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Barclays: Wall Street's new gambler

When Lehman tanked, Barclays saw a juicy opportunity and snatched it up. But now the London powerhouse has problems of its own.

Last Updated: October 21, 2008: 11:09 AM ET

Barclays president Bob Diamond sees Lehman's U.S. investment-banking operations as a perfect fit for his bank.
CEO John Varley believes he will have the wherewithal to grow Lehman despite the global slowdown in investment banking.

(Fortune Magazine) -- Robert Diamond looks wiped. It's just after noon in London, and the president of Barclays - the newest power broker on Wall Street - is trying to snatch a few moments of calm. He ignores the gigantic TV suspended above his desk with its scrolling news of financial doom. European markets have continued to fall, despite an $87 billion British government financial bailout and a concerted round of interest rate cuts by central banks.

"There is no playbook. There is no playbook," Diamond intones about the crisis as he grimly sips lukewarm tomato soup.

An American expat whose office is lined with Red Sox gear, Diamond should by all rights be smiling. He spent the past decade building an investment-banking operation from scratch at the big but unflashy British bank founded by Quakers 318 years ago. Barclays (BCS), with assets of $2.7 trillion, grew to become Britain's third-largest bank after HSBC and the Royal Bank of Scotland.

Then, as Wall Street cratered in mid-September, Diamond, 57, and his boss, CEO John Varley, 52, saw a once-in-a-generation opportunity: Buy the stripped-clean North American business of Lehman Brothers, including most of its people, its brand name, and its clients - but not the toxic assets that bankrupted it. Overnight, the deal would make Barclays a major U.S. player, nipping at the heels of J.P. Morgan (JPM, Fortune 500) and Citigroup (C, Fortune 500).

The Barclays boys went for it, and since then Diamond has mostly camped out in New York City, overseeing the fast-paced integration of 10,000 former Lehman employees into his operation. By the end of this year he wants the whole process wrapped up, including making about 3,000 job cuts once Lehman's operation is combined with the Barclays staff, Fortune has learned.

But now he's back in London to defend the deal. For the past two days he and Varley, an aloof English lawyer who edged out Diamond for the top job, have worked hard to convince nervous investors that the company remains solid and that their strategy makes sense.

"We have our feet on the ground," Varley had told investors at a Merrill Lynch conference the previous day. "We understand very clearly that the environment is difficult. But we mustn't - and won't - allow that to immobilize us. There will be growth opportunities. Now is the time to be ready for them."

Analysts are divided over whether the Lehman acquisition is a stroke of genius or sheer madness. On paper the deal looks like a steal: For $1.5 billion, Barclays got a valuable Manhattan skyscraper, two New Jersey data centers, and a role as a major player on Wall Street. But some analysts worry that the acquisition is also a risky venture for Barclays at a perilous time.

They have a point. Europe's banking scene has changed dramatically in the past few weeks as the plague that began in the U.S. subprime mortgage market has spread across the Atlantic. European banks made many of the same mistakes as their American brethren, deluding themselves into thinking there was no end to heady growth, and taking on outsized risks and leverage with complex derivatives linked to the U.S. mortgage market.

When the deal was first announced, some analysts argued that the bank did not have enough cash to finance its newly expanded operations. In the first half of 2008, Barclays wrote off $4.9 billion in assets, and the concern was that it was, in the words of German investment bank Dresdner Kleinwort, "Britain's least-well capitalized bank."

But this month, Barclays has moved aggressively to strengthen its capital base. The British government has ridden to the rescue of the entire banking sector with a salvage plan that enables banks to recapitalize themselves with taxpayers money in exchange for equity. Barclays, unlike its peers HBOS, Lloyds and Royal Bank of Scotland, has decided against calling on the state. Instead, it is seeking to raise 10 billion pounds ($17 billion) in fresh capital without government support, including by issuing new preference shares to investors and eliminating a dividend for the second half of 2008.

Barclays stock has taken a brutal beating in the markets this year along with other bank stocks, but these latest measures have convinced even some of the biggest skeptics. Citigroup, which has been very negative about the bank, upgraded its recommendation on Barclays stock from "sell" to "hold" following the news.

Varley and Diamond are not easily daunted. At a time when most other banks are in retreat, the two executives have put Barclays on the offensive, seeing in the turmoil as much opportunity as risk.

"It never dawned on us that a major Wall Street firm might be available at a reasonable price," Diamond says. "You can't make this thing up."

It is true that a handful of other European banks are also taking advantage of the turmoil to grow quickly. France's BNP is buying Fortis from the Belgian government that rescued it, and Spain's Santander (STD) has snapped up the retail operation of two troubled British banks and, in the U.S., agreed to acquire the rest of Sovereign Bankcorp that it didn't own. But no other European bank has come close to matching Barclays audacity with its Lehman move.

Diamond couldn't be more pleased by the challenge. He fits every Briton's stereotype of a Yank - a hard-charging sports jock who spends weekends coaching baseball at the American School in London, and whose management motto to encourage teamwork is "No jerks." He started out in Morgan Stanley's IT department with the dream of becoming a bond trader and worked his way up.

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