Spreads on loan-only credit default swaps tightened 10-50 basis points last week as a lack of familiarity and comfort with the product have more people selling than buying. Hertz and Windstream Communications are two deals that saw spreads tighten. Hertz's LCDS spreads tightened to 89-90 from the 110-120 range; Windstream's spreads tightened to 75-85 from 95-105.
Hedge funds continue to represent the majority of the sellers, said a dealer. She said these investors are selling LCDS protection to gain exposure to the loan market rather than buying loans. "It is an easier play for them," she said. Hedge funds are also playing a company's capital structure by selling LCDS to go long the loan portion of deals and buy unsecured CDS to short the bond portion. Windstream fits this example, as hedge funds are selling LCDS protection, while buying unsecured CDS, she said.
Banks continue to represent the majority of buyers of LCDS, said the dealer. Banks that have large exposures to revolvers are buying protection to hedge the risk of carrying these loans, she explained. Another common strategy for investors is to buy a revolver at a discount and then buy protection against that position with the hope the revolver either gets funded or gets taken out earlier than the maturity of the CDS. Assuming there is time left on the CDS contract, it should still have value when it is unwound.