Alex the doorman has in the past few days become used to being asked about
one of his residents, Edward Cahill. At an apartment block in London’s
Docklands, reporters have come looking for Cahill, a financial wizard at
Barclays Capital. Alex has politely turned them away, explaining their
search is in vain. Cahill has become the City’s Scarlet Pimpernel.
Until two weeks ago, the 33-year-old was a little-known employee at Barclays’
successful investment-banking arm, Barclays Capital. The tall Irishman,
described by Alex as a “polite, nice guy”, worked hard, leaving for the
office before 8am and routinely returning after 11pm. As an energetic banker
working in the booming debt markets, Cahill is thought to have earned close
to £1m a year. His top-floor flat, in a converted sugar warehouse, where he
has lived for three years with his brother Michael, is thought to be worth
about £750,000.
But in the past few days Cahill has made an unwanted trip from anonymity to
national news. His name has become closely associated with the credit crisis
that is gripping global markets. And the activities of his team, which
created exotic investment vehicles that have now turned sour, may derail
Barclays’ attempts to pull off the biggest-ever financial services deal, a
€60 billion takeover of the Dutch bank ABN Amro.
Despite his grand title – European head of collateralised debt obligations –
Cahill was not one of the investment bank’s top executives. His business
contributed a minor part of Barclays Capital’s £6.2 billion revenues last
year. He and a small group of colleagues created a version of structured
investment vehicles (SIVs) for clients. These are highly indebted investment
funds that make money by trading on the difference in interest rates between
short-term money and longer-term investments backed by supposedly
high-quality loans, such as American mortgages.
Four debt vehicles, known as SIV-lites, set up by Cahill’s team have hit
problems. Two have been forced to sell assets to pay down debt. On Friday,
Barclays said a third, Cairn High Grade Capital Funding I, was being
restructured in a $1.4 billion (£700m) financing. The bank has also faced
scrutiny over the collapse of German bank Sachsen, a user of its SIV
products, which was rescued by a rival a week ago after problems with
another fund not linked to Barclays.
On August 20, Cahill, described by some colleagues as “pretty arrogant”,
returned from holiday. He knew his luck had run out. For more than three
years, banks and investors had been on a frenzy of buying ever more complex
packages of loans. Now, as the American sub-prime mortgage crisis erupted,
they had lost their nerve and the debt markets were imploding.
For Cahill, the future must have looked bleak. According to some former
colleagues, he faced a stark choice – watch his business dry up, and his
bonus shrink, or get out. He chose the latter, packed his bags, and has not
been seen at his loft apartment since.
Although he has been elusive, Cahill is said to be in contact with Barclays
and serving out his notice.
In less turbulent times, his departure, though odd, would probably have been a
minor event. Suggestions that Cahill could be the next Nick Leeson, the
trader who brought about the collapse of Barings in 1995, are very wide of
the mark – Barclays’ compliance department is understood to have checked out
his operations and found no wrongdoing and nothing untoward. Cahill himself
was unavailable for comment.
Yet Cahill’s resignation sent shock waves through the market, fuelling wild
speculation that Barclays was sitting on losses running to hundreds of
millions of pounds. “It is fear. Fear of the unknown,” said one banking
analyst.
Barclays has not helped its own cause. Twice in just over a week it has been
forced to borrow expensively a total of £1.9 billion from the Bank of
England’s emergency reserves. Such loans are routine, but in the current
fragile markets any hint of financial distress has prompted panic among
investors. Barclays is looking distinctly accident-prone.
As a result, Barclays shares have been hammered, just when the price needs to
be strong to help Britain’s third-biggest bank in its bid to win the
takeover battle for ABN. As investors fret about mounting losses, there are
also fears that Barclays Capital’s stellar growth in profits could hit the
buffers. For Barclays chief executive John Varley and Bob Diamond, its
president and investment-banking boss, it all adds up to a big headache. BY
any measure, Barclays Capital has been a stunning success story. Born from
the ashes of BZW, the stricken investment bank, as a debt-focused operation
a decade ago, the division has been the engine of Barclays’ growth in recent
years. In the first half of this year, profits jumped 33% to £1.7 billion,
accounting for 40% of Barclays’ overall earnings. For the past seven years,
it has been the world’s fastest-grow-ing investment bank.
Under Diamond, Barclays Capital has gained a reputation for being agile,
identifying new markets and responding quickly. That led the bank to expand
aggressively into commodities right at the bottom of the market after the
collapse of the American energy trading giant Enron. The SIV-lite business
was another pioneering move.
For years, sceptics have argued that Bar-calys Capital could not maintain its
astonishing growth. Even before the present market malaise some analysts
were cautious, with Collins Stewart forecasting profit growth of only 10%
next year. Others claim the outlook for big investment banks is ugly. Last
week Nick Hill, an analyst at Standard & Poor’s, predicted their profits
will collapse by 70% in the second half if the credit crunch is as fierce as
in 1998.
Antony Broadbent, an analyst at Sanford Bernstein, said: “Barclays Capital
clearly made hay while the sun shone in the European fixed-income markets
for the past five or six years. That is where they started and that remains
the core of their business. They haven’t done an awful lot wrong, but those
markets have gone pear-shaped, at least in the short term, and Barclays
Capital’s revenues are going to be vulnerable.”
Diamond, a sports-mad American who was paid £22m last year, disagrees. It may
be mayhem in the markets, but Diamond is confident that the debt markets
will stabi-lise within the next couple of months. “You will see us come out
of this market turmoil stronger and with a stronger franchise. I do not want
to be too sunshine-and-lollipops about this because these have been
difficult markets for clients and our shareholders – perhaps the most
difficult I can remember,” he told The Sunday Times. “Are we going to let a
tough month throw us off course? Absolutely not. I have talked about 15%-20%
annual growth through the cycle and there is nothing to make me come back
from that at all.”
Diamond admits there will be losses at Barclays Capital but is adamant that
Cahill’s sudden departure has been vastly overplayed. The losses on the
SIV-lites created by Cahill and his team are capped at a “conservative” £75m
even if the bank had to sell the assets it holds as collateral at knockdown
prices. Though Barclays created SIV-lites for clients, it does not choose
the investments or run the funds. SIV-lites have been thrust into the
spotlight, but the market is tiny – worth $10 billion against $2,000 billion
for the overall asset-backed commercial paper market.
Sachsen Funding 1, the vehicle created for the German bank, is still afloat
and has a top AAA rating. As for Cairn, Diamond said that Barclays “did not
have an obligation to work this out” but aims to find a solution to the
benefit of everyone.
Barclays has blamed last week’s embarrassing decision to borrow £1.6 billion
from the Bank of England on a technical hitch after a breakdown in the
system banks use to clear and settle transactions in the money markets.
“From a headline view, unfortunately each event on its own looked like it
could mean something more,” said Diamond. “The fears over the
SIV-lites, Edward’s decision to resign and the borrowing from the Bank of
England were taken out of context. We need to draw a line under this.”
Observers say this may be difficult to achieve in the current jittery markets,
especially if Barclays suffers another slip. FOR Varley, the big issue is
whether the market malaise will spell the end of his audacious attempt to
merge with ABN.
Right now, the prospects do not look good. With Barclays shares languishing at
613p, the bank’s offer is worth only €60.5 billion, some 4.9% below ABN’s
€63.6 billion current market value and a thumping €10.5 billion behind the
rival bid from the consortium led by Royal Bank of Scotland (RBS).
To compete with the consortium’s cash-rich offer on price, Barclays’ share
price needs to recover to 790p by early October. Before the turbulence in
the financial markets the shares were trading at 750p in mid-June. But even
if stock markets stagea spectacular rally, few analysts believe Barclays’
shares will bounce back enough.
Varley, however, is not giving up. His best bet is to hope the consortium,
which includes Santander of Spain and Fortis, the Belgian bank, either falls
apart or fails to gain clearance from the regulators.
The consortium has yet to get approval from both the DNB, the Dutch central
bank, and the European Union. Some analysts fear the DNB may impose tough
financial conditions on RBS and its partners, though it is not clear if that
would scupper the deal.
The other hope for Barclays is that the consortium’s mammoth financing, which
includes a €13 billion rights issue for Fortis, could collapse.
Varley does not appear to have much room for manoeuvre. Even so, he has
already been creative. In late July, Barclays surprised the City by
revealing that China Development Bank and Singapore’s Temasek had agreed to
invest up to €13.4 billion, injecting 37% of cash into its sweetened offer.
One option is that China Development Bank and Temasek could provide further
support, either through a revised agreement, or by snapping up shares in the
open market.
Selling assets, such as ABN’s Italian or Latin American operations, has not
been entirely ruled out. But this looks unlikely. Varley has consistently
insisted that the Barclays and ABN deal is about growth and he has attacked
the consortium’s proposed carve-up of the Dutch bank.
After a brutal few weeks Varley and Diamond will be hoping there are no more
shocks in store. But their bid for ABN may already be beyond redemption.
THE BID FOR ABN
KEY DATES
Early September Fortis plans to launch its €13 billion rights issue September
14 Barclays will hold meeting for shareholders to approve bid September
19 European Union expected to approve Royal Bank of Scotland - led
consortium bid for ABN September 20 ABN will hold shareholder meeting
to discuss the two bids but will make no recommendations October 4
Deadline for first acceptances for Barclays offer October 5 Deadline for
first acceptances for RBS consortium offer
STRUCTURED INVESTMENT VEHICLES
SIVs – structured investment vehicles – are off-balance-sheet investment funds
created by investment banks for clients. These sell short-term debt in the
commercial-paper markets and use the proceeds to buy longer-term assets,
such as supposedly safe parcels of American mortgages, which pay higher
returns. In the past two years the market has boomed, with assets held in
SIVs doubling to $375 billion by the end of June, according to Cititgroup.
SIVs, which are ongoing open-ended investments, can be very sensitive to the
value of the assets they hold. If these fall sharply, the funds can be
forced to sell some of their holdings. SIVs have run into problems in recent
weeks as the value of their assets has plunged and investors have refused to
provide new short-term funding because they are concerned about the American
sub-prime mortgage market.
SIV-lites also use short-term funding, but differ from SIVs in that they have
a set lifespan. SIV-lites, which were pioneered by Edward Cahill and his
team at Barclays Capital, can be much more aggressive, leveraged at between
40 and 70 times the value of their equity against 12 to 16 times for SIVs.
SIV-lites are still a new area and only a handful have been launched, worth
about $10 billion.
Investment banks design the structures but do not choose the assets or manage
the funds. However, the bank can be called on to provide back-up credit of
up to 25% of the value of the outstanding commercial paper if SIV-lites have
short-term funding difficulties. The investment banks have some security –if
the assets fall by more than 10% the back-up funding can be pulled.
