A handful of bespoke collateralized debt obligations backed by floating recovery rate loan-only credit-default swaps are in various stages of marketing. In a floating-rate LCDS, the protection seller settles at the recovery value of the loan after default, as opposed to fixed-recovery LCDS, where the protection seller makes a cash settlement based on a recovery rate agreed at the outset.
Full capital structure deals have so far been issued using fixed-recovery CDS because some potential users--such as insurance companies--can only buy synthetic deals with fixed recoveries. Issuers also noted that there is a structural benefit in using fixed recoveries in CDOs, because rating agency models will allow for lower attachment points and lower subordination. Lehman Brothers is close to closing a USD500 million LCDO out of its Exum Ridge series that uses fixed-recovery, according to an official at the firm.
The development of floating-rate LCDOs is driven by investors searching for yield. Investors have been looking at using the floating-rate LCDS to construct single-tranche deals at the equity level to soup up returns. Deal specifics could not be gathered as the deals are private single-tranche offerings and it could not be determined how much a single equity-tranche deal constructed using floating-rate LCDS would pay over a full capital structure deal using fixed-recover LCDS.
