Barclays Capital: Contrarian and innovative - or just desperate?

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Barclays Capital's bond underwriting position
All international bonds, 1996
Pos. Manager or Group Amt US$ m Iss. %Share
1 Merrill Lynch & Co 76,289.26 314 10.77
2 SBC Warburg Dillon Read 57,567.85 269 8.13
3 JP Morgan 57,346.58 212 8.10
4 Morgan Stanley & Co Inc 50,675.24 267 7.15
5 Goldman Sachs & Co 50,085.31 122 7.07
13BZW22,817.02893.22
All international bonds, 1997 year to November 28
Pos. Manager or Group Amt US$ m Iss. %Share
1 Merrill Lynch & Co 77,172.00 320 11.00
2 JP Morgan 64,982.99 198 9.26
3 Goldman Sachs & Co 63,363.75 136 9.03
4 SBC Warburg Dillon Read 57,323.07 219 8.17
5 Morgan Stanley & Co Inc 52,436.43 317 7.47
13BZW/ Barclays Capital Group23,040.09833.28
Robert Diamond took charge of global markets at bzw in June 1996. Success has not followed overnight.
Now that the high profile equity and corporate finance advisory parts of BZW have been sold, members of the surviving debt markets division, Barclays Capital, have a tricky time ahead. They must convince their customers that the advantages of dealing with a fully integrated investment bank - advantages which they loudly proclaimed for the 11 years in which Barclays spent £750 million ($1.2 billion) trying to build such a creature - are bunk. Now they must argue that the best type of investment bank to deal with is one focused on its chosen strengths. But the question persists: does Barclays Capital have any strengths beyond sterling bonds and syndicated loans? Even while peddling their new line, those at Barclays Capital must privately question how deep is their own parent's commitment to its new-form investment bank.

On the one hand, the answer should be obvious: "It would be much easier to sell BZW together rather than as two separate businesses," says Robert Morrice, managing director and head of credit business in Europe. "It's too complicated to be part of a two-tier sell-off." On the other hand, rumours persist that Barclays Group chief executive Martin Taylor was planning to sell the whole of BZW, apart from the treasury operations necessary for a commercial bank, and that Robert Diamond, formerly head of markets at BZW and now chief executive of Barclays Capital, returned from this year's IMF meetings in Hong Kong with a mission to dissuade him. Both men deny it. Diamond says he was aware of Taylor's plans to sell the equities and advisory divisions before he left for Hong Kong; Taylor asserts that he never intended to sell the markets division.

Diamond, and the team of bankers he has assembled around him, now face the challenge of having to convince clients, and sceptical rivals, that the new construct is not just viable, but groundbreaking. "It's a contrarian view to decide not to offer services in all areas of investment banking," says Diamond. "But it's also innovative. We don't want to be everything to everyone, but to excel at what we do offer."

By this summer, Diamond had already completed the first phase of turning the markets division around, having sacked 500 and hired around 350. "I didn't tread lightly," he says. "And I wasn't asked to." He can now concentrate on developing the franchise. In doing so, he freely admits he is taking some bets: "We're convinced that Europe is the story to put our resources into. We expect to see an explosion in the credit markets there, and are positioning ourselves to reap the benefits."

In August Diamond recruited Joe Bencivenga from Bankers Trust, one of the big high-yield houses in the US, to run the department. But Barclays Capital lacks the corporate coverage, and has yet to expand on its core client group of governmental and financial institutions. So Diamond's bet appears to be based on the firm's strengths in the UK, something he portrays as an advantage: "Outside of the US, this country has the most developed corporate bond market in the world, and our aim is to leverage this expertise as the credit markets expand in Europe."

BZW/Barclays Capital has been promising to expand beyond its sterling franchise for years, without success. Sovereigns, supranationals and financial institutions have been the staple diet for the debt issuance group, with little sign of them breaking into the corporate debt market. A senior manager at a part of BZW which has been sold to Credit Suisse First Boston is unconvinced that his former colleagues will be able to make that move: "Martin Taylor and Bob Diamond must be deluding themselves. Which group is it which has done all the foot-slogging in Germany and Italy to get our name on the map? They're all in NewCo [the part of BZW which has been sold to CSFB]." It is a view many of his colleagues agree with. "I would not underestimate the strength of reaction among European corporates," says another. "Many of our German clients simply don't understand the logic behind the decision to sell, and this could have a knock-on effect on Barclays' ambitions there and the rest of Europe."

Nevertheless to show his commitment to expanding beyond the sterling-based franchise, Diamond lured Roman Schmidt away from his position as head of the Euro-Deutschmark syndicate at Deutsche Bank. BZW's franchise in Germany was quite limited. Although a major player in the domestic Schuldschein market (and in the top three in structured Schuldscheine), it had made little penetration into the more visible markets. Since joining, Schmidt has tried to change that. Barclays Capital is now, for example, an official market-maker in the jumbo Pfandbrief market, and has been bookrunner on six deals so far. Schmidt says: "It's our aim to be one of the top foreign bookrunners in the Deutschmark market." The new team now boasts a newly enlarged trading group and has been lead manager on 12 Deutschmark deals since June. Whether that is enough to launch Barclays Capital down a path to success is another matter.

There have been some encouraging signs. In recent months Barclays Capital has lead managed two dollar deals for the World Bank. Although not large (just $150 million and $100 million), they were both 10-year callables, and were well received.

The EIB seems to be impressed, mandating Barclays to be joint bookrunner with Salomon Brothers on its $1 billion FRN in mid-November, the day after the sale of BZW to CSFB was announced. The deal was launched at 20 basis points below Libor, a level which rival bankers thought was too tight for an institution which is not zero-risk rated; some on the syndicate claim that they could not even place the paper. To head of origination Abigail Hofman, this is ideal proof that Barclays Capital has a significant role to play: "Liquid FRN issues are a specialized market, and we have a good record for bringing them. We saw the demand for EIB paper which others did not. In one trade we placed $100 million with one investor." Both leads are, says Hofman, now short in the paper.

Diamond has surrounded himself with some of the most capable people in the business, but success has not happened overnight, however, and the Eurosterling deal for Mexico in May seemed to show a bank stretching too far. Having already done the landmark Fannie Mae global, and World Bank Eurobond in sterling, Hofman's team was keen to get an emerging market credit on board. But the deal quickly came in for criticism from outside and inside the firm. At £300 million it was three times the size of the next largest emerging market Eurosterling bond, and was considered to be too expensive. "Basically it came 10 basis points too tight, and we found it incredibly difficult to place," says a salesman who worked on the deal. "Some of the bosses were getting increasingly irate at our lack of success. They wanted to know who we'd called and why they wouldn't buy, but never once did they suggest any accounts for us to try, or pick up the phones themselves."

Could this be proof of what Martin Taylor has said in the past, that you cannot put top-tier investment bankers into a second-tier bank, and expect them to build a first-tier bank?

Diamond rejects this analysis, preferring to concentrate on the group's strengths. Barclays' syndicated loans division is consistently top, or near the top, in the major Euromarket syndicated loans league tables. Run by Tim Ritchie, its coverage of European corporates could provide an adequate base from which to attract debt issues. To aid in that process, he and debt origination head Hofman have continued to develop the relationship between the two desks, begun when Rob Jolliffe joined as co-head of syndicate in 1995 (he left in mid-1996). "Six months ago we moved one of the guys working in syndicated loans into a role originating fixed income and loans in eastern Europe, reporting to both Abigail Hofman and myself," says Ritchie. "It's already starting to pay dividends for both sides of the business." And the groundwork is being laid for the future: Ritchie's team notched up deals for three Russian banks in the second half of this year: Tokobank, Roseximbank, and the country's second largest, the foreign trade bank Vneshtorgbank.

Barclays' Euro commercial paper desk could be another vote-winner with prospective bond issuers. In emerging markets especially, this is the first capital markets instrument which many borrowers turn to. There are only four, or perhaps five, houses committed to maintaining a presence in this market, and Barclays' investment bank is one of them. Combined with a strong syndicated lending desk, and a medium-term notes desk being developed by Jaswhider Sandher, who joined from the EIB at the end of 1996, these three products could provide rich pickings for the debt capital markets team.

Diamond also has the structured finance department to play with. Although not an advisory department as such, it had been responsible for originating various deals in both equities and debt. Earlier this year it became a part of the investment banking department run by Charles Stonehill, himself now gone to CSFB. This had got to a point where, when the sale was announced, several people in structured finance were not sure if they would be part of Barclays Capital or NewCo. It was eventually retained by Barclays Capital.

Bob Mabon, the head of structured finance, remains upbeat about this: "One of the major reasons I came here two-and-a-half years ago is because BZW offered the opportunity to structure financing with both debt and loans, which is not so easy to achieve in a stand-alone investment bank. With the sale of the equity and M&A divisions, we'll be able to focus on that even more, and bring high-yield debt into the equation as well." Brave words, but it's difficult to see how the loss of equity and M&A helps in all this. Large investment banks like Morgan Stanley, Goldman Sachs, Merrill Lynch and DLJ are all becoming much more active arrangers of loans and are already top-tier arrangers of bond and equity finance as well as being top M&A advisers.

The official Barclays Capital line is that this is simply not a concern: "It's not our aim to be all things to all people," says Diamond. "And in the plain vanilla sector for large institutions, there is not much value we can add which others don't already offer. We're planning to go for higher margin business where we have something extra to offer." Such as dollar deals for the World Bank?

There is the question of whether the new configuration will please the staff of Barclays Capital. At the moment all profess their happiness with the new situation. "Before the sale was announced, we were one of three children vying for attention," says Hofman. "Now we are the only child." Each mentions how their division will now be better placed to hire more people more quickly than if they had needed to compete for limited funds with the equities and corporate finance divisions.

But that merely side-steps the question of whether the loss of those divisions will hurt the new firms' ability to compete in the debt business. Virtually all the business heads joined within the last year, when BZW was still aiming to be a global, fully integrated investment bank. This was still the position, as far as most were concerned, until the last two weeks of September. Diamond is well known for his abilities as a leader, and has gathered an effective team of lieutenants around him. But at some point someone on the list of high flyers might question whether they want to work for an institution which they joined as a would-be Goldman Sachs and which is now following the model of a Chase or Citibank.

If the new construct does not perform as well as expected, how likely is it that it, too, will fall under the auctioneer's hammer? The argument that it would be folly to go through a messy divorce only to sell the businesses retained a year or two later certainly ought to be convincing. But one former senior banker at BZW who left this year casts doubt on even this: "Taylor is above all an excellent businessman with both eyes on providing shareholder value. If he thinks that selling the rest of BZW will improve that, he'll sell it."

There can be little doubt that Diamond has spotted some of the major new trends to direct the business towards. The credit market in both investment grade and high yield debt, is almost certain to explode in Europe as the single currency nears. There is a close interplay between loans and capital markets debt, such as in Russia, with both Gazprom and the electricity supplier UES granting Eurobond mandates on the understanding that a bridging loan comes first.

As yet there have been no defections to rival banks, although some headhunters claim to have Barclays Capital staff queuing outside their doors. But it will be a while yet before it becomes clear whether the "contrarian and innovative" service on offer as a result of the disposal of equities and corporate finance will provide Barclays Capital with a shot in the arm, or a lethal injection. Antony Currie