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Derivatives

Loan Default Swaps Buzz Attracts Other Players

Loan credit-default swaps are attracting the attention of credit participants outside of loans, despite some players reporting poor trading volumes.

Loan credit-default swaps are attracting the attention of credit participants outside of loans, despite some players reporting poor trading volumes. One conference attendee from a private equity fund that dabbles in distressed debt, told DW in an aside that his firm is interested in exploring LCDS and this is why he came to the conference.

There are several features of LCDS that differ from other CDS contracts that have the potential to bring in outside investors more quickly. A loan-only credit default swap has a similar probably of default as a conventional CDS, but recoveries would normally be higher. As a result, LCDS loan spreads are generally lower than bond and conventional credit-default swap spreads for the same issuer, noted Jeremy Vogelmann LCDS trader at Barclays Capital.

This anomaly partly reflects the premium cash loans receive to compensate the lender for the issuer's option to refinance the loan at lower spreads, while LCDS generally remain outstanding if the loan is refinanced. Also, the fact LCDS maturities are fixed for five years, for instance, while a cash loan can be amended or extended in some cases, also plays into why these instruments might appeal to players outside the syndicated loan space, traders said.

Another part of the appeal of these instruments is that their spreads should move in line with loans rather than following bond spreads, which also gives capital structure investors another way to express views on secured loans in relation to other securities, Vogelmann added.

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