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Wednesday, 16 September 2009

A bad case of indigestion?

There is a famous aphorism in Computer Science, reputedly from David Wheeler which goes: All problems in computer science can be solved by another level of indirection. It is surprising how often the same applies to finance. I have a theory that the skills required to structure good software programs are similar required to those required to structure and negotiate good financial agreements, but we can leave that for another day.

Barclays, however, appear to have excelled themselves in selling $12.3 billion of dodgy assets to a newly formed investment fund, Protium Finance LP, which has managed to finance the purchase by courtesy of a $12.6 billion loan .... from Barclays.

Let's be clear howver, when we say the assets are dodgy we don't mean to imply that the structured credit assets with a fair value of $3.6bn and monoline guarantees valued at $4.6bn, RMBS/Other ABS assets valued at $2.3bn and residential mortgage assets valued at $1.8bn previously held in Barclays Capital, are in any way likely to default. Oh no. Although monoline guarantees are worth $2.3 bn less than their face value.

The "fund" (initial investors not disclosed) will be run by 2 former Barclays Capital directors, including former SCM tax whizz, Michael Keeley. If you want to know more, you could always apply for a job because they're hiring careers@C12capital.com.

No, the real issue is one of price volatility. Honestly. By pushing the assets down into the vehicle which will be owned by outside investors who have contributed $450 m of equity, Barclays get to put a loan on the books instead of the securitised assets and thus record the asset at its amortised cost rather than its fair value. Students of financial history will remember the off-balance sheet SPV's used by Enron with the 3% minimum capital that allowed the Houston sleazebags (I say that without fear of a libel suit from a defunct firm) to move so many assets off their books - nice to see the boys at Barclays playing the same game to deconsolidate the fund even if they do end up with the loan on their books.

Strange then that the loan from Barclays is actually subordinate to the $450m of equity. How does that look to the SEC and FASB? Stranger still, the senior investors, the Protium investors, get a fixed 7 percent return on their capital contribution, while the Barclays subordinated loan is struggling on at 2.75 percent over LIBOR, about 4% at today's rates.

For a bank like Barclays whose recent post tax profits would be negligible if it wasn't for tax gains, revaluations of acquired assets and gains on their own liabilities, eliminating such variability of earnings would be crucial to preserving directors' bonuses. I mean, smoothing reported profits, but could there be more here? After all, reported 45 people left Barclays yesterday to join C12 Capital, the Protium manager, and avoid any banking bonus restrictions. Hardly surprising that they should all move across when Barclays has reportedly agreed to pay a $40m annual "management fee", which if true, is equivalent to a further 35 basis point haircut on Barclays margin. This does not smell right at all.

Let us not forget that in March of this year two out of three US banks terminated their involvement in a wide-ranging tax-avoidance scheme operated by Barclays. The banks had taken loans from Barclays amounting to $11bn, which they were due to hold for another year. But sources at Bank of America and BB&T confirmed that the loans were repaid. The banks' three loans, totalling $17bn, were made in 2007 and designed to generate tax benefits to Barclays over three years equivalent to approximately $270m a year, at the expense of the UK exchequer. The US counterparty banks were not avoiding US taxes but received a fee in kind from Barclays - in the form of cheap loans - in return for their involvement.

Under the scheme drawn up by Michael Keeley, a series of Cayman Islands and Luxembourg entities and partnerships were created. Three sets of triple entities were used, named Alymere, Claudas and Pelleas, according to accounts held in Luxembourg and at Companies House, through which Barclays was able to accumulate profits virtually tax-free in Luxembourg.

Could it be that Barclays latest $13 bn venture is simply trying to reproduce the earlier deal which went wrong. After all, if Barclays were just looking for someone to manage a fund there are no end of asset managers looking for distressed assets to manage. They didn't have to lose 45 of their own staff in the process, so the smart money would probably go with the notion that all is not quite what it seems and that there is something else going on that has not been made clear, and that is often a tax scheme.

Could that be why the fund is named after a brand of indigestion tablets?

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