The dog that eats up debt

A spate of such deals has occurred in recent days. Clydesdale Bank sold a £1.2 billion portfolio of such loans, dubbed "Project Henrico" on Monday; on Tuesday morning, RBS announced it had cemented a deal to offload a £4.8bn portfolio of Irish loans originally issued by Ulster Bank, dubbed "Project Aran".

The bundled-up loans generally originated in a period of manic over-lending and banker recklessness in the build-up to the 2008 global financial crisis, though most of the loans are likely to have been heavily restructured over the past six years.

The buyer of both the Project Henrico and Project Aran books is New York-based hedge fund/private equity firm hybrid, Cerberus Capital Management - named after the three-headed dog which in Greek and Roman mythology guards the entrance of the underworld, Hades.

Cerberus purchased the portfolios using "special purpose vehicles" (SPVs) registered in the Netherlands for tax-avoidance purposes. These SPVs always contain the words Promonotria Holding, followed by additional names and numbers and the initials BV.

Other US-based private equity firms seeking to profit by taking on parcels of debt from troubled European banks include Apollo, Oaktree, Lone Star and Blackstone.

Deals along these lines are being celebrated as a good thing by investment analysts, the UK Government - which still owns 25% of Lloyds and 81% of RBS - and by banking regulators, not least because they are seen as boosting the Government's chances of selling off tranches of its equity in the banks to private investors. In the case of Clydesdale, the recent Henrico deal is also seen as boosting the chances that National Australia bank will be able to offload Clydesdale either via a trade sale or a stock-market flotation within coming months.

The deals also give the banks a greater chance of sailing through the increasingly onerous stress tests being set by the Prudential Regulation of the Bank of England, under which they must prove their ability to survive a severe economic downturn without further recourse to taxpayer bailouts. Last week, Lloyds and RBS only narrowly passed such tests, while the Co-operative, which received no direct taxpayer support but has recently seen other troubles, failed.

The process of banks offloading unwanted customers in this way is gathering momentum. So far this year, European banks have offloaded €54.9bn (about £42.9bn) worth of European commercial real estate loans in such ways - more than in 2012 and 2013 combined, according to figures released by the property consultant Cushman & Wakefield.

But the deals, which see loan books being offloaded at discounts ranging from 30% to 75% of nominal face value, are not all good news. If vulture funds believe they can handsomely profit from such deals, isn't someone else being short-changed? Would the banks not have been better to hang on to these loan books themselves? And what do such deals actually mean for customers - the borrowers whose loans are traded like bags of flour, sometimes without their knowledge or consent?

The majority of the UK businesses that are having their loans reassigned to private equity owners are commercial real estate companies and property developers, but there are also significant numbers of non-property SMEs and other borrowers as well.

Many of these firms have been living in a state of financial purgatory since the crisis, forced to jump through a string of hoops set by bank managers who changed from being eager cheerleaders to vindictive Mafiosi, seemingly intent on punishing and humiliating them at will (for example, by forcing them to pay tens of thousands for "Independent Business Reviews" or by ratcheting up rates and charges, and imposing often clueless consultants on their firms).

Stephen Rosen, partner at London-based lawyers Collyer Bristow, said the sale by banks of customer loans to groups such Cerberus without the customers' consent "is an extraordinarily serious development both for customers and customer-bank relationship".

He said: "Customers, often small businesses, find themselves hamstrung by legal documents signed many years ago, which almost always places the power in the hands of the bank to transfer the debt to a third party without the customer's agreement, and without even informing them until the transfer has taken place."

Rosen added that in many cases the business people concerned will have been forced over the past six years to throw in extra cash at the bank's behest to keep projects and businesses afloat. "That investment may well be lost if their loan is purchased by a fund intent on enforcement action," which can include administrations and repossessions."

Many of the businesses subjected to such transfers blame their banks for their financial plight. This may be because the bank missold them an interest rate swap which has crippled their business and forced them into a default situation. In certain cases, the banks may also have "artificially" distressed business borrowers in ways described by Government adviser Lawrence Tomlinson in his bombshell November 2013 report - for example, by ascribing false valuations to their ­commercial property assets, designed to put customers in breach of loan-to-value agreements.

Kalvin Chapman of Manchester-based law firm Berg said: "In cases we are aware of, Cerberus has given business owners a month to provide a solution to repay 100% of the debt plus costs or face administration.

"We even had one client who found out that their hotel was actively going to be marketed before they had even been told about the administration. Their hotel was already online."

Affected businesses allege that vulture funds are even more brutal and uncaring with borrowers than the banks' now notorious recovery and restructuring units - RBS's Global Restructuring Group and Lloyds's Business Support Unit. Rosen warns they have fewer scruples about repossessing properties.

Janine Alexander, a partner at Collyer Bristow, said: "RBS is essentially throwing customers to the wolves."

Another source with experience of the distressed debt market said: "The only people who are profiting are Cerberus. Everybody else loses. The real scandal here is an abuse of power. A lot of the distressed debt that's being handed over to these guys is only distressed thanks to the activities of the banks. It often seems the bank's real motive is to clear out anyone who might complain."

John Glare, founder of the NAB Customer Action Group, warned Cerberus that if it "starts to apply pressure on the customers whose loans it has taken over before any attempt by NAB to float Clydesdale and Yorkshire, this is going to erupt". He added: "At the very least we will be seeking to ensure that the conditions that applied under Clydesdale's ownership carry through under Cerberus's ownership."

At least one sizeable Northern Irish business has slapped an injunction on Ulster Bank, barring it from transferring its loans to Cerberus as part of "Project Achill", a smaller tranche of Ulster Bank loans acquired by Cerberus, via the High Court in Belfast. However, businesses that tried to do the same in the Irish Republic were less successful. On December 9, companies controlled by brothers Michael and Richard Larkin failed in their attempt to get an injunction preventing Ulster Bank from transferring some €89 million of their companies' loans to any third party.

However, it is not just customers who are suffering - taxpayers are too. According to Steve Middleton, director of Middleton Financial Solutions, an expert on banks' complex financial plumbing: "Almost every time a bailed-out bank sells a portfolio of under-performing loans to Cerberus, it is the taxpayer who is effectively being robbed."

Cerberus won the Project Aran portfolio in competition with rivals Lone Star and a consortium made up of CarVal Investors, Goldman Sachs and Apollo. It topped a week that Cerberus will have seen as triumphant. Last week the firm also secured the €1bn takeover of a portfolio of Danish non-performing loans - dubbed "Project Mermaid" - from Finansiel Stabilitet, the country's "bad bank", as well as agreeing to pay Clydesdale £1.2bn for the Project Henrico assets.

In April, Cerberus acquired Nama's loan book of Northern Irish property loans, dubbed "Project Eagle", paying around £1.2bn for the £4.5bn nominally valued loan portfolio.

And in the course of some five transactions since 2011, Cerberus has bought £2.6bn of distressed commercial property loans from Lloyds Banking Group. It paid a total of £1.8bn (implying a 31% discount to the "par" value of the loans concerned). Among these are loans issued by HBOS in its reckless and poorly controlled heyday to Kevin McCabe's Scarborough Development Group, which subsequently had been restructured into a new group called Valad, as well as loans to the Fairmont St Andrews Bay Hotel.

In a BBC Panorama programme, a spokesman for Cerberus said: "We stand by our two-decade record of socially responsible and professional management of our business. Over that time we have successfully worked out the overwhelming majority of the loans we have purchased to the mutual satisfaction of borrower and lender."

A spokesperson for Lloyds Banking Group said: "More than two-thirds of customers that go into our Business Support Unit are helped back onto a sounder fi­nancial footing and so far this year more than 1,000 business customers have been returned to our mainstream relationship teams.

"Where we have sold loans on to third parties, as part of the group's efforts to strengthen its balance sheet and focus on its core clients, this is done under the terms agreed with the customer and signed by them when taking on the original loan."

A spokeswoman for NAB said: "We understand that the announcement [of the Cerberus deal] may be unsettling for some borrowers. Our focus is on ensuring a smooth transition for our customers and we are working with the buyer on the legal and systems requirements to deliver this.

"The terms of the documents the customer has entered into with the bank will not change as part of this process."

A spokesman for Cerberus said: "Our operating philosophy focuses on working with our borrowers to restructure loans as that is the way we obtain the most favorable outcomes for both our investors and the borrowers in the loan portfolios that we own.

"There are extensive checks and balances as part of our agreements with the sellers of loan portfolios. We honor all aspects of the loan agreements, and our goal is always to work with our borrowers to restructure loans as that is the way we obtain the most favorable outcomes for both our investors and the borrowers in the loan portfolios that we own.

"The terms and conditions of the loans remain unchanged, and Cerberus is committed to having excellent relationships with borrowers and to achieving mutually beneficial outcomes."