Loan Derivatives Index Soars as Banks Find Takers for LBO Debt

By Shannon D. Harrington and Pierre Paulden

April 25 (Bloomberg) -- A gauge of investor confidence in the U.S. leveraged-loan market is headed for its biggest monthly increase since being created last year as banks find ways to sell loans they have been stuck with the past 10 months.

The LCDX index is rallying as Citigroup Inc., Deutsche Bank AG and the rest of Wall Street whittle down their leveraged-loan liabilities to about $91 billion from a peak of $237 billion in August, according to Bank of America Corp. strategists led by Jeffrey Rosenberg in New York.

The LCDX Series 9, a credit-default swap index tied to the loans of 100 companies in the U.S. and Canada, has climbed 3.5 percentage points to 96.9, according to Goldman Sachs Group Inc. A newer version LCDX 10, used to hedge against losses or to speculate on the ability of companies to repay their debt, is up 2.1 percentage points to 99.1 since it started trading April 8.

``It's been quite a euphoric run for the market,'' said Alan Alsheimer, who trades the LCDX contracts at Goldman Sachs in New York.

As banks are able to move the loans off their balance sheets, they also have been unwinding LCDX trades that were used to hedge against potential losses from those loans, Alsheimer said. Hedge funds and other institutional investors with bearish bets have followed suit as prices rose.

``Banks are unwinding their hedges after selling their loan exposures,'' Stephen Antczak, a high-yield strategist at UBS AG in Stamford, Connecticut, said in a telephone interview.

LBO Debt

The LCDX indexes are linked to much of the debt committed by banks to fund a record amount of leveraged buyouts last year before the collapse of the U.S. subprime-mortgage securities sparked a freeze in debt markets. The index includes credit-card payment processor First Data Corp., acquired by Kohlberg Kravis Roberts & Co. last year, and newspaper publisher Tribune Corp., which was taken private by billionaire Sam Zell.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt or hedge against the risk they won't. They cover losses on underlying debt if the borrower fails to make payments.

The LCDX Series 9 has soared more than 6 percentage points from a low of 90.8 on Feb. 20, Goldman prices show.

The market is now ``at an inflection point,'' Alsheimer said, as investors weigh the potential effect of slowing economic growth, rising fuel and production costs and increased financing costs.

``We are in the early stages of what is expected to be a sustained move higher in actual defaults,'' Alsheimer said.