DBRS Comments on Co-operative Bank following publication of the interim results – Ratings remain URN

DBRS Ratings Limited (DBRS) has today commented that the review of the ratings of The Co-operative Bank plc (The Co-operative or the Bank) will continue until the full details and results of the Exchange Offer are known. This is expected to be in the fourth quarter of 2013. In its recently published interim results the Bank did not provide any new details on the Exchange Offer.

The ratings of the Bank were placed Under Review with Negative Implications on 20 June 2013. This followed the announcement by The Co-operative Group (Group) and the Bank that the Bank requires an additional GBP 1.5 billion of equity capital and that the Bank’s plans to raise this capital include an exchange offer to holders of the Bank’s dated subordinated debt, perpetual subordinated bonds, and non-cumulative preference shares (unrated) as well as the proceeds from the sale of the Group’s insurance businesses (for more details see “DBRS Downgrades Co-op Bank’s senior ratings to BBB (low), URN; subordinated debt to CC, URN” published on 20 June 2013).

On 29 August 2013 the Bank published its interim results for the first six months of 2013. As expected by DBRS, a substantial loss was reported highlighting the challenges facing the Bank and its new management team. The statutory loss was GBP 781.5 million, driven by further high impairment charges, a further write-down of IT assets and further provisions for customer redress. The total impairment charges were GBP 496 million with the bulk of these being in the Non-Core corporate business (GBP 294.3 million) and in the Core corporate business (GBP 140 million). Impairment charges in the Core retail business and in the Optimum business rose compared to the same period of 2012 but were still at manageable levels. DBRS highlights that part of the increase in impairment charges came as a result of improvements in the data on which the Bank makes its impairment assessments, reflecting weaknesses in the Bank’s risk management approach in the past, in DBRS’s opinion. The Bank took a further writedown of GBP 148 million on its IT assets, almost completely writing off the investment that it had made in a new banking platform. This reflects the likelihood that the Bank is likely to be smaller in the future.

As a result of the large losses the Basel II core tier 1 ratio reduced to 4.9%, from 8.8% at end-2012, highlighting the necessity for the Exchange Offer to be successful. Although a successful completion of the Exchange Offer will lead to substantially higher capital ratios DBRS views negatively the Bank’s announcement that, even with the exchange, the core tier 1 ratio will be below 9% at end-2013, on a Basel III basis.

DBRS views positively that liquidity and funding at the Bank remain well-managed and sound. Despite the widespread media coverage of the issues at the Bank the deposit base remained relatively stable. Total deposits reduced by about 5% to GBP 34.2 billion at end-June 2013 from GBP 35.9 billion at end-2012, however the loan to deposit ratio remained solid at 94%, and the bank recruited more retail customers than it lost in the period. The liquidity portfolio also remained substantial at GBP 6.1 billion, albeit reduced from GBP 7.2 billion at end-2012. Importantly for the franchise the Bank also continued to lend with GBP 1.6 billion of new lending to retail mortgage customers and GBP 0.5 billion to the SME sector.

Asset quality, outside of corporate lending, remained resilient with impaired loans reducing in the Core secured and unsecured retail lending portfolios and in the Optimum book. However the level of impaired loans in the corporate books continued to rise, partially due to the fact that all watchlist cases are now classed as impaired. Again these changes, in DBRS’s opinion, reflect weaknesses in the Bank’s risk management approach in the past. As a result of the large impairment provisions the coverage ratio of impaired loans (including fair value adjustments on the legacy Britannia portfolio) has increased to 41%, from 27% at end-2012, and DBRS views positively that the Bank has recently had some success in selling part of the portfolio at values which have been capital accretive.

DBRS also notes that the Bank is still working on the details of the future shape and strategy of the Bank. At this point the Bank has announced that the core bank will continue to focus on retail banking and smaller business customers and the Co-operative Asset Management (CoAM) division will include the businesses and assets which are not consistent with the business strategy. CoAM will actively manage this business for value and oversee the reduction in the assets.

As discussed above DBRS expects to conclude its review of the Bank’s ratings once the full details and results of the Exchange Offer are known. This is expected to be in the fourth quarter of 2013.

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

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]