UK banking and the Co-op bank: what is going on?
by George Hatjoullis
Early in May Moody’s downgraded Co-op bank by six notches from investment grade to junk. Now that is a discontinuity. Something new must have been discovered and it was not good. The new discovery was a large hole where the bank’s capital should have been. It came to light during the Co-op’s planned acquisition of a chunk ( 632) of Lloyd’s bank branches (and attached customers). Except that it was not new, at least not in May.
The capital shortfall and the consequent impossibility of consummating the Lloyds bank branch purchase was flagged in the FT on February 26, 2013 (http://on.ft.com/ZAfptJ). The subsequent downgrade by Moody’s was reported in the FT on May 10, 2013 (http://on.ft.com/12mYzAo). Why did it take so long to implement the downgrade? More important, why were Co-op bank management pursuing such an aggressive expansion without appropriate capital resources? Even more important, why were the government so supportive of the purchase, and dismayed at its demise ( http://on.ft.com/10ONL7A), given the inadequate capitalisation of Co-op bank? Do they want another bank failure?
The source of the capital problem seems to date back to the acquisition of the Britannia building society ,and its less than healthy mortgage book, in 2009. Does this sound familiar? A very good analysis of the nitty-gritty of the Co-op bank case is provided on an ongoing basis by Mark Taber on (http://bit.ly/15mY7PZ) and which I recommend all read. The upshot is that subordinated debt seems capable of absorbing the capital short fall so senior bond holders and uninsured depositors are not at any serious risk. Moreover, the internal resources of the Co-op group may be able to help fill the capital short-fall so even the subordinated debt could remain unscathed. Nevertheless the Co-op bank remains at junk rating and the above questions remain unanswered.
The Co-op bank has since halted new corporate business. It is deleveraging. It is also experiencing some high-profile loss of local council business (http://on.ft.com/11dELbW). It is never good when a bank appears in the news with negative headlines on a regular basis. It is never good when a bank’s debt is rated junk status. It is never good when there is any uncertainty or confusion surrounding the condition of a bank.
The Co-op bank situation has arisen in isolation and does not pose any systemic risk. It is probable that it will succeed in raising capital without a bail in of subordinated bond holders. However, it is not a certainty and the rating suggests it is a material risk. Are senior bond holders and uninsured depositors at risk? Not on the basis of the existing data. Nor indeed on the basis of past practice in the UK ( see previous blogs on banking). However, if you have uninsured exposure to the Co-op bank it is wise to monitor developments. For the vast majority of the population this is impractical and, as a rule, by the time new information gets to them it is usually too late. This was certainly the case for those holding Co-op Perpetual Subordinated Bonds and preference shares.The above chart is of the Co-op 13% Perpetual Subordinated Bond, courtesy of the London Stock Exchange. The information flow to the common man is well illustrated. On February 26, 2013, the price stood at 167.2. On May 9, 2013, it was still trading at 153.5. On May 10 it fell to 105.5 before bottoming at 83.5 on May 14. On May 31, 2013, it stood at 91.5. The capital black hole was public information on February 26 but the significance of this was not priced in until May 10. Food for thought for the complacent.