Co-op-ting the bondholders
I have mixed views about the Co-op rescue plan, partly perhaps because little detail has been provided; we may have to wait until October to get the full picture.
Of course it is to be welcomed that the ordinary customers are (setting aside sentimental attachment to the principles on which the Co-op was founded) unharmed, and that a survival plan has been identified in which Co-op will remain as an independent licence for FSCS purposes (in other words, that those who already have their £85,000 exposure in another bank won’t have to choose between loss of breakage funding costs and an increase in their single-obligor credit exposure, as was foisted upon some ING Direct customers).
But the idea of listing a minority holding of worthless shares, which are most unlikely to recover, sounds like a political gesture with significant nuisance value and administrative cost.
The essential question however is whether it is reasonable for the holders of instruments such as the perpetual subordinated bonds to take the hit. At first sight this is not as outrageous as asking depositors to do so, à la Cyprus: PSB holders were on notice from the rate alone that they had a greater exposure. But many will have bought these instruments in the Co-op on the basis of their conservative reputation, and on financial statements which may or may not have revealed the true state of the lending book and the other exposures that have led to the problem.
The question then boils down to this: if that disclosure was adequate for the PSB holders fully to understand the risks they were assuming, why was it not adequate for the financially sophisticated regulators to see that Project Verde was a non-starter at a far earlier stage – or even to have blocked the Britannia take-over? If the PSB holders had inadequate information and no say in the conduct of the business, it is rather odd to expect them to do the regulators’ job for them.
The fact is that banking really only works with smaller, simpler businesses with equally simple capital structure: no secured debt; senior debt provided pari passu by banks, institutions and depositors; and a large enough cushion of simple ordinary shares that carry full voting rights. That way shareholders can ensure the business is run for their benefit (and their capital can only be used in the business they bought into), and depositors can get their money back since the asset shrinkage on collapse is covered by the equity. PSBs, subordinated bonds, PIBS, Co-Cos etc are all illusions that distract from the brutal truth that our banks can’t generate enough real profit (after staff remuneration) to provide the proper return on correctly-priced equity and debt.
The related issue is discomfort with the arbitrariness of the deal. Rather than following strict winding up procedures in which equity is wiped out completely before subordinated debt, it would appear that this restructuring will leave some value with the parent, and once again shows that we are subject to the whim of politicians and regulators.