Tony's Ten: The Co-op's take over of 632 Lloyds' branches

20 July, 2012

LIBOR? No. Money laundering in Mexico? No. UK economy? Certainly not. How about Co-operative Group's take over of 632 Lloyds’ branches and a number of contact centres? Yeah that is not such bad news.

After months and months, Lloyds has managed to structure a way in which it can off-load the branches earmarked for sale known as Project Verde, and which have been ordered to be sold in return for EU competition authorities accepting the bail out of Lloyds following the disastrous purchase of HBOS. The Co-op has been the preferred bidder for months. However, unlike when Lloyds casually acquiesced to buying HBOS, Co-op seems to have been protected from itself and the deal has been scrutinised in such a way as to make the outcome workable. A couple of the problems have certainly been addressed.

Firstly, how was the Co-op going to pay for the network and the assets and liabilities which went with them and have enough capital to both pay Lloyds and support the new larger balance sheet? Oh and of course banks are being required to have much more capital than in the past to absorb losses if things go wrong. The solution has been to slash the price of the deal with Co-op only paying £350m now, with a further £800m in ""earn out"" payments payable through to 2027, subject to performance of the operation. In today's money the total is valued at £750m, but Co-op only has to find £350m...oh, and the Co-op will find this through a debt issue, fully underwritten by Lloyds itself. In addition, Lloyds are putting £1.5bn into the Verde unit as capital before transferring it to the Co-op.

All this is necessary because Co-ops and mutual companies have a huge hole in their logic; they find it next to impossible to raise capital because they have no shares in the traditional sense. The only way they can raise new capital to act as a buffer if they suffer financial losses so as to protect customers and the tax payer, is to make large profits and use that as a way of building up that capital. Trouble is many of them are not as profitable as their commercial rivals not being subject to the same pressures to perform (he said, without looking for formal evidence).

A second issue for the Co-op was technology. Its share of the UK current account market will go from 2% to 7%. It is not geared for that scaling; hence the need for the contact centres as well as the branches, the Co-op's call centres could not cope. However, Lloyds’ technology capabilities are of much greater scale and the Co-op will retain the Lloyds IT infrastructure and outsource its operations to Lloyds. They will even shift their own customers on to the Lloyds platform. Good business for Lloyds as it will be a large fee earning business.

Not only Lloyds IT though, Peter Pester, Head of the Verde operation, is earmarked to become the head of the banking operations at the Co-op, and the current head of those, Barry Tootell will report to him, subject to FSA approvals, though Peter Marks retains leadership of the overall Co-op operation.

As for assets transferred, these are now substantially reduced from the original £62bn to £24bn, coupled to £24bn of liabilities. A lot of comment has been made about the reduction in the price from £2bn to anything between £350m - £750m in today’s money. However, if banking ever returns to normal and we start to once again see bank assets as, well, assets that actually make banks money and are worth striving for, then off-loading the branches with a substantially reduced asset base, may not been seen as so bad. That is, if normal times return.

So, you can spin it both ways. We have a new major bank, with an excellent operational capability and a different ethical outlook to the current major banks. Or we have Lloyds-lite and a bank which still won't be able to grow to compete head-to-head with the big four because after taking on the Verde network it still has no access to further capital to grow further. Let's go with the first eh.

Dr Tony Gandy, Reader, Postgraduate Programmes