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  • #290

    OldBoyReturns
    Keymaster

    Nearly 3 years on from the passing of the restructuring which kept Co-op Bank out of resolution the bank released its Q3 2016 Trading Update on 11 Nov. The latest on the three key challenges at the time the restructuring was passed nearly 3 years ago does not look positive.

    Challenge 1: IT Transformation

    From the update:

    The Bank’s migration of the majority of its mainframe-based core banking systems has been rescheduled from mid-November to Q1 2017 to allow the remediation of the results of system testing. This delay will lead to additional programme costs.

    The Bank continues to work with Capita to seek to agree a way forward for the transformation element of the mortgage outsourcing contract.

    On 29 Sept the Telegraph reported a dispute between Co-op Bank and Capita over delivery of and payment for the transformation programme.

    http://www.telegraph.co.uk/business/2016/09/29/capita-shares-plunge-20pc-on-shock-profit-warning/

    So on the transformation challenge the bank will incur additional costs, a time delay (hardly likely to please the regulators) and has run into a commercial dispute with a key supplier.

    Challenge 2: Capital Adequacy

    From the update:

    The Bank’s Common Equity Tier 1 (CET1) ratio stood at 12.6% at 30 September 2016 (13.4% at 30 June 2016).

    The PRA has notified the Bank of its new Individual Capital Guidance (ICG), which became effective as of 1 November 2016. As at 30 September 2016, the Bank’s new Pillar 2A was equivalent to 14.1% of RWAs.

    The Bank continues to work through a remediation plan relating to its IRB models and remains in close and continuous dialogue with the PRA in this respect.

    As noted previously, under the PRA rulebook, not meeting the Combined Buffer prevents the Bank from paying variable remuneration during the period of non-compliance.

    On 13 Nov the Times reported:

    The Bank of England is in weekly contact with the lender because it lacks sufficient capital buffers to withstand a financial crisis.

    The Co-operative Bank is to submit a bolder recovery plan to the Bank of England next month amid concerns over its financial health.

    http://www.thetimes.co.uk/article/troubles-mount-for-co-op-bank-bmt8b3kkg

    So the Bank is still reliant in regulatory waivers / forbearance on IRB models and has insufficient capital buffers. In view of the struggle to create a profitable core bank 3 years on from the restructuring (see 3 below), likely future run off losses on the non-core, escalating IT transformation costs and the fact that significant deleveraging and cost reduction have already been achieved it is hard to see how the Bank can generate the capital necessary to remedy this.

    Challenge 3: Sustainable Business

    From the update:

    The Core Bank recorded an operating profit for the nine months to 30 September 2016, driven by the reduction in the FSCS levy and the gain from the sale of gilts, compared with an operating loss in the same period in 2015. The Core Bank recorded a small operating loss in Q3 2016.

    Total Bank operating costs for the nine months to 30 September 2016 were 10% lower than the same period last year and 3% lower quarter on quarter.

    Delivering some elements of the turnaround plan will become more challenging given that interest rates are now likely to be lower for longer and given the uncertainty surrounding the impact of the UK’s decision to leave the European Union.

    So it seems despite the big reductions achieved in operating costs the Core Bank is struggling to generate a profit at the operating level. Then there are the headwinds from continued low interest rates, intense mortgage competition, conduct costs, increased IT transformation costs etc.

    Based on all the above it is hard to see how the ‘recovery plan’ the Bank is preparing for the PRA will not include further pain for bondholders. The market certainly seems nervous with recent falls in both senior and subordinated bonds despite the general strength of credit markets. Co-op Bank 11% 2023 Subordinated Notes are currently trading around 80 representing a running yield of 15.8% and yield to maturity (YTM) of 13.75%. I saw the Co-op Bank 5.125% senior notes which mature on 20/9/2017 have been offered at 91.75 last week representing a YTM of 15.9%.

    Obviously it is highly unusual for much shorter dated senior to be trading at a higher YTM than longer dated subordinated. In this case I put it down to legitimate fears that the combination of the need to have a credible plan to generate capital to satisfy the PRA and the issue of how to fund the £400 million at maturity of the senior next September will be the catalyst for a further restructuring of the Bank’s debt. In these circumstances the current YTM does not look attractive to me relative to the potential downside. Worth keeping an eye on though.

    Addendum

    A VIP reader of this board, who helped me greatly in negotiating the deal for retail investors in the Co-op Bank restructuring, has quite rightly pointed out that a post titled ‘Co-op Bank 3 years on’ should take a look at how the “pensioner / retail outcome” has fared vs the “hedge fund” outcome. So here goes.

    At the start of negotiations the proposal was that the lower ranking subordinated bonds and preference shares (largely held by retail investors) would get Co-op Bank equity while the higher ranking subordinated bonds (largely held by hedge funds) would get new bonds in Co-op Bank.

    I could, and probably should, write a book about what happened next. But for now, to cut a long story short, we managed to negotiate this round to retail getting new Co-op Group bonds while hedge funds got bank equity and bank bonds. The equity was issued in exchange at about £5 a share with the ‘promise’ of a future listing. Still no sign of that listing and £1 a share would be optimistic if you could find a private buyer. Meanwhile the ‘new’ Co-op Group bonds currently trade at around 130 while the ‘new’ Co-op Bank bonds trade at around 80.
    So the retail / pensioner outcome has proved to be quite miraculous despite being achieved against all the odds.

     

    #325

    Jamtomorrow
    Participant

    I used to think the Senior 2017 bonds were a safe place to park cash. However I dumped them about 6 months ago, selling at just over 96p. A capital loss only made feel ok by the interest already received.

    It was the “going concern” statement then that made me feel it wasn’t worth the risk to hold on.

    Any suggestions on where to park cash now?

    Jt

    #371

    JonWBWB
    Participant

    OldBoyReturns (Mark) – Thanks for a great update on the Q3 2016 Trading Update for Co-op Bank.

    I sold my 100,000 nominal holding of Co-op Senior 2017 bond (ISIN XS0542823892) this morning for 92.3p. The counterparty was HSBC and the trade was settled via Euroclear.

    I thought I would use this first post to provide a bit more background to online sources for price transparency for the Co-op Senior 2017 bond. There are two exchanges where there is some information that I am aware of:

    1. The London Stock Exchange (LSE) where the ticker is 77UQ
    2. The Börse Frankfurt: XS0542823892

    The LSE is very hit and miss with regards information and the Börse Frankfurt is – generally speaking – more accurate for prices. The definitive source for virtually all fixed income pricing is the Bloomberg Terminal, but this is unlikely to be available to anyone other than professional investors due to the cost.

    The ability to settle trades in CREST (this is the settlement system used in the UK and Ireland to settle most listed shares) works by blocking off a portion of the bond in Euroclear or Clearstream and allocating that specific portion as a CREST Depository Interest (CDI). Only a very small subset of corporate bonds are setup with a CDI to allow settlement via the CREST system and the size of the allocation (in terms of the amount outstanding of the bond) is usually small.

    CREST (the settlement system) is owned and operated by Euroclear UK and Ireland (the company), so this is one of those cases where google is thwarted on a search of ‘CREST Euroclear’.

    Most of the on-line discount retail stockbrokers in the UK only allow settlement of corporate bonds in the CREST Settlement System. If  you want to settle in the Euroclear or Clearstream systems, you will likely need to use a full service broker where higher fees are charged. 

    [If anyone is aware of discount UK stockbrokers who offer Euroclear settlement, please share the information in this thread.]

    It is quite common for a wide disparity between the price that can be obtained between settlement via CREST and settlement via Euroclear and Clearstream. Generally speaking, the spreads on CREST settlement tend to be wider. 

    I thought it might be a good idea to introduce readers to two of the main Bloomberg screens for the Co-op Senior 2017 bonds. I will point out at this stage that my background is purely as a retail investor. I have no knowledge of the fixed income industry in any professional capacity. I am completely self taught and started back in 2009 on the UK based Motley Fool Banking Sector board (where I also posted as JonWBWB).

    Once the security is loaded in Bloomberg (there are various ways and means, which I will not go into now), there are screens that can be accessed for information.

    DES (Bond Description) – COOPBNK 5 1/8 09/20/17

    XS0542823892 DES

    A few comments on the DES screen:

    • A compressed notation is used to describe the bond (COOPBNK 5 1/8 09/20/17), which is issuer, coupon and maturity date [See top left]
    • The current price is displayed with the time underneath (red if the price is down on prior close, green if it is up) [See top centre]
    • More details (called pages) can be accessed from this screen [See left hand column]
    • Most of the other information on the DES screen is reasonably self explanatory (or can be understood with a bit of googling).

    The screen that makes Bloomberg mandatory for professional fixed income investors is the ALLQ (All Quotes or Pricing) screen. This is one of the main reasons why Bloomberg has a near monopoly on corporate bonds. Whereas most equity (Stocks) trade electronically on open exchanges (and by open, I mean open to all market participants as both retail and institutional can see realistic prices and execute for themselves), for Corporate Bonds, trades are typically over the counter and market makers will post their prices on Bloomberg.

    ALLQ (Bond Pricing) – COOPBNK 5 1/8 09/20/17

    XS0542823892 ALLQ

    A few comments on the ALLQ screen:

    • The level of detail you can obtain on this screen is in itself dependent on data feeds you have signed up for (over and above the cost of a Bloomberg Terminal).
    • The BVAL score is a Bloomberg valuation, on a scale of 1 (lowest accuracy) to 10 (highest accuracy) and it is based on all the data Bloomberg has access to (but that you may not see on your ALLQ screen).
    • Note that the LSE has a very wide spread 85 / 100 and that the Frankfurt Exchange (Börse Frankfurt) has much tighter spread 91.7 / 93.8.
    • For very liquid corporate bonds with lots of visible market makers, this screen flashes constantly as the bid and ask prices update.

    For professional investors who have execution services enabled via Bloomberg, it is possible to execute buy and sell orders directly from the Bloomberg Terminal. If you use a Stockbroker who allows for Euroclear settlement, they will probably execute your order request from within the Bloomberg Terminal whilst taking your order over the phone.

    I have written this from the point of view of what I would like to have had explained to me when I was starting out in Fixed Income as a retail investor. Please do provide some feedback in this thread on whether this has been helpful.

    There will be enough big hitters – many of whom will be professional fixed income participants – who can correct anything I’ve got wrong.

    I intend to explain my rationale for selling my Co-op Senior 2017 holding at some stage, but I don’t have time right now. The gist is that my thoughts are very much in-line with OldBoyReturns (Mark’s).

     

     

    • This reply was modified 2 years ago by  JonWBWB.
    • This reply was modified 2 years ago by  JonWBWB.
    • This reply was modified 2 years ago by  JonWBWB.
    #383

    Wizard
    Participant

    Super post Jon!

    On the second screen can you point me to where I see BVAL, may be wood for the trees but I couldn’t find where it is?

    Edit: of course having posted this I found it immediately!

    Terry.

    • This reply was modified 2 years ago by  Wizard.
    #405

    OldBoyReturns
    Keymaster

    A VIP reader of this board, who helped me greatly in negotiating the deal for retail investors in the Co-op Bank restructuring, has quite rightly pointed out that a post titled ‘Co-op Bank 3 years on’ should take a look at how the “pensioner / retail outcome” has fared vs the “hedge fund” outcome. So here goes.

    At the start of negotiations the proposal was that the lower ranking subordinated bonds and preference shares (largely held by retail investors) would get Co-op Bank equity while the higher ranking subordinated bonds (largely held by hedge funds) would get new bonds in Co-op Bank.

    I could, and probably should, write a book about what happened next. But for now, to cut a long story short, we managed to negotiate this round to retail getting new Co-op Group bonds while hedge funds got bank equity and bank bonds. The equity was issued in exchange at about £5 a share with the ‘promise’ of a future listing. Still no sign of that listing and £1 a share would be optimistic if you could find a private buyer. Meanwhile the ‘new’ Co-op Group bonds currently trade at around 130 while the ‘new’ Co-op Bank bonds trade at around 80.

    So the retail / pensioner outcome has proved to be quite miraculous despite being achieved against all the odds.

    #532

    hiriskpaul
    Participant

    Obviously it is highly unusual for much shorter dated senior to be trading at a higher YTM than longer dated subordinated. In this case I put it down to legitimate fears that the combination of the need to have a credible plan to generate capital to satisfy the PRA and the issue of how to fund the £400 million at maturity of the senior next September will be the catalyst for a further restructuring of the Bank’s debt. In these circumstances the current YTM does not look attractive to me relative to the potential downside. Worth keeping an eye on though.

    Mark, I am a little surprised that you think the bank may have any difficulty funding the redemption of the £400m senior or that this could catalyse debt restructuring. To state the obvious (and I am sure this was not your intent), the senior is not part of the bank’s capital. Nor can it be classified as TLAC as it matures in less than a year. There is also no TLAC language in the prospectus, for obvious reasons. The 550m Euro 2.375% senior was repaid in Oct 2015, seemingly without any problems and the bank currently has over £20B in deposits. Judging by the rates they are offering, they do not appear to have trouble attracting funds.

    Futhermore in the Q3 trading update (http://www.co-operativebank.co.uk/assets/pdf/bank/investorrelations/Q3-2016-Trading-Update.pdf) the bank stated

    The Bank continues to maintain adequate liquidity in excess of the regulatory minimum and has only limited wholesale funding maturities in the next 18 months.

    I find it hard to understand how a statement such as this could be made if next years £400m redemption was viewed as a problem.  I have a substantial position the the 2017 senior, which I added to recently, but would be very interested in hearing counter arguments as to why these are not excellent value at current prices.

    #535

    OldBoyReturns
    Keymaster

    Mark, I am a little surprised that you think the bank may have any difficulty funding the redemption of the £400m senior or that this could catalyse debt restructuring. To state the obvious (and I am sure this was not your intent), the senior is not part of the bank’s capital. Nor can it be classified as TLAC as it matures in less than a year. There is also no TLAC language in the prospectus, for obvious reasons. The 550m Euro 2.375% senior was repaid in Oct 2015, seemingly without any problems and the bank currently has over £20B in deposits. Judging by the rates they are offering, they do not appear to have trouble attracting funds. Futhermore in the Q3 trading update (http://www.co-operativebank.co.uk/assets/pdf/bank/investorrelations/Q3-2016-Trading-Update.pdf) the bank stated The Bank continues to maintain adequate liquidity in excess of the regulatory minimum and has only limited wholesale funding maturities in the next 18 months. I find it hard to understand how a statement such as this could be made if next years £400m redemption was viewed as a problem.  I have a substantial position the the 2017 senior, which I added to recently, but would be very interested in hearing counter arguments as to why these are not excellent value at current prices.

    Hi Paul – I noticed the bank’s statement about its liquidity position with a wry smile as it only referred to  maturity of wholesale funding and not other sources of funding such as the senior bonds. It will take a while longer before I come to read anything Co-op Bank says about its capital and liquidity without a large dose of skepticism.

    I am not suggesting maturity of the 2017 senior need be a catalyst for another debt restructuring. Rather that, against a backdrop of the bank being short of capital and not being able to generate it internally in the foreseeable future, there must come a point where they seek to raise more capital externally. I am sure they will try other things first such as further deleveraging through sale of riskier non-core assets but the plan the bank is formulating for the PRA must contain other options for addressing the capital shortfall if that fails. I am also mindful that the regulators have been burned once through affording Co-op Bank forbearance over several years and so could (should) be wary of repeating that mistake by kicking the can down the road while the bank’s capital is further eroded by operating losses.

    Even if there is a further restructuring I do not consider inclusion of senior as likely but the upside from current levels until maturity is not enough to compensate me for the risk of that (or some other ‘accident’) taking place in the meantime.

    I am also concerned by what may be behind the behaviour of the regulators in progressing the various investigations, complaints and inquiries which were announced after the restructuring 3 years ago. This is summed up well in the following section from the Complaints Commissioner’s decision on my complaint over the delays –

    This was back in July and still the FCA has done nothing nor even responded to elements of my complaints which the Commissioner ruled should be investigated immediately. My suspicion is that the regulators are so fearful of the fragile state of the bank and the affect adverse publicity could have that they are using the ‘financial stability’ objective to bury the past.

    #549

    hiriskpaul
    Participant

    Hi Paul – I noticed the bank’s statement about its liquidity position with a wry smile as it only referred to  maturity of wholesale funding and not other sources of funding such as the senior bonds. It will take a while longer before I come to read anything Co-op Bank says about its capital and liquidity without a large dose of skepticism.

    I was assuming “Wholesale Funding” included the senior unsecured! However, as they do not provide a definition, I guess that means they could later say they were only referring to deposits.

    The lack of progress on the investigation is frustrating. I would be surprised if this caused much more damage to the Co-op Bank or Group though. Everyone responsible for the mess has moved on. IMHO, more likely the delay is due to embarrassment that might be caused to regulators.

    #553

    LogLorry
    Keymaster

    Surely the danger here is that CoOp Bank extend the maturity on the senior. Perhaps they’ll offer a bit of a yield sweetener in the form of a consent fee to get the deal done. I realise that also brings with it all sorts of problems but perhaps the lesser of the two evils. If maturity is pushed back though, even with a bit of a yield bump, they don’t look good risk return here.

    If I was runing CoOp bank – I’d go on a major charm offensive to attract deposits and so reduce my reliance on wholesale funding. The Financial compensation scheme will soon cover £85K of deposits and so I expect if CoOp bank ran a campaign along the lines of ethical saving paying say 1-2% on deposits they’d get a huge influx of deposits. Why pay so much on the senior notes when you could attract deposits so easily?

    Log

     

    #561

    hiriskpaul
    Participant

    To extend the maturity, the bank would likely need 75% of bondholders to agree (I confess I have not checked this point, but 75% is usually the requirement). At present, I just cannot see them getting that, unless there is either a remarkable recovery, massive injection of capital, substantial uplift in coupon, or the PRA pointing a gun at bondholders heads.

    The market leading 3 year fixed deposits are around 1.6%, coop are only offering 1.2%, so the bank does not appear to be working hard to raise funds. I guess that could all change quite quickly, but at present I see no reason why the bank would want to extend the life of the senior when they can raise funds from retail at much lower cost.

    The bank is far from problem free, but they do not appear to have a liquidity problem (yet).

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