The Co-op Bank: how not to manage a crisis

by George Hatjoullis

It is always best to get all bad news out-of-the-way quickly and in one lump. Good news however is best allowed to seep out slowly and at regular intervals. Regular positive surprises create a feel-good environment which can become self-perpetuating. Regular negative surprises corrode trust and can lead to a collapse of confidence. This is certainly the case in banking.

The Co-op management appear to be providing business schools with a nice case study in confidence management within banking. At the start of the year the Co-op was going to buy a chunk of branches from Lloyds, encouraged by the government. However, by February it was public knowledge that it could not because its capital base was inadequate. The reaction in the price of its junior debt was remarkably muted until the bank was downgraded by several notches in May. The price then fell off a cliff and everyone became aware that the Co-op bank had problems. Quite why it took so long is a mystery. All this has been covered in detail in earlier blogs.

A rescue plan was constructed which involved bailing in the junior bond holders and a big capital injection from the Co-op group. The plan has been resisted by the junior bond holders even though junior debt exists, and is priced at issue, to perform precisely this function; capital buffer. As a result of this resistance, the Co-op has remained in the headlines as having ‘problems’ all through the summer. Trust has been corroding continuously.

Today, the Daily Telegraph publish a report ( noting that the Co-op has ‘improved’ the method of valuing its loan book and now calculates the ‘fair value‘ of its loan book to be £3.6 billion less than it had thought.The ‘fair value’ is meant to reflect the market value of the loan book. It is compared to the book value minus any impairment adjustment and the revelation is that the fair value is £3.6 billion less than the book value less impairment adjustments. The implication is that further impairment charges will be made.The bank has indeed warned of further provision for bad debt.

Further bad debt provision implies further erosion in its capital base. It must either make up the capital erosion through retained earnings or raise more capital. It made a large loss in the first half of the year. It could bolster capital further by bailing in bond holders again. The corrosion of confidence continues and at some critical point it could become a (mathematical) catastrophe and result in an exodus of deposits.

The big issue of course is what would the government do? Would it effect a Northern Rock-like rescue of senior bond holders and uninsured depositors or would it seek to bail them in as happened in Cyprus to Laiki Bank and the Bank of Cyprus? From past behaviour, one would assume that the UK government would bail out the senior bond holders and uninsured depositors. However, all those junior bond holders would quite probably lose the rest of their value. Past behaviour is no guide to the future. The big question is does the Co-op represent a systemic risk and the answer may be that it does not.

The interests of all the stakeholders in the Co-op would be best served by a quick resolution to the Co-op problems and ceasing this constant drip of bad news.Otherwise the stakeholders may argue themselves into much more serious losses.