Co-op Bank results make grim reading

After months of bad news stories, the disclosure that the Co-operative Bank made a £1.3bn loss in 2013 – following a loss of £674m in 2012 – was no surprise at all.


Speaking personally, the biggest shock was delivered last month, when we learnt that an additional £400m in capital will be required. This is for further provisions for potential redress for past product mis-selling.  So much, as far as I am concerned, for Euan Sutherland’s earlier claim that his best work as Group CEO was in sorting out the Bank’s finances.


It is unsurprising that the bank does not expect to make a profit either this year, or next year. The focus at present has to be on making it fit and healthy as a modern bank.  There are two immediate priorities, as the bank makes clear in its financial report.  “The Bank’s underlying business and financial systems are dated and suffer from a lack of integration and investment since the Britannia merger; consequently many processes rely on significant manual intervention to cope with a poor systems infrastructure.”  Consequently, there must be substantial investment in a new IT system.


Annual reports sometimes have to say the obvious. So the report also states: “the Bank’s systems of control have been weak and there have been failings by the Bank’s business units in a number of areas in the past”.  Well there can be no argument there, which means it will be recruiting new senior staff and new board members.


For the record, the £1.3bn of losses comprises loan impairments of more than £500m, conduct and legal costs in relation to mis-selling and compliance breaches of more than £400m, an IT write-down of £150m and, despite the massive losses, a one-off tax cost of £150m. As a result, while the industry seeks to achieve cost to income ratios in normal times of between 30% and 40%, for last year at the bank they were 93.6%, up from 73.7% in 2012.


Now for the bank’s good news. Customer loyalty is surprisingly strong, despite the torrent of embarrassing media reporting.  Core retail deposits have remained steady, falling by less than 1%.  The bank has actually succeeded in attracting new current account customers, with the number of primary current accounts rising very slightly.


In line with previously announced decisions, the bank is focusing on the consumer and small business sectors, exiting from the large business and local government markets. Its non-core assets have been reduced by £1.5bn in the second half of last year and now stand at £12.5bn.  It seeks to reduce this figure further to £11bn by the end of this year.


As part of the focus on core operations, the bank is exiting various non-core markets. It is seeking to sell its stake in the Unity Trust Bank, though it will need regulatory approval for this.  It is also closing operations in Guernsey and the Isle of Man.  Staff numbers were cut by more than a thousand last year, with 51 branches closed last year and a similar number to go this year.


I am, though, relieved that the bank is responding to pressure to take action against former executives, who will not receive as yet unpaid performance related remuneration. The annual report explains:  “A total of £4.97 million will not be paid out as a result of the application of malus, performance hurdles not being met, and/or individuals leaving the Bank.”  I confess this had me reaching for the (online) dictionary, which explained that ‘malus’ means obtaining the return of an already paid performance-related compensation where performance criteria were not met.


The move might be seen primarily as an attempt to improve customers’ opinions of the bank, especially as we now learn that the new chief executive Niall Booker is to be paid £4.6m for his first 18 months in post – subject to meeting new performance targets. This is four times’ the pay of his predecessors, though Booker promises to leave the post as soon as the bank’s financial position is sufficiently strong to protect its future – when, as he puts it, less expensive senior management can be recruited.


Customers are to be consulted about the bank’s ethical policy “as we look to rebuild trust in the Bank”. Shaun Fensom of the Save Our Bank campaign urges customers to be forthright in their responses, while staying with the bank through its crisis. “We believe that by sticking together we can hold the bank to its ethical principles and ultimately help a return to co-op control,” he says. “If we leave then we ensure these things won’t happen. We suggest customers contact the bank. Tell them why they are staying and urge the chief executive to take a lead, show the bank is different to other banks and refuse to take the performance-linked payment of £1.7m.”


The Group must now decide how it responds to the need of the bank for yet more capital. As a result of last year’s recapitalisation exercise, some £100m is due from the Group by the end of June, with a further £163m by the end of the year.  It is expected to contribute towards the latest £400m of additional losses, if it is to retain its existing equity stake.


My vocabulary was further expanded when I learnt of Niall Booker’s response to this problem, courtesy of the Financial Times.  Apparently the Group may engage in “tail-swallowing”.  In lay terms, this means the Group may sell some of its rights in the bank in order to avoid paying-up the necessary capital, but use some of the cash to buy new rights at a discounted price.  The result would be that the Group’s ownership stake in the bank would end up at less than the current 30%.


Here we come to the issue of the bank’s name. As far as Companies House is concerned, a new business that calls itself a co-operative “should be owned and controlled by its members, customers or employees” and “members’ should participate in the economic activity of the business”. It seems clear to me, that the bank no longer meets these criteria.  The question then is whether, de facto, different criteria apply to an existing co-operative that changes its business model.


Co-operatives UK explains that where a co-operative goes through a structural change, the secretary of state can decide that the business no longer meets the criteria and then specify that the word must not be used in its title or branding. In the words of the Companies Act: “If in the opinion of the Secretary of State the name by which a company is registered gives so misleading an indication of the nature of its activities as to be likely to cause harm to the public, the Secretary of State may direct the company to change its name.”


That may look clear cut, but it is not. The secretary of state would not take any action without a formal complaint being submitted, which would have to make a very strong case that the public is being misled.  I understand that any such complaint would face a “high bar” of proof.


The changes to the bank’s articles of association specify that it shall promote “co-operative values and ethical policies”, adding that “for as long as Co-operative Group Limited remains both a bona fide co-operative society and holds directly or indirectly 20% or more of the issued ordinary shares…” then, in effect, the bank is regarded as having safeguarded and embedded co-operative principles into the bank’s operations.


Personally, I find the suggestion that this is sufficient to justify the use of the word ‘co-operative’ in the name to be frankly bizarre and it is surely very different from the obligations of a newly registered co-operative. The new bank’s current ownership structure and its articles do not make it accountable to any group of co-operative members and I cannot accept the name is anything but misleading.


However, it seems that if it came to the crunch, the secretary of state may be advised differently. The wording of the articles may be sufficient for his lawyers to advise him to approve the name to stay.  The secretary of state is unable to give an opinion on this at present, as he – Vince Cable – has a quasi-judicial role, which would be prejudiced by giving an opinion prematurely.


Just what, we may reasonably ask, does the name ‘co-operative’ actually mean now?

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