If corporate defaults jump and structured credits undergo another wave of downgrades, we think that the structure of swaps with monolines and other counterparties that BARC put in place to limit losses could buckle — leading to further impairments and/or writedowns. We expect BARC will record major losses in 2009 and 2010.
So begins a detailed report on Barclays’ monoline and structure credit exposures by Panmure Gordon’s Sandy Chen.
Along with the rest of us, Chen is puzzled by some of the movements on Barclays’ balance sheet. Specifically, a £20bn increase in Level 3-type assets and a doubling of net derivatives exposure.
While Chen thinks some of this growth can be explained by currency movements, he reckons gains on derivative contracts with monolines, credit derivative product companies (CDPC) and other quasi-insurers of credit risk also accounted for a lot the gains.
For example.
In the £21bn of monoline derivatives contracts covering CLOs (collateralised debt obligations), it appears that the value of the contracts grew from £408m as at end-2007 to £4,939m as at end-2008. In our opinion, if the monoline contracts hadn’t existed, we think BARC would have had to recognise corresponding mark-to-market write-downs on its CLOs.
BARC point out that impairment charges on these contracts would only be crystallised in the event of a “double default” — i.e. not only would the underlying CLO have to default, the monoline would also have to default on its derivative contract. However, given the rating agencies’ recent warnings on CLOs as well as the recent downgrades on monolines, we think the probability of such double defaults has risen significantly.
Indeed, Moody’s has just put $100bn of US and European CLOs on review for a downgrade. Ambac, a leading monoline, is also on review for similar action.
This leads Chen to conclude that Barclays will take impairment charges of £13bn this year and next, a figure which is £5-£6bn above management guidance.
We expect this to push BARC into major losses in both 2009 and 2010; if BARC decides not to participate in the government Asset Protection Scheme, we see additional capital/dilution risk as well. We cut our share price target from 55p to 40p, and maintain Sell.
Related links:
Barclays questioned on funds – FT.com