April 9, 2012 8:55 pm

RBS and Lloyds tackle legacy of bad debts

When Andy Cumming took over the management of Lloyds Banking Group’s restructuring unit in early 2009, he quickly became aware of the problems stemming from Lloyds’ financial crisis-induced shotgun marriage to HBOS.

“The situation was extremely tough in the early days, when the economy was at its worst. The bad loans were coming to us in a torrent,” he says. “We knew there were problems in HBOS, but with the economy hitting rock bottom, that multiplied the extent of the challenge ahead.”

Even after almost four years of emergency triage and staunching the bleeding from the bad debts at the combined group – with about 10,000 companies now restructured – Lloyds’ Business Support Unit holds about 14,000 loans with a face value of £67bn, much of it in the UK and Ireland.

The frail economic recovery and debts incurred before the financial crisis have continued to trip up UK companies, particularly in exposed industries such as real estate, retail and hospitality.

However, senior restructuring bankers argue that the worst is now behind them. They point to an overall operational improvement in the troubled companies in their impaired portfolios and the slowing drip of newly stricken companies entering their domain.

Although the total number of UK insolvencies edged up 4.2 per cent in 2011, the 5,300 corporate failures in the last three months of last year represented a 1.1 per cent year-on-year decrease.

Royal Bank of Scotland still holds £40.8bn of impaired loans. This is an increase from £38.5bn at the end of 2010 but Derek Sach, global head of restructuring at RBS, says the outlook for troubled companies under his supervision is improving.

The recovery is particularly sharp for larger companies, which have spent the past few years buttressing their balance sheets by retaining earnings, cutting costs and replacing shorter-term bank loans with bonds and other longer-term funding.

“The large UK companies are actually quite healthy,” says Mr Sach. “Even in the halcyon days there would be a FTSE 100 company we’d keep a watchful eye on, but these days there isn’t one that worries us.”

Nonetheless, it will take years for the two banks, which are partially owned by government, to shed the legacy of the pre-crisis lending binge.

In addition to RBS’s official £40.8bn of non-performing loans, Mr Sach looks after a larger portfolio of loans that are not impaired but could become so.

Mr Sach declines to give the overall figure, but RBS’s “non-core” bank which includes business units that the bank intends for disposal – such as aircraft leasing – holds assets of £94bn. That is down from £258bn in 2008.

Ireland remains the biggest headache. Bankers describe the scale of the real estate crash as a “generational problem” that could take decades to resolve. Almost 15 per cent of Irish homes are vacant, and Nama, the “bad bank” that took over Irish bank assets worth a nominal €72bn, has struggled to sell its domestic property and land assets.

Underlining the depth of the problem in Ireland, about 80 per cent of Lloyds’ wholesale, or corporate, loans in the country are impaired in some way.

“The Irish book is without doubt our biggest challenge and will take the longest time to resolve,” says Mr Cumming.

Mr Sach says: “Lending completely lost touch with reality in Ireland. It’s beyond my ken why many of these loans were even contemplated.”

Both banks are keen to stress that restructuring companies – although painful – can prevent many from going insolvent and therefore save jobs. RBS has already restructured 720 companies, which it estimates has saved or maintained 28,000 jobs. Lloyds says it has protected 250,000 jobs.

One of the tools, apart from simple debt reductions, lower interest rates or revised payment plans, is for banks to exchange their debt for equity in the company.

Lloyds holds equity stakes in just under 100 companies, while RBS holds 340 equity ownerships or stakes in its strategic investment group, run by John Davison, a former senior executive of private equity firm Bridgepoint. Aubrey Adams, former chief executive of real estate services provider Savills, came out of retirement to look after the property in RBS’s restructuring division.

“Debt-for-equity swaps are anathema to many banks, as they don’t want to actually run companies and they often do not reduce the debt enough for that reason,” says Mr Sach. “But I’m a great proponent.”

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