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What Is A Loan Credit Default Swap (LCDS) ?

A loan credit default swap (LCDS) allows parties to exchange the credit risk of a syndicated secured loan. The structure of a LCDS is similar to a regular credit default swap, with the main difference being that the reference obligation in a LCDS can only be a syndicated secured loan, not any type of corporate debt. LCDS contracts can be either cancelable or non-cancelable, with cancelable LCDS generally having higher premium rates since the buyer has the option to cancel. The recovery rate for a LCDS is typically higher than a regular CDS since the underlying loan in a LCDS is secured, giving it priority in the event of default.

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41 views2 pages

What Is A Loan Credit Default Swap (LCDS) ?

A loan credit default swap (LCDS) allows parties to exchange the credit risk of a syndicated secured loan. The structure of a LCDS is similar to a regular credit default swap, with the main difference being that the reference obligation in a LCDS can only be a syndicated secured loan, not any type of corporate debt. LCDS contracts can be either cancelable or non-cancelable, with cancelable LCDS generally having higher premium rates since the buyer has the option to cancel. The recovery rate for a LCDS is typically higher than a regular CDS since the underlying loan in a LCDS is secured, giving it priority in the event of default.

Uploaded by

Niño Rey Lopez
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Loan Credit Default Swap (LCDS)

What Is a Loan Credit Default Swap (LCDS)?


A loan credit default swap (LCDS) is a type of credit derivative in which the credit
exposure of an underlying loan is exchanged between two parties. A loan credit default
swap's structure is the same as a regular credit default swap (CDS), except that the
underlying reference obligation is limited strictly to syndicated secured loans, rather
than any type of corporate debt.

Loan credit default swaps can also be referred to as “loan-only credit default swaps.”

KEY TAKEAWAYS

A loan credit default swap (LCDS) allows one counterparty to exchange


the credit risk on a reference loan to another in return for premium
payments.
 A loan credit default swap has the same general structure as a regular
credit default swap.
 The difference is that in the LCDSD, the reference obligation underlying
the contract can only be syndicated secured loans.
Understanding a Loan Credit Default Swap (LCDS)
The LCDS was introduced to the financial market in 2006. At the time, the hot market
for credit default swaps showed that there was still an appetite for more credit
derivatives, and the LCDS was largely seen as a CDS with the reference obligation
shifting to syndicated debt instead of corporate debt. The International Swaps and
Derivatives Association (ISDA) helped to standardize the contracts being used at the
same time as the creation of syndicated secured loans for the purpose of leveraged
buyouts was also increasing. 

The LCDS comes in two types. A cancelable LCDS is often referred to as a U.S. LCDS
and is generally designed to be a trading product. As the name suggests, the
cancelable LCDS can be canceled at an agreed-upon date or dates in the future
without penalty costs. A non-cancelable LCDS, or European LCDS, is a hedging
product that incorporates prepayment risk into its makeup. The non-cancelable LCDS
remains in force until the underlying syndicated loans are repaid in full (or a credit
event triggers it). As a U.S. LCDS has the option to cancel, these swaps are sold at a
higher rate than comparable non-cancelable swaps.

 
The recovery rate for LCDS is much higher than for CDS on bonds because the
underlying assets for LCDS are syndicated secured loans. 1
Loan Credit Default Swaps vs. Credit Default Swaps
As with regular credit default swaps, these derivative contracts can be used to hedge
against credit exposure the buyer may have or to obtain credit exposure for the seller.
A LCDS can also be used to make bets on the credit quality of an underlying entity to
which parties have not had previous exposure.

The biggest difference between a LCDS and a CDS is the recovery rate. The debt
underlying an LCDS is secured to assets and has priority in any liquidation
proceedings, whereas the debt underlying a CDS, while senior to shares, is junior to
secured loans. So the higher quality reference obligation for a LCDS leads to higher
recovery values if that loan defaults. As a result, a LCDS generally trades at tighter
spreads than an ordinary CDS.

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