The Co-Operative Group, the UK’s largest consumer mutual bank, is contemplating selling off its £2.1bn non-core non-performing property loans, in a move which would help stem the bank’s estimated up to £1.8bn capital shortfall and release much-need risk-weighted assets.
The review, which has now concluded, is understood to have analysed the relative merits for best possible capital recovery for the Co-Op’s impaired property loan book, including a disposal of the loans by portfolio, underlying asset sales and running-off the book as a “bad bank”.
Given the heightened fears over the bank’s capital shortfall and loan under-provisioning concerns surrounding the Co-Op, the relatively faster legacy exit route through an NPL sale is thought the most probable direction of travel.
The Co-Op split its property loan book into core and non-core last year, with the latter impaired book comprising £1.74bn in commercial property loans and £300m in residential loans.
The commercial property component is sub-divided into two pools:
- 12 loans with an outstanding balance of £936m, against a carrying value of the assets of £696m, reflecting a 25.6% write-down to date by the Co-Op. At the end of March, £193m of impairment provisions had been taken which, together with the carrying value, leaves £47m to be sourced through property performance.
- Remaining loan portfolio with an unpaid principal balance of £803m, against a carrying value of the assets of £305m, reflecting a 62.0% write-down to date by the Co-Op. At the end of March, £341m of impairment provisions had been taken which, together with the carrying value, leaves £157m to be sourced through property performance.
The figures, published at the time of the Co-Op’s 2012 annual results on 21 March, may require further carrying value write-downs in future as well as increased impairment provisioning, crystallising further losses.
While Co-Op declined to comment, it is thought that the sale of these non-performing loan portfolios, as separate pools, is under consideration.
James Mack, acting CFO at the Co-Op’s banking group – who resigned three months ago but agreed to stay on until a replacement has been found – said Morgan Stanley’s role was to help the bank “consider appropriate ways to increase financial strength, capital efficiency, whilst reducing balance sheet risk”.
Mack added that a variety of strategies were under consideration, including “de-leveraging, risk transfer and asset sales”.
A tumultuous week in the life of The Co-Operative
It all started last Thursday evening. The Co-Op was downgraded six-notches by Moody’s to “junk” status, suggesting that further substantial losses are expected in its non-core portfolio as “demonstrated recently by the unexpectedly significant deterioration of its commercial real estate exposures”.
The Co-Op’s plight, said Moody’s, was exacerbated “by the low level of provisions held against its lending portfolio” and that there is an implied risk of further write-downs “and, potentially, the need for external support to maintain regulatory capital levels”.
Moody’s declaration that the Co-Op may need some kind of government rescue sent alarm bells off in the City, particularly among the bank’s subordinate bond investors, who naturally feared as to whether they would have to share in the pain in the event of any state intervention.
The Co-Op’s subordinated debt securities immediately fell 30%.
The following day, last Friday, the Co-Op’s chief executive office, Barry Tootell, resigned and was replaced by the Co-Op’s retail banking managing director, Rod Bulmer, who was appointed acting CEO by the board with immediate effect.
In an attempt to allay fears, the Co-Op issued a statement re-affirming: “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.”
However, Barclays Capital, in an investor note written the same day, estimated that the Co-Op had a substantial capital shortfall – ranging from £800m in its ‘base case’ to £1.8bn in a ‘stressed scenario’.
These alarming capital shortfalls are exacerbated by the Co-Op’s unusual business structure which precludes typical capital raising measures employed by banks – such as through an equity share pacing.
Furthermore, the sheer scale of the Co-Op’s balance sheet makes its aborted Verde acquisition – of 632 branches from Lloyds – even more incredulous, commentators have argued, with the bank so far declaring the failed acquisition has racked up £38m in costs.
The familiar story of an ill-timed acquisition
Since the turn of the year, the Co-Op has attempted to accelerate its non-core de-leveraging, following a dramatic five-fold increase in the provisions taken for impaired loans in the second half of last year – from £58m in the first of 2012, to £293m in the second.
Mack said this provision spike was due to “the impact of difficult trading conditions for some of our customers; the deferred prospects of meaningful economic recovery, which we now do not anticipate until 2018; more muted forecasts for CRE recovery and; the impact of a small number of individually significant cases, triggering default”.
Indeed, half this impairment charge was driven by the dozen large non-core commercial property loans, in the first of the two NPL sub-pools as described above.
“This discreet number of cases has seen a variety of triggers been hit, such as: restructuring actions, increased refinance risk, or vacancy on lease expiry,” Mack told analysts.
Barclays Capital argued the problems at the Co-Op run a little deeper.
Explaining its estimated capital shortfall of between £800m and £1.8bn in the Co-Op’s balance sheet, the BarCap’s credit research analysts wrote: “The key driver of the shortfall is the losses arising from the non-core corporate book, which consists primarily of UK commercial real estate exposures inherited from Britannia.
“We assume portfolio losses of 35% in a base case and 50% in a stressed case and base these assumptions on recent market transactions of comparable portfolios.”
The members of the Co-Operative and the Britannia Building Society agreed to merge in April 2009, which saw the enlarged Co-Op triple the size of its balance sheet to £46bn, acquiring Britannia’s assets at a discount of 5% on asset value and 4% on loan balance.
This modest discount, reflected expectations of future losses at the time of the transaction. Losses which, four years on, are starting to escalate.
The Co-Operative declined to comment.