How do you solve a problem like the Co-op bank?
The Manchester lender is back in the headlines — and not just because of its Crystal Methodist former chairman
Sohail Malik took a deep breath. It was 7am last Thursday and the 43-year-old hedge fund manager had been taken aback by a message that had buzzed on his mobile phone as he set off on his morning commute.
The Co-operative Bank had just revealed to the stock market that it was in further bother with the Bank of England. The former mutual had already been given a break by the regulators and granted permission to let its capital levels dip further than desired while it got back on its feet. It had just admitted it could no longer honour those promises — and that it had no prospect of doing so before 2020.
Malik was one of the investment managers who bankrolled the Co-op bank before a turnaround plan. He sold out after a hole emerged in its books more than three years ago, which prompted a gang of hedge funds to seize control from the Co-operative Group’s supermarkets-to-funerals empire.
The brief statement from the ethically focused lender left Malik wondering how long it would be before the Bank of England has to push for a more radical reform of the bank — one that could even see it wound up, with its savings and loans sold off to another lender under the watchdog’s cautious gaze.
“The only way the Co-op bank gets out of this mess is through a miracle restructuring plan, but as we saw on Thursday’s statement, this is not happening,” said Malik. “The Co-op bank is in no man’s land.”
The bank had told the market it would keep its tier 1 capital ratio — a measure of its solvency — above 10%. Yet its forecasts had relied on an assumption that interest rates would be rising by now, allowing its profits to improve. When rates are rising, banks make more money.
Last summer’s rate cut to 0.25% in response to the June 23 vote to leave the European Union had derailed all the projections. The Co-op bank’s attempts to sell assets to raise money had also gone off track, the statement revealed.
Roxbury Asset Management, where Malik works, is no longer an investor in the bank. Yet he is not alone in his concerns. One of its biggest investors has told The Sunday Times that the lender is unlikely to remain in its current form “for very much longer”. Senior sources close to the bank have said the Bank of England is monitoring the situation daily, and debating whether to take further action.
Rival banks, meanwhile, claim to be on alert to see whether there will be an opportunity to cherry-pick what remains of the once-feted Manchester-based lender, which continues to champion causes such as financial inclusion.
Creditors are already voting with their feet. A sell-off of the bank’s debt suggests that holders of a £400m bond, which must be repaid in September, are braced for heavy losses. None of this should be any cause for concern for the bank’s customers. Even in the worst-case scenario, depositors would be protected, as they have been in previous bank crises.
Yet the situation has evolved into an increasingly bizarre test for the Bank of England, and the new powers it was given to rescue banks after the global financial crisis and the collapse of Royal Bank of Scotland, HBOS, Northern Rock and Bradford & Bingley.
The cuddly ethical lender seems to have been treated more leniently than bigger banks such as RBS, which have been forced to raise extra capital from a healthier position. The City is looking for answers.
“It’s hard to understand why the Co-op bank is getting all this support. It’s only a matter of time before the Bank of England accepts that it’s flogging a dead horse,” said a senior City banker.
Last weekend, listeners of Radio 4’s flagship religious Sunday programme had the rare experience of hearing the story of a fallen Methodist priest: Paul Flowers.
Better known as the “Crystal Methodist”, Flowers, 66, is the former chairman of the Co-op bank. He had finally been dismissed as a minister, three years after he was secretly filmed buying crack cocaine, crystal meth and the horse tranquiliser ketamine. His addiction, Flowers confessed, remains a problem. “I’m not going to tell you a lie that it’s behind me totally, because it isn’t,” he said.
For critics of the Co-op bank, Flowers is a totem of what went wrong. At a car crash meeting of the Treasury Select Committee in November 2013 — as the Co-op bank’s problems had been flushed into the open — he was unable to answer the most basic questions about the bank, leaving many to query how he came to sit at the helm of an “ethical” lender.
The Co-op bank was never a normal bank. Having evolved as the financial wing of the Co-operative movement — the bastion of mutually owned capitalism established by the Rochdale pioneers — it always had a different character.
Yet, he was not the only Co-op director who lacked the experience to sit on the board of a bank. Around the Co-op’s boardroom table sat a disparate crew of the mutual’s members, including a plasterer, a nurse and a farmer.
Amid the ashes of the 2008 financial crisis, it became fashionable in Westminster to see the Co-op bank and other mutually owned lenders such as building societies as the path to a safer financial future. It was always a misguided notion.
Britain’s financial crisis was not really caused by “casino” investment banks gambling on sub-prime mortgage bonds. The real problem was excess lending for property. Many of the country’s mutually owned lenders were as deep in the mire as RBS or Northern Rock.
“There was never anything explicit said to us about the need to protect mutuals, but there was something in the ether at the Treasury,” one Whitehall source who worked on the bank bailouts later told The Sunday Times.
“We knew we couldn’t tell the world in 2008 that there were big problems in the building societies, as there wasn’t a lot we could do about it. And we had plenty of other things to deal with.”
In 2009, the Co-op was given the green light to buy Britannia, a building society weighed down by millions of pounds in problem commercial property loans. It was breathlessly described at the time as the creation of a “super-mutual” to take on the “nasty” high street banks.
Britannia was said to have been at the top of the Bank of England’s watchlist of potentially problematic institutions, having racked up big exposures to commercial property.
Before the two businesses had even been integrated, the new super-mutual made an attempt to expand further by tabling a bid for a network of 632 branches put up for sale by Lloyds Banking Group — the business now trading as TSB.
That ambitious move fell apart, around about the time that the parlous state of the Britannia loan book became apparent. For 2012, the enlarged Co-op-Britannia racked up a near-£700m loss. By the end of the following year, after a thorough audit from the Bank of England, it was apparent the group was facing a staggering £1.5bn shortfall. To fill its badly depleted coffers, the Co-operative Group was forced to hand over control to the hedge funds and agree to a radical turnaround plan.
HSBC veteran Niall Booker took the reins in 2013 as chief executive and was paid a whopping £3.85m in 2015. Yet after three more years of losses, and three years of access to Bank of England emergency funding lines, progress has been slower than expected. Booker left last month.
The crunch point could come this September. The Co-op bank must repay a £400m bond, just as its profits tumble and capital buffers erode. The unsecured bond is now changing hands at 91p in the pound. That may not sound catastrophic, but it implies a borrowing rate of 10% on a nine-month loan — a clear sign of investors’ growing concern they may not get back all their money.
Analysts have raised questions about the long-term future of the bank and have previously warned it faces a £1bn hole in its finances.
Meanwhile, the Bank of England is facing a philosophical dilemma. Does it step in and test rules that were brought in to manage a bank collapse? With a sub-5% market share, the bank is not deemed to be a systemic risk to the British economy. A wind-down could be relatively painless. An easier option would be to hold out for a white knight, but that would require yet another costly restructuring.
Rival bank bosses say, at the right price and for the right assets, they would be willing to launch a rescue bid. “One thing you can say about the Co-op bank is that through all of the difficulties, customers have remained loyal,” said the chief executive of a rival bank. “If they split out the good bank from the bad bank, there would be interested parties.”
Accounting for Co-op
The shortfall in capital held by the Co-op bank
The total value of loans issued by the Co-op bank
What former chief executive Niall Booker received in pay and bonuses in 2015