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Traditionally banks accept deposits and make loans. The risk of the latter going wrong — called credit risk — is borne by the bank and its shareholders. Assessing this is a key skill for bankers.
They do not have to try so hard when the government guarantees the loans they make, usually at times of economic stress. The state would be on the hook for the loan if the borrower defaults. Its typical aim is to support businesses the crisis might otherwise destroy.
During the coronavirus pandemic, the UK government underwrote some £77bn of loans to keep a lid on bankruptcies and unemployment. News arrived this week from the British Business Bank, which administers the guarantees, that about £1bn of loans are no longer eligible for government support. Banks will have to accept responsibility for any losses.
Guarantees came via three schemes targeting businesses of various sizes. The most controversial was the Bounce Back Loans Scheme, supporting small and medium-sized businesses. BBLS was also the largest scheme with around £47bn of loans made. The usual affordability and credit checks for the loans were overlooked in favour of getting the money out quickly.
The BBB said that most of the voided guarantees related to loans made under the BBLS. It cited failings like duplicate loans, errors in applications and infringements on scheme rules.
The scheme remains in the line of fire because of the ease with which fraudsters were able to access funds. Officially, some £1.6bn of loans have been flagged as potentially fraudulent. Other estimates suggest the final figure could rise to as much as £5bn, or a tenth of all BBLS loans.
When the loan scheme was announced, Lex highlighted its vulnerability to fraud. But we saw this as a price worth paying for supporting a majority of honest borrowers in a crisis. Subsequent criticisms have been made from the comforting security of a world where coronavirus is under control.
Total losses on BBLS are about £7bn. This does not include losses from potential frauds. A further £4bn are in some way distressed and likely to lead to guarantee claims.
Shareholders still face their own pandemic aftershocks as deadlines for central bank funding loom. In order to support emergency lending schemes, the Bank of England created the tongue-twisting Term Funding Scheme with additional incentives for SMEs (TFSME). This supplied commercial banks with ultra low-cost money they could then lend. UK banks borrowed £175bn from the facility at a four-year term. Repayments are due to begin next year.
That is already distorting behaviour. Banks are hungry for deposits to make up for an imminent funding shortfall. That is pushing up deposit rates and eating into profitability.
NatWest reported that deposit rates rose by 70 basis points at third-quarter results last week. The hit to net interest margins might mean profits are 15 per cent lower than previously expected next year. For every 10bp increase in deposit rates, sector profits fall by £1bn or 5 per cent, estimates Jonathan Pierce, an analyst at Numis.
That is good for you if you are a depositor, bad for you if you are an investor and might just about even out if you are both.
Bankruptcy: grave-dancing bankers and lawyers gird for fee bonanza
The only investment bankers getting fees these days are the ones that chief executives never want to see; those who turn up after things have gone wrong. This week, US boutique bank PJT Partners reported that its group revenues were up 11 per cent for the first nine months of the year. The growth came even as two of its key businesses, conventional M&A advice and private equity fundraising, have dipped sharply, the latter by a whopping 50 per cent.
Shareholders should thank PJT’s restructuring group. This works with companies that have run out of money or are about to do so. Corporate creditors are also clients. Recent situations PJT has been involved with include WeWork, Carvana and Revlon.
PJT does not break out restructuring-based revenue but said overall deal advisory fees were up by 24 per cent, even as the M&A portion declined. One rival, Houlihan Lokey, reported restructuring revenue up 17 per cent for the most recent quarter.
Fees charged by restructuring bankers and lawyers have exploded just as corporate borrowing costs have spiked and liquidity has evaporated. For the handful of advisers that specialise in busted companies, the bonanza will be significant at a time when merger and IPO specialists are largely idle.
The messy bankruptcy of cosmetics group Revlon produced roughly $250mn in professional fees for a 10-month assignment. That shocked even jaded industry observers. PJT, according to court filings, billed $26.9mn to the company as its investment banker. Revlon’s law firm, Paul Weiss, billed nearly $60mn, with partners charging more than $2,000 per hour for their efforts.
PJT, however, only had a core team of a dozen or so on the case, unlike the multiples of that figure among the lawyers. PJT was paid monthly retainer fees, fees for arranging exit financing and then a final $15mn “success” fee.
Financial sponsors and hedge funds active in distressed debt have sounded alarms about so-called “fee creep”. There are many reasons a company should avoid bankruptcy. The eye-watering cost is high up that list.
The articles above are edited versions of pieces appearing in Lex, the FT’s flagship daily investment column.