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Co-op Bank: the David that wanted to be a Goliath

The Co-operative Bank’s sudden financial crisis triggers memories of 2008. Daniel Tischer says a hunger for reckless growth was the Co-op’s tragic flaw

October 21, 2013
7 min read

In May this year, the credit rating agency Moody’s issued a statement saying it had downgraded the debt of the Co‑operative Bank by a whopping six notches to ‘junk’ status. This followed news in February of a £1.5 billion hole in the Co-op’s balance sheet – a shortage almost as big as the bank’s total capital.

Of the £1.5 billion, £900 million stemmed from real estate loans; 12 major commercial property developments on the Co‑op’s books were found almost at once to be in danger of default. The Co-op also needs £600 million more in cash to meet new capital funding requirements, introduced by regulators in an effort to make banks safer.

More bad news followed at the Co-op’s half-year financial results in August, which revealed a further £496 million of write‑downs on loans the bank had hived off into an internal ‘bad bank’ to insulate the rest of the company. This took the overall impairment charges on its lending up to almost £1 billion over the past year and a half.

Unlike banks owned by external investors, the Co-op can’t raise capital from its owners. Solutions under discussion have been drastic, ranging from seeking a bailout, to selling parts of the Co-operative Group (the mutual of which the Co-op Bank is a subsidiary), to selling shares on the stock market, an anathema to the bank’s espoused values. In the end, the bank and regulators agreed on a ‘bail-in’: converting £1.3 billion in loans from outside investors to £1 billion in new capital, a step that will see investors lose 25 to 30 per cent. An additional £500 million will be raised by selling off some of the bank’s loan book and the Group’s insurance business.

These problems came as a surprise to many. The Co-op, which traces its roots to the 19th-century co-operative movement in the north of England, has long been celebrated as an ethical alternative to the major high street banks. For those banks, scandals of rate fixing, risky lending and mis-selling savings and insurance products have created a crisis of public trust. The Co‑op emerged relatively unscathed from the economic downturn and flourished on the back of Occupy and a Move Your Money (MYM) campaign that convinced some two million customers to close their high street accounts.

Blaming Britannia

What went wrong? The Co-op itself, Bloomberg, BBC and others blame Britannia. The official story goes that this building society issued risky property loans before its merger with the Co-op in 2009, which only later became apparent. But that skims over the management decisions and politics behind the Co-op’s rapid expansion: a story in which David was keen to turn himself into a giant to beat the high street Goliaths.

The government’s role has also been left out. The 2008 crash made clear that many building societies had engaged in the same risky practises as major banks. To quell the crisis, the government pushed healthier institutions to absorb collapsing ones. It encouraged the ‘merger’ of Nationwide with the troubled Derbyshire and Cheshire building societies, while presiding over the union of the Co-op and Britannia.

Creating a ‘supermutual’ suited both Labour’s politics and David Cameron’s ‘big society’ election campaign. The Financial Times hailed the Co-op/Britannia merger as ‘the solution to the over-concentrated banking industry’.

For management, it was a once-in-a-lifetime growth opportunity, launching the Co-op into sudden competition with Lloyds, NatWest and Barclays. The merging parties appeared well-suited for each other. Britannia was member-owned, like the Co-op, and a substantial player in property, where the Co-op was keen to expand.

Plus, if the Co-op wanted to establish itself as a true competitor on the high street, it needed more than just 100-odd branches in the north of England. Absorbing Britannia meant sudden expansion to the south with the addition of 200 more branches.

Then, possibly fuelled by media attention and government support, Co-op execs appear to have been gripped by megalomania. Neville Richardson, chief exec from the Britannia side, had just taken control of the newly enlarged Co-op when he and colleagues attempted another merger, one that would have tripled the bank’s size for the second time.

Thus began the Co-op’s short-lived entanglement in ‘Project Verde’, a name given to the sale of 632 branches of Lloyds. A successful purchase would have left the Co-op with nearly 1,000 branches. But after details of the bank’s financial problems emerged, the impossibility of the roughly £700 million price tag became clear.

All this raises questions of how much the execs knew about Britannia’s bad loans when they merged, and how much they knew of their own financial problems when embarking on the Lloyds expansion. Why had they planned to press ahead with a risky and expensive reorganisation (around £250 million on a new IT system)?

It is striking that the Co-op’s losses on commercial real estate lending were booked shortly after Project Verde collapsed. It seems rather unlikely that Co-op execs – particularly Richardson, who had headed Britannia – would have failed to understand the risks involved in those real estate deals prior to the collapse of Project Verde. Nor is it likely that all large commercial loans turned bad all at once.

Instead, it seems entirely feasible that those bad loans had been kept off the records or downplayed for the time being so as not to jeopardise the Co-op bid for the Lloyds branches. Had the deal gone through, existing bad debts would have been less significant because the bank would have been well capitalised with a larger balance sheet. But the deal did not go through, and the bank had to come clean.

While we can’t be certain about execs’ involvement in hiding bad debts to secure Project Verde (which probably would have secured them bonuses, too), it is striking that several Co-op execs have jumped ship – ostensibly for personal reasons. And it is worth asking why regulators overseeing the Verde deal didn’t notice the problems lurking below the surface.

Damage done

The independent review headed by Sir Christopher Kelly plans to investigate and present some answers at the Co-op’s AGM in May 2014, though by that time much damage will have been done. Thousands of small investors who bought bonds with the Co-op assuming they were a safe source of retirement income will face a loss. Private equity and hedge (or ‘vulture’) funds that have been circling the Co-operative Group’s assets for months may have the chance to buy, and no doubt disregard what the Co-op has historically stood for. A further danger is a spillover effect on other ethical or mutual banking alternatives, potentially affecting Charity Bank, Triodos Bank and Ecology Building Society, if customers give way to cynicism and declare all banks self-interested and greedy.

As it stands, events at the Co-op eerily resemble the high‑street banking behaviour that prompted so many people to move their money. Execs have acted in their own interests, pursuing over-zealous expansion that the government not only oversaw but promoted. RBS’s acquisition of ABN Amro and Lloyds’ merger with HBOS spring to mind.

Aspiring to be Goliath meant the Co-op had to play by Goliath’s rules. This compromised the interests of millions of members, who have a right to know what happened and to hold execs responsible.

The Co-op could not be reached for comment. Move Your Money declined to comment on the Co-op but said it was reviewing its scorecards. Daniel Tischer has written a PhD on the UK ethical banking sector. He is currently a researcher at the University of Manchester’s CRESC and the Wissenschaftszentrum Berlin, focusing on alternative and ethical banking systems

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