Abigail Hofman: Barclays and the fear of the unknown

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.

"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"

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.