CLN investors will turn to repos, predicts Morgan Stanley

Morgan Stanley says that repos are likely to play an increasingly important role in credit-linked notes, as investors pay greater attention to the market risk of the collateral used to back CLNs.

In its latest Credit Derivative Insights report, the bank says there have been large differences in the performance of different types of collateral used to back structured notes. While treasuries and covered bonds have proved stable in terms of prices, spreads on other assets, such as credit card securitisations and corporate bonds, blew out substantially during the credit crisis, producing big mark-to-market losses for investors in addition to any deterioration in the reference credits.

The report points out that repos were used only sporadically before the crisis, but should now become more common. If investors’ cash is used to buy assets through a repurchase agreement with a dealer, it is the dealer that is on the hook for any change in the price of the assets. Also, the investor is not exposed to the counterparty risk of the dealer, since in the event of a counterparty bankruptcy, the investor would own the repoed securities outright.