In Depth

Has the Co-op Bank secured its future?

It might sound like history repeating itself, but a fresh hedge fund deal could be the start of a new era

Co-op Bank will probably avoid a regulatory winding-up process over inadequate capital reserves, thanks to a hedge fund deal worth hundreds of millions of pounds.

That sounds eerily familiar to October 2013, when the bank was able to fill a £1.5bn black hole on its balance sheet after the Co-operative Group ceded 80 per cent of its ownership to hedge fund investors.

It is now possible that the Co-operative Group's shareholding will be reduced to close to zero - which it what it revalued the stake at earlier this year.

This suggests the ethical "challenger" bank has never recovered or fully moved on from its first near-collapse four years ago.

In fact, according to the BBC, bank executives said the costs of turning around the business, coupled with low interest rates squeezing margins, were responsible for its ongoing problems.

So will it now finally secure its future?

Past troubles

"The Co-op Bank's balance sheet ballooned following a disastrous merger with the Britannia Building Society, and then ran into trouble when it tried to buy more than 600 branches from Lloyds Banking Group," says Sky News

The 2009 merger with Britannia was designed to boost the footprint and scale of Co-op Bank "at nil cost" at a time of strife across the wider banking sector, says Coop News

However, the building society was in worse financial shape than it appeared and had a large portfolio of high-risk property loans.

Consequently, by 2013, the regulator massively increased Co-op Bank's minimum capital reserves requirement from £1.9bn to £3.4bn.

At the same time, existing capital resources were being hit by a number of issues, including a "failed IT replatforming project" and compensation provisions for mis-selling PPI.

Trouble at the top

In a way, though, these could be seen as representative of an underlying malaise caused by management an MPs' report slammed as incompetent.

Banking experience on the board comprised a few non-exec directors among 22 members.

During much of the period of the fallout from the Britannia merger, the chairman was a Methodist minister with no banking background who was unable to quote its capital base to within a factor of ten. Paul Flowers was later embroiled in a Class A drugs scandal.

The management team itself was equally inexperienced: its incoming chief executive at the time of the merger, Neville Richardson, "had never worked at a bank before", while the chief risk officer was also "an actuary not a banker".

That team then overstretched itself trying to buy the 600 Lloyds branches (then known as "Project Verde"; now TSB) while trying to successfully integrate Britannia.

At the same time, the Co-operative Group was pushing on with its own Project Unity, a plan to merge activities that "moved staff between bank and group and changed reporting lines".

Coop News argues that better oversight by a management team that was less stretched and more experienced might have meant its limited capital was more prudently managed.

The Financial Times says bluntly: "The official character of an organisation… [makes] far less difference to its success or failure than how well it is run."

Turning things around

So how much of this has been put right? Well, a cursory look at Co-op Bank's board boasts far more banking background in senior positions than at the time of its 2013 crisis.

Chairman Dennis Holt has 45 years financial services experience, including time at Lloyds TSB and Bank of Ireland, and chief executive Liam Coleman has 25 years in the industry, with stints at Royal Bank of Scotland and Nationwide to his name.

The new funding deal also appears to give some resolution to the big outstanding capital issues, including a plan to pump in fresh money over the coming years and split the bank's pension scheme from the wider Co-op Group and reduce its liabilities.

In total, the agreement will be worth £700m, not including the pension contribution, which includes around £250m of new equity in addition to a chunk of debt being converted to equity.

Combined with rumours that the regulatory capital shortfall in the years ahead was not as wide as first thought, this should mean Co-op Bank has the balance-sheet strength to continue for some time to come.

Hope for the future?

However, for all of that, the bank is still making losses: £477m in 2016, a modest improvement from £610m the previous year.

So, are those hedge funds just throwing good money after bad?

Not according to Nils Pratley, who writes in The Guardian that despite racking up £2.6bn since its funding crisis first emerged, the Co-op "can still bounce back".

Specifically, he says the hedge fund backers, who have banked a decent return from up to 11 per cent payouts on their bonds since 2014, have maintained the ethical principles that are the bank's unique selling point.

That, he suggests, is perhaps why it has held on to 1.4 million of the 1.5 million current-account holders it had in 2014 despite talk of imminent collapse.

The BBC says the bank still has a substantial and viable customer base of four million customers.

Pratley, therefore, suggests the hedge funds might be correct in assuming that once "more of the poisonous commercial property loans" have washed out of the system, there "lurks a profitable retail bank awaiting the balm of higher interest rates".

Only time will tell.

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