The following article was first
published by Bloomberg in February 2005, was Temasek aware of what
they are getting themselves into when buying into Barclays
?
Barclays Opens Up a Pandora's Box of
Derivatives:
Mark Gilbert
Feb. 18 (Bloomberg) -- A Pandora's box threatens to creak open in
the derivatives market, as aggrieved investors seek compensation
from banks that sold them collateralized debt obligations whose
ratings and value subsequently plummeted.
HSH Nordbank AG, a Hamburg-based lender, sued Barclays Plc over
$151 million of collateralized debt it bought in 2000. The German
bank said the bonds ``if saleable at all, have become worth a very
great deal less.'' The London trial was set for Feb. 21.
The case raised the tantalizing prospect of a whole basket of dirty
derivatives laundry airing in public. Pre-trial document teasers
included claims that Barclays invested HSH's notes in another
Barclays issue called Taunton, which invested in a Barclays issue
named Flavius, which itself invested in Barclays notes called
Savannah II, which bought part of two more issues, Dorset and
Tullas, from (you guessed it) Barclays.
``Contrary to its duty and to its promises, Barclays substituted
poorly performing assets,'' including buying aircraft- lease
securities after terrorist attacks destroyed the World Trade Center
on Sept. 11, HSH said in an outline of the case filed in the U.K.
High Court in December.
Barclays said it did nothing wrong in its selling or management of
the HSH bonds, which were named Corvus. The case notes said the
London-based bank ``blames the fall in value of the Corvus notes
primarily upon market conditions.''
Undisclosed Settlement
On Feb. 14, Barclays and HSH issued a joint press statement saying
they'd reached a settlement. The terms of the accord weren't
released. Given that HSH said it invested a further $420 million in
two other collateralized debt sales managed by Barclays, the
accommodation could have been for anything from zero to $571
million. It looked like those of us hoping to see a car crash in
the derivatives market would be disappointed.
Later that day, though, Italy's Banca Popolare di Intra Scrl said
in a statement through the Italian exchange that it's suing Bank of
America Corp. in the U.K. courts for selling it ``securities having
a higher risk than was represented by the seller and for an
excessive price with respect to their risk level.''
The Italian bank, based in Verbania, wants the U.S. lender to
either rewind the sales, which took place in 2000 and 2001, or pay
it 40 million euros ($52 million) in compensation. Bank of America
said ``the allegations are unfounded.''
$350 Billion Question
So here's the question: How many other owners of the $350 billion
of collateralized debt that was in the market by mid-2002 are
forming a line to sue their bankers?
To make a collateralized debt obligation, you bundle together a
package of other securities, such as corporate bonds or credit-
default swaps tied to company creditworthiness. By splitting the
package into slices of differing quality, you make the riskiest
portions absorb any losses first, cushioning the higher-rated
pieces.
Yet, just as the collateralized debt market started to take off at
the start of the decade, global creditworthiness plunged. Some 16
percent of securities that had AAA ratings in January 2002 lost
their top grade in the next few years. The newfangled securities
soured much more rapidly than other, similar asset- backed bonds
had done in the past.
The collateralized debt owned by HSH, for example, started life
with ratings of AAA to BBB from Fitch Ratings, all above investment
grade. By the end of last year, they had dropped by at least 11
levels, to between BBB- and CC, well below investment grade.
Booming Market
The credit derivatives market has boomed in recent years, becoming
very lucrative for the banks and traders involved. Recruitment
consultants estimate that bonuses for U.S. derivatives
professionals climbed as much as 20 percent last year as banks paid
up to stop top performers from jumping on the hedge-fund
bandwagon.
Barclays, for example, said in its 2004 earnings report that it
held more than 191 billion pounds ($360 billion) of credit
derivatives last year, a fourfold increase from the previous year,
as measured by notional value. Moody's Investors Service said last
month it rated $56 billion of European collateralized debt backed
by default swaps in 2004, a 20 percent gain from the previous
year.
As the credit derivatives market has grown, standards have
improved. Everyone uses the same standard documents, and the rules
governing changes in the baskets of assets underlying
collateralized debt have been tightened. That wasn't the case at
the start of the decade, when banks were still experimenting.
The decision by Barclays to settle with HSH will have given heart
to any investor that's considering going to court to seek
compensation. It's easy to see why even a bank convinced of its own
innocence would rather pay off a litigant than see details of its
derivatives dealing pored over in a lawsuit.
Maybe there won't be a flood of similar complaints. Still, as
Dennis Gartman, editor of the daily market strategy report Gartman
Letter, often points out, there's never only one cockroach.
To contact the writer of this column: Mark
Gilbert in London [email protected] .
Last Updated: February 18, 2005 03:17 EST
