Interest rate swap agreements (IRSAs) are acting as a hidden burden not only on businesses that cannot afford to exit them but on the banks – which must make provision for the exit costs. The FSA is due to report on the scandal this week and is likely to instigate a full review.
A typical £1 million small business loan covered by an IRSA now has a “break fee” of £300,000, which means a 30% increase in liabilities for the bank for every IRSA sold.
Investigations by The Herald this month have revealed that IRSAs could have added billions to business interest costs and to borrowing liabilities, while mis-selling was fuelled by reward structures for risk manager salesmen who could earn up to £1m a year in investment banks.
But after making big profits from selling the IRSAs in 2005 to 2008 as a hedge against rising interest rates, banks have now felt the sting of the rates collapse.
Abhishek Sachdev, founder of advisory business Vedanta Hedging, said: “It is costing the banks billions to fund what is a hidden iceberg, because the bank has to provide for these break costs as liabilities, and hold capital to cover them.”
Mr Sachdev revealed that he has reviewed over 50 SME cases and is now advising a raft of businesses on legal claims against the banks for mis-sold IRSAs, including bigger companies. “I have clients with borrowings of over £250m,” he said. “One client has a break cost of £65m.”
Many cases have been settled out of court, on the basis of detailed analysis of “the hedge that the bank should have sold as opposed to the one that it did sell”, he said. “In every one of them we have had to sign the strictest non-disclosure agreements, some of them with 25 or 30 obligations.”
MPs heard last week that a survey by the Bully Banks campaign of its 350 members had found 96% had been approached by their relationship manager with the product, and 88% said they had been unaware that the colleague who sold it was a regulated salesman.
The full report, published today, urges the FSA to force a 14-point action plan on the banks, aimed at uncovering any possible mis-sales over the past 10 years, and ensuring businesses do not have to take legal action. It wants banks to freeze all IRSA obligations, to admit mis-selling when any business conduct rules were breached, and to pay restitution and compensation within four months.
RBS, Lloyds and Clydesdale banks have all told The Herald that in any such transactions, the bank gave no advice, and contractually warned the customer that he should take independent advice. The financial ombudsman has so far accepted those defences, and rejected most mis-selling complaints. In the Court of Session last month, Lord Hodge said that interest rate management was “integral” to the business of small property company Grant Estates, which is suing RBS for mis-selling, implying that the company should have ensured it had appropriate expertise.
However, the Bully Banks campaign group says that prior to 2010 only one company in the UK was offering regulated advice on derivatives to ordinary (non-financial) businesses – and that was dealing only with FTSE-250 companies.
Jeremy Roe, spokesman for the campaign, said: “Although the banks may have stated they were not advising, they must have known that in practice there was nowhere for the small business owner to get advice.”
Mr Sachdev said: “Clients would often ask their accountant or solicitor for advice but none of these professionals are qualified or authorised to give advice on these products – they will not advise because they themselves commit offences if they do.”
One business owner who did not wish to be named, as he is taking action against RBS, told The Herald this week: “Seven days before completion the bank wanted me to fix. I did not want to fix as I felt that rates would fall as I believed we were about to go into recession, but the bank made the swap a condition of the loan.
“Now I am told that they may not renew the loan, and if they do a 4% plus margin will be required so will be paying over 10% when base rates are at a record low.
“No bank will look at refinancing with the swap in place, and we are paying an extra £170,000 a year in interest and have a break fee of £900,000.”
He has discovered that the bank’s profit on the IRSA was £137,000 – and he also paid a £35,000 arrangement fee. “The company is still profitable but I have had to make four people redundant after 20 years working together as a result of my position.”
A spokesman for RBS said the liabilities related to a small proportion of customers and would have “no material impact on the amount we can lend”. Lloyds Banking Group said it had received only a small number of complaints about IRSAs and most had not been upheld by the ombudsman.
The British Bankers Association said: “Interest rate swaps are regulated, and therefore banks have strict guidelines and rules in place.”