The property market has suffered its share of woes in the downturn and the impact of interest rate swaps has proved to be cause of significant damage.
Marketed as a simple means of protecting against rises in the cost of borrowing, these products were in fact highly complex financial derivatives. They came in different forms – known as interest rate swaps, caps and collars – and were sold in their thousands to developers, landlords and other businesses in the property supply chain.
In the vast majority of cases, this form of hedging proved to be unsuitable for property businesses and involved risks that were not explained in the sales process. The products also came with astronomical exit costs.
William Newsom, UK head of valuation at Savills Commercial estimates that more than 90% of bank lending secured against commercial investment property before 2009 was subject to an interest rate swap product.
From 2008, when interest rates started to fall any firms which had swaps found themselves saddled with high costs. In most cases, the lower rates fell, the higher the exit fees became.
Landlords have since been hit by the double whammy of falling asset values at a time when rising swap break fees means the cost of maintaining their properties is even more challenging.
Developers have also been blighted. The Opal Group, which developed student accommodation, fell into administration in March this year, citing the high costs of its interest rate hedging. Smaller scale developers have also been mired in the issue. One of the underlying factors in the success of development activity is a prompt turnaround. Developers will renovate a property and look for a quick sale using the profit to invest in the next project. The significant break costs associated with swap if the loan is terminated early wipes out any profit, thereby preventing investment in a subsequent project and stalling any future development.
In some cases the existence of a swap has proved a deal-breaker where a principal wants to sell an asset. In others, it's forced people to sell up completely or to dispose of assets at below market rates to fund the vast fees associated with exiting these hedges.
The overall impact has been market to strangle the market.
One year ago the Financial Services Authority recognised that there was something seriously amiss with the way these products had been sold in the UK. It announced it had 'serious concerns' about the way these products had been sold to businesses. A subsequent pilot study by the regulator found that in over 90 per cent of the 173 cases it examined, mis-selling had taken place.
It's been estimated that at least 40,000 UK businesses are believed to have been affected but the figure may yet prove to be much higher. Many of those businesses wanting justice have already started down the road to redress.
Taking action to protect your business
There are two main routes to pursuing a compensation claim:
- Work through a process set up by the Financial Conduct Authority, which has replaced the FSA. Claims are administered by the banks themselves, under the supervision of an independent reviewer
- Take legal action against the bank for breach of contract. There's a six-year limitation on claims for breach of contract. The majority of these products were sold between 2005 and 2010. This means that every day businesses lose the right to claim through the courts.
To be part of the FCA compensation scheme your business is expected to fit a definition of a 'non-sophisticated' customer. That is, in the financial year during which the sale was concluded your company met at least two of the following criteria: a turnover of less than £6.5m; a balance sheet total of less than £3.26m and fewer than 50 employees. Those developers with a property portfolio are likely to exceed the balance sheet threshold, but may still satisfy the other two tests.
Many businesses outside of these criteria will feel hard done by and may have the option of taking legal action.
Was your business mis-sold a swap?
The critical issue is understanding whether your business was mis-sold a swap. So it's important that whoever is handling your claim has genuine depth of knowledge when it comes to understanding breaches of banking regulations.
It follows that you also need to know how much any swap products have cost your business. Have you been paying excessive interest charges for years? As these products were complex financial derivatives the answer to this question is not simply a matter of adding up the interest charges on bank statements.
What's required is the recreation of the market conditions over the term of the agreement – and working out how much you have paid and how much money the bank has made from the product it sold you. This is a specialist task – and not a job for a general practice lawyer or accountant. Seneca has the resource to crunch these numbers and provide expert analysis.
As part of a complete claims handling service, the firm prepares specialist reports directly for business customers, as well providing expert support and reports for lawyers and accountants.
Claims require specialist handling. Not only is there a huge amount of information to be reviewed, but these cases are fact-sensitive. The precise manner in which they were sold, the suitability of the product when considering the client's needs and the varying degrees of advisory information provided all need to be considered for each case as well as the actual loss suffered by the customer, not just the swap payments.
In many cases these products were sold over the phone. The terms and conditions would only turn up weeks later, by which time the contract had, in effect, already been enacted.
The FCA accepts that those businesses which were mid-sold swaps will have suffered 'consequential' loss. How much compensation are you due if your business failed and went into administration because of the paralysing effect of the swap a bank mis-sold you?
Questions like these are sure to be tested in the courts – and make a complete nonsense of the suggestion from the banks that businesses don't need independent advice about their claims.
How to tell if you have a claim
The language can vary from bank to bank around interest rate swaps, caps and collars – but it will feature in the paperwork. These products were separate from loans – so had their own agreement documentation.
They also tended to be handled by someone from a different part of the banking team.
The processes the bank's use to review claims does vary somewhat, but for the most part the elements involve:
- The bank invites you to be considered as part of the FCA review
- You submit your version of events, supported by documentary evidence; emails, letters and loan paperwork and possibly a witness statement
The bank then conducts the review of your case. The fact the bank is attempting to police the matter itself is an obvious concern.
The Financial Conduct Authority has given some banks, including Royal Bank of Scotland and Lloyds the authority to begin contacting customers to initiate the compensation process. Other lenders are still engaged in internal reviews to discover the extent of any mis-selling.
It's important to realise that you are not under any obligation to accept offers by the banks. Indeed, there are some concerns that banks may even propose alternative hedging products which are not suitable.
Justice for your business
In general, avoidance of liability is a huge problem and even now, we see communications from banks to customers which are misleading. To suggest, for instance, that people don't need specialist advice is misleading and disingenuous. These products were in reality complex and risky financial derivatives that were sold to businesses which had no idea what they were signing up to. What's required is an experienced and specialist eye to unravel what has been sold and the breaches of acceptable practice.
And act now to avoid losing the right to litigate under the six year rule.
- Daniel Fallows is a director of Seneca Banking Consultants
- T: 01942 271746 Daniel.Fallows@senecabc.co.uk