Future of Co-op Bank hangs in the balance

Most of us can agree, I hope, that by any reasonable definition the Co-operative Bank is no longer a co-operative. For the time being, though, it retains the name and with the Co-operative Group continuing to hold a minority equity stake in the business, the Bank is likely to still be of interest to News readers.  Its latest financial results – for the first half of 2014 – are certainly of interest to me.


Often with financial results, it is not the headlines that a company or co-operative releases in its media statements that are the most important or significant. In the case of the Co-operative Bank’s just released interim financial report, I suggest that the most interesting section is the auditor’s report on whether the Bank is what is termed a “going concern”.  In essence, the going concern judgement considers the question of whether a business is viable and can continue trading.


The Co-operative Bank’s auditors are now EY – known until recently as Ernst & Young – which replaced KPMG, the long standing auditors who approved the Bank’s accounts in the run-up to its near collapse. EY indicates that the question of whether the Bank is a going concern is far from certain.  To quote the auditor’s report, the directors’ explanations of the Bank’s current trading situation “represent a material uncertainty which may cast significant doubt upon the Bank’s ability to continue as a going concern”.


While the directors are more positive about the situation of the Bank, their view is hedged. “The Directors have a reasonable expectation that the Bank will have the resources to continue in business for the foreseeable future”, they explain.  Financial reports usually take a much more positive view of their entity’s prospects for continuation as a viable business.


Specific issues that raise questions about the Bank’s going concern status include the necessary completion of its capital raising, the implementation of the turnaround plan and the necessary “ongoing forbearance” of the regulator, the Prudential Regulation Authority, regarding the Bank’s capital requirements. Problems with the progress of the turnaround, or a more demanding approach by the PRA, could lead to an additional capital requirement.  Failing to meet that could further jeopardise the Bank’s status as a going concern.


One of the elements of this, according to these financial results is “the continued ability of the Co-operative Group… to make the remaining 2014 contribution of £163m and to meet its other commitments to the Bank as they fall due”. The report adds that: “To date, all payments have been paid when due.”  It adds that the Bank is sufficiently confident that the Group will make this payment that this contribution is included in its financial projections.


Spokesman for the Group, Russ Brady, confirms it will make the due payment. “As part of the Group’s agreed capital contribution to the bank recapitalisation plan, the Group at the start of this year owed £263m: £100m of this balance was repaid on 30th June, leaving a balance of £163m, which will be paid on 31st December 2014,” he says.


It could be argued that the Group would be advantaged by now walking away from its engagement with the Bank and not meeting the remaining capital it is committed to provide. However, it is likely to have a legal obligation to making that payment.  The Group did not respond to a question on that point.


A bigger concern for the Bank is the likely outcome of the various investigations taking place into past decisions and decision-making. To quote the report: “The Bank is under intense regulatory scrutiny and expects that environment to continue. The Bank is also the subject of multiple regulatory and other investigations and enquiries into events at the Bank and circumstances surrounding them.”


These investigations include those conducted by the Treasury, the Financial Conduct Authority, the Prudential Regulation Authority, the Treasury Select Committee and the Financial Reporting Council. Those inquiries are distracting from other management functions, are likely to lead to significant financial penalties and their conclusions will inevitably provide reputational damage to the Bank.


Reputational damage is already inflicting pain on the Bank. There was a net loss of 28,199 customer accounts in the half year – which the Bank stresses is less than 2% of total accounts.  Moreover, while it has lost more customers than it gained, it attracted nearly 10,000 new customers – one of the best performances in winning new customers of any bank or building society.


The headline information released by the Bank does show an improving financial position. The pre-tax loss has been cut from £844.6m in the first half of last year to ‘just’ £75.8m in the first half of 2014.  The capital position of the Bank was significantly improved after raising £400m in May this year.  Compliance losses have fallen substantially, with provisions to compensate for the mis-selling of Payment Protection Insurance dropping from £163.0m in the first half of 2013 to £38.6m in the first half of this year.  Moreover, internal reviews of past sales indicate that there are no additional categories of conduct or legal risks for which financial provision needs to be made.


Moreover, previous asset write-downs have been shown to have been too pessimistic. This led to £86.7m of past impairments being written back into the accounts.


What we are left with is a slimmed down bank, focusing on core retail personal and SME business – but one which will slim down even further. Some 46 branches were closed in the first six months of 2014, with another 25 to go later this year.  More than a thousand full time equivalent jobs have gone, with a 21% fall in staffing.  Total costs were cut by £10m in the first half year – though staff costs rose by £4m compared to last year.  Whether that increase in staff costs was entirely the result of redundancy payments, or whether this also reflected higher executive pay, is unclear.  The Bank failed to respond to requests for information on this.


The scale of the continuing financial challenge can be measured, though, by reference to the cost to income ratio. As this column has discussed previously, financial institutions expect costs to be no more than 60% of their incomes – the target of the Co-op Bank itself.  During good times, banks may be able to bring this down to as little as 40%, or even lower.  However, over the last year the Co-op Bank’s cost to income ratio rose from 88.4% in the first half of last year to 96.3% in the first half of 2014.  This illustrates clearly that many of the turnaround steps being taken make matters worse in the short term in order to deliver what the Bank hopes will be a longer term financial improvement.


The situation facing the Bank remains grim. Despite this, chief executive Niall Booker, is optimistic.  “Considering the scale of the challenge we faced a year ago we are encouraged by the progress made to ensure the stability of the Bank,” he says. “By the measures of capital and liquidity the Bank is considerably stronger than it was a year ago. We are ahead of schedule in the disposal of non-core assets and have improved governance, particularly at board level. However, the issues we continue to face in building a sustainable business are deep rooted and there remains much to be done.”


What can we expect in the longer-term? It is difficult to avoid the conclusion from reading the financial results that the Co-operative Bank will continue to struggle as an independent institution.  Its branding has been damaged and the name is impossible to rationally justify.  There must be a suspicion, if not an expectation, that the current executive team is sorting out the Bank’s operations to make it attractive for a sale to a larger or leaner competitor.

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