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Downgrades May Slow Structured Note Sales by Restricting Buyers

U.S. structured note sales may slow further after Moody’s Investors Service lowered ratings on 15 banks last week, as some investors may be barred from buying their securities.

Moody’s downgraded the 11 largest issuers of U.S. structured notes on June 21, with Credit Suisse Group AG dropping the most at three levels to A2, or the sixth-highest investment grade. Bank of America Corp. (BAC), the largest issuer of the U.S. securities, fell one level to the second-lowest investment grade.

This year has already been the worst for U.S. structured note issuance since at least 2010, according to data compiled by Bloomberg. Banks have sold $19.5 billion of the securities, 13 percent behind last year’s pace, as low interest rates have made it more difficult to create attractive terms on the notes.

Moody’s rating cuts “may trigger redemptions for some investors or prohibit those investors from buying more of the securities,” Alexandre Ecot, a director at Societe Generale SA’s group that sells derivatives and structured notes, said in a telephone interview.

Distributors to funds or endowments that are restricted to buying investments at a certain rating or higher “are losing clients, especially on the rate-related notes,” said Flavio Paparella, a partner at TCT Securities and Derivatives LLC, a Miami-based broker-dealer.

Rate-tied note issuance has declined 30 percent this year to $3.11 billion. The five-year swap rate, a benchmark for borrowing costs, is at 0.95 percent, down from 1.8 percent a year earlier, Bloomberg data show.

Downgrade Expected

Randy Pegg, head of distribution of structured products at Advisors Asset Management Inc. in Monument, Colorado, said in an e-mail that the mass downgrade won’t “hurt us much because it was expected.” Most of its clients approve investments as long as they’re investment-grade, he said.

The lowest ranking that Moody’s assigns to the top 10 U.S. structured note issuers is Baa2, shared by Bank of America and Citigroup Inc. The rating company cut Citigroup two notches last week.

The Royal Bank of Canada lost its spot as one of the highest-rated issuers after being reduced by Moody’s two levels to Aa3, or the fourth-highest level. Toronto-based Bank of Nova Scotia is now the highest-rated U.S. issuer among banks, with an Aa1 from Moody’s, which is the second-highest grade, and an AA-, fourth from the top, from Standard & Poor’s.

Moody’s move had little effect on credit-default swap levels because “it was already priced into the market,” Societe Generale’s Ecot said.

Default Swaps Drop

Default swaps on the 15 banks fell to an average of 239.9 basis points the day after the credit rater’s announcement, from 246.7 a day earlier, Bloomberg data show. The swaps, which pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt, have increased to 253.1 since then, Bloomberg prices show.

Structured notes are securities created by banks, which package debt with derivatives to offer customized bets to investors while earning fees and raising money. Derivatives are contracts whose value is derived from stocks, bonds, currencies and commodities.

To contact the reporter on this story: Matt Robinson in New York at mrobinson55@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net.

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