Tailored Business Loans and the questions Nab Group needs to answer.
A Tailored Business Loan (TBL) is a variable, fixed, or structured loan which was provided by several banks during the period 2001-2010. Taken at face value, the TBLs were a flexible way of providing customers with loans which could be purpose built to suit the needs of the customer. If the client wanted a fixed rate loan, that could be arranged under the umbrella of a TBL. Maturities could be anywhere from one year to twenty years.
The margin payable by the customer could also be included in the overall rate, making the monthly interest payment both easy to understand and live with.
Two banks under the ownership of National Australia Bank, Clydesdale Bank and Yorkshire Bank, used TBLs as their structure of preference when lending to SMEs. Having designed a basic Facility Agreement and some generic Terms and Conditions, the banks gave out loans in their hundreds to SMEs during the years 2001 to 2010.
In themselves, there is nothing wrong with the structures of TBLs, until that is, a borrower either requests to repay the loan early, or the bank forces early repayment, in the event of a breach of a lending condition. In the event that this happens, the bank has written itself a clause which allows it to recoup any costs that it suffers from getting its money back early. The level of disclosure of this clause in the agreement depends upon what
version of the Facility Agreement and Terms and Conditions that the customer received, or didn’t receive, depending upon individual circumstances.This clause, which allows the bank to claim a refund of any costs that it has incurred only applies to fixed rate loans, or variable/discounted rate loans, and it relates to ‘replacement’ or other costs that the bank incurs when it gets its money back early. In essence the bank is saying that, in the circumstances where it has agreed to fixed rate financing and has made arrangements with third parties (i.e. other banks) to provide those fixed rates, either by taking fixed rate funding itself, or more commonly from entering into an ‘interest rate swap’, it has the right to recoup any costs incurred from breaking those contracts with third parties by passing
them on to the customer.
Those that have been reading recently about the Financial Services Authorities decision to investigate the banks for potential mis-selling of interest rate hedges will know that these TBLs do not form part of that process, and that therefore there will be no automatic review of the sale. TBLs are excluded because they are not ‘regulated instruments’ like swaps and collars (types of derivatives) and the banks are maintaining that they are regular fixed rate loans.
Once again to reiterate, these TBLs are fixed rate loans until examination the large exit or breakage cost, which are calculated using the same methodology as an interest rate swap. The swap is therefore said to be ‘embedded’ and is not stand-alone, but to be entirely correct, the customer has no swap at all, they are being charged with paying the breakage on the swap that the bank has entered into with a third party bank.
The banks are arguing that they have the right to charge the customer these costs because it is written into the terms and conditions of the loan agreement. However, the workings of these costs have not always been sufficiently well explained (if at all), and their calculation is both unexpected and unfathomable for most. The banks often say that these breakage costs cannot be worked out in advance, but that they could be substantial, but the costs could have been articulated, and examples provided, and what
Certainly the profit that the bank took up front when it booked the fixed rate loan is immediately added to any breakage cost, so the client is disadvantaged from day one. Furthermore, who is there to check the calculation of the costs that the banks claim they have incurred with third parties, and indeed check that the bank entered into a hedging agreement with a third party at all?
These are questions that Clydesdale and Yorkshire Bank are struggling to answer. Banks rarely ‘matchhedge’ their interest rate exposure, so being able to provide clarity on their costs is difficult. Also, what can and cannot be included in ‘replacement costs’ as the banks seem intent on including the profit that they made on day one, as well as making a quick buck on the way out.
Why did these two banks arrange to hand their clients the huge risk associated with long term fixed interest rates, and why did they choose to wrap these within a TBL?
Part of the answer certainly lies with an accounting trick, and part also lies with the power and leverage that a TBL gives the bank. As many SME customers have found, the liability that the breakage cost brings (from day one) has been used by the bank to alter the terms and conditions of lending, to enforce margin increases, and in some cases to bring about termination of the loans themselves.
As the banks cross their fingers hoping still to avoid any inclusion into the FSA’s redress and review, and pressure on Clydesdale and Yorkshire Banks from the Treasury Select Committee mounts, the level of understanding as to how this silent mugging managed to take place is growing, but it is still painfully thin.
Financial Markets Consultant ; QA Legal
Mob (07415) 485849