Co-Op Bondholders Seek Shelter From New Regulations: U.K. Credit

Co-Operative Bank Plc bondholders say new legislation designed to make holding companies more responsible for their financial businesses could save them from being forced to bear the brunt of the lender’s bailout.

Under rules that came into force in April, the Prudential Regulatory Authority can direct a parent company to raise new capital, reorganize its financial unit and fire executives, said Mark Taber, a Bristol, England-based organizer of a group of bondholders who wants the PRA to review the proposed rescue. That could weaken the threat by Euan Sutherland, chief executive officer of parent company Co-Operative Group Ltd. to wind up the lender if bond investors refuse to accept losses, he said.

Co-Op Bank must raise 1.5 billion pounds ($2.3 billion) to plug a capital hole after losses incurred following its acquisition of Britannia Building Society in 2009. The lender plans to raise 500 million pounds by exchanging subordinated debt for equity and another 500 million pounds from the sale of senior debt issued by the member-owned parent company, which has interests from retail to funeral homes. Co-Operative Group plans to put in another 500 million pounds from the sale of insurance interests.

“The potential brand damage for putting the bank into administration would be pretty cataclysmic,” Gary Greenwood, a banking analyst at Shore Capital in Liverpool, England, said in a telephone interview yesterday.

Debt Exchange

Co-0p Bank is a public limited company owned through Co-Operative Banking Group Ltd., a unit of Co-Operative Group Ltd. The parent also owns its insurance businesses through the Banking Group. It sold Co-Operative Insurance Society Ltd., its asset management and life insurance business, this year and now owns a general insurer alongside the bank.

The PRA’s powers “are not applicable to the Co-Operative Group following the completion of the disposal of CIS on July 31,” Manchester-based Co-Op said in an e-mailed statement yesterday, declining to say why the rules don’t apply.

According to a policy document published by the Bank of England in April, “in general, the PRA would consider action to be most effective when taken in relation to the ultimate parent undertaking at the head of the ownership chain, as that is usually where most of the power to direct and control the group resides.”

A spokesman for the Bank of England, which is responsible for the regulation of the U.K. financial system through the PRA, declined to comment yesterday.

‘Onerous Requirements’

The regulator’s powers are “very broad,” Steven McEwan, a partner at Hogan Lovells International LLP in London, said in a telephone interview yesterday. “The practical question would be whether they will engage with the parent company taking into account what is realistic, or use the power to impose onerous requirements that the parent company cannot realistically achieve.”

Regulators across the world have been grappling since the 2008 financial crisis to make banking more resilient and to take taxpayers off the hook for rescues. European Union nations alone provided 1.7 trillion euros ($2.2 trillion) of support to their banking systems since the collapse of Lehman Brothers Holdings Inc., according to EU data.

“The PRA has the power to force them to put the money down,” said Taber, who coordinated a bondholder campaign against individual investors being forced to take losses following the restructuring of Bank of Ireland.

Exchange Effect

The Co-Op Bank’s 936 million pounds of senior subordinated bonds, which can’t be forced to take losses outside of bankruptcy, yield as much as 17.1 percent as investors gauge the likely effect of the exchange offer. By comparison, the average yield on bonds in Bank of America Merrill Lynch’s Euro Subordinated Financial Index is 3.8 percent. The details of the offer are expected to be made public next month.

Co-Op Bank’s 275 million pounds of 9.25 percent debt due in April 2021 fell for a fifth day, declining 1 pence to 68.5 pence on the pound, approaching the 64 pence low reached May 13 after the company was forced to abandon its attempt to buy 632 branches put on sale by Lloyds Banking Group Plc. The lender’s 150 million pounds of 5.875 percent notes maturing in March 2033 were quoted at 65 pence to yield 10 percent, according to Bloomberg prices.

“You need a stick to encourage bondholders to see that agreeing to take a loss is the best way forward,” Roger Doig, a credit analyst at Schroders Plc, which manages about $360 billion of assets globally, said in a Sept. 2 telephone interview. “With junior debt you can switch off coupons, it’s undated and so on, so you have a stick. With more senior debt, it’s dated, you have to pay coupons, so you need a realistic threat,” such as the possibility of winding up the lender, he said.

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