What happened to the Co-operative Bank illustrates how much is still wrong with UK banks

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.

The Auditors

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).

Never Fear

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.

Nice timing!





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  • James

    I am delighted (I write as a chartered accountant) that you have picked up the auditors. The truth is that either:
    1. The audit process could have picked up what went wrong, inwhich case it failed; or
    2. The audit process could not have picked it up.
    Either way, it shows the profession is fundamentally pointless.

  • Anonymous

    Shaun, Thanks for the detail of what went wrong but I am curious to know what property loans turned out to be the problem? I haven’t heard of any down turns in commercial property that would account for this.

    I couldn’t agree more with your comments about auditors! I had a number of manufacturing businesses under my control, a number of years ago, and used A. A as our auditors . I was less than impressed by their audits and the caveats that they covered all their reports with – to the point where I used to think – why do we bother! I was always much happier when our internal auditors had given the business a thorough going through as they understood the business. What I can’t understand is why the Co Op’s own internal auditors didn’t pick up the problems during due diligence?

  • Anonymous

    Hi Shaun,

    ‘The regulator of UK banks seems to have been permanently asleep at the wheel.’

    Merely another example of don’t have a public enquiry until you know the result? Carefully pick the enquiry participants? Do it via a QUANGO so it can be seen to be independent? If you are really in trouble, promise it after the next election (apologies – politics. But then again ….)?

    So maybe the regulator is simply following political guidelines and keeping his head down until a convenient/credible/saleable (pick one) solution happens along? Until then, don’t rock the unstable lifeboat, it could take on more water.

  • Mike from Enfield

    A sign of the times is that my first reaction was… ONLY 1.5 billion!

    I am a little unsure why the Co-op’s directors went ahead with this disastrous merger. Was there something in it for them personally or was it incompetence on a scale unusual even in the British banking sector?

    I assume ‘bail-in’ is already in the lexicon as a synonym for default?

  • MickC

    No downturns in commercial property?
    With respect, outside London and its gravity field, retail, office and industrial space is floundering. A rental uplift on review is rare to say the least, renewals are slow to non-existent (why renew when the landlord is happy just to have an occupier paying the rates at least?)-and new lettings, if any, are on terms highly advantageous to the tenant.
    Much commercial property was overvalued, and mortgaged at that value. The banks do not want to revalue and crystallise the losses, or if they are doing so, are asking the owner to stump up cash to repay part of the loan so the percentage loan is still the same.
    Even if there is a prospective tenant the lenders want it to be a top class covenant (and it won’t be)……..etc. etc.
    I could go on. The reality is that the commercial property market is a disaster which hasn’t yet happened-but it will.

  • Anonymous

    I am also a qualified accountant. I totally agree that the whole approach to auditing is flawed. He who pays the piper calls the tune, which is exactly what you don’t want. The trouble is, all other approaches have their flaws, too. But at least a truly independent auditor would have said something about the crazy things that have been happening. Unless he was subject to political interference, which is another big problem, together with corruption. How the Coop managed to persuade itself to take over the Britannia is a puzzle. A suicide pill if ever there was.

  • Anonymous

    Interesting! I ask the question out of ignorance – especially as I read of Commercial property being a good investment! Have prices dropped and by how much?

  • Mike from Enfield

    I’m mildly surprised the external auditors didn’t do their job, rather more surprised that the internal auditors didn’t get it but I find it amazing that a time bomb like that could have been kept so (apparently) totally secret from the grapevine. Did employees never leave one company to join the other…or meet down the pub or on (golf) courses & conferences? My experience has always been that the people most likely to blab are the more senior managers and that the people most in the know are the local taxi drivers!

  • Rods

    Hi Shaun,

    Another excellent blog.

    Every recession that I can remember has caused big losses for banks with commercial property. They are very happy to allow commercial property developers to borrow against their valuable assets. When the developer goes bust or need to restructure in a recession, the banks then find that the economic peak values that they leant against are a fraction of the recession value. Commercial property prices, rental income and occupancy rates are all extremely volatile where they are linked to economic cycles. Will this get better in the future? No, as I’m convinced commercial property volatility will be much worse if the UK economy gets some growth in the current or next economic cycles. Why, because all of the commercial property owners I know that have empty town / city centre office blocks, which Gordon Brown made them pay full business rates, empty or not, have wherever possible pulled them down or converted them into residential flats. So on future business cycles there will be an even bigger shortage of commercial properties, higher values and rental values, that like nectar to a bee the banks will not want to miss out on, turning massive profits and bonuses on lending on the upside and we all know what will happen on the downside yet again!!!!

    With Lloyds and Co-op it has been a case of marrying in haste under political pressure from Gordon Brown and boy are they now repenting at leisure!

    I’m sure with the Co-op there is an element that the prolonged recession has increased the number of distressed loans, but there may also be an element on how optimistic the directors were to the auditors on the quality of the loan book. IME as a director of a company, there is always a political slant on how you present things to auditors where you have also got to have the best interests of the company and shareholders in mind. So you tend to end up with the auditors and the directors all humming the same tune. There is human fallibility here, the auditors rely on what the directors tell them and directors have to be optimists to drive a business forward! I don’t know what the answer is? Business have to take calculated risks to grow and some will get into trouble and auditing has to be affordable in terms of time and money.

    I think the bailing in of bank bondholders is going to become more common as the banking crisis continues. At the end of the day commercial bonds are a risk, bought by people over 18, that in many instances pay good interest. so you pay your money and take your chances and are quite happy if the interest and the capital are returned, but can’t complain if they aren’t. That always has been and always will be part of the risk of investing. This is much better solution than bailing in depositors. The one caveat to this is mis-selling like has happened in Spain.

  • Anonymous

    There is a simple method to control the risks. Just let failing businesses go bust ….

  • Rods

    Totally agree that is how capitalism is supposed to work. I suspect this is what will happen with smaller banks. But successive Governments have allowed companies to merge to form quasi-monopolies and too big to fail banks. Personally, I would like to see all mergers stopped that produce a market share of more than 10%, so there are a minimum of ten competing companies, rather than the four, which we all too often get in this country now.

  • Anonymous

    I am neither an accountant nor an auditor but I note KPMG were the Co-op’s external auditors. Around the world there are 4 main groups that audit most publicly traded companies ( There were 5 until Arthur Andersen became caught up with Enron) Surely this cannot be healthy for business…….

  • Anonymous

    Shaun, Not todays topic I know but I wonder what you think about Roger Bootle’s article in the telegraph calling for a significant drop in the value of Sterling? I wonder why these people believe that if it hasn’t really worked in the past then more of the same is needed? I know of two quite reasonable sized companies that did nothing to improve their sales on the back of a lower pound but booked higher profit margins as they maintained their prices in Euros. I would bet that the same thing would happen again but the effect on imported inflation would be terrible which would push real salary drops down even further. I sincerely hope that Carney doesn’t go down this road.

  • Anonymous

    Yes that’s what I initially thought as well! A billion here and a billion there and pretty soon we are talking serious money!

  • MickC

    Well, as ever it very much depends on location-but anything other than prime stuff has probably dropped as much as 40-50% in reality.
    The problem is that neither the owner or the banks can afford to sell at that level cos the losses would be immense. So provided the mortgage payments are met it’s a case of “don’t ask, don’t tell”. Owners are sticking in short term tenants without the lenders consent just to get cash flow to do so.
    As for being a good investment, never forget this stuff is not liquid, it is long term-and in the long term we are all dead!
    Resi stuff is prob the best investment still even at these high prices-everyone needs a place to live! And it sells quicker, if it needs to be dumped.

  • David Lilley


    You have not mentioned the Lord Levene bid for the Lloyds branches that was twice that of the Co-op.

    Lord Levene was again on Jeff Randal Live tonight and livid that the Co-op bid was pursued and his well financed bid was rejected. If I remember well, the cost to Lloyds of proceeding with the Co-op bid was £400m.

    Another point is that the EU schedule of splitting off 600+ Lloyds branches must be completed by November.

  • Anonymous

    Hi James

    I believe that we need a complete rethink in terms of corporate governance. Shareholders or members in this case as supposed to gain protection internally from non-executive directors and externally from auditors. Both have fairly clear costs but apart from public relations we are not seeing benefits especially in the financial sector where a sequence of collapses has happened in spite of them.

  • David Lilley

    Commercial property funds, as in renting shops, offices and factory space, ws delivering 18% p yer on yer. But the fund I used to switch into for safety, the Halifax, suddenly dropped 14% in one day and then again some two weeks later and has never recovered since.

  • Anonymous

    Hi HoppingPot

    You are right to point out the unhealthy nature of the oligopoly which exists here. Yet the various regulators around the world seem to keep overlooking it….

  • Anonymous

    Hi DLinneridge

    Here is another suggestion for you from Yes Minister

    “If you believe the security of the realm is at risk you don’t hold a security enquiry, you call in the Special Branch. Government security enquiries are only used for killing press stories.”

    The same for public enquiries?

  • Anonymous

    Hi Mike

    Before this is over I expect the bill to be higher. These processes are like one of those oddly declining verbs and nouns…

    The section on “bail-in” is growing fast!

  • Paul C

    Well worth raising this one on the Co-op. I was surprised to see the talk of shares, maybe my historical perspective is wrong but I thought that the workers had shares in the business and they were not tradeable in the Stock Exchange, would this recent announcement mean the co-op was subject to “nasty” shareholder pressures of dividend payments and short-term performance measurement?

    On a related matter I personally bank with Smile and on the BH weekend of the 25th May (2 weeks after the downgrade) I couldn’t get my money. First my debit card was declined at the petrol station, then I went outside and tried to get cash at the hole in the wall, declined there too. I worried initially that I must have breached a limit, a little embarrassing not paying for the family get together. However a I checked my account status, nothing was wrong, no contact from the bank, no apology, no explanation. Perhaps that is really what happens when the banks fail….

    Reading some of the other blog responses, I concur that the banks are in trouble over CRE. A recovery would fix the value of CRE but as we all know the irony of the financial repression is that is displaces real entrepreneurs who are waiting for a return of a “fair dice” game..

  • Anonymous

    Hi Pavlaki

    Perhaps Roger Bootle has simply run out of ideas!

  • Anonymous

    Hi David

    It looks ever more reminiscent of the Rover debacle does it not? I hope that it has a better ending than that did.

  • Noo 2 Economics

    “Another point is that the EU schedule of splitting off 600+ Lloyds branches must be completed by November” and it’s going to happen.

    I am with Lloyds and have received a letter from them informing me my normal branch will be one of those branches forming part of the new bank called “TSB” (ring any bells anyone who was around about 30 years ago?).

    They’ve even given me a time table saying amongst other things the new “TSB” will be created on 14/08/13. They reckon it will be part of Lloyds banking group until transferred into new ownership which will happen following an initial public offering (nice that the taxpayer gets to pay twice for the same product!!) at an unspecifieed future date. Presumably they can get away wiith this by saying it’s not their fault they can’t find anyone to buy the newly created group.

  • Paul C

    I wouldn’t mind getting into the Banking business, it seems you get given money for nothing by the Govt and get to charge 18% loan rates to folk with good credit ratings. However I would be very uneasy about inheriting an established bankers loan book. I think I would do an internet only offer, move money on demand, pay 1% interest to depositors and advertise Basel 3 compliance in a transparent manner.

  • Anonymous

    Well worth raising this one on the Co-op. I was surprised to see the talk of shares, maybe my historical perspective is wrong but I thought that the workers had shares in the business and they were not tradeable in the Stock Exchange……….I thought that too?