Barclays risky assets move a little too cozy

September 17, 2009

Barclays has come up with an interesting way to solve an optical problem. Concerned that the bank’s shareholders are nervous about possible future writedowns of wobbly assets with a value of $12.3 billion, it has sold them to its own employees.

This isn’t necessarily a bad idea. But there are two things to dislike about this deal. First, it looks pretty cozy to sell to your own workers. And second, the deal looks potentially very favourable for the purchasers.

The deal does not remove the assets from Barclays’ balance sheet. What it does is allow the bank to pull them out of its mark-to-market book, where their carrying value is contingent upon the financial health of some monolines with whom Barclays has taken out credit insurance.

To do this it makes a loan to an entity, which then buys these assets. The loan still sits on Barclays’ books but does not have to marked to market. Even so its value is ultimately still tied to the performance of the assets.

This, the bank argues, will allow the shareholders to sleep easily at nights, knowing that a credit downgrade at some obscure monoline will no longer bring writedowns crashing down upon their heads.

This may seem fair enough. But to achieve this optically pleasing outcome, the bank has cut a deal that offers real upside for Protium Finance — the entity that has purchased the assets — and a group of its own ex-employees that will manage them.

Consider the terms of the deal that Barclays has disclosed.

The bank will sell $12.3 billion of assets to Protium, a fund whose backers are not identified. To fund the purchase, Barclays is lending the entity $12.6 billion for 10 years and Protium’s backers are contributing a further $450 million. The loan and the external capital injection exceed the amount that Protium is actually paying Barclays. This excess capital will be used by Protium to buy other distressed assets.

Protium intends to repay the loan out of the cashflows generated by the assets.
So far so clear. But here there’s a bit of a twist. The Barclays loan ranks junior to the $450 million of external capital Protium is raising. This means that almost all of the risk seems to remain with the Barclays shareholders. Yet all of the upside after the loan is repaid goes to Protium.

So if the assets, which have already been heavily written down, ultimately turn out to be worth $14 billion, say, rather than $12.3 billion, Protium would take home $1.4 billion. Not a bad return on its $450 million. But if the assets were to fall in value by a similar amount, to $10.6 billion, Protium would still get its $450 million back.

What’s more, Protium gets a fixed 7 percent return on its senior capital contribution, while the Barclays subordinated loan is struggling on at 2.75 percent over Libor — which would at present imply an interest rate of about 4 percent.

This all seems a bit back to front.

Indeed it all looks very juicy for Protium and C12, the management company staffed with ex-Barcap employees (who left as the deal was announced) that will run its exposures.
It is quite astonishing that Barclays would choose to complete such a large and complex deal with its former employees without conducting a beauty-parade with other asset managers — as it seems to have done.

There’s no shortage of asset managers looking to commit capital to distressed ABS. An auction would have at least ensured that whoever won paid a fair price.

No doubt the argument will be made that to go outside would have risked the deal being leaked and that the Barcap bankers were best placed to evaluate the assets, but  frankly those arguments look pretty thin.

This is not a senseless deal. But whatever comfort shareholders may have obtained from the optical certainty will have been eroded by its cozy nature.


Comments are closed.