Co-op boss says alternative to meeting regulatory requirements to cover £1.5bn shortfall is to put banking arm into administration
A thwarted attempt to become a major player in the banking industry earlier this year continued to haunt the Co-operative Group on Thursday as its bank reported a £709m loss and raised the prospect of a Northern Rock-style rescue if bondholders failed to back a £1.5bn restructuring bid.
The group, which has operations spanning funeral services to supermarkets, said there would be no quick fixes as directors conceded that shoring up the bank, which has 4.7 million customers, would involve job losses and significant restructuring of the wider group.
Richard Pym, the bank chairman, said that without new capital the banking unit "will not be a going concern".
The Co-op group's new chief executive, Euan Sutherland, said there was no plan B. The only alternative to meeting regulatory requirements to fill a £1.5bn shortfall in the bank's reserves would be a government takeover similar to the bailout of Northern Rock in 2008. Sutherland reported that losses at the bank of £709m sent the wider group into a £559m loss, compared with £18m of profits in the first half of 2012.
He blamed £496m of previously undiscovered bad debts and a £150m write-off on IT systems for the deterioration in the bank's financial situation. "It's inevitable in a restructuring of this size that there will be some jobs at risk," he said, predicting that the bank would be diminished from its current scale of 10,000 staff and 320 branches.
Sutherland said a new management team would devise a turnaround strategy with the management consultancy Oliver Wyman. Sutherland indicated that executives would receive bonuses next year despite the group's travails, saying that a remuneration plan will be announced in March that will reflect the need to retain experienced senior staff.
The Co-op's plunge into loss follows a difficult year that started with an audacious bid by its bank to buy 632 branches from Lloyds Banking Group and ended with the banking regulator insisting it abandon the deal and find £1.5bn to cover previously undisclosed bad loans.
The debacle stems from the Co-op bank's purchase of the Britannia building society in 2009, which had joined several other banks in making indiscriminate loans to corporate customers, many involved in overvalued commercial property deals.
Sutherland said the Co-op bank's bad loans were mostly accounted for by Britannia, with half of all its poorly performing retail loans and three quarters of its roughly £440m corporate bad debts blamed on over-zealous loan agreements sold by the building society.
The Prudential Regulation Authority (PRA), the City regulator, said on Thursday that the scale of the losses did not alter its demand that the Co-op plug the £1.5bn hole in its balance sheet.
A rescue of the bank has the support of the Co-op's board, which is made up of 20 non-executive directors, 15 of whom are elected from regional boards and five from Independent Co-operative Societies. Sutherland said the board had considered all the options and agreed to commit £1bn of the Co-op group's funds to cover bad debts in return for a debt for equity swap by bondholders.
Bondholders ranging from pensioners to hedge funds will have to take a loss on their investment under plans for a "bail-in" in coming months.
They will be forced to contribute £500m through an "exchange offer", which will result in a stock market listing for the bank. Some 15,000 holders of Co-operative Bank bonds have written to the Bank of England's financial policy committee seeking an intervention in rescue of the bank.
Mark Taber, representing retail bondholders who believe they should be spared a haircut on their investments, said there was a "disgraceful" lack of detail in the Co-op's offer. He said: "The PRA should not allow this and should make a direction to the Co-op Bank [to alter the restructuring] accordingly."
While the Co-op's board has agreed the deal, there is likely to be much debate inside Britain's largest mutual organisation about the cost of the rescue, the prospect of running a business with a large number of shares owned by non-mutual institutions and the potential for another banking crash to wreck the wider Co-operative Group.
Sutherland, who replaced Peter Marks in May, said: "We are sorry but we are a new team and grasping the nettle and getting on with fixing the situation."
If a rescue fails
Should the Co-op fail to secure a rescue of its banking division it will fall to the government to step in.
There are several options for ministers and which one they choose will depend on the state of the Manchester-based bank.
A Northern Rock-style takeover would be the most draconian. The government purchased all the Rock's shares and made it a wholly-owned state enterprise.
A bailout of the bank would involve a large injection of cash to cover bad loans in return for partial ownership. The state owns 83% of Royal Bank of Scotland and 39% of Lloyds. In the case of Lloyds, following a £20.6bn injection of funds.
Another option was pursued in the case of Dunfermline building society, which like the Britannia building society began offering loans on risky property deals at the height of the housing boom.
Dunfermline, which was unable to raise extra funds from its members to cover bad debts, was absorbed into the Bank of England on a Friday and transferred on the following Monday to the Nationwide.
In each case the first £100,000 of individual savings are protected.
New tougher rules agreed in Brussels are due to take effect later this year, though no date has yet been set. The Recovery and Resolution Directive will force investors that lend to banks to sacrifice some of their assets as part of any rescue plan. It will also force banks to offload profitable divisions to cover losses under a so-called "living will".
The Co-op has in effect adopted the strategy put forward in the directive before it has become law, telling bondholders to sacrifice around a third of their holdings to pay a third of the £1.5bn bailout package. The Co-op group will also sell its insurance arm.
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