I don’t understand this Co-Op Bank rescue

Of the Co-op’s plan to raise £500m from bondholders and inject £1bn from its own asset sales to fill a £1.5bn capital hole, Mr Gorvin said: “We are now told the group is to inject £1bn but frankly there is a strong view among those to whom I have spoken that the proposals now being mooted represent the minimum pain for the parent; is acceptable to the authorities and has some chance of acceptability by the investors. In the circumstances I do not believe this is good enough.”

But, erm, if the bondholders are being shafted then why hasn’t the CoOp itself lost all its equity in the bank?

What is it that I’m missing here? Why isn’t equity wiped out before debt gets even nibbled?

13 thoughts on “I don’t understand this Co-Op Bank rescue”

  1. It’s not clear how much of the equity the bond holders end up with. If they end up with 1/3, this would mean that the previous equity has been wiped out. (0.5/1.5 = 1/3)

    However, even this is somewhat disingenuous since the bank will save on the interest payments on the bonds that are being swapped.

    If they are getting less than a 1/3 it would be less than fair. I also question if the Coop has (cross-)guarantees outstanding between the financial entities (such that insurance is already entangled) and also with the main entity. Such cross guarantees would be normal practice and could well mean that the bond holders might have a stronger position. Note though that cross guarantees might (well, probably) only hit after the bondholders are wiped out.

  2. I was wondering on exactly the same point. As I understand it the conversion ratio of debt to equity has not been disclosed to the bondholders. So no-one knows (other than the Co-Op) how much they are being offered. Like ken says above, if they get offered less than one third of the new bank, then they are being shafted by the highly ‘ethical’ Co-Op.

  3. It depends on what the value of the group is after the rescue, as well as the co-op group’s percentage.

    If the co-op group as shareholder puts in £1bn and ends up with equity worth £1bn or less, then its old equity has indeed been wiped out and things are fair.

    If it ends up with something worth more than £1bn then its old equity hasn’t been wiped out. If that’s the case, and the bondholders end up with equity worth less than £0.5bn, then they have lost something before the old equity was wiped out and so it’s not a fair deal.

  4. @Richard: “If the co-op group as shareholder puts in £1bn and ends up with equity worth £1bn or less, then its old equity has indeed been wiped out and things are fair.”

    Not quite, they could both be losers, but one better off than the other by a large margin – the Co-Op could end up with (say) £900m of equity, and the bond holders £250m of equity. In such a case the Co-Op’s original share holding has still been wiped out, but they’ve ended up with the lions share of the new bank, more than their share of the capital invested.

  5. It is a complete stitch-up. The Co-op is claiming that shareholders are wiped out and bondholders therefore inherit the entire equity capital in exchange for their bonds and then the Co-op retakes control by injecting some cash on terms that gives it a majority of votes.
    BUT the terms of any post-bankruptcy injection of cash should be determined and agreed by the shareholders *at that time*, not those who have bankrupted the bank. The Co-op have *no right* to retake control: if theyt want to do so, they should make a takeover bid at a substantial; premium just as any filthy capitalist would have to do. Meanwhile NBNK, which has some competent bankers available, could make a rival offer to those now owning the bank after the Co-op has let them down. If I was a bondholder (I am not, wouldn’t touch Co-op with a bargepole) I know in which offer I should put more trust.

  6. Jim, no, because the co-op has put in £1bn of new equity.

    In your example the thing is worth £150m before the co-op cash injection (£900m + £250m – £1bn injection), therefore the bondholders have got £250m post-restructuring in return for a business worth £150m pre-restructuring, and the co-op have paid £1bn for £900m of value – so the bondholders are still up on the deal.

  7. John77, a takeover bid would only be “at a substantial premium” if the thing is worth anything.

    If there is a realistic alternative bid then yes I agree, the bondholders should be allowed to accept that. I don’t know enough about the current deal to know whether there is a realistic alternative to the co-op bid.

  8. @ Richard
    The Co-op obviously think it *is* worth something or they would not be putting in £1bn of their own money!!
    If they put in the £1bn *before* stitching up the bondholders the bondholders would either (a) be unhurt because the equity had not gone down to zero or (b) get 100% of the bank’s equity.
    Co-op bank has a shortfall against the level of capital required by the FSA of £1.5bn – that is *not* the same as a deficit on shareholders’ funds of £1.5bn: Lloyds had net assets of £20-odd billion when it was ordered to have an emergency rights issue.
    The interim balance sheet shows net assets of £1 billion *after* taking a £500m charge for bad loans in the first half (before the Co-op puts in a penny of its own money) so unless there is another £1 billion which they haven’t reported yet there is no excuse for defaulting on the bonds.

  9. @John77: so would it be true to say that if the Co-Op Bank closed its doors today, and was liquidated, everyone would get paid in full, current bondholders included, and there would be a surplus left over for the shareholders?

  10. @ Jim
    My previous comment was based on a couple of minutes looking at their published interim results which are on a “going concern” basis. The numbers would be different if you assumed an overnight closure because a majority of lending is mortgages and the average home part-owner just cannot provide cash from under the mattress to pay off his/her/their mortgage overnight. Direct costs of closure would only make a modest dent in the £1bn of alleged shareholders’ funds since staff wages and salaries totalled £188m last year and some of that will be staff with few years of service; after 10 minutes looking through the 146 badly typed pages of the Co-op Bank accounts I haven’t found the note that used to be compulsory of lease commitments but total lease operating lease costs (which includes computers and cars on short leases as well as property on medium-/long-leases was only £28m. So the question is whether they could get someone to take over their mortgage book for a reasonable rate of return or whether there would be a “fire sale” discount as Darling’s poodle assumed in order to claim that Darling did not owe £billions to the expropriated Northern Rock shareholders.Of the £23bn, nearly two-thirds is “prime residential”, which should be fundable/saleable at par with another quarter “Buy to Let” or “Self-certified” with a LTV of 75%, which would only be saleable at a discount but is probably worth more than par on a going concern basis because the higher interest rate more than compensates for the higher risk. Only 12% is “non-conforming” or “almost prime” – these would only get a “fire sale” price if Co-op closed its doors but they have already been written by over £1bn so they mist be valued not far away from that.
    Obviously the £13m owed by the Labour Party would have to be written off but that is almost trivial in the context of £1bn notional shareholder’s equity. [Pendant alert -there is only one equity shareholder].
    If the bank closed down tomorrow the “going concern” numbers would need to be changed and the ordinary shareholders might be wiped out. I am not convinced that the bondholders would suffer the full extent of tonsure proposed.
    I think it looks *very* suspicious that the Co-op Bank changed its Memorandum and Articles in June 2013, prior to proposing a tonsure for bondholders and that in February 2013 its Annual Report was still reveling in the potential from “Project Verde” months after the regulator had pointed out the shortfall in their capital.
    In conclusion, my guess is that the ordinary shareholder

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