What the RBS downgrade means for bond fund managers

The downgrade by Moody’s of 12 UK banks’ senior debt has thrown the spotlight on financial bonds, although fund managers say the ratings agency’s move is not a surprise and are starting to buy on weakness.

Ignis’s Chris Bowie, manager of the firm’s Corporate Bond fund, said the downgrade has been baked into the price for some time, which has been reinforced by the bank’s credit default swap (CDS) level barely moving on the announcement.

Earlier this month Moody’s downgraded Royal Bank of Scotland’s senior debt by two notches, from Aa3 to A2. This was followed by as similar move by Fitch last week.

Bowie said: ‘We have been roughly 10% underweight banks, although we added around 1% a couple of weeks ago, buying senior Bank of America bonds. We are now dipping our toe in the water and are buying banks much more cheaply.’

He said HBOS’s tier one yield is around 15%-16%, similar to that of RBS. ‘When these yields are closer to 20% for RBS, then we would start buying.’ He said RBS was yielding as much as 30% in 2008 and 2009 although he does not believe they will reach similar levels again, as the bank is much better capitalised. 

Lloyds was also downgraded by the ratings agency, down to A1 from Aa3. Bowie said Lloyds has problems on the commercial property side, although the bank’s debt is getting closer to fair price.

Nonetheless, he said the Moody’s downgrade is retrospective, and will have no detrimental impact for bonds, especially those with a maturity longer than one year.  He said: ‘We have been underweight RBS for the last year, although we could be looking to add to that position.’

John Pattulo, head of retail fixed income at Henderson, said the downgrade is not particularly relevant and bondholders should not be troubled by it. ‘What’s more interesting is the impending recapitalisation of the European banking sector, which is coming,’ said Pattulo. ‘But someone has to pay for it – who takes the pain?’

He said the biggest banks in Europe would get the support of their local governments, although the smaller German Landesbanks and Spanish cajas would be further down the food chain and bondholders will take a greater hit.

‘Countries need a viable bank system with a few notional banking champions,’ said Pattulo. ‘The smallest banks will take the biggest hits.’