HSH Nordbank is allegingBarclays Bank cut USD200 million from the value of the two CDOS, Corvus and Nerva, through substituting credits, according to two HSH internal documents obtained by DW. The contention is one among many in the documents, one of which was prepared to explain large reserve positions. Officials at Barclays and HSH declined comment. These documents, however, obviously only give HSH's side of the story. Given the case appears to be going to court Barclays is expected to vigorously defend the claim.
HSH is taking Barclays Bank to the High Court over the manner in which two CDOs were sold to its predecessor LB Kiel, subsequently managed and the accuracy of pricing information LB Kiel received. Lawyers have been examining whether Barclays has a duty of care to manage the deals on behalf of the investors (DW, 10/15).
One of the papers alleges in making the substitutions, Barclays eroded around 10% of the value of the CDOs with each substitution. In one example, after the Sept. 11 terrorist attacks Barclays reportedly increased the exposure to aircraft leasing ABS by USD8 million and is also said to have substituted several other CDOs, which were "heavily polluted by airline industry exposure" into the deal.
Credits were allegedly substituted at par value in the Corvus transaction. This was possible because it was a synthetic transaction in which the noteholders were effectively selling protection against a list of reference obligors rather than directly owning bonds, which would have had to have been put in at market value. CDO practitioners said although such a transaction would not pass muster with the rating agencies today, in the early days of the CDO industry these substitution rules were the norm. The Fitch Ratings new issue report on the deal states credits could only be replaced with others of equal or better value. The HSH documents say Barclays was able to introduce assets that were trading at wider spreads because the market reacted more quickly to bad news than the rating agencies.
The HSH documents list three grievances. One is although Barclays reportedly committed to retaining the equity tranche these tranches "were from an economic point of view of no substance," because of the amount of money Barclays made on the substitutions. This effectively removed the economic incentive to manage the transaction on behalf of the investors.
The second point is around three quarters of some of the 16 CDOs Barclays created between February 2000 and August 2001 was allegedly not placed in the market, but were instead put directly into the two deals HSH had purchased. HSH claims this is because, "The tranches of Tullas, Taunton and Savannah (face value in excess of USD1.1 billion) were obviously of such a poor credit quality that they could not be placed in the market." The Dorset portfolio contained Conseco, Marconi, Global Crossing and Argentina.
In the third point HSH says, "We have to consider that the CDO system was created to either dump assets from Barclays balance sheet into its customers portfolios or to make huge profits at the expense of its investors." HSH is thought to be paying Barclays a management fee for running the transactions, which lawyers said may mean Barclays has a duty of care to manage it on HSH's behalf. In addition, the fee is divided so that part of it is only paid if the deal performs well. It also appears Fitch thought Barclays was a manager, in the new issue report for Corvus in December 2000 it wrote, "Barclays Risk Finance Group manages more than US$15 billion in asset-backed securities." Fitch declined comment.
The documents show HSH is claiming conflicts of interest arose from short-positions Barclays reportedly retained in its own CDOs. One of the documents states, "This could not be in compliance with the management mandate." The document continued, "Our internal analysis came to the conclusion that investors will lose about 1/3 of their investment [in Nerva Class A notes]. It purports Barclays will make some USD57 million from its USD172 million short position. "A short strategy strongly suggests that Barclays must have expected those tranches to blow up," stated the other document.
|Excerpt From Dorset Portfolio|
|Obligor||Notional Amount||Credit Spread||Market Spread For|
|In Portfolio ($M)||In Mid 2001||That Rating*|
|Conseco Inc||12||1,800bps||LIBOR Plus 133|
|Marconi||12||2,000bps||LIBOR Plus 127|
|Global Crossing||12||2,300bps||LIBOR Plus 133|
|Argentina||9||2,400||U.S. Treasuries Plus 409|
|Nextel||12||1,400bps||LIBOR Plus 563|
|Source: HSH Nordbank|
|*Source: Securitization News. Equivalent market spread is taken from most representative Merrill Lynch index as of June 30, 2001.|