An interesting quick aside from Blue Sky Asset management – you may remember that I think that their free research is probably some of the best in the business, with their work on counter party risk especially compelling. Anyway they’ve started issuing their own Counter Party bulletin or should I say Observer which should make interesting reading if you’re thinking of ever buying a structured product. In the latest edition I noticed the following passage which may be of interest if you’re thinking of taking out a structured product with Investec.

“For UK structured product advisers/investors, perhaps the most important downgrade in March was Investec Bank UK Ltd. and its parent Investec plc. Moody’s downgraded the bank by two notches in one move, from Baa1 to Baa3, which means its debt is now on the very edge of investment grade, and is just one notch above ”speculative grade” or ”junk bond’’ status. This is a significant fact.

In its press release, Moody’s explained the reasons behind the downgrade, with three notable points: (a) exposure of the bank’s parent, Investec plc, to Kensington, which is a mortgage specialist in the UK, dealing with sub-prime borrowers and buy-to-let investors; (b) exposure to non-performing collateral in the private bank division; and (c)Moody’s view that Investec Bank UK needed to be ”systemically important in the UK in order to benefit from a rating uplift that we factor in for the large retail banks in UK”. It is difficult to see the resulting impact on the credit spread on deposits/debt issued by Investec, as the credit default swap (CDS) market for this obligor is not liquid and one cannot find a price easily from publicly available sources. But, as a comparison, according to Bloomberg, 5 year Sterling denominated notes issued by BBB rated finance companies (a composite measure therefore) are currently trading at a yield of around 8.8%, which is 5.85%above the 5 year interest rate currently quoted in the interbank swap market.

UK structured product advisers/investors should take note of this downgrade and the reasons behind it. According to SRP, Investec issued 22 per cent of the total structured products in the UK in February. Investors using structured deposits (issued by any bank) may be tempted to ignore credit ratings and rely on FSCS compensation as a ”safety net” to protect them against default. However, whilst this rationale might seem reasonable in theory, it would seem simplistic to justify taking on exposure to an issuer with a known low credit rating and therefore an identified higher credit risk, based upon a worst case ’safety net’ provision. Further, FSCS only protects up to £50,000 of investment - and it is not clear whether this is on the deposit principal or the mark to market value of the structured deposit, at the time of default/claim.“

David Stevenson is also one of the Four Wise Monkeys at the online TV investment programme

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