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Rebuilding to order?

20 October 08

Contributions on the future for the property market and financial services in Scotland, the cause of the credit crunch, and the legal market in the USA

by Kyle Peddie, Donald Amstad, Owen Kelly, Iain MacSween

It really is hard to believe that only just over a year has passed since the collapse of Northern Rock, such is the extent of the financial crisis that now grips not just the UK and the US but much of the global economy. Who could have foreseen the issues that have affected such illustrious names as HBOS, RBS, Bradford & Bingley, Lehman Brothers, Merrill Lynch, Morgan Stanley, Washington Mutual, AIG, Fortis, Wachovia and others during that relatively short period of time?

The resulting effect on the residential property market in the UK has been devastating, with house prices falling and residential property transactions all but grinding to a halt. The latest figures from the Bank of England show that new mortgage approvals for August 2008 were at a new record low, and 70% fewer than a year ago. Housebuyers may have been put off buying properties because of the continued fall in house prices and widespread predictions of an imminent recession, and many of those that do want to buy can’t secure the necessary loan finance.

Earlier this year many of those involved in the residential property market in Scotland had mistakenly assumed that we were to a large extent immune to the difficulties that were then being faced by our colleagues south of the border, whereas in fact, as is historically nearly always the case with property related trends in the UK, the impact in Scotland was merely delayed. We are now facing the full brunt of the financial crisis in Scotland and the number of resulting job losses in the property sector across the country is increasing on a daily basis.

Long convalescence

Unfortunately, the general feeling amongst those with knowledge of the financial markets is that it will be at least 18 months to two years before there is any sign of a recovery in the residential property market in the UK, and even then it will be slow. The fundamental cause of the problem – over-inflated property values – is still rectifying itself and that’s going to take a long time, and even as banks are saved from going bust, the availability of credit will be far lower than in the good old days of the boom times, which will never return. Added to this we have to consider the controversial introduction of home reports in December, which will inevitably have an adverse effect on what is already a precarious residential property market in Scotland.

Historically, conveyancing solicitors in Scotland have enjoyed an advantage over their English counterparts, due to the fact that in the majority of cases they generated most if not all of their conveyancing work from their own estate agency operations, whereas south of the border, most conveyancers were reliant on their work coming from mortgage brokers, lenders, non-solicitor estate agents and other third parties. This is all very well in an active property market, but the fact is that estate agencies are extremely expensive to operate, relying as they do to a large extent on people, which is generally the largest expense on the books of any business.

What solicitor estate agents are now finding is that they are carrying greater stocks of property than ever before, which are taking much longer to sell and which require even more people to service them, and on top of this they have also to maintain conveyancing departments which in turn are suffering from the lack of sales coming through from the estate agency department. Carrying all of this expense with little or no revenue from either estate agency commissions or conveyancing fees is putting solicitor estate agents under severe pressure.

Money will talk

Ironically, although many financial institutions are also under severe pressure, what is happening in the property sector is actually strengthening their potential control over the conveyancing market, and also enabling them to influence property prices by selectively limiting the availability of funding and on occasion determining the criteria upon which property valuations should be based.

With credit issues currently having such an adverse effect on the availability of mortgages, first time buyers and potential sellers, who historically would have placed their property on the market with a solicitor estate agent secure in the knowledge that getting a mortgage wouldn’t be a problem, are now going to their lender or to a mortgage broker in the first instance to ensure that they will get a mortgage for their proposed purchase.

Although similar credit conditions were encountered in the early 1980s, the landscape is now entirely different. At that time, potential buyers and sellers generally went to solicitors first because most lending was sanctioned at local branch level and solicitors were perceived as being able to influence the availability of mortgage funds through local client deposits etc. Now lending is centrally controlled, generally south of the border, and subject to more stringent criteria. The fact is that lenders will effectively have even greater influence over a buyer who is desperate to secure mortgage funding, and will seek to offer conveyancing services to them, either on a “fees free” or subsidised basis, through panel-appointed conveyancers. Some lenders had already successfully trialled such products pre-“Rock”. The interesting question is, could they also seek to offer estate agency services to them through a panel of appointed estate agents or solicitor estate agents?

High stakes

The reality of this is that, as has already happened south of the border, the provision of residential conveyancing services, and possibly estate agency services, may be polarised among a handful of businesses that are geared up to provide institutions with a service based on volume instructions, at a cost that might be unsustainable to many businesses that are currently operating in the market. This polarisation of the conveyancing market among a small number of conveyancing businesses will mirror the polarisation of the mortgage market among a small but increasingly powerful number of lenders who will effectively monopolise the market.

You might think that in such circumstances these select conveyancing businesses would be in an extremely fortunate position, benefiting as they will from volume instructions, but in truth they too will be under pressure, albeit of a different nature. As is the case with some suppliers to major supermarkets, being selected may well prove to be a mixed blessing. They will predominantly have all of their eggs firmly in one basket, and will be under pressure from institutions to provide sophisticated and expensive IT infrastructures and to perform within extremely tight service levels. In addition to this they will be under constant pressure to reduce their costs, and will have to live with the fact that they will have little or no control over their own destinies and that in certain circumstances they could lose all of their work literally overnight.

Market commodity

This development is nothing new, and the fact is that, with the increase in centralised institutional control, it was inevitable. The current remortgage market, dominated as it is by a handful of conveyancing suppliers, is just one example of the effects of such control. What is new is the fact that the current financial crisis has produced market conditions that have weakened the position of solicitor estate agents and conveyancers in Scotland and that will accelerate the process.

Unfortunately solicitors have in general been slow to react, not only to this relentless increase in institutional influence but also to the fact that consumers increasingly view conveyancing as a commodity service that should be supplied to them in a manner that is consistent with them living their lives in the 21st century, and have failed to invest in technology in particular at a time when they could have afforded to do so. Add to all of this the likelihood of a Clementi-type deregulation of the legal market in Scotland in the next couple of years, and the future for conveyancers in Scotland begins to look

fairly grim.


So what can we do? The commoditisation of conveyancing as a service is already happening at an increasingly fast pace, being driven on not only by institutions but more importantly by the demands and expectations of the consumer, and there is absolutely nothing that we can do to stop this. As a result of this, consolidation amongst suppliers of conveyancing services in Scotland is inevitable. Having said that, there can be no doubt that the current instability in the property market will present significant potential opportunities to those that are prepared to accept what is happening rather than moan about it, and are willing to change and adapt to circumstances, but this will require courage, resolve and flexibility, not to mention investment. To others it will present challenges that may well prove too difficult for them to overcome.

Kyle Peddie is chief executive of Your Conveyancere

Donald Amstad

Where it all went wrong

How did it all happen? Basically, says Donald Amstad, Director, Business Development of Aberdeen Asset Management Asia Ltd, people got greedy. At the Globalscot conference in Shanghai on 25 September, he charted the rise and fall of the USA’s sub-prime mortgage market, which lies at the root of the crisis.

Amstad described how, as low inflation rates stimulated non-inflationary growth and asset prices soared, pressure from investment bankers to generate assets to sell to investors led to mortgages being handed out to virtually anyone. If it went wrong, you just handed back the keys. As property values rose, you were encouraged to borrow more. More assets for Wall Street investors; more fees for commercial bankers.

Governments were happy as tax receipts soared; regulators couldn’t see a problem, because everyone was making money; and shareholders were happy, because share prices kept going up.

Greed, he commented, exists in almost every corner of the financial system. “Most players have been acting logically, responding to the carrots and sticks that have been offered. It is a system where risk and return for many are completely asymmetric. Risk takers, backed ultimately by the US Federal Reserve, have all the upside of large bonuses when they take a lot of risk, and make a lot of money; but shareholders and taxpayers have all the downside when things go wrong… The system is absurd. What is worse is that shareholders have put up with all this nonsense for so long.”

But he maintained that to an extent it’s the investors’ own fault, because they have put their faith in tracker funds rather than fund managers – so they end up buying shares in the most expensive companies, i.e. the ones that dominate the index.

Amstad added a warning that the real economy implications of the bust are just beginning to be seen, in the US unemployment figures. Another wave of write-downs and losses is likely, which could trigger a vicious cycle with even tighter restrictions on lending.

“As humans need water, so economies need credit”, he continued. “The financial system that is supposed to do that, needs to be rebuilt… Because the system is global, we need a global solution. This is a problem because the fixers, governments, are national and regulators are local… ‘We’ will not all survive the crisis.”

So what can be done?

If the cause of the crisis is greed, the solution is confidence, says Amstad. To restore confidence needs two things: real estate markets to stabilise, and banks to start lending again, in particular to each other.

For the first of these to happen, property markets have to fall, especially as mortgages are both harder to obtain and more expensive, and the supply of buyers is also dependent on people having jobs and an income to pay off the mortgage. Stabilisation of the market could take some time yet.

The banking situation is difficult because banks will not start lending to each other “until they have cleaned up their balance sheets, and have confidence that other banks have cleaned up their balance sheets too”. (As we know, there are few banks that are not exposed, directly or indirectly, to the US sub-prime mortgage market.)

“Banks have yet to come clean and until they do, the crisis will get worse, because no one will have confidence in the system. Ultimately, it’s entirely possible that governments will have to step in, and then we will have to see who picks up the tab: shareholders or taxpayers?”

But, he adds, there is some good news out there. Some will survive the crisis, though many will not.

“The winners broadly will be people, companies and countries whose balance sheets are cash rich; the losers are those who are in debt, those who need to re-finance, those who are highly leveraged, those who need to sell. Cash is very much King.”

From the point of view of asset managers, he added, there are other positives. One is that at last people are starting to ask the right questions, of everyone involved in the system. “It’s not a guarantee that the right conclusions will be reached, but it is a sign that past excess will not be tolerated.”

Again, the sell-off in financial markets creates an opportunity for long term investors. Client expectations of what it is possible to achieve in terms of a normal rate of return on investments should also be reduced. And reliance on tools such as computer models and ratings agencies will diminish: people will have to start thinking for themselves again.

Amstad ended by quoting the celebrated investor Warren Buffet: “Be fearful when others are greedy, and greedy only when others are fearful.”

Donald Amstad’s full speech, which is punchy and highly readable, can be viewed via the Scottish Financial Enterprise website at information-and-policy/sfe-blog/ article/credit-crunch-predicted


Owen Kelly

Play to our strengths

The credit crunch or liquidity squeeze has affected our industry in ways that nobody could have anticipated. In a business that relies heavily on confidence, this has been a seriously unsettling time – for industry professionals as much as for the general public.

Asked how Scotland’s financial services industry will survive current conditions (which will, in time, pass), I wouldn’t seek to predict the outcome in any detail. In a global industry, operating at a time of instant communications, the speed at which events on one side of the globe can impact on the other is unprecedented, and makes forecasting ever more difficult.

We do need to remember how far Scotland’s financial services industry has come. With a history dating back over 300 years, the last 10 years have seen remarkable growth – a 60% increase in the industry. The growth happened when we saw the broadening out from traditional core business of banking and insurance to include asset management, investment banking, asset servicing, support services and other linked activity. Our own companies grew and became global, and we attracted overseas organisations to set up bases in Scotland. We built on our traditional strengths to create a highly skilled and experienced workforce.

Part of that change 10 years ago involved company takeovers. But the reinvigorated companies managed to retain a strong presence in Edinburgh, recognising the benefits of using a Scottish workforce. We need to remember that when looking at the planned Lloyds TSB takeover of HBOS. In such circumstances we obviously hope that the experienced and knowledgeable of the staff involved are deployed as effectively as possible.

For the future of the industry as a whole, we need to see a reduction in volatility and a more stable operating environment both globally and locally. This will likely take time, and will involve readjustment and lessons being learned in a number of areas. But we must focus on Scotland getting through this period and remaining a key international hub for the industry.

Central to our success in achieving that will be our professional services – lawyers, accountants, bankers (only the Chartered Institute of Bankers in Scotland now provides chartered banking qualifications in the UK) that stand comparison with any in the world.

Owen Kelly is chief executive of Scottish Financial Enterprises


Iain MacSween

American dream is a troubled one

Iain MacSween, a Scottish solicitor now practising as an attorney in North Carolina, describes how legal firms in the US are faring in the current climate

Since 2001, the legal services industry in the US has been characterised by double-digit profit growth, strong demand, solid productivity and controlled expense growth. On closer review, this does not accurately represent the entire legal profession. Instead there has developed a growing gap between the “haves” and “have-nots,” as the salary gap for US attorneys has widened.

While starting salaries for newly qualified attorneys at mid-size and large corporate law firms have risen sharply in recent years, this has not been the experience of attorneys at smaller firms and in public interest positions. It was reported earlier this year that while 16% of newly qualified attorneys enjoyed starting salaries of $160,000 or more, 38% earned $55,000 or less.

Those now qualifying are reported on average to have law school debt of over $80,000 if they attended a private law school, and over $54,000 if they attended a public law school. As tuition costs continue to rise, fuelled by competition for a limited supply of lucrative jobs with large firms, a growing number will begin their legal careers with combined debts from law school and university in excess of $200,000.

Effects of the crisis

The fall in the US housing market, the decline in worldwide stock markets and the current economic crisis have heralded many changes in the US legal services industry. 2008 has been a difficult year for many firms, with one report stating that as of 30 June, large law firms experienced a drop of 11.8% in year-on-year receipts, compared with an 11.7% increase the previous year.

As in Scotland, the US housing market is regional in nature. Reports of a “meltdown” accurately describe what has occurred in some parts of the country – industry data indicate that in parts of California and Florida house prices fell by over 30% during the year ended 30 June. However, in other areas, such as the Midwest where the fall was only 0.9%, prices have remained relatively stable. The relative effects on law firms reflect these figures.

Compared with Scotland, there is less reliance on attorneys in the house purchase process in the US, because of the widespread use of standardised purchase agreements prepared by realtors (estate agents). Often attorneys are only involved at the closing. However, the real estate downturn is having a broader effect on the legal services market, where developers and banks are left holding undersecured loans. This shortfall affects banks’ ability to make loans without breaching their minimum regulatory capital ratios. The local nature of the thousands of community banks (think of the Bailey Building & Loan Association in It’s A Wonderful Life) has meant that those located in regions most affected by the housing crisis have been hardest hit – exacerbating the credit shortage and so restricting the ability of businesses to enter into transactions requiring attorneys.

Practice areas

Over the past few years, while the financial markets and real estate markets grew, there was significant activity in mergers and acquisitions, structured finance, real estate development, construction and security offerings.

The recent demise of large financial institutions, many of which employed hundreds of in-house counsel, has resulted in mass redundancies. As a consequence, many other in-house counsel are looking for private-sector jobs as they fear for the future of their company.

Law firms with niche practice groups, many of whom experienced tremendous growth over the past decade, are now downsizing. Some firms are reported to have dismissed entire practice groups – including partners.

The practice areas to show growth at present are those which showed more limited activity in the boom years: commercial litigation, especially class actions over securities; bankruptcy; and restructuring (banks renegotiating loans to avoid having to foreclose in a soft market, with businesses attempting to maintain their sources of credit). Also profiting from current market conditions is the energy sector, due to the increase in energy prices.

We are fortunate in my own firm that our practice does not rely heavily on any one industry and that we represent a diverse group of businesses across the US, as well as foreign clients with US business interests. While we have experienced a period of reduced activity on the transactional side, we foresee a rise in the number of mergers and acquisitions originating overseas, as foreign companies take advantage of the continued weak dollar and depressed US stock prices. Anticipated regulation in the banking sector will present opportunities, as will the increase in securities litigation and bankruptcy, internal investigations and white collar crime.

Iain MacSween practised as a solicitor in Scotland for eight years before moving to the USA, where he qualified to practise in New York and North Carolina over three years ago. He is now a partner in Brooks, Pierce, McLendon, Humphrey & Leonard LLP, a mid-size (85 attorney) commercial practice based in North Carolina.


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