A group of 45 bankers at Britain’s Barclays bypassed potential curbs on pay and bonuses by jumping ship to set up a Cayman Islands company and manage 12.3 billion US dollars of Barclays’ most toxic debt. They will be paid at least 400 million USD over ten years.
In an exotic piece of financial engineering, the bank will lend 12.6 billion to Protium, a newly created Cayman Islands-registered hedge fund, to buy the toxic assets.
The bankers, led by Stephen King and Michael Keeley, both British, are setting up C12 Capital Management, a management company that will be paid management fees of 40 million USD a year for a decade by Protium and could make much more if the impaired assets recover in value.
While staff at large investment banks such as Barclays could be crimped by new curbs on bankers’ pay being considered by the G20 nations, C12, a small asset management boutique based in New York, almost certainly would not.
Traders in other investment banks are also quitting before any crackdown. About 20 leading bankers at Société Générale left this week to set up Nexar Capital, a hedge fund, amid the threat of pay curbs by President Sarkozy of France.
Some of the Barclays bankers appear to have been involved in the activity that led to the banking crisis and Barclays’ losses in the first place: creating and trading mortgage-backed securities. Mr. King was head of synthetic asset-backed security collateralized debt obligations at Barclays Capital in early 2007. However, Chris Lucas, Barclays finance director, insisted that the most senior people responsible for the losses had already left.
Barclays said the deal would soften the impact on the bank if the toxic assets fell further in value and would deliver more stable returns. Protium will pay it interest of dollar Libor plus 2.75% on the loan, a sum expected to total 3.9 billion USD over ten years.
But Barclays has sacrificed any of the upside if the assets — mostly mortgage-backed securities underwritten by mono-line insurers — were to recover in value. It also continues to shoulder the risk if Protium were to default. Although Protium has raised 450 million USD of new funding, the equity cushion protecting Barclays is only 16 million, Mr Lucas said.
Barclays shares rose 11p to 380p, although some analysts were puzzled by the deal. Credit Suisse said: “The transaction seems a little strange to us. The bank appears to be giving up any potential upside on recovery in fair value of assets. This seems like a definite transfer of value away from Barclays.”
Mr Lucas said that for regulatory purposes the assets would be accounted for as though they remained on the Barclays balance sheet. The amount of capital backing them might, in fact, have to be increased.
Mr Lucas said the idea for the transaction came from both sides.
Two hedge funds, one from the US and one from Britain, put up the bulk of the 450 million and will receive fixed interest of 7% for ten years and any surplus cash remaining in the fund if and when Barclays is repaid in full. The assets were sharply written down by £1.2 billion in the first half of this year. Protium is paying fair value for them, little changed from the half year-end in June.
Barclays looked vulnerable to any further credit downgrades of mono-line insurers, having to adjust the value of the assets according to daily price movements. Now the exposure will be treated like any other loan.