Wall Street comes to Watton


Paul Adcock: "It has torn the soul out of the business"

Last week I visited Paul Adcock, joint owner of Adcock & Sons, a small retailer of TVs, washing machines and other consumer electrical goods in the small market town of Watton in Norfolk.

Like many retailers, especially in sectors facing sharp competition from the internet, he is struggling. But he has very loyal customers, as I discovered when a posse of the over-60s turned up to give him moral support whilst I interviewed him.

Now, as you know, I can't visit every struggling small business in the UK. So what is special about Adcocks, other than that this is its centenary year?

Well one reason why Adcocks is in serious financial difficulties is that it is paying an interest rate of 9% on a commercial mortgage of approximately £900,000, generating a bill of just under £80,000 a year.

To keep up the payments, Mr Adcock has had to lay off staff. Tearful, he is not sure how much longer he can survive under the interest burden.

So at this time of record low interest rates, why is the long-established Adcocks paying 9% for a commercial mortgage fully secured by freehold properties?

'Betting' on interest rates

Well, the reason is that in early 2007 Paul Adcock entered into a complicated derivatives transaction, which has the daunting name of an asymmetric cap and collar, with Barclays' investment banking arm, Barclays Capital.

Start Quote

We forgot to put the interests of our customers first”

End Quote A bank boss

This version of what is called an interest-rate swap was in effect a bet that the Bank of England's official rate, Bank Rate, would not fall below 4.7%. Under the complicated terms of the derivatives contract, if Bank Rate falls below 4.7%, the interest rate gradually rises for Mr Adcock to a maximum of 6.25% - plus a margin of 2.75%.

Ever since 6 November 2008, when Bank Rate fell to 3%, Adcocks has been paying that 6.25% plus 2.75% - or 9% in total. His business has enjoyed none of the benefit of the record low interest rates engineered by the Bank of England specifically to help struggling businesses like Adcocks during the recession and the subsequent period of economic stagnation.

Bank Rate may have been at a record low 0.5% since 5 March 2009, but not for Adcocks.

In other words, Mr Adcock lost this bet. If he hadn't taken out the swap, he would currently be paying interest on his commercial mortgage of 3.25%.

Your instinct may be that if Mr Adcock gambled and lost, he should stop whingeing and pay up to the winner, Barclays. Caveat emptor, you may think.

However, Mr Adcock says that he didn't know he was making a big bet against interest rates falling.

What he thought he was doing was getting protection against Bank Rate rising above 6.75%, or getting a cap of 6.75% (plus that 2.75% margin) on the interest he would pay.

He says that the salesman from Barclays Capital described the putative protection on offer as "free", in the sense that no fee was being charged for the interest-rate cap. But, as Mr Adcock has now learned to his cost, there was a big contingent cost for him, in the form of the penalty interest rates he pays as Bank Rate falls.

It is unclear whether this contingent cost was explained to him. If it was, it is highly likely that he did not understand it, because I am not sure he properly understands it now.

Now at the time that the transaction took place, on 15 February 2007, Bank Rate was 5.25% - well below the 6.75% interest rate cap. So the interest rate would have had to rise a good deal for Mr Adcock to benefit from this ceiling. And, as it happens, the Bank Rate had not been as high as that since December 1998.

However, at the time the deal was done, Bank Rate was a fraction above the 4.7% "floor", below which the penalty interest rates became payable.

So as someone who has run a successful business for many years, why on earth did Mr Adcock agree to a deal which he now says he didn't understand?

Well he says that having banked with Barclays all his working life, he assumed the bank was serving his best interests (Adcocks has had a relationship with Barclays since his great grandfather founded the business in 1912, he adds).

Mr Adcock also felt grateful to the bank for expanding the size of his commercial mortgage when he refitted and refurbished the shop. He therefore felt under a moral obligation to do what he felt the bank wanted him to do.

Many complaints

I, of course, rang Barclays about all this.

It said: "Interest-rate risk management products were sold by Barclays to customers in accordance with the regulatory framework. Barclays is satisfied it provided sufficient information to enable clients to make an informed, commercial decision about the products it offers. Barclays has an ongoing dialogue with Mr Adcock. We continue to work with the company, utilising the expertise of our Business Support team to respond to the challenging market conditions faced by the retailing sector."

To be clear, Barclays is by no means the only bank facing complaints from smaller businesses that they were sold inappropriately complicated derivatives products, in the boom years before the 2007-8 financial crash.

I have been contacted by clients of HBSC, Royal Bank of Scotland and Lloyds who make similar complaints to those of Mr Adcock.

The important background is that the profit margin for banks on plain vanilla loans has been very low. So the banks did their best to sell customers additional products and services, to boost profits - of which the most scandalous manifestation was the PPI credit insurance that the banks mis-sold to millions of retail customers.

So is there another great mis-selling scandal brewing in the way that the banks encouraged small business customers to take these swaps? Could they end up paying billions of pounds in compensation, in the way they've been forced to do for PPI?

Anecdotal evidence suggests there is potentially quite a serious headache here for the banks - though my sources at the Financial Services Authority (FSA) do not currently believe that the scale of banks alleged misbehaviour will turn out to be as substantial as in the PPI case.

One important issue is that some of the affected businesses are too big to benefit from the strict regulatory constraints that apply when banks sell products and services to retail customers.

Mr Adcock, for example, tried to take his case to the Financial Ombudsman, but failed because he employs half a person more than then the 10-employee threshold for the Ombudsman to have jurisdiction.

Also hard data on the scale of banks' derivative transactions with smaller businesses is hard to establish. I am reliably told that for the market leader in small business banking, Royal Bank of Scotland, just 5000 customers have swaps, or just a fraction of its 1.2m small business clients. At Barclays, roughly 2000 small-business customers have been sold swaps.

If that pattern were replicated across the industry, the total number of businesses with a possible complaint would be less than 20,000.

That said, there could be many more possible complaints, if it turned out that many small businesses weren't told of massive cancellation costs relating to simpler deals where they fixed their interest rates.

'Not PPI again'

Some businesses which claim to be victims of derivatives mis-selling have sued their banks, and so far the banks have preferred to settle out of court than see a precedent set with a judgement.

In a way, this is a story of profound cultural change in the banking industry. During the last 15 years or so, big banks changed from businesses that prided themselves on the way they nurtured long-term relationships with customers and understood their needs, to businesses determined to generate as many transactions as possible.

The problem, as Mr Adcock's pain may indicate, is that the customers didn't always understand that the nature of their relationship with their bankers had changed.

This cultural revolution may have implications for what action the FSA ultimately takes.

The watchdog is very close to finishing a preliminary probe into sales of swaps by banks to small businesses. On the basis of what it has found from a detailed survey of banks' behaviour, it will then decide whether to launch a more aggressive investigation.

Such an investigation could end up with banks paying hundreds of millions of pounds in compensation. Alternatively - and from what I can gather, more probably - it might reveal that the FSA's regulations for these sales are inadequate and need toughening up.

The head of one bank said this to me: "This doesn't feel as big as PPI. But let's be clear, we all went slightly bonkers a few years ago selling products that our clients didn't really need. We forgot to put the interests of our customers first."

For more on swap sales to small businesses, see this Q&A.

Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 285.


    When - if so lucky - we make it to Equal Democracy:

    For every citizen, conscience & initiative will be liberated,

    Democratic eficiency of capital direction will be maximal.

    Socialists will hail their freedom as 'socialist',

    And capitalists will hail efficiency as 'capitalist'.

    Equal Democracy understood, agreed & enjoyed,

    Vanishingly few will wish return of Fear & Greed & Corruption.

  • rate this

    Comment number 284.

    '...he assumed the bank was serving his best interests...'

    Rules 1 to 1001: NEVER, EVER, TRUST A BANKER.

    These greedy money-grabbing thieves should be put out of business.

  • rate this

    Comment number 283.

    We need to start getting really tough with the people who run the banks.
    Selling a so-called product to a small business which results in it paying higher and higher rates of interest when interest rates fall is plainly ludicrous.
    I think society has lost patience with such spivs.

  • rate this

    Comment number 282.

    We have to carefully assess what is meant by 'moral hazard,' and decide accordingly. My leaning is towards the banks being held responsible, for the simple reason that they are a governance arm of society. They should feel the pain in order to grow into a responsible organisational element of society

    Frankly it's time for leadership here and I don't think democratically elected govts are up to it

  • rate this

    Comment number 281.

    Morgan Stanley estimates that the real level of the UK’s private debt to GDP ratio is 950%, 600% of which is in the banking sector. This is insane, and means the UK economy is doomed. Between 1989 and 2007, UK businesses tripled their indebtedness. With little or negative growth, it's hard to see an easy solution. It implies that when the debt slowdown finally hits, it will be very bad indeed.

  • rate this

    Comment number 280.

    "...The head of one bank said this to me..."We forgot to put the interests of our customers first."..."


    It's amazing how these little things can somehow slip the mind, isn't it?

    I'm sure it's a one-off, and utility companies, ISPs etc. are all working tirelessly to better our lives...

  • rate this

    Comment number 279.

    Max Keiser rightly attacks capitalism's dishonesty.
    But he is a Utopian Capitalist. For 'honest' capitalism distributes personal income and wealth unjustly (ie not equally). Socialism uses prices etc to decide what to produce and for whom but under an umbrella of EQUALITY, via constant redistribution.
    Socialism deals easily with the inherent drive to monopoly in modern firms. Capitalism desn't.

  • rate this

    Comment number 278.

    'Crashing' is not deflating an economy. Deflating is the opposite of inflating.

  • rate this

    Comment number 277.

    273 We should take the WHOLE finance industry into public ownership.

    Legal, court and public enquiry activity with respect to that shambles of an indusrty should FOLLOW the Act of De-privatisation (Public Ownership) Finance Industry, 2012.

    For there is a lot of stuff going down about finance industry dishonesty marring capitalism.
    But capitalism is just LEGALiSED theft.


  • rate this

    Comment number 276.

    We should organise our own swap . the inmates of Durham jail for the managers involved, at least you would know what you are dealing with and get a better service.
    Stories like this make my blood boil

  • rate this

    Comment number 275.

    If the commies queued for food, and the capitalists for tat, who're the fools?

    Well, at least the capitalists can choose whether or not to choose for their tat!

  • rate this

    Comment number 274.

    Paul Adcock [says it all] ,no doubt the banksters will help him sew them back on using a darning needle and strimmmer cable

    perhaps they needed his extraaa contribution for themasses

  • rate this

    Comment number 273.

    272 con

    So Barclays knew the Greenspan - King interest rate hikes were designed to deflate rapidly, ie crash, the 'over heating' in the US and UK economies.

    And so they sold swaps to mugs who didn't.

    Which is exactly what NY bank insiders did to London's RBS.

    Barclay's. King's plans. Insiders. Mmm.

  • rate this

    Comment number 272.

    Since the stock mazrket crash here in the late 80s (caused by realisation of what was being done to Japan) the standard 'authorities'' response to a credit crash is to flood markets with cash, driving interest rates down to zero.
    Paul's swap was agreed when BoE rates were still rising - King's hike in rates:


  • rate this

    Comment number 271.

    It doesn't matter who you are - shareholder, customer, whoever - you're just fodder for their greed. Their only regret is that got caught, when they do get caught.

    Tell them any old s**t, just as long as you get their money! That's the financial industry's notion of customer service.

  • rate this

    Comment number 270.

    > Adcocks has had a relationship with Barclays since his
    > great grandfather founded the business in 1912, he adds

    He can always get a job and work the debt off.

  • rate this

    Comment number 269.

    Customers are not “muppets” to use a GS term. They're SMEs encouraged by banks to use debt to grow. Hedging was typically made a loan pre-condition. A NatWest SME told me his RM said “it’s to protect you against rising rates which could expose you – but don’t worry I can sort it all out for you – we have experts in RBS Group (GBM) that can get best deals, Shall I fix a meeting?”

  • rate this

    Comment number 268.

    #146 Whirlygig - consumers of goods are protected by the trade descriptions act. If the trader is found guilty he can be prosecuted, which is exactly what needs to happen here.

  • rate this

    Comment number 267.

    Thomas Betham has missed the point. NONE of the SME's asked for interest rate protection. It was pushed at the behest of the bank. The
    SME's are the casualties of blind trust in their banks, not ill judged speculation !

  • rate this

    Comment number 266.

    #264 keith95 - the difference is they are not bailed out by the taxpayer. The banks are. The banks are on extremely shaky ground at the moment. We are keeping them afloat because we have to.

    Meanwhile the banks, essentially insolvent, are inventing profits, paying themselves huge bonuses, and on top are spiving businesses into risky borrowing plans.

    What happened to bankers you could trust?


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