Bank Results

Last year created a difficult trading environment for The Co-operative Group.  While the Group reported an operating profit of £54m –compared to £526m in 2011 and weak on a turnover of £13.5bn – this converted into a net loss of £599m.

The main cause of the net loss related to difficulties in the non-core activities of the former Britannia Building Society, which merged with the banking group in 2009.  As a result, there was a net loss of £662m on the financial services side of the business in 2012.

There is now a strong focus on separating the core and non-core activities of the banking group.  The core banking business reported an operating profit last year of £120m.  But the non-core business suffered an operating loss of £377m.  This is mostly the result of write-downs and impairments of the value of loans issued by Britannia.

While the core Britannia business was mortgage lending on residential properties, it also built up non-core activities of higher risk lending on commercial real estate.  As with the rest of the banking sector, the property crash and wider recession meant that the value of the loans and the prospect of repayment both shrank.

Two other factors damaged the financial results.  Settling complaints on Personal Protection Insurance has been expensive for the Co-operative, though much less so than for its major competitors.  The Co-op took a hit of a further £150m last year as a provision for the cost of settling complaints.  This is in addition to a previous £94m.

As well as this, the value of the banking group’s IT system was written down by £150m, halving its book value.  This reflects uncertainty as to how the IT system improvements will proceed.  Investment has been constrained until it is clear whether the acquisition of 632 branches from Lloyds TSB under the Project Verde deal will be finalised.  If it does go ahead, the value of the IT investments made to date will be re-assessed.  If the deal is stalled, further investment in IT in the existing banking operation will proceed.

Less significant for the financial results, though still important, has been other expenditure which is hoped will produce future benefits.  Further spending of £38m has been undertaken in pursuit of the completion of Project Verde, while the bank’s existing integration and transformation programme cost £47m during the year.

The strategy now is to focus on core retail banking activities, building on the strong reputation of the relationship banking.  This means much more than not following the example of Britannia in engaging in high risk corporate banking activities.

Non-core businesses – those that do not fit with the strategy of focusing on relationship banking – will be either run down or sold.  This includes the Optimum and Illius portfolios, both of which emerged from Britannia and which have been the main causes of the write downs and impairments. Optimum is the closed book of intermediary and acquired loan book assets, while Illius is a residential property company.

In future, the banking group will be firmly based on banking activities, not insurance.  As part of this, the long negotiated sale of the life insurance business to another mutual, Royal London, has been completed.

Last year’s results show that the banking group’s Core Tier 1 capital ratio fell below the 9% level regarded by regulators as important.  The Financial Services Authority – which ceases to be regulator this month – has reportedly been concerned about the Lloyds TSB deal going ahead unless and until the 9% Core Tier 1 ratio was again achieved.

In fact, the Group reports that the 9% Core Tier 1 level has been met since the year end through a new securitisation arrangement, which lifted the ratio to 9.2%.   But the Royal London deal further helps with the bank’s capital position and could be very important in enabling Project Verde to proceed.

Barry Tootell, chief executive of The Co-operative Banking Group, says that the disposal of Royal London makes sense given the business’s strategy for the future.  “This decision reflects changes in the life assurance market and our focus on developing a compelling co-operative offer for our millions of customers and members,” he says.  “The completion of this agreement is expected to generate a significant release of capital.

“The transfer of our life assurance and asset management businesses to Royal London will ensure the continued protection of our policyholders, within a strong, mutual business with the necessary scale and focus on the long-term savings sector. As member-owned organisations, we have much in common with Royal London, which has a track record of delivering strong performance for policyholders and a real focus on delivering good customer service. We believe this is the best outcome for our policyholders and members.”

It is hoped that the Royal London deal will be followed by another to also dispose of the general insurance business.  While the group would no longer own an insurance business, it will continue to offer insurance products.  Tootell says the banking group is right to move out of insurance.

“We have a clear view of what is strategically important to ensure that the remarkable transformation of The Co-operative Group over the last five years is fully embedded and can be built upon,” he says. “A part of this strategy is to focus on the Banking Group’s core relationship retail and business banking operations.

“The Co-operative Insurance remains a strong, profitable business and has undergone a major transformation over recent years, with a thriving distribution strategy and a home product which in particular is delivering excellent underwriting profits. It’s on this basis that we will explore options for the sale of our GI [general insurance] business, whilst remaining absolutely committed to continuing to provide general insurance products to The Co-operative Group’s customers and members.”

Just as important as the banking group’s bottom line has been its achievements.  Some £2.6bn was loaned on retail mortgages in the year – a big increase from the £1.4bn loaned the year before.  Lending to businesses was nearly static, increasing from £1.2bn in 2011 to £1.3bn in 2012.  Non-core portfolios are being run down.  Reassuringly, the loan to deposit ratio remained strong, at 92%.  A securitisation during the year raised £650m, while an unsecured debt issue raised €500m (£425m).

The banking group’s results demonstrate two things.  Firstly, this is an extremely difficult environment for banks to trade in, with a lot of damage being inflicted across the industry by loans which, in retrospect, should not have been entered into.  In this regard, it was Britannia, rather than The Co-operative, that made those loans.  Secondly, we see the extent to which the banking group is changing its focus and direction – a bigger bank, which is not distracted by insurance.

If all goes well, this very ambitious strategy will also be the start of a very exciting new phase in the business.

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