After weeks of pressure, the Co-operative Group has entered negotiations with bondholders to resolve what had been an impasse over the restructuring of The Co-operative Bank. It is not possible to predict with confidence what the agreed solution will be, but it will presumably not be the complete demutualisation of the bank – with the Group left with zero equity – that some bondholders have demanded.
The first news of the negotiations was released by Mark Taber of Fixed Income Investments, who has been representing the retail bondholders in the bank. As Taber has repeatedly stressed, these include many elderly individuals, who rely on the income from their bonds to supplement their pension arrangements. For them, having their bonds converted into equity – which does not provide a guaranteed income and might take several years to show a significant return – is very unattractive.
Co-op Group negotiations have been underway not only with a two person team from Fixed Income Investments, but also with the hedge funds based in the United States, which bought a position amongst the creditors by buying-out bondholders. This group of lower tier bondholders have called themselves the LT2 Group and have been represented in the talks by the investment bank Moelis. The Co-operative Group has been represented by its advisor, the Swiss bank UBS.
It became inevitable that serious negotiations would take place. As this column has previously explained, the hedge funds involved specialise in taking positions in distressed businesses and also in distressed government debt. One of them, Aurelius, looks likely to obtain through court action more than $1bn from Argentina that its government had defaulted on. The other, Silver Point, also has a successful history in taking tough legal action to maximise returns.
The LT2 Group had put forward a position that was simply unacceptable to the Co-operative Group. The Group had proposed a £1.5bn recapitalisation of the Bank. This was to be achieved by the Group injecting £1bn, of which about £500m would come from the sale of the general insurance and life assurance businesses and another £500m from a new bond issue by the Group. (However, the cost of the bonds is likely to become more expensive in terms of higher interest rates to be paid following the latest Standard & Poor’s downgrade of the Group.) In addition, existing Bank bonds and Permanent Interest Bearing Shares would be converted into equity to the value of £500m, taking an as yet unspecified ‘hair cut’ (loss) on the face value of the bonds.
Under its proposal, the Co-operative Group would retain an equity stake in the Bank of between 50% and 75%. But the LT2 Group, it has been reported, put forward a substantially different option. It seems to have suggested that the bondholders swap debt for equity at the debt’s face value. In addition, the hedge funds would inject new capital as shares, preventing the need for a public share issue. This option would entirely wipe out the Group’s equity stake and have the effect of a complete demutualisation of the Bank.
Such an outcome is resisted strongly by the Group and it seems likely would require a complete overhaul of the organisational and management structure of the Bank – and a name change. Mark Taber believes it would also fall foul of the regulatory body, the Prudential Regulation Authority. “Change of control of a UK bank is a massive thing,” he says. Regulators would take a close interest in matters like capital support, compliance systems and whether the new owners are regarded as fit and proper people to run a UK bank. This is not intended to imply that the hedge fund managers would not pass this test, but running a hedge fund is very different from running a bank – and is probably not want they want to do. Taber believes that the hedge funds put forward their proposal not as a serious option, but rather to force the Co-operative Group to the negotiating table.
An option can emerge that is acceptable to the hedge funds, other institutional investors (who have their own representative group) and the retail bondholders, suggests Taber. “I actually think you can structure something with what the Co-op has announced and which would raise some capital,” he says.
For the Co-operative Group, the objective is to emerge with the biggest possible equity stake in the Bank, preferably more than 50%. But it is perhaps significant that a recent Financial Times article speculated on the Group ending up with a minority equity stake. For the retail bondholders, the priority is to be left with a capital instrument that continues to pay an income. And for the hedge funds, the objective is to achieve a profit over the position they bought into when they acquired bonds that had little market value.
Alongside the onset of negotiations, the Co-operative Group has set up an independent committee of the Bank’s board to consider the proposals from the hedge funds and other groups. The committee comprises the Bank’s new chief executive, Niall Booker, its new non-executive chairman, Richard Pym, and the Bank’s independent non-executive directors. They are being advised by UBS. Under the new arrangements, Booker ceases to be also the deputy chief executive of the Co-operative Group – possibly indicating a much greater separation of Bank and Group.
Almost simultaneously, deputy chief executive Rod Bulmer has resigned, but will serve out six months notice. I understand the Bank tried hard to persuade Bulmer to stay on, but he was determined to leave. He is a sales person by background and presumably wants to revert to a role that expands a business, rather than continue to work for an institution that is seeking to consolidate where it can while shrinking its business. Bulmer, along with former chief executive Barry Tootell, was in charge of the Project Verde operation, I understand.
The issue of how close the Bank should be to the Group has been given a fresh perspective by the evidence of former Co-operative Financial Services chief executive Neville Richardson to the House of Commons Treasury Select Committee. It seems that the current moves towards separation are to a significant extent the rowing back of events of the last three years.
Under Peter Marks’ leadership of the Group, there had been much closer integration of Bank and Group, under the rather grand title of Project Unity. While much of Neville Richardson’s evidence has been strongly criticised, there should perhaps be some serious consideration of his comments Project Unity.
“During 2010 I became increasingly concerned at Co-op Group’s aim to fully integrate CFS within Co-op Group from a management and administrative point of view,” said Richardson in his written evidence to the committee. “I made my concerns that this would cause serious disruption and distraction to the CFS business known to Len Wardle (Group Chair) and Paul Flowers (CFS Chair) on a number of occasions. I felt that the agenda was being driven from Group, and by Peter Marks in particular. It was not taking into account the risks which would be created in the bank.
“I expressed my concerns to Peter Marks directly in April 2010, when he first told me that Project
Unity was going to take place in 2011. I also expressed these concerns to Paul Flowers and Len
Wardle at the Annual Board offsite in July 2010 and at a dinner between the three of us in June/July
2010. I believed that the disruption at a time when the Britannia merger was not complete and the
IT systems replacement was in progress was highly dangerous. I sat on the Project Unity steering
committee and frequently made my concerns over timing and potential disruption to the bank
known.
“The integration commenced in early 2011. My reporting line changed from the Chairman and Board
of CFS to Peter Marks. Project Unity gathered pace and it became apparent it would involve
transferring responsibility for key bank activities including finance, strategy, HR, communications,
governance, legal and internal audit to Group control.”
Given events of recent months, the entire rationale – and cost – of Project Unity will need to be examined. While the Bank faces a struggle to survive the threat of demutualisation, the observations of Richardson appear to suggest that it is not only the expansion plans that have thrown into abrupt reversal.