Co-op Bank
The Co-operative Bank is a Public Limited Company, which is wholly owned by the Co-operative Group.
Until recently it was called Co-operative Financial Services
The Group remains essentially a food retailer and farming business that also does other things – financial services, funerals, pharmacy, until recently travel and has recently broken into legal services.
The Group was originally the wholesaler for local retail societies, such as the Belfast Co-operative Society. It has grown to become a national and giant food retailer through the rescue of various large local societies and by achieving economies of scale through retail mergers.
The food business has been in long term decline. It moved out of direct competition with Tesco, Sainsbury’s, Asda and Morrison by closing or selling hyper markets and concentrating on convenience shops. However, Tesco and Sainsbury’s have built up their convenience store portfolios, challenging Co-op’s position in that sector.
Under Peter Marks’ leadership, Co-op Group recognised its vulnerability and adopted a strategy of focusing on core activities. Those core activities were where it had distinctive value and could achieve scale. Where it could not achieve scale and where it could not be confident of generating long term, sustainable, returns, it would exit.
It therefore sold Co-operative Travel to Thomas Cook, to give the merged business better economies of scale and achieve synergies by closing some branches. This was called a joint venture, but was essentially a sale on partially deferred terms, subject to milestone conditions.
The Group strengthened the food division through the very difficult acquisition of Somerfields.
Marks was also keen to create a stronger and more unified branding across the Group and across the movement. His comment was the problem with the Co-operative movement was that it didn’t co-operate and didn’t move. An expensive rebranding and store upgrade programme was embarked upon.
A parallel approach was taken by the Bank. Project Unity was intended to make the Bank more recognisably part of the Group and to improve cross-selling between the retail database and what was then the Co-operative Financial Services’ customer base. At that time, CFS had three major businesses – the bank, general insurance and life assurance.
CFS embarked upon a very expensive IT system upgrade, which I was told would create the most up to date and highest quality IT system of any UK banking business. However, we have still not seen the benefits of this and the Co-op Bank’s IT system still does not support smart phone banking – which the Ulster Bank says is the fastest growing segment of retail banking. The Bank’s new restructure will involve a £500m investment in IT, proving this is a big weakness and a telling strategic failure.
At the time, David Anderson was CEO of CFS. He initiated a parallel move for the Bank to the Somerfields acquisition by the Group. To create scale for CFS, it acquired the Britannia Building Society under a nil payment acquisition. Neville Richardson, the CEO of Britannia would take charge of the merged business.
The logic of the deal was that the two businesses provided a very useful synergy. Britannia was strong in mortgages and savings, where the Co-op was weak, and it had a large branch network. The Co-op had a small branch network, but had current account facilities and a clearing bank licence.
Peter Marks says that the Group board was reassured regarding the deal by the due diligence conducted by KPMG. But I am told that KPMG only did due diligence on the retail mortgage book. We now know that Britannia’s weakness was the result of its lending in non-core activities – these were commercial mortgage loans and buy-to-let, self certified and high loan to value mortgages. I’m told that KPMG was not asked to do due diligence on these, nor on the acquisition as a whole.
The acquisition was enabled by an Act of Parliament originated by Sir John Butterfill, which enabled different types of financial mutuals to merge.
The acquisition of Britannia reversed key elements of the previous organic growth strategy. The new IT system was no longer appropriate and the focus moved to banking, lending and saving, not on insurance. The IT system had been intended to improve cross-selling between the banking and insurance businesses.
The old leadership of Britannia became the basis for the new leadership of CFS. The scale of losses began to emerge, but the implication of a Moody’s credit report was that these were not adequately reported in the annual accounts.
To cover these losses, CFS moved to sell its two insurance businesses. The life assurance business was sold to Royal London, another mutual, while the general insurance business was put up for sale. Because these were in effect distress sales, the market value has been depressed and the sales have been difficult.
Meanwhile, the Group had pushed ahead with Project Unity. This would greatly strengthen the branding and mutual recognition across the Group and Bank.
Although Neville Richardson was appointed deputy chief executive of the Group as a result of Project Unity, he was deeply unhappy about the level of influence the Group might exert over the Bank through Project Unity.
It was the adoption of Project Verde, against the wishes of Richardson, that pushed him into resigning, arguing that the Bank had become over-stretched. Project Verde was the proposed acquisition of 630 Lloyds TSB branches, along with their customers. Marks was very keen on this, as was Barry Tootell, who had been CFO of the Bank and became acting CEO of the Bank.
But the capital position of the Bank had been effectively destroyed by the collapse in value of much of the non-core Britannia loan book. Moody’s could be said to have forced the Bank’s hand by massively downgrading the Bank, seemingly implying the real level of losses was likely to be greater than had at that time been reported.
At this point, the Bank became imperilled. The regulator was already concerned. High levels of losses were then reported, not just on Britannia, but also on the IT system – which was now recognised as wholly inappropriate for any possible emerging scenario – and on Payment Protection Insurance mis-selling.
This demonstrates that the problems were not just with Britannia but within parts of the Co-op Bank’s own business. The Co-op Bank although claiming to be an ethical bank had made two serious sales mistakes, which were similar to the rest of the UK banking industry. It had mis-sold PPI and moved into the Independent Financial Advice sector. The IFA move was, I believe, a clear mistake, which would have been difficult to undertake ethically. In my opinion, the IFA activities were of poor quality and unprofessional. This shows the tensions between the proclaimed ethics and commercial pressures.
At the same time, the Bank of England and the world’s banking regulators agreed to increase the capital requirements on banks to prevent future government bail-outs. The Co-op didn’t meet existing requirements if it adequately wrote-down its bad debts. It certainly didn’t meet the new requirements. The regulator identified a £1.5bn capital shortfall. However, the Government had meanwhile also made clear that any future state bail-outs would be restricted to systemically important banks – which the Co-op is not.
But it was the Britannia non-core loan book that took the Co-op Bank down. It was not Project Verde. Project Verde collapsed because the Co-op Bank failed to meet capital adequacy requirements.
There were then in-depth conversations between the new regulator, the Prudential Regulatory Authority, and the Co-op Bank. They agreed to ‘burn the bondholders’ converting bonds into a minority equity stake. This involved the Group putting new equity into the business through a new bond issue and injecting cash from the sale of the two insurance businesses.
However, this proposal hit three difficulties.
- As the Financial Times reported, this reversed the normal resolution process of shareholders taking the first hit and then the bondholders.
- Large numbers of bondholders were elderly pensioners, many with a history of engagement in the co-operative movement, who wanted regular cash payments to enhance their pensions or meet residential care costs and who would obtain no benefit from long term gains on share values.
- The approach could only work if the majority of bondholders approved the proposal. It became clear they would not.
Three groups of bondholder action groups were formed. One was the retail bondholders. The second was UK institutional investors. The third was hedge funds, often called vulture funds, which specialise in buying-up distressed debt and taking aggressive legal action to maximise their returns. These were led by Aurelius and Silver Point. They built up a sufficiently strong holding of bonds that they acquired at low cost from institutional investors. The hedge funds were then able to block the proposal from the Group and the PRA.
The result is that the Bank will be listed on the London Stock Exchange. It may have to change its name as it will no longer be a co-operative. The Group will hold a 30% share holding. The hedge funds will have an equity stake of about 35%, with other institutional investors holding between 30% and 35%. The retail investors will have newly issued replacement bonds that generate cash payments.
All the investing groups have agreed the need to reaffirm the ethical trading principles.
The former directors continue to argue that the reason for the Bank’s collapse was the scale of the financial crisis, that basically they did nothing wrong and they would do the same thing again regarding Britannia if they replayed history.
What have we learnt?
- 1. There are dangers for a mutual moving beyond a strategy of organic growth, conservative acquisitions and cautious business strategies.
- 2. Due diligence needs to be comprehensive.
- 3. There are serious dangers from changes in leadership and core strategy that lead to comparatively short periods of senior leadership and inconsistent business strategies.
- 4. Elements of core strategy such as ethical trading principles have to be embedded across all parts and activities of the business.
- 5. There is a serious problem for a financial mutual in dealing with shortages in capital because they cannot raise capital in the market without degrading their mutual status.
- 6. There are serious questions about the quality of some of the past executive and non-executive leadership and corporate governance.
5 November, 2013