Barclays Misled on CDO Default Risk, San Marino Lender Says

Barclays Plc deliberately designed structured notes that would have a much higher risk of default than their triple-A rating suggested, lawyers for a San Marino bank told a London judge today.

Cassa di Risparmio della Repubblica di San Marino SpA, or CRSM, is suing Barclays in London for 92 million euros ($120.5 million,) alleging fraudulent misrepresentation over the sale of collateralized debt obligations. Barclays denies the allegations.

The CDO had been rated AAA, CRSM lawyer George Leggatt told the court today, suggesting that the risk of a default on the bonds and causing CRSM to lose money was “a fraction of 1 percent.” The real probability of default was “of a completely different order -- 25 percent or more,” he said.

Barclays and lenders in the region have clashed before over CDO transactions. The London-based bank and Banca Popolare di Intra Scrl in February settled a claim over derivatives Barclays sold the Italian regional lender in 2000. Barclays had been accused of selling a CDO that was likely to default. Neither party admitted liability in their settlement.

CRSM approached Barclays in 2003 for funding for its units, the San Marino-based bank said in court documents. Barclays loaned 700 million euros on condition that CRSM would buy 450 million euros of structured notes including “highly complex and opaque” CDO squared instruments, CRSM said in court papers.

‘Crossed the Line’

While Barclays did nothing wrong by creating the product, selling it based on a credit rating it knew didn’t properly reflect the risk of the investment “crossed the line into misrepresentation and potentially deceit,” Leggatt said.

Barclays lawyer Andrew Baker said that neither the credit rating nor the 25 percent default risk mentioned by the San Marino bank reflected what Barclays thought “would actually happen to investors’ money.” Comparing the two “is to compare the incomparable.”

CRSM’s case is “without merit,” Barclays said in a separate e-mailed statement. “There is no factual basis for any of the claims and the fraud allegations against Barclays and its employees are strenuously denied,” the bank said.

CDOs are pools of assets such as mortgage bonds packaged into new securities. Interest payments on the underlying bonds or loans are used to pay investors.

Fitch Ratings on Nov. 8 cut CRSM two notches to “BB,” or junk, from investment grade with a negative outlook, after deposits fell, forcing the bank to review its strategy.

The case is Cassa di Risparmio della Repubblica di San Marino SpA v. Barclays Bank Plc, Case No: 08-757, High Court of Justice, Queen’s Bench Division. The case is scheduled to last for the rest of the year.

To contact the reporter on this story: James Lumley in London at jlumley1@bloomberg.net; Elisa Martinuzzi at emartinuzzi@bloomberg.net

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net. BARC LN <Equity> Z IM <EQUITY>

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