The cost of protecting debt issued by Mirant North America LLC has been falling because speculators are selling protection in the belief that there could be no debt left once the company has merged with RRI Energy Inc. (RRI).

Debt protection in the form of credit default swaps has been falling since June 3 and touched 225 basis points on Friday, down from 250 Thursday and 287 at the start of the week, according to data provider Markit. That means it costs $225,000 annually to insure $10 million of the company's debt against default for five years.

An equal amount of protection cost $638,000 before April 12, when Mirant said it would merge with RRI, formerly known as Reliant, by the end of 2010. They have told investors they plan to "address" $1.8 billion in debt at the combined company, which will be called GenOn Energy.

The companies were no more specific about their plan for the debt, but speculators are betting GenOn will pay off Mirant's debts. That has led speculators to write so-called naked CDS--where they do not own the underlying bonds--on the assumption they will be able to collect fees to insure debts that is likely to be retired.

"There is a high probability that (Mirant) CDS will become orphaned, and sellers of CDS will collect a five-year stream of payments for insuring a bond that no longer exists," Andrew DeVries, a senior analyst at CreditSights, wrote in a recent report.

Together, Mirant and RRI had $2.9 billion in cash as of Dec. 31; Mirant had $2.1 billion itself. GenOn could use it to buy back a series of bonds that, according to their covenant terms, investors can sell back to the company at a small premium if the company is sold or merged. It is unclear if bondholders will do this, however, since the bonds are trading above the premium price.

Also unclear is whether GenOn will choose to issue debt under the name of Mirant North America LLC, also known as Mirna, at some point in the future.

"The potential to issue from Mirna, I believe it still there," said Peter Molica, a director at Fitch Ratings. "Every indication is that they will issue at GenOn...but Mirna doesn't go away. I am not sure there is anything that prohibits them from issuing at Mirna."

As of the end of the first quarter, Mirna had $850 million in cash bonds with a 7.375% coupon and $307 million under a senior secured term loan, both falling due 2013. Reliant had $279 million in secured bonds due 2014 and $371 million in industrial revenue bonds due 2036.

There are covenants attached to the debt, which in the case of RRI require any new subsidiaries to guarantee its issuances.

-By Katy Burne, Dow Jones Newswires; 212-416-3084; katy.burne@dowjones.com
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