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Manchester Building Soc v Grant Thornton
- Dec 22, 2021
- Latest News
Manchester Building Society (‘MBS‘) is a small mutual society whose accounts were audited by Grant Thornton (‘GT‘) between 1997 to 2012. MBS’s business model included offering fixed rate lifetime mortgages where the principal loan amount and interest was only repaid on the death of the borrower or on the borrower selling their property. These mortgages were offset against interest rate swaps to guarantee a profit when the mortgages were finally redeemed. The effect of these swaps and their mark-to-market value was to increase the volatility of MBS’s financial position. This affected their balance sheet and MBS were obliged to hold increased capital reserves.
In 2006, relying on GT’s advice that “hedge accounting” could be employed to minimize the impact of the swaps, MBS entered into further swap contracts in order to hedge its interest rate risk. The idea was that the value by which the swaps decreased was matched by the value by which the mortgages increased. Effectively they cancelled each other out and therefore constituted a single entry in the accounts. This reduced the volatile element of the swaps. This allowed MBS to pursue its chosen business model. However, in the majority of cases the swaps had a longer term than the mortgages which meant that they did not often match exactly. Despite this, the auditors signed off the accounts each year using the hedge accounting method, and MBS continued to enter new swap contracts.
In 2013, GT realised that the advice they had been giving MBS regarding hedge accounting was wrong. They advised MBS that they would have to restate their accounts. MBS would need to account for the fair value of the swaps from now on. This heavily impinged on their financial position as by now, with the 2008 financial crisis and falling interest rates, the swaps had lost considerable value. MBS had greatly reduced assets and insufficient regulatory capital. To deal with this MBS closed out the swaps incurring a mark-to-market loss of £32.7million. They sought to recover this sum as damages (less the value of the mortgages) from GT on the basis of professional negligence.
