DBRS Downgrades Co-op Bank’s senior ratings to BBB (low), URN; subordinated debt to CC, URN

DBRS Ratings Limited (DBRS) has today downgraded the ratings of The Co-operative Bank plc (The Co-operative or the Bank). The Bank’s Long-Term debt and deposit ratings have been downgraded to BBB (low), from BBB (high), and the Short-Term debt and deposit ratings have been downgraded to R-2 (middle) from R-1 (low). The dated subordinated debt of the bank has been downgraded to CC from BBB (low) and the Perpetual subordinated bonds have been downgraded to CC from BB (high). All of the ratings remain Under Review with Negative Implications. The Intrinsic Assessment for the bank is now BBB (low). DBRS has also changed its Support Assessment for the Bank to SA3 from SA2 and therefore the Bank’s Long-Term debt and deposit ratings are no longer positioned above the Intrinsic Assessment.

The rating action follows the June 17, 2013 announcement by The Co-operative Group (Group) and the Bank that the Bank requires an additional GBP 1.5 billion of equity capital. The Bank plans to raise approximately GBP 1 billion in 2013 through an exchange offer to holders of the Bank’s dated subordinated debt, Perpetual subordinated bonds, and non-cumulative preference shares (unrated). In addition a further GBP 500 million is to be raised in 2014 through the sale of the Group’s life assurance and asset management business, and its general insurance business, as well as through a cost saving programme at the bank and through the deleveraging of the bank’s non-core assets, including potentially asset sales. Although full details on the exchange offer will not be known until October 2013 the Bank has announced that subordinated bondholders will be offered an exchange into a mixture of senior debt issued by the Group (and potentially also a fixed income instrument issued by the Bank dependent on take-up) and equity in the Bank. As a result of this, a minority equity stake in the Bank will be listed. Given the magnitude of the capital requirement DBRS expects that some form of coercion will be required to ensure that the required take-up of the offer is achieved. DBRS also highlights that the proposal has broader negative implications for bank creditors as it is not in line with the normal creditor hierarchy that would see equity being wiped out before subordinated debt holders are required to take a loss.

The downgrade of the Bank’s senior rating and intrinsic assessment to BBB (low) reflects the strategic challenges facing the bank and its new management team, including the listing of a minority stake in the bank, the potential damage to the franchise as a result of the capital issues and the exit from certain corporate business, and the continuing need to finalise the integration of Britannia. Additionally DBRS expects the bank to report another substantial loss in 2013 as a result of the deterioration in asset quality, especially within the Bank’s commercial real estate loan portfolio. Downward pressure on the senior ratings is mitigated to a certain degree by the capital that is proposed to be raised by the Bank through the exchange offer and the support from the Group. However, if the exchange offer is not successful and the capital not raised, then it is likely that a further multi-notch downgrade would result.

The ratings also take into account the Bank’s relatively solid, albeit limited, customer franchise and the strength of its funding profile. DBRS considers that the Bank’s core operations, which have remained marginally profitable, can support the Bank in its eventual return to profitability.

The UK banking system is dominated by a small number of large banks and DBRS notes that there is a desire on the part of the authorities and other parties to promote competition by encouraging smaller banks such as The Co-operative. Nevertheless, the change in the Support Assessment to SA3 from SA2 reflects DBRS’s view that the likelihood of the UK Government stepping in to provide support which would benefit the senior bondholders of a mid-sized bank such as the Co-operative Bank is low, and indeed the example of the Co-operative provides further evidence that the authorities in the UK look to bail-in subordinated debt when capitalisation is weak.

As a result of the likely coercive nature of the exchange offer and DBRS’s expectation of substantial losses for bondholders the dated subordinated debt and the Perpetual subordinated bonds have been downgraded to CC and remain Under Review with Negative Implications until full details on the exchange are known. A further downgrade of these instruments to D is likely if, when the exchange offer details are available, DBRS is of the opinion that the exchange offer is coercive. DBRS has widened the notching on these instruments beyond the standard notching discussed in our published methodologies due to the high likelihood that substantial losses will be borne by the bondholders.

All of the Bank’s ratings remain Under Review with Negative Implications. The review will focus on the outcome of the exchange offer as well as the medium-term business plan that will be presented by the new management team in August. In addition with regard to the subordinated debt instruments the review will also focus on the full details of the exchange offer.

Notes:
All figures in pound sterling (GBP) unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other applicable methodologies used include the DBRS Criteria – Intrinsic and Support Assessments and DBRS Criteria: Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments. These can be found at: http://www.dbrs.com/about/methodologies

[Amended on June 23, 2014, to reflect actual methodologies used.]

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Ratings assigned by DBRS Ratings Limited are subject to EU regulation only.

Lead Analyst: Ross Abercromby
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 10 August 2009
Most Recent Rating Update: 16 May 2013

For additional information on this rating, please refer to the linking document under Related Research.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/