Barclays monoline insurance ploy pays off

May 7, 2009

Margaret Doyle— Margaret Doyle is a Reuters columnist. The opinions expressed are her own —

By Margaret Doyle

Barclays has avoided the dead hand of state shareholding and, on Thursday’s evidence, it looks as though it will escape completely.

Barclays Capital has enjoyed a storming first quarter — so good it is hard to see it being sustained — which has allowed the bank to make more big write-downs and still report a 15 percent increase in pre-tax profit.

The key question is whether its provisions against so-called level 3 (hard to value) assets are sufficient.

On the face of it, they do not appear to be, because they have provided for a write-down of 24 percent on an alphabet soup of American junk assets. That compares to a write-down of 75 percent taken on a bunch of similar assets by Societe Generale, which unveiled an unexpected first-quarter loss.

Both bought insurance against a deterioration in the value of these assets, in Barclays’ case, 27 billion pounds-worth, from “monoline” insurers.

Analysts have questioned the value of such insurance, as the survival of the monolines themselves has been called into question. Barclays’ defence is straightforward: it says the likelihood of being hit by both a default on the underlying asset and on the insurer is very low. And it is taking more write-downs with each quarter’s results.

But are these haircuts just big enough to be comfortably covered by Barclays’ profits? Is it simply trying to earn its way out of the credit crunch?

It is, of course, in Barclays interests to play a long game. It gave Middle Eastern state investors great terms on a capital injection last autumn in order to avoid having Her Majesty’s Government on the share register.

I-shares, only recently considered to be a core asset, was also ditched in order to help it pass a British stress test. Had it failed, it would have had to buy insurance on punitive terms from the government.

Shareholders have bought the story. The stock price has risen six-fold from its January low. Whether it will continue to rise depends on whether BarCap can continue to turn in profits faster than its American junk goes bad.

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