By Kalvin P. Chapman
To the wider public RBS’s fall from grace, which led to it asking the then Chancellor of the Exchequer for a bail-out to stop it folding into bankruptcy has Fred Goodwin in the lead role. To those of us in the financial litigation sector, Goodwin is a red herring, someone we rarely consider unless we are reading Ian Fraser’s Shredded. No, the name that is almost always at the front of our minds of Derek Sach. Derek Sach has taken on a person of epic proportions in the minds of litigants and their lawyers.
In 2007 RBS was in big trouble. Its finances were in the toilet. By August 2007 the traders at RBS knew they were in serious trouble. Fred Goodwin appears to have thought he could fight his way out of the trouble.
Someone realised that the bank’s Achilles heal is real estate. The bank had, in a really big way, gone after property developers, care homes, caravan parks, hotels and other leisure industries with real estate assets. They had lent money in absolutely remarkable ways. Property developers tell us, often, that in the 2006/07 period they were ordered to take out more lending by their relationship managers or their existing funding would be revoked (at the same time as selling them hedging. In the last quarter of 2007 Fred Goodwin told a conference that the sale of IRHPs was up 90%). By the start of the second quarter of 2007 people in the know knew that RBS had two major problems. Property prices were going to tank, having risen substantially since the start of the golden age in 2004. That would mean that businesses with assets in real estate would have loans that were bigger than the security the bank held. In addition to this, property collapses also mean sub-prime mortgages default in large numbers. RBS had made eye watering sums of money off the back of securitised mortgages, securities the bank had under-pinned with sub-prime mortgages. The US regulators are about to fine RBS between $3 and $15 billion because of its illegality in selling the securitised mortgage securities. The UK regulators have not fined RBS for this.
By August 2007 LIBOR rates had risen through the roof and base rate was expected to fall (and did). Therefore, the cost to the bank of borrowing money was steadily getting more expensive than they what the bank made by charging interest (at base rate) and the margin combined. As a consequence, banks around the world just stopped lending money on the wholesale market. Banks need steady injections of cash from the wholesale markets in order to feed their lending and repay old lending. With the tap turned off most banks were able to cope, but for banks like RBS and HBOS that had built their aggressive lending strategies on borrowing huge amounts on the wholesale markets this tap being turned off meant only one thing: financial oblivion. It killed HBOS and almost killed RBS.
In early to mid 2007 someone realised that the RBS clients who had commercial real estate would become insolvent, or could be made to look insolvent. For the business, real-estate dropping through the floor can usually be irrelevant. Income is made from rent, not the value of the property. So long as they have tenants the loans get paid and the profits get paid, no worries. But for a bank it is different. A bank cannot have more lending than it has security and cash deposits (and other assets). RBS and HBOS both were in this position to such an extent that they were effectively insolvent. So, RBS started moving commercial real estate based clients into a newly set up “turnaround” division. It became known as Global Restructuring Group, or GRG. Those three letters make a lot of people’s blood run cold.
I have worked on one of the first GRG cases from mid-2007. My client was a care home operator. GRG simply walked in one day and told my client he was insolvent. He had to pay substantially more on his loans and he had sell off his care homes to repay the loans. If he did not (which he said he would refuse to do so) the bank would put him in administration. My client and his then business partner were terrified. An auditor, paid by the client but under the direct control of GRG, came in and after a short review confirmed the client was effectively about to become insolvent. In almost every case where the client alleges a forced distress by GRG the same thing happens. The auditors almost always say that they will face a cash flow catastrophe in the next three months. It is never an immediate cash flow catastrophe, nor is it ever an insolvency. It almost every time a future cash flow catastrophe. Obviously, there are businesses that were genuinely insolvent and the auditors said this. I am referring to businesses that claim to have been artificially distressed by GRG. The bank has its insolvency event and defaults the lending and hedging, causing an actual insolvency event thus proving GRG was needed, despite that it was the bank that caused the alleged default. The client was in serious trouble, so the bank agrees to new, but vastly more expensive, lending on LIBOR, PPFAs and the break fees on the hedging is bundled up into new hedging, so the client never notices.
They got very good at this. They forced Property Participation Fee Agreements (“PPFAs) onto the clients. They are a future requirement to pay the bank an excessive amount of money. That agreement acts as security which the bank can use to prop up its balance sheet – it is an actual asset to the bank with a very real financial value. The bank had collapsed because it did not hold enough security. The PPFAs helped change that.
The PPFAs were made out to a subsidiary of the bank, known as West Register. The company is now known as Sig 1 Holdings Limited. This is what GRG did to their accounts:
|Year||Turnover||PPFA Income||Fees||Dividend Income|
So, GRG was set up. It ruined a lot of people’s lives. It stripped SME businesses of their profits. First came the IRHP review into the sale of hedging, then came the Lawrence Tomlinson report in 2014 outing GRG as the nefarious bad witch that came along and ruined viable businesses. It is very true that many businesses that simply were not viable went into GRG – RBS is very quick to point those out. But there were businesses that could have survived and either did not or did survive but being vastly reduced. A lot of businesses will now no longer consider bank lending, even though their businesses can only grow with funding, because of what RBS and Lloyds did to them. It is very distressing and heart breaking to see people whose lives have been utterly ruined by the banks. The nightmare continues for many at RBS and Lloyds.
Bank lending to SMEs is entirely unregulated. The relationship between the bank and its customer is regulated by common law and contract law. The bank can effectively do what it wants, so long as the contracts allow it. This is what a recent GRG claim said