Lenders Seen Facing $15.6 Billion in U.K. Real Estate Swap Bills

Lenders may have to pay as much as 10 billion pounds ($15.6 billion) to settle claims they mis-sold U.K. interest-rate contracts linked to commercial real estate.

Borrowers may receive compensation or preferential loan conditions valued at 5 billion pounds to 10 billion pounds from lenders after the cost of breaking the swaps spiraled when the Bank of England cut its benchmark rate, Broker DTZ said in a report today.

“Swaps have become one of the biggest impediments for investors to constructively refinance or restructure their legacy loans,” Hans Vrensen, DTZ’s global head of research, wrote in the report. When property values fell, the real estate wasn’t worth enough to pay both the swap and the mortgage, meaning borrowers couldn’t refinance or restructure their borrowings, according to the report.

U.K. borrowers used swap contracts to manage the risk of interest-rate increases on the floating-rate market. Before the U.K. real estate crash in 2007, borrowers took out swap contracts of as much as 30 years with five-year commercial property loans. When the Bank of England cut its benchmark rate to 0.5 percent from 4.75 percent, the penalty for breaking the swaps jumped.

Under the contracts, when rates fall, customers may have to pay higher costs to keep payments within the agreed upon range. Borrowers that exit contracts through default or loan repayment are liable for costs running the length of the agreement.

Nearly 70 borrowers have already settled their claims over swaps out of court, DTZ said, citing data compiled by Vedanta Hedging Ltd. The average settlement has been the equivalent of 18 percent of the notional swap amount, according to DTZ.

To contact the reporter on this story: Neil Callanan in London at ncallanan@bloomberg.net.

To contact the editor responsible for this story: Andrew Blackman at ablackman@bloomberg.net.

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