How Banks Profit From Distress (British Edition)

Yves here. Readers will notice how closely the US banking model hews to the UK version (or more accurately, original), particularly in its predatory practices. However, business collection abuses are less visible than the retail debt collection horrorshow. But in fact, many small businesses run on personal credit: business credit cards and most small business loans are guaranteed personally by the principal. I am curious to hear if collection practices are at all different for small businesses, or more precisely, if they have a sense of where and how banks draw the line between individual debt collection (which would include the small end of small businesses) and a “business” debt collection department, and even better, if the incentives to staff are different.

By James Nicholls, a lawyer and an expert in insolvency law, who runs his own Birmingham-based practice, Nicholls & Co. Recent high-profile cases include TWR, Schafenacker and MF Global. Cross posted from Ian Fraser’s blog

Banks are in the business of making money – just like every other business – and they do this by providing bank accounts and lending money at a profit. So far so ordinary. They lend to individuals and businesses and most of the time this all goes well, in that they charge fees and interest and everyone pays them back on time. This is literally called “Good Bank”.

There is another part of each bank called “Bad Bank” which is the part of the bank where problem accounts and loans are transferred. Each major bank has a different name for this part of their business and each uses a different euphemism. Years ago at Royal Bank of Scotland this department was called “Specialised Lending Services” which is about as euphemistic as you can get. It sounds like lending to, say, exotic pet shops or fracking businesses and it is laughable when you realise that “Specialised Lending” means “Asking for money back”! Here is a list of some of the larger banks and the names they currently give their “bad bank” departments:

RBS – Global Restructuring Group
Barclays – Special Situations / Business Support
Lloyds – Global Business Support Unit
HSBC – Commercial Recovery Unit
Santander – Corporate Restructuring Team

Good Bank is the part of the bank that involves relationship managers and salespeople and its primary focus is on trying to sell each customer more services and facilities, sometimes known as cross-selling. All businesses want to sell more of their products and services rather than less. Again, so far, so ordinary. But when things go wrong and a business or individual is struggling to repay a loan two things happen.

First, the “file” or account is transferred from Good Bank to Bad Bank and the person who is dealing with it changes from the smiling, young relationship manager in a branch to a faceless manager in the recoveries department. At the same time, and at the very outset, the Bad Bank person makes a “provision” against the account – which may sound innocuous enough. A provision is an accounting term which means the new manager assesses the account and takes a guess at how much money the bank can realistically expect to retrieve from the customer in default. Obviously, for some accounts, this is quite a simple process, but for others it is very involved and can include getting up-to-date valuations of property assets and accountants to crawl all over the business. The provision is the loss that the bank thinks it will make on that particular loan. Again this all sounds perfectly reasonable – except that this process and its consequences give rise to all sorts of conflicts of interest and unhealthy incentives.

The idea that any of the banks’ recovery departments are there to help businesses is laughable and actually quite insulting to people’s intelligence. GRG and Special Situations etc, are there to help the bank first, second to make money, and if they happen to help a customer along the way, then that’s all well and good. Of course, the banks will tend to lose more money if they push a viable business to collapse but what if, during the process, they realise not only that the business is viable, but also one that they can make more money out of?

This is where the transfer of the account from Good Bank to Bad Bank comes in. The provision or “write-down” of the loan, i.e. the loss, is put through the profit and loss account of the bank and is blamed on the relationship manager in the branch – you know, the poor sod whose targets are to sell as many unwanted facilities and products to his customers as he can, like Interest Rate Hedging Products, premium accounts and insurance.

A case study might be useful here:

Hapless Pet Supplies Ltd borrows £100,000 over 10 years and has a small overdraft of £10,000 but struggles with cashflow and defaults on its loan payments. It owes the bank £110,000 when it is transferred to the bank’s recovery department called Special Care, Attention and Mentoring Section (“SCAMS”).

The manager in SCAMS makes a 50% provision against the total debt and so writes-off £55,000. In fact, he privately believes that he can get all the bank’s money back, but sees no reason to make life difficult for himself. He can blame the 50% loss on the relationship manager and anything he manages to wring out of the situation he will be able to take credit for. And, in this world of incentive-driven capitalism, “credit” means “bonus”. So you can see how there is a massive incentive for everyone in the recoveries department to over-egg their provisions or write-downs, and this includes all the chartered surveyors, valuers, investigating accountants and other supposedly independent professionals employed to advise. Everyone knows, and is “in” on the SCAM of maximising the write-downs so the future write-backs can be maximised. No one needs any explicit instructions to do any of this, it’s just taken as read. Of course, newbies and secondees who arrive in the recovery departments take time to become accustomed to the system, because when they first arrive in the department they probably imagine they have arrived in the caring part of the bank, a bit like an A&E department or the emergency surgery department in a hospital.

So the customer is in the hands of the manager at “Bad Bank” and, because the customer has defaulted on his loans, every default provision in every contract, loan, guarantee and mortgage is triggered. The first thing that happen are that the interest rate on the debts will soar, and then lots of additional charges will be piled onto that customer, including valuation fees and investigating accountants’ fees. Default interest and extra charges adding up to tens of thousands of pounds will be added onto Hapless Pet Supplies’ original loan and overdraft of £110,000. So, after about six months of being transferred to the “Bad Bank”, Hapless Pet Supplies will owe £160,000 instead of £110,000. Remember the provision or write-down is not debt forgiveness or any waiver – it is just an accounting treatment in the annual accounts of the bank.

So what happens next? In a good outcome, the business will somehow manage to sort itself out. It might be that the business owner finds some new money (“refinance”), mortgages their home or moves to another bank. Being in “Bad Bank” is such a distressing experience, some owner/managers will make every effort to sort out their business problems themselves. Whatever happens, however, the bank still wants its £160,000. If it gets the money in full, it is seen as a positive outcome for the bank. The manager had told his superiors he thought he’d only get £55,000 back, but gains kudos and backslaps from his superiors for successfully clawing back the other £55,000 AND making another £50,000 on top. Inured to the pain the process might cause their customers, the bank’s senior management will see the recoveries manager’s activities as a cause for celebration and reward him with bonuses. It is a money-making, let’s milk our customers for fees, process that’s being repeated over tens of thousands of businesses that have the misfortune to cross over from Good Bank to Bad Bank. It is the inevitable consequence of running restructuring and recovery units as profit centres. And, of course, the picture is further muddied where banks have private equity or commercial property arms which have a habit of constantly scouring the Bad Bank, and sometimes even the Good Bank, for assets they can pick up on the cheap.

You may think the banks need to make a handsome profit from good outcomes, like Hapless Pet Supplies Ltd, in order to counterbalance situations in which they cannot retrieve their principal. Well, yes, there are occasions when banks get it completely wrong but these are actually very much in the minority. Remember: the bank lent Hapless Pet Supplies £100,000 and provided an overdraft of £10,000? Well you can be sure that the bank would not have lent anything like that unless it had security over at least £200,000 worth of assets. It would have had a mortgage on the company’s property as well as fixed and floating charges over everything else, and possibly personal guarantees from the owner/managers as well. The truth is, the bank never really had much chance of losing any money at all. Even if the company was put into administration the bank would probably get its money back first and, remember, it would not be looking for £55,000 – it would be looking for £160,000 and it could most probably recoup this by asset stripping the company, leaving just enough funds to pay off the administrators and liquidators. And banks can do all this in a perfectly legal way. If a business customer detects wrongdoing in any aspect of the process and wishes to take action against the bank, one thing is certain.
They will struggle to persuade a decent lawyer to take on their case. Almost every one of the top 200 law firms in the UK, both in London and the regions, is a members of the banks’ “panels”, or else would like to be on the panels or get tossed scraps of work “off-panel”. If approached, they will tell you they’re conflicted and unable to represent you.

If you want to read about the horrors that go on in the related factoring or asset-based lending industry, which is like an extreme version of what happens in the banks’ restructuring departments, I would recommend taking a look at the which gives a fairly good picture of how struggling businesses are actively targeted, milked for fees and asset-stripped by this industry.

The corporate recovery departments are essentially designed to take advantage of their customers when they are at their most vulnerable. The British Bankers’ Association ought to be leading the drive for better ethical practices, but they abandoned any such role decades ago.

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  1. Trisectangle

    The Private Eye (a UK satirical and political/current affairs magazine) covered the dubious behaviour in regional offices of several major banks which seemed to have driven companies into administration so that they could effectively take them over and run them for prfit themselves.

  2. Clive

    Suspicion isn’t proof… But I’ll offer the following for readers’ consideration and you can decide for yourselves.

    A TBTF decided a substantial territory was now “non core” so they shuttered the business in that locality. All the employees there were given the boot. But it wasn’t as bad as you might think. The top management from that division formed a new company immediately (a bit too immediately to make me wonder if it was really such a spur of the moment idea on their part) which by a fluke of luck got to manage the run off of the really yucky loan book which had become most definitely not something which anyone would want in their “core”.

    Why would this have happened in that way ? I wondered to myself what would have prevented the sale of the loan book to any number of vulture funds who are expert in this line of septic tank draining. Did the former incumbents really offer such a hugely better price ? Where did they get the capital to start such a “trash loans management R us” business ?

    I came to the conclusion it was basically a bribe and/or hush money.

    The previous management team knew where the bodies were burried. Nothing like the unemployment line and bills to pay to loosen some tongues — the TBTF might not want to run that risk. A company (the new management organisation given the task of managing the recoveries operation) with just one customer (the TBTF under whose auspices the said garbage barge of horrid lending originated from) is, erm, highly susceptible to “influence” in terms of how borrowers were treated. Who got dragged into security realisation (the hapless uninfluencial) and who got a big no questions asked principe forgiveness (the well connected or outright dangerous / underworld members) could be dictated from London. All through the convenience (i. e. opacity) of an arms length — but tame — third party management company.

    Like I say, suspicion is all I have…

  3. TomDority

    I have always said that there are two types of business, The wealth producing kind (produces an actual tangible product that inescapably requires labor in its production -wealth creation) and the other that strips wealth from an economy – economically rent extractive/predatory). A predatory firm will load debt upon real economic existing capital (stuff that took labor in it’s creation like machines, buildings etal) and inflate the asset (wealth) value to extract economic rent. Look at how little money capital goes into a viable business for improvements to production – real capital improvements, research et al – see hostess twinkies. Money is being used to steal the wealth created by labor – see wealth inequality.
    Until our revenue system is changed from favoring unearned income to one favoring earned income – we will continue toward debt slavery and ultimate disintegration of society and it’s forms of governments that had enabled man to escape tyranny for just a fleeting moment in time.
    Tax predatory and destructive financial practices (economic rent extraction practices from the economy and you will create a free market — a market is defined as a free market when, it is free of economic rent.

    Money takes the path of least resistance. Buy reducing taxation of predatory and destructive, economically rent extractive practices and placing them upon the wealth creative side of our economy….. naturally, money will flow in the direction of least resistance as, we have all seen multiple times and throughout history. We have all been confused by the two types of business practices outlined above – we see that confusion in comments like – tax big corporations (as if they are all the same) instead of discerning between the predatory and financially destructive rent extractive companies and those that produce wealth. Nor do we discern those that invest to strip assets from those who invest to create or improve wealth producing companies.
    I think it wise to introduce impedance/taxes into the predatory side so that money will find easier flow into the wealth creative side of our economy.

    Laborers knowing that science and invention have increased enormously the power of labor, cannot understand why they do not receive more of the increased product, and accuse capital of withholding it. The employer, finding it increasingly difficult to make both ends meet, accuses labor of shirking. Thus suspicion is aroused, distrust follows, and soon both are angry and struggling for mastery.
    It is not the man who gives employment to labor that does harm. The mischief comes from the man who does not give employment. Every factory, every store, every building, every bit of wealth in any shape requires labor in its creation. The more wealth created the more labor employed, the higher wages and lower prices.
    But while some men employ labor and produce wealth, others speculate in lands and resources required for production, and without employing labor or producing wealth they secure a large part of the wealth others produce. What they get without producing, labor and capital produce without getting. That is why labor and capital quarrel. But the quarrel should not be between labor and capital, but between the non-producing speculator on the one hand and labor and capital on the other.
    Co-operation between employer and employee will lead to more friendly relations and a better understanding, and will hasten the day when they will see that their interests are mutual. As long as they stand apart and permit the non-producing, non-employing exploiter to make each think the other is his enemy, the speculator will prey upon both.
    Co-operating friends, when they fully realize the source of their troubles will find at hand a simple and effective cure: The removal of taxes from industry, and the taxing of privilege and monopoly. Remove the heavy burdens of government from those who employ labor and produce wealth, and lay them upon those who enrich themselves without employing labor or producing wealth.

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