November 2009

During the last two years, banking and mortgage lending litigation has increased considerably, after a rather quiet few years. I believe that this is set to increase further as the effects of the Crash work their way through the legal system. 

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. 

Does the growth indicate that some lenders might have been so keen to lend that they deliberately relaxed their requirements and procedures so as to compete? Possibly; but as volumes have increased the quality of their ‘due diligence’ might have reduced. This was not deliberate but there are only so many experienced lenders, and recruitment and training do not always keep pace with the volume of lending applications. 

Lenders will also claim that as business has grown, their reliance on third party professional advisers has increased and that they too might have been under pressure and therefore more likely to make mistakes and give negligent advice. 

Disputes arise in many areas of banking operations but over the years by far the largest categories for me, as a lending expert, have involved commercial property, followed by residential. I believe that this is because commercial property is one of the most cyclical elements in the economy, where fortunes can be made in the good times but easily lost in the bad. Borrowing to finance property development and purchase is an essential element of the industry as it vastly improves the return on capital. However, ‘levereage’ can be disastrous when boom turns to bust. We have seen it all before: it seems impossible to break the cycle.

Due to their committed obligations, banks are often locked into transactions even though the more sophisticated ones might see the warning signs of future trouble, and pause (while others carry on regardless). The collapse in confidence in the commercial property market in 1989 did not mean that banks stopped agreeing property loans. In fact, that did not happen until September 1990. Furthermore, the momentum of previously committed loans meant that lending continued to increase until May 1991, the outstanding amounts peaking then at £41 billion, having risen from £8 billion in 1986 – a five fold increase in 5 years. 

Clearing up after the 1991 property crash, which affected both the commercial and residential sectors, took many years to complete and was painful for the banks, which suffered large losses. This of course 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 2000s 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. 

Echoing times past, the UK Property Capital Values Index 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 have been further reductions in value during 2009 but at a very much slower rate and due more to reduced rentals than increased yields, and it is believed that the worst is over. Bank lending to the commercial property sector was at the same level at the end of October 09 as it was at the end of 2008. 

In the residential sector, the developers have reported large losses as demand has slowed to near standstill. UK house prices have fallen by between 15 and 20% since their peak in Autumn 2007/Spring 2008, given the shortage of credit and the thought of higher unemployment. Although there has been a slight stimulus in recent months, the market is expected to worsen in 2010 with the prospect and implementation of new government measures to tackle the deficit. Recovery is not expected until 2012.

Inevitably the banks and building societies will be showing large losses on their property backed loans and likely to be looking for someone to blame. 

ROBIN BRYANT