Bank damages Co-op Group results

The Co-operative Group’s announcement of a significant loss resulting from its shareholding in the Co-operative Bank should not be a surprise to anyone who has been paying close attention to recent events.  While the bank’s value is not necessarily worthless, the Group has taken the cautious view and reported its equity stake in the bank as now of nil value.  This is what is called the ‘big bath’ – getting the bad news out of the way to avoid a continual process of writing-down the loss.


Group financial performance was very impressive overall, with strong performance in food, funerals and insurance.  But the Group’s £23m profit in 2015 turned into a pre-tax loss of £132m for 2016 on the back of higher finance costs for the Group of £74m, plus the write-off of the value of its equity stake in the bank.  This had been valued at £185m a year before and which had been further written-down to £140m in the last half year report.


In its full year report, the Group explained: “Given that the Bank is in a sale process, the consideration to be received for our share is obviously volatile and potentially has a large range of options and we believe this is a prudent valuation. We are supportive of the process the Bank is going through to find a secure home for members who use their services.  It should be noted that the Group, within its planning for both Rebuild and Renew, does not rely on any cash receipts as a result of holding this investment.”


While we as yet do not know the market value of the bank, it is quite possible that there is little value left.  The Prudential Regulation Authority has reportedly placed the bank under “intensive supervision”, which could be a prelude to its closure.  “The BBC understands contingency plans to ensure the ‘orderly failure’ of the 150-year-old bank are well advanced,” the broadcaster reported late last month.


This is a – negative – step beyond the position previously outlined by the Co-op Bank itself.  In mid-February the bank effectively gave up trying to save itself and instead opted to sell.  The better news is that it is widely rumoured that two other financial institutions are interested in purchasing the bank – which might see the Group recover some of its losses on the bank.  The two potential buyers are believed to be Virgin Money and Clydesdale Bank.  TSB, owned now by Spain’s Sabadell Bank, has ruled itself out of bidding, having been assumed to be the front runner.


As the Co-op Bank has pointed out, it remains above its minimum capital requirements – but its capital position is eroding at speed.  For the 2016 year, the bank made a loss of £477.1m, after recording a £610.6m loss in 2015.  This has had a bad impact on its Capital Equity Tier 1 ratio.  At 11.0% it is still some way above what would normally be its required minimum of 6%, but it is only marginally above the 10% the bank agreed with the PRA.  In the course of last year, the tier one capital ratio dropped from 15.5% to 11.0%.


Clearly at this rate of capital loss, the 10% capital threshold will be breached in the near future – as the bank itself has conceded.  The exceptionally high 10% target agreed with the PRA reflects the expectation by both parties of ongoing losses.  The underlying cause for those losses and reduction in tier one capital is the continued working through of bad debts inherited from the Britannia Building Society.


The only options left are a sale or a fresh input of capital.  With the current rate of loss, existing and potential shareholders are understandably concerned about putting more equity into the business.  Indeed, there is speculation that institutional investors holding bonds will find their stake converted into equity as part of a rescue process.


A sale is more attractive, either in whole or part.  A challenger bank such as Virgin Money could add scale to its existing operation.  From this point of view, the Co-op Bank is attractive as its customer deposits and customer numbers have held up amazingly well.  (Customer deposits fell from £22.4bn to £22.1bn in the year, while the number of current account customers actually increased last year.)  It is widely reported that several banks are interested in individual parts of the business.


The scale of recent years’ losses actually adds an attraction for a profitable acquirer.  The Co-op Bank has built up ‘deferred tax assets’ – tax losses that can be used to reduce an acquirer’s tax liabilities.  That, by itself, makes it likely that the bank will be bought by a trade buyer.  Moreover, as Mark Taber of Fixed Income Investments has commented on his blog, another bank would in all probability be permitted by the PRA to operate the Co-op Bank with a much lower tier one capital target.


There is then the issue of what happens with the name.  The Co-operative Bank has long since ceased to be a ‘co-operative’ under any reasonable definition.  Even if the new owner seeks to use the name for an interim period prior to rebranding, this is surely nearly the end of the road for ‘The Co-operative Bank’ branding.


It is worth reminding ourselves why the bank (and the Group) ended up in this mess.  Forget about the ‘crystal meth’ minister Paul Flowers.  The damage was caused before he become chairman, when the decision was taken by the Group and bank to take over the Britannia Building Society.  We now know the society was itself at risk of collapse – and would probably have done so if it had not been rescued by the Co-op.  That decision lies at the boards of the Group and the bank and any influence exerted by the chief executives of the three entities.  We also know that the Group and bank were unaware of the extent of poor lending decisions by Britannia, because of the very inadequate due diligence carried out by the bank prior to the takeover.  The bank’s then finance director, later chief executive, Barry Tootell, has accepted responsibility for that.


Uncomfortably, history has a tendency to come back and bite us.  Writing-off the £140m of Co-op Bank equity is a real pain for the Co-op Group.  While improving the trading position of the Group has been a mammoth struggle, resolving the bank’s problems has proven simply impossible.

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