The dog that eats up debt
By Ian Fraser
Published: Sunday Herald
Date: 21 December 2014
[Note this the unedited version of a business focus article published in the Sunday Herald on 21 December 2014]
Banks including the Royal Bank of Scotland and Lloyds Banking Group have found a new way of freshening up their balance sheets and ridding themselves of business customers who have been vocal in their criticism of the banks’ activities – they are selling multi-billion pound portfolios of corporate and commercial loans to so called “vulture funds” .
There has been a spate of such deals in recent days. Clydesdale Bank sold a £1.2bn portfolio of such loans, dubbed “Project Henrico” on Monday; and on Tuesday morning RBS announced it had cemented a deal to offload a £4.8bn portfolio of Irish loans originally issued by Ulster Bank, dubbed “Project Aran”. The bundled up loans generally originated in a period of manic over-lending in the build up to the 2008 banking crisis, though most of the loans are likely to have been heavily restructured over the past six years.
The buyer of both ‘Project Henrico’ and ‘Project Aran’ is the New York based hedge fund/private equity firm hybrid, Cerberus Capital Management, which purchased the portfolios using special purpose vehicles registered in the Netherlands, Ireland or similar jurisdictions for tax avoidance purposes. These SPVs always contain the word Promontoria, sometimes followed by additional names, numbers and the initials B.V.
Other US-based private equity firms that are seeking to profit by taking on parcels of debt from troubled European banks include Apollo, Oaktree, Lone Star and Blackstone.
Deals along these lines are celebrated as a good thing by investment analysts, the UK government – which still owns 25% of Lloyds and 80% of RBS – and by banking regulators, not least because they are seen as boosting the government’s chances of selling off tranches of its equity in the banks to private investors. In the case of Clydesdale, the recent ‘Henrico’ deal is also seen as boosting the chances that National Australia Bank might be able to offload Clydesdale either via a trade sale or an IPO within the coming months or years.
The deals also give the banks a greater chance of sailing through the increasingly onerous stress tests being set by the Prudential Regulation Authority of the Bank of England, in which they must prove their ability to survive a severe economic downturn without further recourse to taxpayer bailouts. Last week Lloyds and RBS only narrowly passed such tests, while Co-operative Bank, which has received no direct taxpayer support, failed.
The process of banks offloading unwanted customers in this way is gathering momentum. So far this year, European banks have offloaded €54.9bn worth of European commercial real estate loans in such ways, more than in 2012 and 2013 put together, according figures from property consultants Cushman & Wakefield.
But the deals, which see loan books being offloaded at discounts ranging from 30% to 75% of their nominal face value, are not all good news. The loans in Ulster Bank’s “Project Aran” portfolio, which have a combined face value of £4.8bn, were sold to Cerberus for just £1.1bn. That means, in its desperation to offload them, the bank was willing to accept an offer that was 77% less than their face value. The deal represented just under 9% of Ulster Bank’s pre-crash balance sheet.
If vulture funds believe they can handsomely profit from such deals, isn’t someone else being short-changed? Would the banks not have been better to hang on to these loan books themselves? And what do such deals actually mean for customers – the end-borrowers whose loans are being traded like bags of flour, sometimes without their knowledge or consent?
The majority of the UK businesses that are having their loans reassigned to private equity owners are commercial real estate companies and property developers but there are also significant numbers of non-property SMEs and other borrowers bundled in as well. Many of the firms involved have been living in a state of financial purgatory since their crisis, having been forced to jump through challenging hoops set by bank managers who changed, around the time of RBS’s 2008 collapse, from eager cheerleaders to vindictive Mafiosi seemingly intent of punishing and humiliating them (for example by forcing them to pay tens of thousands Independent Business Reviews or by ratcheting up rates and charges, and imposing often clueless consultants on their firms)
Stephen Rosen, partner at London based lawyers Collyer Bristow said that the sale by banks of customer loans to groups like Cerberus, without the customers’ consent “is an extraordinarily serious development both for customers and customer-bank relationship.”
“Customers, often small businesses, find themselves hamstrung by the legal documents that they have signed many years ago, which almost always places the power in the hands of the bank to transfer the debt to a third party without the customer’s agreement and indeed without even informing them until the transfer has taken place.” He added that in many cases the business people concerned will have been forced over the past six years to throw in extra cash at the bank’s behest to keep projects and businesses afloat. “That investment may well be lost if their loan is purchased by a fund intent on enforcement action,” which can include administrations and repossessions.
One ex RBS insider said “one thing you can be sure of is there will be no KYC [know your customer] policy at Cerberus”.
Many of the businesses that are subjected to such transfers blame their banks for their financial plight.
This may be because the bank missold them an interest rate swap ahead of its own failure. In such instances, these complex derivatives may have crippled their businesses once UK rates fell to 0.5% in March 2009, forcing them into a default situation. In certain cases, the banks also “artificially” distressed business borrowers in ways described by government adviser Lawrence Tomlinson in his bombshell November 2013 report, for example by ascribing phoney valuations to their commercial property assets that put the customers in breach of loan-to-value agreements.
Calvin Chapman of Manchester-based law firm Berg said that “in cases we are aware of Cerberus has given business owners a month to provide a solution to repay 100% of the debt plus costs or face administration. We even had one client who found out that their hotel was actively going to be marketed before they had even been told about the administration. Their hotel was already online.”
Affected businesses allege that vulture funds are even more brutal and uncaring with borrowers than the banks’ notorious recovery and restructuring units – RBS’s Global Restructuring Group and Lloyds’s Business Support Unit. Rosen warns they have fewer scruples about repossessing properties.
“RBS is essentially throwing the customers involved to the wolves,” said Janine Alexander, a partner at Collyer Bristow.
Another source with experience of the distressed debt market said: “The only people who are profiting are Cerberus. Everybody else loses. The real scandal here is an abuse of power. A lot of the distressed debt that’s being handed over to these guys is only distressed thanks to the activities of the banks. It seems the bank’s real motive is to clear out anyone who might complain.”
John Glare, founder of the NAB Customer Action Group, which represent scores of businesses that alleged they have been abused by Clydesdale and Yorkshire Banks, warned Cerberus that if it “starts to apply pressure on the customers whose loans it has taken over before any attempt by NAB to float Clydesdale and Yorkshire, this is going to erupt”. He added: “At the very least, we will be seeking to ensure that the conditions that applied under Clydesdale’s ownership carry through under Cerberus’s ownership.”
At least one sizeable Northern Irish business has slapped an injunction on Ulster Bank barring it from transferring its loans to Cerberus as part of “Project Achill”, a smaller tranche of Ulster Bank loans that was acquired by Cerberus, via the High Court in Belfast. However, businesses that tried the same in the Irish Republic have been less successful. On 9 December, companies controlled by the brothers Michael and Richard Larkin failed in their bid to get an injunction preventing Ulster Bank from transferring some €89m of their companies’ loans to any third party.
Taxpayers are also among those being short changed. According to Steve Middleton, director of Middleton Financial Solutions, an expert on banks’ complex financial plumbing: “Almost every time a bailed out bank sells a portfolio of under performing loans to Cerberus, it is the tax payer who is being robbed.”
Cerberus won the “Project Aran” portfolio in competition with rivals Lone Star and a consortium made up of CarVal Investors, Goldman Sachs’ and Apollo. It topped a week that Cerberus will have seen as triumphant. Last week the firm also secured the €1bn takeover of a portfolio of Danish non-performing loans – dubbed “Project Mermaid” – from Finansiel Stabilitet, the country’s “bad bank” as well as agreeing to pay Clydesdale £1.2bn for the “Henrico” assets.
In April, Cerberus acquired NAMA’s loan book of Northern Irish property loans, dubbed “Project Eagle”, paying around £1.2bn for the £4.5bn nominally-valued loan portfolio.
And in the course of some five transactions since 2011, Cerberus bought £2.6bn of distressed commercial property loans from Lloyds Banking Group. It paid a total of £1.8bn (implying an overall discount discount to the ‘par’ value of the loans concerned of 31%). Among these are loans issued by HBOS in its reckless and poorly-controlled heyday to Kevin McCabe’s Scarborough Development Group, which subsequently had been restructured into a new group called Valad, as well as loans to the Fairmont St Andrews Bay Hotel.
Some Cerberus executives are candid about their approach to former bank customers. Ranald Coggle, who runs Cerberus’s European operations, told the Cheshire-based hotelier Ross Finch, who appeared in a recent BBC Panorama documentary: “What you have to understand about me is I’m a prick”. In the same programme, Stephen Pegge, director of SME markets at Lloyds, said: “We check to make sure that these organisations are doing the job that they’re asked to do and that they do behave in a responsible way.”
In a recent BBC Panorama programme [available to watch on iPlayer until October 2015] a spokesman for Cerberus said: “We stand by our two-decade record of socially responsible and professional management of our business. Over that time we have successfully worked out the overwhelming majority of the loans we have purchased to the mutual satisfaction of borrower and lender.”
A spokesperson for Lloyds Banking Group said: “More than two-thirds of customers that go into our Business Support Unit are helped back onto a sounder financial footing and so far this year more than 1,000 business customers have been returned to our mainstream relationship teams. Where we have sold loans on to third parties, as part of the group’s efforts to strengthen its balance sheet and focus on its core clients, this is done under the terms agreed with the customer and signed by them when taking on the original loan.”
A spokeswoman for NAB said: “We understand that the announcement [of the Cerberus deal] may be unsettling for some borrowers. Our focus is on ensuring a smooth transition for our customers and we are working with the buyer on the legal and systems requirements to deliver this. The terms of the documents the customer has entered into with the bank will not change as part of this process.”
A spokesman for Cerberus said: “Our operating philosophy focuses on working with our borrowers to restructure loans as that is the way we obtain the most favorable outcomes for both our investors and the borrowers in the loan portfolios that we own.
“There are extensive checks and balances as part of our agreements with the sellers of loan portfolios. We honor all aspects of the loan agreements, and our goal is always to work with our borrowers to restructure loans as that is the way we obtain the most favorable outcomes for both our investors and the borrowers in the loan portfolios that we own.
“The terms and conditions of the loans remain unchanged, and Cerberus is committed to having excellent relationships with borrowers and to achieving mutually beneficial outcomes.”
Who are Cerberus Capital Management LLP?
Cerberus is a private equity firm founded by Stephen Feinberg (pictured left), 54, and other refugees from the New York-based junk bond outfit Drexel Burnham Lambert, which collapsed into bankruptcy in 1992. Named after the three-headed dog which guards the entrance to Hades, the underworld, in Greek myth – a connection Feinberg has since admitted he regrets – it has $25 billion under management.
Feinberg is obsessed with secrecy and does not brook egotists within the organisation. “We try to hide religiously,” he told Cerberus shareholders at an event in 2007, “If anyone at Cerberus has his picture in the paper and a picture of his apartment, we will do more than fire that person. We will kill him. The jail sentence will be worth it.”
Cerberus is so well connected with the United States Republican Party, it has the orthographically-challenged former US vice president Dan Quayle and former US Treasury secretary John Snow as co-chairmen. One of Cerberus’s European heads is Pieter Kortewig, a former treasurer general at the Netherlands finance ministry. The son of the former Spanish Prime Minister José María Aznar, José María Aznar Botella, has since 2012 been an adviser to an affiliate of Cerberus.
Cerberus has, or has had, a curious ragbag of companies in its portfolio, including the carmaker Chrysler – which it has since sold to Italy’s Fiat – GM’s finance arm GMAC, Vanguard Car Rental (owner of Alamo and National), gunmaker Remington (formerly known as Freedom Group) and British gambling and bingo company Gala Coral.
The Remington deal has proved particularly controversial. Even though Cerberus has signalled its intention to sell the gun manufacturer, it has so far failed to do so. In September last year Rabbi Andy Bachman turned up at Cerberus’s New York headquarters with a group of activists, and said “We ask you, Stephen Feinberg, we ask you today, what value do you really get from hundreds of millions in profits earned by the blood of innocents?” This followed the Sandy Hook massacre, in which 20 primary school children and six teaching staff were killed. Gunman Adam Lanza was firing one of Remington’s products, a Bushmaster XM-15 automatic rifle.
Feinberg’s enthusiasm for the distressed loan portfolios of British and European banks has been building since 2011. His firm sees value in so called “secondary” commercial properties such as shopping centres, hotels, pubs and industrial units based outside the main conurbations, in the belief such assets are due a major rebound in coming months and years.
What action can borrowers take?
Borrowers can take a number of steps to protect their position in circumstances where they are notified (or suspect) that their bank is intending to sell their loan to a third party. Lawyers Collyer Bristow provide six (full version here):-
1. Know your rights. Check your loan agreement/facility letter – can the bank sell the loan to a third party? Or are there restrictions/conditions the bank must comply with?
2. Can the benefit of any associated security or finance documents be transferred without the consent of the borrower or any guarantors?
3. Make sure that any ongoing disputes or agreements reached with the bank about amendments to terms on your facility, or waivers of the bank’s rights are recorded in writing.
4. What confidential information about your business has the bank disclosed to potential purchasers with the sale memorandum or in the data room? Does the loan agreement allow the bank to disclose such information?
5. Be vigilant. A bank planning a loan sale in the short to medium term may check in advance for terms which restrict its ability to do so and try to achieve (in the course of other discussions/restructuring) amendments to your facility terms to remove any restrictions or other clauses which might present obstacles to selling the loan.
6. Apply to Court for an order restraining the bank from selling your loan…. Injunctions can be a useful tool in these circumstances and in certain cases might lead to a negotiated deal but they must be approached with caution so that you have a full understanding of their pros and cons and of the other options that may be available to you.
An edited version of this article was published as the business focus in the Sunday Herald of 18 December 2014
Short URL: http://www.ianfraser.org/?p=10969