Why the RBS downgrade throws up opportunities

The recent downgrade of the Royal Bank of Scotland and other issuers in the UK could see structured products offer higher payments to investors willing to take on bank debt.

Ratings agency Moody’s last week downgraded the senior debt and deposit ratings of 12 financial institutions, including RBS and Lloyds. The ratings actions saw RBS downgraded by two notches from Aa3 to A2 while Lloyds was reduced by one notch to A1, down from Aa3.

Phil Taylor, founder of the UK structured products platform SPGO, said the recent downgrade brings forth ‘interesting opportunities’ for these products in the UK, similar to the scenario seen in 2009.

He said: ‘It is not so much the downgrade from Moody’s that creates opportunities but the recent increase in the amount the banks are willing to pay for the money investors are loaning to them, by investing in a structured product. This is a similar scenario as it was in 2009.’

Taylor said he saw some of the biggest inflows into structured products in 2009. This followed the fall of Lehman Brothers in September 2008 and the credit crisis, which saw a lot of investor nervousness around banks. ‘The question is now,’ said Taylor, ‘does this mean that structured products are back in vogue again?’

He explained: ‘Banks began to pay increasing amounts to attract investors to lend them money and this is reflected in the terms offered by structured product providers. This, in turn, is reflected in the potential returns from the latest range of structured products, with some strong annual double-digit returns now available.’

The downgrade may also allow for opportunities within the secondary market. Mike Neumann, director of investment management at Bestinvest, said if investors can find a quote in the secondary market and if there is sufficient liquidity, then there will be some interesting issues to buy.

‘The price of some structured products is being ratcheted down to take account of the ratings downgrade,’ added Neumann.

However, he warned although this may provide a buying opportunity, investors and wealth managers should be concerned about credit quality and pay a lot of attention to the issuer.

‘Wealth managers should still be concerned about credit quality – everyone should be. The names that will trade at wider spreads in the CDS market will see the secondary market pricing fall. So exposure to the underlying issuer needs to be questioned,’ Neumann added.