In the last column I wrote that the end game was upon us. It has now arrived and, whatever words anyone chooses to use, the reality is that The Co-operative Bank is demutualising and ceasing to be ‘a co-operative bank’. The Group will have a 30% stake – we will have to wait and see how much real influence this gives it.
If my description of the situation sounds too severe, let us consider the words of Peter Marks, the former Group chief executive, in his testimony to the House of Commons Treasury Select Committee – in which, it is fair to say, he received a roasting. Challenged by MPs, Marks talked down the impact of the actions of the Aurelius and Silver Point hedge funds on the Group as a whole. Marks explained: “the hedge funds are not controlling the group; they are controlling the bank”.
Marks is clearly referring to the fact that the hedge funds have driven the equity restructuring of the Bank. (For clarity, I should explain that this column is written before the publication of the prospectus, though it seems clear what the prospectus will say. Agreement has apparently been reached between the various groups of bondholders and the Group.)
Factually, this is an odd comment. Bondholders do hold the dominant hand, holding between them about 70% of equity in the new business. But the activist hedge funds represented in negotiations with the Co-operative Group by Moelis (Aurelius, Silver Point and another six funds) will have between 20% and 30% of the equity – which is enough to be influential, but not controlling. They are, though, very aggressive investors and have been driving the restructuring process.
Yet Marks’ evidence to the Select Committee was that although he drove Project Unity and Project Verde, he was not responsible for the Bank’s effective collapse. Rather, he says, the unfillable financial hole was caused by other people, the structure of the co-operative movement, its use of democratically elected non-executives and mostly the financial crisis.
“I guess it was a victim of the economy,” said Marks. “The loans that were made in Britannia have gone sour to some extent because of the economy. We should remember that banks need to be able to compete; they need scale. That was the strategy behind the Britannia deal. I repeat that I was not driving the Britannia deal, but as a non-executive director I voted for it when it was proposed.” He added in later testimony: “I still think, looking back, that strategically, the Britannia merger was the right thing to do.”
Marks also argued, rather bizarrely, that the collapse of the Bank could be regarded positively for the Group as a whole. “It is a tragedy, but in many ways it can be seen as a good thing,” he said. “In actual fact, it will force the Co-op to focus on fewer businesses and not stretch its capital in the way it has done.”
The testimony of Marks is enormously interesting – and not just because of the way he passed blame onto others. What I find particularly intriguing is the issue of due diligence – the process by which a respected accountancy firm studies the books and warns a buyer of the risks contained in the business to be taken over.
I have been asking questions for several months about why the due diligence went wrong – and why, specifically, the Group and Bank took over the Britannia when there were problems in the books that might have been expected to have been found as part of due diligence.
Marks ‘ comments confirm that he recognises the importance of due diligence – and we can assume that he oversaw a significant amount of due diligence when Somerfields was acquired by the Group. Regarding the Britannia deal, Marks told the MPs: “We hired consultants -advisers – to do proper due diligence. It was a lengthy process and fair value was attached to the assets of the business. We accepted the advice that we were given.”
A similar impression is given in later evidence. “As a non-executive director of the bank, of course I share responsibility. Should we have merged with Britannia Building Society? If we had had a crystal ball, of course we wouldn’t have, but we relied very heavily on the fair value and due diligence work that was done on our behalf.”
MPs tried to clarify the situation. “How much due diligence did you do?, Marks was asked by Mark Garnier MP. “An enormous amount,” he replied.
Despite this, the evidence on this is confusing. KPMG was engaged by the Bank to do due diligence. The fact that KPMG remains engaged by the Bank and Group as auditor, and has been reappointed since the Bank’s crisis began, seems to show that there is no feeling amongst the current leadership of the Group and the Bank that KPMG made mistakes in its due diligence.
In this context, the statement released by KPMG is very striking – and seems to contrast with Peter Marks’ comments. “KPMG conducted some due diligence ahead of the Britannia deal,” said the firm. “We did not, however, undertake any due diligence on the corporate loan book. Our due diligence work did not include a recommendation on the merits of the Britannia deal.”
My understanding is that the only due diligence work conducted by KPMG was on the retail mortgage book, where there have not been significant problems. It was on the commercial property lending and the buy-to-let portfolios where there have been problems – and where it seems no external due diligence took place.
It will now be for Sir Christopher Kelly’s review to reveal whether Peter Marks’ version of events or the auditor’s line proves to be the more accurate. I know where I put my money.
One point of enormous significance in this issue is that Marks was not only Group chief executive, but also chair of the Group’s risk committee. It would be expected that this committee would have taken detailed professional advice on the risks the Group and Bank were being exposed to from the Britannia deal. Again, I look forward to Sir Christopher’s analysis of this matter.
Peter Marks insists that much of the blame for the failure must reside with the corporate governance structure of the movement. Here he has a point. My engagement with societies dates back nearly 30 years, to when I unsuccessfully stood for election to the main board of one former society and was elected to its member relations committee. I also had contact with managers in several retail societies through my work as an occasional lecturer at the Co-operative College.
My conclusion at the time was that too many officials had disdain for the elected representatives and were keen to provide them with insufficient information to enable them to make reasoned decisions. There were certainly problems with the election of lay representatives, but the problem lay as much with officials that were not up to scratch, as with directors who were below par.
I would suggest a parallel with a London council on which I was once engaged to write a detailed case study. It had difficulties with councillors who attended meetings irregularly, who were insufficiently informed and who made decisions, as a result, that were inconsistent and sometimes of poor quality.
The very effective response of the London borough was to train the councillors to be more effective, teaching them how to speed read committee papers, how to chair meetings, how to make their points more effectively. The result was to transform the council’s decision making process. It enabled officials to trust councillors more and to engage with them more effectively. If that works for a London borough, that should surely also work with co-operative societies.
I agree with Peter Marks is in his description of events as a “tragedy” for the movement. I recommend readers reach their own judgements on how this tragedy took place – and viewing Peter Marks’ evidence, which is recorded on video, is helpful in doing so. His appearance at the Treasury Select Committee can be viewed, below. It is worth watching.