Credit default swaps that reference bank loans appear to be set to take off after several years of idling. Morgan Stanley in Europe has launched a product that will enable banks and investors to either gain exposure or hedge the risk of senior secured bank debt on both agent and non-agent names without owning the cash product. The firm is expected to start sending runs for U.S. names in coming weeks. Meanwhile, a portfolio manager explained that his shop is working with institutions to create a CDS portfolio for investors that will be referenced to loans and anticipates launching it within the next few months.
One banker familiar with Morgan Stanley's plans explained that the introduction is a combination of interest among investors and a lack of product to trade in the market due to the supply and demand imbalance for loans. "There is nothing left to trade. It's invention by necessity," he said. Officials at Morgan Stanley declined comment.
Lehman Brothers has the most developed bank loan CDS product, according to loan market participants, and Credit Suisse First Boston offers a synthetic index product called the Select Aggregate Market Index (SAMI). But the market for bank loan CDS is largely on an individual name basis and to date most credit default swaps reference high-yield bonds.
The swaps will trade off a modified International Swaps and Derivatives Association document and will be callable, a unique wrinkle, said the London-based banker. Extra benefits will be the ease of settlement and the ability to short, which is close to impossible with bank debt, despite several attempts to come up with a solution. "Portfolio managers want to hedge the risk," he noted.
Settlement will be T+1 compared to the standard T+7 on par loan trades and the product will be available on the public side. The investor will not need borrower consent, but will also have no voting rights unless the loan is delivered. Morgan Stanley is encouraging other dealers to get involved, said the banker, who declined to say how many names would be covered.
