Banking, Britain, Economic, Finance, Government

Meddling and mismanagement at the Co-operative Bank…

The Co-operative Bank has unveiled a rescue plan to plug a £1.5 billion black hole that will see the mutually-owned lender trade shares on the stock exchange for the first time in its 169-year history.

The group needs to repair a balance sheet ravaged by bad loans taken on when it merged with Britannia Building Society in 2009.

The bank said £1 billion of the cash will come from the bank’s junior bondholders, who will see much of their debt turned into equity in the ailing bank, which serves some 4.7 million customers.

The deal, to be completed in October, is expected to see around 25 per cent of the bank traded on the London Stock Exchange.

Euan Sutherland, the Co-op Group’s Chief Executive, said that this rescue plan is a comprehensive solution which seeks to be fair to all parties. Mr Sutherland says this will not mean the core values the Co-op have held as a mutual will change when the bank is traded.

Around 7,000 small investors in the £1.3 billion junior Co-op bond will be affected by the debt-for-equity swap. The bank will pay for their financial advice as they plan on what to do next.

The plan is known as a ‘bail-in’ process, which draws funds from bondholders as opposed to the bank bail-outs of 2007-08, which saw billions of taxpayers cash pumped into lenders such as the Royal Bank of Scotland and Northern Rock. The Co-op will find the other £500 million it needs to fill its funding gap by selling a range of financial services firms to rivals.

Earlier this month the Royal London mutual agreed to buy the Co-op’s life assurance and asset management unit for £219 million.

It is believed the bank will shrink its balance sheet by focussing on activities it perceived as being good before the Britannia acquisition. This will include the firm concentrating on lending to individual customers and small businesses. The bank will also boost IT spending in an effort to build its online banking unit, Smile.

The bank believes the deal will give the firm a core tier 1 capital ratio – a key measure of balance sheet strength and liquidity – of 9 per cent by the end of the year. Banking regulator the Prudential Regulatory Authority, which backs the deal, says that all UK banks must have a minimum tier 1 capital ratio of 7 per cent by the end of 2013. The troubles at the Co-op stem from its 2009 purchase of Britannia, which has amassed £14.5 billion of bad mortgage and corporate loans.

In March the bank revealed large losses with an announcement a few weeks later of scrapping a plan to buy 632 Lloyds branches. Since then the bank has made sweeping management changes.

COMMENT & ANALYSIS

The implosion at the Co-operative Bank which will wipe out the savings of thousands of smaller investors and trusts is the result of hubris and mismanagement on a mammoth scale.

Instead of the ultimate owners of the bank – the wealthy Co-operative movement – digging into its own treasure chest, it is the bondholders who are being asked to carry the can.

The debacle at the Co-operative Bank is the closest Britain has come to a Cyprus-style rescue in which ordinary investors are made to pay for errors of management and government.

The crisis at the so-called ‘ethical bank’ is the result of political interference in decision-making and inadequate banking disciplines.

This interference and poor decision-making has left a £1.5 billion black hole in the bank’s balance sheet, placed the whole Co-operative movement at risk and created huge uncertainty for the bank’s 4.7 million customers.

Undoubtedly, successive governments have contributed to the crisis. It was Gordon Brown’s administration that sought to back a new ‘super-mutual’ bank as a challenger on the high street.

The Labour Party’s favourite bank, the Co-operative, was chosen as its preferred vehicle and the Government backed a 2009 merger with the much larger Britannia Building Society. Dozens of Labour MPs, including Shadow Chancellor Ed Balls, are sponsored by the Co-op movement.

The Britannia deal turned out to be a disaster. Large numbers of mortgages on the Britannia’s books were rotten and the building society had become embroiled in commercial property deals that went wrong during the recession. Much of this was hidden from public view until George Osborne gave the nod to the Co-operative Bank bid for 632 Lloyd’s branches.

The former Financial Services Authority should have stepped in and made it clear that the Co-op lacked the management and balance sheet resources to enter the big league.

Not surprisingly the deal fell apart when the Co-op revealed heavy property losses and acknowledged it lacked systems to manage the operations of the bank.

It was then that credit ratings agency Moody’s downgraded the bank’s debt to ‘junk’ status. That meant traditional customers, such as local authorities and non-governmental organisations, could no longer safely hold deposits with the bank.

Under the complex rescue package just unveiled by the Co-op after extensive talks with the Bank of England’s Prudential Regulatory Authority watchdog, it is bondholders rather than the Co-op movement who will bear most of the pain.

That has left investors holding bonds angry, disappointed and disillusioned with both the Co-op and the government that allowed this series of catastrophic errors to happen.

As part of its grand plan, the Co-op will no longer pay income to its bondholders, most of whom are retired. Some were being paid as much as 13 per cent in annual interest – or £1,300 for a £10,000 investment.

Instead, in exchange for their bonds, investors will be offered either a cash payoff, shares in the new bank, or new bonds. But they face losing 35p for each £1 of Co-op bonds they hold.

These bonds are a type of investment, and not to be confused with the fixed-rate savings-account bonds offered in branches. Known more specifically as ‘retail bonds’, they are simply an IOU written to investors to raise funds for business growth. But the price of many bonds has halved over the past couple of months, leaving thousands out of pocket. Some £60 million worth of bonds are held by individual investors that have paid an annual rate of interest of 5.5 to 13 per cent.

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Britain, Economic, G8, Government, Politics

G8 Summit: Making taxation fair…

VIEW

People are often curious and sceptical of global summits. A view often expressed is that they are grand talking shops that produce little in the way of real change.

But in the case of the G8 Summit being held in Loch Erne, Northern Ireland, this might not necessarily be a bad thing. It might even prove to be the best possible outcome.

David Cameron has listed three priorities of the summit: to advance trade, ensuring tax compliance and promoting greater transparency.

The subject of corporation tax, despite seeming staid and dry, is likely to feature at the top of this list. The issue of whether multinational businesses in particular should pay more has turned into a highly-emotive issue.

There is widespread indignation at companies’ minimal corporation tax contributions on multi-billion pound sales in the UK, but the issue is not as simple and straightforward as has been portrayed.

It may appear there is an open-and-shut-case for forcing multinationals to pay more but, as any company executive will know, turnover does not automatically convert into profit.

Sadly, taxes are ultimately borne by shareholders, business owners, employees and customers; some are merely collected by businesses.

It is good in many respects to hear the prime minister professing himself ‘proud to be a low-tax, free-enterprise politician’ and he is right when he says that ‘low taxes are only sustainable if what is owed is actually paid.’

Mr Cameron is on shakier ground, though, when he differentiates between the compliance of small firms and multinational conglomerates, painting the later as simply abusive.

Tax experts will acknowledge that there is no real difference in attitude between large global corporations, small business owners and individuals towards paying tax. They all want to pay as little as possible within the confines of the law, if this maintains an acceptable relationship with Her Majesty’s Customs & Revenue (HMRC).

Global businesses may have more opportunities to manage the system, by channelling payments and receipts to the most tax friendly countries.

Equally, large firms have to contend with a great deal of bureaucracy due to the complexities of operating in different regimes.

It probably would be best if the leaders at the G8 Summit resist the temptation to announce anything but the vaguest form of agreement and focus, instead, on three areas of concern. The first should be to introduce additional measures to prevent tax evasion. Secondly, measures should also be introduced to increase the exchange of information between countries to improve cross-border transparency. And, thirdly, an agreement should be aimed for that sets out a common vocabulary that recognises the public desire to prevent abusive tax practices. Such an agreement should also discourage individual countries from labelling routine and accepted tax planning as avoidance.

The problem, however, is that there is no prospect of an event such as the G8 Summit defining even in the broadest terms, what might be meant by tax avoidance or, indeed ‘aggressive tax avoidance’, because the meaning of these concepts is highly subjective. For example, the coalition government has rightly introduced a number of tax reliefs to promote the UK as an attractive country for business investment. The Patent Box tax regime, introduced to boost research and development in the UK, is seen here as a worthwhile tax incentive, but other countries may believe it promotes tax avoidance. Clearly, then, what one country’s perception of what is a valid and desirable tax break may often be regarded by other countries as an incentive to avoid tax.

The worst outcome of the G8 Summit would be an ill-conceived proposal to change the global approach to taxing businesses, focusing solely on where turnover is generated rather than where profits are earned.

There are plenty of valid reasons to resist a proposal such as this, including the damage this would inflict upon UK companies whose primary sources of revenue lie in overseas markets.

We should hope the prime minister and other G8 leaders resist the urge to make global tax policy on the hoof to provide some popular but transient sound-bites.

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