Co-op blinks first

By:
Louise Bowman
Published on:

Bondholders likely to take control of lender after heavy-handed management intransigence.

As an exercise in face-saving, Co-operative Bank chief executive Euan Sutherland’s recent comments on the UK bank’s restructuring take some beating.

“This is the first bank to be rescued and to survive as a standalone entity without taxpayer money,” he crowed in late October on the news that a deal with bondholders over the future capitalization of the bank had finally been agreed.

What he didn’t elaborate on was that this had only been reached after months of management hubris and intransigence over the situation the troubled lender finds itself in.

The Co-operative Bank, which is not a mutual but is wholly owned by the mutual Co-operative Group, announced a controversial restructuring earlier this year that sought to impose losses on bondholders, but not on shareholders.

This reversal of the basic creditor hierarchy proposed that a £1.5 billion ($2.4 billion) capital shortfall at the bank identified by the Prudential Regulation Authority should be filled with £500 million from bondholders via a debt-for-equity swap together with proceeds from the sale of assets and the issue of new debt.

To add insult to bondholder injury, the Co-op stated that its own £500 million contribution would be conditional on bondholders voting through the plan for a liability management exercise.

Having laid out this proposal, Co-op Group management subsequently refused to engage with bondholders, adopting a unilateral “take it or leave it” stance. In early September, Sutherland, having stated there was no Plan B other than nationalization, said that management would only engage with bondholders once the details of the debt-for-equity exchange were finalized.

The management would “engage with affected bondholders and preference shareholders at the right time”, he said.

Restructuring a bank is a messy business and this is not the way to go about it. Infuriated bondholders swiftly organized themselves into lobbying groups: one comprising lower tier 2 bondholders; CLS Holdings, which has 2% of the debt; and retail investors represented by Mark Taber.

Having built up a sufficient stake to block the original deal, lower tier 2 bondholders, led by activist hedge funds Aurelius Capital and Silver Point Capital, came up with an alternative plan that involves bondholders taking control of the bank. The management finally found the right time to engage with its creditors at the end of September, when it agreed to consider the bondholders’ plan. It is taking advice from Greenhill while Moelis is working with the bondholders.

The outcome of management’s brinkmanship is that bondholders are now set to control 70% of the Co-operative Bank with Co-operative Group reduced to a 30% shareholder. The tacit threat that the group would not inject new capital into the bank until its liability management exercise offer had been accepted by bondholders was aggressive and heavy-handed.

Compound this with the fact the capital hole is necessary because of bad real-estate lending (admittedly largely attributable to the Britannia Building Society acquisition), the abortive Project Verde attempt to acquire branches from Lloyds (which incurred the bank costs of £38.1 million in 2012 and £34.6 million in 2013) and evidence that £148.4 million of IT development costs incurred by a sister group company were charged to the bank, and the value to it of being owned by the mutual has to be called into question.

There might shortly be around 10 activist hedge funds with an important stake in this bank, something many of its customers find deeply unsettling.

Sutherland sought to allay these concerns when news of the bondholder deal broke. “We have embedded the Co-op’s values into the constitution of the bank,” he said.” That’s the reason the franchise is a success. The hedge funds get that.”

It is in everyone’s interest that management failures are not embedded into the constitution of the bank as well.