Could bond-holders lose money in the Co-op Bank crisis?

Jun 7, 2013

Co-operative Bank prepares rescue plan to fill capital hole leaving pensioners and investors at risk

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WHEN the Co-op fell from grace last month, some suggested that its bonds – which had taken a heavy hit following the mutual bank's downgrading to "junk" by Moody's – looked like "a good buy for the brave". That advice doesn't look too clever now, said Michelle McGagh on Citywire.

Amid reports that local authorities have been advised to cut their exposure (more than 100 councils currently have some £500m on deposit), bond-holders are getting "increasingly jittery" that they'll "be forced to take a haircut to pay for the bank's rescue plan". The supermarket-to-funerals mutual is holding a series of asset sales to raise cash. But the proceeds are unlikely to be enough to plug a possible £1.8bn black hole in its accounts.

Thousands of pensioners could lose "a vital income stream", said Philip Aldrick in the Sunday Telegraph. Those most at risk are holders of the Co-op's "junior debt" – including some £310m of "permanent interest bearing shares" (Pibs) inherited from its disastrous takeover of Britannia Building Society; and around £60m in "preference shares". If a business hits financial trouble, these are usually the first to feel the heat because the company has discretion to stop making payments without it being formally classified as a default.

The value of these "Pibs" and "Prefs" has already taken a hiding since Moody's wielded its credit-rating knife in May. The Britannia Pib, paying a 13 per cent coupon, has halved in value. So, too, have the Co-op's 9.5 per cent preference shares.

But holders could now also face a cut in the coupon, its complete cancellation, or (as happened at West Bromwich Building Society in 2009) a switch into a new instrument with a swingeing loss of income. If that happens, expect fireworks: West Brom debt-holders "were so angered by the cancellation of the coupon that they formed an action group to fight the decision in the courts".

Ben Yearsley of broker Charles Stanley thinks the Co-op is a wake-up call for corporate debt investors. Just because coupon cuts or cancellations are rare, doesn't mean they can't happen, he told Citywire. "In the good times" it's often forgotten that "if something goes wrong, bond-holders get hit". That, after all, "is what they are there for".

This article appears in the 7 June 2013 edition of The Week.

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