Reviewing the co-operative year

Posted on January 19, 2014 · Posted in Co-operative News

Farewell to 2013 – and may our sector never have a year as bad again please.  Events for the UK’s co-operative movement have been dominated by the crisis at The Co-operative Bank and the knock-on effects on the Co-operative Group.  As news gradually emerged, confidence ebbed with questions raised about governance and how co-operatives can ensure elected directors are competent and able to hold executive officials to account.

 

The bare bones of the Bank’s crisis are fairly simple.  A £1.5bn capital shortfall was caused by a mix of bad commercial loans issued by the former Britannia Building Society, provisions for compensation for the mis-selling of payment protection insurance and write-offs of past spending on IT systems, along with the need to set aside substantial sums to procure new IT systems.

 

Until now, the main public focus has been on the write-downs on loans issued by Britannia, with which The Co-operative Bank merged in 2009.  But I will be amazed if the review of the crisis being undertaken by Sir Christopher Kelly – a former senior civil servant and chairman of the Committee on Standards in Public Life – does not consider in detail the issue of IT procurement.

 

The Bank spent a fortune on an IT system that is not fit for purpose.  Apparently, one in three banking transactions is now conducted by smart phone – yet the Co-operative Bank’s IT systems are unable to service smart phone banking.  A further concern is that the Group’s ongoing financial support for the Bank is intended to come in part from the sale of the general insurance business.  However, a recent article in the Financial Times suggests the sale price could be substantially below expectations.

 

The nadir of the year was the appearance at the Treasury Select Committee of the Bank’s former chairman Paul Flowers.  Paul was asked the value of the Bank’s assets – he guessed £3bn, when they were actually £47bn.  His air of detachment under questioning was unhelpful, but allegations in a Sunday newspaper about his private life made things much worse and caused difficulties for the entire movement.

 

This is not merely tawdry tittle-tattle.  The Co-operative Bank and much of the co-operative movement branded themselves as ethical businesses.  That perception is severely damaged by the allegations against the former chairman of the Bank.

 

Even more difficult for committed co-operators to accept has been the role of hedge funds in buying up bonds issued by the Bank and using this leverage to take the Bank out of majority ownership by the Group.  After the restructuring, the Group will have just a 30% stake in the Bank, which will be 70% demutualised to become a listed company.  It may soon become clear how much damage has been caused to the ethical bank branding and how many customers the Bank loses.

 

The Group has had a difficult year in other respects, with a change of chief executive and chair.  Euan Sutherland has a good reputation in grocery retailing and as Group CEO is handling the crisis decisively, if with little leeway.  Ursula Lidbetter is the new chair and is greatly respected within the movement for combining ethical trading principles with strong financial results.  The Group needs strong and skilled leadership to emerge from the crisis, especially as the 2012 results were disappointing.

 

The Group’s new leadership must address key strategic challenges, including deciding what constitutes the core business.  It emerged from the written evidence to the Treasury select committee from the Group’s former CEO Peter Marks that he had proposed to the Group’s board that it sell its farming business.  This followed the effective disposal of Co-operative Travel.

 

These moves feel distressingly like selling one piece of the family silver after another, while failing to get to grips with the challenges of the core business.  It is still too early to tell whether the acquisition of Somerfield will be a game changer for grocery retailing.

 

The need for additional capital for the Bank was not just the result of the Britannia bad loans, the IT mess and the PPI mis-selling.  It also flowed from changes in the capital adequacy requirements introduced by the Bank of England.  The Bank of England’s new Financial Policy Committee decided that banks and building societies must increase their holding of risk capital, to prevent the need for future bail-outs by the Government.

 

This requirement also affected the Nationwide Building Society.  The Nationwide had two strengths to overcome its capitalisation problems.  Firstly, it was profitable and so has been able to pledge that it will retain future profits to increase its capital buffer.  Secondly, as a building society it was able to raise £500m by issuing core capital deferred shares, which are accepted by regulators as risk capital.

 

Core capital deferred shares can only be issued by building societies.  As the Co-operative Bank is a PLC wholly owned by the Group, it is unable to take advantage of this.  Ironically, had the Britannia continued as a building society it might have been a better position than The Co-operative Bank to access the market for risk capital.

 

Mutuals continue to face a particular problem in raising capital.  This has been made equally clear in Spain, where Mondragon’s Fagor consumer electrical business has entered bankruptcy protection.  Although the Mondragon Federation’s principle of solidarity has held good for nearly 60 years, eventually the losses incurred at Fagor became too big for the rest of the Federation to cover without risking the future of the wider group.  The parallels with The Co-operative Bank and Group are obvious.

 

Happily much of the co-operative sector has had a good year.  The Midcounties Co-operative once again produced very strong results.  In its first six months of 2013, it grew sales by 36% and profits by 16%.  It highlighted healthy trading performances from childcare, energy and travel.  Its Co-operative Energy business has attracted wide support for its ethical business model and very competitive prices.  It has 160,000 customers and is expanding quickly.

 

Midcounties’ childcare business grew revenues by 20% and it now has 50 nurseries, operating beyond the society’s core geographical region.  Impressively, the size of the travel business doubled, in part through acquisitions of additional stores.  The retail food business also did well, growing by 8% in tough market conditions.

 

The march of retail consolidation has continued, with two large societies – Midlands and Anglia – merging into a new movement giant, though as yet without an agreed name.   The merged business will have a £1bn turnover, a third of a million members and will operate across 16 counties.  The Phone Co-op also had a good year, with turnover rising by 4.6% to nearly £11m – again in tough trading conditions.

 

According to a survey conducted by Co-operatives UK, the sector as a whole remains in good health.  It found a rise in the number of co-operatives by 28% since 2008 and by 4% in a year.  That growth has been helped by the success of community share issues, which enabled the launch of community owned windfarms, other renewal energy projects, pubs and village shops.

 

So it is possible to find reasons to celebrate in a very difficult year.  But if we have any sense of perspective at all, we have to admit that the problems of the Group, the Bank and Fagor cast a pall over 2013.  It may be difficult to emerge from that negative environment in the early part of 2014 – not least because so many parts of the UK movement have benefited from the historic generosity of the Group.

 

We must now wait to see what the full consequential impacts of the Group’s problems will be.