Things are about to become even more interesting for The Co-operative Bank. ‘Interesting’, though, is not necessarily good. In this case, it means additional complications and potential problems.
The Bank’s difficulties are known internationally. We know that not least because at least two big United States hedge funds have bought large quantities of subordinated bonds in the Bank. Both see an opportunity to extract a better settlement for creditors than the Bank and its regulators, the Prudential Regulation Authority, intend.
Aurelius Capital is based in New York and has acquired a substantial amount of lower tier two debt. The purchases were from institutional investors who no longer want to hold the debt and perhaps do not want to be known to have invested in debt which, with the benefit of hindsight, they wish they had not bought.
Aurelius is a $2.5bn (£1.6bn) fund that has a reputation for buying distressed debt cheaply and then aggressively improving its value, by playing hard ball in negotiations. It was particularly successful in doing so with Dubai World – a Middle East investment vehicle that was badly damaged by the global financial crisis.
After a tough stand-off with negotiators, Aurelius doubled the value of its stake in Dubai World. While all other creditors accepted an offer of 50 cents in the dollar, Aurelius rejected the proposal and stuck to its demand for full value restitution. Eventually, according to reports, Aurelius was bought out at near to par value by a party close to Dubai World.
Elsewhere, Aurelius was one of the bondholders – after acquiring the distressed debt cheaply, probably at 20% of face value – in Anglo Irish Bank, which was rescued by the Irish government at enormous cost to the country’s taxpayers. As well as holding an investment itself, Aurelius represented two other funds that bought into the debt.
Aurelius was also involved in heavy negotiations with the Greek government, after buying distressed sovereign debt. The fund is blamed for delaying resolution of a big US company – the Chicago Tribune – in its attempt to come out of protective bankruptcy when Aurelius tried to maximise the value of the debt it is holding. And Aurelius has engaged in legal action against Energy Future Holdings, which is accused of not properly serving the interests of its creditors.
Aurelius is also reportedly in legal dispute with monoline insurers. These are insurers – including the giant American Insurance Group (AIG) – which provide guarantees for municipal bonds and some other types of very large contracts. These insurers were severely damaged by the global financial crisis.
The biggest investment by Aurelius is thought to be in Argentinian government debt, which has become the subject of legal action in the international courts. Argentina has reneged on much of its sovereign debt, claiming that it is effectively bankrupt. In 2005, Argentina replaced old debt instruments with new debt that was heavily discounted. While most creditors accepted these, Aurelius – having bought the debt also on a large discount – refused. Aurelius is willing to be patient – its legal displute with Argentina debt is making slow progress through the courts.
In short, Aurelius is an example of what is sometimes called a ‘vulture fund’, which takes on debt that appears to have little or no value – and then takes aggressive legal action to maximise the value of that debt. It is willing to do this in the face of pleas that the legal action jeopardises a course of action agreed with most of the creditors.
Aurelius is not alone. According to various newspapers, Silver Point Capital has also bought up a large quantity of distressed debt held in The Co-operative Bank. However, we were unable to confirm this with Silver Point, despite speaking to its office in Greenwich in Connecticut.
Silver Point adopts the same approach as Aurelius, though with more than $8bn (£5.3bn) in assets under ownership, it is significantly bigger than Aurelius and is listed as one of the US’s 100 largest hedge funds. It was established in 2002 by two former Goldman Sachs’ bankers, who both had strong reputations for their handling of distressed debt.
Silver Point also has a record of willingness to negotiate hard for its interests and for using the law aggressively. However, its distressed debt purchases have often been motivated by seeing opportunities for improved value in the underlying asset, rather than scrapping over the spoils of a dead business or bankrupt country.
Aurelius declined to discuss its objectives and strategy with us, and it is unclear whether Silver Point – assuming it has acquired debt – will be working in partnership with Aurelius. But the City A.M. newspaper says that ‘hedge fund managers’ told it that the two funds expect to achieve an improved outcome for the largest investors.
City A.M. quoted one hedge fund manager – presumably not employed by Aurelius or Silver Point – as saying: “The Co-op Group is a mutual and to a certain extent will only really care about overall control of the group, rather than quibbling too much about the size of its stake. Whether they own 75% or 66% or even less seems less important than that they bank is recapitalised and they have more than 50%.”
According to some media reports, between them Aurelius and Silver Point may now own the majority of certain classes of debt in the Bank. As yet, though, that is not reflected in the share register. Either way, they will be in a very strong negotiating position.
Mark Taber, who is representing more than 2,500 small investors in The Bank, dismisses suggestions that the two hedge funds’ investment purchases will necessarily damage the interests of individuals holding bonds of smaller values. He argues that the total value of debt held by individuals is so small – about £65m, compared to a total capital shortage currently put at £1.5bn – that there is little to be achieved by squeezing those individual investors.
Taber says he is unsurprised by the activities of Aurelius and Silver Point. “They are hedge funds – and that is what hedge funds do with banks that are distressed,” he says. He also repeated his criticisms of the actions of the Prudential Regulation Authority and of its failure to provide earlier warning of the capital weakness of the Bank. “The PRA should say how much capital [the Bank] needs to raise, or else it will be nationalised,” he suggested.
The Bank and its advisors were aware that hedge funds would buy into its debt as soon as there were indications of serious difficulty in March of this year. But the holdings will greatly complicate negotiations between the Bank and investors. There are now three distinct interest groups amongst the holders of Bank debt.
Small investors will be looking for either cash recompense, or the reinstatement of dividend payments, in full and as soon as possible. Institutional investors that have held on to their debts will be looking to maximise value and may be sympathetic for the proposed debt for equity issue, providing it is on terms that are acceptable to them and if it is accompanied by a prospectus for future development of the Bank in which they have confidence.
We now have the third group of investors, the hedge funds, whose interest will be to show a return against the price at which they bought the debt. Some of the funds may be willing to sell on the debt – or resulting equity – to other investors if the market value rises. Other hedge funds are likely to litigate as they try to insist that debt instruments must be bought back at face value.
Until the half year results on 29 August, those negotiations cannot take place with any seriousness. After that, the meetings will be extremely difficult.