Review September 2018
Continuing work for the expert banking witness
During the last seven years, banking and mortgage lending litigation has increased considerably, although of late it has tailed off, due to the settlement of claims arising from the last property crash in 2008/9.
Prior to 2007 there had been a huge growth in lending generally but particularly in the personal and property sectors. Such growth could not be sustained, but few expected the downturn to be so severe: I return to this theme in my final paragraph.
Such rapid growth could indicate that some lenders might have been so keen to lend that they deliberately relaxed their credit checks and procedures. Also, as volumes increased, the quality of their 'due diligence' might have inadvertently been compromised. Recruitment and training do not always keep pace with the volume of lending applications: overstretched and badly trained staff make mistakes. So, losses were sustained partly because lenders relaxed their lending policies and partly because some lenders failed to adhere even to their revised policies but also because of the property crash.
Lenders will also claim that as their business grew, reliance on third party professional advisers increased and that some of their advisers were under pressure to cut corners, making mistakes and giving negligent advice in the process.
Disputes arise in many areas of banking operations but over the years the largest category for me, as a lending expert, has involved commercial and residential property. The commercial property sector is one of the most cyclical elements in the economy, where fortunes can be made in good times but easily lost in bad. Borrowing to finance property purchase and development is an essential element of the industry as it vastly improves the return on capital. Leverage (gearing) can be disastrous when boom turns to bust. We have been here before, in the property crashes of 1973 and 1990: it seems impossible to break the 17 year cycle, however much one Chancellor thought he had forever rid us of 'boom and bust'.
Clearing up after the 1990 property crash, which affected both the commercial and residential sectors, took many years to complete and was painful for the banks, many of whom suffered large losses. This gave rise to a dramatic increase in banking litigation during the 1990s. Confidence did not return until the late 1990s. Commercial property lending was still at the 1991 level in 1999 and the next decade opened with bank lending to the commercial property sector at £47 billion. It then rose to £251 billion by the end of 2008 – over 5 times greater.
The residential sector saw a boom too, driven by very competitive lending by building societies and, more especially, centralised lenders. This fuelled house price rises; by 235% during the same eight year period when inflation generally was quite low. The lenders have made claims against valuers and solicitors for bad advice and the professionals have pleaded contributory negligence.
Echoing times past, the UK Property Capital Values Index for commercial property dropped 38% between June 2007 and the end of 2008, as yields increased thereby reducing capitalisation rates. By contrast, bank lending to the commercial property sector increased by 27% p.a. There were further reductions in values during 2009 but commercial property values stopped falling at the end of 2009 and a reversal was seen. However, the recovery stalled completely in 2011 before picking up.
In the residential sector, the developers have reported large losses as demand has slowed to near standstill with mortgage lenders demanding much higher deposits. UK house prices at one point had fallen 19% from their peak in Quarter 3 of 2007. The recovery has been uneven and average UK prices recovered to their 2007 peak only in Q3 2014. Prices are now well above the low point in Q1 2009. Those borrowers not tied to higher fixed rates have benefited from very low interest charges: the Bank of England Official Rate has been down at 0.5% for seven years.
In the downturn it has been possible for banks to stave off selling and realising losses on their commercial property lending while funding costs have been so low. This has not been my experience with residential mortgage lending where many transactions have given rise to litigation. As householders and buy to let investors have defaulted, the properties have been sold - in a poor market - and losses have been realised and proceedings brought against solicitors or valuers, or both.
By way of a historical note, Lehman Brothers, the US's 4th largest investment bank, filed for bankruptcy ten years ago this month. This had far reaching consequencies but it was due to the creation of a large number of high risk mortgage loans in the US, generated with low initial interest rates to people who could not afford to service them when borrowing rates were increased to market levels. US investment banks and others bundled up such loans (called securitisation) and sold them off, assisted by the rating agencies which gave them their seal of approval. Such securities were sold around the world to commercial banks and other institutions. The effect was that nobody knew where this 'toxic debt' was held. Consequently, banks were loathe to lend to each other and without this market function they could not operate without government support. This led to the fall in property values and a significant amount of banking litigation.