Co-Operative Troubles Taunt PRA in Test for U.K. Watchdog

The Prudential Regulation Authority may be spurred to intervene directly in the Co-Operative Bank Plc, as the U.K.’s new bank supervisor faces its first test of credibility barely a month after it was created.

The regulator, which expressed concern last month as the customer-owned lender abandoned a 750 million-pound ($1.15 billion) bid for 632 Lloyds Banking Group Plc branches, may require the bank to boost its capital or cut lending following the decision by Moody’s Investors Service slash the lender’s credit rating to junk status on May 9.

“The PRA needs to look seriously at their capital strength,” Barney Reynolds, a financial services lawyer at Shearman & Sterling LLP said in a telephone interview in London. “On the face of it they may look pretty silly if they don’t intervene and something goes wrong. The regulators could tell them to raise capital, maybe to get outside investment.”

The crisis is an early challenge for the PRA, which took over oversight of the U.K.’s largest lenders from the Financial Services Authority last month. The FSA lost the confidence of lawmakers in 2007 when it was taken by surprise by the collapse and eventual nationalization of Northern Rock Plc and then was unable to prevent bail outs of larger U.K. lenders, including Royal Bank of Scotland Group Plc during the global financial crisis a year later.


The Co-Operative Bank, based in Manchester, England, says that Moody’s cutting its rating by six steps to Ba3/not prime from A3/prime doesn’t mean it needs a government bailout. Moody’s said the bank may require “external support” if real-estate losses escalate.

The customer-owned firm’s chief executive officer Barry Tootell quit the day after the downgrade, which saw its 9.25 percent subordinated notes due April 2021 fall as much as 27 pence to 75 pence on the pound, according to Bloomberg pricing data.

The PRA is already reacting quicker than its predecessor by voicing the concerns about capital and management structures that led Co-Op Bank to drop the plan to acquire the Lloyds branches, Reynolds said.

“That’s a positive sign,” Reynolds said. “This is like RBS in a way, but instead Sir Fred has been stopped in his tracks,” he said, referring to former RBS CEO Fred Goodwin.

A spokesman from the PRA declined to comment on the Co-Op downgrade.

Low Capital

Co-Op Bank’s core Tier 1 capital ratio, a measure of its ability to absorb losses, was 6.7 percent in January, less than the 7 percent target set by U.K. regulators, Moody’s said.

An estimate of a 750 million-pound capital shortfall is “credible, albeit not necessarily extraordinarily conservative,” said Eva Olsson, a London-based analyst at Mitsubishi UFJ Securities. The figure suggests the bank will report losses of about 500 million pounds in the coming three years, she said in a note to clients.

The bank has been hit by bad consumer and commercial real estate loans stemming from its purchase of Britannia Building Society in 2009. Impairments more than quadrupled to 468.7 million pounds in 2012, the company reported in March. The bank posted a pretax loss of 673.7 million pounds last year, compared with a profit of 54.2 million pounds a year earlier.

Industry Shortfall

The PRA, which took over supervision of the industry from the Financial Services Authority, has yet to disclose how much capital each U.K. bank will have to raise to plug a 25 billion-pound industry shortfall the Financial Policy Committee identified in March. The PRA may inform the banks at the end of this month.

“More equity in the balance sheet mix can lower the cost of debt funding,” Robert Jenkins, a former member of the Bank of England’s Financial Policy Committee, said in an e-mail. “This is a timely reminder that the opposite is also true.”

We acknowledge “the need to strengthen our capital position in light of the broader economic downturn and the pending introduction of enhanced regulatory requirements,” Co-Op Bank said. “We plan to significantly simplify our business, which will greatly improve our operational effectiveness and also enhance our capital position in the process.”

The downgrade triggered speculation junior bondholders may be forced to take losses as part of a bail-in of the U.K. lender. In February, the Dutch government expropriated about 900 million euros ($1.2 billion) of SNS Reaal NV’s junior debt after property losses brought the fourth-largest Dutch lender to the brink of collapse.

“I think this is about precautionary measures,” Reynolds said. “On the other hand, this isn’t a zero failure regime.”