Just how crucial were the banks in driving the reform process at the Co-operative Group? Very, is the simple answer.
The background to the Group’s debt owes more to the unwise acquisition of Somerfield than to that other disaster at the Co-op Bank, which was caused to a large extent by what it turns out was a similarly mistaken acquisition of Britannia. But at least the Britannia takeover was without a purchase price. By contrast, the Somerfield acquisition came with a big upfront cost – and continuing financial pain.
Somerfield was bought in 2009 for £1.57bn. This enabled the Group to double its market share, achieved by borrowing heavily on the markets. Most of that debt has not yet been repaid. Lord Myners observed, perfectly reasonably, that there was “nothing to show for that deal”.
Or rather there was nothing positive, but a considerable amount negatively to display. The Somerfield grocery empire was based on a disparate collection of stores, of different sizes and in many cases with inappropriate locations for the Group’s strategy of growth in the convenience store sector. Many of those stores came with very expensive leases. As a result, the Group still holds leases on more than 600 stores that are lying empty. That represents an annual lease cost of nearly £500m. Somerfield turns out to have been an extremely expensive mistake.
But the debt problem lies not only with the impact on profits. It also relates to damage in the control of the business. Debt of this level cedes control of the business, to a significant extent, to those who lend the business money.
Here we come to the syndicate of banks, to whom the Group owe a very large fortune. The role of those banks in pushing reform of the Group was made clear in a video posted on the Group’s website, in which the now permanent chief executive Richard Pennycook advocated the reform proposals, since adopted by the special general meeting.
“Throughout this crisis we have been working very closely with our banking syndicate,” he explained. “From time to time we have needed permission from them to do certain things. They have been very supportive.”
But the banking syndicate’s role in promoting reform – and, it could be argued, penalising the Group if reform did not take place – is particularly significant. “They have incentivised us to ensure that the governance reform goes through,” said Pennycook. “We will receive money back from the disposals that we have recently announced [ie the farms and pharmacy chain, and now also Sunwin] – money that we can use to invest in our businesses. That will only come back to us at the point where the governance reforms have gone through and the rule changes have been accepted by the Financial Conduct Authority.
“Those disposals are very important – they have allowed us to reduce debt, but they are also important because we can use some of that money to reinvest in our businesses. I can’t get that money until these reforms have been concluded.”
In truth, we should not be surprised the banking syndicate has adopted this very hard-nosed approach – it is the way bankers operate. The Group was placed in this situation of vulnerability by
the scale of its borrowings to achieve the Somerfield takeover, which created unsustainable debt, seriously damage to Group profitability and, it turns out, loss of ultimate control of the business.
It is in the public domain that one of the bank lenders is RBS. The Financial Times reported that RBS took the leading role on behalf of the banking syndicate in negotiating with the Group. This was denied to me by both RBS and the Group. However, we know that RBS has taken a very tough line in its negotiations with other debtors. RBS has been accused of preventing many businesses in trading difficulty from getting back into financial health, including by holding on to businesses’ income once they have entered the RBS ‘recovery’ unit.
This unit was called the Global Recovery Group, or GRG, and it has been slammed in a report by a then advisor to government, Lawrence Tomlinson. RBS strenuously denies any wrongdoing – but has recently announced that it is closing GRG. It is worth noting, irrespective, that in certain situations banks will prevent clients accessing funds received, if that income is less than the debt owed to their bank.
By coincidence, the Group has another problem with being unable to access capital from a disposal. It turns out that Royal London has not yet completed payment for its acquisition from the Group of its life insurance and asset management business. This is the reason the Group still owes the Bank a promised £163m. A further £180m to £200m may become payable by Royal London, once a court case is completed.
CIS operated two core businesses – general insurance and life insurance. Those two businesses operated a shared reserve, I understand. It is not yet clear how much of that reserve is owned by each of the two insurance businesses. Until that is resolved, the final payment by Royal London cannot be transferred.
A spokeswoman for Royal London confirms: “Part VII of the Insurance Companies Act sets out a process to follow for the transfer of an insurance business to another insurance company. The process requires the appointment of an Independent Expert who looks at the impact of the proposed transfer on the various groups of affected policyholders and submits a report to the financial regulators (FCA and PRA) [the Financial Conduct Authority and the Prudential Regulation Authority] and the Court, primarily considering the fairness of the terms of the transfer to all affected policyholders.
“This process is governed by law and must be approved by the High Court. The final payment from Royal London to Co-op is not part of what is being approved by the court, but is a contractual obligation arising from the terms of the sale to Royal London of Royal London (CIS) by Co-op. However, the payment is dependent on Royal London being able to release certain shareholder funds and the proposed release of those funds is one of the issues which is considered by the Independent Expert, and in turn by the financial regulators and the Court. The transfer is required to be approved by the High Court of England and Wales before it can proceed.”
I understand a court hearing will take place very soon that will indirectly determine the size of, and approve, the final payment from Royal London to the Group. While these matters are very technical, they are also very important.