Put to one side, if you can, the £2.5bn loss reported by the Co-operative Group in its annual results. The biggest issue revealed in the results is that the Group was close to a situation where the directors and auditors would have been unable to declare it viable on a going concern basis.
The immediate triggers for the threat to the Group’s going concern status were the restructuring of the Bank and the impairment of the value of the Somerfield acquisition. By losing 70% of the ownership of the Bank, the Group’s asset base was substantially reduced. The situation was exacerbated by a write-down of £226m in the value of the Somerfield acquisition.
In order to finance the Somerfield acquisition, the Group borrowed heavily on the market. As a result, a group of banks – including Barclays, RBS and Lloyds – are major creditors to the Group. The Group’s net debt at year end stood at £1.4bn (down from £1.7bn a year before). As conditions of the lending, the Group agreed to certain conditions, which became covenants in the loan agreements – in other words, obligations the Group had to meet to avoid the debt becoming immediately repayable.
The Group breached two covenants it had entered into with the syndicate of commercial banks as a result of the situations over the Bank ownership and value of the Somerfield acquisition. Those covenants related to the net asset value of the Group and to the ratio of total debt to the Group’s total value.
By breaching the covenants, the Group would have been obliged to immediately repay the debt had the lenders insisted on this. We can assume the Group could not have met this requirement, so in that case the banking syndicate could have pulled the plug on the Group, by either putting it into administration, or else demanding that it demutualise through a debt for equity conversion. The banks, happily, declined to take this action.
Banking analyst Louise Cooper said: “The creditors that were owed around £500m could have demanded their money back. They chose not to, probably because they realised they wouldn’t get it (and the PR for the banks would have been terrible). But those that are owed in total £1.4bn by the Co-op have been remarkably relaxed, so far. It is best to assume they may not be forever.”
At the end of March this year, shortly before declaring its financial results, the Group renegotiated covenants on some of its debt. Debenture stock (a form of unsecured loan) to the value of £50m that matures in 2018 had covenants regarding the Group’s debt to value ratio removed. Those covenants specified that borrowing should be no more than 125% of the Group’s total value. In return for the removal of the covenant, the rate of interest on the bonds was increased from 7.625% to 8.875% per annum. In addition, bondholders will receive 5% of the value of the bonds at their maturity.
Interim Group chief executive, Richard Pennycook, told the Financial Times: “We amended the covenants as otherwise they would have been tripped by the loss [declared in the latest results]. The organisation is not in breach of its banking covenants. It is servicing its debt and has the support of the banks to bring the debt down.”
However, this is an ongoing crisis, not one that has as yet been resolved. Details are sketchy, but we know the banks are anxious about their investments. Neither RBS nor Lloyds would comment on discussions believed to be taking place with the Group, while Barclays did not respond to our enquiry.
According to the Financial Times, RBS is acting on behalf of a group of six of the Group’s creditor banks, with its own specialist Bob Hedger appointed by the syndicate to work with the Group on a business turnaround plan.
This report is denied by the Group. Spokesman Russ Brady explains: “RBS are one of our syndicate banks, for whom we continue to enjoy a good working relationship with. All that has happened is that they have changed their account management team to be led by a person who has a deep understanding of interfacing into businesses going through significant corporate change and repositioning. That individual is representing no one else other than RBS.”
Despite this reassurance, there is bound to be concern across the movement about the appointment of Bob Hedger and of his reported remit to assist implementation of corporate governance reforms based on Paul Myners’ proposals. Hedger has led for RBS in previous debt for equity restructurings, including that in Thomas Cook – in which the Group has a minority stake through the merger between Thomas Cook and Co-operative Travel.
Hedger is director of RBS’s Global Restructuring Group (GRG), which has faced serious allegations. Business secretary Vince Cable’s former special advisor – a successful business leader, Lawrence Tomlinson – produced a report for Cable which alleged that GRG put viable businesses into administration. He further alleged that in many cases the assets of those businesses were acquired out of administration at below market value by RBS. Those allegations are strongly denied by RBS and a review conducted for RBS by lawyers Clifford Chance found no evidence of fraud or systemic wrongdoing. A separate investigation into GRG is being conducted on behalf of the regulator, the Financial Conduct Authority.
Pressure by lenders combined with the Group’s parlous capital position make it unlikely that the Group will participate in the latest £400m Bank refinancing operation, at least through the provision of cash. The Group may instead meet some of its capital obligations by selling rights in the Bank’s equity and then using these proceeds to provide capital to put into the Bank. According to the Group’s financial results, capital injections in the Bank will be funded “through deferral of capital expenditure, asset and business disposals”.
Richard Pennycook told the Financial Times that more than a hundred offers have now been received each for the farms and pharmacy businesses. Meanwhile, the FT has speculated that the funeral business could also be forced onto the market, saying that “with the need to reduce debt it will be harder than ever for the group to resist selling this business”.
Whether the Group can achieve a fair price for disposals in the current circumstances is a moot point. Pennycook insists the Group is not a distressed seller and can demand full market value for any disposal.
By contrast Louise Cooper argues: “To avoid bankruptcy, the debt has to be reduced and the only way to do this currently is via selling businesses. The general insurance business was up for sale – but after an extraordinary turnaround, which saw sales down and profits tripled, management are now keeping it. Farms and pharmacies are now on the block but no final bidder has been announced for either. Forced sellers generally don’t get good prices.”
There is good reason to retain optimism that the Group will survive – in some form or another. But to survive it looks inevitable that it will sell some (or perhaps all?) of what might be regarded as its non-core operations, leaving it as no more than a retailer and wholesaler of food and convenience store products. The Group should be able to trade viably in these sectors given that it is dealing with a crisis of capital and debt, not underlying profitability in its food and retail businesses.
Perhaps the best we can hope is that the more profitable independent societies may be able to acquire some of those businesses that the Group now regards as non-core.