Another Southsea Bubble?
In 18th Century
Britain, speculation surrounding the stock of the Southsea Company
led to one of the earliest recorded economic bubbles and subsequent
crashes, causing financial ruin for many. The recent collapse of a
small local bank in Southsea has had ramifications for depositors,
borrowers and creditors alike.
The collapse tested new insolvency procedures created by the Banking Act 2009 and highlighted some interesting issues for restructuring and insolvency advisors. In a landmark case, bank liquidators were appointed in the first bank insolvency process in England. But the case really hit the headlines when the Government decided not to top up depositors with account balances over £85k, leaving a number of investors out of pocket.
Southsea Mortgage and Investment Co. Ltd was hit hard by the credit crisis and ensuing property crash. A small bank based on the South coast, Southsea worked to a traditional business model, taking deposits from local residents and lending to local property developers. They offered a higher rate of interest than mainstream banks, but charged higher than average interest on loans. The property crash led to substantial numbers of borrowers defaulting on payments and a significant diminution in the value of underlying property security.
After discussions with the Financial Services Authority (FSA), Southsea began to wind down its business operations. Initial projections indicated that the business was marginally solvent, but Southsea’s finances continued to deteriorate, and members of the Business Restructuring team from BDO were brought in by the Bank of England to advise and prepare for a potential insolvency.
The Banking Act 2009 created a framework to deal with distressed UK banks and building societies in the special resolution regime (SRR) which introduced the concepts of Bank Insolvency and Bank Administration Processes (commonly known, in the trade, as BIPs and BAPs).
The appointment of Malcolm Cohen and Mark Shaw from BDO as joint bank liquidators was the first of its kind under the SRR. Their objectives were twofold: (i) to ensure that each depositor had his/her account transferred to another financial institution or received payment from the Financial Services Compensation Scheme (FSCS); and (ii) to wind up the bank’s affairs in the best interest of the bank’s creditors. To ensure the stability of the UK banking system and protect depositors, the first objective takes precedence.
A Court application to place a bank into liquidation can only be made by the Bank of England (BofE), FSA or HM Treasury. This in itself throws up some challenges to directors and their advisors – at a time when the directors will be keen to demonstrate that they are proactively taking steps to act in the best interests of the bank and its creditors, they will continue to be responsible for the ongoing trading of the bank whilst the tripartite authorities consider whether to enact the SRR.
As soon as a bank liquidator is appointed, a Liquidation Committee comprising representatives from the BofE, FSA and FSCS is established. The Committee meets without the bank liquidator and recommends what objective should be pursued – to transfer depositor accounts to another financial institution or to ensure the depositor receives payment from the FSCS.
All banks maintain SCV (single customer view) files containing depositor and account information derived from the bank’s records. This data is used by the FSCS for the compensation process and, under new protocols, the bank liquidator must present the SCV to the FSCS within 72 hours of being appointed. Although the bank liquidator does not have to guarantee the content of the SCV, the file must be up to date. The ramifications of depositors being compensated for the wrong amounts – or not at all – are obvious.
In the case of Southsea, says Shane Crooks, director in the Business Restructuring department at BDO: “we were brought in to advise the Bank of England and FSA to prepare for potential insolvency under the SRR.
“We fielded a dedicated team of Restructuring and Forensic professionals to deal with the SCV process. This enabled us to rapidly understand how the SCV was created and what testing could be carried out to mitigate the risk of errors and/or inaccuracies. This strategy proved very successful, and we were able to prepare and submit the SCV to the FSCS on the first day of our appointment.”
Compensation cheques were sent to c80% of depositors the following day. In fact, many received notice of the liquidation and their compensation payment on the same date, and therefore experienced minimal distress.
The bank liquidation process as tested on Southsea was generally shown to be fit for purpose. However, it highlighted that contingency planning – key in any insolvency situation – is especially critical for the preparation of the SCV file given the time constraints surrounding the provision of this information and payment of compensation.
The failure of Southsea and the lack of top-ups to depositors with account balances exceeding £85k caused significant interest at a time when the Government is taking every step possible to demonstrate the stability of the UK banking system. It is interesting to speculate whether the Treasury has set a precedent in respect of top-up payments. And if a larger bank fails in the future, will the Government change its stance?
Many other small financial institutions could be in a similar position to Southsea – in the current financial market this may not be the last time that we see a BIP or a BAP!
