High street banks stand accused of exploiting small businesses by selling them costly and complex financial products that made huge profits for banks while crippling once sound firms
All full up and happy,” smiles the white haired lady in the window seat, passing one of Winking Willy’s waitres-ses her plate. She had just polished off the Scarborough café’s £7.90 special – cod, chips, bread and butter and cup of tea.
It is Tuesday lunchtime, the sun is out and the famous Yorkshire town’s seafront is busy. Willy’s is three quarters full – families and pensioners tucking into its simple fare with enthusiasm.
The only distraction is the noise of the builders refurbishing Willy’s second-floor dining room. All in all, business seems good.
But behind the scenes the family business has just emerged from a four-year-long encounter with the world of complex capital markets derivatives and investment banking that saw owners David and Marilyn MacGregor ultimately take their bank, HSBC, to court.
In a plot that would appeal to Scarborough’s most famous resident, playwright Alan Ayckbourn, the family fryer’s plucky challenge to the sharp suits of Canary Wharf could have ended in tears. Yet they lived to tell their tale – or at least they would have done if their out of court settlement had not included a gagging order.
The MacGregor’s experience is not an isolated one. It is shared by hundreds, and possibly thousands, of small firms across the country.
The high street banks stand accused of exploiting the small businesses’ trust, using their standing as adviser to sell highly profitable and complex financial products to some of the smallest firms in Britain.
Traditional standard variable rate commercial loans came packaged with complex bets on the movement of interest rates that were sold on by the bank’s investment banking divisions for huge profits.
Presented as a “no-cost” form of insurance to protect the businesses against adverse movements in interest rates, these unregulated swap instruments turned into significant liabilities. Falling base rates were meant to help small businesses but with these products they generated charges that devoured savings and destroyed some once-sound family firms.
The swaps, typically taken out between 2005 and 2007 – but still being sold today – locked firms into rates of between 5pc and 6pc over base rates. Additional clauses presented as giving firms some exposure to the benefit of falling rates saw banks reduce their own risk of being out of pocket.
As base rates fell, the charges kicked in. Shocked at the amounts of cash being taken out of their accounts, many firms looked to cancel the swap only to find the cost of doing so prohibitive.
One bed and breakfast with a £73,000 turnover faced a six-figure bill to escape. A property developer with £15m in borrowings across three loans and swaps to his name faces a £9m charge.
The businesses contacted by The Sunday Telegraph said they were keen to protect themselves from rising interest rates but imagined they were being offered the commercial equivalent of a fixed-rate mortgage. They did not understand that they were signing up to an obligation that would be sold into the financial markets and then take on a life of its own.
Banks contacted by The Sunday Telegraph denied they were involved in wrongdoing. They said that they had clearly explained the risks and costs to customers.
In the week when the high street banks sent out 12m letters to consumers who may have been mis-sold payment protection insurance, the question on these businesses’ lips is why?
“I trusted them,” is how Paul Adcock, the third generation of his family to run their small electronics retailing business in rural Norfolk, puts it.
Adcocks had been expecting to mark 100 years of mutually beneficial trading with its longstanding banker, Barclays. It has been with the bank since January 1, 1912. Instead, he is now considering litigation after his formal complaints to the bank were rejected.
“How about that for a birthday present,” he said. “If you had asked me in 2007 if it was possible that your bank that has supported you for so long could have sold you a product that could cause so much damage, I would not believe you.”
The 53-year-old prefers to spend his days serving customers out on the shop floor rather than sat at his messy desk in the back office studying bank marketing small print.
“The damage it has caused us is unbelievable,” he says. “We are just a family electrical business, just wanting to get on. Now the best part of £180,000, has gone out and that is in addition to what we have paid in loan repayments.”
In a statement, however, Barclays says it is “satisfied that it provides sufficient information to enable a client to make an informed, commercial decision about the products it offers.”
Liz Hunter, director of Darby’s Glass & DIY in Cleveland, is angry at the impact of saying yes over the telephone to an offer of an HSBC interest rate swap in 2007. Having borrowed £420,000 to purchase the business, the bank suggested the swap as protection.
“I thought it was part of the loan but if we come into the money we could pay off the loan but we’d be stuck with the swap, ” she says. “They have offered us the opportunity to buy it out but it would cost £55,000. Something is clearly wrong somewhere.”
HSBC said it would not comment on individual customers, but stressed it has “extensive processes designed to ensure we provide customers with appropriate products according to their needs, knowledge and experience as well as a full explanation of the products and relevant risks.”
But other businesses contacted by The Sunday Telegraph were nervous about criticising their bank in public, as most still rely on their banks for credit facilities.
One former engineer who had set up a child care centre with his wife told how he was sold a swap when financing the acquisition of a second nursery. The bank agreed to provide a loan of around £400,000 but then the investment banking arm came knocking with the offer of a swap.
“I was told it would act like my fixed-rate mortgage,” says the businessman, who asked to remain anonymous. It proved nothing of the sort. His interest payments on the “cap and collar” swap quickly rocketed, far out-stripping the decline in his loan repayments from falling base rates.
“I trusted the bank and stupidly thought they would act in my interests,” he said. “We were the reliable customers, not risk takers, not gamblers and were easily targeted by these vultures. If someone had really told me what the product was I would not have signed it.”
A 65-year-old women running a care home was caught out when she was sold a swap as she financed the acquisition of a second care home. She gave personal guarantees to secure the loan and as the interest payments soared was forced to sell one care business and then her family home to buy out the swap. Another property firm said it was sold a swap for a larger amount and a longer maturity than the loan itself.
In other cases, banks provided themselves with break clauses in the contracts but did not extend this to the businesses. If interest rates moved against them, they could scrap the deal at short notice. If the rates went the other way, their customers were caught for years.
James Dean, managing director at Legal Plus in Bolton, is handling dozens of claims on behalf of small firms. He says he has seen hotels, bars, boarding kennels, care homes, garden centres, farmers, publicans and small shop owners caught. “I have seen hundreds of people who are desperately caught by this. They are not sharp suited companies. They are ordinary businesses.”
Michael Dempster, Professor Emeritus at the University of Cambridge’s Centre for Financial Research and an expert on derivatives, is not surprised by the cases. He designed the computer models used by many of the large banks to price complex financial products, such as interest rate swaps.
However, he was amazed to see the profits banks were making on selling derivatives to small businesses. “Let’s just say we were surprised,” he says of the day a German lawyer visited him in 2007 to ask him to examine the case of a German business that thought it had been mis-sold an interest rate swap by its bank.
As Prof Dempster looked further into what the bank had done he was alarmed at the way it had used pricing systems like those he had built to lock in large profits on the sale of interest rate swaps. “I liken it to going to bet on a horse race having fixed the result. You’re not guaranteed to win, but you have a heck of an edge on the punters.”
The case of Adcocks highlights just how much of an edge the banks had. Following 12 months of what Mr Adcock describes as “encouragement” from his local Barclays relationship manager, the company in February 2007 took out an interest rate hedge on its £970,000 of borrowings from the bank. Unbeknownst to Mr Adcock, on the day he signed the agreement, Barclays Capital, the bank’s investment banking arm that structured the deal, is likely to have a booked a profit of as much as £100,000 from the sale of the hedge.
How the bank made such a large profit became apparent only in the past year when a derivatives expert picked apart the swap. Instead of a simple interest rate hedge, Barclays Capital had put together a piece of financial engineering more at home on the books of a Mayfair hedge fund than an electrical retailer.
“It took me two days of trying to puzzle out what they had done to this guy. Normally it takes me half an hour, but this was a structured collar, a real bastard thing,” says a former senior derivatives banker hired by Mr Adcock to advise him.
Delving into the paperwork the banker, who asked not to be named for this article, found that Adcocks had been sold a product known as an “asymmetric leverage collar” that effectively penalised the business with £2 of cost for every £1 of benefit it offered.
“It was written into the contract, a two-to-one penalty, basically, but he would never have known that. He was never going to gain anything. The poor guy was never going to know it – it was completely inappropriate,” the adviser said.
James Ducker, a former derivatives salesman for Lloyds and RBS, says that staff were under pressure to maximise profits for the bank, but does not think senior managers knew what was going on.
“I assumed the management knew what it was like on the shop floor, but having met with managers recently I now think they didn’t have a clue,” he said. “They didn’t understand that with the targets and the pressure you simply didn’t have time to spend a month working on a swap for a client.”
Mr Ducker has since left the banking industry and now advises those alleging that they have been mis-sold interest rate swaps on how to negotiate with the banks that pushed them to buy them.
Another former derivatives salesman, Abhishek Sachdev, has reviewed more than 50 cases of alleged interest rate swap mis-selling since setting up his SME advisory firm Vedanta Hedging: “In most cases I see, the true risks and the true downside were never really explained to the client. They may well be contained in some smallprint of the documentation, where-as the advantages would be discussed and extolled in detail.”
A common sales ploy was for the banks’ derivatives salesmen to be introduced to clients with titles describing them as “risk managers”. During the sales talk, bankers carefully avoided saying they were providing advice to the customer, instead presenting a narrow selection of options that the client might like to choose from.
Letters sent by Barclays Capital to Mr Adcock show the bank felt under no legal obligation to judge whether the product it sold him was in his best interests.
“Barclays rejects the suggestion that it was required or had a duty to assess the suitability of the Hedge. In signing the Customer Agreement, you agreed, at clause 4, that Barclays was not responsible for reviewing the suitability of any transaction which you may choose to enter into,” said the bank in a letter written to Mr Adcock last year. Barclays did not comment on individual cases.
The Financial Ombudsman Service is handling a steady stream of complaints and dealing with each on its merits. It can only take on claims made by the very smallest firms – those with fewer than 10 staff and just under £2m of assets.
Many have been rejected where the banks can point to warnings about the potential costs, even if these were hidden in smallprint.
The Financial Services Authority has indicated it wants to see the merits of claims assessed in court. In response to questions by Guto Bebb, the Conservative MP for Aberconwy who has taken up the issue, it stated: “Treasury Ministers regularly meet with the Financial Services Authority to discuss a range of issues. The FSA, as a statutory independent body, is responsible for decisions relating to the Conduct of Business Sourcebook and its enforcement are a matter for them.”
But Mr Bebb says this fails to take into account the mismatch in resource between small firms that are caught and the global financial institutions that sold the products. He has heard the sales call that caught his constituent, Colin Jones. “Having gone through a verbal contract there were certain elements of that contract that I doubt were acceptable practice,” he said. “And then his refusal to sign it was made a condition of whether he received the funds. He was clearly mis-sold in my view.”
Last Friday, a pre-trial hearing was held in Bristol for what could be the first interest rate swap mis-selling case to go through a full English trial. Details of the case are difficult to come by, but The Sunday Telegraph understands it involves the sale of an interest rate swap by Barclays to a law firm.
Stuart Brothers, founder of law firm SRBlegal which is fighting the case, is shocked by the defence put up by Barclays for a “relatively small amount of money”.
Barclays has hired the top London QC, Sonia Tolaney, to fight the case. “I’ve been in financial services litigation for 25 years and have never seen anything as hotly contested as this. It looks like the bank is fighting a point of principle,” said Mr Brothers.
In Scotland, RBS is currently involved in a court case brought by Grant Estates. The case comes after the property developer was put into administration after it took out an interest rate swap on a £775,000 loan that put such a heavy financial strain on the company that it led to it being unable to meet payments.
There are signs the banks are concerned at the potential financial cost if they lose a case. RBS has undertaken an audit into its sale of interest rate swaps to SMEs. “RBS has strict policies in place to ensure that interest rate swaps are sold properly. We regularly carry out audits of our businesses to ensure our policies and procedures are robust, meet the relevant regulatory guidelines, and are followed by staff,” said a bank spokesman.
“I think this could be at least the same size as PPI [payments protections insurance],” says Prof Dempster. PPI claims cost Lloyds alone £3.2bn, and in total Britain’s four main banks have set aside more than £5bn to pay out to customers mis-sold the product. While fewer in number, the size of claims in interest rate swaps cases could be huge. One barrister involved in several claims, estimates banks could be forced to pay between £250,000 and £500,000 on each case, with some claims far larger. In Winking Willy’s case, the company is be-lieved to have settled for £250,000.
Willy’s experience suggests businesses can come out the other side. The workmen and the owner’s BMW X3 with WII LYS number plate, parked outside show the company has moved on.
But for many the battle has just begun. Mr Adcock says: “This is important. The more people that stand up and shout, the more small businesses suffering silently might join them. We have a feeling that it is a volcano waiting to explode.”
BBC Follow Up on Swap Mis-Selling After Original Interview with Abhishek Sachdev
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10 March 2012