The battle for control of The Co-operative Bank is probably now moving towards its endgame. A prospectus is to be published at some point in the final three months of this year – possibly at the end of October. We should then know whether bondholders have accepted the proposed resolution lodged by the Bank and the Co-operative Group.
Over recent weeks a significant shift in attitude has taken place at the Group. Initially, requests by bondholders to meet with the Bank were rejected. Bondholders complained they were given a response that was akin to ‘take it or leave it’ – the ‘it’ being detailed proposals to be revealed later in the year in the prospectus, but of which they had little knowledge. The underlying principles are that the bank’s £1.5bn capital shortfall in the bank would be bridged through the sale of life assurance and general insurance arm, the conversion of £500m of bonds into equity and an additional £500m to be invested by the Group.
Bondholders were angry and demanded to meet with the Bank and Group. I understand that UBS, which is advising the Bank and Group, now meets bondholder representatives on a regular basis. Those bondholders can be divided into three groups. There are the retail investors, including pensioners who rely on the income from their bonds and many of whom invested because of a commitment to the co-operative movement. Their representative is Mark Taber of Fixed Income Investments.
A second group are the UK based institutional investors, who it is reported are being organised with the help of the Association of British Insurers (though the ABI declines to confirm or deny this). This group has remained tight lipped. Mark Taber’s take on this is that these institutions do not want it publicly noticed that they invested in bonds that have now fallen substantially in value. Their interests are also to maximise their income and I am told they may be unhappy at the prospect of accepting equity in place of income generating debt.
The third group are the hard hitters – the so-called ‘vulture’ hedge funds including Aurelius and Silver Point, which specialise in buying distressed debt and using legal recourse to maximise their returns. Aurelius and Silver Point are, along with another eight funds, represented by the investment bank Moelis. I understand that UBS is now liaising closely with Moelis, with the objective from the Bank’s point of view of the prospectus proving acceptable to the hedge funds, as well as to the other classes of bondholders.
However, it is not yet clear that the hedge funds will be won over – and if the publication date of the prospectus slips much into November or possibly into December, that could be a clear indication that a consensus on the proposed resolution has not been achieved.
There has been speculation that the new regulator, the Bank of England’s Prudential Regulatory Authority, has met with Moelis to ensure that if the bondholders take control of the bank they will do so in a way that is acceptable to the PRA and that the team that would take over the running of the bank would pass the PRA’s competence test.
Indeed, The Times published a report earlier this month stating that the PRA’s chief executive Andrew Bailey had met with Moelis, on behalf of the hedge fund bondholders. Neither Moelis nor the Bank of England will comment on this, but I have been assured by one very well placed source that The Times is wrong and no such meeting has taken place.
According to speculation, the hedge funds recognise they would not get authorisation from the PRA to run the Co-operative Bank if they manage to convert their debt into a controlling equity stake. Nor are they actually keen on running a bank. It is therefore more likely that they would sell their shares to a private equity firm. Several private equity firms have been keen to enter the banking market, some having already assembled teams of experienced bankers in an attempt to takeover an existing UK banking operation. These teams are sufficiently strong that they would presumably gain approval from the PRA.
We can guess that some private equity firms would be keen to take over the Co-operative Bank. JC Flowers is one possibility, having in effect taken control of the Kent Reliance Building Society. However, JC Flowers may currently be fully occupied in its position as a prime candidate to takeover the TSB brand that would have been the Co-op’s if Project Verde had not collapsed.
Despite the PRA playing a close watching brief on developments regarding the Bank, there have been strong criticisms emerging of the PRA’s previous approach to the crisis. Bondholders have alleged that the PRA worked exclusively with the Bank’s management to reach a solution, without sufficiently taking into account bondholders’ interests. Mark Taber has been the most vocal of the critics, alleging that by failing to publicise its private concerns about the Bank’s capital shortage, the PRA effectively allowed a ‘false market’ in the bonds to take place.
There is a further concern, affecting not only the PRA, but also its predecessor, the FSA, the Financial Services Authority. It is now clear that the Bank’s leadership at executive and non-executive level was not sufficiently strong. Neville Richardson was approved by the FSA as chief executive of the merged Bank, but was his experience at Britannia sufficient to lead the Bank? With the benefit of hindsight – and a clearer view of the real situation inherited from Britannia – the answer seems obvious.
The weakness at non-executive level has been implicitly recognised by the Bank and Group with the just announced changes to the Bank’s board. Even the Group chair, Len Wardle, has stepped down from the Bank’s board. Duncan Bowdler, Peter Harvey and Bob Newton have all also resigned as non-executive directors. The only remaining Bank directors without experience at a senior level of the banking industry are Group CEO Euan Sutherland and Ben Reid, CEO of Midcounties Co-op.
Further directorial changes are to follow. Three new independent non-executive board members are being recruited, plus another from the Group. This should place the Bank in a position where it is compliant with the UK Corporate Governance Code. In addition, the current deputy chief executive Rod Bulmer will be leaving in a few months and will be replaced.
I understand the directorial changes are not as the result of pressure from the PRA, though presumably the PRA is aware of them and is content. The PRA has worked closely with the Group in recent months to improve governance arrangements at the Bank. The new board is part of the measures taken to obtain support for the prospectus and is intended to provide reassurance to the wider range of shareholders after the debt for equity swap takes place. The board reorganisation is, though, another indicator of the extent to which the Bank is becoming separated from the Group, reversing the so-called Project Unity unification process even before it was completed.
This is a tough time for officials at the Bank and the Group. They are simultaneously fixing organisational and financial problems at the Bank, while drawing up a prospectus for the share issue. The Group will also have its own challenges that need to be resolved, without allowing the crisis at the Bank to deflect them too much.
The review by Sir Christopher Kelly will hopefully reveal much about how this disaster for the Group and wider movement came about and what lessons should be learnt. But the regulator needs to also consider how and why the failure in regulation happened. That is not to deny the Bank’s and Group’s responsibilities – must merely stating the obvious that regulators, as well as boards, are supposed to prevent banking disasters.