LT2 Group set to take the reins at Co-op Bank after sub debt holders attack

Louise Bowman
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Bondholders will vote on a revised offer by November 29; failure to pass resolution will trigger insolvency.

The restructuring proposal announced by the Co-operative Bank on Sunday represents a vastly better deal for its subordinated bondholders than the original debt-for-equity scheme it put forward on June 17.

The deal is also the product of months of dogged campaigning by various bondholder constituencies against the initial “take it or leave it” proposal by the bank.

“There was vocal opposition from retail investors and lower tier 2 (LT2) bondholders to the first proposal and it became clear to the directors of the bank that a consensual solution needed to be found,” says Stephan Wilcke, a member of the informal bondholder steering committee.

Co-operative Group chief executive Euan Sutherland
That clarity was achieved after substantial pressure from LT2 bondholders, who hold 48% of the bank’s subordinated debt, and a steering committee of retail investors, which holds upper tier 2 (UT2) debt and preference shares. The new deal sees the mutual group cede control of the bank to its bondholders.

Bondholders have until November 29 to approve the new proposals – a tight deadline for a group that includes between 10,000 to 15,000 retail investors and which holds £150 million of the bonds. Most retail investors hold 13% UT2 perpetual securities – previously permanent interest-bearing shares issued by the Britannia Building Society.

Holders of these securities and the 9.25% preference shares are being offered two options to preserve income: either a 12-year subordinated bond offering an 11% coupon but entailing a haircut – 15.6% for the UT2 securities and 39.9% for the preference shares – or a 12-year instrument equivalent to existing coupons and principal but offering no principal repayment.

“This is a really good outcome,” says Mark Taber, who led the retail investors’ campaign against the initial proposals. “If you discount the cashflows on both options it comes to about the same, so it will be interesting to see how the market prices both options.”

Depending on how the new cashflows are held, they will qualify as repayment of principal and might be tax-free. Opinion seems to be that the second option, under which existing coupons and principal are paid but capital is lost, might have the tax advantage.

Co-operative Bank subordinated debt outstanding also includes £200 million 5.55% UT2 securities, which are not true perpetual instruments. Holders of these bonds are being offered an exchange into new 11% tier 2 bonds at a 47% haircut.

The 13% bondholders are being offered new subordinated instruments in Co-op Group while the 5.55% bondholders are being offered new subordinated instruments in Co-op Bank. Coupons on both are mandatory, rather than the deferrable coupons on the existing securities.

LT2 bondholders, who have driven the revised recapitalization plan, will overwhelmingly be swapped into Co-op Bank shares under the exercise – 10% of them will get new 10-year tier 2 notes – and will be able to subscribe to £125 million of new shares. This will give them 70% ownership of the bank.

The entire liability management exercise (LME) will raise new capital of around £1.062 billion, on top of – which the group itself will contribute – £333 million from the sale of its insurance business. This goes a long way towards meeting the £1.5 billion additional capital required by the Prudential Regulation Authority.

“Crisis has been averted for the bank, the group, the bondholders and the UK government,” says Oliver Burrows, banks analyst at Rabobank in London. “Though not a done deal until voted for, this is the best, albeit only, way out for subordinated bondholders.”

The plan now needs to be agreed by a substantial majority of those subordinated bondholders. The deal is interconditional – meaning that all classes of securities have to take part and approve it. That could be a tall order, given the nature and number of investors involved.

“People need to vote by November 29 or they will get nothing,” says Wilcke.

The bank has been quite explicit on this point. “The bank believes that, if the LME does not succeed, the only realistic alternative is resolution of the bank under the UK Banking Act 2009,” it warned on announcement of the deal, adding it “believes that if the bank were to enter into a bank insolvency, all holders of the existing securities would receive no recovery at all”.

The bank appointed Canaccord Genuity to provide an independent financial opinion on whether the LME is fair from a financial value perspective for the classes of bonds and equity held by retail investors.

“Under Plan A, there would have been fairly large haircuts all round,” says Taber. “Retail investors needing to sell on day one would have faced significant losses. Now they can preserve income for 12 years and get a substantial amount of capital back as well.”