Drug Scandal to Spur Co-Operative Bank Bond Swap: U.K. Credit

Allegations that Paul Flowers, the former Co-Operative Bank Plc chairman, bought crack cocaine and crystal methamphetamine may assist the lender in securing enough support from bondholders to approve its overhaul today.

The lender, which is trying to plug a 1.5 billion-pound ($2.5 billion) capital shortfall, needs two-thirds of holders of its undated junior debt to vote on a debt-for-equity swap for it to be valid, according to company filings. Of those, 75 percent need to vote in favor by 4:30 p.m. London time today to get the best terms. There’s a later deadline on Dec. 6 offering less per bond.

Regulators are probing Manchester, England-based Co-Op Bank after the Mail on Sunday reported that Flowers, a methodist minister, sought to buy drugs. The allegations propelled the lender onto the front pages, with the Sun newspaper dubbing him the “Crystal Methodist.” That may help convince the pensioners and individual investors who own the most junior bonds and preferred shares an overhaul is essential, said Andre Spicer, a professor at Cass Business School in London.

“The publicity will have had the effect of increasing public concern and worries,” Spicer, who specializes in organizational behavior, said in a telephone interview. “That means people are far more likely to take up the exchange.”

The lender’s 200 million pounds of 5.556 percent perpetual subordinated bonds were unchanged at 57.25 pence today and its 110 million pounds of 13 percent perpetual subordinated bonds fell 0.2 percent to 99.16 pence.

‘Very Tight’

Should Co-Op Bank fail to secure enough support for the swap, the vote can be held again on Dec. 27 with a lower quorum of one third. If the bank still fails to secure approval, it is likely to be nationalized and bondholders may get far less, the lender has said.

“A vote against any of the bond issues would mean the bank would have to basically liquidate,” said Eva Olsson, a credit analyst at Mitsubishi UFJ Securities in London. “If they can’t get hold of two thirds it goes to a second vote, so getting things done by year-end will be very tight.”

Brokers have been rushing to reach bondholders to get them to participate, said Mark Taber, who is organizing individual investors to get them a better deal. Hargreaves Lansdown Plc, the U.K.’s largest retail broker, has written to bondholders three times to let them know their options, said spokesman Danny Cox. About 85 percent have responded, all to vote yes to the deal, he said in a telephone interview.

‘Reputational Damage’

“Recent events may have caused some brand and reputational damage,” Co-Operative Bank said in a statement yesterday. The lender said it may also be also subject to more regulatory scrutiny after the debt-for-equity swap and is also losing checking account customers. A spokesman for the bank declined to comment further.

Co-Operative Group, whose businesses range from supermarkets to funeral parlors, was forced last month to cede control of its banking unit to help plug a capital shortfall at the division. As part of the restructuring, a group owning 48 percent of the lender’s Lower Tier 2 securities agreed to exchange their bonds for shares and new bonds, and to inject 125 million pounds of fresh equity.

That group, which includes hedge funds Aurelius Capital Management LP, Canyon Capital Advisors LLC and Silver Point Capital LP, asked for better terms yesterday, including more shares in the swap. The group still supports the deal and said if the amendment means delaying the recapitalization it should be scrapped. The Financial Times reported yesterday that Aurelius has sold almost its entire stake to Perry Capital.

Flowers was arrested on Nov. 21 as part of a drug investigation, according to a person familiar with the probe. The 63-year-old, who couldn’t be reached for comment, has previously apologized for his conduct. He was chairman from March 2010 until he was replaced by Richard Pym in June.

“There’s been significant bad publicity, largely around governance issues, and the number one item on the agenda is governance,” said Spicer. “Flowers’s activities help justify the changes.”

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