps fell from 326 to 94 basis points.

The situation could change if reference entity Stonegate Pub Company Financing Ltd. is added to the list of guarantors for the new bonds. A similar situation emerged in 2020: The company’s sale of new debt then - needed to fund the buyout of rival UK pub chain Ei Group - was set for a similar orphaning of the swaps contracts, but eventually Stonegate added the reference entity to the guarantors list.

A representative for Stonegate declined to comment. The company’s private equity owner, TDR Capital, also declined to comment.

While orphaned CDS leave investors with no opportunity to directly hedge against a default, Stonegate’s refinancing last week means it likely won’t face any debt problems for some years.

“Pending clarification, outcomes would appear to be binary,” JPMorgan Chase & Co. credit analysts including Neill Keaney wrote in a note last week. However, he said he expects the swaps to settle at higher levels, given the outcome last time and the fact that bondholders are likely to push to add the entity to the guarantors’ list so they can have a tool to hedge their investment.

Meanwhile, Creditsights analysts including Joshua Kramer are taking a different stance. In a note from Monday, they argue that the old credit default swaps are “likely orphaned” and that it’s possible that their prices could drop even further, as “we expect orphaned entities to trade sub 100 basis points.”

Stonegate has struggled since the pandemic’s lockdowns and the UK’s cost-of-living crisis weighed on business. The company refinanced its debt ahead of a £2.2 billion bond maturity in July next year.

  - Bloomberg