Oct. 9 (Bloomberg) -- The Markit LCDX, a benchmark credit- default swap index used to hedge against losses on leveraged loans, fell to a record low as banks tried to sell holdings of the debt.

The index fell 3.35 percentage points, its biggest drop ever, to a mid-price of 85.50 of face value, according to Goldman Sachs Group Inc. The index falls as credit risk increases. It's the lowest price since the index was introduced in May.

Prices of leveraged loans have tumbled to record lows as hedge funds seek to sell assets in the wake of the worst monthly performance in 10 years, the failure of Lehman Brothers Holdings Inc. in New York and the takeover of Kaupthing Bank hf by the Icelandic government today. Lower loan prices make it more expensive for companies to raise capital.

``There's a massive pullback in buyers and there are forced sellers including hedge funds facing redemptions,'' CreditSights Inc. analyst Chris Taggert in New York said.

The price of the average actively traded leveraged loan has plummeted 17.3 cents to 71.1 cents on the dollar since Sept. 9, according to Standard & Poor's LCD. Average prices fell 3.5 cents since Oct. 7.

High-yield, or leveraged, loans are graded below Baa3 by Moody's Investors Service and lower than BBB- by Standard & Poor's.

Capital Woes

Rapid declines in the value of loans will make it tougher for companies to raise capital as banks have greater difficulty calculating the price of the debt, said Brett Barragate, a partner at law firm Jones Day in New York specializing in commercial financing.

Average loan prices have fallen from 94.89 cents on the dollar since the start of the year, S&P data shows. The decline has boosted yields over the London interbank offered rate to a record 1,374 basis points from 394 basis points, assuming four years to repayment, according to an S&P index. A basis point is 0.01 percentage point. Three-month Libor is 4.75 percentage points.

``It dramatically affects the price at which companies can raise money,'' Barragate said in a telephone interview. ``No bank wants to take the risk they've priced a loan incorrectly.''

Loan prices fell today in Europe after brokers began sending details of loans used to fund leveraged buyouts for sale to investors and traders, according to four people who saw the lists.

Bid Lists

``There are several bid lists of leveraged loans circulating,'' said Louis Gargour, chief investment officer at London-based hedge fund LNG Capital, who is setting up a distressed debt fund. ``One is from an Icelandic bank and two are from leveraged hedge funds.''

Europe's Markit iTraxx LevX index of credit-default swaps on loans to 75 companies dropped to a record low of 87.5, from 92.75 yesterday, according to Deutsche Bank AG.

``There are going to be more and more leveraged loans being sold off by a variety of different investors in the coming days and weeks,'' said Charlotte Conlan, head of leveraged syndication at BNP Paribas SA in London. This ``will inevitably have a knock- on effect on the mark-to-market for the rest of the loan investor community.''

Hedge funds lost 4.7 percent in September, the biggest monthly decline since the collapse of Long-Term Capital Management LP in 1998, according to Hedge Fund Research Inc.

Swap Prices

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. An increase indicates a deterioration in the perception of credit quality; a decline, the opposite.

The cost of protecting investment-grade corporate bonds also soared today, the benchmark Markit CDX North America Investment Grade Index shows. The CDX index, linked to the bonds of 125 companies in the U.S. and Canada, jumped 19.5 basis points to 197 basis points as of 3:21 p.m. in New York, according to Deutsche Bank AG.

To contact the reporter on this story: Pierre Paulden in New York at ppaulden@bloomberg.net

Last Updated: October 9, 2008 18:30 EDT