When Barclays Capital revealed its Protium transaction in 2009 many in the market smelled a rat. The Cayman-based off-balance-sheet vehicle to which $12.3 billion of the bank’s most toxic assets had been consigned looked suspiciously like the kind of financial engineering that had rendered the assets so toxic in the first place.
By hiving off $2.3 billion of US RMBS, $1.8 billion of whole loans and $8.2 billion of monoline-wrapped assets into a fund and financing the deal with a new 10-year $12.6 billion loan at 275 basis points over Libor the bank reckoned that it was going to be able to release $3.9 billion for growth over Protium’s lifespan. Critics accused Barclays of using smoke and mirrors to make the risk on these assets simply disappear.
Not so, Barclays declared. Protium enabled it to “derecognize” the assets for accounting purposes (marking the new loan at fair value rather than to market) but the assets would stay on balance sheet for regulatory purposes. Thus the toxic portfolios could be managed down without the bank taking the full mark-to-market hit. “We are comfortable making the loan because we have confidence in the cashflows,” said finance director Chris Lucas when the deal was announced.
However, things haven’t gone according to plan. Last month Barclays’ year-end results revealed that the bank has been forced to take an $824 million impairment charge against the Protium loan, which was supposed to have been releasing capital, not costing it. “The decision we’ve made wasn’t a worry about the loan or worry about the risk,” insisted Barclays chief Bob Diamond on the earnings call. “It was that the levels of capital increased so dramatically from when we originated it.” The amount of regulatory capital that it will have to hold against the loan will triple under Basle III.
It seems rather extraordinary that when the deal was being put together in 2009 – two full years after the structured finance market collapsed – the bank did not factor in the risk that regulators might require banks to hold more capital against risky assets. But it will now seek to wind down the deal as quickly as possible and sell the remaining assets (the size of the portfolio had fallen to £7 billion by the end of 2010).
This will mark the conclusion of one of the more controversial attempts by banks to manage their toxic asset exposure but highlights two important lessons from the credit crunch: off-balance-sheet structured vehicles have a way of coming back to haunt you and if you put crap into them you’ll get crap out.
