We met in New York in mid-June as the Bear Stearns High-Grade Structured Credit Strategies Funds were experiencing a bad bout of bubonic plague. "The trouble with instruments such as CDOs," Paul intoned, "is that they are illiquid and thus hard to value even in the good times."
If you can’t quantify the risk, all you are left with is a black hole of fear. "It’s a classic tale of darkness," another source moaned. "Think: the horror, the horror."
During the past month, Barclays’ senior management have been shadow-boxing with an unseen but fleet-of-foot enemy called "fear of the unknown". The doubters argue the following: Barclays Capital is a market leader in debt instruments. Barclays Capital was involved in structuring the now discredited SIVs (vehicles that fund long-term assets with short-term instruments) and the even more risky SIV-lites. Barcap employees involved with the creation of these conduits have left the firm and, in August, Barclays twice borrowed from the Bank of England’s emergency facility. In essence, Barclays Capital is more exposed to this debt crisis than other investment banks because its focus is fixed income. For the first half of 2007, Barclays Capital contributed approximately 40% of Barclays’ pre-tax profits. So a decline in the potency of the prodigious prodigy would hurt.
"Look," a source sighed. "There’s a lot of jealousy about the success of Barclays Capital. Competitors would love to see them fail." I’m beginning to wonder if things are as bad at Barclays as detractors insist. I base my analysis on three things: convention, charisma and capitulation. First, the convention: the Financial Services Authority’s Disclosure and Transparency Rules would require Barclays to issue a statement if they were aware of information that would "be likely to have a significant effect on the price of [their] financial instruments". Instead, the bank is saying that a conservative estimate of its potential losses associated with SIV-lites is £75 million ($150 million) and it remains silent regarding any other losses.
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| "Charismatic Bob Diamond is conducting a massive charm offensive. He has pitched his caravan in the middle of the press pack and has been forcefully defending Barclays Capital. I have three words for you: Never underestimate Bob" |
Secondly, charismatic Bob Diamond is conducting a massive charm offensive. He has pitched his caravan in the middle of the press pack and has been forcefully defending Barclays Capital – which is the organization he effectively created in 1998 from the ashes of BZW, a sleepy British corporate finance outfit. I have three words for you: "Never underestimate Bob." And finally, capitulation. As investors ran screeching for the hills, and the Barclays’ share price shrivelled, insiders have been buying. In early August, top Barclays executives such as Marcus Agius, Diamond, and John Varley all purchased substantial amounts of stock (for example, Agius, the chairman, invested nearly £500,000 in Barclays shares).
Nevertheless, there are some recent Barclays Capital events that worry me. The decision in late August to provide a £700 million credit protected loan to Cairn High Grade Funding, a SIV-lite that Barcap had structured for the London-based hedge fund Cairn Capital, is odd. Barclays must have known that the publicity associated with this restructuring would be terrible, so why do it? Could the reason be that if Cairn’s assets were sold at a bargain-basement price, this would affect other similar assets that Barclays is holding? Or might it be, as the bank asserts, that it is merely providing assistance to a client? If this were so, however, why not restructure the other three SIV-lites that Barclays Capital arranged and whose credit ratings have also been impaired?
The other event that troubles me is the Cahill conundrum. Edward Cahill was head of European collateralized debt obligations at Barclays Capital. He left the bank in mid-August and the rumour-mill started working overtime. One source gasped down the line: "I’m hearing that when he saw his P&L for the day, one of Barcap’s CDO team had a heart attack and had to be carried off the floor." Rich Ricci, Barclays Capital’s COO, told the Financial Times: "Edward was not asked to resign, he was not fired. There was no disciplinary action and there is none pending." Meanwhile Cahill has hired the leading London law-firm Mishcon de Reya. Why do you need an expensive lawyer if you and your former employer are on good terms?
Cahill was relatively junior at Barcap. He wasn’t even a direct report of co-presidents Jerry del Missier and Grant Kvalheim. "Who is Cahill?" a senior Barclays Capital banker wailed, "I’ve certainly never come across him." A Euromoney journalist was more fortunate in that she encountered the creative financier. Cahill spent the whole meeting slurping on a milkshake through a straw, looking bored. But occasionally he removed the straw to state something clever and pertinent. My sources say that Ed is not the only Barcap employee to have left during the summer.
In some respects, Barclays is suffering from the "made here" syndrome. The British press hover vulture-like above a leading British bank as soon as they smell fresh blood. However, if you pan back the camera, what’s interesting for global markets is whether Barclays can now win the takeover battle for ABN Amro. A conservative commentator would observe that victory looks unlikely. Barclays’ falling share price means that its offer is worth billions of euros less than the RBS consortium’s offer. October 4 is the deadline for the Barclays offer. An expert explained that the significant week for watching the Barclays share price will therefore be that commencing September 24. "Barclays has a dilemma," the expert continued. "If their share price rises significantly, institutions will assume that they may be able to win ABN. The institutions will then sell Barclays shares because if Barclays wins the ABN deal, its share price will almost certainly fall." Ironically, the best outcome for Barclays’ shareholders would be that Barclays’ bid for ABN fails. Barclays will then be vulnerable to a pouncing predator. That can do wonderful things for a sagging share price.
"It’s only when the tide goes out that you learn who’s been swimming naked." Never has this aphorism (often attributed to Warren Buffett) been so true. It will be the third-quarter results that will separate the men from the boys. Bear Stearns, Goldman and Lehman kick the earnings season off in mid-September. I know from my life as a banker that banks are sheep. They move in flocks. Barclays is not the only bank to have had a miserable summer. The warm days and sultry nights have seen other financiers sweating.
"If you had been short volatility," a seasoned trader told me, ‘you would have been killed.’ People have whispered that Citi, Deutsche, Lehman and UBS all have their crosses to bear. Bear Stearns, BNP Paribas, Goldman Sachs and Standard Chartered have already admitted to problems even though the Goldman spin-doctors did try to dress "rescue" up as "redemption". Don’t fool yourself: all investment banks will suffer, the private equity boom has stalled, asset-backed finance has stumbled, M&A mania is no more, and as for wealth management – well let’s wait for the lawsuits, shall we?
In late August, I dined with a bank chief executive. Chief drained his double vodka and said: "This is about earnings and it’s about relative earnings. It’s how I do versus my peers." I am irritated by this "we’re all in it together" mentality. Essentially, senior bankers are bracing themselves to tell us: "Yes I got carried away. But so did everyone else. Therefore, I am blameless." And these paragons of prudent lending are paid (or should that be were paid?) millions of dollars. The only consolation is perhaps I can write a book entitled The Devil Wears Debt and make millions myself.
Do you remember those heady days a few months back when CDOs were hailed as instruments of containment? Different buyers purchase different tranches, so no one institution is too exposed, we were told. Now we discover that CDOs were weapons of mass destruction. Sub-prime land mines, far from being contained, have exploded on all three continents. The Germans, in particular, hit the headlines in August. "You know there’s a real crisis when small German banks you’ve never heard of start going bust," a source said. Sachsen LB, an eastern German public sector bank, was unable to meet its obligations associated with conduits and has been bought by LBBW (Landesbank Baden-Württemberg). IKB (Deutsche Industriebank) a lender to small German companies, also floundered because of off-balance-sheet investment vehicles. The German development bank, KfW, which was a 38% shareholder in IKB, organized a rescue of IKB. WestLB, another German public sector bank, announced a loss for the first half of 2007 after proprietary trading losses exceeded €600 million. WestLB also has exposure to the sub-prime market. "The Germans got it wrong again," an experienced primary trader grumbled. A senior German banker was more philosophical: "There’s a business model crisis. The Landesbanks lost their implicit state guarantees in 2005 and so their access to cheap funding was over. They then hired alchemists who said: ‘we can make gold if you pay us gold’. But they turned out to be stupid alchemists."
So how was it for you then? I have been questioning financiers about how they fared this summer. A friend sounded depressed: "How many times can I call the clients and tell them nothing’s going on?" he groaned. A debt capital market originator was more positive: "The US domestic market had its busiest August ever. But I wouldn’t like to be a trader in this market. Especially as the ‘Let’s leave a bank and join a hedge fund trade’ looks pretty sick right now." The gloom barometer is rising and the words, "hiring freeze" are back in the vocabulary. "People are being repriced rapidly. I’m noticing that the whinge factor has disappeared among my staff," a senior banker told me. "There are going to be big lay-offs in November," another source sighed. "If you leave the firing until December, the suicide rate goes up by 25%."
September will be key. This is the month when we discover whether the 2007 credit crunch was an August phenomenon or something more sinister. And guess what? I’m a pessimist.
Abigail’s top tips for a sanguine fourth quarter:
1. Don’t say: "We’re big in structured credit."
2. Do say: "We’re an old-fashioned commercial bank which believes in prudent lending to proper industrial concerns."
3. If you’re a FWAG (financier wife and girlfriend) refrain from asking: "How was your day at the office, darling?" The only response will be an inarticulate snarl.
4. If you’re a FWAG, take all your couture dresses to the tailors and get the hems shortened by at least three inches. An exhausted financier needs something to raise his spirits even if he is too tired to raise anything else.
5. Whatever, you do, don’t buy a property in central London, prices are going down (and maybe in Manhattan too).