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How the Interest Rate Swap Saga Stifled the UK Property Market

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The interest rate swap mis selling fiasco has been making financial headlines for quite some time, however little has been said about the effect these financial products have had on the property market.

Originally interest rate swaps were marketed as low cost protection against rising interest rates, often as a condition of a business loan, but for property developers and landlords, the products were often a complete mismatch for their business.

Following the slashing of interest rates by the Bank of England in 2008 (which have remained low ever since), companies with an otherwise profitable business have found themselves swamped with massive fees, trapped in binding long term contracts that many see no way out of.

According to William Newsom (UK head of valuation at Savills Commercial) in an interview with The Telegraph last year, he estimates that more than 90% of bank lending secured against commercial investment property prior to 2009 was subject to an interest rate swap product.

Property owners and developers face penalties of up to 23% of their loan if they want to get out of these interest rate swap arrangements.

Landlords have seen their fortunes decimated by plunging asset values and the fees involved with cancelling swap products, meaning maintenance costs are proving harder and harder to meet, whilst further investment is a mere pipe dream for most.

The result is individual properties, high streets, retail and industrial parks that are falling into a sorry state of disrepair.

Similarly, property developers have not emerged unscathed. The success of property development is down to the quick turnaround of a project; developers will renovate a property and look to sell quickly using the profit to invest in the next project. A swap arrangement simply does not work with this business model, as the developer will be subject to significant break costs if the loan is terminated early, thereby wiping out any profit. Subsequent projects are stalled, if not halted permanently.

So with large swathes of the economy effectively financially crippled, and the property market stagnating, what's being done about it?

The FSA has set up a scheme to review and compensate customers of swap products by certain banks (Barclays, HSBC, Lloyds, RBS, Santander, Northern Bank, Co-operative Bank, Allied Irish Bank, Bank of Ireland and Clydesdale and Yorkshire Banks). However in order to be part of this scheme you must be classified as a non-sophisticated customer, that is, in the financial year during which the sale was concluded your company met at least two of the following criteria: a turnover of less than £6.5million / a balance sheet total of less than £3.26 million / fewer than 50 employees.

The scheme was supposed to be quick and easy to use. However it already appears to be running into difficulties, despite only being in the pilot stages. Not only is it behind schedule but customers have also been cynical of a scheme involving the banks, as they see them as the cause of the trouble to begin with. Other issues include customers being discouraged from having legal representation, despite the banks being heavily represented, not to mention a lack of transparency as customers are not allowed a copy of the banks' file of papers.

The delays are, in part, a result of the massive volumes of information to be reviewed (something that was seriously underestimated by the FSA). The cases are highly fact sensitive, which doesn't help to speed up proceedings. The manner in which the interest rate swaps were sold, the suitability of the product for customers' needs and the varying degrees of advisory information provided all need to be considered for each case, as well as the actual loss suffered by the customer.

To add fuel to the fire of the sceptics, even when the review has taken place no definition of redress is given. The process is consensual however the customer is very much in the hands of the bank.
Already disparities have arisen between the settlement expectations of the customer and what the banks want to offer. Negotiation or litigation remains an option should you wish to pursue it, provided it is within six years of the date the swap was entered into.

Only time will tell whether the FSA scheme will be a success and go some way to rectify the many wrongs of the interest rate swap mis selling saga, however, unless the scheme is conducted in a fair and efficient manner then it is unlikely to win the trust of customers and properly compensate them for their loss.