White Knight no more – lessons from Co-operative Bank’s downgrade

10th May 2013

It is certainly quite a role reversal for the Co-operative Bank in the last few weeks. It has moved from an entity which, combined with branches from Lloyds TSB could have been a new force in UK banking, to one that ratings agency Moody’s says might need “external” support accompanied by a downgrade from C- to E+.

The Moody’s judgment reported in the Telegraph today has little to do with the failure of that deal but more to do with a deterioration in its commercial loans book. It also faces residual costs from its takeover of Britannia Building Society back in 2008. The agency concluded that its the loans book had deteriorated significantly, with the percentage of problem loans rising from 8.1pc to 10.9pc, generally seen as a rather high figure.

In terms of any state support, we are not talking about anything that would break the Bank of England. A “mere” billion might be required according to the ratings agency and even then it says it is only a moderate risk. It is more likely that the Co-op could find the finances from other parts of the Cooperative empire. But it is not particularly good news.

Mindful Money has a few thoughts in the meantime about what this all means for our troubled banking sector which we have put together in a list below.

1) The authorities need to be very wary of allowing banking mergers where one party is seeking an alliance because it is in a relatively financially weak position especially when the economic environment is far from normal. The lesson should be burned onto the brains of regulators and policymakers since the Halifax Bank of Scotland / Lloyds TSB merger, turned the latter, from being a relatively strong bank into one which desperately needed help. But Coop’s much less severe troubles are another reminder that regulators can say no to mergers when it is in the public interest.

2) Co-operative remains a mutual organisation and, on balance, we think it should stay as such. A lot of pre-crisis developments in British banking saw building societies convert, allowing them more commercial freedom. They obviously abused it. The Co-op/Britannia deal kept things within the mutual family as indeed did Nationwide’s takeover of the Dunfermline and Cheshire Building Societies. We think different forms of ownership in banking and lending are a good thing. But it is no panacea. On balance the Co-op is better as a mutual but also maybe better staying medium sized.

3) Co-op Bank’s chief executive Barry Tootell has stepped down. The bank says it is due to the failure of the deal with Lloyds and not the downgrade today. At least we now know the some bank chief executives are more honourable than others.

4) Mindful Money has been highly critical of ratings agencies in the past because of their dismal performance during the financial crisis and because of flaws in the business model. There are still many unanswered questions but maybe they have raised their game. One for further debate.

5) The biggest issue in UK banking remains the dominance of four banks – two of which remain state dependent. The key to improving performance should be competition. But is that possible with four banks? Allowing UK competition is arguably more important than creating global champions. Barclays and HSBC – admittedly with slightly tarnished reputations – are surely global enough already. A new force in UK banking needs to be domestically driven. The answer is obviously not the Co-op. But maybe rather than another big bank, we need lots of medium sized banks and some new entrants – with prudence enforced by the new Prudential Regulatory Authority.

Those are our thoughts today. But as it is in the eye of the storm, we think it is appropriate to publish the full Cooperative Bank statement here as well.

“We are disappointed by the ratings downgrade announced by Moody’s. We have a strong funding profile and high levels of liquidity, which are significantly above the regulatory requirements. We do acknowledge, like the rest of our banking sector peers, the need to strengthen our capital position in light of the broader economic downturn and the pending introduction of enhanced regulatory requirements, and we have a clear plan to drive this forward throughout the coming months.

“In March, we announced the sale of our life business to Royal London and also our intention to sell our general insurance business. In addition to these measures we plan to significantly simplify our business, which will greatly improve our operational effectiveness and also enhance our capital position in the process.

“Our banking business is already characterised by excellent levels of customer service and advocacy, as recently highlighted in reports by YouGov and uSwitch. Our primary current account base in recent years has enjoyed significant growth.

“The actions we will now take to strengthen our balance sheet and simplify our business model around a core relationship banking offer, will create a compelling co-operative banking business which is truly distinctive within the banking sector.”

32 thoughts on “White Knight no more – lessons from Co-operative Bank’s downgrade”

  1. Forbin says:

    Hello Shaun

    good ? none at all

    if they want to boost the economy then how about giving every EU citizen 5,000 Euros to spend? except those in Germany of course , they’re rich enough as it is 😉

    mind you they might not like it but as the are already paying for everyone else I guess they shouldn’t complain !

    question : why do they say they don’t want to emulate Japan then go and do exactly the same things?

    still , sit back and watch the show , pass the popcorn please !

    Forbin

    1. Anonymous says:

      Excellent plan Forbin, because of unexpected results. Angry Germans revolt and abandon the euro for a Mark. With the result that the ECB gets more inflation than they bargained for ….

    2. Anonymous says:

      Hi Forbin

      That is exactly the sort of play to respond to DEFLATION (downwards spiral of output prices and wages) except of course that Greece has that and likely Cyprus too but there are 16 others. Regional policy is invariably too weak and in a currency union without fiscal or political union it is even more short-handed.

  2. Andy Zarse says:

    Mario’s attempt to play “Beggar your currency neighbour” hasn’t exactly got off to a flyer has it? Really he’s being asked to do the impossible, the contradictions inherent in the Euro area mean it will never be otherwise until it becomes an actual single economic entity as opposed to an imaginary one.

    1. Anonymous says:

      Hi Andy

      Whilst Mario Draghi played up the unanimous vote on these measures in his press conference they smacked to me of compromise on the objective. So we got various measures splashed about which are unlikely to have a material impact.

  3. JW says:

    Hi Shaun
    Now we have NIRP.
    Don’t want to sound like a broken record, but all the policies from CBs are just exascerbating the divergence of rewards between capital and labour. There is no inflation because V is as near as damn it, zero. So it doesn’t matter how much M they stick in the system it just goes into ‘capital’ and ‘savings’ , demand is still dormant ( unless you count ‘demand’ as represented by investments of capital in London property).
    This ‘cycle’ could take 50 years to play out. Perhaps it never will.

    1. dutch says:

      Bang on JW….when they finally do something that gets V moving north,I’ll sit up and lsiten.Till then,they’re jsut changing the colour of the can they’re kicking down the road.

      1. Forbin says:

        perhaps they should take another “leaf” out of the H2G2 and adopt the leaf as currency

        everyone would be immensely rich and of course there would be this inflation problem …. which I gather , is what the aim is….

        then gain adopt what I mentioned in another post – give everyone 5000 euros but then , here’s the clever bit , put out a rumour that there’s going ot be a bank/savings bail-in

        thus people wont save the money but spend it !

        perhaps if I wrote to Mario……..

        Forbin

        1. Jim M. says:

          €5000 buys a lot of popcorn!

    2. Anonymous says:

      Hi JW

      On that theme I spotted this earlier on twitter on US nominal wage growth over the past 50 odd years.

      https://twitter.com/wonkmonk_/status/475235890831564800/photo/1

  4. GusBmth says:

    Hello Shaun

    I’m left wondering which central banks desire an appreciation of their currency? Not the ECB, Bank of Japan, Bank of England, the Federal Reserve, the Bank of Japan, or the central banks of Switzerland or China.

    It does seem that the risk of moving from an ultra loose monetary policy to one that is accommodative (let alone neutral) is of a significant multiplier effect through currency appreciation, which neither the Bank of England or the Fed would countenance. This inaction is storing problems for the future.

    Part of the problem is the Euro itself, since the currency is undervalued for Germany and overvalued by a little to a lot for most of the rest. The ECB has an impossible job, with a tool kit which is largely ineffective. All it can try to do is talk down its own currency, but with trade surpluses for the Euro area as a whole, that is a tough task.

    1. Jimbob says:

      It seems to me that perhaps instead of following the crowd, UK should appreciate sterling. Our balance of payments is always negative anyway. Everything we import would be cheaper, we’d have more money in our pockets, holidays would be cheaper, it may suppress property purchases from overseas. What’s not to like?

      1. Noo 2 Economics says:

        I thought that was what they were doing anyway via Forward Guidance coupled with an improving economy? (it doesn’t just have to be interest rates) 7% or 8% up in the last year and counting. Trouble is the GBP isn’t worth that much and a correction will arrive, as to the timing well markets can stay irrational for amazingly long periods

    2. Noo 2 Economics says:

      Yes exactly what I was getting at on Tuesday

  5. dutch says:

    In general,I’m struggling to see how hoping to increase the price of oil is going to fuel growth.

    Apologies for an awful pun.

    The Danish experience of NIRP hardly inspires confidence that it’ll kickstart lending.

    1. Forbin says:

      I’d stick my neck out here and predict ( predictions are difficult about the future ) that when we get to average 125$ boe next year with at least one spike of 160$ -+ 5$ , then we’ll see who has shorts on!

      we know NIRP dont work but getting BoE / ECB to accept that output gap and dis-inflation posit ( I wont call it a theory ) is also just fantasy will be difficult

      until then I’d go with Ford Prefect’s observation “…a load of useless, bloody loonies!! ”

      Forbin

      Peak Popcorn? or just peak demand for popcorn ?

    1. Anonymous says:

      Thank you for the link, Dutch. It seems from reading it that the NIRP was reasonably successful in keeping the krone at parity with the euro. So an ECB NIRP might at least be expected to help keep the euro from rising against other currencies. Andrew Baldwin

    2. Anonymous says:

      Hi Dutch

      I covered the Danish experience with negative interest-rates and what the ECB should have learnt from it here.

      http://www.qfinance.com/blogs/shaun-richards/2014/06/06/what-are-the-consequences-of-negative-interest-rates

  6. digger says:

    Is it time to fill yer boots with Spanish Ten Yr’s?What could posibly go wrong?

    1. Anonymous says:

      Hi Digger

      As you hint at there is the saying “what goes up must come down”! After yet another surge in prices the yield of the Spanish ten year closed below that of the UK Gilt last night.

  7. Noo 2 Economics says:

    Hi Shaun,

    I think we are witnessing structural changes of internal devaluations in certain Euro countries via productivity increases unaccompanied by wage rises – ouch! This will take many years to play out, meanwhile the ECB plays for time by trying silly policies to get through the next few months ad-infinitum until the structural changes work themselves through.

    The next move will be ABS purchases a few months down the line, the trouble is, given that banks can’t lend the dirt cheap money they’ve got now, why should they be able to lend even more even cheaper money in the future?

    There is an improving Euro economy, we shouldn’t lose sight of that, we should also consider that the improvements in GDP are not being matched by equivalent reductions in unemployment, or more simply, this is a slow jobless recovery hence the markets surge as they see companies bottom lines improving. This is the price of cheap far east imports. If there is trouble in emerging market economies watch the EZ economy fall into another depression as this will affect Germany tremendously and without the German locomotive where is the EZ?.

    1. Anonymous says:

      Hi Noo2

      The problem for the Euro area is the bottom third if we put it like a league table. Here whilst the media screams deflation/devaluation warnings they mostly miss that these were the objectives of the internal devaluations you mention. Policy makers hoped that inflation would cover it up and if we look at just one variable the oil price it has fallen in Euro terms.

      If the problem countries were outside the Euro their currencies would have fallen. So Germany wins again via a lower currency so far anyway..

  8. Anonymous says:

    Congratulations on predicting the ECB move to a NIRP before it happened Shaun.
    My dad was in a bomber plane on D-Day. He was Canadian but actually flew with the RAF like a lot of Canadians. They were bombing in France that day, and didn’t know why until afterwards. We should never forget what the greatest generation did to save us from a Nazi future. Andrew Baldwn

    1. Anonymous says:

      Hi Andrew

      Thank you and respect to your father for undertaking what must have taken enormous courage. My grandfather was returning to France with the Royal Artillery via North Africa! One of the ironies of life was that his only ventures abroad were with the British Army.

  9. therrawbuzzin says:

    My heartfelt thanks to all who took part in the fight against totalitarianism.
    We owe them a far better peace than this.

  10. David Lilley says:

    Shaun,
    I repeat below my observations on Marius McDermott’s post on Mario Draggi’s latest CB interventions fyi.
    Marius,

    Some brief observations (I did make a comment but lost it):

    1. Subsequent to your interview with John Lappin at the beginning of the year $220b has been pulled out of the Russian Federation and some of this money will have made its way into UK blue chips to drive up the FTSE 100 and London property prices. This explains why London house prices rose so much in April and May.

    2. UK QE has had a myriad of significant benefits for the UK recovery. If we take just one, the fact that the BoE holds 1/3 of the national debt and that is £375b that we don’t have to pay interest on, that is enough to justify our QE.

    3. G20 coordinated QE would have been better than uncoordinated heavy dipping by the US and Japan. If the ECB takes measures to reduce the Euro that negates Japan’s efforts to reduce the Yen.

    4. Mario’s FFL differs from the BoEs because it isn’t going to the mortgage market. It is going to wealth creation.

    5. I find it hard to differentiate QE from FFL, they both go on the balance sheet. They are both printing money.

    6. I cannot understand how Ireland and even Greece can go to the market to borrow. What are PIMCO and the credit rating agencies saying to gilt investors? How can some Euro periferals have better investment grades than the UK as mesured by their 10 year state bond market prices? Is the Eurozone crisis total history?

    1. Anonymous says:

      The banks are betting that Angela Merkel cannot decisively walk away from eurobond default of peripheral countries. Dither, seek consensus and pay up. However, they cannot bet on Merkel bailing out Gilts

  11. David Lilley says:

    Shaun,
    On the subject of WW1 and WW2.
    When we cover WW1 we only mention the Western Front and never mention the Eastern Front which consumed more lives and continued until 1929.
    I am not a historian and considered it a soft subject when choosing O levels and therefore not for me.
    On WW2 I often say that is you have heard of Spitfires and bouncing bombs then you probably know nothing of the conflict. Have you heard of Kursk? To every British serviceman who lost his life 100 Russian’s died

    1. Anonymous says:

      Everybody suffered – nobody should now be resorting to nationalism or empire building to prop up domestic poll ratings.

      Papua New Guinea, Solomon Island, Guadalcanal and Burma were also very unpleasant places to fight. My granddad served in Solomon Island and probably Guadalcanal – but he never talked much about it.

  12. theyenguy says:

    The June 5, 2014 Mario Draghi ECB Announcement of NIRP and Targeted LTROs, produced a stunning moral hazard based prosperity in fiat money, and produced the zenith of liberalism, defined as freedom from the state, as investors drove World Stocks, VT, Nation Investment, EFA, Global Financials, IXG, and Dividends Excluding Financials, DTN, to produce peak Equity Wealth, while Peak Currency Wealth, DBV, and CEW, was achieved in the third week of May 2014, and Peak Credit Wealth, AGG, was achieved the week ending May 30, 2014.

    The age of currencies and the era of credit came to an end the week ending June 6, 2014, as stock investors drove Equity Investments to their grand finale finish, manifesting as three long white candlesticks in the weekly chart of the S&P 500, SPY, at a time when the bond vigilantes, called the Interest Rate on the US Ten Year Note, ^TNX, higher to 2.59%.

    Peak Equity Wealth is seen in the chart of World Stocks, VT, relative to Aggregate Credit, AGG, that is VT:AGG, rising parabolically, and then peaking in value in the week ending June 6, 2014.

    The Mario Draghi ECB announcement of NIRP and targeted LTROs produced a blow off stock market top on Friday June 6, 2014, and at the same time has birthed the Beast Regime, to replace the Creature from Jekyll Island, which ruled in liberal policies of investment choice and in schemes of credit. Soon out of the waves of Club Med sovereign, banking, and corporate insolvency, it will rise to rule the world in authoritarianism, specifically in policies of diktat in every one of the world’s ten regions, and in schemes of totalitarian collectivism in all of mankind’s seven institutions.

    The age of diktat and the era of debt servitude commenced on the June 5, 2014, with the mandate of Mario Draghi for a 0.1% surcharge on money held overnight at the ECB. His word, will and way, will compel the debt serf, to experience economic life in regional fascist leader’s policies of regional economic governance, which establish regional security, stability and sustainability.

    Thus the Mario Draghi announcement of NIRP and targeted LTROs was both a climax event, one of peak wealth. and also a genesis event, one of the beginning of a new economic age of authoritarianism.

  13. Anonymous says:

    Hi Pavlaki

    I think that Mario Draghi and the ECB will not be smiling as they sit down this weekend and note that the Euro is higher (albeit only marginally) than pre their moves. Along the way conventional economic theory (monetary expansion leads to falling currency) gets at best another appendix!

    However the other financial markets are happy to follow the cash with the Spanish 10 year yield for example equaling the UK Gilt equivalent yesterday.

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