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|
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.
Four different bondholder votes must now take place, all of which need a 75% threshold to pass: the LT2 group, holders of the 5.55% and 13% UT2 securities, and holders of the 9.25% preference shares.
The LT2 bondholders act as one class and will go through a UK scheme of arrangement. For the other classes, a quorum of bondholders is needed which must amount to two-thirds of outstanding bonds. Seventy-five per cent of those voting must approve to pass the resolution. If a second vote is required, the quorum drops to one-third of outstanding bonds for the 5.55% and 13% bonds, and there is no minimum for the preference shareholders.
There is no doubt that retail investors are better off under this plan than they would have been receiving equity under Plan A. The LT2 bondholders led by Aurelius Capital Management and Silver Point Capital now face a daunting challenge in turning the bank around.
Many of the lower tier 2 bondholders might well have acquired their bonds at a relatively low price they were quoted at levels below 70p in May, after the six-notch downgrade by Moodys, says Simon Adamson, analyst at CreditSights.
However, we are not sure that owning a majority stake in an underperforming bank would have been part of the original plan.
The bank is struggling with a $14 billion portfolio of non-core assets many of which are non-performing which could cause further trouble ahead as it is run down. The bank made an operating loss of £458 million for the first half of 2013 after taking loan impairments of £496 million.
Future impairment charges should fall as legacy bad lending is dealt with but substantial restructuring will still be required to return the bank to health. This is the challenge its new shareholders face.
We struggle to see the attraction of being a shareholder in a small, shrinking, loss-making UK bank whose future, despite the planned recapitalization, still looks uncertain, says Adamson.