Independent data and trade processing firm Markit launched the first tranched LCDX last Wednesday, with market players forecasting that a new crop of investors would take an interest in the product and create liquid trading conditions.
"We firmly believe these tranches will be popular," Stephen Waugh, a vice president at Deutsche Bank, said on a Markit conference call last Tuesday. Indeed, the "long-awaited" and "highly anticipated" index, as market players referred to it on the call, has already been quoted for several months, according to Citigroup.
In addition, participants touted the convenience of execution, because the trades will use the same standardized documentation. "You will be able to execute across other dealers and unwind across numerous dealers," said Ronnie Jaber, a synthetic loan trader at Morgan Stanley, who was also on the call. The standardized tranche pricing will also provide further guidance on pricing bespoke products, he said.
"What we have seen happen in the investment grade and high yield spaces is that the indices will lead and clients will come in and leverage other credit expertise to come up with bespoke tranches. That is the way the bespoke market can grow in leaps and bounds," he said. "We expect this to be a huge part of the market going forward."
The equity tranche and the junior mezzanine tranche will be trading in all points up front, and the mezzanine and senior tranches will be traded based on a running spread with or without delta, Jaber said, noting that dealers will be quoting the tranches both ways, as well as providing quotes on alternatives to the standard tranches.
New to the Market
The LCDX tranches should generate a further bid for LCDX as structured credit investors become more active in the sector, Lehman Brothers said in a recent report. Deutsche's Waugh echoed these expectations, adding that he anticipated new participants to enter from the cash CLO market as well as loan books to use this product as a hedge. While hedge funds have typically been the first clients to move into the tranche - with real money accounts, such as insurance companies and banks, taking more time to get involved - some of the real money accounts are moving a bit faster to take positions in the product, Jaber noted.
However, one source of concern surrounding the launch was the higher amount of leverage in the new LCDX series 9. With nine recent LBO names added to the new series of LCDX, average net total leverage and average gross total leverage of the LCDX are 5.2x and 5.8x, respectively, according to Lehman. Newly announced LBO transactions that have been added to the index include CSC Holdings, Tribune Co. and United Rentals. Already completed buyouts in the index include First Data Corp., Claire's Stores, Hawaiian Telecom, Intelsat, Realogy Corp., Travelport and Univision Communication as well as 26 other LBO names. While the LCDS contracts in the LCDX reference only senior secured first-lien loans, 12 of the issuers in LCDX have little or no unsecured debt, so there is no "cushion" for loan holders, Lehman added. Twenty-five percent of the names are covenant lite, Markit noted on its call.
Losses in the tranched LCDX structure occur in reverse seniority, similar to a typical cash CLO or investment-grade synthetic deals, but unlike cash deals, there are no OC tests, IC tests or calls on a tranched LCDX, Morgan Stanley's Jaber said.
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