Bank of the Year: Barclays Capital
In an industry with increasingly high barriers to entry, precious few firms have the courage and confidence to challenge the incumbent investment banking oligopoly on its own terms. One firm did just that in 2004, forcing its way towards the top of its chosen businesses and aggressively pushing its own agenda, with stunning results. Barclays Capital is IFR’s 2004 Bank of the Year.
When Barclays Capital reported record half-year pre-tax profits of £599m in June, it was not just the 37% year-on-year increase that turned heads. Impressive though that was, what was more noteworthy was the fact that the combination of Barclays Capital and Barclays Global Investors (BGI), the group’s wholesale/institutional businesses, represented the biggest segment of Barclays’ group earnings, accounting for close to a third of pre-tax profits.
If you look at where each of the businesses has come from in the past two years, and factor in future growth expectations of all group businesses, it paints a remarkable picture. Barclays Capital has arrived, and Bob Diamond can at last feel vindicated.
The charismatic and energetic chief executive of Barclays Capital has been passionately talking up the BarCap story ever since he joined the firm in 1997. His fervent espousal of the debt-only model and his disdainful dismissal of cash equities and traditional corporate finance had become legendary.
Starting from scratch
For some observers, the vehemence and single-mindedness of Diamond’s debt-only vision, particularly during the equity and M&A boom of the late 1990s, threatened to push him towards the outer limits of professional eccentricity. Today, some call Diamond a visionary. But his vision was not born out of any mystical prescience; if anything, the story of Barclays Capital is a story of making a virtue out of harsh necessity.
Back in 1997, Barclays plc had had enough of investment banking and had sold BZW, its ill-fated investment bank. So when Diamond joined the firm after a distinguished career at Morgan Stanley and CSFB, he came to an operation that had trashed its issuer and institutional client relationships, and blown up its advisory network. The genesis of what Diamond wanted to build lay in the opportunities he felt were going to be presented by the introduction of the euro.
Fast forward half a dozen years. What is Diamond’s achievement? In 2004, Barclays Capital is probably the world’s fastest growing investment bank in revenue, profit and market share. Its return on economic capital has risen to 39% from 27% in the middle of last year, and it has a revenue per professional that should be the envy of the industry. Diamond has put the UK back on the investment banking map.
The firm’s rise into the top tier of its chosen businesses throughout the world is astounding. After years of planning, building relationships and laying foundations, the results finally started to come through in 2004.
“We’ve experienced 20% compound growth in revenue in the last five years, 25% compound growth in profits, and over 40% growth in economic profits. We’re not daunted by that. We see the next four to five years with those kinds of numbers,” Diamond said. Revenues in 2004 will come in at around US$5bn.
So is Barclays Capital a dominant force in global investment banking? Not yet. But it is an integrated debt advisory, risk management solutions and financing organisation that is either best of breed or rising rapidly up the ranks of global debt capital markets, structured credit, securitisation, interest-rate, credit and equity derivatives, commodities, syndicated lending, leveraged finance and foreign exchange.
If Diamond delivers on his long-term strategy, Barclays could emerge as one of the half dozen global firms in the top flight of the business. The key to its success has been its step-by-step approach. “It’s all about sequencing. We avoided the tendency to try and do everything at once. Now, I can say that whether you’re looking at cash or derivatives, credit or rates, commodities, inflation, FX, we’re a leader,” said Diamond.
Frenzied hiring
As success bred success in 2004, Diamond engaged in a bold bid to put scale into his organisation. Headcount will probably have grown by more than 2,000 in the past year. Many of those were high-profile teams and senior individuals from the industry’s leading firms, lured by the prospects of being able to participate in a growth story that the investment banking industry only rarely witnesses. And the total headcount is still only around 7,000.
The build-out is not coming cheap. While the net revenue per member of staff rose 18% year-on-year to the middle of 2004, the cost-income ratio also went up, from 58% to 62%. And as long as the firm fast-tracks growth, that ratio is not coming down any time soon.
“While our value-at-risk has increased, it’s increased in the scope of the business. The commitment I have is you’ll see revenue and profits grow more steeply than any of the risk categories whether it’s DvaR [daily value-at-risk], economic capital or credit risk,” said Diamond.
Barclays Capital is now the fourth-largest underwriter of international bonds; it has broken into the top 10 of US investment-grade corporates, and is either the leader or among the leaders in covered bond and sterling underwriting, euro corporates, securitisation and leveraged finance. It is a key provider of liquidity to government bond markets, a leader in inflation-linked trading, and has developed a solid franchise in flow and structured derivatives across all asset classes.
The build-out of the distribution network has been extraordinary. The firm has gone from 325 front-office salespeople at the end of 2002 to close to 500, and per head productivity is up 75%. “Our objectives are adding product capability and scale, and we’re well on the way to ‘derivatising’ our sales force,” said Tom Kalaris, chief executive of BarCap in the US and global head of sales and research. What the firm added in 2004 was a structured solutions overlay, hiring in a series of specialists from leading firms who have added significant depth.
Kalaris’s end-game is a sales force that can see the issues from the client’s perspective.
“When I look at where we add value, what we’re essentially trying to do is to drive our business in a barbell framework. We’re trying to drive as much as possible onto electronic platforms to free up the salesperson’s time to provide solutions. Those are almost by definition going to be derivatives-oriented, because derivatives provide the flexibility that clients need for tailored solutions.”
On the research front, BarCap has around 160 people in economics and strategy, credit, and emerging markets. Like elsewhere in the firm, a lot of talent was hired during 2004 from the leading firms. The research output is geared towards ideas, strategy and quantitative analysis.
“There’s something of a Darwinian approach to this. If our analysts aren’t regarded as being right or able to add to the thought process of the client, they’re in the wrong business. If you’re right a lot, we’ll trumpet it. If you’re wrong, you’ll be doing a different job. Research is not a marketing game for us. If we’re not top of the pack, we’re out of business,” Kalaris said.
Marquee deals
The super-charged sales and research force gave comfort to the bank’s originators and helped them capture many of the year’s marquee transactions across DCM, bank lending and leveraged finance. BarCap did not bulk out its volume by doing a bunch of agency or senior bank trades.
“This year, we’ve done business for by far the broadest set of clients. Our transactions have been across the entire spectrum of geographies and industries. It has been a clear validation that our skill set is accepted not by one particular segment of the market, but by the broad market. It’s also validation of the work put in the last three to four years. It proves that continuity and consistency pay off. The perception has changed. Now people know we can deliver,” said Hans-Joerg Rudloff, the firm’s chairman.
In DCM, BarCap was present in all the sub-sectors. It was joint books on the single outing from the Kingdom of Denmark, a €1.2bn five-year (25% of which was placed with Asian investors); it did euro benchmarks for KfW, Rentenbank, BNG and AFD; and was the only non-French bank on Tec-10 linked issues for CADES and BNG.
In inflation-linked, the firm brought the Republic of Italy (10-year €5bn BTPei), Region of Lazio (€200m Italian CPI less tobacco) and BNG (€150m French inflation).
In dollars, the firm brought sovereign issues for Austria, Finland, Venezuela, South Korea and South Africa. In euro corporates, BarCap also had a good run, bringing a range of borrowers to market, including Autostrade (€6.5bn), Telecom Italia (€2.95bn three-tranche), BMW, Thales, RWE, Enel, Gallaher and Vatenfall.
It also brought euro deals for US corporates (Dow Chemical and Hertz); built a good track record in bringing debut issuers (EWE, Cargill, Elia, Elsam, Albertis, Technip and ASM Brescia); and led deals for a number of UK, European and US FIG borrowers. For its stellar work in the covered bonds arena, Barclays Capital is IFR’s Covered Bond House of the Year (see p126).
In ABS, Barclays maintained a leading presence, bringing issues for all the programmatic issuers. Its Chester Asset Receivables Dealing Issuer Ltd (CARDS) was a milestone in the development of the European ABS market. It was the first fully de-linked issuance platform for a European issuer. The MBNA Bank Europe programme resulted in three classes of seven-year notes (£300m Triple A, €125m Single A, and €175m Triple B) that BarCap sold over an eight-day period in July.
Of particular note in 2004 was BarCap’s performance in the US ABS market, where it lays claim to being third in US autos and fourth in US credit cards. Stand-out deals were SABR 2004-OP1, the firm’s inaugural deal under its SABR shelf and its first home equity ABS deal; USAA Auto Owner Trust 2004-2, BarCap’s debut involvement as lead underwriter for a USAA ABS deal; and the US$400m SABR-NC2. The latter trade was a milestone for the US sub-prime home equity ABS market as it was the first deal 100% backed by IO loans.
Capital commitment
Success has not come on the back of dumb lending, either. Even though the bank is one of the world’s leading syndicated lenders and has a big balance sheet, Diamond is very focused on how the firm’s capital is employed. BarCap will not lend to clients unless it is in their top tier or unless it can convince itself that in a short period of time it will be one of their go-to banks.
“A lot of investment banks think that extending credit to clients is a bad business. The reality is that it’s a hard business that most investment banks do badly, but it’s not a bad business if you do it well. We have developed some practices internally that enable us to use the balance sheet in a controlled way that has a lot of respect in the industry,” said John Winter, head of European capital markets.
The work BarCap did for Autostrade is a good example of this. The company needed €10.4bn to fund an acquisition. Barclays was not the CFO’s first call, but when it went into the bank financing, its involvement provided a level of comfort to a reticent syndications market that helped the bank deal to get done.
For its commitment, BarCap was rewarded with a joint bookrunner role (one of two) on all four tranches of Autostrade’s €6.5bn bond. The four-tranche offering included a €2bn seven-year FRN, a €2.75bn 10-year, a €1bn 20-year and a £500m 18-year sterling piece. It was the largest corporate deal of the year in Europe, and all tranches priced through talk.
BarCap’s role in the sale of the gas distribution units of National Grid Transco provided a classic example of how it benefited from not being in M&A advisory. Of the nine bidders for the assets, Barclays was working with five. When the list was whittled down to five, Barclays was still in with four. When it came down to the final shortlist of three bidding groups, Barclays was working with all three – without being conflicted – on how much to pay, how to structure the financing and how to hedge the deal.
The Bank of Ireland is another good example of the leverage of debt advisory into financing. BarCap had done a lot of work with BoI around capital allocation. Its relationship with the issuer led to BarCap landing a joint bookrunning mandate for BoI’s landmark €2bn ACS covered bond (IFR’s Covered Bond of the Year).
In leveraged finance, BarCap did deals with more than 20 buyout shops and sold aggressively into the institutional market. It was present in all the major themes and across all the major sub-products, including senior debt, mezzanine, high-yield, securitisation and opco/propco.
The firm was sole-mandated lead arranger on the year’s stand-out transaction – the US$1.75bn buyout of Automobile Association from Centrica (IFR’s European Leveraged Loan of the Year) on behalf of CVC and Permira (see p186). Barclays also brought a string of other deals to market, arranging LBOs, secondary buyouts, dividend recaps and corporate leveraged financings.
It was not afraid to apply downward flex on Springer, the deal which was also the first second-lien facility entirely placed in the European market. BarCap also led the first second-lien to be raised for a European issuer (Memec). In the high-yield market, BarCap was a joint bookrunner on SEAT Pagine Gialle’s €1.3bn 10-year LBO take-out. That deal was the largest ever euro high-yield bond and is IFR’s European High-Yield Bond of the Year (see p191).
Non-traditional businesses
Two elements of Barclays Capital gained serious traction during 2004: equities and commodities.
BarCap’s equities group is centred on derivatives, convertibles, prime brokerage and electronic execution. During 2004, equity derivatives sales and trading doubled, while the structuring team quadruped in size. The firm’s business covers all major indices and stocks, and offers clients index replication, pairs trading and special situations.
BarCap executed a landmark US$4.5bn transaction for a European pension fund. The bank provided a turnkey solution that involved examining solvency requirements, tailoring a bespoke basket and creating a hedging strategy to match the fund’s risk requirements.
Elsewhere, the firm introduced several investors and money managers to the notion that volatility could be viewed as an asset class in its own right. Because of the decorrelation of volatility and asset prices (and because vol was very cheap in 2004) BarCap advised balanced managers to put in assets that are sensitive only to equity vol, enabling them to realise a better risk/reward profile and a higher Sharpe ratio.
The bank also sold a series of investment and yield enhancement structures whose payout depends exclusively on realised dividend streams of basket or indices. These looked particularly attractive in light of the downward sloping dividend implied forward curve.
BarCap’s SIMPLE product, which enables investment banks to structure MTNs through investment plans, was adopted by a dozen plan managers, and the Prosper (Perpetual Resetting Open Structure Protecting Equity Returns) product was issued by a range of well-known names, including Zurich Insurance.
In June, the bank launched an innovative single-tranche rated Collateralised Fund Obligation (CFO), offering the combined benefits of exposure to the hedge fund market through an investment-grade bond.
The funds derivatives franchise offered clients structured products linked to funds, as opposed to products linked to stock indices or baskets. The bank offered products linked to managed funds. About 60% of the business, including options, principal-protected structures and leveraged products, is linked to hedge funds, with the balance related to mutual funds.
In convertibles, BarCap was bookrunner or principal advisor on 10 deals, including Bema Gold (US$70m), Apex Silver Mines (US$150m debut), and LionOre Mining (US$140m). The firm also restructured an outstanding US$986m ABB convertible that enabled bondholders to switch from Swiss franc underlying shares to dollar ADS, so avoiding a currency mismatch. It also gave ABB a solution to an accounting requirement under FAS133 that would have required changes in equity option values to be marked to market.
Commodities are a traditional business at Barclays, but one which Diamond has developed to make the firm a world-class player that is fast closing the gap with Goldman Sachs and Morgan Stanley, the two global commodity titans. “It’s one of the things that allows us to differentiate; very few banks that have this product,” said Benoit de Vitry, the firm’s global head of commodities.
Under his stewardship, the business has evolved towards derivatives and tailored solutions, but this remains integrated into the bank’s fixed-income business. BarCap deals in physical and derivatives in crude, base metals, precious metals, power and gas. It specialises in hybrid and cross-asset class product with a product range that runs from simple futures, clearing and execution, to the most exotic derivatives.
In 2004, BarCap sold the first CDO linked to commodities (a CCO). While it was very easy to understand on the client side – helped by a AA rating from S&P – it was very complex to manage. In July, BarCap and Shell completed the first brokered CO2 emissions trade based on the official published version of the ISDA contract. In June, BarCap completed its first power swap.
US build-out
Having gained sufficient traction in its European business, BarCap turned its attention in the past year to its US business. The core rates and ABS businesses were already functional. BarCap was already the leading trader of TIPs, and a top dealer in US Treasuries, agencies and dollar interest-rate swaps.
In US private placements, BarCap reckons it brought issuers from more countries than any other firm. Its 2004 haul included issuers from Singapore, Mexico, Australia and Europe. The firm opened the Portuguese market with an issue for Jeronimo Martins, brought two new Italian names (Merloni and Ricordati) and sold a US$600m debut US offering for Albertis Infrastructure, the Spanish motorway company, having led the firm’s debut €450m deal in January.
Having rates and ABS businesses did not just provide a significant source of revenue, they also gave the bank credibility and led to a higher level of dialogue with clients. So when the firm turned its attention in 2004 to capital markets origination and the domestic US market (commercial mortgages, residential mortgage-backeds and home equity), it felt it had some inbuilt advantages.
In capital markets, BarCap’s role as a lead on SBC Communications’ US$5bn deal was the most overt substantiation of its evolution. Telecoms was one of the firm’s new sectors.
“The SBC mandate was all about people,” said Grant Kvalheim, global head of credit and investment banking. “We hired a senior telecoms banker [Reuben Daniels], added coverage, telecoms traders and research. We stress- tested the bankers in a new franchise, and that led directly to the SBC mandate.” Another big telecoms win in 2004 was the FX programme BarCap did for Verizon.
Besides the SBC win, BarCap did dollar deals for Campbell’s Soup, SC Johnson, Hertz, Pfizer and Kellogg’s, some of which was repeat business.
The firm made significant headway in its domestic US franchise. It hired in top-class talent to build out three major business lines: home equity, residential and commercial mortgages. BarCap built a 35-person commercial mortgage team, and hired a residential mortgage team from Citigroup, including Tom Hamilton (former head of residential mortgage trading at Salomon Bros) and Chris Lesley (former head of the CMO business).
The team is already a top five dealer. In total, Barclays now has 110 people in its US mortgage business. “We’ll do around US$8bn in home equity ABS this year,” Kvalheim said.
“Now we’ve added products, the next step is time. This is a game of house-to-house combat. We’ll pick them off one client at a time. I have no doubts about our ability to do that,” said Kalaris.
Asia franchise
Away from the US, the firm’s Asia business is growing rapidly. In 2004, the firm had a good run in South Korea. It was joint bookrunner on the Republic of Korea’s US$1bn 10-year and jointly led two deals for Kexim (IFR’s Asia-Pacific Borrower of the Year), the US$1.5bn two-tranche global in February, and the US$500m five-year in August. The 144a registration on the February offering brought first-time US investors into the name; US accounts accounted for 61% of the five-year and 52% of the 10-year.
In Thailand, BarCap was sole books on the US$1bn three-year FRN for the sovereign, its largest international bond. The L+13.5bp notes were sold primarily to offshore investors, with strong demand from Japan. The bank was sole books on a structured note issue for TTM (a joint venture between PTTP and Petronas), and is a leading underwriter in the Thai baht domestic market.
In Malaysia, Barclays brought Public Bank’s heavily oversubscribed US$350m Lower Tier Two issue; the firm also led the US$1.1bn two-trancher from Malaysia International Shipping Corp. Again, the 144a option also enabled over half the bonds to be placed with US investors.
In Asian local currencies, BarCap was sole books on Fannie Mae’s debut Singapore dollar bond (a S$550m five-year), as well as the S$325m debut for AIG. In Indian rupees, BarCap was sole arranger on structured offerings for Finolex Industries and Tata Power Company. Its stand-out deal in India was the Rup9.7bn (US$210m) seven-year for Tata Teleservices. Barclays structured the deal was a partially credit-wrapped structure through a combination of onshore sponsor guarantee and a cross-border guarantee from Barclays itself.
Finally, in Latin America Barclays is advising Argentina on its US$100bn restructuring, while in Venezuela, it was dealer manager on the DCBs and Flirbs exchange offer, which resulted in a US$1.5bn 10-year Global. The bank also brought Mexico to the sterling market, with a £500m 20-year.