On Monday, 24 November 2014 Alison Loveday, Berg’s Managing Partner, appeared on Panorama. In the show, entitled “Did the Bank wreck my business?” Andrew Verity, the reporter met a number of entrepreneurs who say the bailed out banks have wrecked their businesses.
One of the tweets by BBC Panorama states:
“We coined the term “the Lloyds effect” as valuations were hammering the property value down by 50% say solicitor @Alison_Loveday #Panorama”
Whilst providing assistance to the programme and then later being interviewed for the programme Alison Loveday provided Panorama with Berg’s Treasury Select Committee Report (which can be seen here)and our Second Treasury Select Committee Report which will be provided to the Treasury Select Committee investigating SME lending this week. In that we provided a number of case studies regarding:
1. RBS’ use of GRG imposing exorbitant interest rates and punitive fees;
2. RBS’ GRG utilising unfair and damaging tactics in order to bully businesses into paying these excessive fees and then later taking the businesses away from the business owners;
3. Lloyds devaluing businesses by having the assets revalued, which can be as low as 50% below the true value of the asset. Alison Loveday confirmed that Berg calls this “the Lloyds’ effect”. The use of the phrase “the Lloyds effect” spread across Twitter that night;
4. Further, Lloyds selling loans, which were primarily commercial real estate loans and hotels, to the American equity firm Cerberus who then put the businesses into administration
RBS’ use of GRG
Panorama looked at the evidence that RBS gave to the Treasury Select Committee investigating SME lending. RBS were very robust in the evidence that they gave.
Unfortunately, 8 weeks later they were forced to issue a humiliating apology letter to the Treasury Select Committee confirming that part of the evidence they had given was not true. The letter was drafted by Derek Sach who is the head of Global Restructuring Group at RBS.
Mr Sach was revealed by Panorama to have received a £400,000 bonus despite the humiliation of admitting to the Treasury Select Committee that he had given incorrect and potentially misleading evidence. You can see the letters from Mr Sach:
You can see the letter from the Chairman of the Treasury Select Committee, Andrew Tyrie MP, to Mr Sach
You will note from the letter from Mr Tyrie to Mr Sach that during the evidence Mr Sach had given the example of a firm called Independent Slitters Ltd, in Oldbury, as an example of a business that had successfully been turned round by GRG. Mr Tyrie states:
“We have received letters from Independent Slitters Limited and their accountants, which are enclosed. You will see that the Managing Director in the Chief Executive of the Company considered that “the comments made [in oral evidence] did not reflect Independent Slitters Limited’s view of GRG.”
The letter from Independent Slitters may be found here.
There were a number of examples given in the programme of SME borrowers who had been forced into GRG and then following this had had their businesses taken away from them. One even had a letter from RBS confirming that they were going to instruct a specific administrator because that administrator would take a very hard line with that client. RBS confirmed that it was inappropriate for that letter to have been drafted.
Berg continues to be at the forefront of GRG issues.
That has been a lot of discussion in the press regarding RBS’ use of GRG. However, there has been little regarding Lloyds use of their business restructuring unit (“BSU”). Berg has been publicly commenting on Lloyds for quite some time now.
We have clients who have provided us with valuations undertaken by Panel Bank Valuers for Lloyds and a valuation by a Bank Panel Valuer for Santander three months later. The valuation by Lloyds was £30 million lower than the valuation by Santander (the Santander valuation was £59 million). We have used the phrase “the Lloyds effect” for quite some time now in relation to this unique position that occurs often at Lloyds, but not so much at other banks. At the time we had difficulties understanding why Lloyds appeared to be purposefully devaluing all of these commercial real estate properties. Then, without warning, many of these businesses found that their loans had been sold to Cerberus. That then made much more sense.
When the issues were put to Lloyds by Panorama Lloyds’ response was that Lloyds would not purposefully devalue a business and then sell the loan for that business to Cerberus for less than it was worth because this would not make commercial or economic sense to do this. That is a very valid question.
It is true that broadly devaluing a business and selling it for less than the original loaned amount does make little economic or commercial sense due to the losses incurred by the bank. However, we are not in normal financial circumstances and Lloyds has not behaved in a fashion that one would expect of a Bank looking after its customers’ best interests. Unfortunately the limitations inherent in a 30 minute telephone programme mean that this issue cannot be fully explored and exposed.
There is a very valid business reason for Lloyds to devalue their commercial real estate asset and to arrange for these to be sold to Cerberus for less than the loan that was made so that, predictably, Cerberus can then put the business immediately, or almost immediately, into administration.
Bailing out the banks
In the last 6 years there has been an economic collapse worldwide, and the banking industry itself has come very close to total collapse. A number of significant banks have folded and many Governments have had to bail out many of the largest banks, who were seen as being too large to fail. If RBS and Lloyds (which therefore included HBOS and Bank of Scotland) had been allowed to become insolvent and collapse in 2008 and 2009 the world economy and the economy of Great Britain simply would not have been able to withstand it.
Consequently the Government pumped billions of pounds into these two banks (which in reality are five banks) to keep them afloat. This has never happened before. It is estimated that the current 2014 total value of funds used by the Government to keep the banks afloat is in excess of £1 trillion.
Lloyds, HBOS, Bank of Scotland, RBS and NatWest heavily lent money to real estate and property investors. A significant majority of their balance sheet assets were commercial real estate properties. In 2008 to 2010 there was a significant collapse in the value of real estate in the UK (and around the world). This collapse is in fact one of the catalysts for the world-wide collapse.
In addition to having significant financial and economic challenges faced by all banks, these two banks also went from having a healthy balance sheet of customers’ assets that were secured for the bank going from an average loan to value rate of 70% to an average loan to value rate of 100% and more. That resulted in the bank being significantly under financed.
At that time all cash left the world banking markets. Almost all banks rely on money from other banks (the interbank market) to carry on day-to-day business. When that money stopped many banks, and HBOS/Bank of Scotland and RBS in particular, were faced with significant debts that must be repaid – the existing interbank loans – plus no new money coming in. It is estimated by the FSA that Bank of Scotland faced a hole of around £200 billion. It was at least £80 billion short when it asked the Government for help.
In mid to late 2009 all banks were in seriously difficulty. Both RBS in October 2008 and HBOS (roughly the same time) had effectively run out of money.
Following on from the collapse, the UK and EU regulators of Banks imposed rules regarding their debt to cash ratios (for reasons of brevity in this article that is a very simplistic summary). That meant that the Banks had to have more cash than debt so that if the debt assets dropped significantly in value the banks would never again have no liquid cash. As noted above, HBOS actually had an approximate £200 billion hole.
The new capital ratios that were required to be maintained were (and are) very difficult. It meant that the banks with the largest commercial real estate lending had a difficult task to comply. The easiest way of complying was to write off hundreds of billions worth of loans and remove their security over the properties. However, the banks could not simply write off one or two hundred billion of loans just to comply with the leverage ratios.
RBS bankrupt and minimizing losses
By April 2008 RBS was effectively bankrupt. The only survived because they raised £12 billion through a rights issue. (They are currently being sued for this.) They aggressively started moving people over to GRG, increased interest rates, imposed punitive fees and forced businesses to sign over a percentage of their businesses and assets to West Register. They were brutal in the manner that they undertook this.
Slowly since 2009 they have been asset stripping businesses, then moving them into administration. The asset stripping created much needed immediate cash flow. The percentage of assets signed over to West Register created additional future cash flows. Then the businesses were put into administration. RBS would make a loss when the administrators sold the assets at a loss. RBS say this is about £2 billion. However, through this process, which is slow, they were able to create a higher income at a time when income dropped because interest rates dropped. They created assets and cash through West Register and, most importantly, the removed the loans from their balance sheets – together with the assets – by putting them into administration.
In doing this RBS minimised its losses but at the same time was able to start moving forward in such a way as to start being able to comply with the new ratios. It certainly created a loss, but it was better to make a minimal loss (£2 billion they say) than simply write off all of the loans and make a huge loss. Where a business was on the cusp of being in default, but was not, RBS would push it over into default by either arranging a new valuation or undertaking a “desk top” valuation, either of which would suitably reduce the value of the assets thus taking them into GRG.
Lloyds minimizing losses with sale of loan portfolios
With Lloyds, they played a similar but different game. They went through a very long process of re-valuing businesses. As noted, we saw values on one hotel group drop from the £70 million our client thought down to £29 million in their valuation, back up to £59 million when Santander valued the property (and subsequently financed our client allowing them to divest themselves of Lloyds). This process confused many in the industry. Then, very quietly, Lloyds started selling vast loan portfolios.
A bad debt still has an economic value. If I lend you £10 and you default I have nothing. But, if someone is willing to spend the time to make a recovery, they might buy the debt. But it is no longer worth £10. They will pay anything from 2p in the pound through to about 25p, and even going higher. Lloyds had defaulted all of these commercial real estate customers, saying their loans were incapable of being repaid plus they all had assets that were significantly below 100% Loan to Value.
We were surprised to find that Lloyds were selling all of these loans, these “toxic” loans, for in excess of 70p in the pound. Typically customers would receive a call that day from their banks telling them that later that day their loan would be bought by a company.
Lloyds stated in the Panorama programme that this is normal, that it would not make commercial sense to purposefully devalue customers and they ensured that the new purchasers would treat the customers fairly.
By selling large loan portfolios to Cerberus Lloyds immediately a) received a significant cash payment and b) removed bad loans and assets from their balance sheet. For Lloyds this was very helpful. If the Government is to sell the last of the shares in Lloyds, Lloyds must be back to being a profitable bank, so getting these loans away from their balance sheet and providing a large cash injection was beneficial to the Bank and to the Government.
However, Cerberus paid such premium prices for the loans because Cerberus, we believe, had an expectation that the assets of the business would likely be sold nearer to 100% of the loan amount. If they paid 70% and sell the asset for 90% of the loan value they have made a 20% profit.
The above is what Cerberus and its subsidiaries have done. They put all of these businesses into administration. In the cases that Berg has worked on this all happened quickly. Cerberus would give the business owners a month to provide a solution to repay 100% of the debt plus costs or face administration. We even had one client who found out that their hotel was actively going to be marketed before they had even been told about administration. Their hotel was on-line.
It is disingenuous of Lloyds to state that it makes no commercial sense to down value assets and sell the loans at a loss. It may, normally. But in these circumstances it produces a large and immediate cash payment into the bank and removal of the loan and asset from their balance sheet. This re-liquidation and significant improvement in balance sheet are beneficial to the Bank going forward. The costs associated with selling the loans are balanced against these benefits. Given that the Banks who are accused of doing similar mis-deeds are the same banks who were bailed out, one must question how they have presented their restructuring groups.
“The Lloyds effect”
berg therefore coined the term “the Lloyds Effect” because so many businesses from the same industries (and most especially hotels) were all finding the same problem. They appreciated that property had fallen, but so much that it was 50% below the expectations.
It made no sense, but it does now when we all look at the larger picture. One should always remember that a Bank sees it as being more beneficial to take an immediate loss rather than wait for something to regain its pricing over the longer term. So, when shares fall drastically, it is economically seen by many that it is better to immediately sell and suffer a loss than to retain the shares (thereby locking up the cash in that investment) for a long time to allow the shares to go back up in value. That is exactly what has happened here. It is better to make an immediate loss than to keep bad loans and associated assets on the balance sheet long term until the prices of property recover.
For more information about any of the above or for practical advice on this or any other aspect of banking and financial disputes, please contact the berg Banking Litigation Team on 0161 829 2599 or email at email@example.com
(The information and opinions contained in this article are not intended to be comprehensive, nor to provide legal advice. No responsibility for its accuracy or correctness is assumed by Berg or any of its partners or employees. Professional legal advice should be obtained before taking, or refraining from taking, any action as a result of this article.)