The background to ‘The Alternative Remedies Package’ is well documented, in fact it could justify a book. After ‘Humpty fell off the Wall’ in 2008 and RBS had to be recapitalized by the UK Government to the tune of £45 billion, the European Commission ruled this was a form of ‘State Support’ and because RBS already had a high market share in the SME banking market, a package of ‘penalities’ was imposed to reduce their ‘unfair advantage’.

Initially they were instructed to ‘divest themselves’ of a large number of SME accounts. The decision was made to physically hive off a large number of SME accounts, and the bank staff that dealt with them, into a dormant bank they owned, Williams & Glyn. The first hurdle was renewing its banking licence (the banking equivalent of letting the MOT run out on your car). The second hurdle was attracting buyers for the resultant business, and the final straw was the inability to ‘decouple’ the IT system for this part of the bank, which killed any possible sale.

RBS then had no option but to agree to an imposed alternative – ‘The Alternative Remedies Package’.

This has two components:

A £425m ‘Capability and Innovation Fund’ which involves RBS having to ‘donate’ this sum for selected eligible organisations to  develop their capabilities to compete in the business banking market. Eligible organizations include challenger banks and so called ‘Fintech’ companies, developing business banking under the new ‘Open Banking’ regulations.

The second part, which affects customers directly, is the #Incentivised Switching Scheme (although it has become known as the #Business Banking Switch scheme). This is a bizarre scheme whereby eligible challenger banks (i.e. smaller competitors) are incentivised to take eligible SME customers from W&G by being paid – by RBS – what is effectively a ‘dowry’ which comes with the account.

A total pot of £225m has been put up by RBS to switch business current accounts – with another £50m to go with loan accounts. Plus there is a budget of £75m to cover the costs to customers of switching, for example if they have to pay for valuations for security or pay early redemption fees. So a total of £350m for RBS to effectively ‘Sell’ their SME customers (incidentally the definition of an SME for this purpose is a turnover of £25m or less)

Only a small number of banks can participate in this and they are going through an Application process.  Clydesdale and Santander appear to be ‘front runners’ both wanting to get involved in improving the practicalities of it to ensure that it goes as well as possible

It will be up to the ‘Receiving Banks’ to decide how to apply the ‘dowries’ that they get. Logically they will use a good part to incentivise the client moving by offering them discounts on loans, fees etc, but they are not compelled to.

The process is as follows:

• RBS have 18 months from the opening of the scheme to achieve what they have been set

• RBS have started contacting eligible customers to formally register their interest in switching. These are of course mainly the same customers who had a letter a couple of years ago saying that they were being ‘sold’ and nothing actually then happened – so they may not treat this too seriously. Also many of the letters went out as early as April 2018 – probably forgotten about now?

• A new RBS ‘microsite’ has been built for people to register on – and by 19^th December the banks participating will be agreed and announced.

• The website goes live for switching customers on 25^th Feb 2019 and it will show them what the offers are from the other banks (a sort of ‘compare the market’ in terms of what incentives are being offered)

The incentives for the current account alone are based on turnover – and are not to be sneezed at – a business with turnover of less than £15k will get £750 but one with turnover of over £7.5m will get £50k – and that is just for the current account. Of course this figure goes to the Receiving Bank and it isn’t known to what extent it will be passed onto the customer.

The dowry for Loan products is calculated as 2.5% of the loan amount. So a loan of say £100k would have a  dowry of £2.5k. A £1m loan (not unusual if a property was involved) would be £25k.

There is also provision for ‘Additional Payments’ which will go through an arbitration process – and cover one-off costs such as revaluations and break-costs (up to £10k per customers has been nominated for legal fees and £1,200 for property valuations – although this is unlikely to cover the actual costs of a valuation unless it is a ‘re-write’)

As well as the turnover criteria it will be ruled that any business will be excluded if it is in arrears or ‘in financial difficulty’ (although there appears to be no definition of that)

In total about 217,00 businesses are eligible for this and RBS have to ensure that a minimum of 120,00 business accounts go to ‘eligible challenger banks’.

It is not difficult to see some issues here:

• Firstly the businesses have to register – which they do through a site called www.businessbankingswitch.rbs.co.uk. Unless they register (when they then get a unique reference code) they will not get further details of the scheme when it goes live on 25^th

• Switching is not mandatory – they cannot be forced to go – but they will be incentivised to do so

• RBS only get recognition if the business transfers to one of the scheme approved banks – they will inevitably be smaller banks and a good sized company, with complex needs, might prefer to move to another large bank.

• The devil is in the detail – talking to one banker closely involved it seems that they are still tying to get basic questions answered about how this will work in practice – and the timescales are tight (offers will be on the website on 25^th Feb and no slippage has been allowed)

• A sudden interest from 200,000 businesses risks swamping a smaller bank. There’s talk of  ‘triage’ teams to decide who they deal with first.

• The new bank will be able to do its own risk assessment and decide if it wants the business and, most importantly, how much they are prepared to lend them and on what terms. They may not be able to replicate the RBS package that the client has (although in some cases they may do better)

• Commercial lawyers and property professionals (especially valuers) are already stretched – this could cause a surge in work loads

• Switching banks is very disruptive to businesses – hence the inertia that is always seen

• On-boarding such accounts is demanding – how will the receiving banks cope and get things right

There are opportunities here of course:

• For the receiving banks selected (decisions will be made as to who they are in December) they will have unfettered access to a chunk of businesses who are being encouraged to leave RBS, by RBS, and will have money to incentivise them. They could significantly grow their SME banking book in a way that would otherwise take years.

• The SME’s affected will be financially rewarded

• SME’s could see this as a way of escaping existing deals which might for example have breakage costs

• Professionals such as lawyers will see an increase of work in respect of legal activity

• SME’s should really seek help in assessing other banks schemes and getting support during the assessment and switching process.

Personally, I’m anticipating having to commit time in 2019 to a small number of SME’s who decide early on that they need to get outside help in:

1. Making an informed decision on whether to switch or not
2. Presenting the best case to a new banker to gain from any improved package that might be available
3. Maximising any payments that might be available – the obvious opportunity is for any RBS/W&G businesses that have SWAP or IRHP deals that they would like to get out of but where they can’t afford the breakage costs.

The first piece of advice is to ensure that any eligible businesses must register. It doesn’t commit them to anything but it does mean they are given the option and will be automatically involved in the next stage.

I was intrigued recently when the owner of a size-able business got in touch because he said he’d read a blog of mine from 2011 and that it was still the most helpful thing he could find on the internet about Mortgage Debentures. Flattering perhaps, but I’ve checked it and there isn’t much out there! He’d been asked to provide one for a business loan and was told it was ‘standard procedure’ but he was the sort who wanted to understand what he was signing.

Rather listen to this as a podcast?  Click below!

I also, coincidentally, met an accountant last week who said that he was concerned about how readily his clients signed these.

I hasten to add that I’m not saying that company directors should not signed these documents – in fact they probably wont get borrowing if they don’t – but I feel strongly that they should know what they are signing.

So…what is a Mortgage Debenture and what does it mean to provide this security to the bank (or any lender to the business)?

There was a time that a bank only asked for this security from a company with significant assets borrowing a size able amount. It wasn’t considered cost effective to do this for smaller loans/businesses because the cost of recovering assets if things go wrong was seen as prohibitive – it was also, understandably, cynically viewed that those assets wouldn’t still be there when it came to it.

But now it is standard for most loans, and that includes ‘peer to peer’ platform lending – and the increasing tendency for buy-to-let portfolio owners to borrow in the name of a limited company has raised its profile in that market too. For many B2L owners this could the first time they have encountered this form of security.

So.. A debenture is, in simple terms, a written agreement between a lender and a borrower which is filed at Companies House and gives the lender priority over other creditors in the event of the failure of the borrower.

The debenture document provides the lender with two types of legal charge.

•  The first is a ‘fixed charge’ which is a charge over a nominated asset of the business. That could be a property (which would be specifically scheduled in the document) but of most interest to a lender is a fixed charge over the company’s debtor book. They own the rights to the Company’s invoices. This is why companies that take up ‘Invoice Discounting’ packages find that they can run into conflict with their bank as the Invoice Discounting lender demands such a first charge and the bank will have to be prepared to give it priority, or cancel their debenture.

• The second form of charge that it provides to the bank is what’s called a ‘floating charge’ over all other assets the company might own – at any time. The ‘floating nature’ of the charge makes it a form of ‘umbrella’ security and the company can operate and trade these assets without the bank’s permission, but they will always be caught whilst the company owns them. This might apply for example with plant, equipment and vehicles – the company can sell them but the bank will automatically have a charge over any replacements.

However, the main reason that banks now take these charges as standard is the other rights that they provide – and key to this is the ‘step in rights’. This is not always well understood but it is crucial as it gives the bank the right to appoint a Receiver (where they can argue it is justified) who can enter the company’s business or property and take control of it – with the aim of disposing of assets to repay the bank debt (and that is really their main responsibility). At this point both forms of charges (the fixed and the floating charges) are said to have been ‘Crystallised’ and the Receiver becomes known as a ‘Fixed Charge Receiver’.

Another aspect of a debenture which is not well understood is that they are considered to cover ‘All Monies’ – not just the specific loan that the business took out – so they secure existing and future loan advances and also Overdrafts.

So, if a Mortgage Debenture gives such powers to a lender, why aren’t Company Directors more aware of what these charges can do and the risks they could create?

One simple answer to this is that ‘the Company’ is the entity providing the charge, so there is no requirement for a Director to take ‘Independent legal Advice’ from a solicitor. This would be insisted upon if they were giving a Personal Guarantee of course – the rules effectively treat this as them giving a charge over their personal assets. A Director can therefore just sign a Debenture with a Board Resolution and not have it explained to them at all. And, of course, they are legal forms which cover every eventuality and not a light bedtime read!

Another reason is they have become ‘the norm’ and if the company needs the loan then there seems little room for negotiation or discussion. So they just get signed.

However, and not many people know this – there is also an opportunity for Directors created by Mortgage Debentures:

Not many Directors are aware that they could take out a Mortgage Debenture on their own company when it owes them money – such as when they have provided a Directors Loan. A simple example would be where you voted to pay yourself a dividend, but you don’t draw those funds out. It is an interesting concept because it means that if the company is ‘wound up’ your loan takes priority over other creditors (including ‘preferential’ creditors). This assumes of course that you have not already given a debenture to another lender.

It also follows that if your company is a lender to another company – such as a debtor who is not paying on time – you could (with their agreement) take out a mortgage debenture over their assets to give you priority if they fail (although legal advice would need to be taken by all parties in this situation as just the act of giving the mortgage debenture could give the company involved a problem).

A final point: Please note that I’m not a lawyer, I’m just an experienced old banker, and none of the above is to be treated as legal advice or opinion. If anyone is in any doubt about the facts or any decision they are taking they should seek advice from a commercial lawyer.

We deal with the practical issues and help in understanding bank security packages and where necessary support Directors in negotiations with banks.

Please feel free to ask us for help – email on steveleverton@cornmillassociates.co.uk

We often have clients – usually property developers – who want to borrow to buy a piece of land which is just a plot, i.e there are no buildings on it. Sometimes it will have a planning consent which might be suitable for what the developer wants to use it for, or sometimes the consent needs to be altered for another use or an improved scheme.

This situation narrows down the lenders that will have an appetite to provide a loan without additional ‘make-weight’ security. Clients find that frustrating as they usually believe the purchase price reflects the true value and the land represents sound security.

So why is this?

•  Firstly, the value is usually attributable to the planning consent. If it doesn’t have any consent but the buyer is confident and skilled at obtaining planning then there could be some ‘hope value’ in the purchase price. Lenders don’t lend against that and will rigidly stick to what their valuers state is the current value ‘as is’

•  Lenders are always mindful of what situation they would be in if they had to take possession of the asset they are lending against. They are not planning consultants and know that if they end up having to manage the asset they face the challenge of following through to get planning agreed or amended, which is not their skill set

• If they do have to take possession and force a sale of the site, they face a hostile market for buyers. There is of course naturally a narrower market for land plots (as opposed to selling bricks and mortar) which will restrict the sale options. They also know that savvy buyers of land will realise the situation that they are in and drive a very hard bargain

The result is that there is a limited market for lending against land alone. Developers therefore may find that they must use bridging finance (some bridging lenders take the view that if it has a Title Number they can lend against it) then complete the planning and then refinance with a lender who will recognise the ‘Planning Gain’

With a third of the MPC having voted for an interest rate rise yesterday (21^st June) the prospects of the cost of funds for SME’s rising this year are increasing.

An interesting article in ‘Accountancy Age’ last month drew attention to the serious impact that this could have on the UK’s mainstay businesses, with additional costs of £355m (in one year) coming from just an increase in base rate of 0.25%.

It is difficult for a business owner to relate to this figure but not tricky to work out that with many businesses working on narrowing margins, and many still relatively highly geared, this will be painful. The graph alone illustrates what a unique period we have come through.

It’s a concerning fact that 5 years ago as much as 50% of SME lending was on fixed rates or ‘hedged’ (a form of insurance protection against rate rises) but this is said to have now reduced to 11%. This means that significantly more businesses will bear the costs of this inevitable event.

The reasons for this appear clear:

• It’s human nature to focus more on ‘insurances’ of any kind once an event becomes prevalent – so you put in security cameras and beef up your home insurances only after a spate of burglaries in your road.

• An extraordinary 10 years of static and low interest rates means this has not appeared priority in a business owners in-tray. Indeed, in many cases (given the life-cycle of businesses) many have never known anything else and don’t have painful experiences to recall.

• The scandals associated with the sale of ‘SWAP’s’ (by the main High Street banks) to SME’s has hurt the banks and destroyed the credibility of these products in the eyes of borrowers. Perceptions would make it hard for a bank to promote this option to SME’s where it has been proven to represent a reputation risk to the bank (it remains a credible option for bespoke, high value packages for Corporates with Treasury functions). It would be a bit like a retail bank going back to selling PPI.

• SME’s have very little if any access to advice on this. Trust in the banks will be thin at best, Accountants are not the best to advise on this (the article in their trade magazine seemed like an attempt to just gain their interest) and specialist advisers in this area tend to be ‘City based’ and focus on the legalities of contracts, with perceptions that they are very expensive.

• If there was a shortage of advice ‘Pre-SWAP-gate’ there will be even fewer now – who is going to stick their neck out on this subject?

• Banks recent pricing of fixed rate products hasn’t created the incentive for SME’s to take up a fixed rate, either by alarming them with the bank’s opinion of where rates are going or by offering them an incentive for their perception that locking into a fixed rate could now be seen as a risky venture.

• Most significantly many banks (particularly the recent entrants to SME lending) are not even offering fixed rates. They find it as difficult as any to predict rates and formulate pricing and would prefer not to carry the risk on their own book. Instead they have a policy of lending and giving the client the option to take out a hedging product with a third party.

The impact of this is that SME’s are exposed to the risk themselves and will carry the inevitable costs. This will of course have a knock-on effect on the banks’ risk – they are only as good as their borrowers. So are the banks ‘shooting themselves in the foot’ by not being more bold or assertive in this area?  Yet again we have a gap in the market for financial products for SME’s due to policy changes by lenders, which requires a careful approach from, and towards, those that may seek to fill it.