Co-op Bank bail-in to hit subordinated bondholders

The Co-operative Bank has decided to hit subordinated bondholders with a bail-in as part of a plan to raise £1.5 billion in new capital, which will also partly demutalise the bank from its parent, the Co-operative Group.

The full details will be finalised in October, but junior bondholders are likely to be hit hardest with a conversion of part of their holdings into a combination of ordinary shares, which will then be listed on the London Stock Exchange, and a new class of bond in the Co-op parent group. Coupons due on affected bonds will not be paid in the meantime.

The mutually owned bank will also be using proceeds of the sale of two insurance units to contribute to the fresh capital.

"This is the biggest ever failure in the UK [mutual and building society] market," said Mark Taber, a professional bond investor who runs a website for retail holders of PIBs, preference and subordinated bonds¹. "There are probably more than 15,000 retail holders affected, far more than the Co-op believes," he added.

The bank's problems began in 2009 when it acquired the Britannia Building Society, whose underperforming loans turned out to be inadequately provisioned. There has been some early warning of the Co-op's problems. The Financial Times in February warned that it had a £1 billion capital hole, equal to half its capital, and in March the bank reported losses of £674 million and tripled loan impairment losses to £474 million.

Yet it was only in April that the Co-op pulled out of a hugely ambitious plan to buy 632 branches from Lloyds Banking Group, which would have tripled the size of the mutual bank. News in May of a downgrade of the Co-op's subordinated bonds to junk status by Moody's led to the immediate resignation of Co-op Bank chief executive Barry Tootell, and a 30-50% hit to the market value of the various debt classes.

The bonds fell another 10-15% on the news today, with brokers saying the cessation of coupon payments had done the damage.

"The most junior bondholders are likely to be given the most equity and the fewest bonds, which seems to make some sense," said Rik Edwards, of brokers Canaccord Genuity. "Unfortunately it is a long wait until October to get the full details. That is presumably designed to soften-up bondholders," he said.

The three tranches of stock principally affected are the 9.25% Non-Cumulative Irredeemable Preference Shares, which is the most junior of the Co-op's 10 affected securities, and the 13% Perpetual Subordinated Bonds and 5.5% Perpetual Subordinated Bonds which stand one notch above that.

For holders of subordinated bonds this has been a shock because unlike public companies it is they, not ordinary shareholders, who are first in the line of fire to take losses.

"Given that retail investors are involved, this is going to be nightmarishly complicated," Taber said. "There is no cash offer, which would at least simplify things."

¹ fixedincomeinvestments.org.uk