If we analyse what has happened in the credit crunch era we find ourselves looking time and time again at the financial sector and in particular our banks. It has long been a theme of this blog that until we properly reform our banks in the UK there will be no sustained economic recovery. This clashes with the official spin and hype that there has been a considerable improvement highlighted by stories like this from the Financial Times.
George Osborne is to give his strongest signal yet that he wants to move Lloyds Banking Group back into private ownership by the 2015 general election,
He will apparently do so at the Mansion House speech on Wednesday. Although there is the inconvenient detail that the Lloyds Bank share price remains at 61 pence a fair way below the 73.6 needed to repay all the costs of the bailout. However even such apparent optimism has accepted that Royal Bank of Scotland is miles away from any similar move even after the “man overboard” cries for its Chief Executive last week.
An inconvenient reality
At the same time trouble has been brewing for the Co-operative Bank which contradicts the message above. Today it has been forced to announce that it needs to raise an extra £1.5 billion of capital to shore up its position. So we see that there is a clear contradiction to the optimism for the UK banking sector as expressed by the Chancellor. The obvious question is to examine how the C0-operative got itself into such a mess.
Chronologically the story begins with the merger between the Co-operative Bank and the Britannia Building Society back in January 2009. At this point in time the official line was as follows.
This proposed merger offers a unique opportunity to create a new force in British financial services – strongly capitalised and with the scale to offer customers a full range of products and services that are ethical, mutual and co-operative.
In fact the description of this merger also told us that we would get this.
new super-mutual as an ethical alternative to shareholder-owned banks.
The word “super-mutual” was always a hostage to fortune was it not? Also we were seeing an example here of exactly the same strategy that has lead to so much trouble for the cajas (saving banks) of Spain. If one hits trouble merge it with a stronger one and hope that the problem goes away. In this instance what Taylor Swift has labelled “trouble,trouble,trouble” was the £21.4 billion of personal and £3.7 billion of commercial lending on the books of the Britannia Building Society which dwarfed lending by the C0-Op itself.
It would appear that the relevant directors and the Financial Services Authority not only ignored this issue back in 2009 as they muttered “hear no evil,see no evil,speak no evil” to themselves.But for the subsequent three years they hoped it will go away until the Co-Op Bank declared losses in its 2012 accounts and told us this.
we have increased the level of provisioning for impaired loans in light of weak economic recovery prospects relating primarily to commercial real estate assets originating from the Britannia book of business.
Actually that part was tucked away in the accounts and the official view was that economic climate was to blame. According to the Chief Executive.
The Bank’s underlying financial strength remains intact
Moodys did not agree
On the 9th on May the ratings agency Moodys dropped its bombshell.
The bank faces the risk of further substantial losses in its non-core portfolio, as demonstrated recently by the unexpectedly significant deterioration of its commercial real estate (CRE) exposures, that will exert downward pressure on capital ratios that are already low relative to its peers.
Moodys backed this up with a downgrade.
Moody’s Investors Service has today downgraded the deposit and senior debt ratings of Co-operative Bank plc to Ba3/Not Prime from A3/Prime 2,
In essence the move from “Prime” to “Not Prime” illustrates what happened here.
Today’s capital raise and restructuring
The first step is in fact a partial default on its junior bonds which is expected to raise most if not all of the first installment of around £1 billion. This is a “bail-in” where existing holdings will be switched for a package of shares and bonds worthconsiderably less. This will be followed by the sale of its insurance subsidiaries to raise another £500 million.
How did we get here?
The original merger
There have to be serious questions asked about the two boards of directors back in January 2009. What due dilligence and investigation was done by the Co-Operative board into the commercial lending of the Britannia? Also we need to know if the financial statements produced by the Britannia were full and complete.
The official line will no doubt be that this is “unexpected” and that this could not have been foreseen. This of course contrasts with the view expressed if banks do well where it is apparently due to skill! I have argued in the past for a new offence to be created to cover “gross negligence” by directors of banks and it would be something that could be applied here.
What happened to the Chief- Executive of the Co-Operative?
Peter Marks was appointed Commander of the Order of the British Empire (CBE) in the 2013 New Year Honours for services to the retail trade
The Financial Services Authority
The regulator of UK banks seems to have been permanently asleep at the wheel. It was nowwhere to be found when the disastrous 2009 merger took place and in the subsequent time period discovered nothing wrong with the commercial loans which have put the bank in such distress now.
We are left with the suspicion that the merger was convenient for the FSA in the same way as the merger of Lloyds Bank with Halifax Bank of Scotland as it kicked a serious problem like a can into the future. Just as a reminder regulators are supposed to to open up banking not look the other way.
If we look at this whole sorry saga we see that there will have been a whole succession of audited accounts. For example the Britannia will have had to present them at the time of the merger and since then both the Co-Op Bank and the overall Co-Operative organisation will have declared three annual statements. Yet in spite of this apparent scrutiny we are where we are.
I find myself questioning more and more the whole point of accounts being audited. What good has it done us?
The Verde deal
For those unfamiliar with this name it is explained below.
The Co-operative Group to acquire 632 branches from Lloyds Banking Group with an estimated 4.8m customers, thus creating an enlarged Co-operative Banking Group
This was supposed to create a new challenger to the oligopolistic nature of UK banking. Except how could the Co-Op have done this?
The Co-operative Banking Group to pay LBG an initial consideration of £350m
This looks now rather like an attempt to muddy the waters and kick the can for the sour commercial loans from the merger with the Britannia even further into the future.
There is a clear irony in the way that the hype and spin presented around the official intention to get Lloyds Banking Group (and eventually even RBS) off the UK government’s books and the difficulties of the Co-Operative Bank. The problems at the Co-Op highlight one more time the number of hidden mines still present in our banking waters. Those that should help us uncover these mines such as directors,auditors and regulators never seem to do so. Any such privatisation accordingly runs a substantial chance of ending up as in effect another miss-selling scandal where nobody was to blame!
Also there is another inconvenient truth that needs to be swallowed here. For all the talk of casinos and investment banks plunging us into the mire we see that here it was relatively basic property lending which tripped up the Co-Op via the Britannia. The same sort of property lending that it is official policy to encourage via Help to Buy and Funding for Lending!
We also learn that a different ownership structure seems to have been of little help. Whilst the bank is a public limited company the Co-Operative group is a mutual. Unfortunately this does not seem to have helped in this crisis as yet again we see directors enriching themselves whilst owners (and bondholder) take punishment.
This reminds me one more time that there is a very long way to go before the UK’ s banks are returned to full health and anybody buying or receiving shares in them should be aware of that fact. It is also an ongoing problem for our economy. Also those involved with the Co-Operative Bank will do well to recall that so far in the credit crunch we are invariably only told what is perceived to be good for us rather than the full truth. Thus it is extremely likely that more bad news will be along in due course.
Why is the coalition government so keen to divest itself of RBS and Lloyds? Apart from a political desire to create a feelgood factor ahead of the 2015 election we also find an answer in the numbers below.
The public sector net debt including the temporary effects of the financial interventions, at the end of April 2013 was £2,210.4 billion (140.2% of GDP), this compares with a public sector net debt excluding the temporary effects of financial interventions of £1,185.3 billion (75.2% of GDP).
This morning the Bank of England has produced news that will be welcomed by anybody who would have taken the blue pill offered in the film the Matrix.
The perceived probabilities of a high-impact event in the UK financial system over both the short and medium term have fallen to their lowest levels since the survey began in 2008.