High LCDS recoveries drive LCDX outperformance, says BoA

In its 16 July research, Bank of America/Merrill Lynch strategists argue that high loan-only credit default swap recoveries in Isda auctions underlie the outperformance of the LCDX series 12 over CDX HY series 12 seen since the beginning of May this year.

Analysts discuss the difference between secured and unsecured recoveries that have become characteristic of recent credit derivatives auctions (see table below), noting various factors that could influence the difference in recoveries. These include: asset valuation, amount of secured versus unsecured debt, earnings potential/cash flow burn of the company through the bankruptcy process, roll-up rights provided to secured lenders (as was the case with Lyondell), and any structural considerations between the operating company and the holding company.

By comparing the difference in secured and unsecured recoveries with the ratio of loans outstanding to bonds outstanding, BoA/ML analysts reveal that lower secured recoveries are seen amongst firms whose debt is financed through loans.

Source: Bank of America/Merrill Lynch